A Macro Analysis of China Pension Pooling System: Incentive Issues and Financial Problem

Over a decade-long of pension reform in China has became much more critical in recent years. Problems of pension reform have started to reveal rapidly and pension reform pace has apparently slowed down. One sign of this is the decision made by the government to suspend a sell off of state-held shares in listed companies to fund the pension shortfall in October of 2001. The pension system built on 1995-reform platform has run into three major problems. First is a huge amount of unfunded pension liabilities inherited from the old system, and second is fragmentation of pension system has increased difficulty to finance pension liabilities. Third is a lack of a capital market to invest pension fund for a higher rate of return. These problems were rooted in the beginning of the pension reform and crippled effective operation of provincial pooling system over the years. And related resulting effects are rising pension deficit, accumulating notional individual accounts, increasing enterprise noncompliance and evasions, declining program participation, continuing financial burden of state-owned enterprises (SOEs) and a fast increase in SOEs retirements, and increasing weakness in central government fiscal conditions. This paper focuses on the incentive problems under the provincial pooling arrangement and aims to understand on a macro-level how adverse effects of the incapability of separation the new system from the old pension liabilities have complicated pension reform process and generated a series of unintended reform problems. The study uses aggregate data from national statistical sources and published data by domestic analysts to analyze incentive issues of state and nonstate sector in the pooling system. The paper answered the three questions. How did individual accounts become notional in the recent years? Why are there widespread noncompliance and evasions among state-owned enterprises toward pension contribution? Why is the non-state sector representing only a small share in provincial pooling pension program? The evidences indicate that current provincial pooling system is in a vicious cycle, financial problems are serious and public confidence in the system is low. Declining share of state sector and low share of non-state sector in contributing to pension program at local levels show that government's approach of expanding pension coverage to solve pension fund shortage at least in short term is ineffective. The government is facing a stark dilemma. Incapable of separating the old pension liability from the current pension financing system has led to an accumulation of unfunded individual accounts. The unfunded pension system and lack of capital accumulation of pension fund have shaken the confidence of current contributors of state enterprises and scares away new contributors from private and foreign invested enterprises. However, limited coverage, low program participation and widespread noncompliance and evasion reduce its pension revenue collection, increase financing gap and in fact double the difficulty to finance the liability, and that would further scare away new contributors too. Caught between the rock and a hard place, the government will have to figure out the approach and structure a reform path that follows pension reform sequencing. First to solve the old pension liabilities through pushing for financial capital market development or by ensuring some sort of central government responsibility. Second, to build the public confidence in the success of the pension system and gain the cooperation and willingness of pubic and private interest in the system. With that in mind, the pension reform outcomes will be both credible and financially viable.