Text prepared for the Adam Smith Seminar on "State funded pension systems", Bank of Latvia, Riga, Latvia, August 27th, 1999.


In France like in many other countries, we have a pension system, which has been consciously built, in the twentieth century, by policymakers.
By saying "consciously" with regard to France, I want to insist upon the fact that policymakers were opposed to property rights and market process and they wanted to reach one objective: the social security.
Otherwise, in France, the principle of retirement has appeared spontaneously in the eighteenth century, and was much applied in the nineteenth, then in the first part of the twentieth century.

If, today, I compare the current French system to other national systems, I find that the French one has two main characteristics: complexity and compulsion.
I shall present them in a first part, particularly because they are too ignored by official studies.

These two characteristics are important because they only result from past political decisions.
I say political decisions because decisions were not derived from the law. The difference is essential, basic, if we want to surround or to understand the current French problem. I shall show it in a second part.

In fact, all these political decisions were not rational in spite of appearance, of talks about them.
Since the beginning, there have always been problems "solved" by increasing contributions.
The problem of today finally seems to be deemed acute and its seriousness to be rapidly increasing.
I shall give you, in a third, some numbers about it and some components of it.

However, "for saving the French pension system, the best of the world" as they said, French policymakers, politicians, and union leaders strive to explain the current problems by introducing false problems, fairy tales, myths. In a fourth and last part, I shall give you some examples.

1. The French pension system today.

A - Not one single state system, but a galaxy of interest group-based systems.

The French pension system is a very complex system. Compared to other national pension systems, complexity is thus its first characteristic.

To be sure, it is not a state organisation but a galaxy of organisations, which are gathering 120 basic pension schemes and 400 supplementary ones.
You can trust me, the term "galaxy" is not exaggerated and you will aware of it in one moment.
So, we shall understand that, although men built the organisation, nobody is mastering it today, in particular, by the means of the mind. Here are two proofs of my affirmation.

Currently, when French are speaking about it, - for example read French newspapers or listen to politicians talks -, they do not refer to the galaxy.
Without telling it, they only refer to the basic compulsory pension system of people who are employed by an employer whose enterprise is classified in the "industry and commerce sector" item.
In French language, it is the "régime général de retraite de sécurité sociale" though this system is not "général", but very special.
Today, two-third of employed population belongs to the system, but the percentage was much less until the last decade.

No attention is paid for people who are not working in this sector.
You are a farmer, you are not hinted at. In fact, you belong to another compulsory pension system.
You are a grocer, you are forgotten. You belong to another one, different.
You are a physician; it is the same thing. You belong to another one, different, special.
You are working in the French electricity monopoly named "Electricité de France", you are forgotten. You have, as it is said, a special system.
You are working in the French central bank named "Banque de France", you are forgotten. You have also a special system, which is different from others.

Myself, as a professor, I am a civil servant, one of the 2.3 millions state servants and I am submitted to a very special system: I am depending upon the state budget. All the other systems do not depend on the state budget.

Second proof of my affirmation that, today, nobody is mastering the organisation, for example by means of mind: always currently and until recently, when the French speak about the pension system, they confound the "basic pension system" with the "supplementary pension system".
As a matter of fact, until the 1980's years, they really forgot "supplementary pension systems". Today, it is different, but only a little bit.

So, in France, today, media and politicians are not mastering the pension system simply by means of mind.

One consequence is that, implicitly, the mind of people who are hearing them is itself directed towards the pension system of workers in the industry and commerce sector as if it was the unique system.
Many persons think they are members of the described system but they are wrong.
In other words, there is an illusion.

While saying that, I allude to one reason of the complexity of the French pension system: French people are influenced, conditioned by authorities and often do not know to react, they are mashed by the system.
For example, French pension system is hardly taught in schools or universities.
I shall add that, until recently, it was "politically incorrect" to debate upon the future of the pension systems.
Above all, after having given conclusive arguments that the pension system could not be lasting, when you are asserting it, you were really sinning.

The reason of the complexity of the French pension system I have just given is not basic.
It hides deeper reasons from which it follows.
And I think that the conjunction of these deeper reasons was resulting in the problem of the French pension system that we record today in France.

Why this French situation, you will ask me? What are the reasons? I am going to develop the answer to each question in one instant.

