Social Security and Pension Reform in China By Martin Feldstein Presented by Ian Easton For Prof. Wu March 3, 2008

Abstract  China had legislated mixed social security pension system  System has defined benefit pay-as-you-go and investment-based defined contribution portion  Paper seeks to analyze economics of two systems in Chinese context while calculating advantage of investment-based portion

1. Introduction  Reform of existing unfunded pension system critical  Enterprise reform  Sound public finance  Retirees well-being  China already beginning to develop investment- based system of individual accounts for urban workers, especially those in State-Owned- Enterprises (SOEs)  Yet important decisions ahead

2. Principles of Social Security Pension Design  Pros and cons of PayGo versus funded, investment-based systems  Funded better long term, lowers costs and taxes  PayGo tempting short-term, but problem as demographics change over time  World-wide trend towards funded system away from PayGo  General academic discussion of possibilities

3. Potential Chinese Gain from Investment-Based System  Estimates 7% growth in real wages and 12% return on capital for coming decades in China  Makes funded system much more attractive than PayGo  Transition fears are wrong, with great long-term gains expected

4. Current Pension System in China  Since 1995 most cities and provinces have adopted 2- part plan for workers in SOEs  One: Employees who work 40 years get 25% of regional average wage  Funded by payroll tax equal to 9% if 3:1 worker-retiree ratio  Two: Employees and enterprises contribute 10% of wages to individual accounts managed by authorities (majority of money to buy bonds with minority in bank savings accounts) sometimes channeled into local projects as bonds and banks can see negative growth  Estimated to be equal to 35% of final year earnings

4. Continued  Broadening allowable set of investment options could increase returns w/ big benefits  Credible promise of pension could impact savings rates, lowering them considerably  Unfunded PayGo would lower household saving rates more rapidly, but would have no pension savings with which to replace it

Critique  Author overlooks or is unaware of tremendous backwardness of PRC system  Corruption dangers (i.e. Shanghai pension schemes)  Massive challenges ahead for China’s investment environment (i.e. Stock Market)  Assumes capitalistic system, reality is very much otherwise  China still a Leninist, communist country and will likely stay so for the foreseeable future  Gov’t economic intervention, no private property, Terrible legal environment, lack of transparency

Facts (CNN Special Report) Facts (CNN Special Report)  PRC saves roughly 50% of GDP  In 2007 China exports valued at 1.2 trillion USD  In 2007 China saw 75 billion USD in foreign investment  U.S. economic downturn will slow demand in China  Chinese domestic demand cannot make up gap  Citibank representative estimates two decades needed for China to create true domestic demand-driven economy

Key Questions for Discussion  Some SOE employees enjoy benefits, what if enterprise goes private?  What about majority of Chinese? Where does their retirement come from? This paper only speaks to a small minority of population  With fewer children, and little gov’t help, will savings rates stay high in coming years?  Big Q: Will China stay stable? History suggests it will not, but strong currency reserves and state security system suggests it will