The Achilles heel of pension reforms

This week the new bill to reform our pension system entered Congress. Several people have said that this third proposal must be successful, after the initiatives of Michelle Bachelet and Sebastián Piñera failed to become law.
The three proposals share a diagnosis: the contribution rate (the percentage of formal salary that finances future pensions) in Chile is 10%, a low percentage compared to the OECD average rate, 19%. And given this, all three initiatives have proposed raising the rate. In the current one it is proposed to add 6 extra points of quotation. Where does the main disagreement that traps the political debate arise? Regarding the destination of the extra contribution that is created: how many points are destined to individual capitalization and how many to collective savings.
The debate focuses on where to place the 6 extra contribution points and loses focus on the main cause of why pensions are low in Chile: our weak formal labor market. Under any pension system, whether individual or collective capitalization, pay-as-you-go or notional accounts, the amount of pensions is determined by the number of years of contributions and by the amount of salary for which contributions are made, that is, formal employment.
I will share some data to give perspectives to the problem we have. According to the database of “Social Security History of Affiliates and Pensioners” (HPA) of the Superintendency of Pensions closed in December 2021, 50% of women retired due to old age contributed less than 10 years to the system and for a salary of less than 7,913 UF ($237,390 in December 2021 currency). In addition 27% of retired women contributed between 0 and 3 years. What about men? 50% of men retired due to old age contributed less than 16.2 years, and 50% did so for a salary lower than 11.8 UF ($354,000 in December 2021 currency).
These data reflect the weak formal labor market experienced by current pensioners. It is difficult to achieve high self-financed pensions with this low level of workers’ contribution.
Then, in the debate, Chile’s pensions are usually compared with those delivered in the developed countries of the OECD. But How is our formal employment today compared to these countries? Not very well. In 2019 (prior to the pandemic) the percentage of Chileans of working age (over 14 years old) who have formal employment was 37%. In the developed countries of Europe this percentage was 51% on average. That’s a gap of 14 percentage points! We cannot aspire to have the same social security as these countries with such a difference in formal employment coverage.
The political debate has spent a lot of energy, time and attention on where to place the extra contribution points, and the debate on how to strengthen our formal employment has been left behind. And this debate will be more important if we want to raise the contribution rate from 10% to 16%, which will have effects on formality.
The effect of increasing the contribution rate on employment is not clear. On the one hand, regardless of where the extra points are deposited (individual or collective savings), the increase discourages the formality of workers since it reduces the liquid salary they receive in the short term, and makes hiring by companies more expensive. But, on the other hand, if this extra contribution is invested in the capital market, the country’s savings will increase, which encourages the growth of our economy and with it jobs.
In any case, if we are going to increase the contribution rate we must do it progressively, and evaluating the effect it is having on formal employment. The worst thing we could do is implement a reform that exacerbates the main cause of low pensions. And along with it, We must advance a public policy agenda that strengthens our formal employment.

There are several proposals: modernize the Directorate of Labor to supervise hiring in companies and end the underdeclaration of formal salaries, carry out an information campaign on the benefits of formalization and the duty of employers to comply with it, improve labor flexibility to help mothers and fathers, design tax aid that encourages the formalization of low wages, etc.
Let’s recover the focus on the pension debate and place it in one of theChile’s problems on social security: the low formality of employment. In this debate, not only politicians must collaborate, but also from the world of academia and civil society with their experience and knowledge.

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Original source in Spanish