Analysis: Pension Fund Running Astronomical Deficit: Current Workforce Contributing Without Assurance Of Future Pension Benefits

China’s pension fund, put into place in the late 1990s, has been running on an astronomical deficit for the past few years, and with the nation's aging population approaching retirement soon, Beijing is facing a tough funding challenge.

When the current workforce, which is 69.2 percent of the total population in 2012, according to Forbes, begins to retire in a few years, they will be cashing in on virtually nothing -- their contributions having been used to foot the bill for current beneficiaries who contributed little to nothing to the fund.

Also, given China’s rapidly aging population, the current support ratio of three contributors to one beneficiary will sink to one contributor supporting one beneficiary. It all adds up to bad news for the current workforce.

According to the 2012 Chinese Pension Fund Development Report, in 2011 alone the deficit reached 76.7 billion yuan ($12.38 billion), and the total deficit since 2011 is more than 2 trillion yuan.

Fund Too New to Keep Up With Aging Population

China’s social security fund, as it stands now, was not established until 1997. Prior to that, private sector workers, now over half of the work force, along with farmers, were not covered at all. The current fund, while a step in the right direction, is not functioning as planned, for two reasons.

First, because the policies surrounding the current fund were not put into place until the late 1990s, many retirees who are now beneficiaries in the new scheme did not contribute to the fund at all, and others contributed for only a few years before retiring. Today’s workforce, by contributing a nominal part of their salaries into their personal retirement accounts, is footing this bill. What this means, unfortunately, is that when this workforce begins to retire in a few years, they will have no fund to draw from. The funds being credited into their personal accounts amount to empty promises. In essence, one generation’s contribution is paying for two generations’ benefits. As a result, China’s pension reserve in 2011 was only 2 percent of its total GDP in that same year, according to Dai Xianglong, chair of China’s National Council for Social Security Fund. By comparison, Dai said, Norway’s pension reserve amounted to 83 percent of its GDP; Japan's, 25 percent; and the United States', 15 percent. This only accounts for basic pensions. Unlike China, most Western countries also have other forms of pension plans, including private insurance. With those, the United States’ pension reserve in 2011 was $17.9 trillion, more than its GDP of $15 trillion that year.

The second cause is China’s solution to its population crisis. By enforcing the one-child policy beginning in the late 1970s, China’s population is now under better control, but in the meantime the population has rapidly aged. Usually, if more than 7 percent of a society is made up of people over 65, that society can be considered old, a cutoff China surpassed in 2000. Its rate of aging is approaching that of the developed countries, but the difference is that these countries became prosperous before they became old, whereas China has aged before its economy has had the chance to develop. This factor heavily influences the pension fund’s support ratio of contributors to beneficiaries, which in turn affects the fund’s income-to-payout ratio. Currently, in cities and towns, the support ratio is around three contributors to one retiree. In 2050, that ratio would fall to one contributor supporting one retiree.

Government Contribution, Civil Servants, And Fund Investment Not Doing Their Part

There are a number of additional problems due to China’s policies that exacerbate the deficit situation.

First, China’s expenditure for social security amounts to only 12 percent of its total expenditure, according to Lin Yi, the dean of the Center for Insurance and Social Security Studies at Southwestern University of Finance and Economics, compared to the 30 percent to 50 percent developed countries usually allot for social security. Many middle-income countries contribute more than 20 percent of their total expenditure.

In addition, China’s pension fund adheres to a double standard that is neither fair nor functional. Public servants, a group with the best job security and benefits in China, do not contribute to the pension fund but are entitled to far higher pension payouts than retirees from the private sector. In fact, this group claims one of the highest pension payouts in the world. The math once again adds up to more people benefitting from the plan than contributing to it.

Third, the majority of China’s pension fund is sitting in the bank gaining meager interest that at best keeps up with the CPI. It would be wise to invest to ensure the fund is not actually decreasing in value due to inflation.

Could China Ask Its People to Work for a Few More Years?

Delaying the retirement age has been suggested as a possible solution to the deficit crisis. At first glance, that looks attractive. Generally, Chinese workers retire at the age of 60, early compared to many developed countries. Recent modeling by pension experts suggests that for every year of delaying retirement, the pension fund would gain 4 billion yuan in pooled income; its payout would decrease by 16 billion, making up 20 billion of the deficit. With this framework in mind, if the retirement age is delayed by three to five years, the pension fund deficit would be made up in a few years.

Unfortunately, this is a simplified, overly optimistic view. In the first place, delaying the retirement age has other ramifications aside from the effect on the pension fund. Some estimates put the yearly number of people who go into retirement at 3 million, others as high as 6 million. If these people all stay in their jobs for an additional year, then 3 million to 6 million younger workers will have to go jobless for the same year. In addition, as China’s economic growth slows from 10 percent to 7 percent per year, the country is losing roughly 3 million jobs, which adds to a whopping 6 million to 9 million jobs per year -- and there are already 14 million unemployed in China. Sacrificing employment opportunities, which affects economic development, to make up the pension deficit may create more problems than it seeks to solve.

In addition, delaying retirement affects workers differently. Civil servants, for example, whose jobs are not physically taxing and which have lucrative benefits, would be more likely to welcome the delay. Factory workers, however, usually begin to lose efficiency beginning at the age of 50 for men, 45 for women. They find it difficult to work, or find work, past this age, creating a gap between the end of their working years and the time when they could collect from the pension fund. It would clearly be unfair to increase the number of gap years this group must endure.