Looking the wrong way

Chile's private pensions have been hailed as a model system. But they exclude half the population, says Peter Townsend; The UN expected to report favourably but was highly critical

Pensions reform is high on the Labour government's agenda. Tony Blair said so at the dispatch box and much has been made of his appointing Frank Field to spearhead such reform.

Those who speak of reforming welfare often cite the private pensions system in Chile as a useful model. At a public lecture in London last week, Dr Jose Pinera, the architect of the Chilean reform, explained what he thought Britain should do; but few yet appreciate what a poor case he has to argue.

The Chilean model was used by the Conservatives in their manifesto plan to privatise pensions - which so enraged Labour when it was announced. Only weeks earlier Peter Lilley had announced plans to introduce a private pension scheme for all young people entering employment, using the shrinking relative value of the basic state pension to subsidise their contributions to private schemes. He also announced that the State Earnings-Related Pensions Scheme would be abolished.

But has Chile's model anything to teach Labour? The House of Commons cross-party social security committee visited the country last year. Its members appear to have been impressed. They should have looked more closely.

The Chilean scheme dates back to 1981, the middle of the 17 years of Pinochet's military dictatorship. A new scheme of individual worker contributions replaced one based on combined contributions from workers, their employers and the state. It was administered by private, profit-making bodies known as administrators of pension funds. They are rather like the "approved societies" which administered social insurance in Britain in the 1930s, which social historians such as Noel Whiteside explained had to be replaced because of their inadequacy in the 1940s.

People were enticed to leave the state scheme in Chile by becoming entitled to place their accumulated contributions to the state scheme into a private alternative. That represented a systematic switch of resources from the public to the private sector and undermined the financial viability of what was left of the state scheme. Each year about a quarter of the state's budget went to meet those pay-outs. Inequality widened and by 1989, 44 per cent of the population lived in poverty.

The long period of military rule ended in 1990 with the inauguration of President Patricio Alwyun, succeeded in 1993 by Eduardo Frei, supported by a democratic coalition government of centre and left-wing parties. Its principal objective was "growth with equity". However, the dual model of social welfare, which had been established during the 17 years of military dictatorship, persisted, and deepened. Chilean analysts such as Pilar Vergara have explained it in depth. In the early 1990s, poverty was reduced but that was more to do with higher levels of economic growth after a period of recession than with the social policies of the Alwyn and, from 1993, the Frei administrations. By 1994, it was increasing again.

In the mid-1990s, in an international review of privatisation, the UN Conference on Trade and Development expected to report favourably on Chilean pensions but came up with a highly critical analysis. For nearly half the population, the scheme had simply not delivered. By 1991 only 52 per cent of those in the labour force were contributors. An "important" proportion of them were going to end up with "acquired benefits less than the guaranteed minimum". The costs of fees and commissions for private pensions remained high and often unnecessarily excessive. Exclusion from membership because of loss of jobs, loss of entitlement for those floating insecurely from one temporary and often part-time job to another - together with the growth of hazardous self-employment and poverty, and late payment of contributions by employers - had dashed the hopes, and intention, of establishing a near-to-universal scheme.

The UN concluded that a fresh balance needed to be struck between the public and private sector, whereby state pay-as-you-go schemes are strengthened and are combined with individual capitalisation schemes. The best alternative, they believed - preferably to be adopted across the world - would be a three-tier pension system: the first being a universal defined-benefits pay-as-you-go state scheme, combining flat-rate and earnings-related components (jointly providing 30-40 per cent of average earnings upon retirement); the second a "compulsorily-defined-contributions individual capitalisation scheme"; and the third personal voluntary contributions to secure a higher replacement rate of previous earnings.

The welfare reforms of the 1990s seem to have made little difference to an unequal society and an unequal pensions system. Consensus-style politics can allow powerful institutional players to override participants who are weakly organised and poor. In Chile in the 1990s, the administration ran up against resistance from business and right-wing opposition parties to its tax-reform policies and was stripped of an essential tool to reduce social inequalities. Proposals to extend labour law reforms to non-unionised workers also made no headway.

Analysis of the country's income distribution shows that social policy has become ineffectual as an instrument of redistribution. Privatisation has created a dual welfare system, in which services of good quality financed from high incomes co-exist with a depleted and under-financed state system for those who cannot afford the alternative.

The writer is emeritus professor of social policy, University of Bristol.