Learn Chinese: Chinesepod - China goes from red to gray

CHINA / Foreign Media on China

China goes from red to gray
By Robert C. Pozen (FORTUNE Magazine)
Updated: 2006-06-14 08:59

An aging population, an underfunded pension system, and half-a-billion
workers who aren't covered could be a drag on economic growth.

If you thought the U.S. had a looming pension crisis, consider the
situation in China, where the population is growing older at an even
faster pace and more than half-a-billion rural and urban workers don't
participate in state-run social security schemes.

Because China generally limits each family to one child, the percentage
of its population that is working will peak by 2010 and the ratio of
workers to retirees will decline dramatically, from six to one in 2000 to
two to one in 2040.

But China has not had time to build up enough assets in public or private
plans to finance retirement benefits. And it is saddled with unfunded
pensions from the pre-reform era, when industrial workers enjoyed a
cradle-to-grave security system.

As China began to restructure its state-owned enterprises in the 1990s,
millions of employees were laid off and allowed to retire early. The
responsibility for paying these so-called legacy pension benefits was
left to the 31 provinces.

China's implicit pension debt is now some $1.5 trillion, according to the
latest estimates by the World Bank, including all legacy pensions as well
as accrued obligations under China's more market-oriented pension system
for urban workers adopted in 1997. Under that system, employers pay about
20% of wages toward a guaranteed schedule of benefits and employees
contribute 8% of wages into personal accounts that are supposed to be
invested in government bonds and bank deposits. The normal retirement age
is 60 for men and between 50 and 55 for women.

But most of those payroll taxes have not gone to fund the new pension
system. Instead, they were often "borrowed" by the provinces to pay the
legacy benefits due retired workers from the pre-reform era. This
borrowing of payroll taxes is particularly troublesome for the 8% of
wages contributed by employees to personal accounts.

Imagine what would happen if millions of Chinese workers found that their
personal accounts contain no actual assets, only notional credits entries
in a ledger based on a bank-deposit rate.

To help the provinces meet these legacy obligations, the central
government created the National Social Security Fund in 2000. This fund
receives monies from state-run lotteries as well as 10% of the proceeds
of initial public offerings of state-owned companies listed overseas.

The fund has also financed pilot programs to help provincial governments
put actual assets, rather than notional credits, into personal accounts.
But even in these pilot programs the personal accounts have been only
partially funded. And the total assets of the fund are less than $30
billion.

So what can be done?

First, the government should finance all legacy benefits out of general
tax revenues on a pay-as-you-go basis. Paying these legacy benefits is
part of the national cost of transitioning from a socialist to a
market-based economy, and China can afford these transition costs given
its high rate of economic growth.

Second, Beijing should take over the administration of the new pension
system from the provinces. With 31 provinces, the pension system is a
maze of disparate rules. It would be more efficient and effective if
payroll taxes were collected by a national agency devoted to this task.
If pension benefits were calculated and distributed by one national
agency, taking into account regional income differences, that would
increase the portability of benefits, so workers could move easily from
one province to another.

Third, the Chinese government should continue to develop other pension
vehicles to help those workers with insufficient or no retirement
benefits. The level of monthly pension payments is modest, especially in
light of rapidly rising standards of living in many parts of China.

To augment these benefits, Chinese firms have recently been allowed to
offer their employees enterprise annuities similar to
defined-contribution plans in the U.S.?in which workers choose payroll
deductions during their careers and receive benefit payments at
retirement. But few such enterprise annuities have been offered because
regulatory and tax rules have yet to be clarified.

In contrast to the limited distribution of enterprise annuities, sales of
life insurance products have been growing rapidly in China, where savings
rates are much higher than in the U.S.

These products are often bought by Chinese families outside the
government pension system. In rural areas, for example, many farmers buy
insurance products in lieu of participating in the government's voluntary
social security schemes.

In urban areas, some state-owned companies have bought group pension
insurance to supplement the modest benefits from the government's
mandatory pension system. If all these types of retirement programs were
better funded and invested, they could be important factors in deepening
China's capital markets. In turn, better capital markets would increase
the returns to Chinese retirement programs.

The National Social Security Fund, which has earned slightly more than 3%
per year, has the potential to become a major institutional investor,
monitoring the performance of Chinese public companies.

But even with higher returns, the pension gap in China is not likely to
be fully closed. As the number of workers per retiree declines, normal
retirement age should be moved back in China, especially for women, who
have a life expectancy of 74, compared with 71 for men.

In short, China must grow rich before it grows too old. While the Chinese
government has introduced some programs to meet this challenge, it is not
yet clear whether they will provide adequate retirement benefits to most
Chinese workers.

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