Abstract: In this paper, the authors suggest China vigorously develop accumulative pension funds by constructing a three-pillar pension system. Incentive mechanisms should be set up to encourage individuals to make more contributions to their pension accounts. And the key to pension system reform is to mobilize funds in the form of bank deposits and real estate investments into pension accounts and transform them into long term capital to support technology innovation and economic development.
Since Bismarck established the mandatory social pension insurance system in Germany in the 1880s, over a hundred countries around the world have followed suit and established mandatory pension systems in the following hundred years. The initial purpose of this system was to provide a social mutual aid income security mechanism for the elderly population, ensuring that ordinary people can continue to receive income from pension insurance after retirement. This income is equivalent to a certain "replacement rate" of income during their working period, thereby avoiding economic difficulties due to reduced ability to work. In recent decades, governments around the world have reformed their pension plans to deal with population aging, according to different philosophies and specific situations, to achieve the goal of continuously paying pensions to retirees.
Under normal population estimates, individual pension contributions begin at the time of employment and continue until retirement, with a contribution period of up to 30 to 40 years. However, due to the intensification of population aging, the period of receiving pensions is increasing. Looking at the flow of funds from the second and third pillars of individual pension accounts, it is inevitable to gradually accumulate in the early stage and gradually flow out in the later stage. From the perspective of the pension system, due to a large number of participants and the long-time span of the pension plan, the contributions of individual pension accounts add up to form a reservoir of social wealth, creating a long-term saving effect on the production and distribution of social wealth in time and space, which has a significant impact on the economic development of countries around the world.
Because there are significant differences in the specific design of pension systems in different countries, this paper will only discuss the problems faced by China's current pension system and the relationship between the pension system and domestic long-term capital.
The characteristic of China's current pension system is the population dividend system of collective security.
China's current pension system is based on the modern welfare state system and tailored to China's contemporary national conditions, featuring strong Chinese characteristics. This is reflected in the following aspects:
(I) Emphasizing collective security in legislative status is a major feature of China's current pension system.
Unlike the three-pillar pension system in some developed countries, the pension system in China has a very strong characteristic of "collective security." In terms of the design of basic pensions, American economist Martin Feldstein believes that China's pension security system is a unique pension security system, that is, a combination of the Defined Contribution (DC) and the Defined Benefit (DB).
Specifically, the payment end of the basic pension consists of a social pooling account and an individual account, among which the payment of the social pooling account is about 2-2.5 times that of the individual account; on the expenditure end of the basic pension, the social pooling account adopts a pay-as-you-go system, which is actually a system of collective ownership of intergenerational transfers; the payment level of individual accounts is related to the savings in the accounts formed by individual payments. Among them, the basic pension, which emphasizes its role as the "social security" the most among the three pillars, has been strongly promoted and developed by the state, legislated at the national level, and formulated the "Social Insurance Law." According to official statistics from the Ministry of Human Resources and Social Security, as of the end of 2021, the number of people participating in basic pension insurance nationwide was 1.029 billion. Considering that the number of people employed nationwide during the same period was only 750 million, and the number of people receiving pensions was 300 million, the coverage rate of basic pension insurance is very close to that of developed countries.
The pension in the second pillar—enterprise annuity in China is implemented based on the Enterprise Annuity Regulation, which is jointly formulated by the Ministry of Human Resources and Social Security and the Ministry of Finance. It belongs to the administrative regulations, and its legal status is far lower than the Social Insurance Law on which the basic pension insurance is based. The enterprise annuity is not mandatory and is sponsored by enterprises on their own, with employees voluntarily participating, and there is also a ceiling for tax incentives. As of 2022, the number of employees participating in the enterprise annuity in China was only 30.1 million, accounting for about 8.3% of the number of urban employees participating in basic pension insurance during the same period; the number of employees receiving annuities was only 2.26 million, less than 1.8% of the number of urban employees receiving basic pensions during the same period.
As the third pillar, personal income tax-deferred commercial pension insurance was piloted in 2018, and some tax incentives were given at the product level. But so far, the number of insured people in the third pillar of commercial pension insurance is only a few tens of thousands, and the premium income is only a few billion yuan, which is very small in scale. In November 2022, the individual pension system as the third pillar was officially implemented, and the number of individual accounts opened in half a year reached 30 million, achieving impressive results. The number of participants not only far exceeded that of the individual income tax-deferred commercial pension insurance but also caught up with the number of corporate annuities that had been in operation for 19 years. But for various reasons, the personal pension payment fund is only 18 billion yuan.
