A tale of two regions in china impact of demography on social security
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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. Agenda. Worldwide perspective Fundamental theory of social security

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A tale of two regions in china impact of demography on social security

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


  • 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?

Basic demographic effect
Basic Demographic Effect

Pension Cost as % of GDP

Source: OECD Aging Populations: The Social Policy Implications. Paris, 1988.

Fundamentals of social security
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)

Social security formula
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

Comments on social security formula
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

Comments on social security formula continued
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

Implication on pension reforms
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

Some social security reforms
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

Other social security reforms
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)

Hong Kong Population

Source: Census and Statistics Department of Hong Kong

Implications of demographic changes for hong kong
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

Brief description of mandatory provident fund of hong kong
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

Description of mpf continued
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

Test effectiveness of mpf
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)

Projection parameters for base case study
Projection Parameters for Base Case Study

Concluding remarks on hong kong
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

Concluding remarks for hong kong continued
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

About chinese demography
About Chinese Demography China

  • 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

2000 Chinese Population China

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

Dichotomy of chinese population
Dichotomy of Chinese Population China

  • 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

Social security for china
Social Security for China China

  • Wide differences among provinces

    • Geographical

    • Economical

  • Many differences between cities and rural areas

  • Xinjiang is an example

  • Begin with study of economic factors

Urban Population of Xinjiang China

Source: Results of author’s population modeling

Rural Population of Xinjiang China

Source: Results of author’s population modeling

Demographic trend in xinjiang

Urban China

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

Additional problems for xinjiang
Additional Problems for Xinjiang China

  • 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

Additional problems continued
Additional Problems (continued) China

  • Mountainous areas

    • Many rural areas not easily accessible

  • Low education level, especially in rural areas

    • Over 25% have not finished primary education

      • Over 11% have not been to primary school

    • Migrants from Rural areas to cities are unskilled, uneducated, and poorly employed

Possible solutions
Possible Solutions? China

Four necessary improvements

  • Improved education level, especially in rural areas

    • Better job opportunities for migrants to cities

    • Better agricultural techniques for farmers

  • Improved utilization of water sources

    • More water means more arid farm lands

  • Better farming techniques

    • More productivity and better conservation of land

  • Better roads

    • Easier communication and migration into cities

Impact of improvements
Impact of Improvements China

  • More farm lands

  • Better farming technology

    • In industrial countries: 5% population are farmers

    • In Xinjiang: 2/3 of population are farmers

    • With better technology, fewer farmers can produce more

    • Higher productivity in Rural areas

  • More migration to cities

    • Migration helps dependency ratio in cities

Comments impact of migration
Comments - Impact of Migration China

  • Migration can provide temporary relief on dependency ratio

  • Long-term solution for Urban must come from two sources:

    • Increase in productivity of Urban population

    • Increase in retirement age of Urban population

Concluding remarks
Concluding Remarks China

  • Aging is a worldwide phenomenon

    • Need to adjust retirement age continually in proportion to increasing life span

  • Increase in dependency ratio must be matched with increase in productivity

  • To produce reasonably retirement income using defined contribution plan:

    • Combined employer-employee contribution rate of over 15% is required