Toward a World of Worker-Capitalists

By José Piñera

[The Boston Conversazioni, Boston University, 2001; uptaded in 2007]

The world would be a better place if every worker were also an owner of capital. Workers would benefit from the appreciation of assets in the long term and feel more connected to the overall performance of the economy. The interests of the workers would be more in line with the interests of those who manage and control those assets, there would be less inequality of wealth, and workers would place a higher value on strong property rights and the rule of law. Above all, workers would find a new dimension of freedom and dignity in their lives.

Karl Marx was right when he asserted that if workers could only sell their labor in the market, many of them would feel alienated from society. But he was terribly wrong in believing that collective ownership of property would give workers a sense of security and control over their lives. Liberating workers requires giving them access to individual ownership of capital in the context of a free market economy.

The worldwide pension crisis has created a great opportunity to empower workers without resorting to expropriations or violent revolutions. In most countries, workers are already compelled to contribute between 10 and 30 percent of their wages to pay-as-you-go retirement systems. The transformation of those unfunded systems into systems in which wealth is accumulated in individual accounts can bring about a new paradigm, a world of worker-capitalists.

This was our guiding vision when in 1980 we fully replaced the state-run pay-as-you-go (paygo) pension system with one of personal retirement accounts (PRAs) that are owned individually and managed by the private sector. In a companion piece— “Empowering Workers: The Privatization of Social Security in Chile”—I explain the essence of our reform.

The average rates of return of the pension funds in Chile have averaged around 10 percent a year, above inflation, since their inception in 1981. Pension assets under management have grown to be around 80 percent of GNP in 2007. As a result of this and other related reforms, the growth rate of the Chilean economy doubled from its historical level to around 7 percent a year for more than a decade. [1]

However, the impact of pension reform in Chile has gone beyond impressive economic indicators. It has led to a radical redistribution of power from the state to civil society and, by converting workers into individual owners of the country’s capital, has created a political and cultural atmosphere more consistent with free markets and a free society.

The Chilean social empowerement model is a comprehensive alternative to the social collectivism initiated by German chancellor Otto von Bismarck at the end of the 19th century, which was the model for the welfare states of the 20th century.

By cutting the link between individual contributions and benefits—that is, between effort and reward—and by entrusting governments not only with the responsibility but also with the management of these complex programs, the Bismarckian pay-as-you-go pension system turned out to be the central pillar of the welfare state, in which the possibility of winning elections by buying votes with other people’s money—even with the money of other generations—led to an inflation of social entitlements, and thus to gigantic unfunded, and hidden, state liabilities.

In Chile the paradigm inaugurated by the 1980 pension reform has already been extended to the areas of disabilty and survivor insurance, health and unemployment.

At the beginning of the 1990s, several Latin American countries followed the path opened by Chile, and today 12 of them have introduced, partially or totally, a system of PRAs.

The late 1990s saw another landmark when Hungary, Poland, and Kazakhstan joined the reforming club. Now 13 former communist countries in Central/East Europe have PRAs.

In January 2001, Sweden, once a model welfare state, allowed its workers to put 2.5 percentage points worth of their 18.5 percentage payroll tax contribution into a PRA. The law passed the Swedish parliament with 85 percent approval.

A Domino Effect in Latin America

In the countries of the region that have introduced PRAs, the structure of the private pension system closely follows the Chilean scheme, and in all cases they are beginning to make a relevant contribution to the establishment of a free-market economy. Of course, the characteristics of the transition process have differed across countries because of the diverse economic, social, and political starting points of the reforms. [2] I will make some brief comments on some countries reforms.

Mexico and El Salvador adopted two crucial features of the Chilean reform: (1) workers eligible for a PRA do not contribute to the pay-as-you-go public pension system, and (2) new entrants to the labor force join the PRA system. Together, those features ensure that, after the transition is finished, the public pension system is extinguished, leaving only the PRA system for the vast majority of workers in the country. Peru has adopted (1) but not (2). In Colombia, Argentina, and Uruguay workers are in both paygo and PRA pension systems (partial privatization).

