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Fatherly control on grandfathers’ funds

Fatherly control on grandfathers’ funds

When people give up money in order to save for the upcoming, the least they expect to have in the future is the same amount of capital or more, not less. The Bismarckian pension system, diffused all over the world, nowadays works exactly the opposite. Beneficiaries are not getting what they expect making this collective capitalization scheme bear with all kinds of difficulties.

It faces a political problem given that the government has the monopoly of the Social Security and it occasionally uses the workers’ money for political purposes. The monthly contributions workers make by law go to a common fund that governments are meant to merely “administrate”, but that sometimes they employ for other purposes leaving no funds for the future.

In Ecuador, for example, the government has always counted on this fund to invest in public bonds or whatever other investment the incumbent administration chooses. Certainly, employees feel entitled to all the benefits that politicians have promised them, but sometimes they don’t get them. For instance, in order to extend the submission of benefits to workers, Spain is one of many countries to recently strategically plan for baby boomers by delaying pension collection. This is an example of measures governments take when they don’t have the payback.[1] Currently, the U.S. is short $1.26 trillion in paying for public employee pensions and other retirement benefits.[2]

Also, the system deals with a demographical trouble as the world’s trend is to have aging societies: while born rates are decreasing, medicine and technology is extending life expectancy.[3] This results in less active workers contributing to the financing of an increasing demand on elderly pensions.

This system causes an economic problem too since it negatively affects savings incentives. Workers trusting the system feel that their contributions are enough so they don’t save more than what is compulsory.[4] However, savings —to keep money for future needs by not meeting the immediate needs— are essential not only to individuals but to the whole economy. More savings increase individual’s wealth and also the capitalization of the entire economy. Thanks to savings, capital goods are produced which turn to produce consumer goods needed in the long-run.

This leads to a cultural matter because the Bismarckian system promotes a paternalist government and discourages individual responsibility. This makes individuals to believe saving is not necessary since the government will cover their old age pensions and other needs. This again, is detrimental for the economy.

Finally, it deals with social and ethical issues since employees receive poor pensions when they reach the old age and most of the times they don’t receive the benefits politicians have been promising throughout their working life. If they do, these benefits have no relation with what they have been contributing.

Luckily, there is one way out and it is called individual capitalization pension system in which workers contribute a percentage of their taxable income to individual savings accounts. These are administered by private PFAs (pension fund administrators), whose objective is to invest these funds in the financial markets. In return for these services, they have the right to charge a variable fee expressed as a percentage of the worker’s income.

The Bismarckian pension system may have worked in the past (and even this is questionable), but new trends make it impossible for the government to grant everybody a “dignified old age”. Instead, it should consider workers mature enough to decide who will administrate their funds until they reach the old age.

Paola Ycaza has B.A. in Political Science and graduated with a B.A. in Economics (thesis pending). Currently she is working on her thesis on the Ecuadorian Pension System.

[1] “Spain raises retirement age to 67”. AARP Global Network. February 2nd, 2011.

[2] “The Great Recession’s Impact on State Pension and Retiree Health Care Costs.” Pew Center on the States. April 2011.

[3] Longman, Phillip. “Think Again: Global Aging. The world faces a Population Boom.” Foreing Policy. November 2010.

[4] Huerta de Soto, Jesús. “El Ahorro y Previsión en el Seguro de Vida”. Unión Editorial Colección Nueva Biblioteca de la Libertad N° 36. 2007