Asia is growing richer, and older. Economic success and population aging are increasing societal expectations. The development of social protection systems seems inevitable.
Over the past three decades, China’s economy grew fifteen-fold. By 2050, India is expected to be the world’s third largest economy. At the same time, declining fertility and increasing survival rates are building a demographic deficit. As longevity rises, dependency ratios (the number of non-working – hence dependent – Asians, as a percentage of the economically active population) are set to surge. China (with its one-child-policy) and India already account for approximately 40 percent of the globe’s over-65-year-olds.
Such population dynamics call for a reform of retirement funding. Across Asia, existing pension schemes suffer from spotty coverage and shaky financial sustainability. To receive a pension, the public sector is a worker’s best bet. The formal private sector offers little coverage, the informal sector none. There is no protection in rural areas. The poor and the vulnerable are systematically forgotten. In China, coverage is prevalent among urban workers of state-owned enterprises. In India, less than 10 percent of the working population is protected. In more industrialized Asian economies this proportion is higher, but still lower than in countries with similar per-capita income levels. Also, the fast growth of the middle class and rapid urbanization (over the next 20 years, 900 million people will move to Asian cities) will inevitably lead – as proven in the academic literature – to a rise in social security expenditures. It is time to think ahead.
Asia can afford growing its social-protection coverage without necessarily repeating the mistakes of developed economies, where aging and fiscal constraints are putting pension systems under untenable pressure, while pensioners – now a large percentage (if not the majority) of voters – are hijacking the social pact. Indeed, Asian governments enjoy a favorable policy environment to successfully tackle the upcoming demographic challenge. Strong fiscal accounts and high savings rates are a great starting-point for reforming social security systems. A healthy obsession for fiscal sustainability and readiness to boost private provision are enabling prerequisites for the creation of efficient retirement schemes. In turn, these are likely to provide funding for the growth of currently immature bond markets and – more broadly – the development of the financial sector. A win-win is at hand, and can be seized over the next decade.
There are three likely developments. First, Asian pension systems will be expanded, to include more people. However, to maintain fiscal sustainability, retirement benefits will be lower than the existing ones. Currently, most public sector pensions are “defined-benefit schemes”, financed with contributions by both the employer and the employee. Retirement benefits are specified ex-ante and paid regularly until death. Given that pensions are disbursed on a “pay as you go (into retirement)” basis, an aging work force inexorably digs large financing gaps, hampering expansion efforts. Over the next decade, most governments are likely to turn to “defined-contribution schemes”, where the only specified element is the contribution of both employer and employee. As the monthly pension is not predetermined but depends on market returns of the amounts accumulated by the worker, these schemes are fully funded. On a social insurance basis, and depending on fiscal availability, the policy makers might decide to top up the benefits to an amount considered necessary to prevent poverty, especially among the elderly, and redistribute income. Private savings schemes not linked to the workplace are also likely to be encouraged. In sum, more citizens will be covered, but with fewer benefits.
Second, increased pension coverage will foster consumption and drive growth. As shown in the experience of the countries belonging to the Organization for Economic Co-operation and Development (OECD) over the past 20 years, higher social expenditures are likely to substantially contribute to increasing household consumption via a reduction of savings rates. Asia’s low consumption (in China at 37 percent of GDP, while in developed economies is above 50) is due to high precautionary savings, caused in turn by insufficient social protection of health and old-age needs, and a steep private cost of higher education. According to the International Monetary Fund, in China a sustained 1 percent of GDP increase in public expenditures – across pensions, health, and education – would increase household consumption by 1.25 percent of GDP. Over time, domestic demand – unlocked by higher government social expenditures – will become progressively more supportive of economic growth. As policy makers intend to reduce Asia’s reliance on exports, such reforms are set to enjoy firm support.
Third, there are clear business opportunities for the private sector. Within a Government-regulated framework, private providers of social services will face a flourishing market, and investors are already positioning themselves accordingly. Over the next decade, private provision of financial services, social protection, and social services, such as health and education, will substantially increase. As the number of citizens covered by essential social-protection scheme rises, companies able to integrate coverage by offering supplemental benefits – such as private life insurance, health and retirement – will see their market grow. Private asset managers will see rising demand for their services, as pension funds will need both higher returns and additional diversification for their investments. Finally, Asia’s domestic demand offers sizeable opportunities. All indicators point to sustained growth in the fields of energy, infrastructure (highways and railways), real estate for the middle class (in secondary and tertiary cities), financial services (banking, leasing, and life insurance), and consumer goods.
Prepared as supporting material for the session: “Demographic Change and its Impact on Funding Retirement in Emerging Markets”, World Economic Forum, Annual Meeting of the New Champions 2011, Dalian, China.