The aging problem of China

Introduction

Today, China is a hot item in the media because of its fast growing economy. Some people are even afraid of this because they think it is a threat to our own economy. This because of the differences in the political and economical system of china compared to our political and economical systems.

The People’s Republic of China, also known as China, was established in 1949. Its land covers a large part of centre Asia. In the 1950s, its population was estimated at around 30 percent of the total global population (Naughton, 2007). Because of this huge amount of people, the Chinese government came up with a plan to put a hold to this growing population. They set a law which prohibited each family to have more than one child, the so-called ‘One-Child Policy’.

The population of China today is relatively young, with a low dependency rate. This is favorable for economic growth (Naughton, 2007). In the future this will lead to an imbalance of the population. This because each working citizen has two elder (parents), this means a working class which is far too small on the total population. Every year, the number of elderly people in China rises with approximately three percent. A way to describe this is calling this a Four-Two-One problem. Which means one child has to take care of two parents and four grand parents (Vandendriessche, 2008).

The research question which I will try to answer is the following:

How is china going to handle the aging problem of the population?

To answer this question, I divided this question into several sub-question, namely:

• How has this aging problem risen?
• What are the difficulties which china is facing because of this problem?
• How do the Chinese old people deal with their longevity financially?

Motivation of the subject:

The subject of Chinese economy is interesting to me because I have little faith in the current economic system of the western society. I believe this economic system based on debts, is not what we would like in the future. And China is one of the few economies which is growing at the moment, despite the current ‘Financial Crisis’. “China’s economy will expand 7.2 percent in 2009 from a year earlier.” (Bloomberg.com, 2009)

But because many economists say capitalism is the best economic system at the moment, I am surprised to see that China does not apply this system.

The reason the subject of the aging of China’s population is important to the economy, is that will one of the greatest pitfalls in China’s economic and societies future. A disproportionate ration of the population will retire in the future, therefore a much smaller group of working people will have to keep the society up and running. Is this possible, or are there many problems which China will have to face in the future? And if there will be problems, is China able to prevent or solve them? This is interesting because of the large number of citizens of China. This cannot be compared with any other country in the world, because it will happen on a much larger scale as for instance in the Netherlands.

Methodology:

First I will try to adumbrate an image of how the situation has developed to the state in which it is at this moment. With this image, certain problems will arise from this. I will try to give a broader view on these problems. These problems, when not solved, will have an impact on the economic environment of China. This I would like to formulate in the third chapter. Finally I am going to investigate whether these, in the future, elder people still have the means to survive on their own, or how the Chinese government is going to assist them with this. This with some kind of pension fund or will the Chinese government terugvallen on the social responsibility of family.

With these sub-answers I would like to give an answer to the main question. How China is going to handle the problem of the aging of the population.

The data which I need I will get from articles from the ‘Chinese Economic Review’, data from the ‘Chinese Bureau of Statistics’, ‘Chinese Data Centre’ and the ‘Chinese Statistical Yearbook’. Furthermore I will search for books on the Chinese economy and the history of the Chinese economy and society.

Structure

The first chapter is about the introduction of the problem and each factor contributing will be explained. In chapter two I am going to give a literature review on five of the interesting papers I have found. Then I will try to find answers to the sub question of my problem statement. These will each cover a chapter.

Chapter three: How has this aging problem risen?

Chapter four: What are the difficulties which china is facing because of this problem?

Chapter five: How do the Chinese old people deal with their longevity financially?

After this I will draw a conclusion based on the previous chapters. With this I will try to give an answer to the main question.

Chapter 2 Literature Review

Population and economic development

Gale Johnson tries to answer the question, what would happen to fertility and population growth if the present population policy were changed to one that emphasized family planning and permitted families to have the number of children that they wished? It seems reasonable to project that there would be an increase in fertility. This would be very small in urban areas and relatively small in higher income rural areas. There would be increased fertility in the lower income rural areas, but it seems unlikely that after two decades or so it could be more than ten percent.

There is evidence to support the following changes in social and economic policies:

1. Significantly improve the quality of rural secondary schools and increase the percentage of girls attending.
2. Create an attractive pension program for rural areas.
3. Give farm people the ownership or permanent rights to the use of the land they farm or, failing that, enforce the policy of no reallocation of farm land on the basis of demographic changes.
4. Change policies and institutions so that families could migrate from rural to urban areas. Which would lead to adaption of the fertility patterns of urban areas, leading to decline in fertility.

