PensionReforms' summary and comments

China's most recent major reforms to state pensions happened in 1997 and 2000.  For many reasons, its attempt to move from PAYG, Defined Benefit pensions to compulsory (Tier 2) Defined Contribution replacements does not seem to be working well.  PensionReforms has looked as different reports on that here, here, here, and here.  There is even an experiment to solve the problem at a provincial level - see here.

PensionReforms thinks the position is not a lot better in Latin America - see here for a region-wide view of the problems.

This report looks at both China and Latin America to see what lessons we might learn from their experience.

"In many respects the reforms in China have not been working out as had been intended.  The major problems faced by the old-age pension reform in Latin America appear again in the newly introduced reforms in China.  These problems include low coverage and compliance rates, poor transparency, and serious fiscal difficulties."

The report focuses on cultural and economic influences that bear on the success or otherwise of the reforms:
"Differences acknowledged, our analysis emphasizes the major cultural and economic factors shared by the countries analyzed.  We argue that the eight selected Latin American countries and China are strong traditional cultures and low-income economies characterized by the centrality of: (1) the family, (2) reciprocal relationships, (3) rules of loyalty, and (4) poverty.  Our analysis highlights the role of these factors in shaping the unfolding of the pension reform process with respect to four areas: (1) coverage, (2) compliance, (3) transparency, and (4) fiscal stability.  The role of the cultural and economic factors considered in this article has been largely overlooked in the literature on pension reform.  Much of this literature focuses on political factors, such as the welfare state, communism, and the World Bank policies..."

The report also uses aspects of more affluent Western countries' experiences to contrast the environments in China and Latin America.

The report suggests that China and Latin America are characterised by the "..context of a traditional culture and low income economy."  The "modernization pathway" that suited richer countries apparently doesn't have the same fit for China and Latin America.  A key difference is the "deeply rationalized culture" of the West - that "everything is explained by reason" and with a "greater reliance on means-ends calculations designed to organize activity so as to more efficiently reach a particular goal."  A "strong and uncorrupt formal legal system" is a sign of such an environment.

By contrast, more traditional practices (including their prevailing religions)are at the foundation of social organisation in both China and Latin America. 

The economic status of the two regions is also clearly different - China and Latin America both face the higher costs of ageing populations before reaching the higher national incomes enjoyed in the West.  The West's Protestantism apparently seems better suited to development than Confucianism in China or "Marianism" (the Catholics' adoration of the Virgin Mary) in Latin America.  That seemingly explains, in part, why the two regions are where they are.

Both China and Latin America are now trying to change, not because their beliefs have changed but because of a perceived need to catch up with the West.

The outcomes of the pensions reform in both China and Latin America are:
-  Low coverage - about 26% in China and that is apparently not going to "substantially increase any time soon".  Families will continue to be the mainstay of support for the elderly in both regions.

-  "Low compliance and low contribution densities" - compliance rates seem now to be falling in Latin America.  Apparently workers in rural areas, low income earners and those in the 'informal' sector prefer other forms of saving like housing and educating children.  And they need money to live now rather than support their future retirements.

-  Poor transparency - even direct theft and corruption that engenders distrust.  Moving from a family-based system of support to a more institutional Western-style framework apparently raises the risk of corruption.

-   Pervasive fiscal problems as moving to pre-funded systems makes pensions more expensive in the transition.  In China, this has resulted in workers having "empty" accounts as authorities used their money to pay for current pensioners.  These can now be apparently classified as Notional Defined Contribution - many accounts certainly have no money in them.  As the report says:

"The discrepancy between the formal structure of the program and what is actually going on must be contributing to mistrust of the government and to a lack of confidence in the pension system. It must also be reducing the incentive to contribute and increasing the incentive to evade paying into the scheme."

The report's conclusion?

"Low-income countries face difficulties as they try to balance the aims of fostering economic growth and poverty reduction as they reform their pension schemes. It is generally assumed that the main objective for an old-age pension system is to provide at least some financial security for the elderly. In those countries with many elderly in or at risk of poverty, the need for income redistribution becomes particularly salient. Minimum and non-contributive pensions can be used to help with redistribution and poverty reduction, but they do not maximize the equivalence principle and do increase the cost of the system."

PensionReforms suggests that if both China and Latin America focussed on addressing directly the problem of poverty in old age for everyone, not just former workers, they might see available resources applied where they are most needed.  Pension-related problems are exacerbated by transparency and fiscal problems but they don't cause them - cultural differences do not explain theft or corruption.  Compulsory Tier 2 solutions simply aren't working in most of Latin America and scarcely at all in China.  In China's case, an average 26% coverage 8-11 years after the major reforms suggests that compulsion should be dropped in favour of direct transfers from taxpayers to the elderly.

The report suggests some fundamental cultural issues that have apparently got in the way of the reforms' success in China particularly but also in Latin America.  In PensionReforms' view, that's another reason for ditching the reforms.  But the more important reason is that the reforms seem not to be working.  "Equivalence" might be an issue but poverty today is more important.  Whether a country can 'afford' to solve the poverty issue is simply a matter of priorities.  (File size 769 KB)  245