Guest Lecture Econ 1101 The Market of Pension Fund Administrators in Peru

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Guest Lecture Econ 1101The Market of Pension
Fund Administrators in Peru
Presented by Manuel Macera
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Plan for this lecture

• Introduction
• Some preliminary concepts
• A description of the market
• The case
• The market in Peru
• Collusion among firms?
• Conclusions

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
1. Introduction
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Some Preliminary Concepts
What is the purpose of a Pension System?

• A pension system has as its main purpose to
  guarantee a source of income for the workers when
  they retire.
  
• People contribute while they are working and they
  receive a benefit later.
  
• Contributions are mandatory

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Some Preliminary Concepts
There are two ways of doing this

• Pay as you go system
• The benefit received by the retired worker comes
  from contributions of current workers
  
• Funded System
• The benefit received by the retired worker comes
  from contributions made by himself during his
  working years

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Some Preliminary Concepts
What are the main differences?
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
A Description of the Market

• In most Latin American countries, the firms in
  charge of collecting workers contributions have
  been named Pension Fund Administrators, or just
  AFPs (Administradoras de Fondos de Pensiones)?

• The creation of these firms gave birth to a new
  market The market of Pension Fund Administrators.

• Question 1 Suppose that the prevailing system is
  a Pay as you go system. Is there a market in
  place?

• Question 2 Suppose that the prevailing system is
  a Funded system. Is there a market in place?

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
A Description of the Market
We do have a market. A very particular one.
3. Who are the consumers?
1. What is being traded?
Financial services. Not Goods!
Workers
4. Who are the suppliers?
2. What is the price charged?
A percentage over workers wages
AFPs
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
A Description of the Market
Example of a transaction

• You work and earn 1000 US monthly. Since you are
  in the labor market, you are obliged to
  contribute to the Pension System.

• There are 4 firms in the market, each of which
  ask you for choosing it as your AFP. Suppose you
  chose one of them based on its financial return
  over the last year.

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
A Description of the Market
Example of a transaction

• You made your choice and go with AFP 1. By law,
  8 of your wage is deposited in your individual
  account. On the top of that, the AFP charges you
  a fee for collecting that money and
  administrating it. Lets say 2.

Still your money!
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
2. The Case
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
The market in Peru

• AFPs were created in Peru in 1993 and they were
  supposed to coexist with the financially broken
  Public System

• Policy makers had in their mind a gradual
  migration of people from public to private.

• They assumed that Funded System would be more
  attractive as they would offer a market return
  for workers contributions

• They also assumed that firms somewhat would
  compete through prices.

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
The market in Peru
Competition through prices
What would happen then?

• Simplify things. This would lead to Marginal Cost
  Pricing. So if the expectations about the market
  performance were correct we must end up very
  close to the competitive market outcome (Point B).

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
The market in Peru
Competition through prices
What really happened?

• People observed high prices (fees), high markups.
  Some started to suggest that the market outcome
  was very close to be monopolistic.

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Collusion among firms?
How can we explain this outcome?
People took a look to the number of firms in the
market
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Collusion among firms?

• Being so few, firms could ask themselves why to
  compete. They are better off by not doing so.

• Splitting the monopolistic pie is better than
  competing.

• We can think of the following game for two firms
  that consider to constitute a cartel

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Collusion among firms?

• If this game is played once, any firm is better
  by deviating.

• If this game is played repeatedly

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Collusion among firms?

• Firms can agree in a policy of high fees. The
  most beneficial outcome would be sustained in the
  long run

• Collusion is illegal!

• But was there an explicit agreement on pricing
  policy?

• Besides Is it so easy to collude?

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Collusion among firms?
Economists in general argue that some conditions
are necessary

• Similarity among firms. (costs)?
• Easy detection of deviating behavior (so
  retaliation is possible)?
  
• Huge firms (scale economies, credible threats)?
• Highly concentrated market.
• Long horizon operation

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
The defense
Expensive? In comparison to what?

• Firms realized that their fees were said to be
  high in comparison with other countries. They
  argued that the reason for that was the size of
  the market. Average cost will remain high as long
  as the number of potential contributors is small.

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
The defense
Competition? It is not my fault there are design
flaws

• Was this so surprising about having an homogenous
  product? In fact, all the firms seemed to have
  the same investment strategy! No difference
  between investment policies. Whose fault is
  that?
• Firms can not discriminate among workers
  according to wages.
  
• They must ensure a minimum return.
  Differentiating implied a risk which is in some
  sense penalized!
  
• They must invest inside the country. Not too many
  options

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
The defense
But most importantly

• Is there any proof?

Any video? Any recorded conversation? Any do
cument?

• Believe it or not, that is what one needs.

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The Market of Pension Fund Administrators in Peru
3. Summary and Lessons
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
About collusive behavior

• So I presented a case of an industry were firms
  were supposed to be colluding.

• Most people seemed to agree that this was exactly
  what was happening. But is never so easy to prove
  it.

• Although, they tried to support their claim using
  economic reasoning. What firms did?

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
About collusive behavior

• Firms used economic reasoning as well, but for
  their own interest.

• Sometimes collusive behavior can be implicit!
  That is, there is no way of finding evidence of
  collusion because there is none!

• What to do then?

• Foster competition! Can it be done?

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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Increasing competition
Suggestion 1 They allowed the firms to offer mo
re than one option. Risky, less risky, non risky.
Loosen some investment limits.
This comes from the necessity of differentiating
the service provided.
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
Increasing competition
Suggestion 2 Lets work on licenses of
operation. The monopolistic outcome is sustain
ed if the game is played repeatedly. For how long?
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ECON 1101 Guest Lecture
The Market of Pension Fund Administrators in Peru
The End