China s s Pension Reform: Implicit Pension Debt and Financing Options Dr. Wang Yan Senior Economist The World Bank Ywang2@worldbank.org
Outline of the paper I. Motivation and Objectives II. Transition issues: concepts III. How to finance transition? International experience. IV. China s Financing Options: simulations V. Conclusions
I. Motivation and Objective China s population is aging fast. Un-funded pension liabilities have become a current threat to fiscal sustainability. Lack of social safety net hinders SOE reforms. Objective: Estimate China s Implicit Pension Debt and transition cost Introducing international experience on how to finance the transition cost Compare various financing options: using general taxation, issuing debt, or using proceeds from selling state assets?
2044 2046 2048 2050 2042 2040 2038 China s aging population (Mn person) Population dynamics 1200 1000 800 600 15-64 65 400 200 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2033 2037 2036 0 40% 35% 30% 25% 20% 15% 10% 5% 0%
Pension systems: a Typology Defined Benefit-publicly managed, or payas-you-go; e.g. SS system in the US Defined Benefit-privately managed, such as employer sponsored pension funds Defined Contribution-publicly managed, e.g. Provident funds in Singapore Defined Contribution-privately managed, e.g. Chile and Latin America Model Multi-pillar systems, proposed by WB
II. China s s Pension System Reform Pre-1995 system Urban- and Enterprisebased PAYGO Experiments with social pooling started in 1982 In 1986, started pooling at the municipal level; Individual contribution started in 1991; moved to a multi-pillar system From 1995 to 1997 Doc #6 proposed multi-pillar system but two plans Local governments were allowed to select, causing high degree of fragmentation Low and variable coverage Inadequate pooling High contribution rates ranging from 10 % to 30 %
China s s Current Pension System Doc#26 stipulates A multi-pillar system Social pooling at provincial level with a small pillar 1 (17% contribution and 20% replacement) Individual accounts with contributions from workers (8%) and firms (3%) Supplementary pensioncommercial insurance Actual Situation (2001): Funding problem is acute: In 00, MoF transferred RMB 20 bn yuan to local pools Individual accounts are largely notional System fragmented: full provincial pooling in 5 provinces/special cities. Social pooling incomplete Coverage narrow and uneven
Current Features of pension system Characters of China s Public Pension System, 2000 Sector State and collective enterprises Other urban formal sector Government and public institutions Cove rage- Empl oyee Cover age - retiree Wage / Labor income Contribution rate (employee plus employer) Replac ement rate* 100 100 81.2 22.5 71.5 62.5 100 81.2 23.3 70.0 25.4 17.6 79.8 23.3 94.5 Source: China Labor Statistics Yearbooks 2001, and Wang and Zhai s estimation *Note: Replacement rate is defined as the ratio of pension benefits to average wage. 8
III. IPD and Transition cost: Concepts Implicit Pension Debt is a stock concept. It is the sum of PV of pension benefits for current pensioners plus the PV of pension rights earned by current workers, if the system were terminated today. IPD represents direct and implicit liabilities of gov t. Transition cost is a flow concept arising from funding gap created when expenditures to pensioners must continue but contributions have been diverted to individual accts. They represent the need to payoff the IPD over time. No termination date.
Table 1 Implicit Pension Debt (IPD) a and Pension Reform Countries that have IPD as % Reforming IPD as % Size of New Not Reformed b of GDP Countries c of GDP Public Pillar d Senegal 27 El Salvador 35 LO Venezuela 30 Mexico 42 LO Cameroon 44 Bolivia 48 LO Congo 30 Argentina 86 MED Brazil 187 Kazakhstan 88 LO Turkey 72 Chile 100 LO Albania 67 Australia e 115 MED China 46-71 United Kingdom e 184 MED Netherlands e 188 MED Ukraine 141 Denmark e 189 MED Switzerland 189 MED United States 113 Sweden 210 HI Japan 162 Hungary 213 HI Germany 157 Uruguay 214 HI France 216 Poland 220 HI Italy 242 Croatia 350 HI Canada 121 Source: James 1999. Estimates on China are based on Wang et al 2001 (71%) and World Bank 1997 (46%).
