Insuring China’s future

The National People's Congress (NPC) is about to consider a major overhaul of China's social insurance laws. But the NPC will have to overcome two formidable barriers – the financial drag of legacy pensions from the pre-1997 economy and the local administration of a pension system for an increasingly national workforce, says Robert C. Pozen, chairman of MFS Investment Management.

Consider:

In the communist era of the "iron rice bowl," state-owned enterprises regularly promised pensions to workers, who made no pension contributions.

In 1997, as China moved toward a market-oriented economy, it adopted a two-tiered payroll tax to finance social security (primarily in urban areas).

Employers now should contribute 20 per cent of wages to support a defined retirement benefit, and employees also are now required to contribute 8 per cent of a worker's wages to a personal account, with a variable retirement benefit based on investment returns.

The responsibility for paying social security benefits rests with local governments – provinces, cities or townships – which also collect the payroll taxes. Unfortunately, this isn't working, says Pozen:

Governments are using much of the employers' 20 per cent payroll taxes to pay pre-1997 legacy pensions to workers who never made any contributions.

Many local governments have even paid legacy benefits with some or all of the 8 per cent in payroll taxes contributed by workers, which are supposed to be invested in personal accounts.

The solution is to pre-fund retirement benefits by holding the contributions in separate trusts and investing them. According to researchers Yaohui Zhao of Peking University and Jianguo Xu of Duke University, China could reduce the employer portion of its payroll tax to below 16 per cent if it pre-funded the social security system; such a reduction would broaden the participation of Chinese employers in the system.

Source: Robert C. Pozen, Insuring China's Future, Wall Street Journal, August 6, 2007.

For text: http://online.wsj.com/article/SB118636068580788836.html

For more on International Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=26

FMF Policy Bulletin/ 14 August 2007