When Zhigang Yuan, professor of economics at Fudan University, looks at China’s pension system, he comes to one conclusion: “The math just doesn't add up.”
But there is good news. Speaking at the N.T. Wang Distinguished Lecture Series at Columbia Business School, Yuan, who is also a Lulu Chow Wang Senior Visitng Scholar, noted that in fewer than 20 years, China has once again done the remarkable on a gargantuan scale: It has rolled out a wide-ranging social security and pension plan that covers a collective 827 million people.
The bad news is the system will inevitably collapse under its own weight if something isn’t done.
It’s a familiar refrain to Americans worried about the future viability of social security, but China faces a basketful of its own challenges when it comes to pensions. To begin with, tens of millions of citizens remain outside the safety net. Overall, benefits are low, especially for urban retirees. Pensions are based on the average income of an area, which means that most low-income and rural Chinese can live reasonably comfortably in retirement, but middle-class and higher earners suffer. Yuan said a current Shanghai retiree, for example, receives about 500 RMB per month, or about a quarter of the minimum wage.
What’s more, China has no wealth-management mechanism in place to allow people to invest for retirement on their own. Perhaps most challenging, a generation restrained by the one-child policy means workers will be increasingly scarce to support the transfer of wages to retirees. (Note: China's government announced in late October parents will officially be allowed to have two children.)
Yuan offered three solutions to China's looming pension collapse: Achieve widespread demographic change to increase the number of contributors while decreasing the number of pension recipients, increase the tax on both employees and employers, and support pensions through investment, primarily from abroad.
China Tackles the Demographic Dilemma
In 2015, the Chinese workforce still outnumbered retirees by nearly three to one. But Yuan warned that figure will drop precipitously to a ratio of 1.2 to 1 by 2050, at least if urbanization does not pick up. Although it will not solve the pension problem, Yuan noted that urban employees, whose wages are higher than rural workers, contribute more in taxes. “Urbanization is the buffer to the pension system.”
Over the past 40 years or so, migrants flocked to pulsating metropolitan areas, pushing the urban share to about half the country’'s population. But “the rural population is no longer seeing enough improvement in their income to move to the cities,” explained Yuan, who said Chinese urban growth will be lucky to reach 0.5 percent this year.
That means cities are aging in place, with more of the cities’ high-wage earners retiring every year. Yuan said China’s cities need to restore their allure to attract more of the rural population.
But that redistribution of age groups still begs the question of how fewer Chinese workers will support greater numbers of retirees. An obvious answer involves raising the country's fertility rate, and Yuan advocates dropping the official one-child policy immediately.
Still, that solution will take at least a generation to kick in, since babies born today won't contribute wages for 15 years or longer.
Another demographic solution has already been explored in the United States and many developed countries: raising the retirement age. In China, women can retire at 55 and men at 60. With longer life spans on the horizon, the average Chinese may have a longer retirement than working life.
“The pension system will see a big improvement if the retirement age is pushed to 65 or the same retirement age is required for women and men,” he said. “There will be no problem with maintaining benefits if it is pushed to age 70.”
China Taxes Its Way Out
Today’s formula calls for employers to pay a 20 percent tax aimed at social security, while employees contribute 8 percent of their paycheck. Proponents of this solution argue the country can afford to raise the tax both on enterprises and workers.
But few governments are keen to raise taxes, especially in an economy that’s struggling to maintain its growth pace. Yuan argues that every 1 percent rise in the tax will result in a 1.46 percent decrease in enterprise profits and reduce the average employee wage by 0.6 percent. He does not expect this solution to gain much traction.
China Rejiggers the Way It Invests
“You need a very good economy when you have a lot of old people,” Yuan observed. China’s growth rate, of course, is slowing. More crucially, the country does not offer any kind of wealth-management system that would allow households to sock away retirement funds.
China is famous for its savings rate. But, with the real estate boom sputtering, most savings sit in non-interest-bearing bank accounts or find their way to often unproductive state-owned enterprises. Eventually that money makes its way to China’s massive foreign exchange reserves, a path that does nothing to cushion the impending pension crash.
Yuan said an overhaul of China’s financial system that allows investment in local and private enterprise could boost ROI since the productivity rate is much higher than with SOEs. The introduction of annuities or other retirement investment vehicles could give individuals a place to put their savings. “China needs to change from ‘financial for construction and development’ to ‘financial for wealth management,’” he said.
In addition, China needs its investors to look beyond its borders, where potential ROI is generally higher, insisted Yuan. The international push should come from both multinational Chinese companies and individuals.
Yuan expects the government to relax policies that inhibit foreign investment and allow for more productive use of investment. “Chinese people don't want to die poor,” he said. “There is a pressure to solve the pension problem.”