B - Everyone is compelled to be a member of one, two, sometimes three and more … pension systems, which he is not free to choose.

Before, I want to say one word on the second characteristic of the French pension system. What is the characteristic? It is twofold

First, today, each employee or each entrepreneur is compelled to be a member of one basic pension system and, most often, to be a member of one other supplementary pension system, sometimes of two other, three other supplementary pension systems.

Second, as an employee or an entrepreneur, you cannot choose the pension system, which you wish to belong to.
According to the economic sector where you lead your activity, you must be a member of a specified basic pension system and, most often, you must be a member of one specified supplementary pension system.

Thus you have no freedom to choose, you are tied to the organisation, and you are a serf of pension systems as, in the past, the serves were tied to the ground. I do not exaggerate: in French language, the authority uses the word "assujetti", it is a synonymous to mean that you are tied to pension systems!

All that being said, I want to tell you, now, how did the French arrive to that system.

2. How did the French move to that system?

The French situation did not fall from the sky; it is the result of several political decisions.

The first one is more than a decision since it is a real, short communist revolution, which took place in 1945, the year of the end of the Second World War.
At this time, French communists were politically predominant. Their revolution thrived to create an organisation of the social security.
For that reason, and contrary to what is often said, French system has not derived from the Bismarck model or the Beveridge model, I am supporting that it is a kind of communist model.
Christian or social democratic majority took the other political decisions since 1947 and they led to the present pension system.

Let us see briefly each decision.

A - The communist revolution in 1945.

The communist revolution has five dimensions, which seem to me essential:
- a political dimension,
- a legal dimension,
- an economic dimension,
- a claimed technical dimension and
- a philosophical or ethical dimension.

I shall briefly describe each one because they are central if we want to understand the current pension system.

1) Political dimension

In 1945, in France, the political mood is very hard, troubled. It is the end of the Second World War.
The communist party is the first political party (about 25% of votes in the just elected French House of Deputies - "Chambre des députés" in French). It is predominant in the political majority, which is gathering social or Christian democratic politicians.

The political consensus is that the economic laws do not exist, that market economy has too many failures and that capitalism has too many abuses.

The consensus is also that the French economy must be no more a capitalist economy. Many enterprises are nationalised in all the economic sectors.

The consensus is finally that the French economy must be no more a market economy. It is the beginning of the effective French planning.
So, they create another economic system.
A plan is implemented in an effort to create the social security in France, that is, in an effort to make the consequences of the social risks to disappear.
So, French social security is at first a "political plan": it is named "social security plan " - in French language, "plan de sécurité sociale" -.

In 1945, besides policymakers of the political majority, interest groups are politically powerful, in particular, one trade union which is next communist party and is named, in French language, the "Confederation générale du travail" (C.G.T. is the acronym).

The social security plan will take notice of these trade unions, which control the economic life.

2) Legal dimension

Given the "social security plan", policymakers of the political consensus thought that a legal framework must be given to the plan of "social security". It will be the "social security legislation".

The French authority, that is, the government and the House of deputies, also created a legal organisation named "social security organisation" and gave it legal means to reach the aim. So did it think?

The organisation is built partly on existing systems, which are nationalised, partly on new principles.

It mixes pension system with industrial injury insurance, health insurance, and family allowances.

Contributions are enacted compulsory but it is also enacted that the social security benefits will be without relation with the contributions.

The individual responsibility is seen as a bad juridical concept: so it is enacted that people will have no freedom of choice, every worker will have to pay contributions to the organisation.

Heritage is declared to foster inequality: so it is enacted that people will receive retirement pension until their death, but after their death their family will receive nothing.

With regard to interest groups, the authority acknowledged several ones; it gives them legal status in the new organisation.
Particularly, it enacted that the social security organisation will not be a state organisation, but an autonomous organisation. The organisation will be centralised and hierarchical.
At the head of every level of the hierarchy, there will be an administration board whose trade unionists and employers' representatives are members.
At the upper level, the board will be under the supervision of the state administration.

3) Economic dimension

Given the "social security plan", given the "social security legislation", policymakers of the political majority and interest groups thought that social security is not a good like others.

So they conclude that it must be produced by a monopoly.

