Abstract: China’s public pension system faces a huge funding shortfall, which is expected to be filled by the private pension scheme. However, for the new scheme to work, the government must provide the public sufficient information to make rational decisions for their future, and more importantly, introduce incentives that account for generational and other differences. Noting the challenges ahead, the author stressed the urgency of pension system reforms and called for permanent solutions rather than temporary fixes.
In recent years, the CPC Central Committee and the State Council have attached great attention to the pension system and pushed forward reforms with new measures rolled out and developments seen, especially the introduction of the private pension scheme, posing a lot of new questions to discuss.
The private pension scheme has caused lots of attention from research institutions and has seen research from various perspectives, e.g., a financial perspective or policy regime. Based on the existing discussions and research, I would like to share some of my preliminary thoughts.
I will start with the policy design and may touch upon management details if time allows.
First, despite some progress made under the private pension scheme, the scheme is still short of stronger incentives.
While discussing incentives, let me first introduce a rational assumption: the incentive is primarily geared toward people who have not retired yet and will make a rational estimate of their lifetime finances based on available data and policies. Then we can find out the scale of the state pension pool. Are there gaps between the two? Can private pension accumulation solve the shortfall? Of course, an adequate rational estimate may not be achieved due to future uncertainties. When I say rational estimation, I mean people make a rough measurement to guide their decisions and adjust to the private pension scheme newly designed as part of the state institutional arrangement.
One reality in China is that it has a large population, and simultaneously the scope of pension coverage continues to expand. In general, due to population aging, pension pools are prone to shortfalls. In this case, a national pension would be a basic arrangement and won’t be of a very high level. In other words, larger pension gaps must be supplemented by private pensions.
So there comes the need to enable the public to better understand about the current reality. Suppose the basic realities are not clearly explained to future retirees. In that case, they will take it for granted, under the inertia of the past system, that the government will take care of them after retirement anyway, so why bother with personal pre-funding? Enterprises will feel the same as well. Why bother with this for employees? Therefore, it is crucial to clarify the current realities to allow future retirees to conduct a rational measurement.
The LFS (Lifetime Financial Security) concept proposed internationally is one basis for rational estimation. According to this concept, income level after retirement is about 70% or 80% of pre-retirement income under different life expectancies. We are still not doing enough in terms of public communication about the conditions that would affect their estimation; the current incentives are still flawed.
Existing discussions show that the newly introduced private pension system is fine, but incentives are weak. There are two issues to discuss here.
First, the existing personal income tax system remains flawed as too large a share of wealth not being required to pay for personal income tax. This needs to change, though it will require long-time efforts. The vast majority of the population needs to pay taxes. Still, improvements need to be made to take into account factors such as taxpayers’ family structure, supporting burden and pensions, and tax deductions or refunds can be applied.
Second, the incentive mechanism was overlooked. In many countries, the private pension plan consists of both individual and corporate contributions of the same share. For example, when individuals contribute by 8%, employers contribute another 8%. From the employees’ point of view, people feel motivated as their 8% contribution can double instantly.
From the enterprises’ perspective, there is still much to discuss. In principle, the wool always comes off the sheep's back. It is not the case that the business owner or employer pays the employee with money out of their pocket for the employee’s personal pension pre-funding, but rather an institutional arrangement that can produce incentives.
Why doesn’t this incentive mechanism work in China? It is largely because the social security contributions paid by enterprises have been used under the pay-as-you-go scheme. This is related to the fund gap due to institutional reform. The contributions paid by Chinese enterprises account for as high as 16%;several years ago, the share was 20%. Since the 20% contribution added too much pressure to business costs and undermined their competitiveness, the rate was later lowered by four percentage points to 16%, which is still quite a high level.
We will discuss later whether it is possible to use this measure to make private pension accounts much more attractive.
We should consider the gap between the practical conditions and the rationality assumption, just like many other discussions on economic issues. At the very beginning, I mentioned that, in theory, there is a perfect market, but in reality, we need to consider some market peculiarities.
