With the ratio of retirees to active workers rising, China faces ever more severe problems in funding pensions benefits for retired workers.
The looming crisis in China's pension system is beginning to attract more attention in the Western press – most often when retirees at state-owned enterprises stage protests to demand the payment of overdue benefits. But such scattered cases of labour unrest may be distracting policy-makers from a major element of the problem: real benefits per retiree have increased substantially since 1997, further inflating the country's huge overhang of unfunded pension liabilities.
The ultimate source of the problem is China's highly decentralised pension finance arrangements, under which each employment unit (typically, a state enterprise) pays its own retirees' pensions out of pocket. The system worked well enough during the prereform era of guaranteed employment, but state enterprises have become steadily less profitable since the 1980s. More recently they have shed labour on a large scale, partly through a wave of early retirements following the Asian financial crisis of 1997-98.
Decline in worker ratio
As a result, the ratio of current workers to retirees has fallen sharply since the mid- 1980s. At the end of 2000, statistics from the Ministry of Labour and Social Security showed one retiree for every three 'employees in urban units' – which excludes migrant and informal-sector employees, who typically do not contribute to the pension finance system in any case.
The worker-to-pensioner ratio varies from province to province, although crude numbers can be misleading. Shanghai reported 1.49 workers per retiree, the most unfavourable ratio in the country. This is a predictable consequence of the city's early dominance in manufacturing, but one that should be easily manageable given its current strong economic growth.
Likewise, the high proportion of pensioners in Xinjiang (1.82 workers per retiree) partly reflects a large contingent of retired workers from the military-controlled Xinjiang Production and Construction Corps, whose benefits are funded independently from the civilian economy.
The same is likely true of Beijing, where retired central government employees enjoy their own, relatively reliable pension system. Urbanised, industrial regions such as Liaoning and Chongqing, however, face much more serious problems in paying benefits. Not surprisingly, most of the unrest involving unpaid pensioners has arisen in these rustbelt provinces.
Although current trends are clearly unsustainable, the government's efforts to reform pension finance have so far been unsuccessful. An ambitious pilot project introduced in 2001 in Liaoning aimed to convert the existing 'pay-as-you-go' system to a fully funded one, in which contributions from current wages would be set aside to fund pension payments to the same cohort of workers in future decades. But the huge number of retirees in Liaoning has defeated the purpose of the reforms, forcing provincial authorities to use these reserves to pay current benefits.
Since few state enterprises have set aside funds for pension benefits (many are deeply indebted in any case, and have few liquid assets to spare), the long-term cost of paying future pensioners represents an implicit government debt. The exact size of the liability is something of a mystery, in part because the system itself is so disaggregated. But while a World Bank study in the mid-1990s pegged the present value of unfunded pensions at 50 per cent of China's GDP, more recent estimates have been substantially higher. Perhaps predictably, the most alarmist valuations come from commentator Gordon Chang, author of The Coming Collapse of China, who argues that the true figure may be 100 per cent of GDP or more.
One little-noted factor in this uncertainty is the strong growth in real per capita pension benefits in the late 1990s – a surprising trend, given the financial weakness of the system. Between 1996 and 2000, average benefits per pensioner rose by more than 43 per cent after adjusting for inflation. The reasons for the rapid increase are unclear, but growth in pensions has outpaced growth in wages or GDP by a wide margin. (Real wages for 'staff and workers' rose even faster over the period, by 48 per cent, partly due to repeated salary increases for civil servants since 1998).
The inertia effect
One possibility is an 'inertia effect' following the large indexation increases granted during the mid-1990s, a period of high inflation. In 1995, for example, urban consumer prices rose by 16.8 per cent year-on-year while average pension benefits increased by 18.6 per cent, leaving pensioners with a relatively modest real gain of 1.5 per cent. In successive years, however, China's economy shifted rapidly into deflationary mode, while pensioners continued to receive double- digit increases in nominal benefits – producing dramatic gains in pensioners' real income and in the real burden of pension liabilities.
Moral hazard may also be a factor, however. With many weak state enterprises relying on 'soft' bank credit to cover their current expenses, there may be little incentive for enterprise managers to restrain the growth of pension spending. In fact, enterprises that are already technically insolvent may have good reason to treat pensioners (and current employees) as generously as their creditors will allow them.
Despite recent reforms to the financial system, China's banks are under strong pressure to provide loans that promote 'social stability'. Funding pension increases may be one of the easiest expenses to justify on these terms – suggesting that the twin problems of bad bank debt and unfunded pension expenses may actually be two sides of the same coin.