1. Pension System

Making Pension Promises More Credible in Asia-Pacific Economies
Mukul G. Asher∗

1. Introduction
The Pacific Economic Cooperation Council (PECC) has initiated a project on Social
Resilience which comprises four elements – pension, medical insurance, unemployment insurance
and macro analysis on savings/ consumption, to provide policy suggestions for the 2010 APEC
meeting in Japan (Japan Institute of International Affairs, 2010). This paper focuses on how thepension arrangements can be improved in Asia-Pacific economies to enhance social resilience.
The need to strengthen pension systems in Asia-Pacific has been evident since at least the
1997-98 Asian financial crisis. As the economic recovery was swift and robust, the initial efforts
to strengthen social protection systems made to address the crisis were not sustained in many partsof Asia. The dominant thinking that Asia should concentrate on high economic growth, and notconstruct robust social protection systems therefore continued among the policymakers andinfluential stakeholders.
The current global crisis is once again leading to intense focus on pension reforms as
credibility of pension promises has come under scrutiny. As the crisis is global, and has
underlined the urgent need for structural as well as financial sector reforms, it is hoped that thefocus on making pension promises more credible will not be short -lived.
The main objectives of any pension system security are consumption smoothing over anindividual’s lifetime; insurance (particularly against longevity and inflation risks); income
redistribution for society as a whole; and poverty relief. However, these have to be traded off
against economic growth, labor market efficiency. As resources devoted to social protection haveopportunity costs, needs of groups other than the elderly in society, and other needs such as health,education, and infrastructure, have to be traded off against allocations for retirement.
Individual, fiscal, and societal affordability should also be considered when constructing
and reforming pension systems. It should be emphasized that the trend of rate of economic growthis among the most important macroeconomic variable impacting on economic security of bothyoung and the old, provided growth is shared widely among different income groups and regions.
Moreover high rate of growth in employment, particularly in the formal sector where workers are
more likely to receive pension and health care benefits, has traditionally been the instrumental
factor leading to expanding coverage of the labor force.
This paper discusses the implications of the Global Crisis for the pension systems and∗ Mukul G. Asher is Professor of Public Policy at the National University of Singapore. He received his Ph. D. from
Washington State University in 1972. His research focuses on social security and public finance issues in Asia, and on India's
economic diplomacy. Excellent research assistance by Bharti Bhargava is appreciated.

25

suggests an avenue for strengthening the pension system with a view to increasing the credibilityof pension promises in Asia-Pacific Economies. The rest of the paper is organized as follows.
Main implications of the 2008 global crisis for the pension systems in Asia-Pacific economies areindicated in Section 2. This is followed in Section 3 by analysis of the demographic and labormarket trends and their implications for the pension systems in Asia-Pacific economies. The
trends portray rapid ageing, and strong tendencies towards informalization of employer-employee
relationships, increasing the complexity and scope of pension reform challenges. A brief overview
of current pension systems in Asia-Pacific economies is provided in Section 4. This is followed bydiscussion of possible avenues to make pension promises more credible. As the discussion ofthese avenues is by necessity fairly general, each Asia-Pacific economy would need to constructpension packages combing elements from different avenues keeping in view the starting point, thepolicy goals, and its economic, institutional and other capacities. The final section provides theconcluding observations.
2. Implications of the 2008 Global Crisis on Pension Systems
The 2008 global economic crisis is arguably among the most severe since the Great
Depression of the 1930’s (IMF, 2010). The crisis has increased the need for strengthening thepension systems in the Asia-Pacific economies, but has simultaneously made the task ofsustaining robust, adequate, and equitable pension systems accessible universally even more
complex and difficult. The crisis is expected to have a significant medium to long term economic,
financial, and social impact globally. For the pension promises in Asia-Pacific, the following
impacts of the crisis are of particular relevance:
Reduction in medium term growth rate, which is the single most important macroeconomic
variable impacting on the economic security of both the young and the old (IMF, 2010).
Adverse impact on the pace and quality of jobs and livelihoods creation (see Section 3).
Potential rise of the cost of debt refinancing (particularly for highly leveraged economies)
as sovereign debt risks have risen. This is indicated by the widening sovereign CDS (credit default
swaps) spreads for many European economies. As an example, between August 3 and August 12,2010 the spread for Ireland rose by 41 percent to 282 basis points (The Financial Times, London,
August 14-15, 2010, p-16). Another indication of the concern is that the US federal government
issued debt in 2009, which was about equal to the debt issued in six proceeding years; and in 2010,
the 2009 debt issue level is expected to be exceeded (The Financial Times, London, August 14-15,
2010, p-15).
The global crisis is expected to adversely impact the growth of remittances flows (Ratha etal, 2008). This is relevant as in many Asia-Pacific economies such as the Philippines, Vietnam,
and Thailand; the inward remittances constitute an important part of the social safety nets for boththe young and the old persons.
Potentially lower medium term real investment returns on pension assets (Pino and Yermo,

26

2010).
Aggressive fiscal and monetary stimulation could lead to inflation, constraining fiscal spacefor expanding social safety nets (IMF, 2010).
On the positive side, the global crisis provides an opportunity to extend pension systems
and social safety nets as an important component of rebalancing the economies (IMF, 2010).
Linking of rebalancing with expansion of pension coverage however will be a complex process
which will take a decade or more. It will also need to accommodate the global concerns about theexisting nature of economic growth, as environmental issues have gained greater prominence, andsocial and human costs of conventional growth patterns which assume ever rising consumption of
goods and services per person become more evident.
3. Demographic and Labor Market Trends
Demographic and labor market trends constitute the essential context within which policies
and programs to make pension promises more credible must function. Tables 1A to 1C provide
selected demographic indicators based on projections by the United Nations (2008) for AsiaPacific economies. The demographic trends suggest rapid ageing in the region due to declining
fertility rates and increasing longevity. In 2030, the number of persons above 60 years of age in
the World is projected to be 1.8 times the corresponding number in 2010, but for Asia it isexpected to double. In some Asia-Pacific Economies such as Singapore, Vietnam, Malaysia andPhilippines the growth in number of population above 60 years of age between 2010 and 2030 isprojected to more than double. In 2010, Asia’s share of World population aged 60 or over was 54
percent, but by 2030 it is projected to be 60 percent, implying more rapid ageing in Asia (Table
1A). Asia will also exhibit more than doubling of the population above 80 years of age. AsiaPacific economies will continue to exhibit among the highest life expectancy in the World (Table
1B). The above trends imply that not only each person will need to be supported in old age for alonger period, but health care expenditure increase disproportionately with increases in longevity(Fuchs, 1998), the total resources needed to support each individual in retirement will also
increase substantially.

27

Table 1A: Asia-Pacific Economies: Selected Demographic Indicators
EconomyTotal Population(million)

Population aged 60
or over (million)

Population aged 80
or over (million)

Year

2010

2030

2010

2030

2010

2030

World

6,909

8,309

759.1 (11.0)

1370.4 (16.5)

105.6 (1.5)

194.2 (2.3)

Asia

4,167

4,917

413.6 (9.9)

821.2 (16.7)

47.3 (1.1)

99.2 (2.0)

Australia

2226

4.2 (19.5)

6.8 (26.5)

0.8 (3.9)

1.5 (6.0)

Brunei010.0 (5.8)

0.1 (13.5)

0.0 (0.5)

0.0 (1.2)

China

1,354

1,462

166.5 (12.3)

342.3 (23.4)

19.3 (1.4)

40.9 (2.8)

India

1,214

1,485

91.7 (7.5)

184.6 (12.4)

8.1 (0.7)

18.0 (1.2)

Indonesia

233

271

20.8 (8.9)

43.4 (16.0)

1.8 (0.8)

4.2 (1.5)

Japan

127

117

38.7 (30.5)

44.5 (37.9)

8.1 (6.3)

15.1 (12.9)

Malaysia28

35

2.2 (7.8)

5.3 (15.0)

0.2 (0.7)

0.6 (1.6)

New Zealand450.8 (18.2)

1.3 (26.3)

0.2 (3.5)

0.3 (5.4)

Papua New Guinea

710

0.3 (4.2)

0.7 (7.3)

0.0 (0.2)

0.0 (0.5)

Philippines

94

124

6.2 (6.7)

14.1 (11.3)

0.5 (0.5)

1.3 (1.1)

Republic of Korea

49

49

7.6 (15.6)

15.3 (31.1)

1.0 (2.0)

2.5 (5.1)

Singapore550.8 (16.0)

1.9 (35.6)

0.1 (2.0)

0.3 (5.9)

Thailand

6873

7.9 (11.5)

15.8 (21.6)

0.8 (1.2)

1.6 (2.2)

Vietnam89105

7.8 (8.7)

19.2 (18.2)

1.1 (1.3)

1.9 (1.8)

Asia-Pacific Economies

Source: Population Division of the Department of Economic and Social Affairs of the United
Nations
Secretariat, World Population Prospects: The 2008 Revision, http://esa.un.org/unpp
Note: Numbers in parentheses is the percentage of total population above 60 and 80
By 2025-2030, only two Asia-Pacific economies, the Philippines and Papua New Guinea
are projected to have total fertility rates (TFR) above the replacement rate of 2.15 (Table 1B). The
median age in Asia in 2010 was slightly lower than for the World as a whole but by 2030 it isprojected to be higher at 35.2 years; indeed, in Japan the median age will be 52 years, Korea andSingapore 48 years, and in Australia and China 41 years.

28

Table 1B: Fertility Rate, Life Expectancy and Median Age in Asia-Pacific Economies
Life Expectancy at
BirthMedian Age

20252030

2010

2030

2010

2030

2.49

2.21

68.9

72.1

29.1

34.2

Asia
Asia-Pacific
Economies

2.26

2.01

70.3

73.6

29.0

35.2

Australia

1.85

1.85

82.2

84.1

37.8

41.2

Brunei

1.95

1.85

77.7

79.1

27.8

33.7

China

1.79

1.85

74.0

76.6

34.2

41.1

India

2.52

1.96

65.2

69.4

25.0

31.7

Indonesia

2.02

1.85

72.2

75.7

28.2

35.4

Japan

1.27

1.4

83.7

85.3

44.7

52.2

Malaysia

2.35

1.87

75.2

77.5

26.3

33.2

New Zealand

2.02

1.85

81.0

83.0

36.6

40.2

Papua New Guinea

3.77

2.8

62.3

66.7

20.0

24.6

Philippines

2.85

2.35

72.9

75.8

23.2

29.0

Republic of Korea

1.26

1.39

80.0

81.7

37.9

47.6

Singapore

1.29

1.44

81.0

82.6

40.6

48.4

Thailand

1.85

1.85

69.9

73.5

33.2

38.8

Vietnam

1.95

1.85

75.4

78.0

28.5

36.7

EconomyTotal Fertility Rate

Year

20102015

World

Source: Population Division of the Department of Economic and Social Affairs of the United
Nations Secretariat, World Population Prospects: The 2008 Revision,
http://esa.un.org/unpp
Note: The average number of children a hypothetical cohort of women would have at the end of
their reproductive period if they were subject during their whole lives to the fertility rates
of a given period and if they were not subject to mortality. It is expressed as children per
woman.
By 2030, China is projected to have 342 million persons above 60 years of age; while thecorresponding number for India, Japan, Indonesia and Vietnam are 185 million, 44million, 43
million and 19 million respectively. Such large numbers suggest that pension reform should notlock an economy into a particular pension arrangement from which reversibility would be very
costly. Even maintaining fairly robust administrative records for such large numbers over a long
period would be a major task, which if not performed with requisite accuracy could adversely29impact on credibility of the pension system.
The Old Age Dependency ratio (ODR) is expected to increase significantly in many AsiaPacific economies. As compared to the global average of 5.6 active workers supporting eachretiree in 2030, in eight Asia-Pacific economies the corresponding figure will be the same orlower (Table 1C).
Table 1C: Trends in Old-Age Dependency Ratios in Asia-Pacific Economies
Economy

Old Age Dependency Ratio

Year

2010

2030

World

12 (8.3)

18 (5.6)Asia

10 (10.0)

17 (5.9)

Australia

21 (4.8)

34 (2.9)

Brunei5 (20.0)

13 (7.7)

China

11 (9.1)

24 (4.2)

India

8 (12.5)

12 (8.3)

Indonesia

9 (11.1)

15 (6.7)

Japan

35 (2.9)53 (1.9)

Malaysia

7 (14.3)

15 (6.7)

New Zealand

19 (5.3)

33 (3.0)

Papua New Guinea

4 (25.0)

7 (14.3)

Philippines

7 (14.3)

12 (8.3)

Republic of Korea

15 (6.7)

36 (2.8)

Singapore

14 (7.1)

46 (2.2)

Thailand11 (9.1)

23 (4.3)

Vietnam

9 (11.1)

18 (5.6)

Asia-Pacific Economies

Source: Population Division of the Department of Economic and Social Affairs of the United
Nations Secretariat, World Population Prospects: The 2008 Revision,
http://esa.un.org/unpp
Note: The old-age dependency ratio is the ratio of the population aged 65 years or over to the
population aged 15-64. All ratios are presented as number of dependants per 100 persons ofworking age (15-64).
Numbers in parentheses refers to persons between ages 15-64 which could potentially support
those above 65; calculated as inverse of the old age dependency ratio.
In many Asia-Pacific economies, the share of formal sector employment is relatively low –in the range of ten and thirty five percent of the total labor force (Forteza et al, 2009). Even in
high-income economies such as Japan, nearly a quarter of the labor force is reportedly no longer
on full-time contracts. So the path followed by the OECD countries in extending coverage