There are three major differences between the actual conditions and the rationality assumption:
First, group differences. In China, group differences are more prominent than in other economies. Since the adoption of the pension system, government agencies and public institutions have belonged to one category, while state-owned enterprises have fallen into another category, with a differentiation between large groups and small groups. Later, there is another different arrangement for private enterprises.
China has a considerable number of farmers who basically do not have pension arrangements. Then there was an argument that land is the security for farmers, but this was not fully specified as a policy arrangement. Therefore, we must consider group differences.
Even if people are rational, different groups will have different calculations of the future. Therefore, it is hard to generalize the rationality assumption to all cases.
Second, generational differences. Due to lots of changes in institutional arrangements during pension reform, there are huge disparities among retired people, young people, and people who have just graduated and started working in terms of rationality and the basis of calculations.
Third, not all people are rational. Pension is an issue related to the future. Some people will hardly think about it now and only consider it more often when they reach middle age or retirement. Hence, there are huge differences between individuals.
In other words, we set up a private pension scheme to encourage future retirees to consider pension arrangement rationally and respond better to the national pension and enterprise pension schemes. However, there is a gap between reality and assumption, so it is necessary to differentiate cases to enhance communication with the public, through which the benefits of the pension system can be better realized.
It would be unrealistic to ignore these differences and make everyone adopt the same pension scheme after retirement. Meanwhile, if we want to unify pension schemes, it also requires various existing non-monetary incentive mechanisms. These mechanisms can also lead to great problems if they do not take effect immediately.
This is also true in terms of macro calculation. Based on the prospect of equalized and nationally coordinated pension funds, we can simply average out the pension to make a calculation. Given the existing fiscal system, the population aging trend, and the need to widen the pension system coverage, the national pension funds in the future would be rather basic or low and thus need the support of private pension funds to satisfy the demand of old-age security.
Of course, some people believe that we will cross a bridge when we get to it, which means when that times come, we can increase the retirement age or raise the pension contribution rate of enterprises.
While there is room to raise the retirement age, there is still a limit. It is related to the average health conditions and productivity of older people, as well as the concern of labor costs from the perspective of enterprises.
The contribution rate of enterprises cannot be adjusted at will either. The enterprise social security contribution rate is reduced from 20% to 16% because the cost burden is too heavy, and business competitiveness has been hurt. The contribution ratio should be 8% for individuals and 8% for enterprises, with a median level of 20%. For enterprises, a 20% contribution rate is too high. Even 16% is still quite a high level globally. In addition, the 16% contribution cannot be included in the employees' personal accounts, which fails to incentivize employees to earn more labor rewards and will affect business competitiveness. In this sense, the view I just mentioned does not fully take into account the aspect of business competitiveness.
Given the gap between reality and rationality assumption, we need to take different approaches for different cases to avoid oversimplification and have an overall picture in mind. We still have a lot of work to do in this regard.
Many differences arise from economic reform. Before the reform, wages did not account for a large share. At the same time, houses, health care, pension, and other things represent a big percentage, indicating a distorted relation between income and cost. The distorted relation among price, cost, and income fails to reflect reality.
Therefore, reform should not proceed too rapidly, or it would leave problems behind. Studies on shaping a reasonable expectation among the retired people in the future so that they plan properly should be combined with research on the entire institutional transition. In principle, labor remuneration must be associated with productivity, and all policies should be designed with this in mind.
Going back to business contribution of pension funds. Where exactly has the money gone? Because of population aging and the pension fund gap, the money has mainly been used on a pay-as-you-go basis, with around 16-20% provided by businesses. But this is not the way it was intended to work.
