The Chinese Social Security System

Introduction

Social security is one of the most important social and economic systems in modern societies. Due to the specific social and economic effects of social security, governments have long attached considerable importance to the construction of a social security system. Social security is the product of the development of modern society, with a relatively short history. Approximately 130 years ago, the first proposition and introduction of social security were given by the German Emperor, William the First (Social Security History, 2018). With the development of living standards, people realize the importance of long-term stable income after accidents such as retirement, illness, and disability. On the other hand, establishing and improving a social security system that is compatible with the level of economic development is an inevitable requirement for coordinated economic growth and social stability (Li 2016). Almost every country now has their own social security system based on national conditions.

The general purpose of social security is to provide a means of income support for people with inadequate or no income. With the continuous development of the social security system, different forms of social security including pensions, unemployment insurance, minimum living standard guarantee, have gradually played an increasingly broad role, benefiting more and more people.

Although the history of social security in the world is relatively short, we have also seen the development of social security in many countries. Some countries have achieved remarkable results, while others face problems such as population aging, and funding deficits. In recent decades, China’s social security system has been constantly explored, learned, borrowed, and experimented. Tremendous changes have also undergone in the Chinese social security system. This essay will mainly introduce and briefly analyze the history of the Chinese social security system. Introduction of coverage, benefits, calculation, and qualifying conditions will be given on the example of pension. Then, discussing the achievements and problems in the Chinese social security system, and potential reforms and solutions for limitations will be given. In the end, this essay will focus on the specific relationship between old-age pension and household consumption.

History

The history of China’s social security system is quite short. In 1950, the year after the founding of the People’s Republic of China, the Chinese government started considering and researching the construction of a social security system. The first document concerning the social security system is a regulation called “Provisional Regulations concerning Relief for Unemployed Workers”. One year later, the law named “Regulations on Labor Insurance of the People’s Republic of China” was enacted by the government. This document is regarded as the milestone of the social security system since it clarified the scope, level, and coverage of labor insurance (Zhu 2002).

In the early days of the founding of New China, the planned economy was the leading factor, and the domestic productivity was lagging behind. Under the egalitarian values, the Chinese government followed the Soviet model of “national insurance”. A state-led social security policy has been formed (Li 2016).

However, after the Chinese economic reform, the value pursuit of social insurance gradually shifted from idealism to pragmatism, and began to explore with the principle of “efficiency first and fairness”. In 1986, the Chinese government proposed social reform of social insurance. In the ensuing period, the social security system showed distinct marketization characteristics. Unfortunately, the Chinese government had not formed a clear idea of how to balance the relationship between social pooling and personal accounts, which has led to the misappropriation of individual accounts by the pooled accounts (Li 2016). Investments and accumulation were difficult to achieve, and the policy results and objectives have deviated.

Another major change in the Chinese social security system occurred in 2000. The government promoted the realization of fairness and justice in social security from the institutional framework and emphasized the development of social security in rural areas. Second, the way in which social security funds are raised has gradually become clear. In 2000, the State Council for the first time clarified that the social pooling fund and the personal account fund should be managed separately, the scale of individual accounts should be reduced. The social security of enterprises should have market-oriented management and operation, and the insurance funds should be raised through multiple channels. At the current stage, fair and sustainable values dominate (Li 2016).

Coverage and benefit—Pension as an example

Pension, as a part of the Chinese social security system, consists of three main parts, including pension insurance, mandatory individual accounts, and the social assistance system (Social Security Administration, 2018). From the perspective of coverage, pension insurance and mandatory individual accounts cover groups of people including employees (including legally employed foreigners and migrants, and part-time employees) in urban enterprises and urban institutions managed as enterprises; self-employed persons and small business owners with no employees; casual workers; and civil servants and certain public-sector employees. The social assistance system such minimum living standard guarantee mainly covers rural and nonsalaried urban residents.

In China, there are several different sources of Social Security. The two most important sources are insured individuals and self-employed individual. As regards insured individuals, the basic pension premium is either zero or determined by local government policies and regulations. In addition, the mandatory individual account is eight percent of gross insured earnings. As regards self-employed individuals, the basic pension insurance rate is twelve percent of the local average wage. Individuals in the mandatory individual account should pay eight percent of the local average rate. In addition, as regards employers, their basic pension insurance is up to twenty percent of payroll, which can vary in different provinces. When it comes to the government, as regards basic pension insurance and mandatory individual accounts, central and local governments will offer subsidies as needed.

Furthermore, the replacement rate is an important indicator of the benefits that different groups of people receive from the pension system. Replacement rate is determined by the benefits received and earnings prior to the entitling event. In the government sector, pension covers all the employees, and every employee can receive a benefit at least 90 percent of their previous income. In sharp contrast, the replacement rate and coverage are extremely low, only a minority number of rural residents receive 55 yuan from basic pension (Wu 2013).

