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Dilemmas of Reform in Jiang Zemin’s China, by Andrew J. Nathan, Zhaohui Hong, and Steven R. Smith (eds.)
8. Financing Unemployment and Pension Insurance
Since 1978 when economic reform began, China’s economy has been growing rapidly. From 1981 through 1990, the annual average increase in gross domestic product (GDP) was 10.1 percent; from 1991 through 1995, the average increase was 11.6 percent. 1 Although reform has improved considerably the average standard of living, it also has profoundly changed the country’s industrial structure. State-owned enterprises (SOEs) have declined in productivity while other types of enterprises (private, collective, and foreign investment) have grown dramatically. Among the enterprises registered at township or higher government levels, SOEs accounted for 72 percent of total output in 1985, but only 47 percent in 1995. During the same period, the total share of output by enterprises with foreign investment, including investment from Hong Kong and Taiwan, jumped from almost zero to 16.5 percent. 2
Implications of such a sharp change in economic structure go far beyond the boundary of economic reform. As Guoguang Wu pointed out in Chapter 2, “political legitimacy is shifting from the communist revolution and revolutionary ideology to the regime’s economic performance.” The welfare system discussed in this chapter reflects one of many aspects affected by the change of political legitimacy. Under the old socialist regime, financing welfare programs was built into the central planned economy. The principle was very clear: everyone contributes to the society based on the state’s economic plan, and the state, in turn, should take care of the elderly and arrange full employment. When the political legitimacy shifted, financing policy for the welfare system changed completely, which resulted in a substantial loss for the middle-aged and older generations.
It is clear that many problems in the current welfare system are rooted in the old planned economy. On the one hand, SOEs complain that they cannot compete with other enterprises because they must shoulder the heavy burden of social programs. Hence, SOEs cannot reform their basic structure without an effective social system to take over their responsibility. On the other hand, an effective social-safety system cannot be established because of the high cost of setting up such a system. This paradox is a typical phenomenon when the financing policy is no longer consistent with the communist ideology. According to Xinhua News, in Shanghai, for every 100 yuan paid to an employee by SOEs, the SOEs must pay 46 yuan for fringe benefits, including pension contributions, unemployment insurance, health insurance, housing-fund contributions, and public transportation restructuring. 3 Management of the government and SOEs in Shanghai is the most efficient in the nation. If SOEs in Shanghai can barely support the social programs, other SOEs across China may not be able to afford such a system at all.
There is no simple solution for reforming social-safety programs. SOEs can afford neither the old system, which is the financial responsibility of each individual enterprise, nor the new system, which is managed by pooling resources at the level of the city or province. After investigating China’s current pension policy, a World Bank team concluded that the current pension system is not viable in the long run. The system’s dependency ratio will rise to 76 percent by 2050, while the sustainable contribution rate is 45.9 percent. 4 In most developed countries, the employers’ contribution to a pension is less than 20 percent of total wages and salaries. In the United States, employers’ total contributions to all social security programs was 13.35 percent in 1995. 5 In comparison, the cost of maintaining the current level of social programs would bankrupt the SOEs.
China’s social programs consist of four major components: pensions, unemployment insurance, health care insurance, and welfare programs. Because each program has its own characteristics, it must be separately analyzed. This chapter discusses the basic problems of financing unemployment and pension insurance in China’s urban areas. It focuses on three aspects of each program: (1) its social nature and reasons for the government’s interference, (2) the impact of the economic transition from a planned to a market economy, and (3) the trade-off among different financing policies and the nature of income redistribution.
Unemployment Insurance
SOE layoffs are the result of economic reform that replaces a planned economy with a free-market system. The planned economy was based on the theory of Karl Marx, which maintains that, in an uncontrolled capitalist system, workers are exploited because they cannot earn enough to purchase and/or maintain the tools and raw materials for their livelihood. As a result, they depend on financial support from the wealthy and must accept payment that is less than their own contribution to their products. In theory, the socialist state provides all citizens with an equal opportunity of working (universal employment), and thus provides everyone with social insurance through universal employment. The theoretical basis of a socialist planned economy is to let the state plan resource allocation, including human resources. Hence, in theory, unemployment does not exist in a planned economy. But since planned economies cannot compete with market economies, most socialist countries have begun economic reform and introduced market mechanisms. As a result of market adjustment, unemployment appears.
