(This essay was published in Hong Kong Economic Journal on 10 September 2014.)
Before 1997, the last British Governor Chris Patten proposed to introduce a pay-as-you-go social pension scheme. The proposal was withdrawn amidst widespread opposition over its fiscal sustainability and impacts on work and savings incentives. In its place, the Mandatory Provident Scheme was introduced in the year 2000. Unfortunately, the embarrassing performance of the Scheme has rekindled public concern over the problem of old age retirement protection.
Public discussions of old age retirement support have always been very confusing because they involve two different concerns: alleviating poverty and getting votes (or building political support).
It is obvious that some advocates are concerned with the plight of the elderly poor. Poverty among the elderly population is particularly devastating because they have ceased to work, and if they have no savings, they must rely on others to support them. Not everyone can ask their children for help.
Hong Kong has numerous social transfer schemes to support elderly poor without means.
Three Objectives of Professor Chow’s Proposal
One can query whether these schemes are adequate, and if not, how they can be enhanced. One can also ask how an enhanced scheme could be financed. But a universal scheme, such as that demanded by politicians and social advocates, is not a necessity for helping the elderly poor.
Why, then, do they advocate this approach?
Since any universal scheme can have income redistribution features to benefit the poor, and since the most efficient and effective solution for tackling any policy problem is to adopt a targeted solution rather than an indirect one, it would seem that a universal old age social transfer scheme is not merely intended to help the elderly poor but to fulfill some other objective.
Consider a recent suggestion by Professor Nelson Chow in his study Future Development of Retirement Protection. This study involves the actuarial evaluation of five earlier proposals that had been put forward by politicians and social advocates, but Professor Chow also offers a sixth proposal – his own.
From an outcomes perspective his proposal achieves three objectives. First, it consolidates existing old age support schemes into a single simplified scheme and pays every elderly person a monthly sum of $3,000. Existing schemes include non-universal schemes targeted at helping the elderly poor (namely the Comprehensive Social Security Allowance and Old Age Living Allowance) and a universal scheme applicable to all elderly persons (namely the Old Age Allowance).
Second, it provides an enhanced level of support for the elderly poor, which is a long time concern of the good professor for which he is greatly respected by the public.
Third, it provides the same level of support to the middle class and even the rich, a much larger group of elderly households.
The first two objectives are easy enough to understand, but why help the middle class and the rich whose numbers are much larger than the poor? Surely they will have to pay for it in part through an increase in payroll taxes.
In Hong Kong, because of our low tax rates, only half of the working population pays payroll taxes. This means about half of the middle class will contribute nil or a minimal amount in order to receive $3,000 a month in old age.
Those who are already retired and no longer have to pay taxes will also see the benefit of such a scheme. Those close to retirement would realize they benefit, too. If individuals considered only their own interest and ignored that of their children who would be burdened by taxes, then the scheme would have a formidable political support base.
The unspoken objective of using a universal old age social transfer scheme to provide retirement protection is, therefore, ultimately political.
Politicians have long learned to use redistribution schemes to harness political support. In mature political democracies, such schemes have long been deployed to help politicians gain power and remain in office.
History of Social Security
Otto von Bismarck, Chancellor of Imperial Germany from 1871 to 1890 and an aristocrat, monarchist and Prussian nationalist, introduced the first social security system in 1889 in Germany for political reasons that had little to do with wanting to extend a social safety net to all. Bismarck had refused to introduce constitutional reforms so as to avoid sharing power with the Church, the socialists, and the Kaiser himself, so he sought to bribe off public dissent with the scheme.
Without exception these schemes have become insolvent mainly because politics has dominated their design. They have had negative consequences on economic growth and burdened future generations with large public debts. While politicians everywhere have raved that these schemes must be reformed, their deeds have fallen far short of their rhetoric.
Typically, these schemes fail to take into account rising life expectancy, which has led to an underestimation of their costs. Almost all schemes have become insolvent over time. When the first scheme was introduced in Germany in 1889 life expectancy at birth was around 42 years.
In the UK, when the Widows, Orphans and Old Age Contributory Pensions Act was introduced in 1925 by Prime Minister Neville Chamberlain with the promise to pay a pension to men reaching age 65 and women age 60, the average life expectancy was 56 for men and 60 for women. These pensions were justified on the grounds that they were a social insurance payment for those who lived longer than expected, and not upon reaching retirement age. By implication, retirement provisions were clearly considered an individual responsibility and not a social one.
But universal suffrage for all men in national elections had been introduced in 1918 and it has a result of preventing the government from raising the start of payout age even after life expectancy has risen. Life expectancy in the UK in 2011 was 81 years, many years longer than what it was in 1925. Politicians in political democracies have not had the courage to restore social pension schemes to solvency by voting to extend the start of payout age.
Achilles’ Heel
Professor Chow’s calculations reveal that his proposed scheme will be in deficit in the year 2026. Three other schemes he evaluated in his study would also be in structural deficit in 2017, 2024 and 2028. Two additional schemes financed by recurrent government expenditures would cost 2.0%-2.38% of projected GDP in 2041 – more than double what the government currently spends on old age support (about 1%). This shows just how costly these schemes can become given our incredible ageing problem.
Unfortunately, even these estimates are on the low side for three reasons. First, the ageing problem does not peak in the year 2041 (which is the end of the projections of the Census and Statistics Department). UN projections show that the ratio of elderly–to-working population will continue to worsen until 2060 and then stay flat until the end of the century .
Second, the payments are projected on the basis that the monthly sums are adjusted only for cost of living. In projections that last decades, this is not a realistic assumption. As the economy grows in terms of real GDP per capita, it is inconceivable that the sums will not be adjusted further upwards. Surely we will not be so heartless as to resist the case for enhancing the support we give to the elderly as real incomes improve in the community decade after decade.
Third, it is doubtful that the population figures have taken into full consideration the trend of future life expectancy. Numerous estimates show that the US forecast contained in the Social Security Administration Table that life expectancy of Americans in 2070 would be 83.9 years is grossly underestimated. One of the best forecasts performed to date, by Professor Robert Fogel (Nobel Laureate in Economics 1993), estimates life expectancy may reach between 92.5 and 101.5 years. If this is even partially correct, and assuming life expectancy in Hong Kong also improves commensurately, then none of the proposed universal old age pension schemes for Hong Kong could ever be solvent. They are non-starters.
Three Measures to Tackle Elderly Poverty
What then should we do about retirement protection? For rich countries straddled with insolvent schemes, there is no solution except to delay the start of payouts by a few years to restore solvency. For Hong Kong, a much better solution is to address the most expensive and important items of expenditure that the elderly are most concerned about.
Hong Kong should (1) invest to expand medical and health care services, (2) radically reform the mandatory provident fund so that savers will get their money’s worth, and (3) privatize public rental housing and lower land premiums on all subsidized housing. Housing policy reforms alone would directly benefit about half the population in Hong Kong. They would also provide a valuable asset to help those without means to finance their spending. This battery of policies could do miracles to address our old age retirement protection challenge, especially for those without means.
Reference
Robert Fogel, The Escape from Hunger and Premature Death, 1700–2100: Europe, America, and the Third World. New York: Cambridge University Press, 2004.