Different Pension Arrangements Among Different Sectors

Source: Wu, L. (2013). Inequality of Pension Arrangements Among Different Segments of the Labor Force in China. Journal of Aging & Social Policy, 25(2), 181-196. http://dx.doi.org/10.1080/08959420.2012.735159.

Since 1998, the coverage of China’s old-age pension has continued to expand. In particular, after the establishment of the rural residents’ pension insurance system in 2009, the full coverage of the system level was achieved by 2012. In 2016, the total number of people participating in old-age pension was 887 million, including 379 million basic old-age pensions for rural workers (including 10.03 million retirees), and 508 million urban residents’ pension insurance (including 152.7 million recipients). The participation rate is approximately 85 percent (Zheng 2017).

From the perspective of average pension and the average replacement rate, urban employees received only 4,375 yuan per year in 1996 with a 70.5 percent average replacement rate. However, the average benefit has increased to 28,236 yuan per year by 2016 and the average replacement rate is stable at approximately 45 percent.

Source: Zheng, G. (2016) China’s Social Security Policy Assessment. China Social Science and Social Security Laboratory.

Calculation—Old-age pension as an example

As indicated by the central government: individuals at age 60 (men), age 60 (salaried ladies), age 55 (nonsalaried ladies), or age 50 (different classes of ladies) with over 15 years of coverage or contribution can get receive benefits when they resign. For people participate in the old-age pension and achieve retirement age with under 15 years of commitments may keep making commitments until the point that they meet the prerequisite; if appropriate, their pension entitlements will be transferred to the frameworks for provincial and nonsalaried urban residents by the government (Social Security Administration, 2018). This is a very important characteristic of social security in China. Those who joined the basic pension insurance scheme before July 2011 and had less than 15 years of contributions, and up to five years of making contributions beyond the retirement age, can make a lump-sum contribution to become eligible for the basic pension. For the disabled who are unable to work while also not meeting the conditions for an early-age pension and relatives of a deceased person, they can correspondingly receive the basic pension and obtain the benefit if the deceased person was a pensioner or in covered employment at the time of death.

According to the Social Security Administration (2018), the benefits that a corresponding person can obtain can be divided into three categories. First, the central government guideline specifies that, for people getting old-age pensions, the pension consists of two parts. One is the basic pension, which is calculated using the formula: local average monthly wage in the previous year plus average indexed monthly earnings (AIME) divided by 2 and then multiplied by the number of years of contribution. The AIME is multiplied by 1% for each year of contributions. More specifically, the average indexed monthly earnings (AIME) is calculated by the formula: local average monthly wage during the previous year times average individual indexed multiplier. This multiplier is determined by the proportion of actual contributions that an individual paid to the social average contribution. This means that if an individual paid more than the mandatory contribution, the multiplier would be larger. This multiplier ranges from 0.6 to 3.

Another part of the old-age pension is the individual account pension, which is calculated using the formula: accumulated contributions in individual accounts divided by the number of months of payments. The formula above makes it clear that the larger the contribution, and the greater the number of years of contribution is, the greater the pension one will receive. One issue requires attention: as the local average monthly wage increases, the pension people will get will increase as well. The upper limit of average individual indexed multiplier actually sets the maximum pension one would receive. This fact indeed reflects the redistribution effect of social security from the rich to the poor. Second, according to the central government guidelines, basic pension insurance will pay 40% of the insured’s monthly wage to the disabled. The minimum pension is set by the corresponding level of government. Third, the survivor pension works such that a lump sum of six to twelve months of the deceased’s last monthly wage is paid, depending on the number of surviving dependents.

Basic Pension=(Local Average Monthly Waget–1+AIME)÷2*Nyear of contribution*1%

AIME=Local Average Monthly Waget–1*Individual Indexed Multiplier Individual Indexed Multiplier∈0.6, 3

Individual Account Pension=Accumlated contributions÷Nmonths of payment

Major problems

Considering China’s basic national conditions, the problems of social security are not difficult to find. China is the largest developing country in the world, with a large population, a low starting point for the economic condition, and an imbalance between regions and between urban and rural areas.

The first major problem is the inequalities of social security between urban and rural areas. From the perspective of income and living standard, rural residents are actually the group most in need of social security. However, the fact is that, until recently, rural residents have participated in social security. Without enough benefits form social security, ordinary rural residents do not work until they lose their ability to work, and the only possible support comes from their children. This trend may further widen the gap between the rich and the poor in society. Therefore, rural residents have difficulties seeing doctors and supporting the elderly.