Establishing an unemployment insurance program cannot solve the unemployment problem in major industrial cities. In many such cities, SOEs are laying off thousands of employees (10 percent to 30 percent of the total SOE labor force). 6 Because SOE layoffs are so extensive, simply pooling SOEs with other enterprises to finance unemployment insurance is equivalent to asking other enterprises to rescue the SOEs. Also, in the planned economy, much of the profits of SOEs have been disbursed to other parts of the country via the central government. Now, these SOEs are facing market pressure and need significant adjustment to survive. Should the entire country share the cost of such adjustment?
Current Financing Plan to Assist SOE Layoffs
Current government policy calls for local unemployment insurance programs to assist the unemployed in urban areas. According to the State Council, in 1994 employers paid 0.6 percent of their total wages for unemployment insurance. The local government decides the pooling level. If a fund has a surplus or shortage, a local government has the power to adjust the premium. The maximum rate, however, cannot exceed 1 percent of total wages. 7 The redistribution effect of this financing policy is to ask sound firms (both SOEs and non-SOEs) to subsidize weak SOEs. The level of the subsidy depends on the proportion of SOE layoffs in the local area. The higher the proportion of SOE layoffs, the heavier the burden to local business firms.
This financing policy can create unfair competition between enterprises with different levels of unemployment insurance payments. For example, a firm in Shenyang (an old industrial center dominated by SOEs) cannot compete with a similar firm located in Shenzhen (a newly developed coastal industrial region with almost no SOEs), even if the former is more efficient, because it has to pay more to support the large number of SOE layoffs.
Using local insurance in response to SOE layoffs also increases the gap among regional economies. If economic development in a city is slow, the proportion of SOE layoffs will be higher and the burden to local business heavier. Because firms located in regions with little economic growth will have greater financial burdens than firms in other regions, they cannot compete. This will further slow economic growth and lead to higher levels of unemployment. In addition, heavy taxation will wash out the advantage of low labor costs and discourage investment from other regions and foreign countries.
The current financing policy for unemployment insurance has at least two practical problems in major inland industrial cities where SOE layoffs are extensive. First, the current premium is not nearly enough to cover unemployment benefits. If insurance pays 60 percent of average local wages to the unemployed and employers pay the maximum amount of premium (1 percent of their total wage), this only covers 1.7 percent of all employees. According to the newspaper Zhongguo gongshang shibao, SOE layoffs in Shanghai, Shenyang, Fujian, Zhengzhou, and Chengdu account for 14 percent, 23 percent, 27.5 percent, 14.8 percent, and 20–30 percent of total employees, respectively. 8 Second, compliance rates in these cities are low. Many SOEs have no money to pay for unemployment insurance at all. Based on statistics provided by the Labor Bureau, the national average compliance rate in 1994 was only 88.7 percent. 9 In fact, SOEs that must lay off a large number of employees are also the ones that cannot afford unemployment insurance, which makes the insurance program more like a rescue program.
Some Chinese scholars have suggested using some of the funds obtained from selling the assets of SOEs to assist the unemployed. 10 The rationale behind this suggestion is that profits created by SOEs during earlier years include contributions for various social benefit programs. Therefore, workers laid off by SOEs should obtain some money from state-owned assets. In 1994, the State Council decided that assets of bankrupt SOEs should be used to assist workers prior to paying any debt. This financing method can reduce the burden of local firms in those major inland industrial cities, but government revenue from state assets will decline accordingly. Government revenue comes from two major sources: taxes and the return on state assets. When state assets shrink, government revenue will decline unless taxes are increased. The redistribution effect of this financing method depends on who gets the money from selling state assets and how the revenue decline is covered. Usually, funds raised from selling state assets do not go to local governments. When the funds are used for unemployment, government banks are more likely to be the losers because most bankrupt SOEs have a considerable amount of debt accrued from government banks. Therefore, financing assistance for laid-off employees of the SOEs by selling state assets will indirectly spread the burden to other areas through government banks or other channels.
