Latin America’s AGING CHALLENGE Demographics and Retirement Policy in Brazil, Chile, and Mexico Latin America’s AGING CHALLENGE Demographics and Retirement Policy in Brazil, Chile, and Mexico by Richard Jackson, Rebecca Strauss, and Neil Howe with contributions by Gabriela Aparicio and Keisuke Nakashima GLOBAL AGING INITIATIVE CENTER FOR STRATEGIC AND INTERNATIONAL STUDIES MARCH 2009 contents INTRODUCTION 1 CHAPTER 1 THE DIMENSIONS OF LATIN AMERICA’S AGING CHALLENGE6 The Demographic Transformation 7 The Old-Age Dependency Challenge 11 The Promise of the Demographic Dividend 12 The Development Challenge 16 CHAPTER 2 LATIN AMERICA’S PENSION REVOLUTION 20 The Advantages of Funded Pensions 21 A Personal Accounts Report Card 23 CHAPTER 3 RETIREMENT REFORM IN CHILE, MEXICO, AND BRAZIL 28 Chile 30 Mexico 33 Brazil 36 CONCLUSION LATIN AMERICA AT A CROSSROADS 42 A NOTE ON DATA AND SOURCES 48 A KEY TO CHART SOURCE CITATIONS 50 ACKNOWLEDGMENTS 51 ABOUT THE AUTHORS 52 ABOUT CSIS 53 introductionIntroduction When people in other parts of the world think of Latin America, they usually picture demographically youthful societies characterized by lofty birthrates, large families, and chronic labor surpluses. The challenge is a population that is too young and growing too fast. While these popular images reflected reality in much of Latin America as recently as the 1980s, they are now hopelessly out-of-date. Latin America, in fact, is in the midst of a far-reaching demographic transformation. Fertility has fallen precipitously throughout most of the region over the past several decades and is now near, at, or even beneath the 2.1 replacement rate in most major countries, including Brazil, Chile, and Mexico—the three countries on which this report focuses. Meanwhile, life expectancy has soared and is approaching developed-world levels. The number of elderly in Brazil, Chile, and Mexico, may have 1 Latin America will triple as older populations than the United a share of the population States. (See figure 1.) by 2050. The coming age wave poses two fundamental challenges for Latin The result will be a dramatic America. The first is to fashion slowdown in population growth national retirement systems capable and an equally dramatic aging of of providing an adequate level of the population. The United Nations support for the old without imposing projects that the share of Latin a crushing burden on the young. America’s population that is aged The second is to boost living 65 or over will triple by mid-century, standards while populations are from 6.3 percent in 2005 to 18.5 still young and growing. While the percent in 2050.1 Meanwhile, Latin United States, Europe, and Japan America’s median age will climb all became affluent societies before by 14 years, from 26 to 40. Latin they became aging societies, Latin America’s coming age wave is by no America may grow old before it means the largest in the world. grows rich. Unless Latin American By 2050, over 30 percent of the countries succeed in promoting more population will be aged 65 or over in rapid development and raising the some fast-aging countries in Europe growth path of their economies, and East Asia. But incredibly, several many will have to pay for age waves Latin American countries, including 1 Unless otherwise noted, all population projections cited in this report refer to the UN’s 2006 Revision “medium variant.”“Children” refers to the 0 to 19 age bracket, “working-age adults” to the 20 to 64 age bracket, and “elderly” to the 65 and over age bracket. The UN projections, as well as other major data sources cited in the report, are discussed in “A Note on Data and Sources.” Latin America’s population will age dramatically. Elderly (Aged 65 & Over), as a Percent of the Population, 2005–2050 1 25% 22.1% U.S. in 2050 = 21.0% 21.0% 21.2% 20% n 19.4% o i t a l u p 15% 14.3% o P e h 11.2% t 10.6% f o 10% 10.7% t 8.1% n e c r 6.1% e 5.8% P 5% of developed-world proportions with a fraction of the developed world’s 0% income and wealth. The future 2005 2025 2050 could bring widespread economic Brazil* Chile Mexico hardship—even a humanitarian *The lower projection for Brazil is the UN medium variant; the higher projection is by CSIS and assumes a aging crisis. constant 1.8 fertility rate. Source: UN (2007) and CSIS calculations Latin America is making impressive progress in meeting to become an enormous burden on that Latin America’s funded pension the aging challenge. the economy as its population ages. systems can, over the course of a 2 Yet it too is building a voluntary working life, deliver higher benefits Latin America is making impressive private system of complementary at lower contribution rates than the progress in meeting both challenges. funded pensions. pay-as-you-go systems they replaced. On the retirement front, it has become To be