China: The End of Ideology?

Will China be able to shed much of its ideology in order to provide for elderly citizens?

December 6, 2001

Will China be able to shed much of its ideology in order to provide for elderly citizens?

Currently, there are six workers in China for every person over 60, the current retirement age. By 2030, there will be only 2.3 workers per retiree. How will the country be able to support its retirees with so few workers?

Raising the age of retirement can help some of its problems. Politically, this is never easy to do, but it clearly is the right thing to do as Chinese life expectancies rise along with wealth. However, the Chinese have determined that just raising the retirement age is not enough.

That is why formerly communist China has welcomed the cooperation of a conservative U.S. think tank, the Cato Institute in Washington, D.C., in its policy planning on the issue. Cato is the leading U.S. intellectual promoter of state-mandated private savings.

A conference on “China’s Pension System: Crisis and Challenge,” held in Beijing in November 2001 was the latest in a series jointly sponsored by Cato and the China Center for Economic Research of Beijing University.

Their cooperation shows the shrinking role that ideology plays in the global economy. The global economy rewards what works, not what is correct according to one or another fixed view of how the world should work.

China is launching its pension reforms at a lucky time. It does not yet pay formal pensions to its farmers, who make up three quarters of its work force. But it must start a system for them soon to maintain their political support.

Before 1996, China did pay pensions to government and university workers and to employees of its state owned enterprises in urban areas. “China knew its demographic future and it knew that a simple tax-based system is unsustainable,” says Michael Tanner of Cato.

China took the first steps toward such a system for its urban workers in 1996. Reforms are still in their infancy. As a matter of fact, one provincial pilot project aimed at converting pensions at state-owned enterprises has already run into difficulties.

The enterprises are losing more money than budgeted and have fallen in arrears on their contributions to the forced saving system. But these are transition pains. China should still provide the giant model needed to propel forced private savings into dominance as the retirement system for the entire world in the 21st century.

The basic problem with Western social democratic state retirement systems is that they are hand-to-mouth. That is, they take taxes from the hands of working-age citizens — and pass them directly to the mouths of elderly retirees. Others call the system “pay as you go.”

This mechanism works provided the number of workers in a country grows as fast as the number of retirees. Under those circumstances, the financial burden levied on the workers and production forces to pay for retirement benefits in the economy remains the same.

But in all societies that have grown wealthier over the last century, birth rates in fact have dropped. Dropping birth rates promises a long-term solution to overpopulation. But it also means that a country’s entire population is aging. There are relatively fewer citizens entering the work force each year in the country in proportion to the growing number of retirees.

This means ever-fewer working hands are available to be taxed relative to the ever-larger number of non-working mouths that now have to be fed.

Most Western democracies have tried to avoid facing this ultimately unavoidable issue by raising taxes on workers to contribute higher shares of their current income to social security and by postponing reform.

Those taxes are now so high in many places in Europe that economic growth is slowing. If the present trend of over-taxation for benefit financing continues, at some point, growth will stop entirely — and, after that, income levels will begin to shrink.

What does all of this imply for developing countries? They essentially had two choices — follow the established pay as you go model prevalent in Western Europe and the United States — or to back out of the established patterns. Developing countries that adopted the first approach — using fixed state retirement systems — have handled the problem with outright deceit.

They were not rich enough to raise high enough contributions from workers to pay for the benefits promised to retirees. In essence, they had to default on their promises for retirement benefits by simply printing currency, launching wild inflations, and the like. The ensuing inflation, of course, reduced the real value, or purchasing power, of the payments promised to retirees.

This practice obviously eased the burden on government finances, but treachery of this sort has produced constant citizen outrage and political turmoil.

The Chinese did not fall for such unsound social and financial practices in 1999. In fact, when the British colonial government attempted to launch a Western “pay-go” model in the last colonial days of Hong Kong, Chinese officials labeled it a “costly Euro-Socialist model” and vetoed it, says Tanner.

Instead, the Third Party Plenary Session of the 14th Central Committee in 1996 initiated a two-part system for China. One part is a central pool of funds to provide a basic fixed benefit.

The second is a personal pension account for each worker dependent on his earnings and the earnings of his account. Employees of state owned enterprises are converting to this system. Most workers in all private companies must join.

Contributions of both employer and employees go into each set of funds, which are now invested by The People’s Bank of China. (The government continues to pay promised benefits to those already retired.)

Both funds in theory are always fully funded, containing enough investment assets actuarially to pay off all future obligations to retirees. This type of funding directly links future benefits, especially the variable personal accounts, to the future ability of the Chinese economy to produce those benefits.

This contrasts to the pay-go Western systems that promise all benefits no matter what the economy does — and no matter how unrealistically high taxes must go.

Surprisingly, modest personal savings systems were being tried in the developing world long before Western experts even began promoting them. Malaysia established one for a limited number of workers in 1951, and India and Indonesia both had small pilot programs.

But Singapore has created the standard Asian model. It features a single fund, built by contributions from employers and workers, managed solely by the Singapore Government Investment Corp. Its investments are secret. But since the Singapore government always runs a budget surplus, the funds, presumably, are invested mostly in Singapore private securities and Western bonds and private stocks.

The Cato Institute urged China to go a step beyond Singapore and adopt the Chilean system. Chile, with 20 years’ success, sends all its personal savings contributions directly into individual accounts owned solely by each worker.

Private investment managers compete with each other to offer good returns to workers under strict, risk-reducing rules laid down by the government.

This way, workers have gotten on average better retirement benefits than other systems offer, and the Chilean economy has benefited from a competitive investment process that stimulates efficiency and overall rates of growth.

What’s the moral of this entire story? Developing countries are widely considered to play catch-up in the global economy. They are importing technologies and free-market systems that were pioneered in Western countries and Japan. But in one vital social area, providing pension benefits, the developing world may be bound to lead the way.

December 6 , 2001