Looking at the stock of pension assets from the four sectors, according to the latest data, the basic pension balance in the first pillar is 7.1 trillion yuan (including urban and rural residents' insurance, as of the end of 2021). In the second pillar, the corporate annuity is 2.87 trillion yuan, and the occupational annuity is 190 million yuan. In the third pillar, the scale of commercial pension insurance is too small to be negligible, and the reserve fund managed by the National Social Security Fund is 2.6 trillion yuan (after de-duplication), totaling 14.5 trillion yuan. Among them, the first pillar and strategic reserve funds account for 67%, while the second and third pillars only account for 33%. From this point of view, the vast majority of pension assets in China come from basic pensions (the first pillar) and national strategic reserves, while the second and third pillar pensions account for a very small proportion.
In contrast to the pension system in developed countries, the three-pillar pensions are basically equal in legal status and are all part of the social security system. Taking the US pension system as an example, the mandatory basic pension in the first pillar is based on the Social Security Act, while the second and third pillar pensions are ensured by laws and regulations such as the Employee Income Security Act and the Internal Revenue Code. Under the relatively equal system arrangement, the second and third pillar pensions, with the nature of personal savings, have been fully developed. Looking at the proportion of US pension assets, the basic pension in the first pillar accounts for about 10% (the US does not have a strategic reserve fund), and the second and third pillars account for about 90%.
In summary, in terms of the different legislative levels and the proportion of pension assets, China's pension system does not equalize the three pillars in legal arrangements. Enterprise annuities and commercial pension insurances, which are characterized by individual insurance, are not positioned as part of social security in the system arrangement but as supplementary matters for personal pension planning and are given limited preferential treatment in the policy.
(II) China's pension system has very limited accumulation, while the overall savings rate of residents is high.
China's basic pension system primarily uses a pay-as-you-go financing method. With the rapidly aging population, the actual pension burden will face severe challenges in the future. According to data from the National Bureau of Statistics, as of 2022, China has a workforce population of 876 million aged 16-59 and a senior population of 280 million aged 60 and above, with an elderly dependency ratio of 32%.
In the national basic pension insurance system for urban employees, the population receiving pensions is expected to increase from 102 million people in 2019 to 137 million in 2025, 190 million people in 2035, and 278 million people by 2050. Assuming the current retirement policy remains unchanged, the pension dependency ratio will drop from 2.65 people supporting one person in 2019 to 1.03 people supporting one person in 2050. According to authoritative predictions, the national enterprise employee basic pension insurance fund is expected to have an annual deficit by 2029 and a cumulative deficit by 2036.
In addition, in response to the impact of the COVID-19 pandemic, the central government decided to further implement a significant "reduction, exemption, and delay" policy for pension insurance contributions in 2020, based on five consecutive years of phased fee reductions. The urban employee basic pension insurance fund has already seen an annual deficit, with an income of 4.44 trillion yuan and an expenditure of 5.13 trillion yuan, resulting in a yearly deficit of 690 billion yuan. This is the first annual deficit since the nationwide unified urban employee pension insurance system was established in 1997.
The current stock of pension fund assets is insufficient to cope with future population aging. For example, the individual accounts of the urban employee basic pension insurance are virtually empty, and the public lacks confidence in the safety of China's pension system. They are forced to adopt precautionary savings to meet pension needs. Therefore, China's resident deposits have already exceeded 100 trillion yuan. Even after deducting resident household loans (approximately 54 trillion yuan, mainly mortgage loans), there are still about 46 trillion yuan of net savings. In addition to bank deposits, the household sector also owns about 26 trillion yuan in bank wealth management products. The sum of these two suggests that the net financial asset savings of the household sector should not be less than 70 trillion yuan. Many residents invest in housing as a form of savings to hedge against pension risks.
The total savings rate of Chinese residents is currently high, but the structure of savings has obvious defects. Most residents' savings are in bank deposits or real estate, leading to three issues. First, a large amount of savings has not formed long-term capital but is transformed into loans through banks, and technological innovation lacks equity support. Second, businesses rely heavily on loans for financing, seriously lack equity financing, have high leverage ratios, and face high economic and financial fluctuations risks. Third, a large number of residents' savings enter the real estate market, leading to high house prices, increasing economic and financial risks, and reducing the competitiveness and vitality of the real economy.
(III) There is a large gap in pension fund reserves between China and developed countries.
The scale of pension funds in OECD member countries is representative, but it also reflects imbalances. South Africa's pension fund is the largest in Africa, exceeding $200 billion. Namibia ranks second, where the pension fund accounts for 50% of its GDP. In Latin America, Brazil and Chile rank first and second in terms of pension fund scale, with Chile's pension fund ranking first in proportion to its GDP.
Image 1 - The proportion of the "Top 7" pension funds in all OECD member countries in 2021
Source: Pension Markets in Focus 2022, OECD, 6 February 2023, p.10, figure 1.2.
