Consumer Behavior in Mexico’s Privatized Social Security System

1. Consumer Behavior in Mexico’s Privatized Social Security System Justine Hastings, Yale University and NBER

2. Motivation • Movement towards increased choice, privatization in traditionally publicly provided markets • Goals of harnessing market power to improve efficiency (education, healthcare, social security) • Efficiency gains depend on consumer behavior • Full-information • Frictionless market • Forward-looking, rational decision making • Look to private markets, we find that many of these assumptions fail to hold, competitive markets don’t always provide efficient solution • Competition on advertising may replace price competition if consumers focus on brand-name more than price (Dorfman and Steiner (1954), Dixit and Norman (1978), Sirri and Tufano (1998), Barber, Odean and Zheng (2005), Cronqvist (2006) and Bagwell (2007)). • Consumers may focus more on brand name or other salient features if prices or their relevance are difficult to obtain or understand (Hastings and Tejeda-Ashton (2008), Hastings and Weinstein (2008), Kling et al. (2008), Abaluck and Gruber (2009), DellaVigna (2009)) • Competitive firms may not have incentive to educate them (Ellison (2006), Gabaix and Laibson (2006)) • May rely on peers for guidance (Duflo and Saez (2003)), leading to network externalities which raise barriers to entry (Katz and Shapiro (1994)) • Switching costs can lead to suboptimal behavior, dampen price competiton (Klemperer (1995), Farrell and Klemperer (2007); Madrian and Shea (2001), Beshears et al. (2006), and Carroll et al. (2009))

3. Goals of Project • Use detailed administrative data from Mexican Social Security System to examine • How consumers decide to manage their private pension accounts • Test how switching costs, peers, advertising, government information effect account management decisions • Draw implications for price competition, government design of markets, directions for future research

4. Mexico’s Privatized Social Security Market • Privatized market in 1997, established private accounts • Market during our time period – 2004-2006 • Approved fund providers (Afores) ; 13 – 21 in operation in the market • Regulated funds (2 Siefores each; no persistent market outperformance) • Centralized administration to decrease fixed costs • Contributions of 6.5% of wage, accrues in account until retirement • Early withdrawal for unemployment insurance, expense of marriage • Affiliates can choose an Afore, switch with low cost between them • Afores charged 2 fees: flow fee and balance fee • No fee for moving accounts between Afores • Regulator published the CEF (CONSAR equivalent fee) that distilled these 2 fees into one fee statistic • Afores hire sales agents to visit/call workers to convince them to switch their account

5. Data and Empirical Approach • Data on all accounts • Employment and contributions – wages, employer id, contributions to SAR account, Afore • Switches – switches between Afores, liquidation amounts and dates • Gender, date of birth, and zip code of residence (in June 2006) • Empirical Approach • Analyze determinants of when workers switch accounts between Afores • Discrete time hazard model; logistic regression • Random utility model of Afore choice • Estimate importance of switching costs, peers, brand name and advertising, management fees • Identification • Switching costs – examine impact of exiting, entering labor force and switching jobs • Peers – construct share of each Afore at place of work. • What is the effect of Afore share on management behavior? • Examine effects of switching jobs to place where your Afore is in the minority • Fees (flow and balance) • Regulatory changes in tenure discounts • Variation in costs across people and within people as employment status changes • Fee changes conditional on Afore fixed-effects; entry of new Afores • CEF • Changes in assumptions that are used to calculate CEF • Advertising • Sales force exposure; control function approach to identify effect off of factors that shift costs of sales force but not demand for Afores (Rivers & Vuong (1998), Villas-Boas (1999), Petrin and Train (2006))

6. Specific Findings • Timing of account switching: • Overall, people do little to manage their accounts, switching only once every 5-6 years on average. • Switching costs are very important: • Entering period for filing for Unemployment Insurance increases probability of switching by 370% • Salience is very important: • Exiting the formal sector decreases probability of switching by 82-86% • Peers/employers are very important for lower-income workers • Changing job to an employer where current Afore is less popular has same impact as direct marketing exposure • Changes in prices are relatively ineffective in moving demand forward in time • Implies price cuts are not profitable except for smallest firms

7. Specific Findings • Timing of account switching: (discrete-time hazard model) • Overall, people do little to manage their accounts, switching only once every 5-6 years on average. • Workers switch very infrequently; increasing in income • Lowest wage earners, 0.002; Highest wage earners, 0.0215 • Switching costs are very important: • Entering period for filing for Unemployment Insurance increases probability of switching by 370% • Salience is very important: • Exiting the formal sector decreases probability of switching by 82-86% • Peers/employers are very important for lower-income workers • Changing job to an employer where current Afore is less popular has same impact as direct marketing exposure • Changes in prices are relatively ineffective in moving demand forward in time • Implies price cuts are not profitable except for smallest firms

8. Specific Findings • What determines Afore choice: (random utility model) • Pessimistic findings: demand is price inelastic • Less elastic to harder-to-determine actual cost • More elastic to government sponsored measure of fees • Both are increasing in income; but not by much • Low income workers focus on peers, brand name • High income workers more likely to chase past returns (even though Afores do not display persistent market outperformance) • Optimistic findings • Investors are responsive to advertising; particularly among low income workers • Requirements that switching accounts sign that they have viewed CEF table has positive impact on elasticity w.r.t. CEF – increases sensitivity by 20% • Sales agents decrease dependence on peers • However, advertising also increases responsiveness to 12 months past returns • Suggests that • Regulation on information; marketing can improve price sensitivity at time of choice • Coordinating market, designing accounts with periodic immediate usefulness of savings can increase demand elasticity over time.

9. Concluding thoughts; future research • Consumer behavior mitigates price competition in private accounts market • Inattention to accounts with subscription good market • Consumers are not price sensitive; behave as if information costs are high generating network effects and competition on advertising • Absent threat of regulation, prices would have been higher • Suggests that market design and marketing can have big benefits • Coordinating demand side, allowing for early contact with account can increase demand elasticity significantly • Lowering switching costs may also have an impact • Information framing and government provision of information may really move demand • Hastings & Tejeda-Ashton (2008) • Field experiments in Mexico and Chile • Moving part of the market towards price elasticity may have large equilibrium effects