This Week:

Quote of the Week

Chile’s Privatized Social Security: “You Have Done So, So Well.”

Galveston, Texas: A Model for the Country?

The British Pension System: A Warning to the U.S.

Greetings,

Last month I talked about all the various things we have been told to convince us that the Social Security system is facing a “crisis.”  The flip side of that coin is the various ways we are told that there is a Pot of Gold waiting for us if we will only go along with a radical transformation of the program.  We'll get a great “rate of return,” and it will be as good as Chile, or Galveston, Texas!  Well, how good are those systems, really?  And, didn't Britain try privatizing its Social Security system a few years back?  How's that going?  This is the subject of this week's Nygaard Notes.

There's so much to say about Social Security that I don't know how long to keep this series going.  Not too much longer, I don't think.  Too many other things to cover.  And, next week will be the spring version (a little late) of the Nygaard Notes Pledge Drive.  Always educational, always crucially important!  So, if you want to send in your pledge of support now and beat the rush, please do.  If you're not sure, don't worry.   In the next issue I'll give lots of reasons why you might wish to contribute to the growing project.

Until next week,

Nygaard

"Quote" of the Week:

Propaganda = Truth!

Here's the official transcript (including laughter, applause, and mangled sentences) from a speech about Social Security last month in Greece, New York by George W. Bush:

“Now, a personal savings account would be a part of a Social Security retirement system.  It would be a part of what you would have to retire when you reach retirement age.  As I mentioned to you earlier, we're going to redesign the current system.  If you've retired, you don't have anything to worry about – third time I've said that. (Laughter.)  I'll probably say it three more times.  See, in my line of work you got to keep repeating things over and over and over again for the truth to sink in, to kind of catapult the propaganda. (Applause.)”

Chile's Privatized Social Security: “You Have Done So, So Well.”

The Chilean Social Security system is “one of the most studied and debated free-market experiments in the world,” according to the Washington Post.  It's been around a while.  Since 1981, in fact, when it was imposed by fiat by the government of dictator General Augusto Pinochet.  As the Washington Post politely put it, Pinochet's “authoritarian government embraced free-market economic theories and implemented them with little resistance.”  (Little resistance, that is, that wasn't killed or disappeared.)

Since the Chilean dictatorship fell, Pinochet's social security minister, José Piñera, has made a career of pushing Social Security privatization around the world, basing his operations out of Santiago at his “International Center for Pension Reform,” which the Wall Street Journal says “is essentially a one-man operation.”  Mr. Piñera “says he is an admirer of President Bush,” the Journal tells us.  And Mr. Bush, for his part, “has cited [the Chilean system] as a model for his push to restructure Social Security.”

(Perhaps Mr. Bush had Mr. Piñera's success in mind when, early in Bush's first term, he lamented the fact that “The president doesn't get everything he wants” when negotiating with Congress.  “A dictatorship would be a heck of a lot easier, there's no question about it,” he commented, as a “joke.”)

Chile: How Does It Work?

The privatized Social Security system in Chile – which is similar in some key respects to the plan that President Bush seems to want – doesn't work very well, it seems, and there are three main reasons why.

1.  High Fees.  The administrative costs of U.S. Social Security eat up about one-half of one percent (0.5%) of annual contributions.  The Chilean system, in contrast, eats up somewhere between 16 percent and 33 percent of annual contributions (studies differ).  Yes, that's right, it costs between 32 and 66 TIMES AS MUCH to administer the Chilean system as it does the U.S. system.  This is because of all the costs associated with individual accounts, such as management fees, commissions, marketing costs, accounting, and so forth, most of which do not apply to a social insurance system.

Mr. Piñera claims that “the average real return on the personal accounts [in the Chilean system] has been 10 percent a year” since 1981.  The Chilean brokerage firm CB Capitales calculated that, when commission charges are taken into consideration, the total average return on worker contributions in Chile between 1982 and 1999 was 5.1 percent, “substantially lower than the 11 percent” reported by the superintendent of pension funds (and Piñera's 10 percent).  That report found that the average worker would have done much better simply by placing his or her pension fund contributions in a savings account.