I believe the largest impact on the fertility rate, when present policy towards this is changed, will be in the poorer regions of the rural areas. But I do not think all changes give will work. The improvement of educational quality and increasing the percentage of girls will be the one of the most important measures to be taken. This will give an re-allocation of human capital. With this re-allocation, people will get other jobs and therefore a need for many children to work on the farms will decrease. Pension funds are in my opinion essential in order for elderly citizens of China to get by financially. This because the life expectancy rate is increasing. The right of ownership is a viewpoint which will be very sensitive. This because China still has a communistic government. But when pension funds are not one of the future measures which will be taken, this is one of the other options for Chinese citizens to make enough money in order to cope with their longevity financially.

Sources of China’s economic growth 1952-1999: incorporating human capital accumulation

Wang and Yao, find that first, the accumulation of human capital in China, as measured by the average years of schooling in population aged 15-64 years, was quite rapid and it contributed significantly to growth and welfare. However, the rate of growth of human capital declined in the reform period in 1978-1999 and its contribution to GDP growth was smaller compared to the pre-reform period.

In the industrial countries, the contributions to growth by the factor input have declined and the growth of TFP has become the driving force. In China, the potential to further increase factor inputs is limited especially after one considers the rapidly aging population, a decling labor force in the future, and the constraints in natural resources. China has to rely more on productivity growth.

Futher productivity growth would depend very much on two factors: First whether or not China can improve allocative efficiency by continuing reforms in the state and financial sectors and by increasing regional integration, allowing freer factor mobility across sectoral devides, such as rural-urban and state- nonstate, and second whether or not China is able to transform itself from an imitation based economy to an innovation based knowledge economy and continue its progress in industrial upgrading.

I agree with Wang and Yao on the fact that productivity has to grow in China. But in order to do this China has to open up more to other countries. Otherwise this would take too long. China is in need for knowledge, this can be seen in the imitation based economy. When China would have the knowledge, they would invent these products themselves. China’s economic environment has its limitations to grow, this because of their ownership laws. China does not have to change into a Capitalistic society, but I think it does have to loosen up in order to cope with the problems it faces.

Pension reform in China: preparing for the future

According to Loraine West, a combination of pension plans, including defined benefit and defined contribution, are replacing the former single defined benefit plan. The specifics of each plan, including indexation for inflation, and the combination of plans available to workers vary across regions.

By focusing only on the urban labor force, which presently comprises just 27 percent of China’s total labor force, the reformed old age security system is unlikely to address the issue of growing rural-urban inequality.

The proliferation of regional and industry-based pools diminishes the potential benefits of pooling, such as risk sharing, lower administrative costs, and enhanced labor mobility, and also makes it more difficult to achieve the goal of a national level pool.

The key objectives of the new pension system is to move away from a pay-as-you-go system to partial funding in preparation of the aging of the population.

However, to have a successful pension system in the future, the financing burden has to be shared by employees, employers and the government rather than being borne exclusively by the individual work unit. In the short run, it is critical that regulations and supervision catch up with the new system. In the long term, expansion of coverage and benefit adjustments need to be considered.

I agree it will be hard to implement a new old age security system in China. However, I believe it will be key to implement a system which is the same in every part of China. Otherwise the differences between rural and urban areas will only expand, and thus create an even higher burden on the economy than it is at this moment. This will be difficult to fulfill because which groups have to contribute the most. This might even call for a similar system as in the Netherlands, where the government guarantees a minimal pension wage and where the rest is contributed by the companies and working force.

How can China solve its old age security problem? The interaction between pension, soe and financial market reform.

According to Estelle James, she suggests a plan which sets up individual accounts for each worker, with funds that are productively invested. This is similar to reforms that have been sweeping Latin America, Eastern Europe and are now being considered in the United States. Besides making the system more fiscally sustainable and avoiding peak contribution rates, prefunding can be used to increase saving that is committed for long term investments and pension funds can be used as engines to financial market development and corporate governance.

This can be done with two mandatory pillars; one publically managed and tax or pay-as-you-go financed, the other privately managed, with the object of building and managing retirement savings. This to avoid high payroll taxes as the populations age, thereby making the system more sustainable, and to increase national savings that are committed to the long term.

However, the part of the economy that is growing most rapidly, in part because it faces low taxes, liabilities and regulations, would suddenly be hit with a heavy legacy of the past. The challenge for China is to find a way to implement a more funded system, that includes decentralized competitive management of the funds, quickly, before coverage increases become a social necessity and makes the transition more difficult.

Here I have the same critique as on the previous literature, namely about the rural and urban separation. When the pension system first only reforms the urban part and later expands its coverage towards the rural area, the cost will only increase more and more. But it will be complicated to implement a new system immediately for the entire country, this because it will give a huge burden on the current working class.

Chapter 3: The history of China.

The year 1949 can be viewed as the First major divide in Chinese history. Before this year, no rapid growth ever occurred in Chinese economy. This was completely different after 1949, when rapid growth was considerably normal. The government is also drastically different after 1949.

