[Market Economy Guide] Chile Overcame Welfare Dependency

Chile was ruined in the 1970s by a giveaway-style pension system,

but it revived its economy through pension reform that increased individual choice and responsibility.

Chile was one of the earliest countries in the world to introduce a social security system. In 1820, it introduced and implemented a pension system for retired military personnel, and later expanded pension programs for civil servants and state-owned enterprises. In 1924, it established a workers’ social security fund mainly for blue-collar workers, and in 1925 it also created a private-sector employees’ social security fund and a national social security fund for the public sector and journalists.

600% inflation in the 1970s

Along with the government’s radical welfare policies, state intervention in the economy also intensified. The Allende government, which took power in 1970, attempted radical socialist reforms. Along with expanding the social security system, it implemented expansionary fiscal and monetary policies.

The results were disastrous. In 1973, prices in Chile soared by more than 600%. The government’s fiscal deficit reached 25%. Economic growth also showed appalling figures. In 1972, the economy contracted by -1.2%, and in 1973 the situation worsened further, with growth falling to -5.6%.

Excessive government intervention and reform

In fact, Chile’s economic conditions were those of a developing country. Without going through a normal course of economic development, excessive redistribution-oriented economic policies and government intervention rapidly worsened the Chilean economy. But the Allende government paid no heed and pressed ahead with its reforms. It pushed for the nationalization of private property and income redistribution. It strengthened government intervention across all sectors of the economy and even nationalized businesses and financial institutions. These reforms under the Allende government made Chile’s economy even more difficult.

The turning point came in 1973. Augusto Pinochet launched a military coup, ousted Allende, and seized power. In September 1973, Pinochet became president of Chile and began full-scale reforms. The starting point was a neoliberal economic revolution. Pinochet drew intense criticism at home and abroad for his iron-fisted dictatorship, but there is a different assessment of what he achieved in Chile’s economic reforms.

Backed by strong authority, the Pinochet government reduced the size of the state apparatus and cut government spending. In particular, it strongly pursued social security reform, eliminating privileged pensions and unifying the fragmented social security system. It also transformed the government-monopolized pension system into a privately led funded pension system. Even by the late 1970s, Chile’s pension system was on the verge of collapse. Although the economy was deteriorating, pension payouts did not decrease but continued to rise, and the finances of Chile’s pensions and broader social security system steadily worsened.

The Pinochet government reformed the pension system so that, rather than having contributions withheld at source from wages, workers would deposit 10% of their income into individual pension savings accounts and make additional payments by choosing disability insurance and life insurance. In particular, pensions were paid according to accumulated contributions and rates of return, making individuals responsible for their own retirement. This had the effect of increasing individual freedom of choice and responsibility, while also encouraging competition among pension fund management institutions and promoting sound pension finances.

Introduction of the private pension system

In fact, Chile’s pension reform, which began in 1981, had a positive effect on the Chilean economy. After the introduction of the private pension system, Chile’s gross savings rate increased. The savings rate, which had fallen to 1% in 1982, rose to above 20% after 1989. As savings increased, there was also a positive effect on economic growth. Chile’s pension reform is a good example of the problems of inefficient state management and giveaway-style pensions, as well as the direction for improvement. If Chile had continued to maintain its existing public pension system, it could have suffered not only enormous fiscal losses but even economic collapse.

The most important element in policy is sustainability. No matter how good a policy may appear, if it is not sustainable, it can never truly be called a good policy. When economic conditions are favorable and public finances are ample, there may be little immediate concern, but the real problem arises when the economy contracts and fiscal resources run short. Even a leading welfare state in the world can face grave economic crisis if it continues overly expansive welfare policies. Welfare is never free, and we must remember that someone must always pay the price.

■ Please remember

In fact, Chile’s pension reform, which began in 1981, had a positive effect on the Chilean economy. After the introduction of the private pension system, Chile’s gross savings rate increased. As savings increased, there was also a positive effect on economic growth. Chile’s pension reform is a good example of the problems of inefficient state management and giveaway-style pensions, as well as the direction for improvement.

Sung-no Choi

President, Center for Free Enterprise (CFE)

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Original title: [시장경제 길라잡이] 복지병을 이겨낸 칠레

Author: Sung-no Choi

Date: 2020-07-27

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=column&pn=7&idx=22960