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Pension Reform in China

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To be presented at the Conference onTable 1Pension Reform in China: Its Progress and Challenges Athar Hussain Asia Research Centre London School of Economics To be presented at the Conference on Financial Sector Reform in China September 11-13, 2001Pension Reform in China: Its Progress and Challenges Athar Hussain Asia Research Centre London School of Economics (Preliminary Outline) 1. Introduction The presentation consists of three parts. The first part (Section 2) reviews the current old age pension arrangements focusing on the changes in recent years and outstanding problems. Section 3 discusses the problems concerning the transition from the old to the new system. Section 4 analyzes the financial issues of the transition and the conditions for ensuring the financial sustainability of the system. 2. The Current Pension Arrangements 2.1. Three Component System The current Chinese pension arrangements consist of three components: ♦ A system that in principle covers most of urban employees. ♦ A system for government employees, armed forces and employees of public (but non-governmental) institutions such as universities and research institutes. ♦ A system for the rural population. The first two are mandatory, the first only in principle but not in practice. The third is voluntary. The principal characteristic of these schemes is that they are run completely independently of each other. They are managed by different institutions and are financed differently. However, they share one common characteristic: they are all highly decentralised. Leaving aside the arrangements for government and public employees, the first is largely organised at the level of cities and the third at the level of villages or townships (the lowest government tier in rural areas). The important point is that the units of organization are too small to provide sufficient risk pooling for a sustainable pension scheme. Both the urban (the first) and the rural (the third) are in transition in that their final design remains yet to be decided. 2.2. Pension System for Urban Employees Following a period of discussions and test trials, the principal foundations of the new pension system for urban employees were laid down in the 1997 State Council Circular. Compared with the old system, the new system introduced the following three important changes:♦ The old-age pension would cover the whole of the employed labour force, including the self-employed. Various industry specific pension schemes would be incorporated in the unified scheme. ♦ The responsibility for the operation of the pension scheme, including the keeping of employee records and the payment of pensions, would be transferred from units of employment (work unit in Chinese terminology) to government agencies. The process is known as “socialisation” in China and “government agencies” refer to the Ministry of Labour and Social Security (as the Ministry of Labour was renamed in the 1998 governmental re-organization) and its territorial subsidiaries, Bureaux of Labour and Social Security at the provincial and municipal level. ♦ The old-age pension would be multi-tiered. which after successive modifications is structured as follows: Table 1 Tier Pay-Out Financing Status A Defined Benefit, equal to 20% of the Average local wage PAYGO. Paid from a social pool financed by employer contributions with the government making up any deficit Operational 1 B Defined Contribution, dependent on accumu-lated reserve in the individual account Pre-funded, in principle but as yet not in practice. Financed jointly by employers and employees, From this year only financed by employee contributions. Operational in principle, but individual accounts are notional 2 Defined contribution, Employer sponsored Employer contributions Details not finalized 3 Voluntary Employee contributions Not finalized Note: PAYGO: Pay-as-you-go Effectively only the first tier (or pillar) is operational but its details are not fully finalized. The Pillar 1A (hereafter referred to as Pillar A), which is set at 20-30% of the local wage, is aimed at making sure that pensions cover a minimum subsistence for the locality. The exact percentage would depend on the number of years of contribution. The maximum of 30% would be payable to participants with contribution record of 15 years or more. Since 30% of the average wage may not be sufficient to cover a minimum subsistence, the assumption is that in most cases there would be at least enough in Pillar 1B (hereafter referred to as Pillar B) to cover the difference. Pillar B is an earnings-related component and tightly linked to the contribution record over the employee’s working life1. Pillar A has a re-distributive aspect to it in that all retirees get between 20-30% of the average regardless of their actual wage before retirement. The 1995 State Council circular that first introduced the new system set the goal of establishing a unified and socialized pension system by the end of 1999, a goal that has been realised in principle but yet not in practice. The two-pillar system (A & B) follows principles that have been tested and tried and tested in many countries. It is geared to fulfilling two principal aims of an old-age pension system on the benefit side: first, preventing 1 The arrangement for the financing of 1A was changed at the end of 2000. The earnings-related component is to be financed entirely from employee contributions with all employer contributions going into the social pool. There was in addition also a voluntary employer-sponsored supplementary pension.poverty amongst pensioners and, second, helping to maintain a living standard in retirement that conforms to earnings over the working life. The system also addresses the long-term financing issue by introducing the pre-funding of what eventually would be a larger component of the pension. The rest of the presentation goes on to discuss particular aspects of the system. 3. The Benefit Side and the Transition Period The benefit side of the new system (consisting of Pillars A & B) would not raise any major problem if it concerned an entirely new pension system. That is, a system which covered only new entrants to the labour force or employees with a long enough remaining working life to qualify for a full pension. The qualification is 10 years of continuous employment or 15 years’ total employment with periods of


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