Banker-bashing, hedge-fund bashing, speculator-bashing: one of the legacies of the financial crisis will surely be a hugely negative perception of financial markets. These are now widely perceived as strongholds of short-termism, irrationality and self-indulgence, inherently unstable and volatility-prone. A casualty might well be political reforms that look to a greater role for markets, whether this is in terms of the pension system, the NHS or the social care system. This is a great pity. As the case of Chile’s pension scheme shows, the mechanism by which something is funded is important and competition has an important part to play. One of the world’s purest examples of a savings-based pension system, Chile’s scheme shows that these systems can weather a major crisis remarkably well.
In the Chilean system, people can choose between five types of savings funds, denoted A to E, defined by their ratio of fixed-interest to variable-interest assets. Fondo A is the most risky one, with up to 80% of its assets invested in equities. Fondo E is the most conservative one, consisting of fixed interest bearing bonds only. The other ones are intermediate solutions. In 2008, the value of Chilean pension assets crashed spectacularly. Average annual returns after inflation looked grim:
Fondo A: -40%
Fondo B: -30%
Fondo C: -19%
Fondo D: -10%
Fondo E: -1%
Critics rejoiced. However, in 2009, real values rebounded:
Fondo A: +43%
Fondo B: +33%
Fondo C: +23%
Fondo D: +15%
Fondo E: +8%
These are averages, which lump all pension fund providers together. But thanks to competition, even the worst-performing company had recovered a large proportion of the initial losses by the end of 2009. Is volatility of pension funds a problem at all then?
It depends. From the perspective of someone who had long envisaged retiring in 2008, and selling their entire assets at once to purchase a lifetime annuity, it is. It would force them to delay their plan. But what critics of private pension provision frequently forget is that state pensions are by no means insulated from ups and downs. They are usually pegged to some fluctuating macro-aggregate such as median wages, and suffer, in addition, from arbitrary political interference. In fact, about 30% of Chilean pension assets are invested abroad, making Chilean pensioners less dependent on the domestic economic situation. This provides a degree of security which state PAYGO systems could never achieve. Lacking any reserves, they are backed by nothing but the power to tax, which, by definition, ends at the national border.
Ultimately, what matters are longer-term average returns, and in those terms, Chile has much to boast about. Between 2002 and 2009, savers benefited from annualised real returns between 4% (Fondo E) and 9% (Fondo A). The dreaded casino-capitalism turns out to be a real blessing for ordinary workers.