Policy Considerations
The current unemployment insurance program will be viable and its financial status sound only if the laid-off employees receive financial assistance from the central government. As discussed earlier, SOE layoffs are the result of structural adjustment due to the transition from a planned economy to a market system. It is very hard for local governments to handle such large-scale economic adjustment. The key question is whether all local provinces can agree to the establishment of a national program to assist SOE layoffs. A program financed through the central government may have negative effects if it is not properly managed. Sending money to cities with large numbers of laid-off workers may encourage local governments to do nothing but wait for financial aid from the central government, and the number of layoffs may increase when more funds flow in. In addition to other factors, management efficiency and the financial capability of local governments are major determinants of economic development. Hence, a multidimensional program is needed to assist the large number of laid-off workers during the economic transition.
Many believe that the lack of a functional social insurance program is a major obstacle to SOE reform. It seems that if SOEs do not lay off large numbers of workers, reform cannot proceed. This impression is enhanced by many newspaper reports. For instance, Zhong Jianqin and Luo Jun 11 reported statistics from the Ministry of Labor showing that during the Ninth Five-Year Plan, 15 million state employees will be laid off. When this is added to the current SOE layoffs (estimated at 15 million), the total number of workers laid off during the Ninth Five-Year Plan will be 30 million. This number ignores the possibility that the number of workers laid off may be reduced if the structure of SOE management is successfully reformed. A typical example is the well-known Wang Yitang incident reported by Zhongguo qingnian bao. 12 A county-owned cement factory replaced twelve directors and still lost money. Finally, the county contracted with an entrepreneur, Wang Yitang, who was once a farmer, and gave him complete control of the factory’s management. The factory made a profit of 700,000 yuan in the first year and 2.5 million yuan the next year. He did not lay off any workers and did not even change regulations. He just fired the previous director and eight associate directors and strictly enforced existing regulations. Of the 415 factory employees, only about 20 left the company. They had been previously paid without actually doing any work. This example suggests that if reform is successful in SOEs, layoffs may be minimal.
Many believe that people laid off are “extra” employees of the firm. Based on economic theory, if the marginal return of a worker is less than his or her marginal cost, the worker is an extra employee because the firm’s cost will be reduced or its profit will be maximized if this worker is laid off. Because most SOEs are inefficiently operated, reform may improve their efficiency, increase workers’ productivity (marginal return), and reduce the number of laid-off workers. It should also be kept in mind that those laid off might not be those whose marginal return is less than their marginal cost. It has been observed that the relationship between the worker and the manager is an important determinant of being laid off. If reform goes in the right direction, economic considerations will be used to decide which employees are laid off.
Another factor that should be considered when reducing the number of SOE employees is the overall cost to society. When a worker is laid off, the government has to assist the worker and his family. In this case, even if the worker’s marginal return is less than his marginal cost, it is better for both the state and the worker if he can continue to work as long as the money being lost is less than the cost of government assistance. Of course, in the long run, resources are better allocated if layoffs lead workers to be more productive. In many situations, however, workers laid off by SOEs have difficulty transferring into more productive careers.
The problem of layoffs is closely related to China’s history. Layoffs affect a generation that grew up under the planned economy. Most of them have been assigned to the same job since they started working. When they suddenly lose their jobs, they do not know where to go, what to do, and how to find another job. Industrial workers used to be treated as the leading class. Because losing a job means losing social status, many laid-off workers are deeply depressed. Therefore, the government should provide various assistance programs to help them, such as job training, market information, and psychological consulting.
SOE layoffs and slow economic growth often go together in large industrial cities. Without financial capability, none of the present social programs will be available. It is true that SOEs are not efficiently organized and cannot compete with other types of enterprises, but SOE employees have worked very hard to follow each economic plan and contributed a great deal to the nation’s economy before the economic reform. During that period, economic planning, including resource allocation and income distribution, was controlled by the central government. Therefore, SOE layoffs are the cost of national economic reform, rather than a local problem. Should the entire country share the cost? Market factors cannot be allowed to answer this question. It must be answered by society.
Pension Insurance
The Dynamics of Pension Finance
To understand the problems of pension reform, an understanding of the dynamics of pension finance is necessary. There are two basic principles for financing pension programs: individual accumulation and pay-as-you-go. Individual accumulation takes the form of mandated personal savings. All citizens are required to put aside a certain amount of money while they are able to work. In the early years of such a program, one’s contribution depends on the number of years left before retirement. To obtain the same level of benefits, people who are closer to their retirement have to contribute more. Therefore, a pension completely financed by individual accumulation is feasible only for young people who can gradually increase their accumulation as time goes by.
