Public Pension Reform: Does Mexico Have the Answer?
Mexico may have found a formula for avoiding most of the misfortunes that could arise when individuals invest their own funds. What's the right way to support an aging workforce? And why is it that a concept—life-long security—that should bring comfort to all of us is so distasteful to address in public?
Judging from responses to the January column, the debate concerning reform of the social security system in the U.S. will take many directions before the question can even be framed adequately. If the responses are an indication, any attempt to encourage a rush to a decision would almost certainly fail for lack of adequate education and reflection.
Responses ranged from those suggesting that the reform should be labeled a tax and approached head-on, to those proposing that it be regarded as an investment program. Typical of the former was that of Blaine Mineman, who said, "My opinion is that the Administration should be candid and recognize that social security is a TAX used to fund a basic retirement benefit—the pension equivalent of food stamps. Higher income retirees should not receive a social security benefit. We need to stop kidding ourselves and face the reality that is needed to bring long-term solvency to the social security program." In contrast to this was the view of Fernando das Neves Gomes, who commented, "We can view the money (contributions to the fund) in two different ways: 1) It is money that I as an investor put in now to collect later in my retirement, or 2) It is money I put in now to pay people who are already retired. I prefer the first view ... ."
There was support for forced savings programs. Bill Bittner said, "[Without one] I am afraid a large portion of the population would find beginning retirement savings in their twenties unfathomable." No one, however, supported individual decision making regarding investments. In Edward Hare's opinion, "The average Joe could get fleeced badly and find that he's still unprepared to finance his Golden Years. Does he then turn back to taxpayers to foot his bills?" As Cesar Franco put it, "Relying on individuals to invest their pension proceeds themselves is a mistake. I help people with their finances...and can tell you the majority of people are not ready for that responsibility." For that reason, he supports some kind of federal government-imposed investment guidelines similar to those in Mexico, whether the money is publicly or privately managed.
Several questioned whether the framing of the challenge that the column posed was even correct. In Bittner's words, the real problem is "where the money that is collected is spent." Jerome Golden even raised the question of whether a new system should provide a defined benefit (as it essentially does now) as opposed to basing individual returns on a defined contribution. As he put it, "The debate around 'private investment accounts' (PIA) as a social security option is the wrong discussion ...Instead of creating the equivalent of mini-401(k) accounts, the focus on social security reform should be on the income side. By utilizing an institutionally-provided defined benefit approach that better integrates investment and annuity elements, the cost of providing lifetime income benefits should be dramatically lower than...under the proposed PIA approach."
These comments raise some questions for us. Given how politically sensitive this matter is, just how different, structurally, can a new U.S. system be from the old? What is the "uniquely American" (as some of you put it) solution to this challenge? What, if anything, should be done to get the country ready for the debate? What do you think?
There is little political capital in addressing pension reform. Who wants to engage willingly in an exercise in balancing disappointment and dissatisfaction? And yet, the aging workforces of developed countries around the world have created long-term fiscal challenges that are forcing their governments to address this issue now.
Take the situation in the U.S., for example. We are being told that if 25 percent of the contributions to the social security system can be deposited in private versus public accounts, the transition "cost" (really a fiscal budget deficit) will be up to $2 trillion. Theoretically, the impact of this on pensioners could be substantial. If one accepts often-referenced calculations, the current total return on all social security contributions made to the U.S. government is the equivalent of about 2 percent in benefits returned to individuals. By diverting 25 percent of one's contributions to investments that could yield even as little as 5 percent, the rate of return, on average, would rise to 2.75 percent. It may not sound like much, but a 37.5 percent increase in benefits to the average recipient of social security could look very attractive. Further, it would address a potential shortfall of huge proportions in the government's flow of funds that would begin to be felt sometime in the 2040s.
Great Britain has had roughly a similar government-sponsored system, combining public pensions with something called personal pensions, since the late 1980s. It is projected to result in a 26 percent decline in government pension costs over the long term. But as many as one in five Brits are thought to be at risk of not supplementing their eventual loss of government pension income with adequate returns from their personal pensions. The fear is that they will eventually have to turn to the state anyway for help through various programs that provide a "safety net."
In 1997, Mexico inaugurated a program in which all pension contributions are collected by the State and transferred into individual investment accounts managed by private organizations, called AFORES, registered with the government and required to invest in Mexican government bonds. As of January 1, 2004, AFORES were allowed to begin investing up to 15 percent of fund assets in the Mexican stock market and up to an added 20 percent in foreign securities. This ruling is thought to have helped fuel a 40 percent increase in the value of the stocks on the Mexican Bolsa during 2004. Although start-up costs have been high, returns to the accounts are outpacing inflation, and because there are strict investment guidelines, the hope is that the AFORES program will avoid most of the misfortunes arising from allowing individuals to invest their own funds.
What is the answer to this societal issue, one that will be perceived as doing the least harm to a status quo that is not perceived by most (at least in the U.S.) as being currently painful? What kind of trade-offs should be made between personal responsibility, free enterprise, and selective gain and pain on the one hand, and collective responses and shared gain and pain on the other? Is the British model best for the U.S.? Does Mexico offer a better response? Or is there some other preferred alternative? And why is it that a concept—life-long security—that should bring joy, comfort, and self-satisfaction to all of us should be so distasteful to address in public? What do you think?