30through the expansion of formal sector employment is less applicable, particularly in low andmiddle income economies of the Asia-Pacific as labor markets will continue to be characterizedby high informal sector employment. Moreover, as many economies in Asia-Pacific are rapidly
ageing, they will have a more mature demographic profile before they attain high income status.
There are four major implications of the above demographic trends suggesting varying
levels and pace of aging among Asia-Pacific economies may be noted.
First, the above demographic trends suggests that time available for extending coverage ofpensions is also relatively less than was the case in the OECD countries. Therefore acting in time
to reform pension systems, and recognizing that such reforms are a process and not an event,
merit greater urgency and focus of the policy makers.
Second, rapid population aging signified by rising old-age dependency ratios, andincreasing life expectancy at birth, suggests that greater resources will have to be devoted to theelderly. These will involve not only higher pension costs, but also higher health care costs as thesetend to rise disproportionately with improved longevity trends (Fuchs, 1998).
A substantial share of the increase in resources will be through the government budget.
Finding more budgetary resources, particularly when the medium-term growth rates are likely to
be moderate, will be a challenge as there will be other demands on such resources. Better
management and governance by social security organizations, and the need to undertakeparametric reforms in the design of various provident and pension fund schemes to ensure theirmedium-term financial sustainability, have therefore become even more urgent in Asia-Pacificeconomies.1
Aggressive fiscal stimulus packages by Asia-Pacific economies to sustain growth during thecurrent global crisis may also constrain future fiscal flexibility as the resulting future budget
deficits will need to be financed. In Australia, the budget deficit is projected to be 2.3% of GDP in2009 and 3.5% of GDP in 2010, a sharp contrast to the average annual surplus of 1.7% of GDP
during 2003–2008 (IMF, 2010). Similarly, the International Monetary Fund (IMF) projects that in2009 and in 2010, Japan’s budgetary deficit will be close to 10% of GDP, as compared to 5.2% of
GDP during 2003–2008. If the slowdown in global economic growth continues, the fiscal
situation in most Asia-Pacific economies will become even more constrained. However, some
economies such as the People’s Republic of China have considerable fiscal capacity to expand
government expenditure, including that required for social security and safety nets (The
Economist 2009). In some Asia-Pacific economies, such as Japan and the Philippines, large debt
to GDP ratios constrains capacity for continuing fiscal stimulation measures (EIU, 2009).
Third, the social security needs of foreign workers will need to be addressed by Asia-Pacificeconomies. Many economies in the region, such as Korea, Japan, Malaysia, U.S., Australia,
Thailand, and Singapore, are large and persistent recipients of foreign labor, much of which is1

Giang and Pfau (2009) have undertaken a stochastic actuarial assessment of pension finances in Vietnam and found that thedemographic changes are likely to deplete the pension fund by about 2052 with a 90% confidence interval range of 8 years.

31supplied from economies, such as Bangladesh, Sri Lanka, India, Myanmar, Philippines, Thailand,
and Viet Nam. Several economies in Asia-Pacific such as U.S., Australia, China, India andThailand have significant bi-directional flows of manpower as they simultaneously host asignificant number of foreign workers while their own nationals are also working abroad.
Totalization agreements2 and agreements involving working and living conditions of foreign
workers, involving Asia-Pacific economies, will need to be encouraged. Recent agreements by
Japan with the Philippines and Indonesia for special arrangements for workers from these two
economies to be employed in Japan on a temporary basis represents an example of taking
advantage of demographic complementarities, as well as drawing attention to the social security
needs of foreign workers.3
Fourth, between 2010 and 2030, it is projected that Asia-Oceania will need to generate 56.5
percent of the total livelihoods to be generated globally, followed by Africa (38.2 percent) Latin
America and Caribbean (8.4 percent), Northern America (2.1 percent), while Europe and Japan
will exhibit a decline in the economically active population (Table 2). In the Asia-Oceania region,
India alone will need to generate 26 percent of the global livelihoods, while China will need togenerate only 1 percent. The labor market challenges therefore will vary among the economies,
with the livelihood creation priority being high for India, while improving labor productivity as apriority being high for China and Viet Nam.

2

Totalization agreements are designed to ensure that individuals and employers do not end up paying social security taxes orcontributions in more than one jurisdiction, or alternatively avoid paying them in either jurisdiction. They also assist inrecognition of pension rights and in cross-border social security administration. The Philippines has entered into about 10
such agreements, mainly with economies in Europe and with Canada. India has also made several such agreements, primarily
with European economies.
3
The main objective of leveraging demographic complementarities is to help expand economic space, and to achieve greater
economic integration among Asia-Pacific economies. Rapidly aging Asia-Pacific economies such as Japan, Korea, andSingapore could make more extensive and innovative use of off-shoring activities, involving those economies such as India,
Philippines, and Vietnam, which are currently in a demographically favorable phase (i.e. where the share of the working-age
population to total population is rising). They can also use technology to minimize use of labor in economic activities,
including elderly care. Some Asia-Pacific economies, such as Malaysia, see hosting the affluent elderly as long-term
residents from rapidly aging Asia-Pacific economies as a good business opportunity.

32

Table 2: Potential Livelihoods Generation* by Region (2010-2030)
Potential Livelihoods Generation by Region (2010-2030)
No% of world(Millions)

total

World

931.1

100.0

Asia-Oceania

525.8

56.5

India

241.1

25.9

Indonesia

31.8

3.4

Vietnam

10.4

1.1

China

9.9

1.1

Japan

-13.0

-1.4

Africa

355.5

38.2

Europe

-47.6

-5.1

78.3

8.4

19.1

2.1

of which

Latin America andCaribbean
Northern America

Note: *This is defined as the number of economically active persons, defined as those between 15
and 64 years of age in a given region, for whom livelihoods will need to be generated in theformal or the informal sectors.
Source: Calculated from Population Division of the Department of Economic and Social Affairsof the United Nations Secretariat, World Population Prospects: The 2008 Revision,
http://esa.un.org/unpp/
4. Pension Systems in Asia-Pacific Economies: An Overview
Asia-Pacific economies have overtime constructed fairly elaborate social security
arrangements involving old-age, sickness and maternity, work injury, unemployment and family
allowances (Table 3). This range suggests that there is a general acceptance of the importance ofthe role of pension systems in ensuring equitable growth and social stability. Since spaceconstraints preclude a detailed description of the pension systems in each economy, the discussion
is confined to the broad features and characteristics of Asia-Pacific pension systems.

33

Table 3: Availability of Programs under Different Branches ofSocial Security in the Asia-Pacific Region
Old age,Economydisability, andsurvivors

Sickness and maternity
Cash benefits Work
benefits for plus medical injury
Cash
both

care

Unemployment

FamilyallowancesaAustralia

X

X

X

X

X

X

Brunei

X

b

d

X

b

b

China

X

X

X

X

X

X

India

X

X

X

X

X

b

Indonesia

X

b

d

X

b

b

Japan

X

X

X

X

X

X

Myanmar

b

X

X

X

b

b

New Zealand

X

X

X

X

X

X

X

b

d

X

b

b

X

X

X

X

b

b

X

b

d

X

X

b

Singapore

X

X

X

X

b

b

Thailand

X

X

X

X

X

X

Vietnam

X

X

X

X

X

b

Papua New
GuineaPhilippines
Republic of
Korea

Sources: Constructed from OECD, 2009; andhttp://www.ssa.gov/policy/docs/progdesc/ssptw/2008-2009/asia/ssptw08asia.pdf
a. Coverage is provided for medical care, hospitalization, or both.
b. Has no program or information is not available.
c. Old-age benefits only.
d. Medical benefits only.
e. Maternity benefits only.
The considerable heterogeneity in pension systems in Asia-Pacific economies reflects a hostof historical and other factors, including the level of economic development and structure of theeconomy. The role of public sector provident fund and pension organizations is predominant inmost of the Asia -Pacific economies. This reflects the structure of the formal sector, where public
sector employees and a relatively small proportion of private sector employees are covered by34

state-mandated and administered schemes. Only the two economies of Hong Kong, China andAustralia operate privately managed defined contribution schemes. There are also programs
financed from the government budget which provide income support to the elderly.
The availability of a pension system, however, does not necessarily imply that it is welldesigned, has wide coverage, or is financially sustainable. Nor does it imply that the pension
system organization administering it is well governed, or that different components of the social
security system complement each other to bring about systemic effectiveness and financial
sustainability. Therefore, in many Asia-Pacific economies greater substance would need to be
injected into the formal social security arrangements with particular emphasis on extending
coverage (Asher, 2009).
In most of the low- and middle-income economies of Asia-Pacific, between ten and thirty
five percent of the labor force is covered by formal pension systems. This reflects relatively low
formal-sector employment in these economies (Forteza et al, 2009).
The contribution rates for old-age income, unemployment insurance, and health care varyconsiderably among Asia-Pacific economies (Table 4). The variations in contribution rates areusually motivated by the larger macroeconomic and political economy factors. For instance,
Thailand’s Social Security Fund, in view of the current global economic crisis, has reduced
contribution rates from 5% to 3.5% for all employers and employees. The state’s contribution toplans will also be reduced from 2.75% to 2.25% in 2009. Estimates suggest that the reduction incontribution rates will collectively save Thailand 22.6 billion Baht for employers and employees,
and 3.8 billion Baht for the Government.

35

Table 4: Contribution Rates of Social Security Programs in Asia-Pacific, 2008 (in percent)
Old age, disability, and survivors
Economy(pensions)

All social security programs a

Insured person Employer Total Insured person Employer Total
Australia d

0.0

9.0

9.0 e

0.0

9.0 f

9.0 e

Brunei5.0

5.0

10.0 h 5.0

5.0 f

10.0

China d

8.0

20.0

28.0

11.0

29.0 f40.0 cIndia d

12.0

17.6

29.6

13.8

22.3

36.1

Indonesia

2.0

4.0

6.0

2.0

7.0 f

9.0

Japan d

7.7

7.7

15.4

12.4

13.1

25.5 cMyanmar d

0.0

0.0

0.0

1.5

2.5

4.0

New Zealand

0.0

0.0

0.0e

0.0

0.0

0.0e

Papua New Guinea

6.0

8.4

14.4

6.0

8.4f

14.4

Philippines d

3.3 b

7.1 b

10.4 b 4.6

8.3 f

12.9

Republic of Korea d

4.5

4.5

9.0

8.5

16.1

Singapore d

20.0 b

14.5 b34.5 b 20.0

14.5 f

34.5

Thailand d

3.4 b

3.4 b

6.9 b

5.0

5.2

10.2

Vietnam d

5.0

11.0

16.0

7.0

18.0

25.0

7.6

Total may not add up due to rounding.
Source: Constructed from OECD, 2009; andhttp://www.ssa.gov/policy/docs/progdesc/ssptw/2008-2009/asia/ssptw08asia.pdf
a. Includes Old Age, Disability, and Survivors; Sickness and Maternity; Work Injury;
Unemployment; and Family Allowances. In some economies, the rate may not cover all of these
programs. In some cases, only certain groups, such as wage earners, are represented. When thecontribution rate varies, either the average or the lowest rate in the range is used.
b. Also includes the contribution rates for other programs.
c. Government pays the total or most of the cost of family allowances.
d. Contributions are submitted to a ceiling on some benefits.
e. Government pays the total cost of most programs from general revenues.
f. Employers pay the total or most of the cost of work injury benefits.
g. Employers pay the total cost of cash sickness and maternity benefits.
h. Government pays the total cost of the universal old-age and disability pensions.
j. Government pays the total cost of unemployment benefits.
k. Employers pay the total cost of family allowances.
l. Plus flat-rate contributions.

36

m. Government pays the total cost of the universal old-age pension.
n. Government pays the total cost of cash maternity benefits.
Singapore’s Central Provident Fund reduced the contribution rate for those aged 55 andabove from 33% (employee: 20%; employer: 13%) in 2003 to 27% (employee: 18%; employer:
9%) in 2006. This was done to enhance wage competitiveness of older workers and to make themmore employable.
In some Asia-Pacific economies, the total contribution rates are quite high. Thus, thePeople’s Republic of China total contribution rate is 40%, India’s 36.1%, Singapore’s 34.5%,
Japan’s 25.5%, and Viet Nam’s 25%. The pension systems contributions are statutory levies andtherefore impact on the cost of hiring workers. They also adversely affect the disposable income
available to workers, leading to liquidity constraints; and create compliance challenges. As aresult, these economies have very limited room to raise contribution rates to improve retirement
benefits.
At the other end of the scale, the contribution rates are quite low for some economies like
Australia (9%) and Indonesia (9%), Brunei (10%), and Myanmar (4%) (Table 4). These
economies therefore have greater flexibility in improving retirement benefits through higher
contributions.
Several Asia-Pacific economies, such as Malaysia, do not require civil servants tocontribute to their pensions, and finance pension liabilities out of current revenue. In several
economies, such as Indonesia and Thailand, contributions by civil servants cover some proportionof the pension costs, with the remaining financed out of government’s annual budget.
While there is evidence of parametric reform in civil service pension schemes, fundamental
systemic reform has not been widespread (Asher 2000). Such reforms however are needed
particularly in economies such as Malaysia, Thailand and Indonesia where there is considerable
scope for either improving the sustainability of existing civil service pension arrangements, or forbringing about more equitable treatment of pension provision and accessibility between the civil
servants on the one hand and the rest of the labor force on the other.
Pension Assets and Investments: For a variety of reasons, pension assets in Asia-Pacifichave been exhibiting rapid growth. The region’s pension assets increased from USD 1,251 billion
in 2003 to US$2,951 billion by 2008, surpassing those in Europe, but still behind assets in North
America, which had US$4,686 billion in 2008 (Watson Wyatt 2009). Many of the largest pension
funds in Asia, such as those in People’s Republic of China, Japan, Korea, and Singapore aresovereign wealth funds (SWFs). SWFs are an integral part of what has come to be known as the
shadow banking system, with hedge funds and private equity funds constituting other components.
China’s foreign exchange reserves of USD 2,500 billion as at mid 2010 will have profound
implications for financial and capital markets globally; and for investment policies and asset
allocation of pension funds in Asia-Pacific. There is however considerable uncertainty about the37