But, according to them, the good is so special that the monopoly must also be special. It has not to be a state monopoly.

It will be a monopoly managed by the trade unions and employers syndicates in partnership.

It will cover three economic activities:
- industrial injury insurance,
- health insurance, and
- pensions.

It will also manage family allowances system.

But no employment insurance system is imagined.

The monopoly aggregates the economic activities. So there will not be a pension system, but only a social security system in which the pension system is not identified.

4) Claimed technical dimension

Given the "social security plan", given the "social security legislation", given the "special monopoly", policymakers and interest groups thought, in 1945, that the capitalisation - or actualisation - technique is a bad technique to insure or manage social risks. For example, they used to say or to write: look at the past insurance activities, they insured the rich and they did not insure the poor (insurance premiums too high). Do not trust in stock exchange, it is speculation, remind you of the crisis of Wall Street in 1929.

They consider that there is another technique, which can be used: the pay-as-you-go scheme. It is much better. Today's contributions fund today's benefits, no need of financial services.

So the special monopoly will be using it.

5) Philosophical or ethical dimension

Given the "social security plan", given the "social security legislation", given the "special monopoly", given the "pay as you go scheme", policymakers and interest groups thought that poverty, inequality, social injustice and social insecurity would disappear because they would make disappear the causes, which they have surrounded, that is, failures of market economy, abuses of capitalism, injustice of the law.

They told that, with the new social organisation, there would be no poor, every worker (and his or her family) would be protected against social risks, full employment and peace would be maintained, growth and development would be better. We know what it happened, I am going to describe it in one instant.

B - The Christian or social democratic policymakers who have governed France since 1947.

But many people were opposed to the planning, to the potential power given to communists. They succeeded to limit their influence from 1947. Afterwards, communists lost, progressively, their political predominance and Christian or social democratic governments governed France.

Many people were also opposed to the social security legislation and partly succeeded in their opposition. First great result I shall underlined, some past pension systems succeed to resist to nationalisation (for example, in farming); but progressively, several new ones (for example, for physicians) will appear more or less compelled by the authority. Among new ones, I shall also remark that there are supplementary pension systems for workers in the "industry and commerce sector". They became compulsory from the end of the 1950's.

So, the result of the opposition to the social security legislation was several pension systems instead of one general pension system.

Second great result, as soon as the beginning of 1950's years, politicians began to consider that there are too many health expenses and to build "remedies" to reduce them (increase in contribution, cut in benefits, price control, etc.). But in spite of the new regulations, health expenses are increasing. Consequently, in 1967, they implemented the first great reform. They decide to reform the social security organisation of workers in "industry and commerce sector" and, particularly, to separate pension system, industrial injury insurance, health insurance and family allowances.
From now, the special monopoly will cover four separated systems and, in particular, the basic pensions system of workers in "industry and commerce sector".

Many people were also opposed to the special monopoly but they did to stop its emergence. They did no more succeed to impede the creation of new pension monopolies. In 1970's, nearly each employee or entrepreneur is member of a monopolistic pension system.

Finally, many people were opposed to the social security utopia, which was only a disguised communism aimed at social risks.
But they did not succeed to persuade people in spite of the writings of Ludwig von Mises - Human Action in 1949 -, Friedrich von Hayek (Nobel Prize in economics in 1974) - The Road to Serfdom in 1947 -, Karl Popper or the Frenchman Jacques Rueff.

So, the Christian or social democratic majorities on the main part of its initial communist basis developed the social security organisation.

All that being said, I want to tell you, now, which the current French problem consists in.

3. The current French problem

These five dimensions of the communist revolution and the following political decisions of Christian or democratic majorities were resulting in the problem of the pension system that we record today in France.

In numbers, the problem is the following one:
if the tendency which led to situation of 1998, described in the table below, is continuing in the future,

Year 1998
- population 60 millions
- active population (AP) 22 millions
- retired population 12 millions
- unemployed population in % of AP 3 millions : 12 %
- Gross national product (GNP) 8200 billions of francs
- retirement benefits
* general system : 350 billions of francs
* all the systems: 1040 billions of francs
* in % of GNP  : 12,7 %
about 2040,
with an unemployment rate of 9% (realistic assumption), retirement benefits would be 16,6 % of GNP;
with an unemployment rate of 3 % (optimistic assumption), they would be 15 %.
These forecasted percentages are deemed not sustainable.

