How can China solve its old-age security problem? The interaction between pension, state enterprise and financial market reform

Abstract

Like most countries, China faces a rapidly aging population and a looming social security crisis. Prefunding and unifying a fragmented system are at the heart of the government's projected reforms that are intended to prevent this crisis. The Chinese plan to set up individual accounts to deal with these problems is retarded by three key factors:1 transition costs must be covered in any move toward prefunding, and the Chinese government is still trying to figure out how to accomplish this;2 the current social security system is characterized by fragmentation and decentralized administration, which lead to principal–agent/ moral hazard issues that make it more difficult to cover transition costs, decrease early retirement and increase compliance;3 the funds that have accumulated have not been invested in diversified portfolios by competitive management and have not earned a high rate of return.This paper focuses on these three problems as well as the complex interactions between pension, financial market and state-owned enterprise (SOE) reform. We summarize the bold steps that the government has announced during second half of 2001 to link pension, financial market and SOE reform.