China first established the three pillars - social planning, individual accounts, and commercial insurance - at the 4th Plenary Session of the 13th CPC Central Committee, which replaced the planned-economy-style old-age care system in the past. It later conducted trial programs where individuals and businesses respectively paid 8% of the total funds: the 8% contributed by businesses was supposed to go to the individual account, but since companies felt burdened as they were also asked to contribute the pay-as-you-go amount under the social planning pillar, the amount was later reduced in many provinces; at the same time, much from the businesses’ contribution was used on a pay-as-you-go basis, or as a matter of fact, diverted, resulting in the system deviating from its original purpose.
Can we set it straight? By enhancing incentives, can we move the diverted money back to the individual account? It’s not impossible, and there have been many discussions in this regard globally.
There are now two solutions to fill the gap in the pay-as-you-go fund. First, implement a nominal account for the pension funds contributed by businesses, where numbers are debited without any money actually transferred to the account – and so there is no money available for investment. But it can change gradually from an empty account to a de-facto one, and the rate of return on the funds could equal that on government bonds.
The other solution is to return some of the state-owned assets, especially the state-owned equity in listed companies, back to the pension system. China began to consider this possibility two decades ago and has made some minor and flawed attempts. It could continue to work on the solution, which I see as very plausible.
Business pension contributions have long been used on a pay-as-you-go basis in China, making its “three pillars” different from that in other countries. China’s first pillar is managed by the government; the second pillar is contributed by businesses; and the third pillar is the commercial individual account. This is different from the “three pillars” defined by the World Bank and the OECD and different from the further-refined “four pillars” and “five pillars.”
Why should China refer to the international definition of the “three pillars”? Building a sound pension system is a long-term effort. China will not accumulate sufficient experience unless it keeps doing it for decades, and without feedbacks from its near-term attempts, the international experience could serve as a meaningful reference. It could look to the international experience to evaluate its past work, plan for future improvements, and align its definitions and standards with international ones. Some of the officials and scholars have already brought this up in the previous years.
In conclusion, I would like to make five points:
First, face the problem with the pension system. Don’t dodge it.
Second, stop saying this is a long-term issue and procrastinating, as that will only make things even harder.
Third, stopgap solutions are not enough. We need to address the root cause of the problems. Painkillers kill pain, but they don’t kill the disease.
Fourth, China has a long, challenging way to go in terms of pension development. The pension system in China needs to be prepared against a huge and severely aged population, and the pension gap could be even wider as a result of institutional change.
Fifth, China has a tremendous pre-pension fund pool that amount to trillions. But let’s make a simple international comparison: pre-pension funds in most of the other countries account for 50-100% of GDP, or even higher, but the proportion in China is below 10%, and the estimates vary: some say it’s 6%, some say it’s 2-3%.
These betray the weak foundation of China’s pension system, which has a bumpy road ahead. We must attach great importance to it and conduct in-depth, fact-based research to address population aging, institutional change, and related old-age care challenges in order to achieve high-quality development.
In recent years, the CPC Central Committee and the State Council have attached great attention to the pension system and pushed forward reforms with new measures rolled out and developments seen, especially the introduction of the private pension scheme, posing a lot of new questions to discuss.
The private pension scheme has caused lots of attention from research institutions and has seen research from various perspectives, e.g., a financial perspective or policy regime. Based on the existing discussions and research, I would like to share some of my preliminary thoughts.
I will start with the policy design and may touch upon management details if time allows.
First, despite some progress made under the private pension scheme, the scheme is still short of stronger incentives.
While discussing incentives, let me first introduce a rational assumption: the incentive is primarily geared toward people who have not retired yet and will make a rational estimate of their lifetime finances based on available data and policies. Then we can find out the scale of the state pension pool. Are there gaps between the two? Can private pension accumulation solve the shortfall? Of course, an adequate rational estimate may not be achieved due to future uncertainties. When I say rational estimation, I mean people make a rough measurement to guide their decisions and adjust to the private pension scheme newly designed as part of the state institutional arrangement.
