By Hugo Restall, Editor (The Asian Wall Street Journal, November 21, 2001; Excerpt)

Over the next five years, China's pension system deficit is projected to reach $35.4 billion, compared to $4.3 billion last year. The present value of China's unfunded pension obligations is estimated at 50% of GDP.

The encouraging development is that experts appear to agree on the necessary course of action. Earlier this month, at a conference cosponsored by the Cato Institute—a U.S.-based libertarian think tank—and the China Center for Economic Research at Peking University, there was near-unanimous consensus that the solution lies in transitioning to fully funded individual accounts.

José Piñera, the pioneer of this model in Chile, was present to deliver a lecture. He was also invited to multiple meetings at China's Ministry of Labor and Social Security, indicating that the consensus is beginning to extend to government officials.

To date, China has only managed to enlarge the "pooled funds" of money that companies and workers pay to finance the pensions of current retirees. In other words, the thousands of small pay-as-you-go systems administered at the municipal and provincial levels are being consolidated under regional governments. As Zhao Yaohui writes, when benefits are distributed by a distant bureaucracy, local authorities and workers themselves lose all incentive to ensure contributions are made. Companies are evading payments without repercussions, thereby exacerbating the deficit.

China has even fallen into a trap previously warned about by the World Bank: so-called notional accounts. Workers are told they are accumulating a pension in their own account and even earning a low interest rate on it. Upon retirement, their pension is calculated based on the balance shown in their statement. In reality, however, no money backs these accounts, as the state continues to pay retirees' pensions with contributions from active workers.

The solution is to allow individuals greater direct control over their own savings and to enable them to use the services of private fund managers. Moreover, the accounts should not be limited solely to younger workers who still have time to accumulate a full pension.

Of course, challenges would need to be addressed. China's capital markets remain in an early stage: stock exchanges are volatile, and the first open-end mutual fund has only recently been launched. Therefore, workers with a short investment horizon would likely be restricted to investing in government bonds with low yields.

The primary benefit would accrue to the reform process itself: establishing the advantages of fully funded accounts for all workers and shielding them from the ravages of the pay-as-you-go system.