Actuaries have long talked about China's 1-2-4 equation: one child supporting two parents and four grandparents. (And it doesn't get better adding a spouse because that just doubles the problem to 2-4-8.)
"The way to look at this is that, within one generation, China's population will be very elderly," Stuart Leckie says. "And if we compare that with other countries like Sweden, Germany and Japan, which have elderly populations today, these countries became rich before they became old, whereas China will become old before it becomes rich. (See dependency ratio chart opposite page.)
The Hong Kong-based pension expert collaborated with colleague Yasue Pai on their just-released Pension Funds in China – A New Look (ISI Publications) and one can imagine Hollywood easily turn it into a pretty convincing horror flick. "The speed of change is particularly noteworthy," Leckie says. "There is a pretty good chapter in the book on the demographics with all sorts of scary numbers. Basically, what was happening in the urban sector in the '50s, '60s and '70s after the founding of the People's Republic in '49, [was] you typically worked for a state-owned enterprise for more or less your whole working life and then at 60 or 65, you got a pension or salary continuation of 80% of your previous salary."
It was Utopia sustained, unfortunately, by numbers pulled out of the air. "That was a hugely generous formula – no country, and certainly not China, can give its whole working population 80% final-salary pensions," Leckie says. "So as we get into the '80s and '90s, there was tremendous pressure on the SOEs to get profitable and downsize."
The SOEs, hardly lying, told the central government they could not keep carrying all these thousands of pensioners on their books. They had to be relieved of the so-called legacy pension costs, or sink. "So in the early '90s, there were a number of State Council directives, the most critical one being Document 26 – in 1997 – which said China was going to move towards a three-pillar model, which is pretty much in line with what the World Bank advocates." Document 26 says, in essence, that the whole urban population of China should get a pension of 20% average local earnings which, as Leckie notes, "is a long way south of 80%." China's three-pillar policy called for a state "social pool" pension (which employers pay into) and an individual account pension (accounting for 11% of salary, with employers typically chipping in 3% and employees 8%) along the lines of Hong Kong's mandatory Provident Fund (MPF). Supplementary pension plans sold by private sector insurers made up the third pillar.
"Now here most individuals are paying about 8% of salary, which is quite a high contribution rate, plus their companies are paying about 20%," Leckie says. But payments vary: in Shenzhen, which has a comparatively young population, employer contributions are on the order of 13%-14%. "In other cities with much older populations already, companies are paying in the high 20s or even over 30% of wages towards pensions."
"It varies city by city, depending on your own finances and population demographics, but it means that China is trying to have what they call basic "social pool" pensions, plus individual account pensions depending on your own earnings, plus supplementary pensions (from private sector schemes) on top," he says. "The idea is to give a certain amount of tax relief to supplementary pensions, so for those who can afford and want extra benefits, there will be a framework to do that."
But this isn't half the story. Someone somewhere is undermining China's best efforts to get a viable pension system going – and time is running out.
Example: Investors are enticed into cities with invitations to slip through loopholes to avoid the pension bite. One trick: hiring workers on a casual part-time basis, rather than as full-time employees, and skipping out on paying the extras.
Example: Employers, pleading poverty, can get left off the pension hook, making only partial contributions or none at all.
Example: The state itself dips into the pool to pay for whatever problem happens along – like handing out cash to the destitute of China's restructuring economy. Worthy though their intentions may be, every dip makes China's shambolic pension system more of a shambles. "If people are destitute, so be it," Leckie says. "But the government should [pay] them unemployment benefits or social security assistance – what they're doing is just fudging the problem."
There is a whole lot more fudging going on, as excerpts from the following interview with Stuart Leckie makes plain.
Q: The three-pillar model sounds like a move in the right direction.