One reality in China is that it has a large population, and simultaneously the scope of pension coverage continues to expand. In general, due to population aging, pension pools are prone to shortfalls. In this case, a national pension would be a basic arrangement and won’t be of a very high level. In other words, larger pension gaps must be supplemented by private pensions.
So there comes the need to enable the public to better understand about the current reality. Suppose the basic realities are not clearly explained to future retirees. In that case, they will take it for granted, under the inertia of the past system, that the government will take care of them after retirement anyway, so why bother with personal pre-funding? Enterprises will feel the same as well. Why bother with this for employees? Therefore, it is crucial to clarify the current realities to allow future retirees to conduct a rational measurement.
The LFS (Lifetime Financial Security) concept proposed internationally is one basis for rational estimation. According to this concept, income level after retirement is about 70% or 80% of pre-retirement income under different life expectancies. We are still not doing enough in terms of public communication about the conditions that would affect their estimation; the current incentives are still flawed.
Existing discussions show that the newly introduced private pension system is fine, but incentives are weak. There are two issues to discuss here.
First, the existing personal income tax system remains flawed as too large a share of wealth not being required to pay for personal income tax. This needs to change, though it will require long-time efforts. The vast majority of the population needs to pay taxes. Still, improvements need to be made to take into account factors such as taxpayers’ family structure, supporting burden and pensions, and tax deductions or refunds can be applied.
Second, the incentive mechanism was overlooked. In many countries, the private pension plan consists of both individual and corporate contributions of the same share. For example, when individuals contribute by 8%, employers contribute another 8%. From the employees’ point of view, people feel motivated as their 8% contribution can double instantly.
From the enterprises’ perspective, there is still much to discuss. In principle, the wool always comes off the sheep's back. It is not the case that the business owner or employer pays the employee with money out of their pocket for the employee’s personal pension pre-funding, but rather an institutional arrangement that can produce incentives.
Why doesn’t this incentive mechanism work in China? It is largely because the social security contributions paid by enterprises have been used under the pay-as-you-go scheme. This is related to the fund gap due to institutional reform. The contributions paid by Chinese enterprises account for as high as 16%;several years ago, the share was 20%. Since the 20% contribution added too much pressure to business costs and undermined their competitiveness, the rate was later lowered by four percentage points to 16%, which is still quite a high level.
We will discuss later whether it is possible to use this measure to make private pension accounts much more attractive.
We should consider the gap between the practical conditions and the rationality assumption, just like many other discussions on economic issues. At the very beginning, I mentioned that, in theory, there is a perfect market, but in reality, we need to consider some market peculiarities.
There are three major differences between the actual conditions and the rationality assumption:
First, group differences. In China, group differences are more prominent than in other economies. Since the adoption of the pension system, government agencies and public institutions have belonged to one category, while state-owned enterprises have fallen into another category, with a differentiation between large groups and small groups. Later, there is another different arrangement for private enterprises.
China has a considerable number of farmers who basically do not have pension arrangements. Then there was an argument that land is the security for farmers, but this was not fully specified as a policy arrangement. Therefore, we must consider group differences.
Even if people are rational, different groups will have different calculations of the future. Therefore, it is hard to generalize the rationality assumption to all cases.
Second, generational differences. Due to lots of changes in institutional arrangements during pension reform, there are huge disparities among retired people, young people, and people who have just graduated and started working in terms of rationality and the basis of calculations.
Third, not all people are rational. Pension is an issue related to the future. Some people will hardly think about it now and only consider it more often when they reach middle age or retirement. Hence, there are huge differences between individuals.
In other words, we set up a private pension scheme to encourage future retirees to consider pension arrangement rationally and respond better to the national pension and enterprise pension schemes. However, there is a gap between reality and assumption, so it is necessary to differentiate cases to enhance communication with the public, through which the benefits of the pension system can be better realized.
It would be unrealistic to ignore these differences and make everyone adopt the same pension scheme after retirement. Meanwhile, if we want to unify pension schemes, it also requires various existing non-monetary incentive mechanisms. These mechanisms can also lead to great problems if they do not take effect immediately.