The Wall Street Journal quotes Juan Correa, a Chilean auditor and account holder, saying, “This program was imposed at the point of a bayonet, and today, I have to pay management fees even if I lose money.”

2. Low Participation Rates.  Many of the poorest Chileans do not contribute to a pension fund at all, because they earned much of their income in the underground economy, or are self-employed, or work only seasonally.  When I say “many,” I mean that almost a third of the Chilean labor force is entirely outside of the Social Security system.

3.  Increased Poverty.  Social Security payments are now so low that 41 percent of those eligible to collect pensions continue to work.  And, according to a 2004 study, “A majority of [Chilean] workers surviving to their mid-80s are expected to receive at least some of their retirement income from anti-poverty benefits.”  That is, their Social Security pension is so low that they have to go on welfare.

The good news is that, despite the claims of Mr. Piñera (the Journal calls him “the pied piper of global pension reform”) and other privatization advocates, the less-attractive reality of the Chilean model has been fairly widely reported in this country.  Here is a sample of recent headlines about Chilean Social Security from U.S. newspapers:

“A Personal Burden; Chile Switched to a Privatized Pension System Nearly 25 Years Ago, and Millions of Workers Still Fall Through the Cracks” (Los Angeles Times, Feb 13); “Solving Social Security. Chile's System: Small Deposits, Small Returns; Model for U.S. Fails to Serve Many Workers” (The Atlanta Journal-Constitution, March 6);  “A Safety Net With Some Holes” (Washington Post, April 11)

President Bush, in a 2001 press conference, said this to Chilean President Ricardo Lagos: “I think some members of Congress could take some lessons from Chile, particularly when it comes to how to run our pension plans.  Our Social Security system needs to be modernized, Mr. President, and I look forward to getting some suggestions as to how to do so, since you have done so, so well.”

Mr. Correa reminds us that, however “well” they have done, it was “at the point of a bayonet,” so perhaps the most telling commentary on the desirability of the Chilean model is the choice that was made by the holder of that bayonet.  The Century Foundation, in a recent report, says it clearly:

“The [Chilean] military does not participate in the privatized system.  While the military imposed the private accounts on all other workers entering the labor force after 1981, it continues to receive pensions under the old, favored governmental system.”

Galveston, Texas: A Model for the Country?

Along with Chile, another oft-cited example of how great things would be if people could liberate themselves from Social Security is Galveston, Texas.  In 1981, Galveston and two other Texas counties did just that, opting out of Social Security and establishing their own substitute Social Security systems for county employees.  Their plans provide retirement, survivors, and disability benefits.  Proponents of Social Security privatization love to talk about Galveston, Texas.

Mr. Bush, for example, traveled to Galveston in April and sang the praises of the system, his main point being that recipients get a higher rate of return in the three Texas counties than people elsewhere get from Social Security.  The idea that the “Galveston model” is the answer to our problems is not universally shared – not even in Galveston.  As an April 24th editorial in the Galveston County Daily News put it, “We're open to changes in Social Security but don't think the Galveston Plan is the best model for change.”

There are at least three reasons why Galveston is not the best model.

1.  The Galveston Plan is not like what Mr. Bush is proposing.  They don't have individual accounts, but rather the county government invests the money as a block and then guarantees the return on the investment.  Also, participation in the system is mandatory in Galveston, unlike the President's idea of voluntary accounts.  And Galveston raised its payroll tax so that it's now higher than the Social Security rate, while Mr. Bush has ruled out an increase in the payroll tax.

2.  Retirement benefits are lower for many workers under the Galveston Plan than they would be under Social Security.  It's the worst for low-income workers and married workers with kids.  Even the high-income workers, who do better in the beginning, should understand that their  benefits are not indexed to inflation, so “After 20 years, all of Galveston's benefits are lower relative to Social Security's.”  (That's a quote from a 1999 study by the Social Security Administration.)

