D-day for social security

On July 1, China's long awaited Social Insurance Law will come into force. The United Kingdom passed its first National Insurance Act 100 years ago and the United States started issuing social security numbers as a key to its New Deal legislation 75 years ago. Will China's law have the same momentous impact or will it prove something of a false dawn?

At first sight, the law should not be expected to have the same impact. After all, the British and American moves were the starting point for the development of their social security systems. In China, social insurance has been around since the late 1990s, and without any primary law the system has expanded massively in terms of participation and funding. That is partly reflected in the nature of the evolutionary rather than revolutionary law, which codifies what is already there instead of introducing radical changes or new plans.

Nevertheless, it is easy to underestimate the law's potential impact. The law has some important new provisions, especially those relating to the inclusion of foreigners, the transferability of entitlement between different authorities, unified social insurance collection (which should reduce the costs for business), improved financial management and transparency and legal recognition of social insurance fraud.

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But the law is primarily framework based, leaving much difficult details to be resolved and implemented through State Council and inter-ministerial regulations. A key element for its success will therefore be the swiftness with which the differences between stakeholders can be resolved and new regulations issued. The present timetable for finalizing the regulations remains unclear, and it is vital that the government keeps its eye on their implementation.

In the five years since the European Union-China Social Security Reform Project has been in business, the nature of discussion on social security has changed. In 2006, the focus was on increasing access and participation. The crucial issue now is the system's relative costs and benefits, and the disparities between the benefits offered by the main programs and those for civil and public servants.

To tackle this problem, the government has to resolve a series of long-standing issues, which remain as pertinent today as they were in 2006. The first is the cost of social insurance. Adding all five social insurances to the local housing fund (for those with local hukou or housing registration) will be an expensive proposition, more than 50 percent of an average person's salary in most areas - which is very high in international terms, particularly for developing countries. This represents a formidable deterrent to enroll employees and employers both, especially because of the rising wage costs.

Reducing this figure to a more acceptable 35 percent requires sorting out the local housing funds and pension, which contribute the bulk of the total cost for employers. Reducing employers' contribution to a small percentage with the aim of raising funds for public housing schemes and combining a smaller individual account, perhaps with the medical insurance individual account on a Singapore-type model, could reduce percentage contributions to housing to no more than 7 percent.

A key issue for pensions is that the funds have been used to pay workers who retired from State-owned enterprises in the 1990s or before. While the Ministry of Finance grants large subsidies to the pension project, the funds have not been properly matched and adjusted to take care of the "legacy costs", leaving the social insurance funds struggling to pay workers and retirees. Increasing the level of subsidy to fully fund the "legacy costs" could allow a reduction of perhaps 5 percent in the employers' pension rate. The two measures together, in the longer term, could raise the level of participation and overall amount of contribution.

The second issue linked to "legacy costs" is what to do about the individual enterprise account in the urban enterprise program. This has become more acute after the introduction of the new rural pension system with individual account in 2009. In the urban pension system, most individual accounts are kept nominally on a bookkeeping basis, with the funds that should have been included in it being used to pay pensioners. There has been a somewhat halfhearted attempt to refinance these. But since 2006 this has been in abeyance, and funds restricted to low interest-bearing bank deposits have lost money in real terms.

Since the government has coupled the individual account with the rural system because it appeals to the culture of individual savings, one strong possibility for the government would be to handover the management of these funds to licensed fund management companies as has happened in much of Eastern Europe. This would save the government the responsibility and cost of managing the funds directly - and by providing additional tax or matching incentives, it could increase private pension savings.

A third problem relating to the system's financial sustainability and administrative cost concerns the level of pooling and the hundreds of small local setups. Although the government plans to raise the pooling level in practice, this largely means local governments run the system as they have always done but with more fund adjustments to plug the holes.

This is neither fair nor efficient. It has meant that the level of benefit is somewhat dependent on location (the postcode lottery as it is called in Britain). It also makes the administration of the system inefficient, and many small-scale local programs exist under the radar of effective supervision with the ever-present danger of fraud and theft. It will be a critical test for the new legislation to set down regulations that will enforce higher level of pooling and program unification.

Finally and linked to the administrative organization issue is the capacity of civil servants. The effort of the EU-China social security project, although important, remains a drop in the ocean, given the size of the country. Social security needs to be recognized as a proper career in the government, and civil servants at all levels have to be trained in disciplines such as finance, IT management, customer service and assessment of social care needs. Only a systematic and well-financed capacity building program supported both by central and local governments can give China the administrators it needs and deserves.

With the world economy still uncertain and with an ever-increasing percentage of workers likely to change jobs on a regular basis, social security is not a luxury but a necessity for the development of a harmonious society.

The author is resident fund management expert with the EU-China Social Security Reform Project.