China must reform system
China must reform system to cope with ageing crisis
Under the previous socialist regime in the People’s Republic of China, a typical worker was paid by whichever State Owned Enterprise employed him throughout his working life, until retirement at age 60 for men or age 55 for women. At retirement a pension of approximately 80% of final salary becomes payable for the rest of the worker’s lifetime.
This pension was not funded but was paid from the SOE which in turn was financed by the Chinese State Owned banks, which were in turn funded by the government.
As is now well known, China has adopted a “one child policy” and this is rigorously enforced in urban areas. At the same time, the expectation of life in China has improved by about 20 years since 1949.
These two factors in combination mean that China will face a very severe ageing population crisis in two to three decades time. Quite simply there will not be enough workers to support the growing population of retirees under the previous pay-as-you-go system.
The dependency ratio, i.e. the number of employees of working age for each retired person, will deteriorate more rapidly than for any other country in the world. This fundamental and inescapable fact means that it is essential for China to reform its pension welfare system.
At the same time as the dependency ratio inexorably worsens in China, the Beijing Government is now implementing a major policy change in order to restructure and corporatise the State Owned Enterprises.
The successful and profitable SOEs will be expected to list on one of China’s two stock markets, or on the Hong Kong Stock Exchange.
The unsuccessful and unprofitable SOEs will have to merge, close or downsize. Many individuals will be displaced or become unemployed for a lengthy period of time - the question then arises as to how will pensions and benefits be paid from defunct SOEs.
China has therefore had to recognise that the government must make major reforms to the whole area of social welfare and financial security in old age.
The broad plan is for employees and employers to take responsibility for a large part of the overall pension burden and for the introduction of a funded system of pensions.
In July 1997 the PRC Government passed a law concerning the changes set out above. Since the beginning of 1999 each province has to put in place a programme for the implementation of the new pension reform system in the light of its own circumstances.
In any society financial security in old age can come from some or all of the “three pillars” state, employer and individual.
China’s new system will fulfil the three pillar model as follows: a basic pension of 20% of average municipal wages will be paid to all retired employees; an individual account accumulating contributions of 4% of salary from the employee plus 7% from the employer will be established for each employee. The accumulated lump sum will then be converted into a monthly pension at retirement age by dividing the lump sum by 120; there will be the possibility of each employer effecting voluntary supplementary pension benefits. All employers in the urban areas (with the exception of 11 designated nationalised industries) will be required to pay a maximum of 20% of salaries up to a specified ceiling and each employee will pay 4% of his salary. The ceiling is currently three times the average wage in the relevant municipality, and the employee’s contribution will increase by 1% every 2 years until it reaches 8%.
Although the new unified pension system is a national law, it does not apply to the rural population. However, the urban population has perhaps 350m people and there are over 100m people who will have to contribute towards their pensions in accordance with the new law.
All of the accumulated pension assets will initially be managed on a local municipal basis, but will eventually be managed at provincial level. The employers’ contribution in excess of 7% of wages will be used to pay for current pensions and also to build up reserves for the future.
At present all of the assets have to be invested in deposits or Chinese Government bonds. However, it is recognised that in due course the pension money must be diversified into equities, mutual funds, real estate and perhaps infrastructure and international investments in the long run.
Clearly the growth of assets over the next several decades will be very significant.
A number of areas are not yet completely clear. For example, the transitional arrangements from the pension of 80% of final salary under the old socialist model towards the basic benefit of 20% of average wages plus the individual account has yet to be finalised. In addition there are questions concerning taxation which are far from clear as well as the transfer arrangements should an employee move from one part of the country to another.
In conclusion, China is making dramatic progress in moving towards an appropriate three-pillar system for the urban work force. In China there is a non-profit making organisation called the Employee Benefits Forum (EBF) where members are the multinationals employing significant numbers of staff in China, plus several Chinese ministries and universities. The EBF is undertaking invaluable work through high level dialogue with the Chinese Government.
Meanwhile, in Hong Kong, the Mandatory Provident Fund has just been passed by Legco after years of delay. One of the intriguing thoughts is that in the long run the MPF in Hong Kong must converge with the unified pension system in mainland China.
Long before that, there is a need to significantly develop the fund management industry in China to cope with the massive flow of funds. The good thing is that this capital should be available to finance the stock market listings of many of the viable SOEs.
Stuart Leckie is chairman of Woodrow Milliman China in Hong Kong and is author of “Pension Funds China”, published by ISI Publications