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Deutsche Bank: China pensions face crisis

By United Press International   |   Feb. 17, 2006 at 12:24 PM
FRANKFURT, Germany, Feb. 17 (UPI) -- China's pension system is facing a demographic time bomb -- the consequence of the one-child policy -- which could seriously damage its future economic prospects, says a new report from Deutsche Bank's research department.

"Low retirement age compounds the demographic problem. China is graying fast but at a very low income level. Low effective retirement ages will see the working age population already reaching its peak between now and 2010 and will lift the old-age dependency ratio much higher than conventionally thought," says the report.

In effect, China is getting the demographic profile of an advanced industrial country with a mature welfare system, but with an economy still clambering out of developing status. And repairing the existing pension crisis is going to cost a minimum of 7 percent of its gross domestic product.

The DB survey lists three structural challenges in today's system that need to be addressed. The first is that the pension system is burdened by a large amount of legacy debt (i.e. unfunded liabilities from the old pension system).

The second is that decentralization of economic planning has led to fragmentation and a lack of transparency; and the third is that China's "immature capital markets make it difficult to find suitable investments with high returns."

The report argues that the best course of action to improve the system's viability is "a combination of increased coverage for the pay-as-you-go pillar and a higher rate of return on investment for the capital accumulating in individual accounts. Government action is needed to improve the incentives to contribute to the system, the report stresses, capital markets need to be liberalized and China should widen the available pool of financing by allowing foreigners unmitigated access to domestic capital markets."

When China's pension system was introduced, it was part of a cradle-to-grave security system provided by state-owned enterprises to their employees: the so-called "iron rice bowl," the report says.

"This system, however, became unsustainable when the enterprise reforms started in the 1980s and large pension liabilities began to weigh on a company's competitiveness and ultimately on its solvency. Promises of pension payouts had been rather generous, while funding had been neglected. The lack of portability of pension claims became a major obstacle to the restructuring of state-owned enterprises and to boosting labor mobility, which was already impeded by a system of household registration which in part also determines entitlement of welfare," the reports adds.

"Adding to these problems is a demographic shift towards fewer children which is quite normal when a country's standard of living rises. However, in the case of China, this shift has been reinforced by the so-called 'one-child policy' instituted in 1979, which limits a majority of couples to just one child. As that generation is now entering the workforce, the traditional system of children caring for their parents and grandparents in their old age is likely to face significant strains," says the Deutsche Bank paper.

"Basically, one working child will need to be able to provide for two parents and four grandparents while at the same time saving for his or her own retirement," the report warns. "Pressures on state coffers will rise since everybody entitled to any state pension payouts will be sure to claim them, while possible old-age poverty for those whose children cannot provide them with a decent living could become a socially disruptive force which the government needs to address."

China's demographic challenge is worse than conventionally thought, the report says, adding that China is graying fast but at a much lower income level than countries like Japan and Germany, which are also aging fast but at a much higher income level.

"China's demographic development has started to resemble that of more mature economies: It is facing a rapidly aging society; according to the latest U.N. projections, between 2005 and 2050 the median age in China will jump by 12.2 years to almost 45 years, compared to Germany's increase of only 5.3 to 47 years," the report says.

"However, China's population is aging at a much lower income level (and thus at a much earlier stage of economic development) than industrial countries. Today, China is still relatively poor, but its median age is not far from the international average," the DB report adds. "Other countries have also reached a similar age bracket as China's today of between 32-34 years at a much higher income per capita and thus at a later stage in their economic development."

This rapid aging of China's population has a significant impact on its labor pool. The working age population as a portion of total population will peak around 2010 at 72.2 percent according to the conventional definition (i.e. 15-64 year-olds as a percentage of total population) and will then steadily decline to 60.7 percent in 2050 according to U.N. projections. This problem is exacerbated by China's currently low retirement age, which is 50 for women (55 for those in managerial positions) and 60 for men, and some early retirement schemes allow men to claim pensions as soon as the age of 50.

"According to the conventional definition, in 2050, China would have 39 elderly persons per 100 working age persons, but taking into account the earlier retirement ages, the figure would rise to 79 retired people for 100 working age persons," the DB report calculates.

"This is a higher ratio than for Japan under the conventional definition and a clearly unsustainable ratio for a pay-as-you-go social security system," the German bank report concludes.

"The transition from the current pension system towards a more financially sustainable one will be a daunting task and will require significant government resources," the report adds, noting that an International Monetary Fund estimate suggests the minimal transition cost of shifting to a viable pension system would be 7 percent of GDP in 2003, or roughly $100 billion -- without counting local government obligations.

© 2006 United Press International, Inc. All Rights Reserved. Any reproduction, republication, redistribution and/or modification of any UPI content is expressly prohibited without UPI's prior written consent.
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