How to spread the pension cake
THE subject of mandating a retirement protection scheme for Hong Kong will soon top the Government's domestic agenda. The way Hong Kong decides to go on this issue will have widespread implications for the territory's future economic and political development. At issue is not just a new public programme but the choice of a new social order in the run-up to 1997 and beyond.
Despite political pressures to emulate a central provident fund or a Western-style pay-as-you-go system, Hong Kong would do well to follow a more efficient path for promoting social welfare, by choosing a decentralised programme based on greater individual choice, market competition, and prudent government guarantees.
Originally, mandated social security plans were mainly intended to provide financial benefits to retirees that were tied to their contributions during their working life. This principle has been abandoned by the present, pay-as-you-go programmes in the United States and other Western countries. These programmes are now in serious financial trouble, and most face the spectre of financial collapse early in the next century unless they are thoroughly reformed. Can Hong Kong afford to ignore the lesson? The problem with pay-as-you-go (PAYG) systems is that they are defined-benefits plans, where mandated benefits to retirees and contributions by workers are dictated by the political system. The financial crises threatening the viability of these systems have resulted from legislation of generous benefits to retirees while the population continues to age.
In the US, the system's support ratio - the number of people in the age group 20 to 64 relative to those of 65 and over - has declined from 7.1 in 1950 to 4.8 in 1990, and is projected to fall to 3.3 in 2020. The numbers for Britain, France, and Germanyare even more alarming. The same trend is also apparent in Hong Kong.
Moreover, recent research suggests that the PAYG system itself can exert adverse effects on fertility, private savings, or productivity growth. The latter are of particular concern since even a minor reduction in the real growth rate, say 0.36 of one percent, in an economy like Hong Kong can result in an accumulated real loss of HK$195 billion in 10 years - enough to build a new airport.
Some Asian countries have chosen to establish a central provident fund (CPF) rather than a PAYG system. The CPF is essentially a forced-savings plan based on mandated individual contributions that are deposited in individual accounts and managed by the government. The latter feature has predictable consequences. In Singapore, the CPF has been used as a source of borrowing to subsidise foreign investments and to finance government projects.
The mandated contributions per salary income for employees and employers rose to a peak of 25 per cent each in 1984, and dropped to 15 per cent and 23 per cent in 1989 for the two groups respectively. Even so, it is still an exorbitant level of forced saving. The monopolised public system has already been criticised for yielding low returns and slowing economic growth.
One may question whether government intervention in the market for pensions is justified in the first place. Why mandate workers to contribute a significant amount of their hard-earned dollars to a government-managed savings and insurance scheme when there are effective free market alternatives? In Hong Kong one-third of the labour force, in addition to public service employees, is already covered by voluntary pension plans, and private savings appear to be quite high. Furthermore, the time-tested ''family insurance'' system remains a powerful means of proving private security.
Government intervention may be defended, however, as a means of casting a wider social safety net to protect workers who are victims of unexpected economic hardships, or are otherwise incapable of fending for themselves. This concern is compounded by theageing of the population. The percentage of people 65 and over in Hong Kong has risen from 6.2 in 1979 to 8.7 in 1991, and is projected to reach 12.1 in 2007.
Regardless of justification, any mandated system should be fair to contributors and exert the least adverse effects on the economy. The Community-wide Retirement Protection System (CRPS) recently proposed by the Government is an attempt to reach these objectives. The proposed system is based on pure actuarial principles that leave little room for politicians to legislate excessive benefits or high taxes, and allows for competition by banks, insurance companies, employers, and even employee groups. It leaves in place all the extant old-age social insurance allowances, and provides for the private schemes to be phased into the new system.
Compared with the PAYG systems of Western countries, CRPS avoids these funds' financial hazards and much of their potential deleterious effects on economic growth as long as the mandated savings rates are not excessive. Compared with the Singapore-style CPF, the system removes the government from the business of managing insurance and investing in private capital markets. And its reliance on competition among providers should work for the benefit of the covered workers.
The main controversial aspect of CRPS concerns the absence of government guarantees. Workers who are forced to subscribe to a retirement protection scheme have the right to expect the government to guarantee a fair return on their compulsory contributions. At the same time, unqualified government guarantees of the system's financial viability may be abused by irresponsible insurance companies that would make inefficient or excessively risky investment decisions.
This problem is exacerbated by the HK monetary system. The full linkage with the US dollar implies that interest rates on ''safe'' long-term government bonds, such as the 30-year US treasury bill, yield negative real rates of returns at current inflationrates. Since there is practically no local corporate bond market there is a need to rely on the equity or real estate markets, or on foreign bonds. The relative riskiness of these assets intensifies the moral and political dilemma concerning guarantees to workers.
None of the shortcomings in the proposed scheme is unavoidable. An interesting example is the privatised social security system in Chile. Established in 1981 following the practical collapse of the Chilean public system, the new system offers similar elements of competition and choice as in CRPS. In addition, the government provides two types of guarantees. First, it mandates a minimum real rate of return on deposits to be achieved by the private insurers. Companies that fail to meet these required returns from their normal or set-aside profit funds can lose their business altogether, in which case the Government's second-type guarantee kicks in, providing a minimum level of real pension benefits to qualified workers.
The performance of the privatised system in Chile has been outstanding, providing a 12.6 per cent inflation-adjusted rate of return from 1981-1990. And the pensions awarded so far under the privatised system have exceeded those in the old system by 43 per cent.
An effective alternative for Hong Kong would be to mandate the competing insurers to create a reinsurance pool that would be financed by the companies themselves. Both CRPS, adequately amended, and the Chilean system provide far better alternatives to Hong Kong than the Singapore-style CPF. Should the Government adopt a CPF, it would be managing huge investment funds accumulating at the rate of over HK$20 billion per annum. It is neither the relative advantage of the Government nor its responsibility to actively manage such funds, and there is no evidence anywhere that it will be able to yield rates of return exceeding those of private insurance companies.
Hong Kong should not try to buck the emerging trend toward decentralised, market-oriented systems in countries that have become disillusioned with their public systems. By reinforcing the elements of choice and competition in CRPS with prudent guaranteesfor covered and uncovered workers, Hong Kong would be able to combine concern for the elderly with continued prosperity and economic growth for all of its citizens.
The author is a visiting professor of economics at the Hong Kong University of Science and Technology and a leading professor of economics at the New York State University in Buffalo