Hong Kong adopted a capitalization system for pensions in 2000, called the Mandatory Provident Fund (MPF), following the Chilean model.

 

The debate over what kind of pension system Hong Kong should adopt lasted more than 30 years. Starting in 1966, there were several proposals to implement Singapore's system, but the Hong Kong government rejected them. In 1993, the governor proposed a pay-as-you-go system, but it was scrapped due to opposition from numerous economists. In the end, the government decided to follow Chile's capitalization model for pensions.

 

Under the new system, all Hong Kong citizens must contribute 5% of their income to the MPF, with employers adding another 5%. Employers select the private funds that, in a competitive environment, manage their employees' contributions.

 

The capitalization system has the advantage of being independent of a society's demographic structure, unlike a pay-as-you-go system, where an aging population requires ever-higher taxes on workers. In capitalization, people save for themselves. If they expect to live longer, they'll need to save more. They don't have to worry about whether there are more seniors than young people. In my research, I've shown that pay-as-you-go systems reduce investment in human capital and therefore have negative effects on economic growth rates.

 

Since employers here choose the fund where employees' money will be invested, workers unfortunately have less incentive to closely monitor efficient fund operations. On the other hand, funds invest significant sums in marketing themselves to the employers who select them, which tends to drive up operating costs and management fees. It would be better if workers had the right to choose their own investment funds. That would lower management fees and encourage fund administrators to improve their investment performance.

 

The resulting pension level will depend on how high the savings rate is, the funds' rate of return, the length of the contributory working period, and the expected retirement period.

 

We can think of Hong Kong's system as an incubator that prepares people and fund administrators for the much greater challenges of implementing a capitalization system in mainland China. Capitalization requires a robust capital market to invest pension funds. And there's no doubt that, in this regard, Hong Kong has a huge advantage over mainland China.

 

Hong Kong's experience with capitalization will, in the long run, enable the introduction of this system in mainland China and in other Asian countries seeking more efficient ways to build capital to fund their citizens' pensions.