Academic journal article Contemporary Economic Policy

Estimating the Incidences of the Recent Pension Reform in China: Evidence from 100,000 Manufacturers

Academic journal article Contemporary Economic Policy

Estimating the Incidences of the Recent Pension Reform in China: Evidence from 100,000 Manufacturers

Article excerpt

1. INTRODUCTION

China launched an ambitious pension reform during the late 1990s, extending the coverage of the pension system to non-state enterprises. (1) Firms were instructed to contribute the equivalent of 20% of their total wage bills to pension funds. (2) The reform has made steady progress since, with national pension funds increasing by around 25% annually, reaching 2% of gross domestic product by 2007. (3) The unusually large scale of pension reform in China could have had a significant impact on the economy. The goal of this study is to empirically estimate that impact.

A feature of this ongoing pension reform is that its compliance varied across regions, making it possible to estimate the effect of the reform. In particular, we provide empirical evidence utilizing a large data set that covers over 140,000 firms (the population of medium and large firms in China) in 2004 and 2006. (4) We first follow the existing literature to test whether the increased pension costs have reduced the wage expenses of firms (Summers 1989; Montgomery, Shaw, and Benedict 1992; Olson 2002). Following Card, Devicienti, and Maida (2009), we use the change of the pension contribution rate of firms of the same industry in neighboring juris-dictions as the instrument. Although there is no evidence of a trade-off between pensions and the nominal wage, we find that the pension contribution increased faster in regions with higher inflation rates. Hence, a significant amount of the pension cost might have been transferred to employees through reducing their real wages. (5) This is consistent with a model of pension-wage trade-off with a sticky nominal wage, as in Sommers (2005).

We further divide jurisdictions by their agglomeration levels (measured by the number of firms) and estimate the impact of the pension reform. We find that in more agglomerated regions, firms could not fully transfer the pension burden to the employees so their profits significantly declined: increasing the pension-wage ratio by 1 percentage point would have reduced the profit by 1%. In contrast, in less agglom-erated regions, the change of the pension-wage ratio actually increased wages, employment, and profit. We argue that this was because local governments in less agglomerated regions had stronger incentives to attract investors by providing them with subsidies to reduce pension burden. In fact, our estimates suggest that the local governments may have over-subsidized firms: the implied "leakage" of government subsidies to wages and profit amounted to around 9 billion yuan (over I billion U.S. dollars) during 2005 and 2006.

In a similar attempt to ours, Nielsen and Smyth (2008) focused on the trade-off between wages and employer-provided social insurance in Shanghai. They found a minor substitution effect between the nominal wage and social security contributions. In comparison, our study uses different instrumental variables, and examines the effects not only on wage, but also the employment and performance of firms. Moreover, we use data on all median and large firms in China.

The remainder of this article is structured as follows. The next section introduces Chinese pension reform and other relevant policies. In Section III, we propose an empirical framework to estimate the effect of pension provision on firms. The data and empirical findings are summarized in Sections IV and V. Section VI concludes the article.

II. PENSION REFORM IN CHINA

In this section, we introduce the recent pension reform and other relevant changes to the Chinese social welfare and tax systems.

A. The Pension Reform

China maintained a Soviet-type pension system between the 1950s and 1991, covering only the employees of state-owned enterprises. (6) In 2003, a major reform imposed uniform pension mandates on all firms (both state-owned and non-state-owned) In this system, firms will be obliged to contribute 20% of their wage bills to pension funds when the reform process is completed. …

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