As of the end of 2021, the total scale of the second and third pillar pension funds in the current 38 OECD members reached $58.9 trillion. Seven countries' pension funds accounted for over 90% of the total pension fund scale of all OECD member countries. These countries are often referred to as the "P7" in the industry. They are: The United States, which has the world's largest pension fund market, ranked first with a total of $40 trillion, accounting for 67.3%; the United Kingdom ranked second with a pension fund scale of $3.8 trillion, accounting for 6.3%; Canada ranked third with $3.2 trillion, accounting for 5.4%; Australia ranked fourth with $2.3 trillion, accounting for 3.9%; the Netherlands came fifth with $2.1 trillion, accounting for 3.5%; Japan ranked sixth with $1.5 trillion, accounting for 2.5%; Switzerland ranked seventh with $1.4 trillion, accounting for 2.3%. The remaining 31 member countries account for 8.8% in total.
When we examine the development changes of pension funds over the 15 years since the 2008 global financial crisis, we find that the scale of pension funds in many OECD countries has grown significantly, with some increasing nearly twice, some even more than doubled, while only a few countries like Finland, Hungary, Japan, Spain, and others show a downward trend.
In the proportion of pension funds to GDP 2008, only Canada, Denmark, Iceland, and the Netherlands had pension funds exceeding 100% of their GDP. However, by 2021, nine countries had pension funds exceeding their GDP, including Australia, Switzerland, the UK, the USA, and Sweden. Among the P7 (Top 7 Pension Countries), only Japan's pension fund was 31.4%, not exceeding 100% of GDP. Although Denmark and Iceland's pension funds exceeded 100% of GDP due to their scale, they did not enter the P7 in terms of scale.
From the P7 or other countries with developed pension funds, we can find a regularity: in countries where a multi-pillar pension system is established and the second and third pillar pensions are developed, especially the second and third pillars that have quickly transitioned from DB to DC, pension fund scales grow very rapidly. Conversely, the scale of the pension fund is relatively small, and some countries even start from zero.
For example, the Greek pension system is a single pillar. Compared with many other European countries, the Greek pension system is unreasonable, and the burden of the public pension in the first pillar is heavy. To change this structurally imbalanced situation, Greece began to establish a voluntary pension in the second pillar, the "Occupational Insurance Fund" in 2002, which is Defined Contribution, an accumulation system paid by employees and employers, but its development has been slow. By 2007, participants was only 11,800, accounting for 0.2% of its 4.92 million workforce; all assets were only 246 million euros, accounting for 0.01% of its GDP of 228.9 billion euros that year, ranking last among OECD member countries. After the outbreak of the European sovereign debt crisis in 2010, Greece accelerated the development of the second pillar. The proportion of the second pillar pension assets to GDP only reached 0.5% in 2013, and it was still less than 1% in 2021, still at the "bottom" position among OECD member countries.
China's multi-tiered pension fund reserve is only slightly better than Greece when compared with OECD countries, and far behind other countries. The simple average proportion of pension fund assets to the GDP of OECD member countries is 49.7%, and the weighted average is 126%. Obviously, from any angle, the scale of China's pension fund assets lags far behind the average level of OECD countries. It is very disproportionate to China's position as the second-largest economy in the world, presenting a huge contrast.
China's Pension System in the New Era Should Shift towards a Capital Dividend Pension System
The long-term capital shortage is an increasingly significant factor that constrains China's technological innovation, hinders the potential for growth, and amplifies economic cyclical fluctuations. The experiences of other countries have shown that pensions are a source of long-term capital, especially for incremental long-term capital. In the new era, China's pension system must enhance the role of pensions as savings, increase the scale of pension reserves, and establish a market-oriented pension investment system to effectively leverage the function of pensions as long-term capital.
(I) Increasing the scale of pension reserves is an urgent need in response to the peak of aging.
As previously mentioned, the primary goal of establishing a basic pension is to ensure the timely and full payment of retirees' pensions. During the initial stage of China's current pension system (around the year 2000), the retirement wage standard for urban employees was relatively low, barely maintaining the basic standard of living. Despite this, due to the absence of accumulation, many provinces and cities' pooled pension insurance funds were in a state where income for the month was used to pay for that month's expenditures. Some even misappropriated individual account funds, leading to a deficit pension system. In this situation, the pension system played a significant role through a high proportion of collective pooling and pay-as-you-go, ensuring the basic income of retired employees during the early stages of the system transition for more than twenty years later.
Since 2005, the payments of China's basic pensions have been raised for 17 consecutive years. In 2020, there were 128 million urban retirees in China, corresponding to a basic pension expenditure of 5.13 trillion yuan. The per capita pension income was approximately 40,200 yuan/year, while the per capita disposable income of urban residents nationwide was 43,800 yuan. This level of pension benefits achieved a high-income replacement rate.