dynamics of such a major development, particularly the long run implications for global financial
and capital markets and for pension investment policies and performance.
In many low- and middle-income economies of Asia-Pacific, the limitations of domestic
financial and capital markets, and lack of capacity or unwillingness to engage in international
diversification of pension fund assets, have meant that investment risks have been concentrated interms of geography (domestic assets) and allocation of assets. In economies such as India, muchof the provident and pension fund investments are in government securities, while in economies
such as Indonesia, domestic bank deposits account for more than half of total investments of thenational provident fund. Nearly all of the sizeable assets, of Malaysia’s Employees Provident
Fund (EPF), equivalent to about half of its GDP as at end 2009, are invested domestically.
Consideration, however, is being given to diversifying the investment allocation of EPF balancesinternationally. Some Asia-Pacific economies, notably People’s Republic of China; Hong Kong,
China; Korea; Japan; Singapore; and Thailand have, however already diversified their pension
assets internationally to varying degrees.
As in other regions, the global economic crisis has added to the challenge of investing
provident and pension fund assets of Asia-Pacific economies in a manner that generates high real
rates of return over a prolonged period (Watson Wyatt 2009).
Provident and pension fund governance and regulation: The governance and regulation ofprovident and pension funds involve managing principal–agent (or agency) relationships. These
arise when principals (provident and pension fund beneficiaries, and tax payers when government
funding is involved) need to rely on agents (provident and pension fund managers and trustees,
government bureaucrats) to pursue their interests. While there has been increasing recognition of
the need for institutionalizing good governance practices involving clarity, accountability,transparency, and management of differing interests among stakeholders, progress among AsiaPacific economies has been relatively modest. State domination of provident and pension fundsponsorship and management in Asia-Pacific has led to less receptivity to the role of an
independent pension regulator who would enforce good governance practices.
There are, however, encouraging signs that governance and regulation issues are beginning
to receive the due attention of policymakers. It is in this context that the establishment of India’s
interim Pension Fund Regulatory and Development Authority may be regarded as an encouraging
sign. International organizations such as the International Social Security Association (ISSA) andthe Organization for Economic Co-operation and Development (OECD) are also increasingly
emphasizing good governance and regulatory practices by their members. Most Asia-Pacificeconomies are members of at least one of these two organizations. Increasing the role of private
occupational pensions in Asia-Pacific economies, and the pressures to generate better returns on
pension assets, are also likely to increase the importance of good governance and regulation.4
4

Thus Japan’s Government Pension Investment Fund (GPIF), with assets of US$1.2 trillion, became an independent
institution in April 2006. Earlier it was part of the Ministry of Health, Labour and Welfare.

38

5. Making Pension Promises More Credible
The description of pension systems of Asia-Pacific economies in Section 4 suggests thatthese systems are diverse with respect to their philosophy, design features, contribution rates,
investment policies and performance, and coverage. As the starting point and the objectives
concerning destination are different, no single blueprint of pension reform is applicable to all
Asia-Pacific economies. The desired replacement rate (ratio of post-retirement to the preretirement income) would however need to be obtained from a variety of tiers, including fromengaging in economic activities during the retirement period. A mixture of state intermediated andprivate savings and other support will be needed in economies at all income levels. In general theshare of the state intermediated pension is likely to decline for most groups, except the elderly
poor for whom retirement income transfers, sometimes called social pensions may become more
prominent, provided fiscal space exists.
Elements in Reform Packages to Making Pension Promises More Credible
As noted, each Asia–Pacific economy would need to plan pension reform to suit its context,
policy objectives and fiscal economic and institutional capacities. The reform package can be
structured from the following elements:
Core Functions: Modernizing and professionalizing existing social security organizations in
performing core functions. Each provident and pension fund must perform five core functions
with a reasonable degree of competence and efficiency. These are: reliable collection ofcontributions, taxes and other receipts (including any loan payments in the security systems);
payment of benefits for each of the schemes in a timely and correct way; securing financial
management and productive investment of provident and pension fund assets; maintaining aneffective communication network, including development of accurate data and record-keeping
mechanisms to support collection, payment, and financial activities; and production of financial
statements and reports that are tied to providing effective and reliable governance, fiduciary
responsibility, transparency, and accountability (Ross, 2004). The use of modern technology,
management and governance practices is a prerequisite for ensuring credibility of pension promise.
In many Asia-Pacific economies a sixth core function concerns promotion of financial literacy andgreater understanding of pension economics, policymakers, trustees or provident and pension fundorganizations and other stakeholders.
Parametric reforms: In pension formulas, increasing retirement age, indexing, etc will need to be
managed better. This also applies to civil service and military pensions. Parametric reforms
involve changing one or more parameter of the pension system, such as altering the pension
benefit formula, increasing the retirement age, and changing pre-retirement withdrawal provisions.
The examples of parametric reforms in Asia-Pacific economies include:
Introduction of deferred annuity scheme by Singapore, called CPF Life, to help address thelongevity risk. The CPF Life does not increase the resources available to an individual inretirement but changes the timing of withdrawals, and introduces a private risk-pooling insurance

39scheme financed by the members themselves.
New Zealand has introduced a portable, defined contribution scheme called the ‘Kiwi Saver
Scheme’, to help manage additional resources needed to address longevity risks
Several economies, such as Japan, Malaysia, and Singapore are encouraging retired
individuals to be at least partly active in the labor market through a variety of measures.
Systemic reforms: A systemic reform involves substantive changes in such areas of the pension
system as basic philosophy (such as a shift from social risk pooling to individuals bearing pension
risks), or pension methods (such as a shift from a defined benefit to defined contribution methodof pensions). This may include for example a shift from Defined Benefit (DB) to DefinedContribution (DC) pension systems, with appropriate grandfathering provisions.
China and Vietnam are considering a possible shift to Notional (sometimes called Non
Financial) Defined Contribution (NDC) for their pension systems for formal sector workers. The
NDC arrangements are complex, but they generally involve pension benefits according to the
choice by the member in resaving retirement benefits, and some sharing of risks by the retirees inpost-retirement longevity increases and when wage growth is relatively low.
Takayama (2006) has argued in favor of adopting NDC arrangement to address Japan’s
pension challenges.
Indonesia’s 2004 social security law (SJSN) envisages the fundamental change towards thecomprehensive social insurance mechanism method for covering not only pension by health careand other social security risks on a universal basis. The current coverage of the pension system inIndonesia is only around one-sixth of the total labor force.
Retirement Income Transfers: More creative and extensive use of retirement income/social
assistance transfers, which do not depend on formal labor market relations, requires fiscal spaceand efficiency in delivery of public services.
Chile’s recent reforms emphasizing social pensions, and non-contributory transfers are
instructive in this regard.
In 2007, Beijing Municipal Government extended coverage of old-age benefit to all elderly
citizens under its jurisdiction. This may be regarded an example of a social pension.
A 2007 Korean initiative expects to cover 70% of all senior citizens through a basic old-age
pension financed by the Government.
Others: These include such diverse measures as converting home equity into retirement
consumption through reverse mortgages and other avenues; occupational or private pension plans;
using the microfinance sector to develop micro-pension products support from family andcommunity; an income derived from physical and financial savings accumulations.
Peoples Republic of China, Philippines, and Thailand are encouraging occupational private
pension plans or individual retirement accounts (or both) to broaden the sources of retirement
financing and risk sharing.
Indonesia and Philippines are encouraging the linking of pension with microfinance. Policy

40makers hope that this will also help enhance financial inclusion and strengthen social cohesion.
Korea and Singapore are experimenting with schemes designed to convert home equity into
retirement income stream.
6. Concluding Remarks
Enhancing social resilience in Asia-Pacific economies would require that pension reforms
are regarded as being integral to overall economic, social and political management of an
economy rather than being of secondary concern. Moreover pension reforms will requirecomplementary reforms in other areas such as fiscal policies, labor markets and financial andcapital markets.
There are several factors which have increased the urgency of conventional and innovative
initiatives concerning pension policies and processes with the objective of making pension
promises more credible in Asia-Pacific economies.
First, Asia-Pacific economies are exhibiting rapid population ageing arising from declining
fertility rates, and increasing longevity. It is projected that Asia’s share of World population aged
60 or over will increase from 54 percent in 2010 to 60 percent in 2030, implying more rapid
ageing in Asia. Asia will also exhibit more than doubling of the population above 80 years of age,with many economies in the Region exhibiting the highest life expectancy in the World. By 20252030, only two Asia-Pacific economies, Philippines and Papua New Guinea are projected to havetotal fertility rates (TFR) above the replacement rate of 2.15. The median age in Asia in 2010 was
slightly lower than for the World as a whole but by 2030 it is projected to be higher at 35.2 years.
Second, increasing informalization of the labor market relationship requires innovative
approaches; including better designed and funded social pensions, to extend pension coverage.
Third, rapid ageing, and accelerating industrialization and urbanization in Asia-Pacificeconomies are expected to increase the resources, both public and private, needed for pensions
and for health care.
Fourth, pension arrangements for cross-border workers have acquired greater importance as
their numbers grow, and because of opportunities to take advantage of potential demographic
complementarities between low fertility economies such as Japan and Republic of Korea andSingapore on the one hand, and those economies where share of working age population to total
population is still rising such as Indonesia, India, and the Philippines.
The urgency of pension reforms has increased, but the 2008 global crisis has made this taskeven more complex; primarily due to its adverse impact on the medium term growth and fiscal
sustainability, and considerably less benign environment for generating returns from pension
assets.
The paper argues that each Asia-Pacific economy would need to construct a pension reform
package suited to its policy objectives, and economic, fiscal, and institutional capacities. Major
elements of such a package for each economy would include a differing mixture of greater

41

competence or professionalism in performing core functions of provident or pension fundorganizations; parametric and systemic reforms; budget financed retirement income transfers;
creating the labor market environment in which a part of retirement income can be obtained by theelderly from remunerative economic activities; converting home equity into retirement income
streams; and using the microfinance sector to develop micro-pension products. Healthcare
measure and habits which enable individuals to resist the onset of old age diseases should acquire
greater prominence, if elderly are to be able to participate in remunerative economic activities.
In constructing context specific pension reform packages, the Asia-Pacific economies would
need to pay considerable attention to, and be open to innovations in pension design and delivery
systems. The reversibility issue in pension design would also need to be addressed. Construction
and maintenance of robust databases, strong analytical capabilities, appropriate organizational
structures and mindsets, and understanding of the subtleties of pension economics (particularly
sustainability over a long time-horizon, the tyranny of seemingly small numbers exerting a
powerful impact on pension scheme viability) will also be needed. It is vital that provident andpension fund organizations publicly communicate to stakeholders stochastic actuarial assessments
providing long-term projections of the impact of changes in demographic, labor market, and othervariables on the sustainability of current pension arrangements. The importance of social pensions
financed from the budgetary resources, requiring fiscal and public service delivery capacities,
would need to be recognized.
As the single most important macroeconomic variable in social resilience is medium term
trend in economic growth, which is widely shared among the population groups, the task ofsustaining such growth without undermining environmental and social capital of the societies
merits serious consideration. This will require rethinking current assumptions about economic
growth which assume ever rising consumption of goods and services. As the nature of growth andgrowth processes become more context specific, greater emphasis on developing indigenous
research capacity, including in pensions policies, and the willingness of the policymakers toincorporate relevant research findings into pension design, processes, delivery systems, andgovernance structures will be essential.

42References
Asher, M. G., 2009 “Extending Social Security Coverage in Asia-Pacific: A Review of Good
Practices and Lessons Learnt”, International Social Security Association (ISSA), Geneva.
Economist Intelligence Unit (EIU). 2009. Global Debt Comparison. http://buttonwood.

economist.com/content/gdc?source=hptextfeature
Forteza, A., Lucchetti, L. and Pallares-Miralles, M. (2009), “Measuring the Coverage Gap”, inHolzmann, R., Robalino, D. and Takayama, N. (eds.) (2009), Closing the Coverage Gap:
The Role of Social Pensions and Other Retirement Income Transfers, Washington D.C.: The
World Bank, pp. 23-40.
Fuchs, V.R., 1998. “Provide, Provide: The Economics of Ageing”, Cambridge: National Bureau of
Economic Research, working paper 6642 http://www.nber.org/papers/w6642
Giang, T.L. and W.D. Pfau, 2009 “Demographic Change and the Long-Term Pension Finances inVietnam: A stochastic Actuarial Assessment”, Population Ageing, April 2009.
International Monetary Fund (IMF), 2010. The World Economic Outlook: Rebalancing Growth.
Washington, DC: IMF
Organization for Economic Cooperation and Development (OECD), 2009. Pensions at a Glance.
Available online at http://www.oecd.org/dataoecd/33/53/41966940.pdf
Pino, A. and Juan Yermo, 2010, The impact of the 2007-2009 crisis on social security and private
pension funds: A threat to their financial soundness?. International Social Security Review,
63: 5–30.
Ratha. D, Sanket Mohapatra & Zhimei Xu, 2008. Outlook for Remittance Flows 2008 2010:
Growth expected to moderate significantly, but flows to remain resilient. Migration andDevelopment Brief, No.8. Washington, DC: World Bank
Ross, S.G., 2004 “Collection of Social Contributions: Current practice and Critical Issues”, Paper
presented at the International Conference on Changes in the Structure and Organization ofSocial Security Administration, Cracow, Poland, 3-4 June
Takayama, N. 2006 “Reforming Social Security in Japan: Is NDC the Answer?” in RobertHolzmann and Edward Palmer (eds.) Pension Reform: Issues and Prospects for NonFinancial Defined Contributions (NDC) Schemes, Chapter 24, 639-647, Washington, DC:
World BankThe Economist, 2009.The End of Retirement. June 27–July 3.
The Japan Institute of International Affairs, 2010 Proceedings of the International Workshop on
Social Resilience, Tokyo, 4-5 March.
United Nations, 2008 World Population Prospects: The 2008 Revision, http://esa.un.org/unpp,
Accessed July 07, 2009.
Watson Wyatt, 2009 “WW/P&I 300 Analysis 2008”, available at http://www.watsonwyatt.com

