A Tale of Two Regions in China - Impact of Demography on Social Security

1. A Tale of Two Regions in China - Impact of Demography on Social Security A speech at Conference on Chinese Healthy Aging and Socioeconomics: International Perspectives, August 20 – 21 by Michael Sze, PhD, FSA, CFA

2. Agenda • Worldwide perspective • Fundamental theory of social security • Pension reforms in various countries • Some older economies • Some younger economies • Some Asian economies • Situation in Hong Kong • Mandatory Provident Fund • Ultimate solution for Hong Kong • Situation in Xinjiang • Aging demography • Income disparity • Possible solutions?

3. Basic Demographic Effect Pension Cost as % of GDP Source: OECD Aging Populations: The Social Policy Implications. Paris, 1988.

4. Source: Estelle James: The European Pension Crisis

5. Source: Estelle James: The European Pension Crisis

6. Source: Estelle James: The European Pension Crisis

7. Source: Chris Daykin – Speech at IAA meeting

8. Source: Chris Daykin – Speech at IAA meeting

9. Fundamentals of Social Security • Let B be average pension benefit per retiree R be number of retirees • Total pension payment = R x B • Total output = W x P, where W is number of workers, and P is productivity • Output not consumed by workers is used to pay retiree pensions: W P (S + T), where • S is saving rate, and T is tax rate RB = W P(S + T)

10. Social Security Formula RB = W P(S + T) R / W = P (S + T) / B Ln R – Ln W = Ln P + Ln (S + T) – Ln B Taking partial derivative with respect to time r’ – w’ = p’ + (s + t)’ – b’ where each term denotes % rate of increase of the term

11. Comments on Social Security Formula • Left side is completely dependent on demographic changes • To keep the equation in balance, we must narrow down the gap between retiree increase and worker increase • Most effective way is to increase retirement age according to life expectancy increase

12. Comments on Social Security Formula (Continued) • Right side depends on economic increase vs. benefit increase • There is no solution to social security problems without economic expansion • Social security is part of the economy • A healthy national economy is essential

13. Implication on Pension Reforms • Technical formula is independent of • DB or DC method • Full funding or PAYGO • Some fallacies in reform policy • Moving from PAYGO to full funding will not save social security • Moving from public to private funded pensions cannot avoid tax increase • Difference between DB and DC plans: easier detection of trouble in DB plans

14. Some Social Security Reforms • US not been able to agree on any reform • Canada’s tax increase and benefit cut in 1999 found inadequate in subsequent years • Italy’s proposal in 2002 to increase RA to 65 by 2008 failed after general strike by 25% of workers • France’s proposal to increasing RA gradually from 60 to 65 resulted in strike by over 2 million workers in April, 2003 • Germany’s encouragement to workers to take out private pensions or company options found not adequate (2001) • UK: Modest minimum benefit funded by public PAYGO plan, plus private savings found to provide inadequate pensions, leading to wide spread protests

15. Other Social Security Reforms • Japan DB reform: increasing RA gradually from 60 to 65 • Singapore Central Provident Fund contribution • 20% from employee, 16% from employer • Combined contribution rate recently decreased to 33% • Used for housing, education, medical care, retirement • Malaysia Employee Provident Fund contribution • 9% from employee, 12% from employer • Hong Kong implemented Mandatory Provident Fund in 2000 • 5% mandatory employee contribution, with equal match from employer (to be discussed in following slides)

16. Hong Kong Population Source: Census and Statistics Department of Hong Kong

17. Source: Census and Statistics Department of Hong Kong

18. Source: Census and Statistics Department of Hong Kong

19. Dependency Ratios

20. Annual Rates of Increase

21. Implications of Demographic Changes for Hong Kong • Continual decline in mortality rates • Life expectancy from birth: 78.2 for males and 84.1 for female in 2001; 82.3/87.8 in 2031 • Dependency ratio increases from 22% in 2002 to 54% in 2031 • Two workers must carry one retiree • % rate of retiree increase exceeds that of worker by 4-5%. Possible remedy includes • Productivity increase: not easy • Benefit decline: not desirable • Savings and tax rate increases: only choice