The pay-as-you-go system is a quick-fix method to initiate a pension program. Unlike individual accumulation, pay-as-you-go does not require accumulation; it simply pays the retired by taxing the working population. Therefore, it can immediately cover the entire retired population. A special feature of pay-as-you-go financing is that almost all adults would benefit from the new program, especially those who are close to age sixty-five or older, and no one is worse off. The system would reach its stable status after the cohorts who entered it at age twenty-one die. Then, the new system financed by the pay-as-you-go method would become the same as the one financed by individual accumulations. Because most adults are better off and no one is worse off, a pay-as-you-go pension plan is easily accepted in a democratic country.
However, if a government wants to change from a pay-as-you-go pension plan to one financed by individual accumulation, the redistribution pattern would be just the opposite. During the transition to individual accumulation, all adults, especially older people, will lose and no one will benefit. Older people do not have enough personal savings and would have to reduce consumption considerably. The aggregate impact on the economy would be that consumption decreases and saving increases. When the entire working generation dies, the system would reach stable status. The implication of changing from pay-as-you-go to individual accumulation is that the public debt owed by the next generation to the current generation would not be honored.
Reform and Policy Consideration
The financing method used for the previous pension program in the SOEs is equivalent to the pay-as-you-go plan outlined above. The principle of the current reform of pension finance is to transfer from that system to individual accumulation. As pointed out in the previous section, this change involves the problem of public debt. The currently retired and employees in middle age or older have contributed a great deal of their lifetime income to support the people who retired before them. Now they will have to take care of themselves. To ease this problem, the current reform includes a social-pooling plan to pay the currently retired with savings acquired from the young.
There are three basic problems under the previous pension system in the SOEs. First, unlike other pay-as-you-go systems, the previous pension finance system does not have a clear accounting of the contributions, distributions, and balances. Pensions are distributed through the payroll account and retired persons receive their pensions from the company they last worked for before retirement. When SOEs accept financial self-responsibility, they also have to pay the pensions of people who retired from them. As a result of the financial self-responsibility principle and the old payment method, the previous pension finance becomes, after the economic reform, a company-based pay-as-you-go system. If a company loses money, it cannot pay any pensions. If a company is very old and has a large number of retired employees, the working employees in that company will have very heavy burdens funding their pension program.
The second problem with this system is the rapid growth of nonstate-owned enterprises. Before economic reform, SOEs accounted for 99 percent of industrial production. From 1985 through 1995, the production of foreign- and joint-owned enterprises grew from 0 percent to 16.5 percent. 13 Most foreign- and joint-owned enterprises are new and hire young people. As the ratio of retired to working employees in SOEs increases, along with this shrinkage of SOE production, the burden on SOE employees is incrementally heavier than before.
The third problem is the increasing proportion of the aging population. Due to family planning and an increase in life expectancy, the ratio of the retired to the working is rising significantly. Pay-as-you-go financing will place a heavy burden on future generations as the population grows older.
Of these three problems, only the last one is related to the pay-as-you-go financing method. It is caused by the aging population rather than by economic reform. Even the aging problem can be solved by gradually increasing accumulations in the pension fund. For instance, the U.S. pension system is financed by pay-as-you-go. Realizing the problem caused by an aging population, the U.S. Congress passed a law in 1983 that increased pension taxes and extended the retirement age from sixty-five to sixty-seven. Its financing method is still pay-as-you-go and no dramatic change is needed. Because China’s pension program only exists in SOEs and government agencies, however, more than 80 percent of the population still depends on family to support the elderly. Therefore, the problem of the aging population will not be as serious as in a country with a universal pension program.
To solve the first two problems of the previous pension program, retired employees will have to be separated from enterprises. If the pension-financing pool is based on a community such as a city, the entire working population should be included to finance the system. A program such as that can be financed by a community-based pay-as-you-go method. However, the current policy, expressed in State Council Document 6 of March 1995, provides two basic plans for local authorities to choose from. Both plans involve individual accounts and social pooling, although they are organized in different ways.