However, the high level of current social security is mainly due to the intergenerational collective transfer of demographic dividends. Given the structural factors of the population, if the goal of the pension system is to ensure "current distribution" without increasing the scale of accumulation, China's pension system will inevitably struggle to fulfill its mission of social security in the future, as the peak of aging approaches. Moreover, as China's economy develops and the standard of living rises, higher demands are placed on the protection level of future pensions, which will inevitably increase the pressure on future pension payments.
Therefore, shifting from a pay-as-you-go collective security based on demographic dividends to a capital dividend accumulated pension system is an urgent task before us, which is significant for realizing Chinese-style modernization. From a historical perspective, the fundamental way out is transitioning from a pay-as-you-go pension system to a pre-accumulated one.
(II) As China's economic development enters a new stage, it puts higher demands on long-term capital.
Before 2012, China's economic growth was primarily driven by domestic urbanization and economic globalization. However, economic growth in China has since entered a new stage of slowing down and improving quality, with development momentum facing structural adjustments. In order to maintain growth, China must rely more on innovation on the supply side and more on consumption on the demand side. The global economic environment has also played a role in China's economic development. Since 2015, economic globalization has slowed down noticeably, and friction in investment and trade between countries has intensified. The COVID-19 pandemic in 2020 has further accelerated the adjustment process of the global industrial chain.
Since the reform and opening up, China’s real economy, in general, has lacked equity capital. After joining the WTO, China attracted approximately $50-150 billion in foreign direct investment (FDI), much of which was long-term equity capital. By the end 2018, China had accumulated $2.1 trillion in foreign investment. However, most retained earnings of domestic A-share listed companies were used to supplement the company's capital, and the cash dividend rate to shareholders remained below 30% for a long time. Despite this, the long-term capital needed for domestic economic development still struggles to meet demand.
In China's social financing structure, various forms of debt financing make up the vast majority. According to the data from the People's Bank of China at the end of 2022: the scale of social financing was 344 trillion yuan. Among them, loans to real enterprises in domestic and foreign currency amounted to about 214 trillion yuan, corporate bond balances were 31 trillion yuan, and government bond balances were about 60 trillion yuan; just these three items accounted for nearly 90%. Non-financial corporate stock financing balance was only 10.6 trillion yuan. If we add the principal balance of RMB private equity and venture capital funds invested in real enterprises, which is 8.05 trillion yuan, the total is about 18.65 trillion yuan, accounting for only 5.4% of social financing under China's financial supervision system.
Generally speaking, bond financing is characterized by short-term, fixed returns and principal repayment upon maturity. This makes it suitable for supporting large-scale infrastructure project financing and operating cash turnover but not suitable as long-term capital. Enterprises require financial investment for development, especially during high-growth stages. At this point, they need long-term equity capital rather than short-term bond capital. Without the support of long-term capital, these enterprises' innovative development would be like a tree without roots and a river without a source.
Therefore, a common issue for domestic enterprises, especially high-growth ones, is that they struggle to meet capital needs through their own capital cycles and must continuously seek external financing. The reality of the domestic enterprise financing environment is the scarcity of long-term equity capital, forcing enterprises to choose a high proportion of debt financing, raising the normal liability level of real enterprises. When the environment changes unfavorably, enterprises are prone to debt crises, leading to financial and economic fluctuations.
This situation shows that China's financing system has not kept up with the intrinsic needs of economic development. At the national level, how to promote the formation of long-term capital, especially long-term equity capital, through institutional design has become an urgent issue for healthy economic development.
Contrastingly, in the 40 years since the reform and opening up, a large amount of foreign capital has entered China, fully utilizing China's market and human resources to gain substantial capital dividends. Apart from a large number of foreign companies investing in factories in China, representatives of China's new economy, including Alibaba, Tencent, JD.com, Baidu, ByteDance (the parent company of TikTok and Toutiao), are all controlled by overseas shareholders from a legal structure perspective, with many of the ultimate shareholders and beneficiaries being foreign pension funds. The combined market value of Alibaba and Tencent, two overseas-listed companies, approached 10 trillion yuan during the peak period of 2020-2021, equivalent to 10% of China's GDP in 2020 and 12.5% of the total market value of all domestic A-share listed companies, which includes almost all leading enterprises in China's financial, energy, transportation, manufacturing, real estate, consumer goods production, and other important industries.
It is because of the institutional absence of long-term domestic capital that long-term foreign capital has gained ample return from China. In other words, because developed economies like Europe and the United States have a stronger ability to form long-term capital through the savings pension system than China, these foreign capitals have provided long-term equity capital support for China's development over the past 40 years and have also reaped substantial returns.