This is also true in terms of macro calculation. Based on the prospect of equalized and nationally coordinated pension funds, we can simply average out the pension to make a calculation. Given the existing fiscal system, the population aging trend, and the need to widen the pension system coverage, the national pension funds in the future would be rather basic or low and thus need the support of private pension funds to satisfy the demand of old-age security.
Of course, some people believe that we will cross a bridge when we get to it, which means when that times come, we can increase the retirement age or raise the pension contribution rate of enterprises.
While there is room to raise the retirement age, there is still a limit. It is related to the average health conditions and productivity of older people, as well as the concern of labor costs from the perspective of enterprises.
The contribution rate of enterprises cannot be adjusted at will either. The enterprise social security contribution rate is reduced from 20% to 16% because the cost burden is too heavy, and business competitiveness has been hurt. The contribution ratio should be 8% for individuals and 8% for enterprises, with a median level of 20%. For enterprises, a 20% contribution rate is too high. Even 16% is still quite a high level globally. In addition, the 16% contribution cannot be included in the employees' personal accounts, which fails to incentivize employees to earn more labor rewards and will affect business competitiveness. In this sense, the view I just mentioned does not fully take into account the aspect of business competitiveness.
Given the gap between reality and rationality assumption, we need to take different approaches for different cases to avoid oversimplification and have an overall picture in mind. We still have a lot of work to do in this regard.
Many differences arise from economic reform. Before the reform, wages did not account for a large share. At the same time, houses, health care, pension, and other things represent a big percentage, indicating a distorted relation between income and cost. The distorted relation among price, cost, and income fails to reflect reality.
Therefore, reform should not proceed too rapidly, or it would leave problems behind. Studies on shaping a reasonable expectation among the retired people in the future so that they plan properly should be combined with research on the entire institutional transition. In principle, labor remuneration must be associated with productivity, and all policies should be designed with this in mind.
Going back to business contribution of pension funds. Where exactly has the money gone? Because of population aging and the pension fund gap, the money has mainly been used on a pay-as-you-go basis, with around 16-20% provided by businesses. But this is not the way it was intended to work.
China first established the three pillars - social planning, individual accounts, and commercial insurance - at the 4th Plenary Session of the 13th CPC Central Committee, which replaced the planned-economy-style old-age care system in the past. It later conducted trial programs where individuals and businesses respectively paid 8% of the total funds: the 8% contributed by businesses was supposed to go to the individual account, but since companies felt burdened as they were also asked to contribute the pay-as-you-go amount under the social planning pillar, the amount was later reduced in many provinces; at the same time, much from the businesses’ contribution was used on a pay-as-you-go basis, or as a matter of fact, diverted, resulting in the system deviating from its original purpose.
Can we set it straight? By enhancing incentives, can we move the diverted money back to the individual account? It’s not impossible, and there have been many discussions in this regard globally.
There are now two solutions to fill the gap in the pay-as-you-go fund. First, implement a nominal account for the pension funds contributed by businesses, where numbers are debited without any money actually transferred to the account – and so there is no money available for investment. But it can change gradually from an empty account to a de-facto one, and the rate of return on the funds could equal that on government bonds.
The other solution is to return some of the state-owned assets, especially the state-owned equity in listed companies, back to the pension system. China began to consider this possibility two decades ago and has made some minor and flawed attempts. It could continue to work on the solution, which I see as very plausible.
Business pension contributions have long been used on a pay-as-you-go basis in China, making its “three pillars” different from that in other countries. China’s first pillar is managed by the government; the second pillar is contributed by businesses; and the third pillar is the commercial individual account. This is different from the “three pillars” defined by the World Bank and the OECD and different from the further-refined “four pillars” and “five pillars.”
