Letter to Newt Gingrich: Privatized Social Security is Not the Answer

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Written by Dean Baker   
Thursday, 26 January 2012 12:20

The Honorable Newt Gingrich
3110 Maple Drive
Atlanta, GA 30305-2650

Dear Speaker Gingrich:

I have seen you refer to the privatized Social Security system in Chile several times as a model for the United States. I believe that you would not hold this view if you were more aware of the details of the Chilean system.

First, you have often claimed that the Chilean system is voluntary. This is not quite right. The system is mandatory for workers in the formal sector. However like most countries in Latin America, Chile has a large informal sector where participation is de facto voluntary. (The Chilean military and policy forces are an exception to this rule. They were allowed to remain under the traditional defined benefit system. This presumably was in part due to the fact that the program was put in place under the Pinochet dictatorship.)

The second point is that the system is not simply a defined contribution system that does not require funding from the government. The system guarantees workers who have participated for at least 10 years a minimum benefit. To get this benefit workers turn over the money they earned in their accounts and then get the minimum benefit from the government, with the government making up the difference.

In fact, most workers in the informal sector go this route. They effectively vote with their feet for this government-guaranteed benefit, generally participating in the system only long enough to qualify for the minimum benefit. Part of the reason is likely that they fear the volatility of financial markets and also they resent seeing 20-30 percent of their contributions siphoned off by the financial industry.1 (The corresponding figure for administrative costs for the U.S. Social Security system is roughly 0.5 percent.)

The privatized system was in fact not popular with the Chilean people. Reform of the privatized system was the major issue in the 2005 presidential campaign. Both major candidates promised to reform the privatized system, including Sebastian Pinero, the current president and brother of Jose Pinero, the designer of the reformed system under Pinochet.

Finally, it is difficult to understand the possible basis for your claim that we would reduce inequality in wealth by 50 percent with this system. Since the payback structure of Social Security is quite progressive, low-income earners would almost certainly be losers under a privatized system, which would make inequality greater not lower.

I would be happy to discuss this background more with you or your staff.

1 For more background on the privatized system in Chile and other Latin American systems, see Gill, Indermit, Truman Packard and Juan Yermo, 2004. Keeping the Promise of Social Security Reform in Latin America. Stanford, CA: Stanford Economics and Finance.