From a more macro perspective, long-term capital is not just an economic and financial issue; it also affects all aspects of social governance. In recent years, a series of market order rectifications conducted by the Chinese government around the internet and new economic fields, such as personal data protection, addictive games, internet finance avoiding financial regulation, labor protection for temporary workers, excessive extracurricular tutoring, and comprehensive governance in the cultural field, are all related to the divergence of corporate behavior from public interests, naturally affecting foreign capital invested in these enterprises.
Behind these phenomena, a perspective for discussion is the interaction between the asymmetrical capital arrangement between China and Western developed countries in the context of globalization (China has not established a savings pension system like Western developed countries) and business: due to the lack of local "onshore" long-term equity capital, new technologies and business models in the process of economic globalization and technological innovation first attract "offshore" long-term capital with long cycles and high-risk tolerance, quickly turning China's huge market potential into new business models. These new business models, to some extent, change and affect the existing public interest and governance order, creating enormous social tension.
According to Lazonick's innovation theory, real valuable innovation provides higher quality products at lower costs under existing conditions, and value creation and value realization are the essence of innovation. Companies need to respond through their corporate governance system, such as strategy, organization, and financial arrangement. For companies, the long-term capital system is an external financial arrangement which needs to be combined with strategy, organization, and other elements to truly produce socially valuable innovation. As members of society, companies should ensure their innovation activities conform to social values. Conversely, the capital system provided by society also needs to work with other governance elements to promote corporate innovation.
Therefore, in the context of the dual circulation economy, how to improve the mechanism for the formation of "onshore" long-term capital at the institutional level and adapt to the overarching framework of social development is a topic that requires serious research.
(III) Accumulative Pension Funds and a Healthy Capital Market Complement Each Other
As early as 2003, the Chinese government proposed to establish a multi-level capital market. In 2004, China introduced the SME board, and in 2009, the Growth Enterprise Market (GEM) was established. The third plenary session of the 18th Communist Party of China (CPC) Central Committee in 2013 clearly stated that improving the multi-layer capital market system is an essential part of improving the modern market system and is a strategic task to promote China's economic transformation and upgrading. In 2019, the Shanghai Stock Exchange STAR Market was officially launched. On 2 September, 2021, President Xi Jinping announced at the Global Trade in Services Summit of the 2021 China International Fair for Trade in Services that the Beijing Stock Exchange will be established to deepen the reform of the National Equities Exchange and Quotations. It should be said that the central government attaches great importance to the construction of the capital market, and the relevant departments have done a lot of work.
However, it should also be recognized that these efforts have mainly focused on enriching and improving the stock market itself. The focus has been on how stocks are issued, traded, and circulated. There is a need for more in-depth and systematic research on issues such as how equity capital is initially gathered, how it subsequently circulates, and how risks are shared.
Discussions regarding capital market reform have increased in recent years, but the differences between equity capital markets and stock markets, and between long-term and short-term capital, are often overlooked. These discussions primarily focus on developing capital markets and direct financing, with a focus on the issuance of stocks by mature companies (Although the requirements for listing companies have gradually relaxed, the focus remains on relatively mature companies). Additionally, there is a lack of in-depth discussion on the equity capital market and the domestic long-term equity capital supply mechanism. The discussions on how the long-term equity capital market influences resource allocation at all stages of enterprise creation, development, bankruptcy, and restructuring, as well as the relationship between the long-term equity capital market and the stock market, are not enough. These topics are important to retail investors, but they are often ignored in mainstream discussions.
Strictly speaking, except for a small number of investment funds in the stock market that subscribes to new shares and becomes long-term capital in the real economy, most of the funds circulate at the level of securities assets through stock and fund transactions. Long-term investment in stocks does not necessarily equate to "long-term capital," so although stock markets at various levels are very important, they are not the entirety of the capital market and not even its most fundamental part.
When discussing the functions of pensions, as Peter Drucker pointed out in The Pension Fund Revolution, discussions about pensions "rarely mention the impact of pensions on the economy, such as on the capital market or the composition of capital. They discuss only various actuarial problems and investment portfolio management issues." Drucker believes: "Corporate pensions have always been forming capital, and they are still forming capital... Corporate pensions have always been one of the two major institutions of real capital formation in the United States. The only comparable fund is retained earnings of corporations." After Drucker, academia has done some supplementary research and discussion on the relationship between pensions and the capital market. But given China's specific national conditions of heavy reliance on bond financing and short-term financing and a lack of other effective mechanisms for supplementing long-term capital, the impact of the attribute of long-term pensions on the structure of social capital has not received enough attention.
With the deepening of China's market economic system, the Chinese government proposes to give full play to the decisive role of the market in resource allocation, and the capital market is precisely the key place for long-term capital allocation. For China's economic system, the accumulated pension is like high-octane gasoline with high calorific value, the capital market is like an engine, and the macroeconomy is like a running car. A well-ordered capital market engine can continuously provide (allocate) the power generated by burning high-octane gasoline (production elements) to the macroeconomic car; conversely, gasoline cannot perform its function without the transformation of the engine.