Mexico—despite a long tradition of state paternalism—undertook in 1997 a major reform by completely eliminating the public pension system for private sector workers and replacing it with a system of PRAs managed by competing companies. All private sector workers who were previously participating in the paygo program had to begin contributing 11.5 percent of their wages to their retirement accounts, to which the government also contributes. In 2007, a law was approved incorporating also public sector workers to the PRA system. The PRA system now has 35 million participants, the most of any country in the region.

El Salvador—a country torn by civil war in the 80s—approved its pension reform in 1998, even with the votes of some former guerrilla commandants turned members of Congress. The features of the system are very similar to those of the Chilean system, with workers contributing 10 percent of their salaries to PRAs.

Peru—the first country to follow the Chilean pension reform—established a PRA system in 1993. Peru gives workers the choice of moving to a private system managed by companies of their selection and provides recognition bonds for those who do. Peruvian workers place 10 percent of their wages into their accounts and pay nothing to the state. But the paygo pension program has stayed in place for new entrants to the labor force, leaving open the door to an unfunded system that politicians may once again abuse.

Colombia—even under threat from Marxist guerrillas allied with drug cartels—introduced pension reform in 1994. It too allowed workers to opt for investing 10 percent of their wages in a PRA. A unique and most troublesome feature, however, allows workers to switch back and forth between the public and the private systems, giving rise to a permanent struggle between a state-run agency and the private system and perpetuating the paygo system.

Argentina—under a government that engineered a partial break with the populism of the disastrous Perón era—set up a PRA system in 1994. Argentine workers are given the choice of placing 11 percent of the salaries in their retirement accounts. However, the paygo system was kept in place, providing all workers, including those in the public and private systems, a so-called “basic pension.” The law establishes that all workers put 16 percent of their salaries in the public pension program. Those workers opting to stay in the public program face a total of 27 percent of payroll taxes for pensions and receive benefits on top of the basic pension. By allowing the public pension scheme to continue, the Argentine government continues to add to its unfunded pension liability.

Uruguay—the Latin American country most influenced by the European social model—introduced a limited reform in 1996, similar to the Argentine reform in that it keeps the paygo system in place for all workers but allows for a portion of wages to be diverted into PRAs.

It must be emphasized that many of these reforms have important flaws that have to be eliminated before their full potential can be realized. But the basic structure of PRAs is firmly in place, and new constituencies of workers, entrepreneurs, and experts have emerged that will defend it in the future. If Mexico and El Salvador are successful, pension reform will spread sooner or later to all the Central American nations.

The biggest laggard on the continent is Brazil. Even though some companies offer their workers private pensions, the largest country by size and population in Latin America suffers under the weight of an unfair and unaffordable paygo public pension system, the deficit of which amounts to around 5% of GNP. So far, the government has kept the social and economic problem from exploding by tinkering with the system, an approach that is reaching its limits.

From Communism to Property Rights

In the late 1990s, Hungary, Poland, and Kazakhstan, as part of the transition from a collectivist system to a market one, reformed their paygo pension schemes and allowed workers to use payroll taxes to build their own PRAs. [3] Later the reform spread around the region to another 10 countries.

In 1998 Hungary became the first of the former communist countries in Europe to allow a portion of workers' salaries to be invested in PRAs. Its paygo public system was already experiencing deficits in the 1990s, while imposing 30 percent payroll taxes. With an already large elderly population, the country would have had to raise payroll taxes to an unfeasible 55 percent, and each pensioner would have been supported by one worker by 2035. Current workers were given the choice of staying in the public system or moving to the new one. New entrants into the labor force are required to enter into the new system. However, all workers still contribute to the public pension system. Twenty-four percent of the wages of those in the private system go to the pay-as-you-go system, and only 6 percent go to their own PRA. The main shortcomings of Hungary's system are similar to those of Argentina and Uruguay: high payroll taxes are used to maintain the public system, thereby discouraging job creation, and the system remains vulnerable to political manipulation.

Kazakhstan—an oil-rich former Soviet republic—opted in 1998 to reform its pension system by allowing workers to place 10 percent of their wages into a PRA managed by competing pension fund companies, while continuing to contribute 15 percent of wages to the state-run paygo system. As in Argentina and Mexico, there is a state-run pension fund company that competes unfairly with the private sector.