A: Is it a good thing for China to have a three pillar model? Yes, definitely. But the way the rules [work] it is not really sustainable. Some companies which claim to have no money to pay in are basically let off the hook or they may be two or three years in arrears. The other problem is men are supposed to retire at 60, female office workers at 55, female factory workers at 50 and what happens in many parts of the country is that people retire much earlier, particularly in Dongbei, where they have huge restructuring unemployment problems and people go on full pension as early as the age of 40 because it's a way of hiding unemployment. So it's good from the point of view of hiding your unemployment problem but pretty awful for pension finance. So there are all sorts of abuses – it's not on a reduced basis, which is what happens in the West [where early retirees get reduced payments and late retirees enhanced payouts]. In China you get the same amount no matter what age you retire, so that's screwy. The retirement age is far too early in China. Age 60 was fine when people only lived to sixty-three and a half. Now people are living much longer and China like every Western country has to start increasing its normal pension age. That is highly political – you have to increase it gradually over 20, 30 years.
Q: How do you resolve the problem of unemployment and establishing a pension system?
A: From the pension point of view, they've got to enforce existing rules, get people to join the system, get people to pay contributions in full and on time and get people to not collect their pension until they get to the regular retirement age. So the first thing is to get people to operate within the current rules. The second thing is the rules have to be modified. For example, with an individual account, you're accumulating up to 11% over a period of several decades and when you get to age 60 or 55 [in the case of females], you divide the lump sum in your account by 120 to get your monthly pension – and that is far too generous a factor. It should be maybe 120 if you retire at 65 or 70 but a much bigger number for early retirement.
Q: Certainly if you retire at 40.
A: Yes, but there's another big problem. That system based on Document 26 has been in existence for about three years. It gradually became apparent that the scale of the payments to people already drawing a pension was so big that the monies going into the first pillar were just insufficient – so what Liaoning and other provinces were doing was just helping themselves to money in individual accounts. This is like the US government taking money out of your 401K plan to pay existing pensioners. So you had this problem of individual accounts. [Former Premier] Zhu Rongji got onto this in Liaoning and from mid 2001, he forced the province to put real money into its individual accounts. I was involved in that as part of a project for the Asian Development Bank and that's described in the book. Liaoning was subsidized [inasmuch as it] was allowed to pay a smaller tax amount to central government as long as they stopped robbing individual accounts to pay existing pensioners. But there are problems following on from that – even though there is now real money in individual accounts in many provinces, the way money is invested is restricted: basically, put into bank deposits and government bonds.
Q: So that's another issue – how the money is invested.
A: Exactly. Typically, returns are 2%-3% [which] doesn't even match last year's price inflation. For any pension system to work, if you're taking money out of people's salary, you want to be able to invest it and get a rate of return that's higher than your rate of salary increase. That's a huge issue for China – how it's going to invest pension assets. And the great anomaly here – the great dichotomy – is if the economy is growing at 8% or 9%, how come returns are so lousy? Somehow or other, they're going to have to get money into real assets, whether it's equities, funds or property, to give themselves a chance of making real money over the next two or three decades. That in itself is very challenging because in order to go into any investment that's volatile – and, obviously, you have to accept some volatility if you're going for higher returns – you have to have a unitized system like a mutual fund and China is just not geared up for that administratively. Basically, every time you see a problem and think of a solution, another problem opens up.
Q: Was Liaoning a bigger problem because of its heavy concentration of SOEs?
A: Liaoning is very interesting. It's actually the only province outside of the four city provinces where more than 50% of its population [42m] is actually classified as urban – it's about 53%. And, of course, it had all the smokestack industries – iron, streel, coal, heavy machinery, et cetera. And conditions varied enormously. In average urban pay, Dalian was the richest city – the 2003 figure was RMB1,100 a month. If you go to a place like Anshan, a one-employer town, the average pay was RMB400. That was in one province – never mind going to Western China; in the same province the factor was three times.
Q: What else to say?