Moreover, for accumulated pensions, one of the best places to allocate them is the capital market, especially the long-term equity market. With the gradual establishment of a benign order in China's capital market, the systematic risk of pension investment in the capital market will be further reduced. It can be said that the era of mutual growth between China's accumulated pensions and the capital market is coming.
The Pension Reform Should be Viewed Beyond Its Social Security Role and as a Part of the Reform of Production Elements
The pension reform is not only about ensuring the long-term financial sustainability of social security, but it is also an essential part of the long-term reform of factors of production in the socialist market economy with Chinese characteristics. In recent years, the pension reform has implemented many effective measures, such as increasing revenue, cutting expenditures, and adjusting allocations, which have yielded good results. These measures include extending the retirement age, establishing a central adjustment system, implementing nationwide overall planning, transferring state-owned assets, enhancing payment incentives, expanding the cake, enlarging the second pillar, and establishing the third pillar. However, in theoretical discussions, some people believe that personal account pensions and corporate annuities with features of strong self-protection are inconsistent with the mutual aid role of the first-pillar basic pension (especially pooled account funds) and the redistribution of social wealth. They think that encouraging the expansion of saving-based pensions will exacerbate social inequality.
These concerns seem reasonable, but they overlook two basic issues: first, China's current pension system, which is mainly based on "collective security" was a necessary choice under the poor conditions at the beginning, and the empty account operation was also the result of these conditions. However, ignoring the fact of population aging and the negative future intergenerational dividend, if we do not consider building a truly sustainable pension system through accumulation, reservation, and value enhancement, we will fall into a collective predicament of aging in the future.
Secondly, there is a surplus of funds in the current first-pillar pension insurance system. This surplus shows that the population dividend in the previous period has produced a considerable scale of accumulation effect to a certain extent. However, according to current regulations, for the past 20 years, most of these funds have only obtained low-risk bond returns, missing out on the benefits of high-speed economic growth that long-term funds should be shared. This is a great waste.
Due to institutional deficiencies, China's economic system is in a long-term capital deficit: on the one hand, most of the existing first-pillar pension surpluses in China have not shared the benefits of China's high-speed economic growth, nor have they been used for current payments. Instead, they remain idle and undistributed; Furthermore, the long-term capital desperately needed for China's economic development cannot get enough supplements in the existing system, resulting in a long-term capital deficit for the economy. Specifically, China's financial system undergoes a systemic debt-to-equity swap every few years due to the absence of a supplement mechanism for long-term equity capital. This systemic debt-to-equity swap easily encourages moral hazard, implies high institutional costs, and can easily cause unnecessary disturbances to normal production activities in society.
Since around 2013, many banks have operated "fund pools" in their large-scale asset management business. They allocate some short-term funds to long-term assets to obtain higher investment returns from financial products. At its peak, the total size of financial products was estimated to be around 30 trillion yuan, with the scale allocated to long-term equity at the level of trillion yuan. The fund pool's operation mode has played a role in pooling small short-term funds into long-term capital, but this practice involves certain liquidity risks and affects the stability of the financial system.
After the implementation of new asset management regulations in 2018, bank financial products must match the term and product. From the perspective of financial supervision, these policies and measures are correct, but in practice, individual investors rarely buy long-term financial products with a term of more than five years. From the perspective of macro allocation of financial resources, transforming household savings into long-term equity capital is actually difficult to achieve. The bank wealth management market's practice in the past few years shows that without a reasonable institutional arrangement, no matter how many short-term funds there are, it is difficult to spontaneously gather into long-term capital. It is like bundling numerous small sampans together to make an aircraft carrier, which is impossible.
Pension reform is not just the historical evolution of the social security system, but also an important proposition for the long-term reform of production elements in the socialist market economy. Zhou Xiaochuan pointed out, "Pensions are an important source of long-term stable funds in the capital market, and they are crucial for the effective allocation of financial resources; Pension reform is closely related to productivity and whether China can smoothly cross the middle-income trap."
In general, pension reform should be discussed not only in terms of security but also from the perspective of the long-term savings and long-term capital supply needed for overall social and economic development. We must recognize that China's social and economic advancement into a new historical stage requires a more effective market for factors of production. Only in this way can we have a panoramic view and strategize to solve the problems.
