The MPF has achieved an annual return of 5.1% since its establishment in 2000. Inflation during this decade averaged 0.37% annually. The annual return was therefore only 4.7% after inflation. These are poor results and the public knows it all too well. An early change to an individual portable MPF scheme would improve yields for all. It would help the neediest, who save less and depend more on a better performing MPF. 

In redeeming the MPF, we would have less populist demand for a social retirement benefits scheme. One that would have redistribution features to transfer money from the rich to the poor or from the younger generation to the older generation. Such social schemes are destined to be held hostage to populist political demands, inevitably become insolvent, cause negative work effort and savings incentives, produce an enormous fiscal burden as our demographic profile ages rapidly, and damage Hong Kong’s fiscal health.

Otto von Bismarck, Chancellor of Imperial Germany from 1871 to 1890, an aristocrat, a monarchist, and a Prussian nationalist, put in place the first social security system in 1889 in Germany for political reasons that had little to do with his wish to extend a social safety net to all. Bismarck had refused to introduce constitutional reforms and to avoid sharing power with the Church, the socialists, and the Kaiser himself, he sought to bribe off public dissent against himself with the scheme. Modern pay-as-you go systems are intellectual descendants of Bismarck’s scheme. They became widely adopted after the Great Depression in many countries, especially in populist countries.

Without exception these countries have introduced redistribution features into the schemes. As expected, the schemes have unfortunately become essentially insolvent mainly because politics have dominated the design of such schemes. The consequences on economic growth have been negative and future generations are burdened with large public debts. While politicians everywhere have raved that these schemes must be reformed, their deeds have fallen far short of their rhetoric. 

Singapore’s CPF not a good benchmark

Purely private schemes do not usually have redistribution features. They are essentially individual retirement accounts, like Hong Kong’s Mandatory Provident Fund. Singapore’s Central Provident Fund, started in 1955, is uncommon among social schemes in that it does not redistribute money across generations and by income groups. It essentially operates individual savings accounts and is happily solvent but the returns are just as poor. Singapore has wisely recognized that as a small open economy it cannot afford such a redistributive social scheme and risk eventual economic decline. But Singapore has not had a populist government throughout its history and is therefore able to resist falling into this trap.

The CPF has essentially three accounts: ordinary, medisave, and special-retirement benefits. The CPF scheme commits to paying account holders a 4% annual return on its medisave and special-retirement benefits accounts. Between 1980 and 2009 the inflation rate in Singapore was 2.1% and the annual return after inflation is only 1.9% over these 30 years.  In the recent decade from 2000 to 2009 the inflation rate was 1.5%, producing an annual return of 2.5% after inflation. The committed annual return on the ordinary account in the CPF scheme is lower at 2.5% resulting in almost negligible real returns after inflation.

A comparison between Singapore’s CPF and Hong Kong’s MPF shows very little difference in the performance between the two Funds. Hong Kong has been able to achieve a slightly higher nominal rate of return of 5.1% over Singapore’s 4%. But inflation in Hong Kong has been higher than Singapore and this wipes out any modest gains achieved after taking into account inflation. Singapore’s miserable 55-year track record is the wrong benchmark for Hong Kong to follow.

These modest returns are a real problem. The seventy eight economists in Hong Kong, who signed a public statement in September 1994 advocating the establishment of a private MPF in opposition to Chris Patten’s proposal to set up a pay-as-you-go social security system, expected the private MPF to produce a much better investment performance.

Chilean system rebounds strongly

The world’s first private retirement benefits scheme was introduced in Chile in 1980 by Jose Pinera, a Harvard trained economist, during his tenure as Secretary of Labor and Social Security in Pinochet’s government. When he explained the system in 1980 to the Chilean people, Pinera used a 4% real rate of return as an example of the system’s possible performance to convince the population.

The Chilean scheme allows for fully portability of funds to be determined solely by the employee, even though employers also contribute funds to the retirement benefits scheme. The people of Chile could invest in five types of savings funds, denoted A to E, defined by their ratio of fixed to variable return assets. Type A is the most risky one, with up to 80% of its assets invested in equities. Type E is the most conservative one, consisting of fixed interest bearing bonds only. The other ones are intermediate solutions.

