Wednesday, May 20, 2009

China Needs Bold Retirement Policy Reform

China's current retirement schemes are provided to only a distinct minority of workers, have limited portability, are mostly unfunded and deliver an inadequate benefit at retirement. To meet the challenge of an aging society, in which the elderly will constitute 24 percent of the population by 2030, China needs to start over with a new system that is universal and provides a better benefit at a lower payroll cost, according to economist Richard Jackson and fellow researchers at the Center for Strategic and International Studies.

By Robert Stowe England

May 20, 2009

"China needs to develop a [retirement] reform strategy every bit as bold as the demographic challenge about to overcome it," according to Richard Jackson, program director and senior fellow of the Global Aging Initiative at the Center for Strategic and International Studies (CSIS) in Washington, D.C.

Jackson offered his own bold proposal for reform at a policy forum yesterday (May 19) at CSIS.

The demographic challenge for China is "premature aging," Jackson said, meaning that China will grow old as a society before it has grown rich and, thus, will have a more difficult challenge in providing retirement income for an expected 24 percent of the population that will be elderly by 2030, just over 20 years from today. By 2050, people over age 60 will constitute 33 percent of the population.

The population shift is a result of efforts by authorities since the 1960s to dramatically reduce the bith rate, an effort that culminated with the declaration of the draconian one-child policy in 1980.

The current urban retirement system evolved from a series of reforms of the generous old enterprise-based system for state-owned enterprises (SOE) that before the mid-1990s provided a benefit of 80 percent of average local wages, which were quite low by today's standards. There is now a basic pension or first tier funded by a pay-as-you-go payroll tax of 20 percent and a second tier of personal accounts administered as a collective pool that is funded by an 8 percent required employee contribution.

Only about 31 percent of China's workforce "is earning a pension benefit of any kind," Jackson said. This is because the pension system is largely confined to the 37 percent of the population that lives in urban areas, while the 54 percent rural population is virtually uncovered by any retirement benefit and its elderly rely on their sons to take care of them, he said.

The current system is costly, amounting to 28 percent of payroll, because it includes legacy costs of laid-off workers in restructured industries, according to Jackson. Further, it is going to provide an inadequate benefit at a 35 to 40 percent replacement rate for the worker's average earnings, he noted. This is far lower than the 60 percent claimed by the central government.

The second tier of the current system also has another and perhaps more severe problem. Many of the accounts are mostly empty, even though funds have flowed from employees and employers into the accounts for many years now. The problem is that local and provincial governments that manage the decentralized social security system have been taking the funds in the second tier to pay out benefits in the first tier to current retirees.

The central government has been gradually funding the shortfalls in the personal accounts system from general revenues.

A detailed analysis of the current system and recommendations for reform are contained in a monograph China's Long March to Retirement Reform, written by Jackson and CSIS colleagues Keisuke Nakashima and Neil Howe.

Jackson told the forum that providing a much better benefit for the entire population of China would require that the government fund a new basic benefit from general revenues and take over the considerable unfunded liabilities of the current system.

By starting over with a new system for all workers, China will be able to provide a universal, portable and more adequate retirement benefit. The basic components would be as follows:

  • The new zero tier or social pension would be jointly funded from general revenues by the central government and the provinces and would provide a benefit equal to 20 percent of the local average wages.

  • The new, funded second tier of personal accounts would require an 18 percent mandatory payroll contribution rate. The projected benefit for the personal accounts system would be 50 percent of local average wages. (From the 18 percent payroll contribution, 16 percent will go to personal accounts and 2 percent for disability and young survivors benefits.)

The expected higher benefit also assumes that the contributions earn a market rate of return. In the existing system personal accounts earn a mandated rate of return that is extremely low.

By pre-funding its retirement system, China will have to spend less overall to meet benefit obligations and, thus, mitigate the drag on the economy that will come with the aging of the population, Jackson said.

The balances in the personal accounts will be personally owned and privately managed and invested. The system, however, would remain a public social insurance program regulated and supervised by the government.

The funded system will also help broaden and deepen China's capital markets and help assure the vast Asian nation will have sufficient capital for its needs at a time 25 years from now when some economists are predicting that China will have a capital shortage, according to Jackson.

The complete background report, with the proposed retirement reform, can be downloaded in pdf form at this link:
http://www.csis.org/component/option,com_csis_pubs/task,view/id,5419/type,0/

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