PensionReforms' summary and comments

China is in the process of unstitching its social and economic fabric.  China's size and population shape mean that, as the paper points out, one quarter of all the world's people who will be over the age of 60 in 2025 will live there.  If ageing OECD countries thought they had a pensions problem, nothing can really touch China for size and scope.  PensionReforms allows itself slightly more space than usual to consider the China Case in this 100th abstract.

"The challenges of population aging and rising dependency ratios are in part the result of increased life expectancy, but the major factor has been the rapid decline in fertility, due, in large part, to China's strict one-child policy instituted in the mid 1970s.  In the future, many Chinese couples will face the task of caring for four elderly parents as well as some grandparents.  These changes in family structure and the increase in rural-urban migration due to uneven rates of economic growth are two of the factors contributing to a breakdown of the traditional family support system, which remains the major source of old-age support."

The ageing problem is compounded by the economic transformation.  Inefficient State-owned Enterprises (SOEs) retain their pensions baggage while privately-owned employers tend to provide less generous benefits and are also less subject to political influence.  As many as 9% of China's workers could be unemployed.

China's system of retirement pensions has been through a number of phases that started at the employer level, moved to a national arrangement then to municipal pools (in the mid 1980s).  All failed to meet the problems created by geographic and economic diversity and by inadequate enforcement at either a central or local level.  The final (current) change was to implement a 'two pillar plan' in 1997.

This saw pensions moved from beyond SOEs to 'Town and Village Enterprises' (TVEs).

"The contribution rate for the two pillars (which varied by municipality) was set at no more than 20% of the wage bill for employers with an additional 4% contribution by workers. The first pillar was a pay-as-you-go defined benefit (PAYGO DB) scheme based on social pooling and was originally intended to be completely funded by 13% of the 20% total contribution from the enterprises. The remaining enterprise contribution (7%) was to go into the second pillar comprised of employees' individual accounts."  The workers' contribution (4%, increasing to 8% by 2002) was to go directly into employees' individual accounts and was aimed at enhancing transparency of worker contributions. In 2000, in State Council Document No. 42, the 1997 two-pillar model was revised to formally separate the funding of the two pillars and alleviate corruption problems that seemed to be the result of the mixed funding of the two pillars."

The trouble is that the new system has been patchily introduced, if at all. The transition from the previous arrangements was not thought through. PensionReforms agrees that ". transition funding, that is, paying the pensions of those already retired, during the transition years, remains one of the most difficult problems associated with a pension reform that calls for the introduction of an FDC [funded defined contribution] pillar."

The new arrangements are bedevilled by  'funding shortage', non-compliance, and wide-spread evasion.  According to the paper, "many accounts [are] empty due to diverted funds but, in most municipalities, most of the workers are not contributing the full 8%."  Even the 'National Security Fund', started in 2000 to deliver emergency subsidies to municipal pension pools, seems inadequate to the task.

As if all this were not enough, the benefit design seems flawed with inadequate thought having been given to how the annuity rules apply (or even work) for the emerging benefits.  Financial markets seem ill-equipped to run the investments with wide-spread evasion, inappropriate investments and an inability to invest outside China.

"Chinese policymakers have the difficult task of balancing the reform of an unsustainable enterprise based pay-as-you-go defined benefit (PAYGO DB) pension program while maintaining political stability and assuring that the economy does not falter. China's shift to a multi-pillar pension scheme in the late 1990s represents a serious effort to bring about much needed pension reform, but the new scheme has been plagued by problems."

"Our answer has been that partial privatization, at least in the long run, might well have a number of benefits for the overall economy, but there would also be substantial offsetting costs to many individual workers along the way. In particular, partial privatization represents a shift away from the logic of social insurance with its focus on shared risk, collective provision, and protection against various sources of income insecurity in a way that typically provides substantial income redistribution favoring low-wage workers.. In the case of China it is very likely that the most vulnerable (including recent immigrants from the countryside, unmarried women, low-wage workers, and those who have had irregular work histories due to mental health and other problems) are going to be put at the greatest risk and the most affluent workers are most likely to benefit. The scheme is going to be much less redistributive than the scheme it is replacing. This is a particularly serious problem for a nation with so many expected to be living at the economic margins during their retirement years."

The paper suggests that "economic globalization" has been a significant influence in the changes to the pension system.  Outside investors apparently need to be convinced that China has a proper system of property rights that are protected under a "market oriented economy."  Then there are the economists at the World Bank who have been influential.

"Given current demographic trends, the rapid rate of economic growth, the huge demand for investment capital, the central government's very limited capacity to extract payroll tax revenues from workers, and the strong support among policy elites for economic policy based on neoliberal ideology, which seems in large part to be derived from and reinforced by policy experts from organizations such as the World Bank and the International Monetary Fund, it is not at all surprising that China has decided to partially privatize its public pension system.  But have they made a decision that is going to benefit China's most vulnerable urban workers?  For a number of reasons including the volatility of Chinese financial markets and the associated risk of inadequate pension benefits for low-wage workers, the current move to partially privatize the public pension system is, in our view, not a wise decision, particularly at this point in time."

The paper discusses the options that China could look at including basing "the entire Chinese social security system on the PAYGO DB model" and drop[ping] the supposedly  " 'funded' individual accounts pillar that to date has been unfunded for most workers."  That option seems not to be on the agenda. PensionReforms thinks that's a pity.

Then there is the "provident fund model", such as in Singapore and other (formerly British colonial) countries.  They do not have a great track record.

A notional defined contribution model (NDC) is a third possibility (see here for more on this). The paper suggests that these have been introduced "with some success" in a number of countries.  

PensionReforms doesn't understand how the current arrangements could be characterised as a "step in the right direction".  The paper itself notes that "The pension system has also been plagued by excessive fragmentation and corruption, leaving it with little public credibility."  That doesn't sound much like progress.

However, PensionReforms agrees with the broad conclusions of this paper though we suggest that it might have been helpful to avoid the labels of "isms" and "ists".  Whether China has been helped or hindered by "neoliberalism"; by "neo-institutionalists" or by "world culture theorists" seems less important than whether or not compulsory, Tier 2 pensions are suitable for China at this time.  The gathering evidence seems to be that they are not, particularly in a country where the economic and social fabric is being radically refashioned and where property rights seem in their infancy.

Faced with the alternatives described, PensionReforms suggests that China has no real choice.  It hasn't done the World Bank's model properly and, even if it could make it work, PensionReforms agrees that a compulsory Tier 2 pension scheme will fail to address most of the reasons for the state's intervention in pensions.

The government itself seems, in China, to be the only body that is able to credibly promise anything on pensions. The answer can only be some kind of return to a PAYGO DB basic, flat-rate Tier 1 that is more flexible, more effective in meeting coverage and anti-poverty goals and that can be structured to take account of the different conditions that apply in different provinces. Tier 2 arrangements can evolve as capital markets develop but that is not a precondition for their development. While China does not yet have to worry about old voters, it will eventually have to answer to workers who struggle with the financial burden of ageing parents. So it was a good idea to reform the unsustainable social security arrangement.

But to minimise the inevitable and perhaps unbearable strains on China's economic and social fabric, more thinking needs to be done. For private saving and investment accounts to perform their expected goal of providing retirement income, it is paramount that legal and financial institutions are well established to safeguard and protect the wealth that is accumulated over long periods of time.  It is also essential that the savers and investors have enough income from steady sources, as well as the psychological willingness and financial literacy to save and invest.  China still seems to have some way to go before those conditions might be satisfied.   100