Why is there a problem?

Because of the political decisions and because they derive from a mistaken analysis. It is impossible to create a permanent world without obeying to the economic laws, it is impossible to create the world we wish except if we respect these laws (read writings of Mises, Hayek, Popper just alluded).

If I had much time, I could take again every political decision and show you the mistakes. I miss time, I shall only take the dimension of the pay-as-you-go scheme: this dimension is in fact very important, particularly, because it is the only common point of all the French pension systems.

A - The pay-as-you-go scheme is not a technique

In 1945, many people were opposed to the pay-as-you-go scheme. But they did not succeed to prevent its adoption and its use.

They knew that it is not a technique, but a claimed technique, it is a legal robbery of resources to some persons and a destruction of the liability of all. To be functioning, it must be compulsory. So if the amount of contributions is less than the amount of pensions, there is a deficit and the state advances cash to fill the gap before contribution rates are increased or future pensions reduced.

It is the basic stone on which the socialism and the planned economy were built. So, it has a fundamental flaw. That flaw is lack of a link between what people put into their pension program and what they take out. So the pay-as-you-go scheme is a false conception of how human beings behave.

Since 1947, curiously, a consensus appeared among Christian and social democratic politicians to declare that the pay-as-you-go scheme is satisfying. And it must be applied to every pension system. We know what it happened: increases in contribution rate.

In the social security system of 1947, the contribution rate of a worker in the "industry and commerce worker" was 16% of the monthly labour cost (in the limit of a given arbitrary ceiling and the contribution to family allowances system being excluded).

In 1967, after the great reform of the "general" pension system, the contribution rate appears to be 8,5% of the monthly labour cost (under the given arbitrary ceiling). In 1996, always with regard to the only "general" pension system, the contribution rate is 14,75% (under ceiling) and 1,7% (above ceiling, that is, on the whole wage). Compared to the ceiling of 1947 and adjusted to the price level increase, the 1966 ceiling is also fixed to a level, which is 16,1% higher!

Moreover, the rapid increase in pension expenditure in France started causing concerns during the 1980's and led to increases in contributions and efforts to reduce benefits. But no major reform was adopted until 1993.

So, nearly constrained and compelled by official forecasts, the French government made its political majority vote the legislation of 1993 July 22nd reforming the method of calculation of pensions in the general pension scheme and in the schemes aligned to it.

The reform consisted of the following points:
- the contribution period for a full-rate pension will be gradually increased from 150 to 160 quarters;
- the number of best years used for the calculation of the reference wage will be gradually increased from 10 to 25 years, which will have the effect of reducing the average pension paid;
- pension adjustments will be based on the consumer price level instead of gross wage growth;
- the "Fonds de solidarité vieillesse" is created with the main task of financing the non-contributory old-age benefits resulting from national solidarity.

It is said that this reform contributes to improving of financial prospects for the pension system by 2005.

Supplementary pension systems of workers, members of "general" pension system, were partially reformed in 1996.

In 1999, a "financial reserve fund was created by the state: it received two billions of francs and it is forecasted that the amount should grow to 18 billions from now to 2003.

Today, the political consensus also forgot or hid that the result of the working of the pay-as-you-go scheme is not the same for all the pension systems.
For example, benefits from the basic scheme of workers in "industry and commerce sector" are determined by the number of years the beneficiary has contributed, as well as the average wage earned over a certain number of years, indexed by either changes in price levels or average wage increases. The benefit is always superior (or equal) to a minimum and inferior (or equal) to a maximum: in 1998, the maximum was 7045 francs a month (that is 50 % of the monthly ceiling).
For every other system, the determination of benefits follows other rules.
In average, and all the pension systems of the private economic sector being taken in account, the average pension of a retiree was about 5900 francs a month in 1998 (47 % of his last monthly wage).

Comparatively, and all the pension systems of the public economic sector being taken in account, the average pension was 9600 francs a month (75 % of the last monthly wage).

Moreover, in each economic sector, the disparity around the average is high.

So, not only contributions and benefits are unrelated because they are defined politically depending on the power of interest groups, but also retirement age, contribution rates and calculation of benefits may vary considerably between the different schemes.

