REVERSALS As Europe advances towards individual capitalization, some in Latin America advocate return to Pay-as-You-Go 1 Prologue Elevated informality rates, coupled with factors such as increased life expectancy, have meant that average pension payouts in Latin American countries correlate increasingly less to wage levels upon retirement. This dynamic is driving pension reform throughout the region. Instead of focusing on improving replacement rates, reform efforts have primarily limited to attempts that resuscitating antiquated, impracticable frameworks and reversing reforms based on individual capitalization. Due to demographic constraints, Pay-as-You-Go (PAYG) pension systems stopped being sustainable alternatives long ago. In the limited number of cases where nations did manage to generate sufficient replacement rates, pensions were limited to individuals accruing 15 to 20 years, and failure to meet this threshold meant one paid into the system and then received no payout. ILO Convention 128 asserts that only workers contributing for more than 30 years can rationally expect a full pension. Therefore, those failing to accrue this amount of contribution periods have a right to a partial pension. And lastly, individuals failing to generate more than 10 years in system should not expect to receive a pension upon retirement. This ILO norm, together with the evidence that countries with PAYG pension systems are beginning to adopt individual-capitalization mechanisms to alleviate the fiscal deficits they face, and the nearly unanimous opinion of experts, has not been an obstacle for ideologically-motivated sectors to see an opportunity to reintroduce, even partially, PAYG pension systems. Unfortunately, their intransigence does not end there. Many have refused to even give thoughtful consideration to reforms designed to remediate the shortcomings of individually-capitalized frameworks (e.g. increasing contributions, voluntary savings). This is ostensibly because such measures’ fail to comport with political agendas that include efforts to reintroduce public PAYG pension systems or other such collectively-funded frameworks. Instead, they advocate for individual-capitalization reversals on the basis of the purported failure of same. Pro-PAYG rhetoric increasingly points to arguments included in books such as Reversing Pension Privatizations: Rebuilding public pension systems in Eastern Europe and Latin America. While at first glance this publication may appear to be an ILO-sanctioned document, this is not the case.1 In the hope of generating a more informed pension debate, FIAP is proud to present this publication. Our deepest hope is that it will contribute to progress in terms of generating better pensions for more individuals throughout Latin America and the Caribbean. Entitled Reversals: As Europe advances towards individual capitalization, some in Latin America advocate return to Pay as You Go, it was prepared by sector specialists Rodrigo Acuña and Karol Fernández, Agnieszka Chlon-Dominczak, who provided an analysis of the reforms in Central and Eastern Europe, and the FIAP editorial board, made up of Francisco Margozzini, Manuel Tabilo and Rodrigo Vidal. The publication highlights the strengths of individual-capitalization schemes, and delineates what our societies can do to perfect them. It then addresses the dangers of reverting to PAYG or collectively- funded pension schemes, and concludes with a refutation of the rhetoric put forth by political leaders who have repealed their nations’ individual-capitalization reforms. Guillermo Arthur Chairman, FIAP 1 Though the article’s authors (Isabel Ortiz, Fabio Durán-Valverde, Stefan Urban and Veronika Wodsak and Zhiming Yu) hold positions at the ILO, the study was not a product of said organism’s tripartite processes. 2 Index Contents Executive Summary _______________________________________________________ 4 I. Introduction _________________________________________________________ 9 II. Contribution of individual-capitalization programs to pension improvements ____ 10 A. Multi-pillar systems: clarity of objectives and financing sources ___________________ 10 C. Financial sustainability of pension frameworks _________________________________ 23 D. Social equity within pension frameworks _____________________________________ 33 E. Pension system coverage __________________________________________________ 41 F. Pension-system administration transparency __________________________________ 46 H. Returns generated through pension fund management __________________________ 50 III. True reasons behind the reversal of individual capitalization reforms __________ 70 A. Central and Eastern Europe: Financial crisis and EU criteria _______________________ 70 B. Argentina: Financial crisis used to further a populist agenda ______________________ 82 C. Other purported retreats __________________________________________________ 85 IV. Negative consequences of individually-capitalized pension system reversal _____ 87 A. General comments _______________________________________________________ 87 B. Damages due to reforms of critical individually-capitalized pillar components ________ 87 3 Executive Summary Certain political sectors within several Latin American societies have proposed pension reforms aimed at reinstating or bolstering PAYG or collectively-financed schemes, with defined benefits and public centralized administration, with the goal of debilitating or completely eliminating individual capitalization systems. The expropriation of worker pension funds has even been proposed. This publication presents ample and convincing evidence from Latin American and other international contexts that said reversals, which have failed in the past, constitute major setbacks for pension systems, the economy and individuals and their families. It is urgent to stop them, because far from delivering what they promise, they do not contribute to the improvement of pensions in the long term, on the contrary, they generate lower pension payouts and greater insecurity among workers. The experience of expropriation of pension funds in Argentina has been disastrous for workers who contribute to the contributory system, since they lost ownership of their savings in exchange for a mere promise to pay a pension in the future, lower than what was projected in the individually- capitalized system. According to FIEL economists, nationalization was unnecessary, populist and will have strong negative impacts on the pension system. It was unnecessary, because it was promoted under the argument of the decrease in the value of the assets under management being due to the international financial crisis, in circumstances that said decrease was due to the decrease in the value of Argentine public securities and Argentine share values.2 It was also not justified by the transitional fiscal deficits generated by the creation of the individually-capitalized system, whereas during the period of operation of the system deficits were reduced, releasing fiscal resources for other public policy aims. It was populist, because it was used to obtain additional resources to finance generous "moratoriums", which allowed people to access pensions without having made the required contributions, mortgaging the future financial situation of the pension system. In addition, nationalization impaired transparency in the management of pension funds, politicized investment decisions, granting subsidized and doubtful loans, devalued funds, and lowered investment returns. The proposals to reinstall or strengthen PAYG or collective savings pension systems, centralized public administration and defined benefits, basically imply transferring the power that fund participants currently have to make certain individual decisions to politicians who are in government and the legislative branch. Members lose their property rights, so that they no longer have their savings to finance their pensions, retirements or provide an inheritance in the event that there are no survivor pension beneficiaries. They also cannot choose who manages their savings. It is the executive and legislative powers that will decide the destination of the accumulated collective funds, the benefits that will be delivered and the way in which they will be distributed within a generation or between generations. This type of reform goes against the greater awareness and appreciation of individual ownership of savings on the part of participants of pension systems, which have been shown by various surveys in a variety of countries. PAYG pension systems are financially unsustainable, due to a number of insurmountable factors, increases in life expectancy, decreases in birthrates, and other structural problems. This situation will be exacerbated in the future given the demographic trends and fiscal constraints that our region will experience. Introducing frameworks that rely on collectively-funded mechanisms only addresses short-term aspects of the problem, because these types of systems involve high levels of risk and deficiencies that materialize over the medium and long term as said frameworks mature. 2 FIEL: Latin American Economic Research Foundation 4 Collective ownership of pension funds exposes retirement assets to the danger that they will be used for purposes other than the aims of the pension system. In fact, during the 20th century pension systems began as collective capitalization schemes, but over time accumulated assets were partially or completely utilized, resulting