Here’s a Cautionary Tale of Pension Privatization From Chile

Among free-market fans, Chile’s privatized pension plan has long been held up as a model for us to follow. The problem, as the Financial Times notes today, is that it’s performed pretty dismally. Daniel Gross suggests that it was all well-intentioned, but for some reason just didn’t work out:

There’s one thing Gross and I agree about: net returns of 3 percent during the booming market of the past 35 years is indeed a disaster. It’s the “just turned out” part that deserves closer scrutiny. Sadly, I can’t read Spanish and therefore can’t inspect the primary source for this debacle, but there’s no way that management fees indistinguishable from highway robbery just happened to happen. This may not be corruption in the sense of fund managers embezzling trillions of pesos for hookers and blow, but it’s certainly corruption in the more refined sense of deliberately allowing the financial sector to enrich itself at the expense of workers who are required to give them their money.

Why is this becoming a big issue now? Because for its first 35 years, when it was being hailed as a free-market miracle, not many people were actually retiring. Now they are, and it turns out their pensions are pretty paltry. If net returns had been closer to the 8 percent retirees deserved, their pensions would be three times higher. Fees like this are basically legalized theft.

This is not some obscure detail of pension investing, either. Management fees are one of the most crucial aspects of long-term fund management and everyone knows it. Normally, you’ll hear arguments about whether fees of 1 percent are larcenous compared to, say, fees of half a percent. But fees big enough to reduce returns from 8 percent to 3 percent? That’s no accident. It’s the predictable result of an unregulated free market working on behalf of unsophisticated investors. Everyone involved in this knew exactly what they were doing.