Briefly, the pay-as-you-go scheme is a source of inequality, of inequity, of injustice.

It is the common mistake of pension systems and it should be given up. The only technique to manage retirement system is the capitalisation technique or, if you prefer, the financial technique. This technique should be used; it has not any arbitrary or coercive rules.

That being said, I shall draw three fatal consequences of the pay-as-you-go scheme.

B - The unfunded liabilities of systems are increasing

The pay-as-you-go scheme creates unfunded liabilities at every moment. I would like to underline that the arguments of critics of capitalisation technique ignore or seem to ignore that point.

Consequently, the amount of unfounded liabilities of the French pension system is, officially, put aside. No official body knows and does want to know its amount.
And these unfunded liabilities have costs. The elderly have a claim on employees and entrepreneurs.

And there is an accumulation of unfunded liabilities. And, because this accumulation has also a cost, it should be a major concern for every one because it can only be managed by reform.

But, for a long time, the concern was forgotten or put aside by interest groups or politicians for good or bad reasons.

C. - President Mitterrand's election pledges from 1981.

Other example, in 1981, in France, the concern was put aside for presidential election reason.

The cash flow deficits of pension systems began to appear in the 1980's after generalisation of compulsory pension systems in the 1970's but, above all, after the fulfilment of M. Mitterrand's election pledges from 1981:
- to reduce retirement age to 60 years old,
- To shorten the worked week (39 hours) and
- To increase compulsory paid holiday entitlement (fifth holiday week, a year).

To be sure, all these demagogic political decisions have accelerating the damaging of the French pension system and the financial position of future retirees.

D. - The lack of will of political majorities face to the threats of strike by trade unions.

Since the end of the 1940's, trade unions lost their members. For example, in 1946, the C.G.T., the first trade union in France, had near of 6 millions of members, in 1995, it claimed 630 000 members. Today, it is admitted that members of trade unions represent around 11 % of the wage earners.

But trade unions survive because of their legal status: in particular, they are subsidised by the state and they manage the different social security systems. And their own members are often employed in social security organisms.

They have yet an important strength in the state monopolies, which have, everyone, a special pension system (electricity, gas, railways, etc.) or in the state administration.

So the political influence of labour unions progressively decreased in France. But it is yet existing.

Second example for showing that the concern of accumulation of unfunded liabilities is forgotten or put aside by interest groups or politicians for good or bad reasons, the behaviour of political majorities since 1986. Political majorities are afraid of trade unions strikes in response to a reform of special pension systems. And consequently, they are also afraid of not being neglected.

The reform of 1993 left many questions unsolved particularly the sustainability of the special pension schemes.

Bringing these schemes back to balance was to involve, in particular, the extension from 37,5 to 40 years of the duration of contribution required benefiting from a full-rate pension.

Provided for in the November 1995 plan, this reform was finally abandoned following strikes in the public sector at the end of 1995.

In spite of this retrieve, the political majority lost elections in 1997.

I shall also remark that union leaders have been among the most vocal opponents of privatising pension system. Their opposition is something a mystery, because union workers would be among those who would gain the most if pensions systems were transformed to a system of individually owned, privately invested accounts.

Such system
- would provide people with better and more secure retirement benefits,
- would give them a greater voice in corporate management and a sense of ownership and participation in the economy, and
- would avoid painful contribution hikes or an increase in the retirement age.

All that being said, I want to tell you, now, what are the false problems, which some people often talk about to minimise the French current problem.

4. False problems or myths

We have to distinguish, on the one hand, the real problems posed by communist dimensions and Christian or social decisions of pension systems and on the other hand, the false ones, the myths. I see three main myths
- unemployment and weak growth myth,
- ageing myth
- transition costs myth.

These are Malthusian theories-based myths, which strengthen socialism. They cannot explain anything because they ignore preferences of people (values) and market process (prices or interest rates). After assuming that the economic law did not exist to build the organisation, they use mistaken economic law to strive preserve it!

A. - Unemployment-and-weak-growth myth

Usually, we can hear or read arguments like the following ones:

"[…] the financial situation of the pension system depend on such factors as the activity rate and the situation on the labour market, which determine the growth of the wage bill, and, as a result, the resources of the pension schemes".

