MEETING THE CHALLENGES OF AN AGEING SOCIETY Asia-Pacific Finance and Development Centre Shanghai, October 17, 2007

Pension Reform in China: The Need for a New Approach Presentation by Vivek Arora IMF Senior Resident Representative, Beijing. The views expressed in this presentation are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

Pension reform: outline Pension reform experience in China Pension reform experience in China Remaining problems Remaining problems Proposal for a new approach (based on Dunaway and Arora (2007)) Proposal for a new approach (based on Dunaway and Arora (2007))

Population is aging rapidly…

…increasing the dependency ratio

Ageing comes at relatively early stage of China’s development…

…so ability of workers to finance elderly is limited. …making pension reform all the more urgent. …making pension reform all the more urgent.

Pension reform experience “Iron rice bowl” until 1990s SOE reforms. “Iron rice bowl” until 1990s SOE reforms. Pilot experiments with employee contributions. Pilot experiments with employee contributions reform: objective to cover all urban enterprise workers reform: objective to cover all urban enterprise workers. 2-pillar system: social pension + individual accounts. 2-pillar system: social pension + individual accounts.

Pension reform experience since 1997 Broad urban coverage not attained (less than 50%). Broad urban coverage not attained (less than 50%). Rural coverage very small. Rural coverage very small. Table 1. Contributors to the pension system EmployeesEnterprise workers In millions In percent of urban employment Sources: China Statistical Yearbook (2006); China Labour Statistical Yearbook (2006).

Remaining problems in the pension system Reform bogged down over “legacy costs” of transition from old system. Reform bogged down over “legacy costs” of transition from old system. Fiscal costs will continue to rise. Fiscal costs will continue to rise. Decentralized, fragmented system prevents effective pooling. Decentralized, fragmented system prevents effective pooling. Pilot projects: address some of the problems, but experience mixed Pilot projects: address some of the problems, but experience mixed

A New Approach Separate into 2 problems: Separate into 2 problems:  (1) set up new pension system for all workers, and  (2) deal with “legacy costs” separately (central government, local government). Unlike the current approach, fiscal costs will diminish steadily over time.

A New Approach (contd) Basic structure: 2-pillar system already established by State Council. Basic structure: 2-pillar system already established by State Council. Finance with payroll tax. Parameters (contribution rate, etc.) in line with social objectives and viability. Finance with payroll tax. Parameters (contribution rate, etc.) in line with social objectives and viability. Social pension: fully/largely funded; individual accounts: fully funded. Social pension: fully/largely funded; individual accounts: fully funded. National pension administration. National pension administration.

A New Approach (contd.) Assets managed professionally, managed by central government. Assets managed professionally, managed by central government. Separate social pension and individual accounts assets. Separate social pension and individual accounts assets. Initially invested offshore. Initially invested offshore.

Conclusions Ageing society urgently needs new pension system with broad coverage. Ageing society urgently needs new pension system with broad coverage. A way forward: separate out legacy costs, and move quickly to put in place new system. A way forward: separate out legacy costs, and move quickly to put in place new system. It is feasible, and the right time is now. It is feasible, and the right time is now.

References Based on Steven Dunaway and Vivek Arora, “Pension Reform in China: The Need for a New Approach” Working Paper (IMF/WP/07/109). __ and __, “Pension Reform: Cutting the Gordian Knot,” in China Economic Quarterly, 2007 Q3, Volume II, Issue 3 (pp ).