In the first 25 years of operation, the Chilean scheme returned an average annual rate of return of 10% above inflation.  Even the worker who was making the minimum wage was getting average annual returns of 10%, for 25 years and at a compounded rate. These returns are almost 6 to 7 times better than those in Hong Kong and Singapore after inflation.

The Chilean system also performed well in the previous decade, which covered the period when the financial tsunami hit the capitalist world economy. Between 2000 and 2009, savers benefited from annualized real returns between 4% on its most conservative investment fund Type E and 9% on its most risky investment fund Type A.

In 2008, the value of Chilean pension assets crashed spectacularly. Average annual returns after inflation looked grim:

Type A:           -40% 

Type B:           -30%

Type C:           -19%

Type D:           -10%

Type E:           -1%

However, in 2009, real values had fully rebounded:

Type A:           +43%

Type B:           +33%

Type C:           +23%

Type D:           +15%

Type E:           +8%

These are averages, which combine all pension fund providers together. But thanks to competition, even the worst-performing company had recovered a large proportion of the initial losses by the end of 2009. Private pension funds have turn out to be a real blessing for ordinary workers in Chile.

Ultimately, what matters are not returns over a year or two, but longer-term average returns, and in those terms, Chile has much to boast about.

Hong Kong regulations prevent competition

The huge differences in rates of return between Hong Kong and Chile during the same period of comparison are very troubling. They suggest that the regulation of Hong Kong’s MPF is seriously flawed. Fund managers and those who appoint the fund managers in Hong Kong should be just as competent as those in Chile. Incompetence cannot explain such large systematic differences in returns over long periods of time.  These differences suggest that regulatory restrictions may have seriously impeded effective competition.

A tell tale sign of the lack of effective competition among fund providers is the hefty 1.8% that is charged for annual management fees.  These are too high for an MPF operating in Hong Kong.

That employers rather than employees select the fund manager seriously impedes competition. This effectively provides the fund managing industry, including large banks and insurance companies with a captured clientele.  As long as employers are willing to stay with the same fund manager when they fail to deliver performance, competition will necessarily be severely compromised.

Other expensive fees are also levied when you move money from one fund to another. Given Hong Kong’s high labor market turnover, a worker often ends up with multiple separate small funds that are employer designated. These scattered funds discourage individuals from becoming better informed about their investment performance and to take action.

We are assured of poor returns as long as those whose funds are under management cannot select the manager, as long as those who select the fund managers are not concerned about performance, and as long as those who manage the funds do not lose business when they fail to perform.

Employee fund portability is essential for triggering effective competition among fund management providers. The Chilean example shows clearly that returns can improve.

MPF administration should also be hugely simplified once this principle is embraced. Fragmented individuals accounts could be consolidated to attain economies of scale. Individuals will be able to manage their entire retirement benefits investment portfolio through a single account administered through the MPF.

The idea that individual fund portability should not be allowed because employers contribute 5% of salary to the employees MPF is totally unconvincing as a reason for not making the change. It is an error to believe that there is a distinction between employer and employee contributions.  Every first year student of economics knows that in a competitive market, the employers’ contribution must also come out of the employees’ wages and salaries in equilibrium. In the first year or two when the MPF was first introduced, there might have been some adjustment to equilibrium. Ten years have since passed so whatever initial adjustments that had to be made would have been completed by now.

Prompt action needed to improve MPF

It is also argued that since the benefits from employer contributions to the MPF are used to offset against long service and severance payment, therefore, employers should be allowed to retain their privilege to select the fund manager, at least for the 5% share they contribute. Surely this can be resolved with some modest procedural innovation. Moreover using employer contributions to retirement benefits to offset against long service and severance payment is neither necessary nor desirable, but this is another subject.

The government should encourage an early shift to improve yields for all, especially the needy who save less and depend more on a successful MPF.  It would mean a life of reduced poverty in old age.  The MPF is a preferred scheme; it can be made even better if we allow it to happen.  It 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.

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