Four Suggestions for the Reform of China's Pension System
As mentioned above, pensions are the best long-term capital, characterized by long-term and wealth savings. The government should guide the accumulation of pensions and their transformation into long-term capital through reasonable institutional arrangements. The specific approach is to consider the first, second, and third pillars of pensions within a unified policy framework, establish necessary incentive mechanisms, improve the willingness to contribute to each pillar of the pension, promote the transformation of the first pillar from a pay-as-you-go system to a pre-funded accumulation system, and increase the scale of accumulation of the second and third pillars. This will accelerate the pace of entering the investment system, promote the transformation of accumulated pensions into long-term capital, and respond to various future challenges with the accumulated pension system. Meanwhile, it will contribute to the formation of long-term capital and control of the macro leverage ratio.
In this way of thinking, the core of pension system reform is to optimize the savings structure: mobilizing some of the savings that are deposited in banks and real estate to pension accounts and transforming them into long-term capital supporting economic development and technological innovation (especially equity capital) through an efficient investment system. Based on this understanding, we propose the following four specific reform suggestions for pension reform:
(I) Expand the coverage and scale of accumulated pensions through institutional arrangements.
Expand the coverage of the accumulated pension system and increase the stock scale of pensions from an institutional arrangement perspective. Apart from the basic pension insurance of the first pillar, the enterprise annuities and occupational annuities of the second pillar, and various pension products covered by the personal pension system of the third pillar should be formally included in the pension insurance system framework and the legislative level should be raised, formally incorporating the three-pillar pension structure into the social security system in the name of national legislation.
China's three-pillar pension system has three accounts. In addition to tax concessions, more incentive mechanisms can be considered to improve transparency, enhance the willingness to save pensions voluntarily, and increase the accumulated stock. The basic pension insurance personal account in the first pillar has a compulsory savings function. If the contribution rate is too high, it may limit the development of other pillars' pensions and reduce personal disposable income, which is not conducive to economic development. The second and third pillar pensions are part of voluntary savings systems. If the pension products they cover can be included and defined for retirement purposes in the system design of tax concessions, then the overall social pension stock is likely to be greatly improved. This is an inevitable choice to cope with the peak of population aging.
In short, increasing the scale of pension stocks fundamentally depends on transitioning to pre-funded accumulation and vigorously developing the second and third pillars. In the long run, this is the ideal choice for China's pension system arrangement. Of course, for the Canada Pension Plan, which does not have a personal account, a partial accumulation system of defined benefits can also achieve the purpose of increasing the scale of pension funds. It is also an option, but it requires great effort to forge ahead.
(II) Attach high importance to the social reserve function of pension funds in addition to their social security function.
From the perspective of the organization of social production elements and long-term capital appreciation, we must pay attention to the social reserve function of pension funds in addition to their social security function and rationally formulate the investment policies of pension funds. As Zhou Xiaochuan pointed out, pension reform is a complex multidimensional system. With the development of China's economy, the issue of pensions should not be regarded as an exogenous variable of economic development; its characteristics of long-term reserve and the enormous scale effect have become important endogenous variables of the economic system. The design of the pension system will have a significant impact on the economic output of the entire society. This impact, in turn, will affect the social security function of pensions.
In other words, promoting the transformation of the pension system and gradually increasing the scale of pension accumulation are beneficial for two reasons. First, it allows for the sharing of economic development benefits with pensions, improving social security, and properly responding to population aging. Second, it addresses the institutional absence of long-term capital in China, providing long-term capital support for China's economic development.
Therefore, in the face of new circumstances, policymakers must consider the real long-term security needs in tandem with domestic long-term capital institutional arrangements and reevaluate investment policies for pensions, especially accumulated pensions. In the long run, it is important to value both the social security function and the social reserve function of pensions. By considering both functions, we can essentially solve the problem of a lack of long-term capital institutions, which in turn can solve problems in driving China's economic development and providing long-term capital support. A good economic development environment and favorable capital market conditions can then feed back into the growth of pension funds, allowing them to share the benefits of social and economic development and provide material security for coping with population aging. Thus, a virtuous cycle can be formed where pension guarantees, capital markets, technological innovation, and economic development mutually promote each other.
(III) Develop the saving function of individual accounts in favorable conditions.
Over 20 years ago, urban enterprise employee basic pension insurance was designed as a system that combined social pooling and individual accounts. The aim was to achieve both social mutual aid and redistribution while also "inserting" the function of real account accumulation to mobilize individual initiative and enhance the financial sustainability of the system. However, due to various reasons, particularly the rapid growth of GDP that has driven the rapid growth of average social wages, all levels of government have been unenthusiastic about creating real accounts with low bank deposit interest rates. Aaron Conditions cannot be met in the development stage and growth background, so part of the accumulated pension system will face huge welfare losses.
From 2000 to 2012, a dozen provinces piloted creating real individual accounts, but the final effect was unsatisfactory. In response, the Central Government made a resolute decision in 2013. They changed the goal from creating real individual accounts to improving individual accounts and converted real FDC accounts to NDC accounts based on vouchers.
