Pension reform in Asia will benefit more than just its greying population

Andrew Sheng says such funds can help stabilise capital markets with a focus on the long term

PUBLISHED : Friday, 22 November, 2013, 7:41pm
UPDATED : Wednesday, 28 September, 2016, 8:44am

The relaxation of China's one-child policy accepts that demographics play a major role in a country's economic fortunes. Asia's fast growth was built on favourable demographics, a growing labour supply at relatively cheap rates, and open economies. But in many parts of Asia, as the population begins to age rapidly, there is genuine concern that Asians may grow old before they become rich.

Last year, nearly 450 million people or 11 per cent of Asia's population were 60 years and over. By 2050, these numbers will more than double to 1.2 billion, or 24 per cent of the population, not far behind projections of 27 per cent in North America and 34 per cent in Europe. The old-age dependency ratio will rise rapidly in Japan, Greater China, Singapore and India.

Pension funds can take long term equity positions that invest in future green growth

There is, however, a major difference between being old in Asia and being old in the advanced countries. In 2011, private pension funds in nine Asian economies had assets of US$663 billion, or only 5.3 per cent of gross domestic product in 2011, way below the OECD average of 70 per cent of GDP.

In the past, when families were large, the young were the "pensions" of the old, because it was taken for granted that the young would care for the old. Today, when many families have only one or two children, this is no longer possible.

In fact, the reverse is happening. In Japan, single children in their 20s still living with their parents are called parasite singles. A single Chinese child today is showered with gifts and love from six adults (four grandparents and two parents). But when he or she becomes an adult, one cannot take care of four to six old ones.

The lack of pension coverage or under-funding of pensions is a serious problem in Asia. Even in rich countries like Japan, low interest rates mean many pensioners face a lack of income from their financial assets for adequate retirement purposes. There are several good reasons why governments should reform pensions as a priority. First, there is a question of adequacy of retirement income. Second, to be fair, more people should have pension coverage. Third, pension funding should be sustainable.

There is a further reason why pension funds play a major role. They can contribute significantly to capital market development, more efficient long-term resource allocation and national financial stability. It is no coincidence that during the May/June market shocks, due to the fear of reversal of US quantitative easing, the markets that had the least exchange rate and interest rate volatility were those with deep pension or provident funds.

Domestic pension funds could easily buy up local bonds and foreign exchange sold by the foreigners when there is capital outflow. Countries without such large institutional funds had to rely on the central bank to be the major defender of exchange rate and interest rate stability.

Because pension funds take the long view, they can contribute to long-term strategic investments in growth sectors such as infrastructure, green technology, financing for small and medium-sized enterprises and social enterprises. This will reduce over-reliance on short-term bank financing or foreign financing that is inherently subject to liquidity risks and market volatility.

Furthermore, effective pension management also plays a major role in improving corporate governance, because active pension funds can vote against bad management.

The lack of development of long-term institutional investors, such as pension, insurance and long-equity investors, means Asian financial systems are overly dependent on the short-term banking system.

Indeed, the current global financial structure is essentially "long debt and short equity", meaning it is biased towards increasing debt and not capital.

There are several reasons why leverage in the world is getting worse, not better. First, the higher the leverage, the greater the return on equity, but at higher risk. Corporate owners and managers with share options can easily increase their returns by borrowing from banks, rather than raising capital, since it is neither cheap nor easy to raise capital from the stock market.

Second, interest on debt and write-offs on bad debt is tax deductible; investments in equity, or equity losses, are not.

The leverage game is the main reason advanced markets got into trouble. It is also why I am not convinced that quantitative easing is a solution to the global crisis. It fundamentally tries to solve an excess debt problem with more debt. Unfortunately, pensioners and savers are the ones who suffer from near-zero interest rates and the potential bursting of asset bubbles.

A stable, more equitable Asian financial architecture needs to "long equity and short debt". More pensions for more people will make for a more equitable society, and pension funds can take long-term equity positions that invest in future green growth.

As Tennessee Williams said: "You can be young without money, but you can't be old without it."

Andrew Sheng is president of the Fung Global Institute