Poland—the most successful of the former communist countries—introduced a pension reform in 1999. Workers between the ages of 30 and 50 at the time of the reform were given the choice of staying fully in the state-run old-age pension system—in which they have to pay a 19.52 percent payroll tax—or diverting 7.3 percent of their salary into their own PRA and paying a 12.2 percent payroll tax to build “virtual” individual accounts in the state-run system. Younger workers must join the private pension system, while older workers must stay in the paygo one. Almost 12 million workers (70 percent of those who could choose a retirement account, that is, people between the ages of 30 and 50) enrolled in the PRA system.

Russia has also introduced a small and partial Chilean-style pension reform. [4] China has been studying ways to solve its coming pension crisis by adopting a PRA system.

The Coming Crisis in Western Europe

Global demographic megatrends, such as longer life expectancy and reduced fertility rates, will accelerate the crisis of pay-as-you-go pension systems, especially in mature developed economies such as those of Europe, the United States, and Japan. As former U.S. secretary of commerce Pete Peterson has observed: “The costs of global aging will be far beyond the means of even the world's wealthiest nations—unless retirement benefit systems are radically reformed. Failure to do so, to prepare early and boldly enough, will spark economic crises that will dwarf the recent meltdowns in Asia and Russia. . . . For this and other reasons, global aging will become not just the transcendent economic issue of the 21st century, but the transcendent political issue as well.” [5]

In stark contrast to some of their neighbors to the east and in Latin America, the political elites in western continental Europe have so far been unwilling to engage in structural pension reform. For Europeans, that political paralysis will be disastrous if it continues, since the region's looming pension crisis is perhaps the most severe in the developed world.

According to the Organization for Economic Cooperation and Development, the unfunded liabilities in Europe are enormous—more than 200 percent of GDP in France and Italy and more than 150 percent of GDP in Germany, for example. [6] By 2025 nearly one-third of Europe's population will qualify for public pensions. In 30 years, in Germany and Italy each retiree will be supported by one worker. Given those countries' generous benefits and weak or nonexistent private savings for old age, drastic tax hikes or benefit cuts will be necessary just to keep the public pension schemes going. Italians, who already face 33 percent payroll taxes for pensions, could see those taxes increase to 48 percent, for example. In a region that faces chronically high unemployment rates, such a move would only make job creation more difficult.

Yet even though continental European countries are spending up to 15 percent of GDP on public pension outlays—a figure that may rise to more than 18 percent within 40 years for some countries—they have so far implemented only expediency measures. Germany, for instance, has recently proposed raising payroll taxes and using state funds to encourage workers to put additional money into private accounts. Needless to say, such a move would hardly solve the coming crisis in a country whose pension system costs 11.5 percent of GDP—more than twice the U.S. figure.

Spain's pay-as-you-go public pension system, the most expensive program in its federal budget, gives workers a minimal rate of return. Yet despite the facts that an economically feasible transition to a private system has already been identified and that the government is committed to economic liberalization in other areas, political inertia has prevailed. [7]

In Italy—the country with the lowest fertility rate in the world—annual public pension outlays stand at around 14.5 percent of GDP. There is, moreover, blatant corruption in the system. In 1997 a Finance Ministry study discovered that the government had been paying disability pensions to 30,000 dead people. Spot checks of 15,000 recipients of disability pensions found that 5,000 of them had faked their handicaps (including a young woman who was collecting a pension for blindness while working as a chauffeur).

France's pay-as-you-go system is also in deep trouble. The generous public pension system will go into deficit after 2010. Attempts by different governments to tinker with the system have been crushed by across the board opposition. The almost total lack of a parallel private pension system will make matters worse for future retirees.

As UK economist Tim Congdon observed in 1997, “If Europe's governments cannot solve the problem of unfunded pensions, they will not be able to control their larger fiscal difficulties or to prevent rises in taxation which will wreck their economies.” [8]

“The Promise of America”

Several developed countries have substantial private pension systems, especially the United States, Japan, the United Kingdom, the Netherlands, Switzerland, and Canada. But those private systems coexist with important and flawed public pension systems.