43Social Resilience, Means-testing, and Capital Taxation –Reflections on Economic Paradigms
Cagri Kumru∗ and John Piggott∗∗1. Introduction
Throughout the developed world, pay-as-you-go (PAYG) social security has been the
backbone of retirement income support for most of the 20th century. Over the last two decades or
more, however, governments everywhere have retreated from their unsustainable promises, as
they try to balance adequate retirement benefits against manageable tax burdens and fiscal stress.
The trigger for this tension has been demographic shift. Pay as you go plans worked well whenlabor forces were always growing relative to retired populations. The prototypical social security
plan is a Ponzi scheme in which ever- increasing human resources are required for sustainability.
Retirement financing has become the battleground for social resilience. It is imperative thatat least the less well-off elderly receive government assistance, since they have few resources,
neither human capital nor financial or real assets. But funding all the retired adequately requires
tax rates on the working population that will test social cohesion. Most governments have copedwith this by reducing benefits surreptitiously – reducing survivor benefits, for example, or alteringindexation arrangements. Such changes provide short-term political relief, but do little in the longterm to buttress social resilience – the beneficiaries of survivor benefits, for example, are likely tobe among the oldest and poorest in the retired pension community.
With this scene setting in mind, this paper re-visits means-testing as a policy option. Meanstesting has a surprisingly bad name among policy makers world-wide. The main reason forsummary rejection of this policy paradigm is that the marginal tax rates faced by those fromwhom a benefit is being withdrawn are usually very high. But we will argue that this has been
overblown, and that, in fact, the distortions and adverse impacts on consumer choice from ameans tested program may be less than that associated with a typical social security program.
The case for means-testing has been strengthened in recent years not only by theimperatives of demographic transition, but also by new analytic insights that indicate that a means
tested program may in fact be second-best optimal. If this is true, then means-tests, which, when
they do crop up, are typically very crude, will require detailed attention to optimize their design
impact. Means-test design has received virtually no attention either by academic researchers or bypolicy-makers, and their potential has not yet been anywhere near realized.
∗ Cagri Kumru is Postdoctoral Fellow, Australian Institute for Population Ageing Research (AIPAR), University of New
South Wales.
∗∗ John Piggott is Professor of Economics and Director of Australian Institute for Population Ageing Research, University of
New South Wales. He received his Ph. D. from University of London in 1980. His research focuses on applied generalequilibrium, public economics and economics of pensions and retirement.

45

We begin in section 2 by describing the retirement income system of one of the very few
economies in the world to embrace means-testing – Australia. Australia has lower public pension
outlays, as a proportion of GDP, than any other developed economy. In 2006, Australia’s public
pension spending was 3.5 % of the GDP while the average public pension spending of the OECD
countries was 7.2% of the GDP (OECD, 2009). Section 3 offers an intuition for why means tests
might dominate more traditional social security paradigms, based on what might be termed classic
arguments. In section 4 we introduce some new analytic insights to further support our case.
Finally, section 5 concludes.
2. The Australian Approach to Retirement Transfers1
For more than a century, the mainstay of retirement income support in Australia has been
the Age Pension. Introduced in 1909, it has served as the social welfare safety net for the elderly
and has provided a major source of retirement income for most retired people. In 2007 around
77% of the retired of eligible age received some Age Pension – while just over half of new maleentrants were paid at the full rate, 56% of new women entrants were paid at the full rate. However,
only 13.3% of pension recipients relied solely on the Age Pension (Harmer, 2008).
The Age Pension is payable to women aged 62 years and over, and to men aged 65 years
and over. (The eligibility age for women is being increased to age 65 by the year 2014). Claimants
must also satisfy certain residency qualifications. It is means-tested by either a person’s income
or assets, whichever determines the lower rate of pension, and is automatically indexed twice
yearly. A higher rate of pension is payable to a single person than to each member of a married
couple. Since 1997, indexation has been against the greater of the growth of the Consumer Price
Index (CPI) and male average earnings. The Age Pension is subject to personal income tax but apensioner tax rebate applies which fully exempts full-rate pensioners from income tax andprovides partial exemption for part-rate pensioners.
In July 2009 the Age Pension amounts were $A14,614.60 pa for single people (around 25%
average male earnings) and $A12,207 pa (around 20% average male earnings) for each of amarried couple.
Means-testing
The Age Pension has been means-tested since its inception. Initially both an income test anda separate property (assets) test applied. The annual rate of pension was reduced on a pound forpound basis once earnings exceeded a free area and also by one pound for every ten pounds of thevalue of property (including the family home) above a second free area. In December 1912 thefamily home was made exempt from the property test, and remains so.
The means tests remained largely unchanged until the late 1960s, when the reduction of theincome test withdrawal rate from 100% to 50% in 1969 marked the commencement of a period of
1This section has been adapted from Bateman and Piggott (2003).

46

liberalization. In the 1972 Federal election campaign, both major parties undertook to abolishmeans testing for the Age Pension. Following this election the pension free amounts were doubled
and, by 1975, the means tests had been abolished for those aged 70 and above. By 1976 the assets
test was abolished.
This represented the highpoint of liberalization of the Age Pension means tests. In 1978
tightening of the means tests commenced when partial means testing was reintroduced for persons
aged 70 or more. By the mid-1980s, means testing on both income and assets was again being
applied to all retirees.
Recent policy has reflected an increased emphasis on targeting, with an attempt to simplify
the administrative burden.2 Under current rules (as of July 2009) the income test the Age Pension
is withdrawn at the rate of 40 cents for each dollar of private income in excess of a free area of$A138 fortnightly (for single pensioners) and $A240 fortnightly (for a pensioner couple). The
assets test operates to reduce the Age Pension by $A1.50 per week for every $A1,000 of assets
above a statutory threshold: $A171,750 for a single homeowner, $A243,500 (partneredhomeowner), $A296,250 (single non-homeowner) and $A368,000 (partnered homeowner). As
noted earlier, the test paying the lower rate of Age Pension applies (Harmer, 2009).
Means testing has ensured that a high proportion of government transfers are received by
the poorest aged, thereby generating significant redistribution (Bateman et al. 1994). It has also
helped to keep the aggregate value of transfers modest.
For some time now, successive governments have maintained the single rate Age Pension ata minimum of 25% of male average earnings. 3 Recently, this rate was increased to 27.7%.
Compared with other rich developed economies, these magnitudes are favorable for safety net
payments, but fall far short of the payments promised under typical public earnings-related
pension schemes.

2

The thrust of the simplification is the extension of ‘deeming’ for financial assets. That is, income to be tested under theincome test is determined by applying a statutory (deemed) rate of return to the capital value of financial assets. 2009
deeming rates are 3 per cent for the $41,000 of financial assets held by a single pensioner or $68,200 for a couple, and 4 percent on amounts above this.
3
Increases flow-on to the partnered rate.

47

Table 1: Features of the Age Pension (a)Established

1909

Eligibility

Residency
Age (males age 65, females age 62 (b))
Means-tested (income and assets)

Funding

General revenues
PAYG

Amounts

Single rate - $A14,614.60 pa
Partnered rate - $A12,207.00 pa(Subject to income and assets means-tests)
Indexed to greater of growth of CPI and male average earnings.

Other benefits

Rent allowance, concessional pharmaceutical benefits, public transport, public
utilities etc.

Taxation

Pensioner tax rebate fully exempts full rate age pensioners from income tax,
partial exemption for part rate pensioners

Means-tests

Income test:
Pension withdrawn at the rate of 40c for each $A1 of private income in excess ofa free area of $A138 fortnightly (single rate), $A240 fortnightly (married rate).
Assets test:
Pension withdrawn by $A1.50 per week for every $A1,000 of assets above
thresholds:
SingleMarriedHomeowner$A171,750$A243,500

Non homeowner$A296,250$A368,000

Thresholds and limits indexed to annual movements in the CPI
Part pension based on whichever test determines the lower rate of pension(a) The dollar amounts are for July 2009.
(b) Until recently the eligibility age for women was age 60. An increase to age 65 is being
implemented over the period 1995 to 2014.
Second pillar support – the Superannuation Guarantee
The Superannuation Guarantee was introduced in 1992, following compliance problems
identified with the inclusion of superannuation in industrial awards. The Superannuation
Guarantee mandates employers to make superannuation (retirement saving) contributions on

48

behalf of their employees to superannuation (pension) funds of their choice4. Employers that failto do so are subject to the Superannuation Guarantee Charge. The superannuation contributions
are placed in individual accounts in private superannuation funds and invested on behalf of theemployees. The guarantee is essentially a guaranteed payment to a superannuation fund of 9% of
earnings. In the last budget, the Government foreshadowed an increase of this mandated
contribution to 12%.
3. Means-testing – A Conceptual Approach5
Like any other tax-financed financial transfer, retirement income transfers impact on
incentives at two points in economic transactions: when the tax is levied, and when the transfer isreceived. These two points of price distortion must both be taken into account in assessing the
economic efficiency effects of a tax-transfer policy.6
To capture both these points of intervention, however, it is necessary to adopt an economywide conceptual framework. Indeed, there are complex interactions between effective marginal
tax rates facing those eligible to receive transfers, those not eligible, and those who are being
taxed to finance it. The problem is also complicated by dynamic inter-temporal effects: theperspective of benefiting from a transfer during old-age might affect decisions about labor supply
and savings during active life. So, individuals who would not be eligible for a transfer if thetransfer program did not exist would become eligible for a transfer because the program is inplace. In fact, even if the transfer is not targeted, individuals might have incentives to change
labor supply and savings rates over the life-cycle, simply because their endowments have beenenhanced by this entitlement.
The usual place to start when assessing the incentive effects of retirement income transfers
and social assistance programs in general, is to look at the effective marginal tax rates (EMTRs)
facing potential beneficiaries.

Targeted programs can induce large EMTRs and can reduce

incentives to work and save for individuals close to the “eligibility line.” Because efficiency costs,
or excess burdens increase disproportionately with EMTRs, their estimation is a natural focus foranalysis. There are, however, potentially important tradeoffs between the EMTR, the number ofpeople affected by the targeting, and other explicit taxes in the economy. We discuss these issues
next.
Assume for the moment that we wish to compare a targeted with a universal social pension.
First, while a means tested pension will impose high EMTRs on those at the margin of eligibility,
where withdrawal of the pension is operative, many individuals potentially impacted by auniversal pension will be unaffected by a targeted pension. The rate of withdrawal of the means
tested pension, sometimes called the taper rate or claw-back, will impact on this. The lower the4

Superannuation is analogous to private retirement saving and superannuation funds are analogous to pension funds. These
terms may be used interchangeably throughout the paper.
5This material draws heavily on Piggott et al. (2009).
6
For a discussion of links between redistribution and incentives see also Robalino et al. 2008.

49

taper rate, the lower will be the EMTR, but the more people will be affected.7 Second, as thetaper rate (and the associated EMTR) is reduced, the overall revenue requirement of the program
will increase, and this will require higher tax rates to be applied to others in the economy,
probably workers. If they already pay high taxes, as in developed economies, then the same
argument about disproportionate efficiency costs of high marginal tax rates will apply, offsetting
the EMTR reduction among pension recipients. If the economy is less developed, with low tax
rates, it is likely that the tax imposition will retard the development of the formal sector – or affect
employment levels when programs are financed through pay-roll taxes (the common approach inthe case of minimum pensions). Overall, the efficiency impact of the two designs will be asomewhat subtle trade-off between keeping a low EMTR for potential beneficiaries and keeping
the tax-burden of the economy at affordable levels.
Figure 1 captures these effects graphically. The upper panel of the figure maps grossincome, yg (on the horizontal axis) into net income, yn (vertical axis). M gives the level ofminimum income available under the assistance scheme.8 A 100% taper, that is, dollar for dollar
withdrawal of the transfer with increments in gross income, is represented by the horizontal line
MA. A 50% taper is represented by MA’. For an individual at any level yg* the cost of the pension
is given by the vertical distance between the 45 degree line and the relevant disposable income
line, MA or MA’. The fiscal cost of the program, however, will depend on the number ofrecipients, whose frequency is mapped in the lower panel. While the frequency distribution
shown is illustrative, it is consistent with available evidence. The revenue cost increases
dramatically as the taper rate is reduced, necessarily requiring increases in distortionary taxes
elsewhere in the economy. Moreover, the income effect generated among those not affected by
the claw-back can still change behaviors regarding labor supply, savings, and retirement.

7This point was first made by Blinder and Rosen (1985). Sefton et al. (2008) makes the same point in the context of means
tested pensions in the UK.
8
Depending on the nature of the scheme, this may be guaranteed to all, all above a certain age, or only to those enrolled in asocial security program.

