Green Light to the Pensions Reform in Chile.
Country Risk Chile sheds light on the significance of a pensions reform in Chile and the links to a "deeper dilemma" the country faces today. To that end, the analysis will focus on the bill implications for the market, productivity, and the political forces at play. Country Risk Chile will bring 3 variables under critical analysis: the draft bill itself, the local job market, and the shift in the political equilibria representing the distribution of power since the privatization of the pensions was introduced under Pinochet's rule.
Setting the scene:
August 11, 2017: Finance Minister Valdes, Labour Minister, Alejandra Krauss and Interior Minister Fernandez standing next to President Bachelet send a strong political message to the pensions market and its key actors. It is "green light" to the pensions reform in line with mobilizations and the population sentiment that the time has finally come to improve the pension scheme in Chile.
The pensions reform has a major political significance. It lies at the heart of a first Governmental attempt to reform the system in over 40 years since its privatization during military rule. But the reform also explains the actors and interests shaping the state preference in a post-transition period, where middle-classes have empowered and demand gaps are closed.
First and foremost, the Chilean government has been clear nationally and internationally that the privatized system of pensions is not to be dismantled, but reforms are highly needed in the light of an aging population and gaps in private accounts. National consensus goes in that line and it is widespread: from stakeholders, experts, and political parties. However, they hold differences on how to proceed to carry out this reform.
In words of Michelle Bachelet, on August 11, referring to the Pensions Association:
"reality shows that the promise they had made on pensions 40 years ago has not been fulfilled for millions of Chileans".
A Deeper Dilemma:
Country Risk Chile estimates that President Bachelet's draft bill - to be dispatched for parliamentary deliberation - is inexorably linked to a much deeper dilemma - one that Chile faces as a country in transition to full development. This dilemma is not only about the unequivocal and pressing need to improve the pensions for Chileans, but also on the need to jump onto the road of sustainable growth to support this reform (or any other reform), and calls for the success of the quality and efficiency of public policy. Indeed, against the backdrop of economic slowdown and the end of a super cycle, which had sent copper exports soaring (particularly to China), social change and empowered middle classes have also come to the fore. At a time of contestation and social demands to tackle inequality, Chile has embarked on several fronts to satisfy new actors and implement new state preferences. Hence, Bachelet's center-left governing coalition's decision to introduce 2nd generation reforms to keep governance and stability.
This recently-added draft reform, aiming to improve the safety net, inexcusably points to the composition of our local job market, its income level, the local skill formation, and the impending need to jump to an innovation-driven economy to overcome the middle-income trap that Chile faces today, due to its dependency path on copper sales.
"Institutions matter"
As with the great majority of reforms that tackle economic institutions, political forces will be strained during the negotiation of incentives for those who see their interests at stake; therefore, the ideological battle will inevitably follow in Parliament, and the tradeoffs will naturally take place on the technical aspects of the reform. In order to reach consensus, the debate will undergo a push-pull ideological tension over a legal initiative which seeks to increase in 5% the monthly contribution that Chileans make to their private accounts, to be paid by local employers. This 5% increase is designed to improve the social security pillar, of which 3% should go to the private accounts and 2% will be used to cover the intra-, and intergenerational gap, as well as help women and third age pensioners as of now. To that end, a "Consejo de Ahorro Colectivo" (CAC) - Collective Savings Council - would have to be formed by way of a Constitutional arrangement, and would be in charge of administering this additional 5% contribution. CAC is designed to act autonomously just like the Central Bank does. In a 6-year horizon, pensioners are thought to enjoy an improved scheme by way of increasing up to 15% their contribution to their private savings. Hence, advocates of the pensions reform conclude the bill should apply in a gradualist fashion.
The political message derived from this initiative cannot be underestimated, given the departure on how this additional 5% should be administered. Not by the private system or AFPs, but by the CAC. AFP's will continue to administer the remaining 10% as usual. Not surprisingly, some Pension Companies have already started sending letters to their affiliated clients stating that, while they agree on the need to reform, they strongly believe this 5% should be totally administered by them at zero cost. The discussion on whether it should be CAC or AFP's handling this additional 5% depicts the political relevance of this reform. A pensions reform after 40 years points to the "persistence" of economic institutions. Due to their influence on the distribution of economic gains, not all groups or individuals will prefer the same set of rules (Acemoglu, Robinson, 2008)
Country Risk Chile analyses the risks and opportunities involved in this green light, the political significance of the reform and its economic impact. Given the political bias that any analysis might be subject to, Country Risk Chile's insight will go directly into the macro-constraints from an open economy and a privatized pension system, as well as the micro-level pressures such as the NO+AFP movement (repeal the private pensions system movement). Country Risk Chile takes into account the voice of experts, interest groups and the ideological view from political parties, as the actors and individuals who compete in shaping the state preferences and determine how the Government will eventually act.
Critical Analysis:
After the draft bill announcement, however, attention was focused on the bill ramifications. It was the productivity report which made stakeholders worried. In the best case scenario, the pensions reform would cost around 390 jobs and in the worst case scenario, the loss would be of nearly 390.000 posts - if the reform were to be applied straight away. Hence, and what is in line with a tradition in policy-making in Chile, gradualism was advised, and the Government gave assurances the bill would be implemented that way. As result, a consensus-oriented policy-making has already been put in motion as usual in 25 years of transition to democracy.