Why should China refer to the international definition of the “three pillars”? Building a sound pension system is a long-term effort. China will not accumulate sufficient experience unless it keeps doing it for decades, and without feedbacks from its near-term attempts, the international experience could serve as a meaningful reference. It could look to the international experience to evaluate its past work, plan for future improvements, and align its definitions and standards with international ones. Some of the officials and scholars have already brought this up in the previous years.
In conclusion, I would like to make five points:
First, face the problem with the pension system. Don’t dodge it.
Second, stop saying this is a long-term issue and procrastinating, as that will only make things even harder.
Third, stopgap solutions are not enough. We need to address the root cause of the problems. Painkillers kill pain, but they don’t kill the disease.
Fourth, China has a long, challenging way to go in terms of pension development. The pension system in China needs to be prepared against a huge and severely aged population, and the pension gap could be even wider as a result of institutional change.
Fifth, China has a tremendous pre-pension fund pool that amount to trillions. But let’s make a simple international comparison: pre-pension funds in most of the other countries account for 50-100% of GDP, or even higher, but the proportion in China is below 10%, and the estimates vary: some say it’s 6%, some say it’s 2-3%.
These betray the weak foundation of China’s pension system, which has a bumpy road ahead. We must attach great importance to it and conduct in-depth, fact-based research to address population aging, institutional change, and related old-age care challenges in order to achieve high-quality development.
In recent years, the CPC Central Committee and the State Council have attached great attention to the pension system and pushed forward reforms with new measures rolled out and developments seen, especially the introduction of the private pension scheme, posing a lot of new questions to discuss.
The private pension scheme has caused lots of attention from research institutions and has seen research from various perspectives, e.g., a financial perspective or policy regime. Based on the existing discussions and research, I would like to share some of my preliminary thoughts.
I will start with the policy design and may touch upon management details if time allows.
First, despite some progress made under the private pension scheme, the scheme is still short of stronger incentives.
While discussing incentives, let me first introduce a rational assumption: the incentive is primarily geared toward people who have not retired yet and will make a rational estimate of their lifetime finances based on available data and policies. Then we can find out the scale of the state pension pool. Are there gaps between the two? Can private pension accumulation solve the shortfall? Of course, an adequate rational estimate may not be achieved due to future uncertainties. When I say rational estimation, I mean people make a rough measurement to guide their decisions and adjust to the private pension scheme newly designed as part of the state institutional arrangement.
One reality in China is that it has a large population, and simultaneously the scope of pension coverage continues to expand. In general, due to population aging, pension pools are prone to shortfalls. In this case, a national pension would be a basic arrangement and won’t be of a very high level. In other words, larger pension gaps must be supplemented by private pensions.
So there comes the need to enable the public to better understand about the current reality. Suppose the basic realities are not clearly explained to future retirees. In that case, they will take it for granted, under the inertia of the past system, that the government will take care of them after retirement anyway, so why bother with personal pre-funding? Enterprises will feel the same as well. Why bother with this for employees? Therefore, it is crucial to clarify the current realities to allow future retirees to conduct a rational measurement.
The LFS (Lifetime Financial Security) concept proposed internationally is one basis for rational estimation. According to this concept, income level after retirement is about 70% or 80% of pre-retirement income under different life expectancies. We are still not doing enough in terms of public communication about the conditions that would affect their estimation; the current incentives are still flawed.
Existing discussions show that the newly introduced private pension system is fine, but incentives are weak. There are two issues to discuss here.
First, the existing personal income tax system remains flawed as too large a share of wealth not being required to pay for personal income tax. This needs to change, though it will require long-time efforts. The vast majority of the population needs to pay taxes. Still, improvements need to be made to take into account factors such as taxpayers’ family structure, supporting burden and pensions, and tax deductions or refunds can be applied.
Second, the incentive mechanism was overlooked. In many countries, the private pension plan consists of both individual and corporate contributions of the same share. For example, when individuals contribute by 8%, employers contribute another 8%. From the employees’ point of view, people feel motivated as their 8% contribution can double instantly.