22. Brief Description of Mandatory Provident Fund of Hong Kong • Implemented in 2000 to cover workers aged between 18 and 65 • High compliance rate, as of 12/31/2003 • 95.4% of employers • 96.3% of relevant employees • 81.5% of self employed • Contribution Rate • 5% pay from employer and employee each • Employees with monthly pay < HK$5,000 may opt-out

23. Description of MPF (Continued) • Tax deductible contributions • Employee: 5% pay, up to $1,000/month • Employer: 5% pay • Investment options: flexible for employee • Investment income: not taxable • Retirement age: flexible • Retirement benefit: lump sum of individual accumulated fund, with no tax

24. Test Effectiveness of MPF • Stochastic simulation program constructed to test the effectiveness of MPF • Analysis of impact on retirement income as % of pay due to various strategies on • Contribution rate • Retirement age • Entry age • Investment • Retirement income % is called Pay Replacement Ratio (PRR)

25. Projection Parameters for Base Case Study

26. Investment Strategies

27. Data Source

29. Source: Results of author’s stochastic simulation

31. Source: Results of author’s stochastic simulation

32. Concluding Remarks on Hong Kong • Need for assurance varies with individuals • The higher the assurance, the higher the contribution rate • For older employees without sizeable savings, retirement income is grossly inadequate • For these employees, a contribution rate of over 30% is required to produce decent retirement income at age 60 • Better if they retire at 65 • Severe transition issue must be addressed

33. Concluding Remarks for Hong Kong (continued) For young employees: • 10% contribution is inadequate • It takes over 15% contribution to produce reasonable retirement income • For early retirement, say at 55, more than 25% contribution may be needed • Starting at 45 instead of 30, 5% more contribution is bu 5% less • Current investment strategy is quite optimal

35. Source: 2000 Population Census of People’s Republic of China

36. About Chinese Demography • Mid segment of population is broad • Current working population is sizeable • When this segment retires, there will be much pressure on country’s finance • Population at lower ages is smaller • May cause increasing dependency ratio problem • We should consider different dichotomy of the population

37. 2000 Chinese Population Source: 2000 Population Census of People’s Republic of China

38. Dichotomy of Chinese Population • Consider percentage of population at younger ages • Percentage for Urban population much smaller than that for rural population • Old age crisis more imminent in cities • Fewer young people among Han population than in minorities • Old age crisis more imminent among Han population

39. Social Security for China • Wide differences among provinces • Geographical • Economical • Many differences between cities and rural areas • Xinjiang is an example • Begin with study of economic factors

40. Basic Statistics of Xinjiang 2003

41. Source: Xinjiang Lingdao Ganbu Shouce 2004

42. Source: Xinjiang Lingdao Ganbu Shouce 2004

43. Source: Xinjiang Lingdao Ganbu Shouce 2004

44. Souce: Xinjiang Statistical Yearbook 2003

45. Source: Xinjiang Statistical Yearbook 2003

46. Urban Population of Xinjiang Source: Results of author’s population modeling

47. Rural Population of Xinjiang Source: Results of author’s population modeling

48. Urban Lower fertility Decreasing mortality Rapidly aging population Dependency ratio increases to 38.5% by 2030 Rural area Higher fertility Decreasing mortality Migration to Urban increases aging Dependency ratio increases at slower rate to 32.7% by 2030 Demographic Trend in Xinjiang

49. Source: Results of author’s population modeling

50. Additional Problems for Xinjiang • Water scarcity • Limited amount of surface water, • Only 60% available for cultivation • Only 8% of underground water has been developed • Expanding desert: • Covering 42.4% of province • Scarcity of forest, further depleted by • Unplanned expansion of cultivated land, • Over grazing • 20% of good farm land destroyed since 1980