The Free Market 14, no. 1 (January 1996)
The sad spectacle of political stalemate in the United States suggests that Americans are stuck with our current size and scope of government—and the lackluster economy that the government’s strictures cause. Is the welfare state a tangled web from which no nation can escape?
Evidently not. Chileans and New Zealanders have shown that big government can be rolled back. By diminishing the size and scope of government, they have halted the growth of their public debt, accelerated their economic growth, and restored hope for a better future.
Since the mid-1970s the Chileans have transformed their backward welfare state into one of the world’s fastest growing economies. They reduced monetary growth, scrapped trade barriers, and privatized state-owned enterprises, lopping off two-thirds of the public sector. By cutting taxes and expenditures even more, the government has eliminated its deficit, recently running a surplus of about 2% of GDP.
Chile’s domestic saving rate has risen to more than 25% of GDP (twice the U.S. rate), allowing a correspondingly high rate of investment, which is augmented by a hefty influx of foreign investment. The economy has grown at 7% per year over the last decade (more than twice the U.S. rate).
Like us, the Chileans had a government-run, pay-as-you-go system of old-age pensions that had been shamelessly twisted and bankrupted by politicians. As demographic changes caused the number of pension recipients to rise relative to the number of taxpayers, the system’s outlays, after the late 1970s, increasingly exceeded its revenues.
In 1981, the Chileans began to privatize social security. In place of a faltering Ponzi scheme, private companies were allowed to compete to manage the retirement savings of workers, who have wide latitude in deciding how much to contribute—from 10% to 20% of wages. (U.S. workers pay 12.4% counting the employee’s and the so-called employer’s portion of the OASDI tax.)
Nine out of ten Chileans chose to enter the new system. Now workers own their own retirement accounts. At retirement they may receive a private pension or purchase a life annuity from a private insurance company. According to José Piñera, the minister who managed the privatization, “workers have not lost a dime” and pensions under the new system are 40-50% higher. Because many workers chose to put away more than the minimum, Chile’s private saving and investment have soared.
New Zealand is also instructive. After World War II the growth of government choked its progress. Extreme protectionism, high farm subsidies, huge national debt, elevated tax rates, and profligate welfare all contributed. Says John Wood, New Zealand’s ambassador to the United States, by 1984 “we were as tightly regulated, protected, and centralized as any East European country, and performing about as well.”
To reverse this disastrous course, New Zealanders in 1984 elected a new government that began sweeping reforms. It abandoned foreign exchange controls, deregulated the financial sector, and slashed tariffs by two-thirds. Farm subsidies, which had accounted for 30% of farmers’ incomes, were virtually eliminated.
By a two-step process, New Zealand sloughed off many of its state enterprises. First, firms were required to operate on a near-commercial basis and given the flexibility to do so. Second, firms were sold to private owners. Since 1987 the government has sold 21 state enterprises. Public employment has been reduced by 59% since 1984.
At Telecom New Zealand, commercialized in 1987 and privatized in 1990, employment dropped from 26,500 to 9,300. Telecom replaced its antiquated technology with a modern digital system and now competes with MCI on long distance and Bell South on cellular service. Formerly it soaked up subsidies; now it earns profits.
New Zealanders repealed restrictive labor laws and deregulated labor markets. They reformed welfare, reducing benefits. A law passed in 1989 holds the head of the central bank personally responsible for keeping the rate of inflation below 2%.
New Zealand’s economic growth rate recently has been about 5% and its inflation rate below 2%. The government deficit, which was 9% of GDP in 1984, has been eliminated, and a surplus is now anticipated. Public spending has fallen from 41% to 34% of GDP, making it about the same as the U.S., which is far too high, but, unlike the U.S., it continues downward. Unemployment has fallen from 10.9% to 6.6%.
Of course, neither Chile nor New Zealand presents a perfect example of economic reform. Neither has created a regime approximating laissez faire, nor are their recent successes guaranteed to continue without the political will to dismantle even more government programs.
Despite Chile’s far-reaching reform of social security, for example, the system remains mandatory. Further, the government restricts how companies can invest workers’ funds, requiring, for instance, that at least half be invested in government securities. And because the government still guarantees every worker a minimum pension, Chilean taxpayers continue to bear ultimate responsibility for the system’s liabilities.
But Chile’s reform of social security, now being imitated in some degree by Peru, Argentina, Colombia, and Italy, suggests that Americans might well adopt similar reforms—ideally going much farther. The key is to give workers a private property right in their investment savings and to invest the funds entirely in the private economy, where they will be genuinely productive.
Both Chile and New Zealand had fallen into desperate straits before adopting their reforms. Will conditions here have to deteriorate even more before defenders of the status quo are sufficiently discredited? Let us hope not.
Meanwhile Chile and New Zealand can serve as instructive examples of how citizens can gain by chopping away chunks of the welfare state. Even after the mire of social democracy, economic revitalization is possible.