The first plan, designed by the State Commission for Economic Restructuring of Economic Systems, emphasizes individual accounts. All new workers will use individual accounts for their pension and a social pool would be responsible for pensions for those already retired and current workers not fully covered by individual accounts. Contributions into individual accounts would be approximately 16 percent of total wages and would consist of three parts: (1) an individual contribution of 3 percent of total wages; (2) an enterprise contribution of 8 percent of each worker’s wages; and (3) an enterprise contribution of 5 percent of the average local wage. 14
The second plan is based on the previous model developed by the Ministry of Labor, which focuses more on social pooling than on individual accounts. The basic pension insurance premium would be paid by both enterprises and workers, according to a proportion to be decided by local governments. Part of the pension funds will be contributed to individual accounts. For those whose payment period is longer than ten years, the pension will be granted as follows: (1) a social pension, which equals 20–25 percent of the local average wage; (2) a premium pension, which is about 1.0–1.4 percent of basic wage figures; and (3) all money in individual accounts. 15
In principle, both plans combine social pooling with individual accounts so that the pension finance will be eventually transferred into individual accounts. Rather than reducing the burden on SOEs, this policy, in fact, doubled the SOEs’ financial responsibilities. In addition to providing pensions for retired workers, SOEs now have to contribute to individual accounts. In most industrial cities, enterprises contribute from 20 to 30 percent of total wages and workers contribute 3 to 5 percent of their own wage. 16 If 16 percent of total wages is deposited into individual accounts, the social pooling will not be enough. In this case, many local insurance programs use the money in individual accounts to pay those currently retired. Individual accounts thus soon become empty accounts.
The major advantage of individual accounts disappears when they are empty. First, there will be no return from individual accounts. The promised interest from individual accounts will have to be paid by future contributions. Moreover, individual accounts will reduce personal savings because workers feel that they already have their pension saved. Also, there will be less savings flowing into investment, which in turn may slow economic growth and increase the burden on future generations. With empty individual accounts, the financing method of pension insurance is equivalent to a pay-as-you-go system.
The World Bank has made feasible suggestions for reforming the pension system. 17 In 1996, a World Bank investigation team suggested that the pension system should consist of three pillars. The first pillar is completely financed by employers and controlled by the government. Its benefit is equal to the poverty level. Since many nonstate-owned enterprises do not have retired employees, the World Bank team estimates that this part of the pension system would cost about 9 percent of total wages. The second pillar is mandated individual accounts jointly financed by employers and workers at 8 percent of an individual’s wage. This is only half of the current contribution to individual accounts. Because the contribution to the social pooling is less than before, enterprises should be able to afford it. The most important feature for individual accounts is full accumulation. The entire fund in individual accounts should be fully invested in holdings with sound returns. Individual accounts can smooth the financial problem caused by the aging population. With good returns, 8 percent of a worker’s wage can be a considerable amount of money for retirement in forty years. The third pillar is any complementary program provided by employers.
The World Bank plan has two important features. First, the first two pillars include all workers in the plan so that contributions to the basic plan (the first pillar) from enterprises with large numbers of retired workers are considerably reduced and become affordable to them. The second feature is that the benefit of the basic plan is reduced to poverty level, which also reduces the burden to all employers. The World Bank plan, however, does not consider how SOEs with serious financial problems will pay for the pension. Many SOEs are close to bankruptcy and have no money to pay any pensions. In many inland industrial cities, about 20 percent of SOE employees have been laid off and receive no pension from their enterprises. According to the World Bank report in 1996, the compliance rate in Beijing and Tianjin is 95 percent, Shanghai is 90 percent, and Shenyang and Changchun are 80 percent and 76.9 percent, respectively; Chongqing is the lowest, with only 70.2 percent compliance. 18 Therefore, even following the World Bank plan, local governments must subsidize the basic plan for some employees so that they can obtain at least poverty-level financial assistance when they retire.
Conclusion
This chapter has discussed the relationship between financing methods and two common social-safety programs: unemployment and pension insurance. Almost every social-safety plan contains two features: welfare and insurance. If a plan is more like welfare, its collecting principle is often based on income, reflecting redistribution from the rich to the poor. If a plan is more like insurance, its premiums should follow the risk levels of individual workers. The riskier the person, the higher the premium. Many economic disasters are insured through the market and carried out by private insurance companies. Some events, however, cannot be insured through the market because charging insurance premiums according to personal risk level conflicts with the moral standards of society. A person with chronic medical problems is riskier than a healthy person. If, following the insurance principle, sick people pay a higher premium, this creates a situation that is unacceptable in many societies. Hence, many governments either provide a national health insurance program, or strictly regulate private health insurance so that sick people are not excluded. As society’s moral standard is closely related to a country’s cultural and historical background, so is the financing principle of social-safety programs.