Only two rich nations—the United Kingdom and Australia—have so far undertaken structural reform of their public pension systems. In 1986 the United Kingdom gave its workers the choice of opting out of the second tier of its public pension system and, with 4.6 percent of their wages, purchasing either defined-contribution or defined-benefit plans in the private sector. Two-thirds of British workers have opted out and contributed to the private funds. Currently, all workers contribute a percentage of their wages to the first, pay-as-you-go, tier and on retirement receive the basic state pension from the government. The United Kingdom’s public pension system still has an unfunded liability of around 40 percent of GNP. Australia’s previous system was a state-run operation funded by income taxes. In 1992 employers were required to establish superannuation accounts for all workers (9 percent of wages will be deposited by 2002), which will form the primary source of retirement income for most workers. But workers freedoms are unnecessarily curtailed by several restrictions, the main one being the obligation to contribute to the pension fund of their own sector.

There is the possibility of a breakthrough in the United States, where the government-run pension system, at $600 billion, is the largest government program in the world. Whatever its advantages to the first generation that has received its benefits, the way it was structured has prevented common workers from owning their retirement savings and has politicized decisions that should rightfully be made by individuals instead of politicians. Even though 40 percent of Americans have some sort of private retirement fund (IRA, 401[k], etc.), another 60 percent do not. Yet all workers are still required to put one-eighth (12.4 percent) of their covered earnings in a system that does not give them ownership, market returns, or security.

There are six key arguments for introducing PRAs in the United States:

1. The Moral Argument. A paygo public pension system is a collectivist scheme that deprives individuals of freedom in organizing their lives and planning for their futures. A mandatory PRA system keeps compulsion to a minimum (the mandatory savings), thus maximizing the freedom to choose within a national retirement scheme.

2. The Rate of Return Argument. Paygo systems are, by their very nature, a good deal for the earliest recipients, but with time, what is essentially a financial pyramid scheme begins to expropriate younger workers. Today the implicit rate of return for current workers is less than 2 percent, and those born today will probably see negative returns. Mechanisms to postpone the public pension system's insolvency, such as increasing payroll taxes or the retirement age, reduce the already minimal rates of return. In contrast, in the period from 1802 to 1997 in the United States, the annual real rate of return has been 7 percent for stocks and 3.5 percent for long-term government bonds. From 1802 to 1995, the average real rate of return for corporate bonds was 4.97 percent. [9] So a private retirement system can provide a higher rate of return, even if all the funds are invested in zero-risk government bonds.

3. The Fairness Argument. Since the poor tend to start work earlier in their lives and have a shorter life expectancy than do the better off, the paygo old-age retirement system is actually regressive for certain categories of workers. [10] Under a system of PRAs, poor workers would be accumulating savings in their accounts and therefore would be allowed to benefit from the rewards that markets are giving to wealth ownership, mitigating the recent increase in the so-called wealth gap—an unsurprising result given that most workers are forced to place all their savings in a program that gives them less than a 2 percent rate of return.

4. The Property Rights Argument. A system of PRAs gives retirees clearly defined property rights in their benefits. The elderly can make programmed withdrawals from their accounts, leaving money to their heirs if they die before they fulfill their life expectancy, or use the savings to buy indexed annuities from an insurance company. By contrast, the Social Security system provides no such rights to the money workers are forced to pay for their retirement, as ruled in 1960 by the Supreme Court in Nestor v. Flemming.

5. The Macroeconomic Argument. The public pension system negatively impacts labor markets and savings because funds are immediately spent, rather than invested, and the payroll contributions amount to a tax on hiring labor. Harvard economist Martin Feldstein estimates that privatization of Social Security could add $10 trillion to $20 trillion in net present value to the U.S. economy. [11] Contrary to conventional wisdom, the transition to a privatized system does not entail new costs to the government or to the economy. It would indeed make an unfunded liability explicit and force policymakers to find a way to pay for the promises made, while generating the mentioned gain to the economy.