3.  The Center for Budget and Policy Priorities points out what I think is the most obvious and least-often-noted problem: “The 5,000 municipal employees covered by the plans run by Galveston and the two other Texas counties opting out of Social Security do not make any contributions to support current Social Security beneficiaries.  If the United States as a whole adopted a Galveston-like plan, there would be no one left to pay the $500 billion annual cost of benefits for the nation's 45 million current Social Security beneficiaries.” (Emphasis in original.)

A February 18th article on the Galveston experience in the Chicago Tribune pointed out that “boosters of the Galveston plan [claim] that retirees can earn benefits that are two to four times higher than those provided by the Social Security system, without higher costs or greater risks.”  But the Tribune reporter talked to actual retirees in Galveston, and here's a comment from Joyce Longcoy, who retired in 1998 after 23 years working for Galveston County:

“I get around $460 per month now, but under Social Security, I would have gotten $1,000.  They are putting this up to be a model for the rest of the country.  Some model.”

The British Pension System: A Warning to the U.S.

One model the President doesn't talk about too much is the British system of Social Security.  That's probably because the British experience with their partly-privatized Social Security system has been “disastrous.”  And that's the adjective used by the Wall Street Journal, which has rarely  met a privatization scheme it didn't like.

Since Mr. Bush seldom bothers to talk about it, that means the U.S. press seldom bothers to talk  about it.  But the partially-privatized system in England is perhaps the closest in some ways to what Mr. Bush seems to have in mind for our country, so I'll just make a few basic points about it here.

England has a “Basic State Pension,” or BSP, which is similar to our Social Security, but smaller.  Kind of like what ours would be under the Bush plan.  That is, it replaces around 15 percent of workers' wages, as opposed to between 45 and 85 percent in the current U.S. system.  They also have something called the State Earnings Related Pension Scheme, or SERPS, which used to be mandatory and was intended to supplement the meager BSP.  That all changed in the 1980s, under Prime Minister Margaret Thatcher, when the SERPS benefit was reduced and, even worse, when people were allowed to “opt out” of the program and start up their own private accounts.  Again, just like Mr. Bush has in mind for us.

Here are the three main problems that have been seen since the Thatcher reforms of the 1980s:

1.  Fraud.  Also known as the “mis-selling scandal,” this is the situation in which over 2 million people were sold private retirement accounts that actually would have left them worse off in retirement than they would have been in the public system.  The U.S. Social Security system, in contrast, has never had a scandal in its 70-year history.

2.  Exorbitant Administrative Costs.  Although it's not often labeled as such, this is also a scandal, and one that is standard under such plans wherever they have been put in place.  In Britain, the scandal is that individual accounts line the pockets of the companies that sell them to the point where 10-20 percent of workers' contributions are soaked up by fees and administrative costs.  This contrasts with less than one percent for administrative costs in the public U.S. system.  It is estimated that the total overhead costs in the British system reduce the value of an individual account by 43 percent over a typical career and retirement.

3.  Increasing Income Inequality.  The Century Foundation quotes pension experts at the Organization for Economic Cooperation and Development as saying of the British system, “What looked like a very good idea from a financial perspective in cutting costs has put pensioner poverty, which had been all but eradicated, back on the agenda.”  Because benefits are so low, fully one-third of British  pensioners now rely on additional means-tested benefits such as income support and housing subsidies.

The official “Pensions Commission” put it plainly in its first report on the system, released last October.  They said that, for the past 20 years, Britain has been living in a “fool's paradise” which “has come to an end.”

I can't do any better in conclusion than this summary of the British privatization experience done by The Century Foundation:

“The consequences associated with [the Thatcher reforms] were significant...  Many Britons found themselves with smaller pensions because of a change in the index for inflation and poor investment decisions with their private accounts (as well as unscrupulous brokers).  Lower pensions led to an increase in means-tested income maintenance programs.  Finally, the national government was left with new administrative expenses, lost tax revenues, and responsibilities to bail out some failed private pension programs.”

That sounds sort of like a combination of the current situation in the U.S. and the situation that awaits us if Mr. Bush gets his way.  And let that be a warning to us.