The difficulty with China’s social-safety programs comes from its special historical background, which is the thirty-year experience of trying to establish a socialist country. From 1949 through 1978, China had a series of political movements and disasters, about one every three to five years. A majority of the people who need help now are those in middle age or older, the same people who survived the thirty-year political storm. The currently retired generation has dedicated its entire life to the country’s economic development. Most retired people have little savings for their retirement. All they can rely on is the socialist state and the enterprises for which they worked. Most middle-aged employees not only have no savings but also have no training for today’s job market. What they do have is family responsibility, including children to raise and parents to support. When the political legitimacy is shifted from the communist ideology to a regime of economic performance, its impact on people who have followed the old regime for most of their lives is much deeper and longer. The society is challenged to keep balance between smoothing the intergenerational transfer due to policy change and establishing a more efficient economic system.
The limitations to this discussion are as follows: first, this chapter only discusses urban social-safety programs. But this does not mean that rural problems are less important. In fact, compared with urban residents, rural people have almost no social-safety programs at all. However, the financing method in rural areas is quite different. There are no employers in rural areas to subsidize the social-safety system. Second, the financial issues discussed in this article may not be problems in many coastal and developed cities because these cities either do not have a large proportion of SOE employees (such as Shenzhen), or do have a fast-growing economy to support a social-safety system. Because of differences in the economies among urban areas, financial strategies for a social-safety system should be different.
Endnotes
Note 1: China National Statistics Bureau, Zhongguo tongji nianjian, 1996 [China Annual Statistics, 1996] (Beijing: Zhongguo tongji chubanshe, 1997), p. 30, table 2–3. Back.
Note 3: Zhong Jianqin and Luo Jun, “Zaijiuye yali jiujing you duoda?” [“How High Is the Pressure of Reemployment?”], Jingjixue xiaoxibao (Economics Highlights) (Chengdu: Jingjixue xiaoxibao chubanshe), March 21, 1997, p. 1. Back.
Note 4: World Bank, China: Pension System Reform, The World Bank Country Report, Report No. 15121-CHA (Washington, DC: World Bank, 1996), pp. 36–39. Back.
Note 5: U.S. Social Security Administration, Social Security Programs Throughout the World—1995 (Washington, DC: GPO, 1996). Back.
Note 6: Zhong Jianqin and Luo Jun, “How High Is the Pressure?” p. 1. Back.
Note 7: Deng Dasong, Zhu Shifan, and Song Shunfeng, “Lun Zhongguo shehui baozhang shuishou zhidu jiqi gaige wanshan de silu yu duice” [“Concepts and Policies of China’s Social Safety Tax Structure and Its Reform”], in Zhongguo shuizhi gaige [China’s Tax System Reform], ed. Xu Dianqing and Li Yanjin (Beijing: Zhongguo jingji chubanshe, 1997), pp. 250–264. Back.
Note 8: Zhong Jianqin and Luo Jun, “How High Is the Pressure?” p. 1. Back.
Note 9: World Bank, China: Pension System Reform. Back.
Note 10: Hu Yicheng, “Zouchu chengzhen pinkun yu yanglao kunjing” [“Get out of Urban Poverty and Pension Problems”], Jingjixue xiaoxi bao (Economics Highlights), March 21, 1997. Back.
Note 11: Zhong Jianqin and Luo Jun, “How High Is the Pressure?” p. 1. Back.
Note 12: Wang Yitang’s surprising success was reported by Zhongguo qingnian bao (China Youth Daily) in 1997. Back.
Note 13: China National Statistics Bureau, China Annual Statistics, 1996, p. 30, table 2–3. Back.
Note 14: World Bank, China: Pension System Reform (Appendix), pp. 96–99. Back.
Note 15: Ibid., pp. 100–102. Back.
Note 16: Ibid., pp. 9–10. Back.
Note 17: Ibid., pp. 43–55. Back.
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