5. The Chilean Pension System: Contentious Economic Governance

Business leaders argued that the opposition would return to the policies implemented by Allende. An economic team composed of Christian Democrats and Socialists would foster a social situation that, by their own account, was characterized by social protest, fiscal deficits, and overwhelming demands. It was likely these demands—that is, revisiting privatization processes, from which they had profited dearly—that dominated their concerns (Gárate 2012, 361). International financial circles also mistrusted the new center-left economic policies (Cavallo 1998, 57).

Simultaneously, the Chilean peso (CLP) started to depreciate in real terms after a long trend of appreciation (Banco Central de Chile 2020).

Because not every change to the institutions studied here is relevant for the argument, their presentation is not exhaustive.

It created a scheme providing a minimum pension for the poorest 60% of the population within the “solidarity pillar” (Larrañaga, Huepe, and Rodríguez 2015). Other pillars are the contributive pillar, which is the system studied in the present work, and the voluntary pillar.

The Commission was created in 1959 and was chaired by Jorge Prat, a respected politician (Chumacero et al. 2007, 126) who was presumably a deal broker. Gárate (2012, 185, 239) asserts that Prat belonged to a profoundly antidemocratic current in Chilean politics.

These systems are based on intergenerational transfers. As current workers contribute to the system, the resources they provide are used to pay the pensions of the preceding generation on the spot, i.e., “pay as you go.”

A Defined-Benefits system offers the workers contributing to it a given income regardless of their contributions provided they fulfill some conditions. In contrast, a Defined-Contribution system establishes a periodical contribution to workers but offers no guarantee as to how much the retirement income will be. In the former, financial and actuarial risks are the responsibility of the fund administrators; in the latter, the burden of the actuarial risks is on each worker as the fund’s administrators do not offer any guarantee concerning retirement incomes.

The actuarial balance of a pension regime is the difference between the present value of its liabilities, i.e., pensions to be paid, and the present value of its revenues, i.e., contributions plus financial returns received until the maturity of its liabilities (ILO-FACTS 1998, 2; Plamondon et al. 2002, 483).

The next paragraphs rely on Gárate (2012).

They came to be known as the “Chicago Boys,” because they had graduated in economics from the University of Chicago during the 1950s and 1960s. When they returned to Chile, they became industrialists or heads of banks, until they became the technocratic core of the military regime. Valdés (1995) and Silva (2009, 143ff) provide details about the Chicago Boys and their relationship with the military regime.

ODEPLAN was created during the government of Eduardo Frei Montalva (1965–1970) to assist the president in the complex process of planning the country’s development. Although it was created in 1967, it had been operational since the beginning of Frei’s government (Silva 2009, 123). Gárate (2012, 215–221) discusses the relation between ODEPLAN and the different generations of Chicago Boys.

Hepp (1980, 1) lists as the first symptom of the crisis of the pension system that there “does not exist a direct relation between the level of contribution from affiliated workers throughout their lives and the benefits, in form of pensions, they receive” (Author translation).

Chief among these complexities was the proliferation of regimes, both in terms of organizations, e.g., cajas, and in the conditions to obtain benefits. Even if the existence of many cajas is not problematic per se, this trait was considered an incentive to seek benefits without bearing the corresponding costs.

This was certainly the case for General Leigh, who, after an interview in the Corriere della Sera in which he severely criticized the government, was removed by the military junta in 1978 (Gárate 2012, 242 fn. 45).

Alfonso Serrano Spoerer. Interview with the author. Santiago. August 20, 2014. Serrano was the Under-Secretary of Social Protection from 1976 to 1985, making him an important member of the team in charge of shepherding the reform from conception to completion. He was later nominated (in 1985) as Vice-President of the Central Bank and, after the reform granting independence to the institution, in 1989, he was chosen to be a Member of the Board of Directors.

Among these were the leveling of the minimum pensions for blue-collar and white-collar workers with Decree-Act 255 of January 1974; non-minimum pensions were adjusted to the purchasing power they had at the moment of retirement with Decree-Act 2444 of September 1978. Finally, with Decree-Act 2448 of February 1979, mandatory requirements were established: e.g., time of contribution (35 years) and different age requirements for women and men, adjustment of pensions following the Consumer Price Index—CPIn—and the substitution of pursuer-pensions with an adjustment of the last income following the CPIn, instead of receiving all the benefits of the active worker (Hepp 1980, 5–8).

