Deficits, Empty Individual Accounts, and Transition Costs: Restructuring Challenges Facing China's Pension System

Driven by the twin pressures of economic reform and an aging population, China began to reform its pay-as-you-go (PAYG) pension system in the mid-1980s. In 1997, the Chinese government issued a document to formally establish a new, partially funded pension system for urban workers. The new system, featuring a social pooling account and individual accounts, was developed with the joint goals of equity and efficiency in mind. To date, however, the system has failed to achieve these goals. Individual accounts are currently in debt and are accumulating mounting annual deficits. The same is also true of the social pooling account. We identify four major drivers behind the system’s current problems—namely, rapid growth in the number of retirees, the economic decline of the State sector, a decline in payroll tax collection rates, and underreported wage levels. We then examine the linkages between these drivers and the costs arising from the transition from the PAYG system to the partially funded system. On the basis of our analysis, we develop and analyze several recommendations designed to ensure that the new system achieves its goals. Recommendations include government asset sales to fund transition costs, bond issuing, a reduction of the system’s replacement ratio, and an increase in the rate of return on pension assets.