A: Well, with Document 26 in 1997, Beijing really wanted pensions to be the responsibility of the provinces. But by the end of 2000, as part of what was going on in Liaoning and other places, they'd set up this National Social Security Fund, which was meant to be a fund of last resort. This is now about RMB160bn, US$20bn. It gets money either from the ministry of finance and the lottery, but mostly from 10% of the money raised from every international rights issue or IPO. So this gets lots of attention from fund managers in China and the international community. Sooner or later, they're going to start international investment as well as domestic investment [to earn better returns].
Q: What does Beijing mean by fund of "last resort"?
A: There have been the usual conflicting statements by officials. What they're saying is they're setting up this fund because they know China's population is aging and this fund is going to become very big and powerful and it will be there when the population gets old. But are they going to give grants or loans to Liaoning? As of now, they haven't distributed any money because once they do, you can bet as soon as you give 10 yuan to one province, every other province will be wanting handouts. Is it good to have the fund? Yes. But do we know what exact purpose it will be put to? The answer is 'no', so it's very unsatisfactory. Again, the money is not under trust – it's not like the Canada Pension Plan under trust, it's just there. If tax revenues are down or any other problem comes along, they can just dip into it.
Q: How about using the fund as some sort of incentive to encourage provinces to clean up their pension systems?
A: That would be a neat way of doing it. The whole issue of governance of pensions is hardly started – in terms of where the money is invested, disclosing results, which managers have done well, what are the benchmarks, annual accounts, external audits, total transparency – all this has got to happen.
Q: Hong Kong's Monetary Authority and the GIC in Singapore have turned to the banks to manage funds – what's happening in China so far as outsourcing goes?
A: You've got three things at the moment – the central fund in Beijing, the provinces looking after basic old-age pensions (plus the state individual account pensions), and then you've got the private sector – the fund managers and insurance companies which sell and manage supplementary private sector benefits. One of the things we talk about in the book a lot, after China entered the WTO, there were many examples of foreign JV fund management and insurance companies who would love to think they're going to get a big slice of 100m people in China having supplementary pensions at some stage.
Q: Would there be any move for foreign players to do more than supplementary pensions?
A: Well there has been all sorts of loose talk – about the provinces and the state individual account systems – this 11% thing – why don't they outsource that to professional managers? Well, that would be very exciting for private sector fund managers and that might happen but it could easily take 10 or 15 years. Again, there are all sorts of problems – you can't have every province employing its own team of experts on bonds, equities, cash management, et cetera, because these guys are highly skilled and highly paid and that would not sit easily with your average provincial social security bureau.
Q: But that would argue all the more for outsourcing, no?
A: Well, I would guess some outsourcing down the line. I think more people in China recognize the problem. The subtitle here could almost be Pensions in China: Crisis or Opportunity. There could be huge opportunities for fund managers, both domestic and Western, also insurance and trustee companies, banks, consultants and so on. Or, if China doesn't manage to get, say, 50% of its pension liabilities funded within 20 years' time, then they may not win this race, because there's going to be this 'tsunami' of elderly people really taking an ever increasing share of total resources in China.
Q: How is Shanghai doing?
A: Shanghai has a comparatively elderly population right now, so its contribution is 5%, so it's higher than 20%. One of things Shanghai did a few years ago was that when people were paying in their employee and employer contributions for the state pension system, the Shanghai government hit on this novel idea of trying to force companies, especially foreign companies, to pay extra contributions for supplementary benefits so they were forcing people to have supplementary benefits and they were collecting the money and investing – not very wisely, according to some reports, but they were getting some sort of modest return on it. Beijing stopped Shanghai forcing companies from making supplementary benefits but quite a number of companies, now that they got into the habit, voluntarily pay extra contributions to Shanghai Social Security Bureau for what is really a private sector activity (since it should not be a government activity at all).
Q: Pensions today are not only lower, compared to the old 80%, but they have to go much farther in a market economy.
A: That's right – the two big things when you think about retirement are medical and housing – so how does that get factored into the equation. Pensions are a big thing – if China doesn't get this right, there are pretty horrendous implications for China, not to mention the rest of the world.