The Promise of a Better Tomorrow: China's Pension System
September 02, 2004 | BY
clpstaff &clp articles &Pension reform in China has been high on the government's agenda for many years. Issues such as providing for an aging population and generating the institutional capital that can be reinvested in the economy will be discussed in this feature.
By Ying White, World Bank, Washington DC
In developed countries, both public and private sector pension funds are major participants in the capital markets. In the US, for example, pension assets stood at $12 trillion by year-end 2003, and accounted for 20% of stock market capitalization.1 In Japan, the combined assets of public pension reserves and employee pension insurance programmes totalled 170 trillion yen by March 2003.2 In the last few years, pension assets have accounted for over 100% of GDP in the US and around 34% in Japan.
By contrast, as of year-end 2003 China's National Social Security Fund (SSF) had only Rmb132.5 billion in assets, which is equivalent to slightly more than 1% of the country's GDP. Corporate enterprise pension funds had Rmb26 billion in assets by year-end 2002 (equivalent to 0.3% of GDP). These paltry figures come in spite of the fact that in 2000, China already had 89 million people over the age of 65, a figure accounting for almost 7% of the population. By 2030 this number is estimated to reach 150 million, or between 10-15% of the population.
World Bank studies have shown that pension reforms in developing countries, in particular, those that create privately managed pension systems, not only have a positive impact on savings, growth and welfare, but also facilitate capital market development.3 If China follows this road, its development of pension funds (both publicly and privately managed) will not only accommodate its aging population, but also facilitate the accumulation of institutional capital, increase specialization in investment decision-making processes, and promote better transparency and corporate governance. These funds could become significant long-term institutional investors in China's domestic capital market and help anchor an otherwise highly speculative and short-term oriented investment environment. Given China's WTO commitments and recent decision to allow the SSF to invest overseas, pension funds also have the potential to become significant sources of capital inflow into the global capital markets.
CHINA'S PENSION SYSTEM AT A GLANCE
China's pension system is governed by a multitude of State Council and government departmental policies and directives. China has not yet enacted a national social security law. The current pension system is differentiated between rural and urban areas. The rural system is poorly developed, and relies mostly on individual family resources, while the urban system is broadly separated into government and corporate enterprise sectors. The corporate enterprise pension system is itself subdivided into three tiers.
CHINA'S PENSION SITUATION TODAY
In rural areas, there was no formal social security system until the 1990s. Rural residents relied on traditional extended family networks for old age support. In 1991, the Ministry of Civil Affairs adopted a Basic Plan for Rural Old Age Insurance at the County Level (xian ji nong cun she hui yang lao bao xian fang an, hereafter the Basic Plan). It was an individual accounts scheme to which rural residents and collectives could contribute on a voluntary basis. The level of retirement benefit would be based upon accumulated contributions and investment gains and losses in the account. Except for a few coastal areas that implemented a modified version of the Basic Plan, the scheme was unsuccessful and coverage was small. Accumulated funds tended to be deposited in banks, and did not earn a positive real return. Nor were deposited funds insulated from abuse and embezzlement by local governments. Consequently, rural residents did not have confidence in the scheme, and continued to rely mainly on traditional family networks.
In urban areas, the current pension system differentiates between the corporate enterprise sector and the government / public institution sectors. Employees in government agencies (ji guan) and public institutions (shi ye dan wei) come under the Ministry of Personnel's jurisdiction. Their retirement system largely remains a pay-as-you-go (PAYG) defined benefit scheme supported by the state. (Please see the box on the next page for definitions of the key terms used in pension systems, including PAYG.) Retirees receive pension benefits at about 80-90% of the replacement rate, which is high by international standards and imposes a heavy burden on the state. The goal of reforms is to make this sector's pension system parallel to the one established for corporate enterprises and eventually have a unified Tier I basic old age insurance plan for all urban workers.4 In addition, ongoing reforms that aim to transform a majority of public institutions into non-profit organizations will separate them from the state sector. In the end, it is envisioned that at least public institutions will have a pension system that resembles a corporate enterprise pension system.5 Because the pension system for the government and public institutions is still in the early stages of reform, not much can yet be said about them.
Unlike that of the government sector, the corporate enterprise pension system has moved along the reform process in parallel with changes in the economy as a whole. As a result, the structure of corporate pensions is much more complex and represents the most advanced part of the present pension environment. Currently, corporate enterprise workers' pension plans fall within the jurisdiction of the Ministry of Labour and Social Security (MOLSS). Workers in corporate enterprises, either state-owned or private, participate in a three-tier pension system:
¡P Tier I: a mandatory basic old age security and national social security fund;
¡P Tier II: a voluntary employer-based supplementary pension; and
¡P Tier III: voluntary individual retirement savings.
THE PENSION SYSTEM FOR CORPORATE ENTERPRISE WORKERS
China's pre-1980s pension system was a PAYG, defined-benefit system. Enterprises were responsible for providing pensions (along with other welfare benefits) and paid as much as 80% of a retiree's pre-retirement salary. Contributions were made entirely by enterprises. Where there was a shortfall in paying the promised retirement benefits, the government made fiscal transfers to cover it. Hence the description of China as a "from cradle to grave welfare state" had an actual meaning because of the peculiarities of the corporate enterprise pension system.
As might be guessed, this system created a heavy fiscal burden on enterprises, impaired labour mobility, and retarded the reform of state-owned enterprises (SOEs). Many SOEs, faced with increasing competition from the private sector, became unable to pay their retirees promised pension benefits.6
In 1991, the State Council issued a policy document that set forth China's approach to reforming its over-burdened PAYG defined-benefit system.7 Both individuals and enterprises were required to contribute toward future retirement benefits. In 1993, the State Council formalized the system of combining social pooling with individual accounts.8 It became a hybrid scheme of defined benefit and defined contribution. In 1997, the State Council further clarified the pension reform framework by establishing a unified three-tiered pension system9 (see the chart on the next page).
Tier I: Mandatory Basic Old Age Insurance
The Tier 1 system provides basic benefits with a target wage replacement rate of 58.5% for an average pensioner. Funds come from mandatory contributions by enterprises and individuals. Within Tier I, there are two components Â
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