50

Figure 1: Means-tested Transfers
Disposable
income (yn)(Private+

pensions)A’

BenefitM

Private income (yg)

Yg*

F(yg)

Implications of Means-tested Pension Program in a Large Scale OLG Model
In a recent paper, Kumru and Piggott (2010) study a stylized UK-type means-tested pension
program, to quantify the effects of means testing on economic aggregates and social welfare. Theydevelop a large scale stochastic closed economy overlapping generations model that incorporates
a model-equivalent representation of the UK tax and transfer system. In the model individuals
face mortality and idiosyncratic income risks and they face borrowing constraints in an
incomplete market setting. Hence, the means-tested pension program has an insurance role in themodel. Although the insurance benefits provided by the means-tested program is welfare
enhancing, the program creates distortions on individuals’ saving and labor supply decisions. In
particular, a decrease in the taper rate increases the tax burden on workers and makes themheavily dependent on the public retirement in their old age. In contrast, an increase in the taperrate decreases the tax burden and encourages individuals to save more for their retirement. Yet,although these two effects positively affect workers’ saving and labor supply decisions, anincrease in the taper rate leads old individuals to decumulate their asset holdings as early as
possible to receive more pension benefits.
They show that the existence of another pension program in the economy (the UK has anearnings-dependent PAYG financed pension program as a second tier) affects the aggregate andwelfare implications of the means-tested pension program. In particular, they show that when
there is another pension program, individuals decumulate their asset holdings less rapidly thanwhen there is only means-tested pension program in the economy. Therefore, an increase in the51taper rate creates more positive impact on economic aggregates. They conclude that in thisenvironment, a 100% taper rate is optimal.
In a related paper, Sefton et al. (2008) assess the quantitative implications of the UK’smeans-tested program in a simpler environment than that of Kumru and Piggott (2010). In
particular, they consider the effects of a recent policy reform applied in the UK that reduced themarginal tax rate on private income of means-tested retirement benefits from 100% to 40%. They
conclude that policy reform encourages poor people to save more and delay retirement but has the
opposite effect on richer households. Since Sefton et al. (2008) analyze the means-tested pension
program in isolation by assuming away the earnings-dependent pension program, the negative
effects of the 100% taper rate on after retirement asset decumulation is over-emphasized.
It is clear from both Sefton et al. (2008) and Kumru and Piggott (2010) that analysis ofmeans-tested pension program is complex, and results can be affected from the simplifications
made in the model. Both studies clearly show that higher taper rates positively affect higher
income groups’ saving and labor supply decisions while they negatively affect lower income
groups’ economic decisions. But the extent of the negative impact crucially depends on theavailability of other sources of public retirement income.
Empirical Evidence on Behaviour
The empirical evidence on the impacts of means-tested programs is limited.9 In the US,
Neumark and Powers (1998, 2000) empirically analyze the effects of the means-tested pension
program of the US, the Supplemental Security Income (SSI) program, on individuals’ labor
supply and saving decisions. They show that an increase in SSI benefits results in a reduction inaggregate labor supply and savings because potential participants of the program, in particular
those who are close to retirement age reduce their savings and labor supply.
In a similar vein, Disney and Smith (2002) empirically analyze the behavioral implicationsof the UK’s pension program. They show that abolition of the earnings test raises working hoursof older male workers by around 4 hours a week, with a lesser impact on women’s behavior.
In developing economies, findings are even less settled. Ardlington et al. (2007) analyze theSouth African means tested pension, received by most blacks. While the standard result of
reduced labor supply held for workers resident in the household, the ability of households
receiving a pension to help its younger members find work elsewhere offset this effect. As theysuggest:“If social transfers allow households to overcome credit constraints, enabling households tobankroll potential migrants or potential work seekers who need financial support to look for jobs,
then social transfers like the pension may promote employment and help households to break outof poverty traps.” (Page 2).

9

Piggott et al. (2009) provide a brief overview.

524. Some New and Relevant Analytical Insights
The case for means testing, and the more sophisticated development of means tests, hasbeen given new impetus over the last two decades by new analytical work on optimal taxation.
The received wisdom since the 1980s has been that it is inefficient to tax capital. This result
has been challenged by number of writers: the zero capital income taxation result might not holdif there is market incompleteness and/or the life-cycle framework is used. Alvarez et al. (1992),
Erosa and Gervais (2002) and Garriga (2003) show that it might be optimal to tax capital when
the lifecycle framework is used. In particular, Erosa and Gervais (2002) prove that it is optimal fora government to tax or subsidize interest income. The reason is simple: Individuals’ optimal
consumption-work plan is not constant over the life-cycle. As a result, the government always
wants to use age-varying consumption and labor income tax rates. If it is not possible to condition
tax rates on age, a positive capital income tax rate can be a substitute for age-conditioned
consumption and labor income tax rates.
Conesa et al. (2009) quantitatively characterize the optimal capital and labor income tax byusing an OLG model in which individuals face uninsurable idiosyncratic income shocks andpermanent productivity differences. They find that the optimal capital income tax rate issignificantly positive at 36 percent. This result is not surprising. In the absence of truly age-based
consumption and labor-income tax rates, the positive capital income tax rate is the second bestsolution and hence, it should be positive. Nakajima (2008) extends Conesa et al. (2009)’s workby adding housing into the model to compare whether and how the optimal capital tax rate differs
between the model with housing and without housing. He showed that the optimal capital tax ratein the model with housing is 13%, substantially lower than the Conesa rate.
It is interesting that the idea of age based taxes has not been further developed in a policy
setting. This is possibly because in the US, such a tax would be regarded as discriminatory. In fact,
however, age based programs do exist – the US Medicare program is one example. In Australia,
older people are entitled to a personal income tax offset which effectively changes the rates of
personal income taxation.
The most important implication of the studies above, however, is that means testing now
has a positive rationale. This is because an age pension means test on assets, or capital income, isexactly a tax on capital. Moreover, it is better targeted than a generic capital income tax, because
it directly addresses the complementarity between retirement saving and retirement leisure.
Further, the age based tax literature suggests that means test withdrawal rates could be far better
tailored than they currently are. Taper rates could vary with the value of wealth, and also the ageof the pension recipient. This is an important research program which has barely begun. But it
may hold the key to resolving the tension between providing adequate income to the retired, andkeeping the associated fiscal requirement under control.

53

5. Conclusion
Demographic transition is rendering earnings-dependent PAYG financed public pension
programs unsustainable at the levels of benefit traditionally promised. Therefore, both academic
economists and policy-makers are increasingly interested in alternative ways of providing old age
income. Means-tested pension programs offer one possible solution to providing old age-income
by reducing distortions on individuals’ saving and labor supply decisions. Although theoreticaland empirical analyses of means-tested pension programs have been neglected by economists fora long time, they have been successfully implemented by a few economies including Australia andthe UK.10
Recent theoretical developments shed light on a further role of means-tested pension
programs as a proxy for the optimal age-dependent consumption and labor income tax. This inturn implies that means-tested pension programs are not only a less burdensome way of proving
benefits to retirees, but also a good proxy for optimal consumption and labor taxation.

10

The earliest analysis of the means-tested pensions –to the best of our knowledge- was provided by Feldstein (1987).
Sefton et al. (2008) and Kumru and Piggott (2010) carried Feldstein’s early research to more realistic environment at theexpense of the analytical tractability.

54References
Alvarez, Y., Burbidge, J., Farrell, T., and Palmer, L. (1992), “Optimal Taxation in a Life-cycle
Model”, Canadian Journal of Economics, 25, 111-122.
Ardington, C., Case, A., and Hosegood, V. (2007), “Labour Supply Responses to Large Social
Transfers: Longitudinal Evidence from South Africa”, Working Paper 13442, NBER,
Cambridge.
Bateman, H., Kingston, G., and Piggott, J. (1994), ‘The Equity Implications of Mandated FundedPension Schemes’, in J. Creedy (ed) Taxation, Poverty and Income Distribution, Edward
Edgar, England: 163-74.
Bateman, H and Piggott, J. (2003), “The Australian Approach to Retirement Income Provision”,
the UNSW Working Paper.
Blinder, Alan and Rosen, H. (1985), “Notches”, American Economic Review, 75, 4, September,
736-47.
Disney, R. and Smith, S. (2002), “The Labour Supply Effect of the Abolition of the Earnings
Rule for Older Workers in the United Kingdom”, Economic Journal, 112, 136-152.
Erosa, A. And Gervais, M. (2002), “Optimal Taxation in Life-cycle Economies”, Journal of
Economic Theory, 105, 338-369.
Feldstein, S. M. (1997), “Should Social Security Be Means Tested?”, Journal of Political
Economy, 95, 3, 468-484.
Garriga, C. (2003), “Optimal Fiscal Policy in Overlapping Generations Models”, Working Paper.
Harmer, J. (2008), “Pension Review”, Background Paper, Department of Families, Housing,Community Services and Indigenous Affairs.
Harmer, J. (2009), “Pension Review”, Report, Department of Families, Housing, Community
Services and Indigenous Affairs.
Kumru, C. and Piggott, J. (2010), “ Should Public Retirement Pensions Be Means-tested?”, the
UNSW Working Paper.
Neumark D., and Powers, E. (2000), “Welfare for the elderly: the effects of SSI on pre-retirement
labour supply”, Journal Public Economics 78, 51-80.
OECD (2009), “Pensions at a Glance 2009: Retirement-Income Systems in OECD Countries”
Robalino, D., Rao, G. V., and Sluchinsky, O. (2008), “Preventing Poverty among the Elderly in
MENA Countries:

Role and Optimal Design of Old-Age Subsides”, Forthcoming in

Pensions Primer Series. World Bank. Washington DC.
Piggott, J., Robalino, D., and Jimenez-Martin, S. (2009), “Incentive Effects of Retirement Income
Transfers”, Working Paper.
Sefton, James, van de Ven, J., and Weale, M. (2008), “Means Testing Retirement Benefits:
Fostering Equity or Discouraging Savings”, Economic Journal, 118, April, 556-590.

55

Social Issues and Policy Agendas in Korea
Hyungpyo Moon∗

1. Introduction
The Korean society has gone through a number of changes and faced several newchallenges since the foreign exchange crisis in 1997. As for the change in the role of thegovernment, the government has put forth enormous efforts for the past decade to increase its
social expenditure which had been disregarded during the period of high growth. The size ofsocial expenditure today recorded a rapid annual growth rate of 13%, as shown in Table 1. As aresult, social expenditure grew nearly four-fold in the past decade.
The basic framework of Korea’s social security system was finalized during this period, andmany new systems were adopted, such as the Employment Insurance in 1995, and the launch of
the National Basic Livelihood Security System in 2000. More recently, Korea reinforced its social
safety net through the Basic Old-age Pension (2008) and Long-term Care Insurance (2007) for theelderly. Not only that, in the context of ‘Workfare,’ it also adopted the Earned Income Tax Credit(EITC) and the public childcare system.
Despite the government’s efforts to increase social expenditure Korea’s social safety net has
not sufficiently fulfilled its role in ensuring economic security and upward social mobility ofvarious vulnerable groups in the society. Many loopholes and blind spots are still prevalent within
the social safety net. On the other hand, the continuous deterioration of income distribution andthe rapid pace of population ageing in recent years increased social demands for a more completesocial security system.
Under this background, this short paper aims to suggest a new social policy direction to thepresent Korean policymakers. First, I will briefly go over the current social issues and problems in
Korea and discuss the meaning and agendas of new social policy, followed by suggestions on theprinciples and challenges that should be emphasized in the process of developing andimplementing the policy. The specific issues in pension coverage are also included in the later partof the paper.

∗ Hyungpyo Moon is a senior research fellow at the Korea Development Institute and the managing director of its Economic
Information and Education Center. He received a PhD in economics from the University of Pennsylvania in 1989. His work
has focused on taxation and fiscal policy, social security and pension economics.

57

2. Current Social Issues and Problems
Rising income inequality
Despite the rapid increase in social expenditure, Korea’s income inequality has continued todeteriorate since the mid-1990s. As shown in Figure 1, the Gini coefficient rose sharply from0.275 in 1996 to 0.321 in 2008. Moreover, the relative poverty rate, which is the proportion ofhouseholds with less than 50% of median income, increased even faster from 9.3% to 14.3% overthe same period. Such a drastic change raises a concern now that the momentum of equitable
growth, which the Korean society has been long boasted, particularly, during its development
decades, might come to an abrupt end because of the advent of the information era, globalization,and structural changes in the labor market.

58

0.330

15
14

0.310
13
12

0.290

11
0.270

10
9

0.250
Income Gini
RPR
0.230

8
7

82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

The deterioration of income distribution is mainly attributable to the failed trickle-down
effect from the economic growth into poor households. According to data released by the Korea
National Statistics Office, the real disposable income of poor households, especially those in thelowest 20% in the income decile, has stagnated since the crisis in 1997 as shown in Figure 2. The
deterioration also has weakened the foundation of middle-income class, stating that the proportionof the middle class, which is households with 50%~150% of median income, has fallen by morethan 10 percentage point from 68.7% in 1996 to 56.4% in 2008.
Given that a large middle class is crucial to sustaining social stability and balanced growth,such a large fall should inevitably lead to weakening the foundation of social integration.
Furthermore, continued deterioration in income distribution in spite of the increasing social
expenditure implies that existing welfare expansion policy, which focuses on simple income
transfer, might not be enough to substantially reduce poverty and restore the middle class under
the changed conditions as today.

59

30
20

10
0
-10

-20

nominal disposable income
real disposable income

-30
1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

Weakening social mobility
Another concern is the decline in social mobility and the subsequent weakness in economic
dynamism in Korean society. In particular, the failing public education contrast to booming
private education has widened the educational gap among income classes, resulting in theintergenerational transmission of poverty. For example, high-income households spend 10 times
more on private education than low-income households, and students from high-income
households turn out to record higher scores by more than 30 points in the National Scholastic
Aptitude Test, compared to those from low-income households. (Moon, ed. [2009]) Along with
this, as Table 2 shows, there is a growing gap of wage and job security between labor union vs.
non-union, large company vs. SME, and regular workers vs. non-regular workers. This dual
structure of the labor market serves as an additional factor that has limited the upward mobility
among income classes.

Despite the increase in relative poverty, Korea’s social safety net has not sufficiently
fulfilled its role in preventing and extricating from poverty. The expansion of social insurance so60

far has been highly centered on regular workers; hence its protection for temporary and selfemployed workers is very weak. For instance, at present, the Employment Insurance subscription
rate of non-regular workers is only 39% and more than 6.5 million of the National Pension isdelinquent insurers. (See Table 3). Furthermore, there are a large number of poor households withno access to the benefits of the National Basic Livelihood Security System, and the “all-ornothing” type of comprehensive pay system is also pointed out as a problem that greatly reduces
the incentives to work in order to extricate from poverty.