From the enterprises’ perspective, there is still much to discuss. In principle, the wool always comes off the sheep's back. It is not the case that the business owner or employer pays the employee with money out of their pocket for the employee’s personal pension pre-funding, but rather an institutional arrangement that can produce incentives.
Why doesn’t this incentive mechanism work in China? It is largely because the social security contributions paid by enterprises have been used under the pay-as-you-go scheme. This is related to the fund gap due to institutional reform. The contributions paid by Chinese enterprises account for as high as 16%;several years ago, the share was 20%. Since the 20% contribution added too much pressure to business costs and undermined their competitiveness, the rate was later lowered by four percentage points to 16%, which is still quite a high level.
We will discuss later whether it is possible to use this measure to make private pension accounts much more attractive.
We should consider the gap between the practical conditions and the rationality assumption, just like many other discussions on economic issues. At the very beginning, I mentioned that, in theory, there is a perfect market, but in reality, we need to consider some market peculiarities.
There are three major differences between the actual conditions and the rationality assumption:
First, group differences. In China, group differences are more prominent than in other economies. Since the adoption of the pension system, government agencies and public institutions have belonged to one category, while state-owned enterprises have fallen into another category, with a differentiation between large groups and small groups. Later, there is another different arrangement for private enterprises.
China has a considerable number of farmers who basically do not have pension arrangements. Then there was an argument that land is the security for farmers, but this was not fully specified as a policy arrangement. Therefore, we must consider group differences.
Even if people are rational, different groups will have different calculations of the future. Therefore, it is hard to generalize the rationality assumption to all cases.
Second, generational differences. Due to lots of changes in institutional arrangements during pension reform, there are huge disparities among retired people, young people, and people who have just graduated and started working in terms of rationality and the basis of calculations.
Third, not all people are rational. Pension is an issue related to the future. Some people will hardly think about it now and only consider it more often when they reach middle age or retirement. Hence, there are huge differences between individuals.
In other words, we set up a private pension scheme to encourage future retirees to consider pension arrangement rationally and respond better to the national pension and enterprise pension schemes. However, there is a gap between reality and assumption, so it is necessary to differentiate cases to enhance communication with the public, through which the benefits of the pension system can be better realized.
It would be unrealistic to ignore these differences and make everyone adopt the same pension scheme after retirement. Meanwhile, if we want to unify pension schemes, it also requires various existing non-monetary incentive mechanisms. These mechanisms can also lead to great problems if they do not take effect immediately.
This is also true in terms of macro calculation. Based on the prospect of equalized and nationally coordinated pension funds, we can simply average out the pension to make a calculation. Given the existing fiscal system, the population aging trend, and the need to widen the pension system coverage, the national pension funds in the future would be rather basic or low and thus need the support of private pension funds to satisfy the demand of old-age security.
Of course, some people believe that we will cross a bridge when we get to it, which means when that times come, we can increase the retirement age or raise the pension contribution rate of enterprises.
While there is room to raise the retirement age, there is still a limit. It is related to the average health conditions and productivity of older people, as well as the concern of labor costs from the perspective of enterprises.
The contribution rate of enterprises cannot be adjusted at will either. The enterprise social security contribution rate is reduced from 20% to 16% because the cost burden is too heavy, and business competitiveness has been hurt. The contribution ratio should be 8% for individuals and 8% for enterprises, with a median level of 20%. For enterprises, a 20% contribution rate is too high. Even 16% is still quite a high level globally. In addition, the 16% contribution cannot be included in the employees' personal accounts, which fails to incentivize employees to earn more labor rewards and will affect business competitiveness. In this sense, the view I just mentioned does not fully take into account the aspect of business competitiveness.
Given the gap between reality and rationality assumption, we need to take different approaches for different cases to avoid oversimplification and have an overall picture in mind. We still have a lot of work to do in this regard.