The comparison of retirement hazard rate between urban and rural residents will reflect this problem obviously. In rural areas, solely 25% of the people choose to retire by the age of 65, and almost a quarter of the people remain in the labor force until they reach their 80s. However, only 1% of urban residents would make the same decision. With urbanization and economic needs, an enormous number of rural adults came to urban areas and seek jobs, which furtherly left aging parents with less reliable support. According to Ebenstein and Leung (2010), along with the impact of one-child policy implemented in the 1970s, an adult couple in the rural area normally have four elderly and one child to support, the heavy burden on their shoulder force them to save more money. What’s more, the Chinese government has liberalized the second child policy, Chinese adults are facing an increasing burden to support the family.

In addition, financing sustainability is another major problem of the Chinese social security system. As the proportion of Chinese people over the age of 65 in the population will double between 2010 and 2030, the problem of population aging is becoming increasingly serious and obvious (Fang and Feng, 2018). The shrinking of the workforce contributes less and less to the pension system, and the current financial balance of the pension system is helped by the government subsidies. According to Fang and Feng (2018), in 2017, the government subsidy for the pension system is as large as 800 billion RMB, which is equivalent to 1 percent of GDP. As Fang and Feng simulated, the accumulated deficit to GDP and balance as a percentage of GDP would basically be under the increasing trend. If the Chinese government does not propose appropriate reforms in the following ten years, the problem of funding and financing sustainability will only worsen and Chinese citizens will pay the price.

Table—Simulations for future fiscal balances of basic old-age pension system

Source: Fang, H. and Feng, J. (2018). The Chinese Pension System. SSRN Electronic Journal.

Moreover, developing countries such as South Africa, Mexico, and China are facing the challenge of population aging when ensuring the well-being of the elderly (Ling, Hong, Ye, & Zhong, 2016). The demographic structure had changed because of the one-child policy implemented by the Chinese government. The population of the elderly over 65 years was doubled in only 25 years (Apergis & Li, 2016). When it comes to the dependency ratio, the children’s dependency ratio is decreasing and the elderly’s dependency ratio is increasing. Besides, the fifth nation-wide population census of China in 2000 has already shown that 6.96% of the total population is over 60-year-old (Dong, Tang & Wei, 2017). According to the projection given by the United Nations, by the end of the 2010s and 2030s, approximately 11.5% and 22% of the Chinese population will be over 65 years old. Combining with the impact of rising life expectancy, falling birth rates, and reductions in wage growth rates, the problem of an aging population cannot be overlooked.

Source: United Nations 2009: Population Database, Panel 3: Country Profile, http://esa.un.org/unpp/index.asp?panel=3 (accessed 05 November 2018).

Potential reforms and solutions

In order to effectively solve the major problems and limitations present in the Chinese social security system, proposing and discussing possible reforms and changes are important. The most important and urging issue to address is the inequalities between urban and rural areas. One effective approach is to take the needs and interests of specific groups of people into account. For instance, under the urbanization progress, people who leave rural areas and find jobs in the cities and those who do not have stable jobs and migrate several times in one year are possibly not able to consistently participate in the pension system for over 15 years and be qualified for the old-age pension. The benefits of such a massive group of people should be ensured by the government with specific efficient and effective pensions. Social assistance program such as the Minimum Living Standard Guarantee (MLSG) and “Wubao” should be further upgraded. According to Zhou and Xie (2016), over 20 million rural residents in the MLSG program can only get less than 300 RMB every month. As the program assisting rural people with disabilities, no ability to work, or under the poverty line, the Chinese government should endeavor to extend the coverage and benefits.

The Chinese government should explore more effective ways to finance the pension system. According to the National Council for the Social Security Fund (2018), in 2000, the Chinese government established a national council for the social security fund (NSSF), and its roles are to supplement and adjust the social security spending during different periods of time. In 2017, the investment income of NSSF was 184.6 billion RMB, and the investment yield was 9.68%. Since the establishment of NSSF, the annual average investment yield was 8.44%, and the accumulated investment income was 1007.4 billion RMB. However, the investment income from NSSF is still far behind the deficit of the pension system. The government should keep seeking effective and various approaches to finance the pension system, including transferring more funds to the NSSF based on significant investment yield, and experimenting the fully funded pension plan instead of pay-as-you-go pension plan.

Table—Statutory retirement ages by country, high-OECD countries

Raising the retirement age is another common option. Comparing with many other countries in the world, China has a relatively low retirement age. Almost every high-OECD country has a retirement age over 65, which is quite higher than the 60-retirement age in China. Along with the increasing lifespan of Chines population and development of the economy, it is reasonable to have the labor force retire at a higher age. By doing this, the economic burden on the young generation will also be reduced. Besides, possible reforms include that improving the labor productivity, unlocking housing wealth for retirement, and reducing benefits for high-income groups.