Ageing society
Along with the issues mentioned above, Korea’s low fertility rate, among the world’s lowest,
and rapidly ageing population increasingly threaten as serious social issues. In particular, an
insufficient support system available for women to rear children while simultaneously pursuing aworking career, overly excessive costs of private education, and prevalent discrimination in theworkplace for married women are obstacles that restrain both fertility and women’s labor
participation rate.
As shown in Figure 3, Korea’s elderly dependency ratio is expected to rise by almost six
times from 12.6% in 2005 to 72% in 2050. Rapid ageing population will not only undermine thegrowth potential by reducing labor supply and savings, but also will substantially put additionalpressure on supporting the elderly. This phenomenon of ageing population is likely to serve as astumbling block for Korea to join the ranks of developed economies. The rapidly ageing society
carries ominous warnings for Korea such as a decline in growth potential, decrease in the working
population, and surging demand for welfare expansion including medical care and public pension
provision, among others.
A rapidly ageing population will also make old age income security more important, whileat the same time, significantly affecting public pension finance. In this regard, Korea now faces
two major policy challenges—that of enhancing the role of the old age income security system as
early as possible and, at the same time improving the financial sustainability of the public pension

61system. These two policies, however, could potentially clash. For example, in the case ofoveremphasizing the function of public pension as a social protection measure, a rapidly ageing
population could undermine the system’s sustainability. On the other hand, if Korea focused
mainly on stabilizing pension finance, its function for old age income security could weaken.

40,000(thousand)

(%)

80

72.0
35,000

70

64.5
56.7

30,00060

46.8

25,000

50

37.7
40

20,00029.1
15,00030

21.7

10,000
12.6

15.0

17.6

20
10

5,000

0

0
2005

2010

2015

2020

15~64

2025
65+

2030

2035

2040

2045

2050

old-age dependency ratio

3. Directions for New Social Policy
Objectives
The Korean society, today, is faced with new challenges such as deteriorated income
distribution, declining social mobility, low fertility rate, and ageing population. Further, increasing
instability in various social sectors calls for the government to move beyond the existing ex-post,
residual, and passive attitude in its social policy stance and to intervene in a more active andpreemptive manner. In particular, there is an urgent need to preemptively build and invest in thefoundation to enhance human capacity, potential, and will in order to overcome poverty andrevive the middle-income class.
Under this context, the current Korean government launched “Human New Deal” in March2009 and has declared its strong will to protect the middle class from erosion, promote new
entries, and foster future entrants through comprehensive measures that focus on the middle class.

62

The term “Human New Deal” has not been coined exactly, yet, but in a broad sense, it could beinterpreted as social policy for preemptive social investment and system improvement with an aim
to build competency to counter potential risk factors in individual life cycle and enhance
individual progress. (Moon (ed.) [2009])
New social policy should put an emphasis on ‘investment in human.’ In other words, thecore value of social policy in the future should be to embody “integrated society pursuing shared
growth” through building a foundation to strengthen the capacity of all members of the society inorder to actively participate in the knowledge-based economy of the 21st century. The objectivesof the new social policy are to establish a society with a large middle class as the foundation forsocial stability and balanced growth, a society that guarantees equal opportunity and high upward
mobility of social strata, and a society with a sustainable and broad-based growth potential.
Strategies
In order to accomplish these policy goals of new social policy, there are three driving
strategies to pursue. First, since sustainable and endogenous economic growth requires theaccumulation of human capital resources, the social policy needs to focus on preventive
intervention in poverty and income inequality through preemptive investment that aims toenhance competency-based human resources. In doing so, it is important to strengthen noncognitive skills such as endurance, motivation, self-control, etc. as well as to foster cognitive
skills through education and training. (Heckmen and Krueger [2002]) Also, to lessen humancapital inequality, intensive focus should be put on the low-income class through investment on
human capacity development so that equal opportunity will be guaranteed to all income levels.
Among these preventative and investable approaches, one of the most important would be
the investment on children. As pointed out by numerous studies, childhood poverty leads to poor
school performance and inferior social and economic status later in life. Therefore, new social
policy needs to considerably strengthen early intervention programs to heighten human capitaldevelopment of children from poor families. “Head Start” of the US and “Sure Start” of the UK
are some of the good examples.
Second, a user-oriented integrated approach is needed. Existing social policies on welfare,education, labor, etc. are provider-oriented, which caused efficiency loss, frequent overlaps andomissions. Even the method of financial support is provider-oriented as well, weakening theperformance incentives. The educational policy, in particular, was implemented by the principle of
input equality, undermining the performance incentives of teachers and schools, which serve asfactors for the collapse of public education and expansion of private education.
In order to solve these problems, we need to focus on the enhancement of comprehensive
human capacity, such as intelligence, social, and emotional aspects, through integrated care,education and training services. It is also necessary to make financial assistance available througha direct Voucher method to users in order to expand their selection choices as well as to improve
the service quality of provider institutions through healthy competition.

63

Third, because each life cycle of each individual differs, risks faced and development stagesof each individual differ as well, and hence, the role of the government for each individual will
differ. Therefore, we need to put concerted efforts on accurately identifying different risk factors
in different stages of life such as preschool, school, productive age and old age so that step-bystep customized services will be available.
As mentioned earlier, in order to correct deficiencies in human capacity due to poverty,
early intervention beginning in infancy and pre-schooling is most effective. Accordingly, thestrategic investment scheme of new social policy should put its priority on early intervention suchas in the preschool stage for substantial development in human capacity.
4. Major Policy Agendas
Under the basic concept of new social policy, mentioned above there are four major policies
I would like to suggest for implementation in each sector.
Firstly, in order to pursue a broader growth through restoring the middle class, it is crucial
to reinforce social safety net which would improve economic security and upward mobility. As
the Hamilton Project from the Brookings Institution [2006] states, a proper social safety net will
surely help each individual to recover from economic difficulties and also it will encourage people
to invest in the uncertain future through start-ups or taking vocational training programs. In otherwords, it will function as a “springboard for a better future.” In this regard, Korea needs to expand
the coverage of social insurance as the primary social safety net and that of public assistance as
the secondary safety net. Particularly, policy measures should be prepared to encourage those
excluded from social insurance to actively signing up by the subsidizing insurance premium for
low-income and non-regular workers and self-employed to the coverage.
Specific policy measures that need to be considered include,- Health Insurance: expanding its coverage and approving loans for medical bills for unemployed.
- Employment Insurance: subsidizing the insurance premium for low-income workers andpending approval on including self-employed to the coverage.
- National Pension: pending insurance-matching support measures for low-income atypical
workers.
- Long-term Care Insurance: improving access for the near poor elderly.
- National Basic Livelihood Security program: In order to strengthen the incentives to escapepoverty, allowances for medical, housing, education, etc. should be separately provided for acertain period of time to past recipients who are no longer eligible for the benefit.
Secondly, it is important to guarantee equal education opportunity through the quality
improvement of public education and reduction in the cost of private education. To strengthen
performance of teachers and schools, it is important to establish a student-oriented teacher
evaluation system, strengthen schools’ autonomy and accountability, and expand the rights of64

student/school selections. To reduce the cost of private education, which is the main culprit forexcessive burden of the middle-income households and their low rate of fertility, it is necessary toenhance the quality of public education, improve the school entrance system, and prevent
excessive growth of the private academic institute industry.
Along with this, to provide equal opportunity of education, it is necessary to implement
mandatory infant education, support more after-school programs, provide more education funds,
and launch “Lifelong Learning Account” projects. Further, it is also important to integrate
education and childcare programs as well as strengthen their quality along with providing more
flexible working hours for woman workers, considering their rise in the labor market.
Thirdly, as for welfare service, it is necessary to strengthen poverty prevention and social
mobility through aggressive early investment policies, which allows for equal opportunity at thestarting line. To that end, it is important to expand the Dream Start project nationwide, which is an
ongoing program that integrates healthcare, childcare, and welfare focusing mainly on thechildren from low-income areas. In addition, it is necessary to implement the Healthy Start
program which provides house-to-house health services to households with infants and toddlers.
Efforts are needed to prevent the fall into poverty due to temporary financial adversity andsupport should be strengthened to help people in need to escape poverty through jobs. To that end,
it is necessary to expand the coverage and scale of emergency support programs for sudden
accident, sickness, or business closure. It is necessary to implement the Self-reliance Support
program which incorporates a self-help project, social employment, and micro-credit programs. It
is also necessary to expand EITC to strengthen work incentive, and to adopt an earnings disregard
system to the unemployment benefit.
Lastly, a core challenge to restoring the middle class is job creation. Hence, policies that
promote quality and creation of jobs should be pursued as well as sustained. To put it another way,under the premise that the government does not create jobs but ultimately jobs are created byprivate investment, it is necessary to consistently implement measures that alleviate the dual
structure of the labor market, upgrade labor management relations, correct unfair trade practice,and enhance productivity of service industries.
To boost employee productivity, it is important to develop their fundamental competency
and support career development. To that end, more tax benefits should be provided for educationand training, and voluntary on-the-job-training and selective training programs by employees in
the private sector should be encouraged. It is also necessary to come up with active measures toencourage hiring of female workers as part-timers so that they can manage both work and family.
Consistency is also needed to streamline laws and regulations to correct gender and age
discrimination practices in the labor market.

65

5. Issues in Pension Coverage1
Narrowness of the pension coverage
Despite the continuous economic growth, deep poverty in the elderly population in Korea
still remains as a very critical problem. As demonstrated in Figure 4, when the relative poverty
line is set at 40% of the average household income, about one fourth of the households with a 60
or older household head and around half of the households with their head aged 70 or over
expectedly fall in the poverty category. This figure is two times and four times higher,
respectively than the average poverty rate of the whole society. Likewise, Korea’s poverty rate of
the elderly households is highest among the OECD member countries and the relative income gap
between working families and elderly households is also widest (Whitehouse [2008]).
The reason for the elderly poverty rate can be easily understood by looking at thecomposition of income sources of elderly households as seen in Table 4. As the table shows, theprivate transfers account for the largest part, 25.8%, of the total income source of elderly
households in Korea while the public pension amounts for only 12.8%. This clearly contrasts withthe fact that the public pension plays the most important role as a major income source for theelderly population in other advanced economies. Furthermore, even the sum of the public
transfers including public assistance and other social welfare subsidies still accounts for less than
20%, showing a lower proportion than the private transfers. This tells us that a majority of elderly
households are financially dependent on their offspring, which has been the tradition.
<Figure 4> Poverty Rates by Ages of Household Heads in Korea1 (2006)
50
45
40
35
30
25
20
15
10
5
0

(%)

49.1

24.9

11.7

20~29

5.6

6.5

30~39

40~49

12.6

9.3

50~59

60~69

70+

average

Note: 1) Poverty line is set at 40% of the median income and the number of households isconverted by applying an equivalence scale.
Source: Korea National Statistical Office, 「National Household Survey」(2006).
1

This section partly relies on Moon [2009].

66

(age)

<Table 4> Composition of Income Sources of Elderly Households1(Unit: %)IncomePayrollBusiness Asset

Privatesourceincomeincomeincometransfers

22.8

9.7

10.9

25.8

Pubic transfers
Publicpension
12.8

Non-ordinary

Othersincome

7.8

10.1

Total

100.0

Note: 1) Based on the households with a 65-year-old or over household head.
Source: Korea National Statistical Office, 「National Household Survey」(2006).
The insignificant role of the public pension is basically due to the fact that Korea’s public
pension system has a very short history. In the case of the National Pension Scheme, it was first
introduced to payroll workers in 1988 and expanded to self-employed in 1999. Therefore, amajority of participants have not reached the minimum participation period (10 years), and even if
they receive their pension benefits, the amount is not so sufficient to lift them out of poverty inmany cases. Making matters worse, those who were already older than 60 when the scheme was
first introduced as well as dedicated housewives have not been given any opportunity toparticipate in the scheme.
Another problem in the application of the National Pension is that many of the participants
do not actually pay contributions. As seen in Table 5, 5.1 million participants, or 28% of the total,
are classified as exempt payers, meaning they are given a grace period for the time being because
they cannot afford to pay contributions. Even more serious is that the number of those people ison the rise recently. Many of them fall into the poor or near poor class, so a substantial number of
those exempt payers will continue to have difficulties in securing the right to receive their pension
in the future.

67

<Table 5> Current Status of National Pension Exempt Payers(Unit: thousand, %)
Total

2005

2006

2007

participants

Workplace participants Regional participants

Exempt payers

17,074

7,951

4,489

4,634

(100.0)(46.6)(26.3)(27.1)

17,691

8,605

4,150

4,936

(100.0)(48.6)(23.5)(27.9)

18,212

9,149

3,956

5,107

(100.0)(50.2)(21.7)(28.0)

Source: National Pension Service.

Policy implications
The narrow coverage of the National Pension, or the issue, the so-called “pension blind
spot,” has been raised as one of the current social issues along with the long-term financial
insecurity. Recognizing this issue, the Korean government put forth its effort to expand thepension coverage and compliance of the challenging groups. Besides building up theadministrative ability to detect the actual income of temporary or daily workers and the selfemployed, more radical policy measures are currently under active discussions. One of suchpolicy options would be the provision of a contribution subsidy to atypical workers with low
income. The main purpose of a contribution subsidy would be to prevent the potential old-age
poverty in advance, rather than providing ex-post financial support after people become actuallypoor in the latter stage of their life.
Contribution subsidy can be considered as a pre-emptive social investment, as it will
alleviate poverty among the elderly in the future. It is also a policy option which costs much lesscompared to the financial burden of the introduction of non-contributory universal basic pension.
Therefore, it would be worthwhile to provide financial incentives for voluntary participation in thepension plan to the low-income class such as atypical workers and poor self-employed, before wejump into the implementation of more drastic structural reform of the Nation Pension.
Currently, many atypical workers are not paying their contributions mainly because neither
workers themselves nor their employers have enough incentives to participate in the pension plan.
Thus, in designing the subsidy scheme for atypical workers, it is important that it should provide
incentives both to workers to voluntarily participate in the National Pension, and to employers toconvert the individually insured workers into workplace-based insured. One way to achieve this68

goal would be relieving the contribution burden partly from both workers and their employers.
6. Conclusion
Undoubtedly, the social safety net, if properly designed, plays a crucial role in ensuring
economic security and social mobility of each individual in a society. In particular, its importanceis growing with increasing various economic risks due to the recent global financial crisis andrapid population ageing, among others. However, the social safety net in Korea is still not
sufficient enough to play the role of ensuring economic security and preventing poverty due to its
short history and narrow coverage. Hence, it is imperative that the Korean government should
place a top priority in strengthening the basic social safety net in order to protect the middle classfrom erosion and promote new entries.
The reinforcement of the social safety net can also help increase consumption demand andpromote economic recovery, as it will generally reduce the precautionary motive for savings. It
does not seem desirable to me, however, to expand the social safety net for the purpose ofboosting domestic consumption. Since expanding the social safety net not only takes time but also
is very costly, it would be a less effective measure for economic stimulus compared to othertraditional macroeconomic, both fiscal and monetary, tools. The causality should be the other way
around; consumption increase is the result of, not the purpose of, a strengthened social safety net.

