Reforming the Chinese Pension System

Editors’ Note: this paper discussing the sustainability of China’s pension system in the face of changing demographics was originally commissioned by the Paulson Institute at the University of Chicago. The author explains how China could save its pension system by ending its one-child policy and raising the retirement age for women to match men’s.

China has made great strides in expanding pension coverage for its population over the last fifteen years. Before 1997, state-owned enterprises (SOEs) provided their workers with so-called legacy pensions without regular contributions. Since 1997, China has established a contributory pension system, which covered over 280 million urban workers in 2011. More recently, China has established a pension scheme for rural workers; by the end 2012, the rural pension scheme had grown to cover roughly 460 million individuals.

The “Chinese pension system,” as currently constituted, actually has four main subsystems. The Urban Enterprise Pension System (UEPS) covers urban workers, who in practice are mainly employees of large private enterprises and SOEs. The recently established Rural Pension scheme allows rural workers to make voluntary contributions to individual accounts that are subsidized by local and central governments. The structure of Rural Pensions is similar to the structure of the new and much smaller pension plan for non-employed urban residents (though this smaller plan is sometimes seen as a subset of the UEPS). Finally, the civil service pension system covers most employees of government agencies and related governmental bodies—without contributions required from these workers.

Yet these pension programs face major and urgent challenges. Some of these challenges are the result of underlying economic and demographic trends in China. Other challenges derive from the design of the Chinese pension system, particularly its decentralized administration.

Organized into three parts, this policy memorandum describes the current state of the Chinese pension system, as well as its shortfalls, and then offers some suggestions to help address these issues. First, it will discuss the key challenges facing the Chinese pension system: the aging of the population, the fragmentation of the system, the lack of advance funding, and the low level of investment returns. Second, it will examine the causes of each of these challenges. Third, it will put forward several proposals to address each of these challenges. In each of these three main parts, the memorandum will focus primarily on the UEPS portion of the Chinese pension system.