How China can defuse its looming demographic crisis; Why not implement a two-child policy and undertake a ‘Big Swap’ for the fragmented pension system, writes Robert Pozen

August 19, 2013 5:59 pm

How China can defuse its looming demographic crisis

By Robert Pozen

Why not implement a two-child policy and undertake a ‘Big Swap’ for the fragmented pension system, writes Robert Pozen

One of the most notorious facets of Chinese life may be about to change: it has been reported that Beijing is considering much broader exemptions from the “one-child” policy, which limits most urban families to one child. This change cannot come soon enough: the country is heading into severe demographic problems. The share of the population that is of working age (19 to 59 years old) relative to the country’s total population peaked three years ago, and is declining rapidly. Under current conditions, the proportion of the population that is aged 65 or older is projected to double by the early 2030s. By 2050, without significant reforms, there will be fewer than 1.6 workers for every retired person in China.

Allowing every family to have two children would increase the number of workers supporting each retired person, and limit the number of forced abortions. Yet it would not automatically lead to a fertility rate of 2.1 per household, the rate necessary to hold China’s population level. In industrialised Asian nations without population control laws, as people move from the land to cities and more women join the workforce, fertility rates have been dropping below 1.5 children per family.

The ratio of workers to retired people can be further improved by making the retirement age for women the same as for men – today, it is either 50 or 55 for women and 60 for men. Moreover, the normal age of retirement should be moved above 60 as life expectancy rises. China has used the age of 60 for retirement since the 1960s, although life expectancy has risen from below 60 then to almost 74 at present.

At the same time, China should reform its pension system, which is now run by each city or comparable unit of local government – all with different rules. Such fragmented administration, together with a minimumvesting period of 15 years, is a barrier to permanent labour mobility. If workers move to a new city or province without obtaining a new hukou (residency permit), they are likely to lose a share of their accrued pension benefits.

Such decentralised management also creates opportunities for corrupt practices. For example, a few years ago Chen Liangyu, the Shanghai Communist party chief, was jailed for diverting pension funds to other uses. Most local governments do not have the resources to meet their obligations to pay the retirement benefits promised in the “iron rice bowl” phase of the Maoist era. State-owned enterprises during that period pledged benefits with few, if any, pension contributions from workers.

To pay these legacy benefits, local governments have been using most of the current pension contributions from urban employers (20 per cent of wages) and even “borrowing” employee contributions (8 per cent of wages) to individual accounts. As a result, the system is mainly pay-as-you-go with little advance funding.

To the extent that contributions are invested, they have low returns because of government restrictions. The assets in individual pension accounts may be invested only in domestic bank deposits or government bonds, both of which pay interest below China’s rate of inflation. More broadly, pension contributions may not, in general, be invested in securities overseas.

So why not undertake a “Big Swap” for the pension system in the next decade? Beijing would take over legacy benefits from local governments and establish a centralised pension system. In return, local governments would give up their roles as collectors of pension contributions and payers of retirement benefits.

This Big Swap would have several crucial advantages. Beijing has the resources to pay legacy benefits without relying heavily on current pension contributions. And if a centralised pension system were established, workers could move permanently to locations with the most attractive jobs – without the threat of losing part of their accrued pension rights. If the pension system were rationalised, most contributions could be invested in diversified portfolios with higher returns.

Of course, a two-child policy, the Big Swap and related changes would take years to implement in a sensible fashion. But China should start soon on these pension reforms since the clock is already ticking on its demographic time bomb.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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