Mexico Overcomes a Large Part of Its PDD (Pension Deficit Disorder). Can We?
In a subscriber-only op-ed a week ago Monday, Mary Anastasia O’Grady noted that Mexico may do for its retirement system what the US lacks the political will to do:
Pension Deficit Disorder
March 26, 2007….. it looks like (Mexican President Felipe) Calderón, who is less than four months into his six-year term and lacks a majority in Congress, may be about to pocket a major legislative victory. And on no less an issue than the transformation of the pension system covering federal workers from pay-as-you-go to a fully funded system of individual accounts.
….. The catalyst for this reform is the grim outlook for Mexico’s Institute of Social Security for Government Employees (known by its Spanish initials as Issste and pronounced ee-stay), which manages the pension accounts and health benefits of some 2.8 million active and retired federal employees. These include bureaucrats, doctors, nurses, health-care workers and teachers, but not the employees of the state-owned oil company Pemex.
Issste’s pension arm currently provides retirement benefits to 580,000 individuals and like so many pay-as-you-go systems, the agency is operating in the red. With an average retirement age of 56 and retirees living longer, Issste has obligations that far outstrip its income and every year the deficit grows. In 2000, Issste’s pension deficit was 10 billion pesos ($909 million). This year the government has set aside 42 billion pesos to fill the gap. By 2012 the shortfall is forecast to hit 77 billion pesos. According to the Finance Ministry, Issste’s actuarial deficit in pensions is equal to over 50% of Mexican gross domestic product. Issste is a ticking time bomb.
It’s not like Mr. Calderón and Treasury Secretary Agustin Carstens had to convince union leadership of this reality. Mexicans have been known to joke that the best workers in the Issste system could hope for is to die early, before the house of cards collapses. Still, the Calderón government did have to win agreement from the union bosses for individual accounts and it also had to find enough votes in Congress from the opposition to get it through. That’s what makes this victory historic.
The centerpiece of the reform, which passed the lower house last week and is expected to pass the Senate this week, is the establishment of worker-owned, individual accounts to replace the communal pool at Issste. There are no changes for those already retired. Current workers will have the choice of staying with the government’s defined-benefit plan and accepting gradual increases in the retirement age, or migrating to the new individual account, defined-contribution system.
There is no reason why individually controlled investment accounts shouldn’t be employed to avoid a similar (actually probably worse) train wreck that is coming to the US’s Social Security system.
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UPDATE: The Institute for Policy Innovation elaborates, and points out something I didn’t know about the private-sector retirement system in Mexico –
Unfortunately, the government will be managing a bunch of the money. That’s a bad idea. But at least Mexico got most of it right.
And this plan comes on top of the creation of personal accounts for the private sector in 1997.
For our part, we think this sounds like a good model for both the public and private sector in the U.S.—all except for the government investing the funds. Much better to leave that money in the hands of approved private sector financial managers, which have a fiduciary obligation to serve the best interests of the account owner, not some politician running for reelection.
I would add a limitation that would force private sector financial managers to invest only in index funds.