In 1950 a new law was introduced which stated that: ‘Parents have the duty to raise their children well and the children in their turn have the duty to support their parents’. This was a good way for the Chinese government at that time, to not be directly responsible for the attendance of the elder citizens. This was an indication of the change from a harmonious civilization towards a more individualistic civilization. During the fifties, a five-guarantee program had launched for the rural areas. This program mend support from the government for elder who had no offspring or other people who took care of them in the form of food, clothing, shelter, medical care and a funeral. (Naughton, 2007) in 1951, the Chinese government came up with the act “Labour Insurance Regulations of the People’s Republic of China”. These first pension regulations where only for citizens working at state enterprises. This mend that all employees of such enterprise have to give three percent of their salary to a mutual fund within this company, and when they reached the age of sixty and they had worked for more than twenty years they would receive a pension. (Frazier, 2004) This reality, this resulted in a relatively low percentage of people who received a pension, because until 1971 nobody could reach this twenty years of work experience.

At the end of the seventies, two major new regulations were introduced. First in 1978 where China opened their borders a tiny bit for foreign companies to do business with Chinese companies, but still under heavy oversight by the Chinese government. This also led towards a higher independency of the state enterprises. These where allowed to keep their profit. But also the responsibility of pensions was now entirely for these companies. It was now also allowed for Chinese citizens to start up their own company. (KNAG, 2007) However, these new private owned companies were not able to give the same pension security as these former state enterprises. Therefore the Chinese government came up with a new experiment of pension funding in 1982. They tried to create pension funds not just per company, but pension funds for an entire city to create a higher safety net. These funds were filled by employees working in this city on a pay-as-you-go (PAYG) basis. This means the pensions which are currently paid, are funded by the taxes and contributions from the working people at the same moment. That means there are no assets being set aside.

The rural area did not benefit from all these regulations. Because of this new kind of economy, the rural areas decentralized. This took a lot of security away for the elder in these areas, because they were still dependant on the help of family.

The second regulation introduced in the late seventies was the ‘One-Child Policy’. This because the government of China began to see the great threat of the exponentially growing population. This phenomena I will explain in the next chapter.

In the years 1991 and 1995 the government tried to reform the current PAYG system by creating a ‘multi pillar system’. (Vandendriessche, 2008) This system contained three pillars which all contributed to one overall pension fund. The first pillar was the basic pension for every employee of a company funded by the state. The second pillar was a individual fund which was filled during the years of work of each person. Frazier calls this ‘Defined Contribution’. The third pillar is optional, and is an additional payment made to the pension fund to increase the pension received later in the employees lives.

But even with this new reformed pension funding, it is far from ideal.

Chapter 4: How has this aging problem risen?

“Aging of population (also known as demographic aging, and population aging) is a summary term for shifts in the age distribution of a population toward older ages. Which is a direct consequence of the ongoing global fertility transition (decline) and of mortality decline at older ages.” (Gavrilov and Heuveline,2003)

These two factors can both be seen in the ‘statistical yearbook of China’. (Appendix 1)

One of the factors, the mortality rate decline at older ages (See Appendix 1F), can be explained mainly by a better health care; more knowledge of the human body and better medicine (especially anti biotic). The New Rural Co-operative Medical Care System (NRCMCS) is an new project set up in the year two-thousand-five to improve the health care sector in China, especially to make it affordable for the rural area. (China daily, 2005) This NRCMCS covers around eighty percent of the total cost of the hospitals. “Under the new policy, the central government, local governments, and individual farmers each invest 10 yuan (US$1.23) per year to establish a medical insurance account. The money accumulated is then used to fund hospital treatment.” (China daily, 2005) Thought this initiative, many Chinese citizens are now covered for their medical insurance. Around eighty percent of all Chinese citizens living in the rural areas have signed up, which are approximately 685 million people.

The second factor, the fertility rate is harder to explain.

Deliberately decreasing the fertility rate has been an issue of the Chinese government since 1971. In 1970, the total fertility rate was 5.8. At the time of 1978, the fertility rate has decreased with fifty percent to 2.7. This due to the policy known as wan-xi-shao, meaning “later marriages, longer spacing between children, and fewer children in total”. Through 1979 the probability of a couple having a second child, given that they had already given birth to a first child, was 95 percent (Feeney and Yu, 1987). China’s leaders where still worried because china’s “baby-boomers” where now reaching marriage age. These baby boomers where born in the years before this wan-xi-shao policy because of the ‘Great Leap Forward’. China’s leaders thought these group of people would have to many children and this would outgrow the population carrying capacity.

