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«D I R E C T I O N S I N D E V E LO P M E N T Human Development Public Disclosure Authorized The Elderly and Old Age Support in Rural China Challenges ...»

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———. 2009b. “Guiding Suggestions of the State Council on Developing New Rural Pension Scheme Pilot.” Document 32 [In Chinese.] Accessed October 12, 2011 http://www.gov.cn/xxgk/pub/govpublic/mrlm/200909/ t20090904_33900.html?keywords=.

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Issues for the Evolution of theRural Pension System

Building on the national rural pension pilot, this chapter outlines issues for further development of the rural pension system over the medium term. As noted in the previous chapter, the national pension pilot is an exciting and positive development in expanding pension coverage to the rural population. At the same time, as the system evolves, opportunities for further adjustments in policy may arise to realize the government’s objectives over the longer term. This chapter lays out ideas as well as relevant international experience for Chinese policy makers to consider as they continue to refine the rural pension system.1 Several key issues

are addressed:

• The appropriate level of the matching subsidy on individual accounts and its role relative to the basic pension benefit with regard to incentives to participate in the scheme

• Individual account contributions and options for reducing the problem of low rates of return that have been seen in the urban funded system

• Whether the basic pension benefit in the national pilot should in time evolve into a “social pension” in which coverage does not depend on contributions 112 The Elderly and Old Age Support in Rural China

• The interaction between the funded portion of the rural pension system and the basic benefit in the longer term

• Prospects for eventual integration of rural pensions and urban “residents’ pension” schemes Pension System Design Principles Both in China and internationally, general agreement exists that an effective and sustainable pension scheme should have the following


• Adequacy. The benefit levels provided should be sufficient to perform the most basic function of promoting security in old age.

• Breadth. The system should provide basic protection to the vast majority of workers and retirees (that is, it should have broad coverage), offering the possibility of saving for retirement and life-cycle consumption smoothing, including individuals without stable income.

• Sustainability. The system design needs to be robust in the face of shocks and demographic trends (the latter is of special concern in China, as was noted earlier).

• Affordability. The government, individuals, and employers should be able to afford the system, both in a strict financial sense and, more broadly, at a level that does not inhibit labor market efficiency and the economic competitiveness of enterprises.

• Multiple layers. Although perhaps not as axiomatic as the preceding principles, international experience strongly points to the benefits of diversification of risks during the accumulation and decumulation phases of a pension system, thereby contributing to benefit predictability.

Issues Regarding the Individual Account The Matching Subsidy Offering a matching subsidy in the national scheme represents a major shift and recognition by authorities that incentives are needed to attract the participation of rural populations (a lesson that also has relevance for urban nonwage populations). The policy direction is also consistent with experience in many member countries of the Organisation for Economic Co-operation and Development (OECD) and in a number of middleincome countries, such as Brazil and Mexico, as discussed later in this Issues for the Evolution of the Rural Pension System 113 chapter.2 The Chinese literature has addressed the need for incentives, and the move toward public subsidies for rural pensions has generally been supported.3 Determining the appropriate matching rate by the public sector (and hence the fiscal cost of the match) is not straightforward; the performance of the new scheme should be closely monitored to select the most appropriate match. This determination will depend on several factors, including available resources, the elasticity of take-up against different rates of matching (see below for an illustration of this relationship), and the interaction of the contributory system with other forms of public transfers for the elderly. Despite widespread matching for fully funded pension schemes, virtually no robust evidence exists to relate matching rates with participation rates. Too low a match will create an insufficient incentive for participation. Too high a match will create a large fiscal burden and is poorly targeted with regard to poverty alleviation because everyone will benefit from the match, including those who are comparatively well-off. A related question is whether the match should vary as a function of the level of individual contributions or should be flat, perhaps based on some share of average rural income or urban wages in the area.

This may invoke a trade-off between equity and fiscal concerns on one hand and the relative strength of incentives to contribute more than the minimum rate on the other. The evidence on saving behavior in China suggests that concerns about incentivizing saving for retirement may be less acute than they are in many countries, thus strengthening the justification for focusing on the lower end of the distribution.

Although no strong evidence exists to suggest an optimal matching defined contribution (MDC) matching rate, simulations are instructive.

Palacios and Robalino (2009) estimate that an MDC approach can be cost-effective provided that (a) the take-up rate matching elasticity is not too low (below approximately 0.15) and (b) the individual contribution rates are not too low (below approximately 5 percent of average earnings).

Overall, the study posits that (a) matching rates that are too low could cost more in the long run than do social pensions and that (b) “too low” could be below 0.50 or even one to one (Palacios and Robalino 2009).

These findings must be interpreted with caution, however, because much of the evidence on matching comes from voluntary urban enterprise occupational schemes and the 401(k) experience in the United States (see figure 6.1). However, the findings raise questions about whether the current level of matching in the national rural pension pilot will be sufficient to sustain incentives for younger workers to participate.

114 The Elderly and Old Age Support in Rural China Figure 6.1 Take-up Rate and Matching Contributions 1.0

–  –  –

Source: Palacios and Robalino 2009.

Note: The take-up rate is defined by TR = exp(z)/(1 − exp(z)) where z = −3.45 + b*(0.05*m)/0.5, where b/100 is the take-up rate matching elasticity and m is the level of matching. In this example, 0.05 refers to the contribution rate expressed as a share of average earnings and 0.5 is the income of the plan member relative to average earnings. The parameter −3.45 was calibrated to reproduce a take-up rate of 3 percent when m = 0.

Apart from the total amount (or rate) of the match, a clear decision should be made on which level of the system should fund matching contributions for individual accounts. From an equity standpoint—and, in insurance terms, to promote a higher level of risk pool—the higher in the system the match’s source, the better. However, this decision must be balanced against both the practicalities of matching in an environment in which contributions will vary across and within provinces (and hence potentially complex for the national government to determine the matching funds or to demand a flat match that would result in variable incentives across space) and the objectives of the central government that may place more weight on the flat portion of a future scheme. In this light, the recommendation is that matching funds come from the provincial level or below, or possibly some mix of the two, with the province providing a “floor match” of some agreed-on flat amount and localities supplementing it if they are able and willing.

Another important question is whether to mandate that employers and collectives contribute to matching individual contributions in cases in which such an employment relationship exists. Although such Issues for the Evolution of the Rural Pension System 115 contributions may well be desirable in principle—and would provide closer parallels with the urban worker pension scheme—experience of previous rural schemes suggests that such a requirement may not be realistic.4 The rural pension pilot allows such contributions but does not rely on them to the degree that some schemes have in the past.

Investment and Management of Individual Accounts The rules governing the investment of accumulations will have important repercussions for the level of income replacement the individual account will provide. Experience thus far with rural and urban pension schemes in China suggests that investment of accumulations is a key vulnerability in a scheme’s ability to provide adequate benefits at retirement. At this point, an appropriate governance and investment management framework for rural or urban residents’ pensions is lacking. Low and volatile returns on contributions in rural pension schemes have been one of their greatest weaknesses to date, a vulnerability shared by China’s funded urban schemes. The People’s Bank of China requires investments to be made in one-year time deposits, which have generated low real returns over the past decade (on the order of 1−2 percent annually in the urban individual account system), far less than both rural and urban income growth. At the same time, policy makers are understandably reluctant to expose rural and urban nonwage populations to significant investment risk, given their general lack of financial sophistication and the underdeveloped state of governance.

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