The relationship between old-age pension and individual consumption

Introduction

In addition to the general picture of the Chinese social security system, considerable emphasis should be placed on the relationship between social security and macroeconomics. The main purpose of social security is not only to provide a means of income support for people with inadequate or no income, but also to promote the sustainable growth of the economy. Since the pension system covers a large proportion of social expenditures, and most of the population, pension system and household consumption, saving, and the macro-economy are closely related (Qing, Zhen, & Tianchang, 2018).

In recent years, especially after the 2008 financial crisis, many governments have been seeking effective approaches to stimulate domestic consumption and economic growth. Not coincidentally, the expansion of social security is a strategy adopted by the Chinese government.

The exact relationship between social security and household consumption has always been a debatable issue. Some researchers hold the point that pension system has a crowd-out impact on individual savings, while some the other researchers state that pension revenue has a very limited impact on individual consumption (Qing, Zhen, & Tianchang, 2018).

Theoretical framework and models

However, researchers such as Qing, Zhen, & Tianchang (2018), and Dihong, et al. (2018) built up models and analyzed the relationship between old-age pension and household consumption in an empirical style. The two groups of researchers applied quantitate methods to the panel data of China Health and Retirement Longitudinal Study (CHARLS) 2011 and 2013, and drew conclusions accordingly.

Specifically, researchers Qing, Zhen, & Tianchang (2018) corporate the Ando and Modigliani ’s consumption function with the life-cycle theory, emphasizing that population structure is an indispensable factor concerning with saving rates. In addition, with the model of overlapping generations (OLG) (OLG assuming individuals live for 85 years; individuals from 20 to 63 years to work; individuals above 64 years old live off their accumulated assets, pensions, and family transfers) constructed by Curtis et al. (2015), they drew budget constraints for household with children and retirees as follows:

ct,j=1–τt–τcwt,j+1+rtat,j–at+1,j+1–nt,jct,jc j∈0,43

ut,j=μnt,jct,j1–σ1–σ+ct,j1–σ1–σ  j∈[0,43]

ct,j

: consumption of an individual with age j in the year t, where j=0 corresponds to real-life age 20;  rt

: interest rate earned on assets; at,j

: assets; nt,j

: number of dependent children; ct,jc

: consumption of each dependent children; τt

: proportion of wages into formal pension system; τc

: informal family support; ut,j

: lifetime utility; σ

: inverse of the elasticity of inter-temporal substitution; μ∈[0,1]

: the weight parents put on utility from children’s consumption.

Furthermore, the consumption function and utility function for retirees are as follows:

ct,j=pt,j+1+rtat,j–at+1,j+1  j∈[44,65]

ut,j=ct,j1–σ1–σ  j∈[44,65]

pt,j

: financial support from pension system and family support.

Researchers Qing, Zhen, & Tianchang (2018) combined all the theories mentioned above, and then construct the panel data model as follows:

Consit=β0+β1Incit+β2Inc_decileit+β3Assetit+β4Pensionit+β5Demographicsit+β6Pensionit*Incdecileit+αi+γt+εit (i=1, 2, …, N;t=2011, 2013)

In this panel data model, Inc represents income; Inc_decile

represents income groups with deciles; Asset represents asset property; pension indicates the level of pension benefits. Here pension enrollment could be regarded as exogenous in according to the specific characteristic of China’s pension policy because the participation in public pensions for urban and rural residents is voluntary Qing, Zhen, & Tianchang (2018). Demographics include gender, marriage, education, family size, the number of children, Hukou type (a system of household registration and employment status); αi

indicates time variables including unobserved heterogeneity, and εit

represents time-variant and unobserved factors that may predict the dependent variable.

In this empirical study, pooled OLS, fixed-effect (FE) and random-effect (RE) will be applied. Why FE and RE model?

Data and Variables

The China Health and Retirement Longitudinal Study (CHARLS) is hosted by Peking University and aims to collect high-quality microdata representing households and individuals in China aged 45 and over. CHARLS is designed with reference to the Health and Retirement Study (HRS) in the US, the English Longitudinal Study of Ageing (ELSA) and the Survey of Health and Retirement in Europe (SHARE). CHARLS began its first survey in 2011, tracking every two years, covering more than 28 provinces and 150 counties across the country. By 2015, the CHARLS sample has covered approximately 23,000 respondents in 12,400 households (Qing, Zhen, & Tianchang, 2018). The CHARLS questionnaire includes: demographic background, work, retirement and pension, income, consumption, assets, and health status, etc. Following is an illustration of variables included in this empirical study.

Table—Illustration of the variables

Source: Zhao, Q., Li, Z. and Chen, T. (2016). The Impact of Public Pension on Household Consumption: Evidence from China’s Survey Data. Sustainability, 8(9), p.890.

Results of the analysis

In the rest of the essay, an extension of the empirical work of Qing, Zhen, &Tianchang (2018) will be given.

Conclusions

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