In other words, if economic growth is slowing, if unemployment is appearing and increasing, the pension system will have difficulties.
If economic growth is accelerating, if unemployment is decreasing, the pension system will go out difficulties. But that is wrong.

The opposite is right: the pension system put at risk enterprises and economic activity because it prevents people to save and enterprises to invest.

It put at risk entrepreneurs because, to bridge deficits, it requires to increase contributions and, consequently, wages.

So the root is the pay-as-you-go scheme.

B. - Ageing myth

Usually, we can hear or read arguments like the following one:

"The majorities of the difficulties with which the pay-as-you-go pension scheme will be confronted in the medium and long term result from the ageing of the population. The share in the population of elderly people over the age of 60 years will increase rapidly in the years to come".

In other words, if there is a decrease of retirees/contributors ratio, the pension system will have difficulties.

That is right. But why?
Because of the pay-as-you-go scheme.
The scheme has no technical rules.
I said that its rules are robbery of resources to some people, and coercion of all. These rules are in opposition to the dignity of human person. The pension system cannot be last for that reason, not because of ageing of population.

C. - Transition costs myth.

One of the more common concerns is the transition cost one. Since French pension system uses a pay-as-you-go scheme, today's contributions fund today's benefits. If those contributions go into personal retirement accounts, how do we fund the transition? How much will it cost?

Critics claim that, while transforming pension system's pay-as-you-go financing into a market-based structure, people would be unduly burdened because they would have to pay twice - one for their own retirement and one for those already retired.

This double expense would be so prohibitive, it is argued, as to warrant rejecting privatisation even if it were meritorious on other grounds. Firstly, such arguments ignore the enormous unfunded liabilities of the current pension system resulting from the pay-as-you-go scheme.
Any valid discussion of the costs of moving to a market-based pension system must compare those costs with the costs of maintaining the current system, including the costs of meeting those unfunded liabilities.

The transition costs should be measured against the costs associated with doing nothing at all.

In fact, it would probably be more accurately to talk about "preservation costs" instead of transition.

Let's define the "transition costs" for the French pension system as the total amount of money that must come from sources other than contributions at the current level and the small portion of the income tax on benefits paid to certain higher-income retirees.
Thus, increasing the contributions would count as part of the transition costs as would any general revenue that is transferred to the system.

The easiest way to measure this cost is to look at the annual cash flow deficits of the pension systems under both the existing program and the various proposals that have been made.

The phrase "there is no free lunch" has never been truer than in this situation. To the extent that the money is borrowed, future generations will bear a significant interest cost that will be in addition to the base transition cost. If the organisation borrowed a significant amount for pension systems, under some circumstances, this could cause an increase in interest rates for the overall economy. This in turn could lower economic growth, thus reducing contribution collections below anticipated levels.
No matter what future contributors will bear a significant additional burden to pay benefits of that time's retirees.

The benefits of individual accounts would take some time to develop. Even if a contributor were allowed to begin to morrow, the accounts would not grow large enough to offset any significant amount of the traditional benefits for a good 20 to 30 years.

If a portion of the existing contributions were diverted to individual accounts, there would be a direct relationship between the amount that could go into an individual account, the size of the initial deficits, and how soon the deficits could end. Diverting part of the contributions would reduce pension systems income and cause almost immediate deficits.

On the other hand, the more that went into the individual accounts, the faster they could grow to a significant size and replace much of the traditional benefit.

However, because the early deficits could be so large, reform initially could limit individual accounts to an amount equal to 2 percent of income.

Of course, there is more to be considered than just aggregate costs. The simple fact is that for millions of low- and moderate-income families, pension system is the only retirement plan they have. Unfortunately, for most of them today's pension system is not a good investment.

Therefore, redesigning pension system as a marked-based system of personally owned retirement accounts does not actually entail any new costs. Indeed mowing to a marked-based system can ultimately result in substantial savings.

What workers are paying for in the transition to the new system is simply the cost of the increased savings involved in fully funding the system. That is the same as the cost of any other savings increase - foregone present consumption equal to the amount of the savings increase.

