Pension reform can help China realise its vision of economic transformation

Erik Tollefson says government ambitions to foster a consumption-driven economy and inject stability into the stock market will rely greatly on a better-managed pension system

PUBLISHED : Friday, 11 September, 2015, 9:18am
UPDATED : Friday, 11 September, 2015, 9:18am

China faces an increasing number of economic policy challenges. Indeed, as Chinese markets have continued their vertiginous spasms, the lack of a long-term investor base, coupled with reduced government support, has resulted in further losses. At the same time, a slowing economy has raised concerns that China's necessary transition from an investment-based economy to one based on consumption may be stalling.

At first glance, these problems may seem tangentially linked, especially with roughly 2 per cent of China's population investing in the stock market. A policy solution does exist, however, that inherently addresses both problems: pension reform.

China's pension system suffers from a legacy of unfinished reforms. Indeed, while Deng Xiaoping and other leaders aggressively moved to open the economy and develop the manufacturing sector, the pension system remains a relic of the mixed state-market system.

Pension reforms, however, will not be a silver bullet for China's financial and economic woes. They require a long timeline

Currently, three main pension schemes exist. The civil servant pension system, which was established shortly after the People's Republic was founded, is a central-government funded scheme that offers generous benefits. Private-sector workers and citizens in urban areas have their own city and county-level schemes primarily funded via personal and employer contributions. Finally, many rural citizens did not have a formal pension scheme until reforms were announced to establish a rural pension system in 2009.

This patchwork system has given rise to a number of problems. First, different schemes have different contribution and pay-out regulations; this asymmetry reinforces economic inequality, and particularly inequality between rural and urban areas.

Second, although the pension system boasts substantial assets in the aggregate, roughly 3.5 trillion yuan (HK$4.2 trillion), it does not play a substantial role in the country's equity markets. This dynamic was clearly observed in June and July as retail investors entered and subsequently exited the market amid a dizzying array of margin calls. Yet, in other equity markets, pension funds play a key role not only by maintaining ownership in key national companies, but also in stabilising the market by purchasing and holding shares in a downturn.

Finally, the lack of a comprehensive pension system may contribute to precautionary saving. China boasts a high savings rate compared with many other economies. While the high savings rate is due to many factors, including the lack of (stable) investment opportunities outside China, the piecemeal pension system is arguably a main reason older individuals and working households save more.

The country's ageing demographic profile also means it can expect a decreasing number of workers who can support the country's elderly population.

Beijing has introduced reforms to help bridge the gap. The State Council announced early last year that the urban and rural pension systems would be combined by 2020, attempting to standardise benefit payouts and pension administration.

The government also introduced an important reform last month to allow the nation's fund to invest in equity markets, a step that should increase returns and provide greater market stability.

Pension reforms, however, will not be a silver bullet for China's financial and economic woes. They require a long timeline, and their implementation is made more challenging still in China by the relations between the central and local governments. Indeed, Beijing's willingness to tackle the complexities may serve as a broader proxy to undertake critical economic reforms.

Erik Tollefson is a freelance economic analyst