Financing the transition: International Experience Ways to finance transition Reduce IPD by downsize the old system or retain a PAYG pillar Find special resources such as privatization proceeds; or, expand coverage /reduce evasion Use general taxation and borrowing What has China done? Retain a small PAYG pillar and do a partial switch Use an extra 4 % payroll tax and expand coverage Borrow funds from individual accounts When in deficit, use local or central gov t tax revenues
Size of IPD and Transition cost Estimation of IPD If system terminates in 1994, IPD would be 46% of GDP (World Bank 1997) Our estimation: if system terminates in 2000, IPD would be 71 % of current year GDP, based on our baseline assumptions Estimates of Transition cost 0.3-0.6% of GDP annually (Wang et al) 0.5-0.6% of GDP (Ma and Zhai 2001) 0.36% in 2030, 0.75% in 2050 and 0.89% in 2075 (Dorfman and Sin 2000)
Transitional Cost / Fiscal Resources needed Transitional Costs - Including Public Institutions (10 Bn Yuan, 2000 price) 100.0 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 2000 2003 simulation results from Exp. 2.2 2006 2009 2012 2015 2018 2021 2024 2027 2030 2033 2036 Deficits in pillar 2 for middle-aged workers Ratio to GDP 2039 2042 2045 2048 Figure 4. Transition cost defined as deficits in pillar 2 for middle-aged workers, including public institutions and government workers. 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 (%)
IV. China s s Financing Options Limited reform is not an option since there are severe constraints for raising retirement age Using general tax revenues. Our paper shows using personal income tax or VAT tax would be conducive to equitable growth. Issuing debt: there is some but limited room for debt finance, as current debt/gdp ratio is relatively low, at around 42% Selling state assets: corporatization proceeds could reach RMB 100-300bn, or 0.1-0.3% of GDP depending market condition. But.. A lot remain to be done.
Reform and finance the transition Cost with taxes Simulation set 1: No Reform: contribution rate:8% of wage by employee and 20% of wage by employer; and replacement rate 60%. Exp 2.1Multi-pillar, as in SC Doc 26 (1997) Exp 2.2, 2.1 and expanding to public org Exp 2.3 SC Doc 42, 2000, 20% from employer Exp 2.4, a proposed new system: gov t pays the transition cost by VAT tax Pillar 1: 13% from employer, 20% replacement Pillar 2: 3%+8%, reserves managed separately. Exp 3.1 and 3.2: After injecting fiscal resources for transition, expanding coverage and raising retirement age.
Simulation Results: No Reform 40 Pension Fund Annual Balance (10 Bn Yuan) 20 0-20 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050-40 -60-80 -100-120 -140-160 Base Case Exp 1.1 Exp 1.2 Exp 1.3 Figure 2. Pension Fund Annual Balance without major reform Source: Wang et al 2001.
After proposed reformchanges in GDP over baseline 4.0 Percentage change of GDP relative to base case 3.5 3.0 2.5 2.0 1.5 Exp 2.4 Exp 3.1 Exp 3.2 1.0 0.5 0.0 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 Figure 5. Change in GDP in experiments 2.4, 3.1 and 3.2 Source: Wang et al 2001.
Cumulated reserves in Pillar 1 2500 Reserves in Pillar 1 (10 Bn yuan) 2000 Exp 2.4 1500 Exp 3.1 1000 Exp 3.2 500 0 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 Source: Wang et al 2001. 18
Summary Current pension system is not sustainable Using taxes to finance transitional cost is good as required tax hike is modest. VAT tax may be used The pension system will become financially sustainable if tax revenue is used to finance the transition, and funds in individual accounts are allowed to accumulate and managed independently, without being diverted to finance the implicit pension debt. Utilizing the proceeds from corporatization to fund the transition cost allows us to combine the pension reform with SOE reform, and is conducive to capital market development