Guest post: Bruno Bonizzi, Jennifer Churchill and Diego Guevara
In early spring 2020 emerging economies (EEs) were hit by the largest ever episode of portfolio outflows. Stock and bonds were sold as investors fled to safer investments in Europe and the United States, showing once again the fragile nature of EEs’ financial integration. To overcome this problem, one suggested solution is to allow for a larger base of domestic institutional investors, such as pension funds, which can stabilise financial markets. While having a large institutional investor base can be a source of demand for domestic financial securities, it is important to review the evidence from the experience of those EEs where pension funds have existed for more than two decades.
As we show in our forthcoming article, the experience of Colombia and Peru can be instructive. Their pension system, while maintaining a significant parallel public Pay-As-You-Go structure, has a sizeable funded private component with assets that have grown to over 20% of GDP. These were established as part of the Washington Consensus reforms in the 1990s, following the prior example of Chile.
However, more than two decades since the creation of private pension funds, capital markets in the two countries, as in the rest of Latin America, remain small and underdeveloped. It is perhaps for this reason that the experience of pension funds in Latin America remains under-researched by financialisation scholarship. However, recent literature has put forward the idea that financialisation patterns, while having common tendencies, can present “variegated” forms. Pension funds play a role in this process by exerting an important role in shaping the demand for financial assets, even if this does not occur, as in typical “Liberal Market Economies” by fuelling domestic capital markets.
Some key characteristics of Colombia and Peru’s political economy have acted as the distinct determinants of pension fund demand for assets, shaping a specific form of financialisation. Firstly, pension funds in these countries reflect the characteristics of Hierarchical Market Economies, the Latin American variety of capitalism. Workers and unions have very limited control over how pension fund assets are invested, as pension funds are provided by private companies as pure individual retirement accounts. Investment policy is therefore heavily shaped by the interest of the financial industry, which was also key in promoting their establishment and in shaping their regulation since.
But next to these considerations, pension fund asset demand in Colombia and Peru has been structurally constrained by the limited by limited effective space in domestic capital markets. These two countries have a highly “extraverted” growth regime, where commodity exports play a key role in determining aggregate demand. As a result of the 2000-2014 commodity price boom, companies had substantial financing coming from export proceeds and foreign direct investment, therefore limiting their issuance of securities in domestic capital markets. Governments too limited their net borrowing during this period, thanks to booming revenues and limited increases in public spending. Additionally, the countries have attracted considerable interest by foreign financial investors, whose weight in domestic bond and stock markets increased. These characteristics reflect the status of Colombia and Peru of as subordinate emerging economies in global financial markets.
Pension funds in Colombia and Peru have looked for other investments. Supported once again by the domestic and international financial industry, these have been found in “alternative assets”, most typically private equity, infrastructure and real-estate funds, as well as in foreign investment, which now account for more than a third and more than 40% of total assets in Colombia and Peru respectively. The latter have been important in stimulating a derivative market to hedge foreign currency positions, mostly vis-á-vis US dollars.
Therefore, pension funds have been important in shaping the financialisation trajectory in these two countries, despite the limited development of domestic capital markets. This can serve as an important lesson to calls for the promotion of private pensions to stabilise capital markets. In emerging economies subject to subordinate forms of economic and financial integration, and where the interests represented are those of a highly concentrated financial industry, pension funds may fail to act as catalysts for deep, liquid and stable domestic capital markets. They may instead contribute to finance privatised forms of infrastructure and real estate and reinforce the hierarchies of global finance.