Therefore it is wrong to speak of "transition costs" involved in the privatisation of pension system. For such reform does not involve "cost" in the true sense of that word, meaning a sacrifice or consumption of resources. The funds paid into the private system are not lost; they are saved for the future, and are put to productive use in the meantime, earning a return that further helps to pay for future benefits.

Therefore, what is involved in privatisation of pension system is an issue of transition financing, not transition "costs".
It is a question of how to finance the savings for the fully funded system, not how to pay a cost, which involves a permanent.

The mechanisms for paying those costs remain the same whether one attempts to prop up the existing system or shift to a new, market-based system - debt, additional revenue -

Regardless of the mechanism used to pay those costs, moving to a market-based system will always be less costly than attempting to preserve the current system.

- The case of Chile : about the transition to the new system.

Chilean government began by assuring every retired worker that the state would guarantee his pension; he had absolutely nothing to fear from the change. Pension reform should not damage those who have contributed all their lives. If that takes a constitutional amendment, so be it. Second the workers, already in the work force, who had contributed to the state system, were given the option of staying in the system even though it was thought its future was problematic.

Those who moved to the new system received what we call a "recognition bond", which acknowledges their contributions to the old system. When those workers retire, the government will cash the bonds.

New workers have to go into the new private system because the old system is bankrupt. Thus the old system will inevitably die on the day that the last person who entered that system passes away. On that day the government will have no pension system whatsoever. The private system is not a complementary system; it is a replacement that we believe is more efficient.

As Jose Pinera said at a CATO symposium of 1995, the "real transition cost" of the system is the money the government ceases to obtain from the workers, who moved to the new system, because government is committed to pay the pensions of the people already retired and of those people who will retire in the future. That transition costs can be calculated. In Chile, it was around 3 percent of gross national product.

How we financed it is another story.
It will be done differently in each country. Even though governments have enormous pension liabilities, they also have enormous assets.


To conclude, I shall say that the true French pensions problem is juridical, it is a law problem.
It mainly lies in its communist roots and in the successive Christian or social democratic policies, which never cut these roots. It lies in the 1945 communist revolution, that is, in the denial of the rule of law. Politics must derive from the rule of law and policymakers have not to build legislation or regulation on the basis of their dreams to achieve their aims, even if they are elected.

We have to restore, in France, the rule of law in the retirement area, that is, the property right, the responsibility and the freedom to contract.

We have to transform the current system in fully funded pension systems, in which people are allowed to divert their contributions to individually owned, privately invested accounts.

Such reform
- would provide people with better and more secure retirement benefits,
- would give them a greater voice in corporate management and a sense of ownership and participation in the economy, and
- would avoid painful contribution hikes or an increase in the retirement age.

How to be succeeding to reach this objective?
I shall say that we have to apply solution that Chile's authority enacted at the beginning of the 1980's.

A. - The Chilean solution is to apply

I think that, in one moment, Dr. Julio Bustamante will be speaking to us about it. According to what I could read on the reform, the Chilean solution is based upon:
- freedom of choice,
- private sector management and
- property rights in the retirement accounts.

If we apply the Chilean pension solution in France, I think there will be no transition costs because these costs do not exist. If you prefer, these costs are trifling compared to the costs we are bearing today in France, that is, the human dignity lost in the retirement area, the poor and their increasing number, the unemployment and its high level, and the lasting increase in unfunded liabilities.

In fact, I really think that the situation of the French system is near of the situation in which the Chilean pension system was at the end of the 1970's.

This result is not wondering when we know that it main dimensions are in fact next to the dimensions that the Chilean system got.

However, one seeming difference with the Chilean system could be underlined: the Chilean pension system was created in 1925 and the French one in 1945, i.e. twenty years later.

But this difference explains why, in 1999, we are in France in the situation of Chile, in 1979: we find the lag of twenty years.

So you will easily understand that I hope that the Chilean pension system reform be applied in France before three years to stay in line with Chile.

I hope that French authority does no longer forbid a private fully funded system of individual retirement accounts managed by the market process.

B. - The French pension system is not an example to adopt

Thus, what have we to think about the French pension system? It is not a social security system, although "social security" was its genuine claimed "raison d'être". Past and current problems prove it is a social insecurity system.

Given these problems, the system is not indeed an example to admire, to adopt and to try to build.

