Family insurance or social insurance policy options for China's Social Security Reform.

• Author: Li, Ling

Abstract

The paper starts with a cost-benefit analysis of two alternative systems to provide support for the elderly: family insurance and social insurance. The conclusion is that when a nation's average income is high enough, the social benefits of a properly designed social insurance program outweigh its social costs. Based on the theory and experience of Western countries' social security systems, the paper provides a number of policy options for the on-going social security reform in China.

Introduction

In general, an economy can either solely rely on individual families to care for their elderly, a system we call family insurance, or establish some kind of social insurance program to provide income support for the elderly. With industrialization, urbanization, better education, and higher per capita income, there was an evolution from family insurance to social insurance in most developed countries. The majority of developing countries, however, still mainly rely on family insurance to support the elderly.

Currently, most of Western countries' social security programs are financed on a pay-as-you-go basis. According to the Samuelson-Aaron theory, current and future generations could maintain positive real rates of return on contribution as long as both the growth of real earnings and the growth of the population remain positive. In contrast, what have happened in Western countries is the pay-as you-go system couldn't fulfil the commitment between generations. The declining fertility rate, rising aging population and the incentive problems embodied in the social insurance system made most of social insurance systems in trouble to finance them.

China is experiencing rapid population aging. The one-child policy and significant improvement in the living standard accelerate the aging process and make China's aging problem more serious than any other countries in the world. According to a World Bank report, China's aging population will reach the peak by 2030 (The World Bank, 1994). There will be 0.3 billion people over 60, which will account for 22 percent of the total population. Old age dependency ratio is expected to rise from currently six workers for every retired person to only two workers for a retired by 2030. China faces the greatest challenge to support the huge aging population. In reforming its social security system, China should avoid the mistakes the Western countries have made.

The purpose of this paper is to analyze the old age family insurance and social insurance from an economic and social development perspective. It provides a general analysis of the trade-off between these two systems. Based on the theory and experiences of other countries' old age insurance systems, it argues that when a nation's average income level is high enough, the social benefits of a properly designed social insurance program outweigh its social costs. So it is inevitable that a social insurance will replace the family insurance as an economy and society developed. After analyzing the current situation in China, the paper provides a number of policy options for the on-going social security reform in China.

The rest of the paper is organized as follows. Section 2 briefly reviews the history and evolution of family and social insurance for the elderly in the West. Section 3 is a comparative analysis of family insurance and social insurance. Section 4 discusses the history and current situation of China's old age insurance system. Section 5 provides policy options for China's old age insurance reform. The last section concludes the paper.

The History and Evolution of Social Insurance for the Elderly

A nation's insurance system for the elderly is determined by the nation's economic and social development. The human society started with family insurance. Taking care of the elderly has been one of the key functions of families. However, the industrialization that started in the European countries during the later 18th century fundamentally changed the landscape of the human society. Urbanization, more migration, better education, lower fertility rate, and the breakdown of traditional social norms diminished the function of extended families in supporting the aged. The poor and the unemployed among the aged became predominant social problems during that time. Politicians and social engineers began to seek alternative options to support the elderly. In 1889 Germany became the first nation in the world to enact a national compulsory old-age pension system, which was one of several social insurance programs introduced in Germany during the 1880s. In 1908 British enacted "The Old Age Pension Act." The United State passed "The Social Security Act" in 1935. After World War II, rapid economic growth fostered further development of the social security programs. So far, most of industrial countries have established a comprehensive social insurance system for the aged. In these countries, the function of providing income security for the elderly has mostly transferred from families to the society.

In contrast to this development in industrial countries, most of developing countries still rely on family insurance for the elderly. Table 1 illustrates this point by showing the composition of different sources of income of the elderly from selected high and low income countries.

A Comparative Analysis of the Systems of Family Insurance and Social Insurance

We compare the two alternative systems in three aspects. First, the two systems have different impact on a society's fertility rate, savings rate, and economic growth rate. Second, the two systems interact differently with different financing schemes. Third, the two systems have different impact on living arrangement, life style, inter-generation relationship and old age life quality.

In the first aspect, the major social cost of family insurance stems from the fact that it has limited resources and lacks risk pooling. The living standard and quality of life of old-aged parents directly depend on the number of children they have and the income of the children, which depends in turn on the parents human capital investment on the children. In order to hedge the risk of losing supports by children in later stages of life, parents have the incentive to have more children, which gives rise to the rapid population growth and slower accumulation of financial assets, slowing down the growth of per capita GNP. On the other hand, there is an opposite effect. That is, in order to increase their children's future income, parents have the incentive to increase human capital investment on the children, which is beneficial for the economic growth. However, most researches find that overall, the negative effect on the economic growth outweighs the positive effect of the human capital. (e.g., Zhang and Zhang, 1995).

The social benefits of old age social insurance are risk pooling and efficiency of alleviating poverty due to economies of scale. With a social insurance program, the living standard of an elderly is no longer dependent on the number of children he/she has and the children's income. Instead, his/her income depends greatly upon the aggregate income of the economy. Social insurance reduces parents' incentives to raise a large family. Meanwhile, a social insurance system implies a weak, if any, relationship between an individual's work efforts when he/she is young and his/her old age income, resulting a lower savings rate, less education investments in children, less working incentives, and earlier retirement. Hence, a social insurance program could hamper the economic growth. Another drawback of social insurance stems from politicians' short-term behavior in a democratic political system. To gain the popularity and political support, in the West, social insurance program has been over-expanded and has become too generous to finance it (Feldstein, 1998).

Regarding the second aspect of our comparison, most country's social security programs are operated as pay-as-you-go (PAYG) schemes, in which current contribution revenues pay for current pension commitment. According to the Samuelson-Aaron "social contract" model, current and future generations could maintain positive real rates of return on contribution as long as both the growth of real earnings and the growth of the population remain positive. In contrast, what have happened in western countries is that the pay-as you-go system could not fulfil the "social contract" between generations. The decline of population growth and escalating costs to support a rapidly aging population have caused serious trouble for most social insurance systems. According to estimates of the Economist magazine (September 9, 1995), under current policies, the present value of the net public pension liabilities in the U.S. amounts to 44 percent of GDP in 1994. Therefore, the Clinton administration recently announces that the priority of tapping the federal government budget surplus is to save the Social Security Program.

In light of the first two aspects of the comparison, an effective old age insurance system has to strike a balance between risk pooling, individual incentive, and promoting economic growth. The individual retirement saving accounts approach seems to be an effective approach to achieve these goals. Chile provides a successful experience in this regard. In the Chilean model, the old age insurance mainly consists of mandatory individual retirement saving accounts, while the public pension only provides a minimum income secure for the...