(This essay was published in South China Morning Post on 23 September 2015.)
The Mandatory Provident Fund (MPF) is back in the news following press reports that next year’s Policy Address will end the practice of letting employers use their MPF contribution to offset severance and long service payments. While the Secretary of Labor Matthew Cheung says the government is still gathering views on this issue and has no position at this time, the matter has raised concerns.
Some businesses, especially small and medium enterprises, say this will hurt their interests. Labor representatives welcome the change. But this is not a zero sum issue. Society will gain hugely if the practice is ended.
The “offsetting” arrangements were offered as a sweetener to induce business interests to support the MPF when it was introduced in 2000. I and other economists argued against the idea that employers contributed to the MPF because it was largely an optical illusion. Given time, it would all come out of adjustments in the wages paid to employees and prices charged to customers.
As it turned out, employers benefitted from “offsetting” in two ways. First, it allowed them to pass on some of the cost of severance payments and long service payments to employees. Second, employers were able to secure the privilege of selecting the investment funds on behalf of their employees. This incentivized banks and investments fund managers to provide preferential credit terms to employers rather than better investment returns to employees for the MPF funds they managed.
The result was to create an MPF scheme that served the interests of businesses that needed credit, rather than maximized the returns for pensioners.
This was not what was envisioned in the model for such a scheme, the world’s first private retirement benefits scheme that was introduced in 1981 and has produced much better investment returns than the MPF.
Chilean workers contribute 10 percent of their salaries to a government-supervised scheme, which invests the money in a variety of fixed income and equity securities at home and abroad.
Its supporters were promised a 4% real annual rate of return as an example of the system’s possible performance. In fact it achieved 8.7% over the 34 year period from mid-1981 to mid-2015 because competition among investment funds has kept management fees low and maximized returns.
Compare the results to Hong Kong’s MPF, which since mid-2002 has achieved a real rate of return of 2.28%, well short of Chile’s 5.48% over the same period.
The Hong Kong public knows their MPF has very poor results and are deeply unhappy and worried for their retirement. The problem is the lack of effective competition aimed at maximizing investment returns for the pensioner.
“Offsetting” has produced the wrong type of competition – appealing to employers rather than employees.
There are other restrictions on competition, too. Individual portability of account funds is allowed only for funds contributed by employees, but not by employers.
The large number of funds that an individual can choose from – currently 457 funds belonging to 6 different broad categories – leads to confusion and less effective competition.
Chile, on the other hand, allows for the full portability of funds to be determined solely by the employee, and people choose from five types of savings funds defined by their ratio of fixed to variable return assets.
Another telltale sign of the lack of effective competition among fund providers in Hong Kong is the hefty annual administration costs and total fees as a percentage of assets under management are, 0.75% and 1.74% respectively. Chile’s are 0.27% and 0.60% according to the MPF’s own report in 2007.
Incompetence cannot explain the large systematic differences between Hong Kong’s and Chile’s returns over long periods of time. Rather, regulatory restrictions appear to have seriously impeded effective competition.
An early end to the “offsetting” arrangements would allow a change to a fully, individually portable MPF scheme and would improve yields for all. Further reforms to simplify the MPF administration platform would allow individual account holders to exercise a meaningful choice over a much more limited, comprehensible range of funds. The Chilean example shows clearly that fees can be lowered and returns improved.
The sooner this is done, the less populist pressure there will be for a pay-as-you-go social pension scheme. Such schemes are destined to be held hostage to politics, inevitably become insolvent, and damage Hong Kong’s fiscal health.
The MPF should not be held hostage to the interests of banks, insurance companies, and employers. It is a matter of old age security for all, and for the less fortunate.