Like many national other ones, it is a bankrupt pay-as-you-go retirement system. We have to reform it.

Given the past and given the current problem, the objective of the reform must be more than just restoring the financial health of the system.

Pension system reform must improve the retirement income for low- and moderate-income workers.

It is time to allow every French family - no matter what their income level - to have the opportunity to fully participate in our economy.

So we have to adopt a fully funded pension system and to transform our current galactic system.

A last word: the history of twentieth century empirically showed what many economists, particularly the French classical liberal economists (for example, Adam Smith, Jean-Baptiste Say, Frederic Bastiat, Ludwig von Mises, Friedrich von Hayek) had logically explained, that is, coercive experiments have always problems, are always problems for people and can never last a long time.
The French pension system is a coercive experiment; it should no longer be yet lasting much time.

Appendix about the Chilean solution.

The stone of the Chilean pension reform is that benefits must be linked to contributions.
According to José Pinera:

"We decided that the minimum contributions should be 10 percent of wages. But workers may contribute up to 20 percent. The money contributed is deducted from the worker's taxable income. The money is invested by a private institution, and the returns are untaxed.
By the time a worker reaches retirement age - 65 for men, 60 for women - a sizeable sum of capital has accumulated in the account.
At retirement the worker transforms that lump sum into an annuity with an insurance company. He can shop among different insurance companies to find the plan that best suits his personal and family situation. (He pays taxes when the money is withdrawn but usually at a lower rate than he would have paid when he was working.
A worker can contribute more than 10 percent if he wants a higher pension or if he wants to retire early […]

If you want to retire at 55 […] the computer then does some calculations and says that you must contribute to 12,1 percent of your income to carry out your plan.
You then go back to your employer and instruct him to deduct the appropriate amount […]

The system is managed by competitive private companies called AFPs (from the Spanish for pension fund administrators).
Each AFP operates the equivalent of a mutual fund that invests in stocks, in bonds, and government debt.
The AFP is separate from the mutual fund; so if the AFP goes bankrupt, the assets of the mutual fund - that is, worker's investments - are not affected.
The regulatory board takes over the fund and asks the workers to change to another AFP.
Not a dime of the workers' money is touched in the process.

Workers are free to change from one AFP to another […]

The AFP market opened on May 1, 1981 […]

Today, we have 20 AFPs. In 14 years no AFP has gone bankrupt. Workers have not lost a dime.
Of course, we created a regulatory body that, along with the central bank, set some investment diversification rules." (Cato Policy Report, XVIII, 4, July/August 1995).

Critics of the Chilean system often point to
- High administrative costs,
- Lack of portfolio choice and
- The high number of transfers from one fund to another as evidence that the system is inherently flawed and inappropriate for other countries, including the United States and those in continental Europe.
For example, administrative costs are about 1 percent of assets under management, a figure similar to management costs in U.S. mutual fund industry.

By comparison, I shall remark that the administrative costs of the French basic "general" pension system (5,6 billions of francs in 1998) is about 1,6 percent of the amount of pensions, (and not of the amount of assets!)

To the extent the criticisms are valid, they may result from the same problem: excessive government regulation.

The existence of government restrictions on fees and return has probably created distortions in the optimal mix of price, quality and service individual fund manager would offer to his customers under a more liberalised regime.

As a result of those restrictions, most of the emphasis is placed on the one variable over which the manager has the most discretionary power: quality of service.

Although those restrictions could make sense at the beginning of the system in a country with little experience in the private management of long-term savings, it is clear that such regulations have become outdated and may negatively affect the future performance of the system.

Thus, in addressing the challenge of the system as it reaches adulthood, Chilean authorities should act with the same boldness and vision they exhibited 18 years ago.

They should take specific steps, for example:
- To liberalise the commission structure to allow fund managers to offer discounts and different combinations of price and quality of service, which would introduce greater price competition and possibly reduce administrative costs to the benefit of all workers;
- To let other financial institutions, such as banks or regular mutual funds, enter the industry, that would result in lower prices for the services provided;
- To further liberalise the investment rules, so that workers with different tolerances for risk can choose funds that are optimal according to their preferences;
- To let pension fund management companies manage more than one fund, that could reduce administrative costs if workers were allowed to invest in more than one fund within the same company.

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