Looking ahead, as the economic growth rate gradually slows down, the growth rate of average social wages will remain stable. In favorable conditions, there should be timely consideration of gradually developing the saving function of individual accounts. If individual accounts are canceled because the current practice adopts nominal accounts, it means that the pension's function as a saving vehicle for the future is discarded. In light of this, the current system that combines social pooling and individual accounts should remain, and individual accounts should not be canceled. Instead, there should be an urgent study on how to realize the saving function of individual accounts.
To enhance the incentive for system payment and improve the saving function, the scale and proportion of individual accounts should be increased, not reduced. The transformation of the pension system from pay-as-you-go to pre-collection accumulation is a choice made by many transforming countries. The central government's proposal to "improve the individual account system" in favorable conditions also implies the necessity of creating real individual accounts in China.
(IV) Accelerate the First Pillar Basic Pension Insurance Fund's entry into the investment system and appropriately adjust its investment policies.
International experiences have shown that in the global trend of pension reform, the establishment and reform of pension fund investment systems are increasingly important.
For example, China's National Social Security Fund Council established the National Social Security Fund in 2000. From then until 2021, the fund has grown to an equity of 27,005 billion yuan, with an average annual return rate of 8.3%. In 2020, it had an investment return rate of 15.84%. The accumulated investment appreciation balance was 17,958 billion yuan, while the cumulative net fiscal allocation was 10,271 billion yuan, exceeding the original investment amount.
In the Canada Pension Plan Investment Board (CPPIB), the investment strategy of the Canada Pension Plan (CPP) was to purchase government bonds prior to 1997. The total contribution was 6.10% (3.05% employer, 3.05% employee). However, due to an aging population, the contribution rate is predicted to continue increasing. By 2030, it is expected to reach 15.43% to maintain a balanced income and expenditure. After the 1997 investment system reforms that aimed for marketization and internationalization, the total contribution rate became 9.90%(4.95% employer, 4.95% employee). This rate can be maintained until 2100 without any increase in contribution rate. In other words, the market return on investment has "reduced" the contribution rate for Canadian people, making a significant contribution to resisting population aging.
After more than 20 years, all operating parameters of Canada's pension fund system reform remain reasonable. They are consistent with the forecast, and some of them are even slightly better than the forecast at that time. The cases of China's National Social Security Fund and the Canadian Pension Fund show that the National Basic Pension Insurance Fund should establish a professional and market-oriented investment management system as soon as possible. The strategic decision of the Central Government to allow China's urban basic pension insurance fund to "enter the market" is correct. It is an important way to improve the financial sustainability of the pension insurance system, and it is also significant for transforming pension funds into long-term capital.
For historical reasons, China's urban employee basic pension insurance pilot program started at the grassroots level, with cities and counties as the main levels of fund pooling. This approach helps to consolidate the responsibility of local governments in collecting social security fees, increase their enthusiasm, and maintain the balance of fund income and expenditure in the region. However, due to labor mobility and other factors, the accumulated balance of pension insurance funds between regions is inevitably unbalanced. Coastal developed areas have more funds deposited, while underdeveloped areas always have insufficient income, leading to large annual subsidies from all levels of finance, and making concentrated fund investment difficult.
Although the Regulations on the Investment and Management of Basic Pension Insurance Fund have been in effect for nearly 8 years, only 1.7 trillion yuan of the 6 trillion yuan accumulated in China's urban employee basic pension insurance fund has been invested and entrusted to the National Social Security Fund Council. The agreement bank deposit interest rate for funds not in the investment system is only 3%, resulting in an annual investment income loss of about 100 billion yuan compared to the average return rate of 5.6% for urban employee basic pension insurance funds entrusted for investment and operation by the National Social Security Fund. Considering the nationwide pooling (adjustment nature) of urban employee basic pension insurance in January 2022, it is recommended to accelerate the investment process of the basic pension insurance fund to maximize the financial sustainability of basic pension insurance.
In addition, it should be noted that, due to supervisory concepts, pay-as-you-go system design, and other reasons, China's pension fund system has already invested several trillion yuan in pension funds through market-oriented investments (partially entrusted basic pension insurance funds, enterprise annuities, occupational annuities, pension insurance products). The investment policies are based on the liquidity requirements for current payments, which means that the system fails to leverage the advantages of long-term funds. It is just like a "long-distance runner constantly undergoing sprint training".
If accumulated pension funds remain highly liquid for a long period, they cannot transform macro savings into long-term investments and will miss out on opportunities to share the most valuable part of economic growth. In this way, they also lose their significance as accumulated pension funds. Therefore, we should study and adjust pension fund investment policies to fully leverage their role as long-term funds.