Many differences arise from economic reform. Before the reform, wages did not account for a large share. At the same time, houses, health care, pension, and other things represent a big percentage, indicating a distorted relation between income and cost. The distorted relation among price, cost, and income fails to reflect reality.
Therefore, reform should not proceed too rapidly, or it would leave problems behind. Studies on shaping a reasonable expectation among the retired people in the future so that they plan properly should be combined with research on the entire institutional transition. In principle, labor remuneration must be associated with productivity, and all policies should be designed with this in mind.
Going back to business contribution of pension funds. Where exactly has the money gone? Because of population aging and the pension fund gap, the money has mainly been used on a pay-as-you-go basis, with around 16-20% provided by businesses. But this is not the way it was intended to work.
China first established the three pillars - social planning, individual accounts, and commercial insurance - at the 4th Plenary Session of the 13th CPC Central Committee, which replaced the planned-economy-style old-age care system in the past. It later conducted trial programs where individuals and businesses respectively paid 8% of the total funds: the 8% contributed by businesses was supposed to go to the individual account, but since companies felt burdened as they were also asked to contribute the pay-as-you-go amount under the social planning pillar, the amount was later reduced in many provinces; at the same time, much from the businesses’ contribution was used on a pay-as-you-go basis, or as a matter of fact, diverted, resulting in the system deviating from its original purpose.
Can we set it straight? By enhancing incentives, can we move the diverted money back to the individual account? It’s not impossible, and there have been many discussions in this regard globally.
There are now two solutions to fill the gap in the pay-as-you-go fund. First, implement a nominal account for the pension funds contributed by businesses, where numbers are debited without any money actually transferred to the account – and so there is no money available for investment. But it can change gradually from an empty account to a de-facto one, and the rate of return on the funds could equal that on government bonds.
The other solution is to return some of the state-owned assets, especially the state-owned equity in listed companies, back to the pension system. China began to consider this possibility two decades ago and has made some minor and flawed attempts. It could continue to work on the solution, which I see as very plausible.
Business pension contributions have long been used on a pay-as-you-go basis in China, making its “three pillars” different from that in other countries. China’s first pillar is managed by the government; the second pillar is contributed by businesses; and the third pillar is the commercial individual account. This is different from the “three pillars” defined by the World Bank and the OECD and different from the further-refined “four pillars” and “five pillars.”
Why should China refer to the international definition of the “three pillars”? Building a sound pension system is a long-term effort. China will not accumulate sufficient experience unless it keeps doing it for decades, and without feedbacks from its near-term attempts, the international experience could serve as a meaningful reference. It could look to the international experience to evaluate its past work, plan for future improvements, and align its definitions and standards with international ones. Some of the officials and scholars have already brought this up in the previous years.
In conclusion, I would like to make five points:
First, face the problem with the pension system. Don’t dodge it.
Second, stop saying this is a long-term issue and procrastinating, as that will only make things even harder.
Third, stopgap solutions are not enough. We need to address the root cause of the problems. Painkillers kill pain, but they don’t kill the disease.
Fourth, China has a long, challenging way to go in terms of pension development. The pension system in China needs to be prepared against a huge and severely aged population, and the pension gap could be even wider as a result of institutional change.
Fifth, China has a tremendous pre-pension fund pool that amount to trillions. But let’s make a simple international comparison: pre-pension funds in most of the other countries account for 50-100% of GDP, or even higher, but the proportion in China is below 10%, and the estimates vary: some say it’s 6%, some say it’s 2-3%.
These betray the weak foundation of China’s pension system, which has a bumpy road ahead. We must attach great importance to it and conduct in-depth, fact-based research to address population aging, institutional change, and related old-age care challenges in order to achieve high-quality development.
This paper is a speech made by the author at the Fifth Global Asset Management Forum on Feb. 25. It is translated by CF40 and has not been reviewed by the author. The views expressed herewith are the author’s own and do not represent those of CF40 or other organizations.