The system incentivized rent-seeking and free-riding behaviors. Rent-seeking refers to the action of deriving a rent that does not correspond to the fair price of a good or service in the market (Krueger 1974). Free-rider behavior refers to an action whereby an agent that takes advantage of a public good to which he does not contribute, while also making it impossible to stop him from doing so. Mas-Colell, Whinston, and Green (1995), specifically chapter 11, provide a precise definition of free-riding and its microeconomic implications. Free-riding has also been studied within the framework of collective action (Olson 1965; Ostrom 1990). In the Chilean pension system, rent-seeking occurred when a group of workers tried to enact a generous pension regime well above the prevalent conditions of other regimes. The free-rider problem came about when a group of workers enjoyed the benefits of a social security regime as a public good without making the corresponding contributions.

Alfonso Serrano Spoerer. Interview with the author. Santiago. August 20, 2014.

Alfonso Serrano Spoerer. Interview with the author. Santiago. August 20, 2014.

Promoters said the new system would provide financing for activities in need of a significant amount of resources, such as infrastructure and housing (Piñera 1988a, 317); however, others, like Myers (1988), suggested that the interest of Chilean officials in the possibility of spillovers from the new pension system should be moderate because a pension system, obviously, is intended to pay pensions.

Alfonso Serrano Spoerer. Interview with the author. Santiago. August 20, 2014.

Berstein and Chumacero (2003) and Iglesias-Palau (2009, 17–18) point out that a fraction of the funds could be invested into companies belonging to the same group that owned the AFP; however, neither of them provide a date when this change might have taken place. It probably took place in the 1980s (ca. 1985), since Pérez (1988, 226) refers to this possibility too.

Examples of changes in such dimensions include: Act 18255 of June 1983, Act 18398 of January 1985, Act 18646 of August 1987, Act 18964 of March 1990, Act 19301 of March 1994, and Act 19389 of May 1995.

Jaime Ruíz-Tagle. Interview with the author. Santiago. July 30, 2014. Ruíz-Tagle is a sociologist; he was Director of the Labor Economics Program, Head of the Office of Forecasting Studies at the Ministry of Planning, and has been involved in social security issues since the 1980s.

Alfonso Serrano Spoerer. Interview with the author. Santiago. August 20, 2014.

The fiscal equilibrium policy was abandoned for a more pragmatic approach because of the financial crisis and the subsequent economic downturn.

Joaquín Vial. Interview with the author. Santiago. August 5, 2014.

The coalition of parties opposing the military regime has won all the elections but two since the democratization in 1990. The main parties are the Christian Democrats (DC), the Party for Democracy (PPD), the Radical Social-Democrat Party (PRSD), and the Socialist Party (PS). Later on, Michelle Bachelet, in the campaign for her second term (2014–2018), proposed a new name for the coalition, the New Majority, which incorporates, among other social movements, the Communist Party.

The terms of that debate illustrate to what extent this was an obscure subject for the majority of Chilean workers. This continues to be the case (Berstein et al. 2009, 161–164). Ignorance about how the system works was mentioned as one of its main weaknesses by both Alfonso Serrano Spoerer and Joaquín Vial.

Subsequent paragraphs rely heavily on Uthoff (2001, 236–238).

If the profitability of a given fund falls short of the industry average, the AFP must use its own resources on the compulsory deposit to compensate its affiliates. Therefore, the incentive is to avoid such patrimonial drawback.

The evidence for this point remains anecdotal. In addition, in September 2019 there was a legal challenge to the entire pension system based precisely on the property rights over the accumulated resources (CNN-Chile 2019). The Appellate Court of Antofagasta on its decision of a Recourse of Protection (Rol Nº 2797-2019) accepted the challenge where the claimant argued that her last income before retirement was CLP 1,200,000, while her pension was only CLP 185,000. Such discrepancy led her to ask for the totality of her balance held by the AFP on the basis of her property rights over such resources because she needed them to pay her mortgage, which she could not otherwise continue to service. The Appellate Court asked the Constitutional Court to rule on the matter, who ruled later in December of that year that the property rights over the balance of each pension accounts are limited and therefore could not be used to other ends different than paying pensions. However, in July 2020 the Chamber of Deputies, in response to the crisis the pandemic created, changed the Constitution authorizing the withdrawal of up to 10% of the individual accounts in a time window of one year after the reform (Superintendencia de Pensiones - República de Chile 2020).