The One-Child policy was established as a law in 1980 by the former Chinese leader Deng Xiaoping. He implemented this law to limit the birth rate of China. This policy was instantly controversial because of it was strictly enhanced in the first years. There was for example a policy for mandatory insertion of intrauterine devices for women with one child and sterilization for couples with two or more children. At 1984, resistance (both nationally and internationally) has risen to a crucial level. The Chinese government relinquished these strict policies and the overall law loosened up. This mend for example that regional governments, especially in rural areas, a policy which allowed couples to have a second child when their first child was a girl. In more urban areas the One-Child Policy was maintained more strictly.

But not only due to the one-child policy fertility rates has gone down. There are significant similarities between China and other surrounding Asian countries in their fertility rates. (See Appendix 1E) However, this has not the same reason is these countries.

“In some countries, notably Japan and Korea, the low birth rate may be partly attributable to rising job opportunities and earning power for women. But that is not the case in Taiwan, Singapore or Hong Kong, where women have excellent work opportunities and access to low-paid domestic help from Southeast Asia. There is a reluctance to marry, particularly among the better educated women, as well as a preference for few, if any, children.” (Bowring, 2007)

But because the ‘Great Leap Forward’ in China, their fertility rate has risen in the years between 1955 and 1970. This in contrast with the other Asian countries shown in this graph (See Appendix 1E).

Chapter 5: What are the difficulties which china is facing because of this problem?

The most obvious problem China will face is the increasing group of elder people. According to Estelle James, “In 1990 only nine percent of China’s population was over the age of 65, bu by 2030 this proportion will more than double, to twenty-two percent”. This means that more than a quarter of the elder people of the entire world will live in China by 2030. As you can see in Appendix … the dependency ratio of elderly people in rural areas will be approximately 0.34 in 2030, and 0.18 in urban areas. Zeng et al. (2008) suggest that, if urbanization reaches 75%, the dependency ratio is likely to continue to rise rapidly in rural areas and may exceed 0.6 by 2050, versus just over 0.3 in urban areas. With such a high dependency ratio, a high contribution rate is required from working people to cover the current bill.

The second problem is the gender imbalance in China. There is a huge surplus of men. At this moment there is are thirty-two million more Chinese boys than girls under the age of twenty. (NYTimes, 2009) These surplus of boys are known in China as “guang guan”. Together with the fact that not everyone will marry or have a child when the sex-ratio is normal, there will be a lot of elderly in the future who do not have children to support them and must rely on some sort of pension. Lin Jiang believes there will be almost four million elderly citizens in the rural area by 2030 who do not have a single child.

The third problem is that the growth of the working age population will drop off quickly and reach zero growth after 2015. (see appendix…) He calculated this because of “The persistence of fertility and mortality rates combines with the existing structure of the population to produce predictable patterns of change of the labor force”. Also According to Naughton, “The labor market is just now absorbing the last huge birth cohort (the “baby boom echo” born in the late 1980s)”

The GDP rate per capita (appendix 2) is still increasing. However the rate of increasing is declining in the last two years. This in accordance with the future growth/ decline of the working age population a conclusion can be drawn that the growth of GDP rate per capita will also decline, not taken into account the growth of the economy. Therefore it is important to stimulate this growth of economy.

This has to be reacted on in order to stop the rising burden on the currently employed after 2015, because of the change in population structure.

Chapter 6: How do the Chinese old people deal with their longevity financially?

It is difficult to ascertain exactly how other countries have financed the transition because of the fungibility of money and the ambiguity of the counterfactual. Most reforming countries in Latin America and Eastern Europe have utilized “parametric” changes that downsized bloated benefit obligations, to reduce the IPD and the financing gap. Beyond that, the following revenue sources appear to be common:

• Keeping part of the system PAYG, so contributions continue flowing into the PAYG pillar–as in Poland, Hungary, Uruguay and Sweden;
• Raising revenues from contributions by increasing the payroll tax or the compliance rate-an add-on was used in OECD countries and most other countries are trying to decrease evasion;
• Using other special revenue sources such as a lottery or a value added tax (Argentina);
• Using general revenues or social security surpluses that are available at the municipal, provincial or state level (Chile);
• Applying proceeds from the sale of SOE assets to cover pension liabilities (assetdebt swaps)-SOE and pension reform were linked in Peru, Bolivia and Poland;
• Borrowing in the short run and repaying with the surplus that the system would run in the longer run, as the individual accounts take on a greater portion of the total pension responsibility (most countries have used this method to smooth the burden of transition costs over many cohorts). Most of these methods would be appropriate for China. China is now using proceeds from a national lottery, a tax on interest income and, as already discussed, direct allocations from the MOF. We concentrate here on a source that has just been tapped– proceeds from the sale of state assets-and another source that is essential but has yet to be seriously addressed–benefit reduction. These two sources, between them, could cover much of the transition costs.

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