69

References
Altman, R., J. Bordoff, P. Orszag, and R. Rubin, The Hamilton Project : Advancing Opportunity,
Prosperity and Growth, The Brooking Institution, 2006.
Heckman, J., and A. Krueger, Inequality in America : What Role for Human Capital Policies ? ;Cambridge, MA: The MIT Press, 2005.
Moon, H., “The Role of Social Pensions in the Republic of Korea,” in Closing the Coverage Gap,
R. Holzmann, D. Robalino, and N. Takayama(eds.) Washington, DC : World Bank, 2009.
Moon, H., (ed.) Human New Deal Policy, Korea Development Institute, 2009. (In Korean)Whitehouse, E., “Socioeconomic Status of Older People”, presented at the World Bank Hitotsubashi - MOF Workshop on Closing the Coverage Gap: The Role of Social Pensions,Tokyo, 20-22 February, 2008.

70

Development of Pension Arrangements andFuture Pension Policy Issues in Japan
Noriyuki Takayama∗

1. Introduction
In the past, families and occupational schemes on a private basis were the major old-age
safety net in Japan. The principal social security pension program was introduced during theWorld War II. It had developed gradually under the period of high-speed economic growth. Its
development looked like a dividend from economic growth. An enormous shift of the populationfrom farmers to salaried-men took place during the rapid growth period, along with longer life
expectancy. The household size has become smaller and smaller on average. The rise and the fallof private enterprises have been very common in this period. These factors forced a major sourceof old-age income to shift from families and occupational schemes to social security pension
programs.
The future demographic and economic situations of Japan will make the current, generous
social security pensions hard to maintain, however. It is still an open question whether or not
Japan will manage to contain the increasing social security pension cost, while assuring its people
stable lives over the whole life-cycle.
This chapter first explains changes in Japan’s social security pension programs. Second, it
discusses future pension policy options in Japan.
2. Changes in Japan’s Social Security Pension Program
Japan had six social security pension programs covering different sectors of the population.
The earliest plan was established in 1890; the most recent, in 1961. The earliest plan was formilitary servants, which asked no individual contributions. It was totally financed by generalrevenue. The scheme was then expanded to civil servants. The old-age benefit for military andcivil servants was based on the final salary and its benefit level was generous from the outset.
The principal program mandatory for private sector employees is the Kosei-Nenekin-Hoken(KNH), which was enacted in the wartime in 1942. Old-age pensions of the KNH were forced tosuspend immediately after the end of the war and the KNH contribution rate was reduced from
11% to 3%. The KNH was rebuilt in 1954 shifting from an earnings-related pension to a two-tierbenefits system with flat-rate basic benefits.

∗ Noriyuki Takayama is Professor of Economics at the Institute of Economic Research, Hitotsubashi University. He received
his Ph. D. from University of Tokyo in 1982. His research focuses on social security pensions, using the Japanese micro databases.

71

2.1 High-speed Growth Period
The social security pension system was and is to be reformed at least every five years. In
the early stages, the KNH benefit level was not charming yet, and for the old-age retirees at thattime a lump-sum retirement benefit provided on a private basis by their employers was often ofmuch more significance. On the other hand, pension benefits for civil servants were considerably
higher. This difference induced “gap-decreasing” adjustments in benefit levels between private
and public sector employees. Drastic improvements in the KNH old-age benefits were takenplace in 1965 and in 1973; the replacement ratio in gross wage terms was increased to 40% andthen to 60%. In 1973 the updating of past salary together with the benefit indexation enabled
retired people to afford to manage in their old-age with the generous KNH benefits. In themeantime, there happened the sharp decline in the real significance of their lump-sum retirement
benefits provided privately by their employers.
Under the KNH, equal percentage contributions are required of employees and theiremployers. The 3% contribution rate had been gradually increased and the total percentage went
up to 7.8% in 1973.
At the outset, the KNH was established as a defined-benefit plan on a fully funded basis. It
was initially regarded as a compulsory saving program to prevent inflation. Its finance shifted
gradually from funded to pay-as-you-go. Currently the KNH has a reserve fund of about 128
trillion yen in March 2010. KNH contributions used to be accumulated in a reserve fund to beinvested in social overhead capital for the construction of highways, railways, bridges, airports,
and other public projects.
Before 1961 the self-employed, people engaged in agriculture/forestry/fishery, theunemployed, persons with no occupation, and employees working in small firms were still
excluded in the social security pension system. The Kokumin-Nenkin (KN) Law was put into
effect in April 1961, embracing all the people, previously uncovered, under social security. The
participation in the KN has been compulsory for everyone (even for the jobless persons) between
20 and 59 years old.
The basic structure of the KN is a flat-rate basic benefit and a flat-rate contribution on an
individual basis. One-third of the KN benefits were financed by subsidy through general revenue.
The full old-age benefit of the KN was payable initially after 25 years of contributions from age
65, although an actuarially reduced or increased benefit could be claimed at any age between 60
and 70. The transitional KN old-age benefit with a special 10-year-contribution requirement
began to be paid actually in 1971. A majority of the elderly came to enjoy receiving this special
benefit, which contributed to making the public aware of a significant role of social security
pensions in old-age income security. “Go and Go” policies were immediately adopted. The
benefit formula of the KN had been revised to be more and more generous. Meanwhile automatic
indexation of the KN benefit was also enforced in 1973.

72

2.2 Period of Diminished Expectations
The KN started with a very small contribution, which was politically difficult to increase.
The KN soon faced severe difficulties in financing benefits. An enormous shift of the populationfrom farmers to salaried-men during the rapid growth period obliged some revenue-sharing
scheme between employees’ and non-employees’ pensions to be necessary. The scheme wasestablished in 1986, and since then, the first-tier basic flat-rate benefits of all the pension systems
have been financially integrated. Currently the flat-rate pension benefit is financed on a fully payas-you-go basis. The 1986 reform has changed some requirements of the KN; the full old-age
pension is payable after 40 years of contributions, provided the contribution were made before 60
years of age. There have been introduced special transitional provisions for those born after 1926
with at least 25 years of coverage. They can receive the maximum pension even with fewer
contribution years, provided they had been contributing since 1961.
It should be noted that those covered by the KNH (and the other employee pension systems)
are not required to make individual contributions to the KN, while the KNH itself is responsible
for the financial participation in the integrated first-tier, flat-rate basic pensions.
Since the 1986 reform, if the husband has the contribution deducted from his salary andplaced in the KNH, his dependent wife has been automatically entitled in her own name to theflat-rate basic benefits, and she has not been required to make any individual payments to the
public pension system. Through this, the women’s right for pension has been comprehensively
established.
The 1986 reform included another advance in the flat-rate disability pensions. A dependent
child of age less than 20 got to be entitled to the flat-rate basic benefits in case of disability.
Though the medical check was (and is) very strict, the handicapped children largely came to besupported by the social security pension system and not by the special welfare program.
Through the 1986 pension reform, the accrual rate for the earnings-related component of theKNH old-age benefits was to be reduced gradually from 1.0% per year to 0.75% cohort by cohort.
The reductions corresponded to the longer average contribution years of the younger cohorts. On
average, each cohort was expected to receive 30% of his career average monthly real earnings as
the earnings-related component.
The future demographic situations of Japan were getting darker and darker; the total fertility
rate (TFR) showed an unexpected sharp decline from 1975 and the current level in 2009 is 1.37.
There is still little sign that the TFR will stabilize or return to a higher level. Japan’s total
population began to fall from 2005, reaching 45% of its current level by 2100. On the other hand,life expectancy was steadily increasing. Consequently, the proportion of the elderly (65 years andabove) for Japan was 22.7% in 2009 and became the front runner in the world. It is expected toreach 30% by 2020 and more than 40% around 2050. In the 1990s, the Japanese economy
changed dramatically, too, when the asset bubble finally burst. The colorful dreams that Japaneseyouth have placed in their economy would be likely to be destroyed.

73Both demographic and economic factors in the future will probably impose greater stresses
on social security pension programs which are based on pay-as-you-go defined-benefit financing.
The biggest political issue in the Japanese pension system was when to start benefit payments.
The pension age was 60 years for workers in the 1990s. The government had proposed twice in1979 and 1989 to raise the eligibility age for all workers to 65. The proposal was turned down by
the Diet both times since trade unions and opposition parties were strongly against the bill.
In summer 1993, the political situation changed dramatically. The Liberal Democratic Party(LDP), which had been ruling Japan ever since the end of the Second World War, fell from power.
It was replaced by a coalition of opposition parities (excluding the Japanese Communist Party). It
was this coalition that prepared the 1994 legislation.
The approved legislation guaranteed that the tier-2 earnings-related benefits for retired
employees between 60 and 64 will be paid without any reduction. The tier-1 basic benefits forthis age group were to be phased out by stages (between 2001 and 2013 for men), and eventually
nobody under 65 will receive full basic benefits (the phasing out of basic benefits for female
employees will be delayed by five years starting only in 2006).
Up to October 1994, benefits were adjusted in line with the hikes in gross wages, but since
1994, they have been in net wages.
In December 1998, the government decided to increase existing pension benefits in fiscal
year 1999 to reflect only changes in the CPI over the previous calendar year, though fiscal
year 1999 was previously anticipated as seeing net-wage indexation of existing pension benefits
after a five-year interval.
In July 1999, the government submitted the 1999 pension reform bill to the parliament andthe bill was passed through it in March 2000. Its main points are as follows:a) Earnings-related benefits are to be reduced by 5 per cent; specifically, the current annual
accrual rate of 0.75 per cent is to be decreased to 0.7125 per cent from fiscal year 2000.
b) Both the flat-rate basic benefits and the earnings-related pension benefits once paid are to be
CPI-indexed after age 65 from fiscal year 2000.
c) The normal pensionable age for earnings-related old-age benefits is to be increased step bystep from age 60 to 65 for men from fiscal year 2013 to 2025. The phasing out of earningsrelated old-age benefits for female employees in their early 60s will be delayed by five years
starting only in 2018. In exchange, those between 60 and 64 will become eligible for newly
provided advance payment, at a reduced rate, out of the earnings-related benefits. The rate of
reduction will be 0.5 per cent by one month (6 percent by one year). If a person begins toreceive the advance payment from age 60, his/her benefit level will be 70 per cent of thenormal amount.
d) An earnings test for those aged 65 to 69 is to be introduced from fiscal year 2002 (currently
Japan has no such test for them). Increases in earnings-related old-age benefits for delayed
retirement between ages 65 and 69 are to be abolished accordingly.

74e) Employers are to be exempted from paying their share of social security pension contributions
for their employees on child-care leave from fiscal year 2000.
f) The monthly standard earnings base for social security pensions is upgraded to the 98,000 to
620,000 yen range from October 2000.
g) The benefit/contribution base is to be shifted from monthly standard earnings to annual
earnings including semi-annual bonuses from fiscal year 2003. The shift is to be adjusted toinduce no changes in aggregate income from contributions in 2003.
h) The rebates on contributions for contracted-out schemes are to be frozen from fiscal year 1999.
i) A 50 per cent reduced flat-rate contribution for the non-employees is to be newly introduced
from fiscal year 2002. This is mainly for low-income groups. Their basic benefit will be twothirds of the full amount. Students aged 20 and over are to be able to postpone paying in theirflat-rate contributions for ten years at the most. They are, however, to be eligible for the fullbasic disability benefit during years of non-payment.
By these measures, aggregate pension benefits will be reduced by 20 per cent by 2025. As aresult, the contribution rate for the KNH will peak by 2025 at 25.4 per cent, instead of 34.5 percent anticipated without any reforms (the rate estimated on the basis of monthly standard
earnings). The flat-rate monthly contributions for non-employee people will peak by 2021 at
18,500 yen (instead of 26,400 yen) at 1999 prices.
2.3 The 2004 Pension Reform
The administration of Prime Minister Koizumi Jun’ichirō submitted a set of pension reformbills to the National Diet on February 10, 2004, and they were enacted on June 5. This section will
describe the gist of the approved reforms and explore issues that remain to be addressed.
Salaried workers are, as a rule, enrolled in the KNH, which is part of the public pension
system. Contributions under this plan have since October 1996 been set at 13.58% of annual
income, paid half by the worker and half by the employer, but the newly enacted reforms raise thisrate by 0.354 percentage points per year starting in October 2004. The rate rises every September
thereafter until 2017, after which it will remain fixed at 18.30%. The portion paid by workers will
accordingly rise from the existing 6.79% of annual income to 9.15%.
For an “average” male company employee earning JPY360,000 a month plus annual
bonuses equivalent to 3.6 months’ pay, contributions will increase by nearly JPY20,000 a year
starting this October 2004, and by the time they stop rising in September 2017, they will havereached just under JPY1.03 million a year, and the share paid by the worker will be just over
JPY514,000. This comes to 35% more than the current level of contributions.
Those who are not enrolled in the KNH or another public pension scheme are required toparticipate in the KN, which provides just the so-called basic pension. (The basic pension also
forms the first tier of benefits under the KNH and other public pension system.) Contributions
under this plan will rise by JPY280 each April from the current JPY13,300 per month until they75