Country Risk Chile analyses the risks beyond the damage control over the loss of jobs, to highlight the need for better-paid salaries to sustain this 5% increase, the necessity for an innovative market to sustain inclusive and innovative growth, and the bottom-up pressures to satisfy demands such as gratuity for low-quintiles students accessing higher education at a time of economic slowdown and top-down constraints to keep the fiscal rule in place. If we add to this picture, Chile's recent downgrade by S & P's from AA- to A+, risks are prominent. But why all these variables matter in a pensions reform?
According to a recent report by the World Economic Forum, inequality is linked to poor variables in education, and low levels of innovation. Chile is in transition to development and to that end, an innovative market paired with high levels of R&D and value added products are the undeniable targets to hit. In 25 years of democracy, GDP levels rose to an average of 5% during the super cycle, counter-cyclical measures and the fiscal rule in force, allowed Chile to save for rainy days and use revenues on infrastructure. Overall, since 1989 to 2014, poverty was reduced from a staggering 47% in 1989 to 21% in 1998 and to 11,7 in 2015. GINI remained around 0.528 from 1989 to 1998 and then improved to 0,482 in 2013. Bolder policies to tackle the growing structural heterogeneity in 25 years, were too mild, too constrained or omitted (Ffrench Davies, 2014). Ben Ross Schneider (2010, 2014) suggests micro-level discontent (students protests, no+AFP movement) derive from an economy too dependent on raw material resources and with little incentives to improving educational variables, key in the innovation drive. WEF Country Report 2016-2017 ranks Chile as the Latin American leader in business climate but describes the "workforce" variable as showing little innovation power, which in turn correlates with local students' performance on international PISA and TIMMS examinations, contradicting Chile's sound macro economic figures, thus having a negative impact on productivity levels.
Therefore, the discussion on a pensions reform and the ideological battle that follows take us to the deeper dilemma that Chile faces today. A successful path from "transition to full development" to "full development" entails all these aspects: pensions, education, innovation in the job market and sustainable growth. These are related to the nature of the Chilean economy and the need to carry out reforms that lead the country to attain those goals. Growth is stalling in Chile not only because reforms are in place, but also because Chile - as a country in transition - needs to find new modes to grow, with added value to the production chain, with cheaper energy (here, Chile has hit one big success with renewable energies, ranking the country as nr 1 in that field, in Latin America), with new pools of investment with value added (like the lithium tendering projects in motion) and with excellence in the training of professionals.
Equity has been a banner in the Nueva Mayoría center-left governing coalition. IMF and OECD call for more inclusive growth. The "bringing-all-Chileans-on-board" report from OECD has sounded all possible alarms. The latest IMF country report calls for more inclusion, while it recognizes transactions costs from the tax reform have hit Chilean investment levels despite measures taken to minimize the impact. Resources devoted to helping poor students reach higher education at a time of record-low copper prices has been the source of intense ideological debate, especially in an electoral year. However, equity, quality and efficiency in Education (Meyer, 2014) are 3 different variables which do not run consecutively. They conflict with each other, therefore, greater resources on equity in education will require investment injection in research quality and robust quality assurance institutions with credible teeth and muscle to move HE output to the level of innovation. But then, the task is not quite complete, as the market should move from raw material to value added and the creation of jobs in that line.
On the ideological battle that usually follows on draft reforms, and while Greif and Kingston (2011) agree that "there is no guarantee that the process will lead to the selection of efficient rules, in many cases those with political power will try to select rules that generate distributional benefits for themselves, that is, to maximize their welfare rather than that of society as a whole", Country Risk Chile believes that changing the economic institutions implies changes in the political equilibrium and the corresponding distribution of power. President Bachelet's 4-year path of reforms has undoubtedly produced a shift in the distribution of social and economic preferences; therefore, the resulting accords over the pensions reforms "will be in line with procuring a stable political correlation of forces, which, in turn, produce another equilibrium outcome" (Greif and Kingston, 2011, p 16).
The debate on a pensions reform in Chile took momentum by 2015 when the Bravo Commission elaborated a final proposal to improve the system. Proposal A and B were put on the table by the Commission with an emphasis on the solidarity pillar, but at the same time, the Commission stood against a pension-sharing system (proposal C) explaining it would be unrealistic and it would discourage investment and savings. It was during Chile Day 2017, in London, that Finance Minister Rodrigo Valdés expressed satisfaction with the current management of AFPs (Asociación de Fondos de Pensiones) or Private Pension Management in accordance with what the law had mandated 40 years ago. However, factors like an aging population and gaps in contributions were acting against the legitimacy of the private system. That very lack of legitimacy prompted the No+AFP movement to take momentum and rally discontent to the streets. By then the results of the Bravo Commission were made public, both pro-AFP and anti-AFP actors began showing signs that the time had come to reform.
Some conclusions: 2017 is an electoral year in Chile. President Bachelet's 2nd generation reforms have responded to the entrance of new actors in the political arena (students' leaders from the mobilizations that reached a peak in 2011), who have contributed to the formation of new state preferences, prioritizing inequality issues. A controversial tax reform and a difficult-to-pull education reform to bridge the gaps have been at the center of a fierce ideological battle during parliamentary debates, reflecting the challenges to reach a new equilibrium on economic accords.
However, a great opportunity lies in the fact that Chile embarked on reforms, at a time of global trends in capitalist democracies, such as contestation and mobilizations, in which middle classes press the state to tackle disparities. Governance and stability as of 2018, will require the intelligent balance between inclusion and growth beyond the copper-related paradigm.
Soledad Soza, August 26, 2017