The Recognition Bond is a one-time deposit made by the state to the pension account of each worker who contributed to the former system.

Gonzalo Cid. Interview with the author. Santiago. August 1, 2014. Cid was Head of the Pension Studies Directorate within the Chilean Ministry of Labor (2014–2018). Before that, he was the Head of the Pension Unit of Centro de Estudios Nacionales de Desarrollo Alternativo—CENDA (Center for National Studies on Alternative Development), a Chilean think-tank at the left of the political spectrum. CENDA is part of what is known in Chile as the extra-parliamentarian left, which seeks through its policy propositions a replacement of the Chilean democracy-market model, and therefore does not participate in the marketplace of ideas on Chilean policy and is not recognized as legitimate by other think-tanks (Gárate 2012, 476).

The latter was never enacted (Borzutzky 2019).

Carlos Ominami. Interview with the author. Santiago. August 12, 2014. Ominami was Minister of the Economy (1990–1992) during the government of Patricio Aylwin and was elected Senator in 1993 and reelected until 2009. He participated in the transition team from the military government to the democratically elected government.

The state had been increasing its presence in the economy ever since the Great Depression with organizations such as CORFO, which served as a holding for several state-owned enterprises (Lüders 1993, 138–144). Mainly through CORFO, the Allende administration nationalized 500 medium- and large-sized firms (Chumacero et al. 2007, 97).

Schamis (1992) provides a broad political perspective on privatization in the Chilean and international contexts.

The state retained ownership in strategic sectors, namely mining, with Corporación del Cobre de Chile—CODELCO, the national copper mining company, and the Empresa Nacional de Petróleo—ENAP, the national oil company (Lüders 1993, 149).

Indexation prevents the deleterious consequences in terms of revenue of the Oliveira-Tanzi effect. This effect appears when the real value of the collected tax disappears between the moment in which the tax is incurred and the moment it is paid. Bacha (1994) discusses how inflation can be central to governmental finances, albeit focused on the Brazilian hyperinflation of the 1980s and 1990s.

This paragraph relies on Valdés (1993, 412–420).

This bail-out operation signaled an implicit unlimited warranty over deposits by the government. This, in turn, led actors to engage in riskier practices.

Quantitative restrictions to external indebtedness of commercial banks were gradually lifted between 1975 and 1979, without fundamentally changing the exchange regulations that had been in place since the early 1960s. However, between June 1979 and April 1980, these were lifted completely without changing the destination of such operations, that is, foreign trade loans or domestic dollar-denominated loans. Therefore, access to foreign currency was artificially restricted, giving the banks some rents over these assets, which were taken advantage of by their controllers through related loans, giving them in turn a lower interest rate (Fontaine 1996, 66).

This move seemed to be an easy compromise, since other liberalizing reforms, such as trade liberalization, were being implemented simultaneously. Thus, avoiding the bankruptcy, through a thorough intervention in the middle of a broader liberalizing process, was a small price to pay to save policies that were high among policymakers’ priorities. Valdés (1993, 422–427) offers details concerning the bankruptcy of the Banco Osorno y la Unión and of other financial institutions.

The bailout created a moral hazard, because actors considered that there was no limit in the guarantee provided by economic authorities of savings in the financial system, thus leading numerous actors to take bigger risks. The weak position in which financial companies were in the early 1980s was among the reasons for the banking crisis.

The government implemented other changes in economic policy, including a less radical view about the role of the state in the economy (Ffrench-Davis 2014, 210–213). Silva (1996) and Schurman (1996) discuss how the Chilean state played an important role in strengthening sectors and supporting entrepreneurs.

In June 1982, the government allowed a devaluation of the Chilean Peso by 14% and subsequently its flotation in July, thus creating an exchange crisis. With the banking crisis reaching its peak in January 1983, alongside the major intervention in the system, Chile found itself with “twin crises.” The term “twin crises” is used when a banking crisis takes place at the same time as a balance of payments crisis (Diaz-Alejandro 1985; Kaminsky and Reinhart 1999).