sure, funded systems subject a laboratory for pension reform— The global financial crisis and the retirement benefits to the risks of ups and an inspiration to reformers in plunge in world stock markets are and downs in financial markets. developing countries around the causing policymakers in some Latin Economists largely agree, however, world. Chile led the way in the early American countries to question the that workers nearing retirement can 1980s, when it initiated a transition wisdom of basing old-age security be protected from sudden financial from its traditional pay-as-you-go on funded retirement savings. One downdrafts by prudent regulations public pension system to a fully country has gone beyond questioning. that require them to move into funded system of personal retirement Argentina, which introduced a dual fixed income assets at older ages. accounts. Since then, nine other Latin public pension system with parallel A growing number of Latin America’s American countries have enacted pay-as-you-go and personal accounts personal accounts systems, including reforms that shift their public pension options in the mid-1990s, nationalized Chile’s and Mexico’s, now encourage systems at least in part to a funded its pension funds in November 2008 such lifecycle portfolio allocation. basis. Among the three countries and is now shifting back to a purely The financial risk of a funded system, featured in the report, Chile and pay-as-you-go system. of course, can never be entirely Mexico have fully “privatized” While these concerns are understand- eliminated. But neither can the their public pension systems. Brazil able, they are misplaced. An effective “political risk” of a conventional maintains a purely pay-as-you-go retirement policy must focus on the pay-as-you-go public pension public pension system that threatens long term—and there is no question system—that is, the risk that future politicians will reduce its benefits. investment rules also make it difficult workers—and in some countries the That risk will rise steadily as Latin for pension fund managers to maxi- great majority—will thus arrive in old America ages and the ratio of mize long-term risk-adjusted returns— age with an inadequate pension or no beneficiaries to workers soars. and hamper their response to near- pension at all. They will be dependent term crises like the one that now grips on social assistance to keep them out Latin America’s funded financial markets. Meanwhile, with the of poverty, or else they will have to fall pension systems confer exception of Chile, most countries are back on traditional family support important advantages in failing to realize the full macro benefits networks, which will themselves be confronting the age wave. of their funded retirement systems. weakening as families shrink in size. While experts agree that these systems A high level of elder dependence on There are other potential advantages 3 are already playing a crucial role in the subsidized “minimum pensions” and to funded systems. Unlike pay-as- development of Latin American capital means-tested social assistance may you-go systems, which will impose markets, most countries have financed be manageable in today’s relatively a rising burden on workers and the “transition cost” from pay-as-you- youthful Latin America. In the much taxpayers as societies age, funded go to funded systems by issuing debt, older Latin America of 2030 or 2050, systems take pressure off public which means that the potential boost to the economic and social costs will budgets. In the near term, they can national savings may never materialize. be enormous. help to broaden and deepen Latin America’s capital markets. In the The greatest cause for concern Latin America’s retirement and long term, they can help to buoy up is the limited reach of formal development challenges are thus national savings, which is likely to retirement systems. closely related. The right kinds of decline as dependency burdens rise. retirement policies can make successful Along the way, they can foster a The greatest cause for concern, development easier by minimizing the middle-class ethos of thrift and however, is the limited reach of Latin fiscal burden of Latin America’s aging stewardship and, over time, help to America’s formal retirement systems— populations, increasing rates of savings narrow today’s high levels of inequality and this is a problem that applies and investment, and speeding the in income and wealth. equally whether they are funded or development of capital markets. pay-as-you-go. The large size of Latin But successful development is also To be sure, there are real problems America’s informal labor markets essential to long-term retirement with Latin America’s funded retirement means that much of the workforce security, which will prove elusive so systems.