6. The Social Harmony Argument. The privatization of Social Security would end the division between capitalists and workers by turning the United States into a country of worker-capitalists, with consequent changes in the country's political dynamics. It may well represent a massive blow against the political manipulations of the “transfer state.” As Cato Institute president Edward H. Crane has observed: “Social Security privatization means changing the political dynamics of America in a very fundamental sense. For when members of labor unions, the average blue collar worker, blacks, etc, ...start investing in stocks and bonds on their own, rather than counting on government as a security blanket, their attitude toward the free enterprise system, toward corporate profits, and indeed, toward big government itself is going to change. This dynamic has in fact already occurred in Chile.” [12]

It is very encouraging that the President of the United States, George W. Bush, has made a principled case for pension reform: “My plan reforms Social Security so that every worker can be a saver and an owner. There is no human dream stronger than the dream of having something you can call your own. It is the promise of America. It is the promise of independence and dignity.”[13]

If the United States institutes this reform, it would not only transform every American worker into an owner of capital, it would also encourage the rest of the world, especially continental Europe and Japan, to reform their systems. The benefits to workers and economies would be enormous. It would be a giant step toward liberating workers around the world.

1. According to economist Klaus Schmidt-Hebbel, the rate of growth of the Chilean economy went from an average of 3.7 percent per year, in the period from 1961 through 1974, to 7.1 percent per year in the period from 1990 through 1997, and of that extra growth of 3.4 percentage points per year, the pension reform would have contributed .9 percentage points per year, that is, more than a quarter of the total. Of the total increase of 12.2 percentage points in the rate of savings during those two periods, the pension reform contributed 3.8 percentage points, that is, 31 percent of the total increase. See Klaus Schmidt-Hebbel, “Does Pension Reform Really Spur Productivity, Saving and Growth?” Documentos de Trabajo del Banco Central (Chile) no. 33, April 1998, pp. 25, 29.

[2] For a review of these countries’ pension reforms, see Luis Larrain, “Privatizing Social Security in Latin America,” Policy Report no. 221, National Center for Policy Analysis, Dallas, January 1999. For reviews of reforms in individual countries, see Ian Vásquez, “Two Cheers for Mexico’s Pension Reform,” Wall Street Journal, June 27, 1997; L. Jacobo Rodríguez, “In Praise and Criticism of Mexico’s Pension Reform,” Cato Institute Policy Analysis no. 340, April 14, 1999; Herman von Gersdorff, “The Bolivian Pension Reform: Innovative Solutions to Common Problems,” World Bank, Financial Sector Development Department, Washington, July 1997; and Juan Manuel Santos, “Testimonio: La Reforma de las ‘Pensiones en Colombia,’”

[3] See Krzysztof Ostaszewski, “Testimony: Poland’s Pension Reform,”

[4] See José Piñera, “A Chilean Model for Russia,” Foreign Affairs, September–October 2000.

[5] Peter G. Peterson, “Gray Dawn: The Global Aging Crisis,” Foreign Affairs, January–February 1999, p. 43.

[6] Paul Van der Noord and Richard Herd, “Pension Liabilities in the Seven Major Economies,” OECD Working Paper, 1993, cited in the book by the World Bank, Averting the Old Age Crisis (New York: Oxford University Press, 1994), p. 139.

[7] See José Piñera, “Una Propuesta de Reforma del Sistema de Pensiones en España,” (Madrid: Círculo de Empresarios, 1996).

[8] Tim Congdon, “Europe’s Pensions Time Bomb,” The Times, March 1, 1997.

[9] Jeremy Siegel, Stocks for the Long Run (New York: McGraw Hill, 1998); and “Stocks, Bonds, Bills and Inflation,” 1997 Yearbook (Chicago: Ibbottson Associates), pp. 266–75.

[10] See Peter Ferrara and Michael Tanner, A New Deal for Social Security (Washington: Cato Institute, 1998).

[11] Martin Feldstein, “Privatizing Social Security: The $10 Trillion Opportunity,” Cato Institute Social Security Privatization Paper no. 7, January 31, 1997.

[12] Edward H. Crane, “The Case for Privatizing America’s Social Security System,” S.O.S. Retraite-Sante Conference, Paris, December 1997,

[13] George W. Bush, Speech given at Western Michigan University, Kalamazoo, Michigan, March 27, 2001.

(A revised version of this essay has been published as Cato Letter N° 15, by the Cato Institute, under the title "Liberating Workers: The World Pension Revolution").



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