In the late 1980s, the market was starting to saturate with the volume of resources managed by the AFPs (Pérez 1988).

Acts 19768 and 19769 enacted on October 24, 2001, 20190 enacted in June 5, 2007, 20448 enacted on August 16, 2010, and 21130 enacted on January 12, 2019.

For details on prudential regulation and its variants, see Brunnermeier et al. (2009).

The list of complex policy legacies is a long one. In the political realm, it includes socialist and bureaucratic-authoritarian governments. In the economic realm, it includes widespread expropriation in the 1970s and an economic crisis that contracted GDP by almost 15% in 1982.

This paragraph relies heavily on Valenzuela (1997).

These acts regulated: (1) The suspension of possible inquiries by the Chamber of Deputies of any military or public servant of the military government; (2) A freeze of the civil service, which restrained the available nominations for the incoming president to 400, from a peak of 30,000; (3) Central Bank independence; (4) A law about municipalities, in which Pinochet would nominate council members responsible for subsequent mayoral nominations; (5) Regulation of the Judiciary, allowing for the nomination of a favorable Supreme Court; (6) Civilian-military relations; and (7) An electoral law establishing the binomial system (Valenzuela 1997, 35–37).

This was the strategy of CIEPLAN from the mid-1970s; since its members’ academic credentials were impeccable, and very similar to those of technocrats at the time, they could not be dismissed (Kinney 1997, 237). In the last years of the military government, this continued to be the case. Puryear (1994) analyzes the role of intellectuals in the opposition to the military government and subsequent transition to democracy.

While only Carlos Ominami, Minister of Economy (1990–1992) of the Alwyn government (1990–1994), was interviewed by the author, he consistently referred to the opposition as a group during the interview.

Carlos Ominami. Interview with the author. Santiago. August 12, 2014.

Carlos Ominami. Interview with the author. Santiago. August 12, 2014.

José Pablo Arellano. Interview with the author. Santiago. August 8, 2014.

Joaquín Vial. Interview with the author. Santiago. August 5, 2014.

In the mid-1990s, AFPs competed for new clients based on transfers of already affiliated workers, hence the increase in their sales force. However, this increased the costs of the AFPs and therefore decreased the return of workers’ funds. Because this was a result of a loophole in the regulation authorizing unlimited transfers among AFPs, the response of the authorities was to restrict the possibility of transfers to very specific situations and to impose a series of relatively strict conditions (Berstein 2010, 136–137).

Mas-Colell, Whinston, and Green (1995, 350) define market failures as “situations in which some of the assumptions of the welfare theorems do not hold and in which, as a consequence, market equilibria cannot be relied on to yield Pareto optimum outcomes” (italics in the original). That is, they are situations in which the market allocation of resources does not lead to the most efficient outcome, hence market failure.

Cifuentes, Desormeaux, and González (2002) offer a detailed discussion of the causes of the market shrinkage in the mid-1990s.

Braun and Briones (2008, 158–159) provide an explanation for the virtual oligopsony in the market for corporate bonds where AFPs and insurance companies account for 80–90% of the outstanding corporate bonds. Both AFPs and insurance companies are legally bound to buy securities rated above the BBB level, restricting the pool of successful issuers in the bond market. This insight also offers a possible explanation for the lack of consolidation of a deeper capital market despite the increasing availability (~70% GDP in November 2016) of resources administered by AFPs (Superintendencia de Pensiones - República de Chile 2016, 1). By definition, non-risky investments must be a small share of the whole pool of possible investments; therefore, AFPs would have a difficult time deepening capital markets so as to invest in smaller businesses, which are riskier. Otherwise, their investments would continue to be concentrated in the bigger, and less risky, companies.

The inversed auction implies that the bidder with the lowest price will win the auction. In this case, the AFP offering the lowest fee will win the auction.

Joaquín Vial. Interview with the author. Santiago. August 5, 2014.

As shown in footnote 34 above, people are finding ways of questioning the arrangements through both legal and political channels.

Gonzalo Cid. Interview with the author. Santiago. August 1, 2014.

Mario Marcel, a prominent technocrat and current President of the Central Bank, said Chile “could become a country with a more solid and sustainable social contract that resolves the legacy issues [left by the Pinochet dictatorship]” (quoted in Economist 2020).