plateau at JPY16,900 (at 2004 prices) in April 2017. The actual rise in KN contribution is adjusted
according to increases in general wage levels.
In addition, the government increased its subsidies for the basic pension. One-third of thecost of basic pension benefits is paid from the national treasury; this share was to be raised instages until it reaches one-half in 2009.
Lower Benefits Despite Higher Contributions
Benefits under the KNH consist of two tiers; the flat-rate basic pension, which is paid to all
public pension plan participants, and a separate earnings-related component. The latter iscalculated on the basis of the worker’s average preretirement income, converted to current values.
Until now, the index used to convert past income to current values was the rate of increase in takehome pay. Under the 2004 reform, though, this index will be subject to a negative adjustment overthe course of an “exceptional period” based on changes in two demographic factors, namely, thedecline in the number of participants and the increase in life expectancy. This period ofadjustment is expected to last through 2023.
The application of the first demographic factor will mean that benefit levels will be cut toreflect the fact that fewer people are supporting the pension system. The actual number of people
enrolled in all public pension schemes will be ascertained each year, and the rate of decline will
be calculated based on this figure. The average annual decline is projected to be around 0.6
percentage points.
Introducing the second demographic factor, meanwhile, will adjust for the fact that people
are living longer and thus collecting their pensions for more years; the aim is to slow the pace ofincrease in the total amount of benefits paid as a result of increased longevity. This factor will not
be calculated by tracking future movements in life expectancy; instead, it has been set at anannual rate of about 0.3 percentage points on the basis of current demographic projections for theperiod through 2025. Together, the two demographic factors are thus expected to mean a negative
adjustment of about 0.9 points a year during the period in question.
How will these changes affect people’s benefits in concrete terms? Let us consider the caseof a pair of “model” KNH beneficiaries as defined by the Ministry of Health, Labor, and Welfare:a 65-year-old man who earned the average wage throughout his 40-year career and his 65-yearold wife who was a full-time homemaker for 40 years from her twentieth birthday. In fiscal 2004
(April 2004 to March 2005), this model couple would receive JPY233,000 a month.
How does this amount compare to what employees are currently taking home? The averagemonthly income of a salaried worker in 2004 is projected to be around JPY360,000, before taxes
and social insurance deductions. Assuming that this is supplemented by bonuses totaling anequivalent of 3.6 months’ pay, the average annual income is roughly JPY5.6 million. Deducting
16% of this figure for taxes and social insurance payments leaves a figure for annual take-home
pay of about JPY4.7 million, or JPY393,000 a month.
The JPY233,000 provided to the model pensioners is 59.3% of JPY393,000. But this76

percentage, which pension specialists call the “income replacement ratio,” will gradually decline
to an estimated figure of 50.2% as of fiscal 2023 (assuming that consumer prices and nominal
wages rise according to government projections by 1% and 2.1% a year, respectively). Over the
next two decades, then, benefit levels will decline by roughly 15% by comparison with wage
levels.
The revised pension legislation stipulates that the income replacement ratio is not to fall
below 50% for the model case described above, and so the exceptional period of negative
adjustment will come to an end once the ratio declines to 50%. This provision was included toalleviate fears that benefits would continue to shrink without limit.
How will the reforms affect those who are already receiving their pensions? Until now,
benefits for those 65 years old and over were adjusted for fluctuations in the consumer price index.
This ensured that pensioners’ real purchasing power remained unchanged and helped ease
postretirement worries. But this cost-of-living link will effectively be severed during theexceptional period, since the application of the demographic factors will pull down real benefits
by around 0.9 points a year. In principle, however, nominal benefits are not to be cut unless there
has also been a drop in consumer prices. Once the exceptional period is over, the link to theconsumer price index is to be restored.
Provisions for Working Seniors and Divorcees
People aged 60-64 who are receiving pensions and also have wage income have up to now
had their benefits reduced by a flat 20%, regardless of how much or little they earn. This rule has
been abolished so as not to discourage older people from working. But these people will still be
subject to the current rule that if the sum of wages and pension benefits exceeds JPY280,000 amonth (after factoring in annual bonuses), the pension benefits are to be cut by 50% of the amountin excess of this level.
Workers aged 70 and over, meanwhile, have been exempt from paying into the KNH, even
if they are still on a company’s payroll. And they have not had their benefits reduced no matter
how much they earn. Beginning in April 2007, though, their benefits were reduced if they werehigh-income earners. Those receiving more than an equivalent of JPY480,000 a month in wages
and pension benefits will have their benefits cut by 50% of the amount in excess of this level. Thisis a rule that currently applies to those aged 65 to 69, and it will be maintained for this age group.
The over-70 group will still be entitled to the full amount of the basic pension, and they willcontinue to be exempt from paying contributions.
Divorced wives were not legally entitled to any portion of their former husbands’ earningsrelated pension benefits, but this changed under the revised legislation. Couples who divorce after
April 2007 are able to split the rights to the earnings-related portion of the husband’s pension that
accrued during their marriage. The wife is able to receive a share of up to 50% of these rights; theactual share is to be determined by agreement between the two. For rights accruing after April
2008, moreover, a full-time homemaker is able to automatically receive half of her husband’s77benefits in case of divorce by filing a claim at a social insurance office. Underlying this rule is theassumption that even though the contributions are paid in the husband’s name, the wife has
provided half of the couple’s livelihood through her work as a homemaker. (Note that theprovisions for working husbands and dependent homemaker wives apply conversely in cases
where a home-maker husband is dependent on the wife.)
Widowed spouses younger than 30 and without children under the age of 18 had been
entitled to lifelong benefits under the survivor’s pension scheme (based on the earnings of thedeceased spouse). After April 2007, however, they receive benefits for no longer than five years.
Workers taking child-care leave are exempt from making pension contributions, and toprevent a decrease in their future benefits due to this period of nonpayment, they are treated ashaving continued their full payments, even when they have no income. This special exemption
was claimed for up to one year after childbirth, but starting in April 2005 the period was extended
until the child reaches age three.
Also from April 2005, parents who change their working arrangements to put in shorter
hours so as to care for children under age three and who take a corresponding cut in pay will betreated as having worked full time and earned a full salary. Actual contributions during this threeyear period, though, will be based on the lower earnings.
Additional Adjustments
As a rule, a person cannot simultaneously receive more than one public pension. But the
recent reforms have created an exception. People with disabilities who had gainful employment
and paid pension contributions from April 2006 were entitled to not only their basic disability
pension but also the earnings-related component of the old-age pension or survivor’s pension.
This measure is designed to encourage employment among people with handicaps.
Participants in the KN who have low incomes currently pay either half of the regularcontributions or none at all. There was a finer tuning of payment exemptions starting in July 2006,
when low-income earners also were exempt from paying one-quarter or three-quarters of theregular contributions.
The reform covered private pension plans as well. The upper limit of the amount that could
be put aside each month under company-funded defined-contribution pension plans was raised
from JPY36,000 to JPY46,000 in cases where there was no other corporate pension plan and from
JPY18,000 to JPY23,000 in cases where there was another plan in effect. The ceiling on monthly
installments under individually funded defined-contribution plans for salaried workers was raised
from JPY15,000 to JPY18,000 where there was no corporate pension coverage, while the cap forthe self-employed remained unchanged at JPY68,000. The higher ceilings for private plans were
designed to make up for the anticipated smaller benefits of public old-age schemes.
3. Future Pension Policy Issues
Social insurance payments in Japan already exceed the amount collected in national taxes,

78and contributions to the pension system are by far the biggest social insurance item. If this alreadyhuge sum is increased by more than JPY1 trillion a year, as the government plans, bothindividuals and companies are bound to change their behavior. Government projections ofrevenues and expenditures, though, completely ignore the prospect of such changes.
Companies will likely revamp their hiring plans and wage scales to sidestep the higher
social insurance burden. They will cut back on recruitment of new graduates and become more
selective about midcareer hiring as well. Many young people will be stripped of employment
opportunities and driven out of the labor market, instead of being enlisted to support the pension
system with a percentage of their income. And most of the employment options for middle-aged
women who wish to reenter the work force will be low-paying ones. Only a few older workers
will be able to continue commanding high wages; there is likely to be a dramatic rise in thenumber of aging workers who will be forced to choose between remaining on the payroll with acut in pay or settling for retirement. Many more companies will either choose or be forced toleave the KNH, causing the number of subscribers to fall far below the government’s projections
and pushing the system closer to bankruptcy.
The jobless rate on the whole will rise. The Ministry of Economy, Trade, and Industry has
estimated that higher pension contributions will lead to the loss of 1 million jobs and boost the
unemployment rate by 1.3 points. The government plan to increase pension contributions annually
up to 2017 will exert ongoing deflationary pressure on the Japanese economy. For the worker, arise in contribution levels means less take-home pay; as a result, consumer spending is likely tofall, and this will surely hinder prospects for a self-sustaining recovery and return to steady
growth.
Another problem with increasing pension contributions is that they are regressive, since
there is a ceiling for the earnings on which payment calculations are based and unearned income
is not included in the calculations at all.
One major objective of the reforms is to eventually eliminate the huge excess liabilities of
JPY500 trillion in the balance sheet of the KNH. The plan is to generate a surplus equal to thisamount by (1) hiking contributions, (2) increasing payments from the national treasury, and (3)reducing benefits. But the combination of higher contributions and lower benefits will mean the
future participants will end up getting back less than they pay into the system. It is estimated that
their benefits will amount to only about 80% of their contributions. This is hardly likely to
encourage people to participate. Higher contributions will further alienate younger workers fromthe pension system and deepen their distrust of politics.
As noted above, those who are already receiving their pensions will see their benefits
decline in real terms by an average 0.9% per year. The government scenario sees consumer prices
eventually rising 1% a year and take-home pay 2.1% a year. This means that the model
beneficiary who began receiving JPY233,000 a month at age 65 in 2004 will get roughly
JPY240,000 at age 84 in 2023; nominal benefits, in other words, will remain virtually unchanged

79

for two decades, despite the fact that average take-home pay of the working population will haverisen by over 40%. The income replacement ratio, which stood at nearly 60% at age 65, willdwindle to 43% by the time the model recipient turns 84. The promise of benefits in excess of
50% of take-home pay does not apply, therefore, to those who are already on old-age pensions.
The so-called demographic factors are likely to continue changing for the foreseeable future.
The government itself foresees the number of participants in public pension plans declining overthe coming century: The estimated figure of 69.4 million participants as of 2005 is expected to fallto 61.0 million in 2025, 45.3 million in 2050, and 29.2 million in 2100. This corresponds to an
average annual decline of 0.6% through 2025, 1.2% of the quarter century from 2025, and 0.9%
for the half century from 2050. In other words, the decline in the number of workers who arefinancially supporting the public pension system is not likely to stop after just two decades.
The 2004 reform, though, adjusts benefit levels in keeping with the decline in thecontribution paying population for the next 20 years only; the government’s “standard case” does
not foresee any further downward revisions, even if the number of participants continues to fall. If
the government really anticipates an ongoing decline, there is no good reason to abruptly stop
adjusting benefit levels after a certain period of time. Sweden and Germany, for instance, haveadopted permanent mechanisms whereby benefit levels are automatically adjusted for fluctuations
in demographic factors.
The decision to keep the model income replacement ratio at 50% at the point when pension
payments commence represents, in effect, the adoption of a defined benefit formula. Maintaining
both fixed contributions on the one hand and defined benefit levels on the other is not an easy task,
for there is no room to deal flexibly with unforeseen developments. The government will beconfronted with a fiscal emergency should its projections for growth in contributions and areversal in the falling birthrate veer widely from the mark.
The government based its population figures on the January 2002 projections of the
National Institute of Population and Social Security Research. Under these projections, themedium variant for the total fertility rate (the average number of childbirths per woman) falls to
1.31 in 2007, after which it begins climbing, reaching 1.39 in 2050 and 1.73 in 2100. Actual
figures since the projections were released have been slightly lower than this variant, and there areno signs whatsoever that the fertility rate will stop declining.
If the government is to keep its promise on an upper limit for contributions and a lower
limit for benefits, the only policy option it will have in the event of a financial shortfall will be toraise the age at which people begin receiving benefits. The reform package makes no mention ofsuch a possibility; the drafters of the bills no doubt chose to simply put this task off to a futuredate.
In fiscal 2009 the share of the basic pension benefits funded by the national treasury wasraised from one-third to one-half. This means that more taxes will be used to cover the cost of
benefits. Taxes are by nature different from contributions paid by participants in specific pension

80

plans, and there is a need to reconsider the benefits that are to be funded by tax revenues.
The leaders of Japanese industry tend to be quite advanced in years. For the most part, they
are over the age of 65, which means that they are qualified to receive the flat-rate basic pension.
Even though they are among the wealthiest people in the economy, they are entitled to the same
basic pension as other older people hovering around the poverty line. Using tax revenues tofinance a bigger share of the basic pension essentially means asking taxpayers to foot a bigger bill
for the benefits of wealthy households as well. For an elderly couple, the tax-financed portion of
the basic pension will rise from JPY530,000 a year to JPY800,000. If a need arises to raise taxes
at a future date, who will then actually agree to pay more? Few people will be willing to toleratesuch wasteful uses of tax money.
On 30 August 2009, there was a dramatic change in the political arena of Japan. The LDP
fell down from power, and it was replaced by the Democratic Party. The new administration plans
to implement a drastic pension reform by 2013, including an introduction of a minimum pension
funded by consumption tax, with integrating all the existing earnings-related pension systems to aunified one. The concrete reform contents still remain to be drafted.

81