The current economic mess in the developed world is easy to explain and hard to fix.
This is a demand-driven downturn, where aging populations choose to save more of what they earn, take on less debt, and generally rotate to a risk-averse world view.
The change isn’t new. It happens to almost all of us as we get older.
The difference this time is that the aging generation is so big compared to other generations that their actions take on outsized importance.
There aren’t enough young people to drive our economies higher. Empty-nesters don’t spend as much because they want to pad their income in retirement. State-sponsored pension programs aren’t typically generous, so this makes sense. As these people spend less, domestic consumption slows down, dragging GDP with it.
While this storyline applies to many countries, one of the hardest hit is China. Its working-age population is shrinking because of the one-child policy from the late 1970s, and aging workers are fearful that they will be destitute in retirement.
They have good reason to be scared.
An Uncertain Social Security Program
The Chinese Social Security program is set up nationally, but funded and administered in the provinces. Employees of private companies are required to contribute eight percent of their pay and their employers kick in as well. After a minimum of 15 years of contributions, workers can retire at age 60 for men, and 55 for women and start claiming their benefits.
What they will receive differs by province and location (urban versus rural), but a typical urban private sector employee is expected to receive 40% of his salary. That might sound alright, but it puts many retirees under the poverty threshold.
In addition to worrying about how much they receive, like retirees around the world relying on state programs, aging Chinese must also worry about whether or not their funds even exist. With several hundred billion dollars in surplus, the excess pension funds are supposed to be invested in a mix of mostly bonds, with a little bit of equity as well.
However, many provincial governments have taken the liberty of loaning the funds to their own coffers for building projects and other uses. If the loans to the local governments don’t pay off, then what? Do the citizens demand a tax hike on themselves? Will the national government step in and make the programs whole? No one knows.
Worried about how much they will receive and if the funds are even available, the Chinese save… a lot.
From 1990 to 2010, the personal savings rate of disposable income shot up from 15% to 30%. In the US, that rate sits at just under five percent.
Saving is great for a single person or a household. But when large swaths of the population are socking away cash instead of spending it, the economy suffers.
The Chinese economy has long relied on capital investment (domestic building projects) for growth. As GDP exploded, this sector grew from 35% of GDP in 2000 to 48% in 2014, according to the World Bank. Exports fell slightly from 23% to 21%, but household consumption dropped from 47% to 36%.
With domestic building slowing down and exports falling, the Chinese government wants consumers to pick up the slack. Unfortunately, they are running headlong into the problem of individuals preparing for their own retirement.
Like I said, the problem is easy to see, but hard to solve. If the government greatly increased the level of pensions, then perhaps consumers would spend more today, boosting economic growth. But there’s no indication that the central government wants to make such a commitment. They could institute a wealth tax, more or less confiscating unspent funds and funneling it to retirees in the form of higher current pension payments, but that might lead current workers to save even more.
One of the few real solutions is a growing labor force, which would mean more workers and therefore more overall spending. Unfortunately, that’s nowhere in the cards for China. Of course, the current situation doesn’t apply equally to all Chinese retirees.
While private sector workers pay in eight percent and receive around 40% of their salary, government workers have a different deal. They pay in nothing, and retire with pensions up to 95% of their final salary.
Maybe the solution is to have everyone work for the government.
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