Impact of Pandemic on Chile’s Pension System Threatens Viability, Highlights Vulnerability to Political Risk
A new article examines Chile’s defined contribution pension system, suggesting that the impact of the COVID-19 pandemic threatens its viability, undermines its financial foundation, and exposes its vulnerability to political risk. As Chile drafts a new constitution, debates about the efficiency and equity of the pension system continue. And actions taken as a result of the pandemic demonstrate that the pension system failed to live up to its original promise of ending political risk and preventing the diversion of pension funds, the authors argue.
The article, by Silvia Borzutzky, an academic at Carnegie Mellon University (CMU), and Stephen J. Kay, the director of the Atlanta Fed's Americas Center, will appear in International Social Security Review, a journal of the International Social Security Association, later this year.
In October 2019, a major social movement shook the foundations of Chile’s political and economic system, with pension reform as one of protesters’ main demands. The government responded initially with force, but later agreed to draft a new constitution that could end the economic and political model put forth in 1980 by the military dictatorship.
A few months later, due to the economic crisis provoked by the outbreak of the COVID-19, workers demanded access to their pension fund savings. After much legislative debate and conflict with the executive branch, workers were permitted two emergency withdrawals from their pension fund savings accounts to meet immediate needs, and a third withdrawal was approved by the legislature in April 2021.
Using pension funds during an economic crisis is not new—several countries in Central and Eastern Europe diverted defined contribution pension funds to cope with fiscal stresses during the Great Recession. But while the withdrawals provided immediate financial relief, they depleted the capital of Chile’s defined contribution pension system, to which workers make mandatory contributions to individual savings accounts.
“The demands for pension fund withdrawals pose a threat to the financial viability of the defined contribution pension system in Chile and represent a devastating political failure,” explains Borzutzky, teaching professor of political science and international relations at CMU’s Heinz College.
The authors provide a brief history of Chile’s pension system before the pandemic, including its inception in 1924, privatization in 1981, and reforms in 2008 and from 2014 to 2020. Then they discuss the October 2019 political protests, the advent of COVID-19, and the emergency withdrawals in 2020. By mid-August of 2020, 80 percent of pension fund account holders had applied to withdraw funds, with the average request amounting to about 40 percent of each individual’s account. Nearly 10.5 million workers withdrew about $20.2 billion in the first round.
Early withdrawals, while very popular, undermine the principle of defined contribution pensions, the authors argue. The subsequent two withdrawals saw even more funds removed and set a dangerous precedent of allowing workers to use pension funds for basic needs, a trend that may continue.
“Pension funds were intended to be used only for retirement, but now the precedent has been set that workers can access retirement funds for other reasons,” notes coauthor Kay. “Permitting workers to access their pension funds was a fundamental shock to both policy and politics, and has led to a high degree of uncertainty about the future of Chile’s private pension system as the country drafts a new constitution.”
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Summarized from an article in International Society Security Review, Can Defined Contribution Pensions Survive the Pandemic? The Chilean Case by Borzutzky, S (Carnegie Mellon University), and Kay, S.J. (Federal Reserve Bank of Atlanta). Copyright 2021. All rights reserved.
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