The effect of an expansion of the pay-as-you-go social security system in China.

• Author: Lin, Shuanglin

Abstract

China is in the process of industrialization with a large amount of the labor force moving from the agricultural sector to industrial sectors. An expansion of the pay-as-you-go social security system benefits current urban retirees, and may solve the social security payment problem faced by many state enterprises. Also, although facing a declining population growth rate, China may not have a social security crisis under a pay-as-you-go social security system just covering the wage earners, as many industrialized countries face. However, the expansion of the pay-as-you-go social security system may have an adverse effect on capital accumulation in the long run, hurting the rural old, and either benefiting or hurting the wage earners in urban areas before the completion of industrialization, and is likely to reduce wage earners' welfare after industrialization.

Introduction

As economic reforms in other areas proceed in China, social security reform has become urgent. China has a pay-as-you-go social security system which covers only a small portion of the population. The social security reform can go different directions: expanding the existing system to cover more people, or privatizing the present system by establishing individual accounts, or a combination of the two. This paper analyzes the effect of an expansion of the current pay-as-you-go system on the Chinese economy.

Many countries in the world provide social security to their residents. Most social security systems are pay-as-you-go in nature, i.e., government collects taxes from the working generation to finance the benefits to the retired generation. This system is also called an "unfunded system" because the benefit received and the taxes paid by an individual may not be the same. Under this system population growth will benefit each generation since there will be more young people supporting the retirees. Problems arise when the population growth rate begins to decline, i.e., each generation has to pay more and more to keep the parent generation as happy as their grandparent generation. As capital markets become well-developed, it is also possible for a person to provide old-age security for him- or herself. When working, each individual deposits a portion of his or her salaries into a fund. Over time the fund would accumulate interest, and on retirement, each individual receives the principal and accrued interest as old-age security benefits. This form of old-age security can be called "individual security," and it is a fully-funded system because individuals receive exactly what they paid in terms of the present value.

Recent research on Chinese social security reforms have identified two major problems China's new social security system must solve. One is to reduce the social security burden of the state enterprises, and the second is to avoid a social security crisis due to the decrease in the population growth rate (Zhou and Wang, 1994; and the World Bank, 1997). To solve these problems, a mixed social security system which combines a social account (an account through which the government collects social security contributions from the young and pays social security benefits to the old) and an individual account (a mandatory savings account through which an individual saves when young and withdraw savings and interest when old) has been recommended. On one hand, this proposed system is an expansion of the current pay-as-you-go social security system since more workers are covered; on the other hand, the system is a partial privatization of the existing system since each worker has his or her own mandatory saving account. The size of the social account and the individual account is essential to determine the nature of the social security system. At present, the social account is the major part. Thus, the social security system is largely pay-as-you-go in nature.

This paper argues that a pay-as-you-go social security system can easily solve the social security payment problem in the state enterprises. China's current social security system only covers the employees of state enterprises, state institutions, and government agencies. Each state enterprise takes care of its own employees and the government pays social security benefits to the employees of state institutes and government agencies. Many state enterprises are unable to pay social security benefits due to the decline of their profitability. Most non-state employees are not covered by the current system. Expanding the pay-as-you-go system to all wage earners will enable the government to collect enough funds to pay social security benefits to the retirees in the state enterprises.

This paper also argues that, unlike the industrialized economies China may not have a social security crisis in the near future with the pay-as-you-go system covering all wage earners. Due to decreased population growth rate, U.S. and other industrial countries will have a social security account deficit around 2030 if the current systems are not reformed (see Kotlikoff 1996). Facing the imbalance of social security accounts in the future, some countries, such as the U.S., now have adopted a partially funded system, i.e., save some of the tax revenues in order to pay the social security benefit to the future retirees. China is in the process of industrialization, and more and more rural laborers are becoming wage earners. Thus, there should be more and more young workers supporting retirees in industries, even though the growth rate of the total population has declined.

One problem prior studies on Chinese social security have disregarded is the effect of a social security system on capital accumulation. Many studies on social security have shown that social security has an adverse effect on private savings and capital accumulation (see, for example, Feldstein, 1974, 1996; Blinder, Gordon, and Wise, 1981; Diamond and Hausman, 1982; and Kotlikoff, 1979). (1) China is a developing country which needs a large amount of capital goods. This paper shows that a pay-as-you-go social security may reduce capital accumulation in both the short run and the long run.

Another problem which has not been addressed is the differential effects of the social security system on urban wage earners and the rural farmers. If the pay-as-you-go system is established, the young workers who just migrated to cities must have double social security burden, i.e., pay social security taxes to finance the benefits to city retirees and make transfers to support their rural parents; the rural old might be worse off since their children who migrate to cities may transfer less to them; the current urban retirees will be better off due to the increase in social security taxes while the future generations may be worse off due to lower capital stock.

This paper is organized as follows. Section 2 describes the stage of Chinese economic development and the social security system from a historical perspective. Section 3 presents an overlapping generations model. Section 4 provides comparative static analyses of the effects of a pay-as-you-go social security system on the real interest rate, the real wage rate, and capital accumulation. Section 5 analyzes the effect of a pay-as-you-go social security system on industrial workers and rural farmers. Section 6 discusses the effect of a decrease in the population growth on the pay-as-you-go social security system. Section 7 provides concluding remarks.

The Stage of Chinese Economic Development and Current Social Security System

When discussing social security reforms in China, we must take into consideration the stage of Chinese economic development. China is a low-income developing country. The population increased from 0.55 billion in 1950 to 1.24 billion in 1997. (2) In 1990, the life expectancy at birth was 68 for men and 71 for women. The per capita GDP in 1997 was

6,097 Chinese yuan, equivalent to $735.5 based on the official exchange rate. (3) In 1996, 0.86 billion people, or about 70% of the population, lived in the rural areas, while 0.37 billion people, or 30% of the population, lived in urban areas.

China is in the process of industrialization. The agricultural GDP share declined from 33.27% in 1982 to 20.24% in 1996. The growth rate of population is declining. The annual growth rate of population was 1.93% from 1952 to 1980, and dropped to 1.34% from 1980 to 1996. However, due to industrialization, the annual growth rate of population in urban areas has been rising. The annual growth rate of population in urban areas was 3.51% from 1952 to 1980, and rose to 3.94% from 1980 to 1996. In 1952, the share of rural population in total population was 87.54%. It decreased to 82.85% in 1978 and 70.63% in 1996. The annual growth rate of population in rural areas was 1.64% from 1952 to 1980, but only 0.52% from 1980 to 1996. In fact, the rural population even declined from 1991 to 1993. The decline in the population growth is not caused by a decrease in the rural birth rate, but by growth of rural-urban migration. As industrialization proceeds, the decline in agricultural population is inevitable.

Every society has its own old-age security. Like other traditional societies in which agriculture dominates, for a long time in China, several generations of a family lived together, and people raised kids to support them in the old age. This can be called "family security." (4) The old-age security had a great impact on Chinese culture. People wanted to have sons to support them in their old age. (5)

China's social security system was established in the 1950s. In the early 1950s, China undertook a socialist reform, i.e., eliminating all private enterprises in industrial sectors, and collectivizing...