Economic efficiency and social insurance reforms in China

HAIZHENG LI [*] This study discusses efficiency issues related to social insurance provisions and their implications for the newly established three-pillar pension system and three-tier health insurance system in China. It shows that these new systems can be improved substantially through some restructuring to reduce efficiency losses. The discussion of efficiency consequences focuses on correction for market failure and alternative mechanisms for financing and providing social insurance benefits. Alternative methods for financing the transition are also discussed. (JEL H55, P35, O53) 1. INTRODUCTION Profound economic reform in China has been moving the country toward a market-oriented economy. Key features of this economic transition include the separation of the government from daily economic operations, a reduction in the share of state-owned industry, and the establishment of a market system. When it comes to social insurance, however, the transition appears to need the reverse course: the market mechanism may not provide an efficient level of social insurance, and government intervention is thus generally needed. This situation complicates the reform of China's social insurance system: on the one hand, a good social insurance system is necessary to facilitate the economic transition toward a market system; on the other hand, the market mechanism itself may not result in a good social insurance system. One concern regarding government intervention is loss of economic efficiency. Any government action will inevitably involve collecting monies and distributing benefits in some way. This intervention may distort the market outcome. The possible distortion and especially the reduction in employment caused by a social insurance program will have a significant impact on China's economic transition. A natural question is whether there exists a mechanism that provides the same amount of social insurance services but causes fewer efficiency losses than other alternatives. This study discusses efficiency issues related to social insurance provision and their implications for the reform of China's social insurance system. Previous studies have evaluated two sources of efficiency loss resulting from social insurance programs: declining labor force participation resulting from early retirements in pay-as-you-go pension systems (Gruber and Wise, 1998), and the evasion of workers to informal jobs, which generally have lower productivity (James, 1996). This study discusses a third source: distortions caused by alternative mechanisms for financing and providing social insurance benefits. Two types of mechanisms are discussed: indirect mandated provision and direct public provision. There exist a number of studies of China's social insurance system. Selden and You (1997), Hussain (1994), and Song and Chu (1997) survey and examine China's old-age insurance system, World Bank (1997a) outlines a three-pillar pension system for China, World Bank (1997b) assesses China's health care system, and Gertler (1998) reviews the Asian (including China) experience of social health insurance. This study differs from the existing literature in the following aspects. First, since 1997, there have been significant changes in China's old age insurance system and health insurance system. Some issues and potential problems have surfaced and have not yet been discussed in literature. This article assesses the new pension system and heath insurance system. Second, this study focuses on economic efficiency in the design of a social insurance program. It discusses the means of correcting for market failures and the efficiency consequences of alternative mechanisms for a social security program. Third, this study proposes a restructuring for the new Chinese pension and health insurance systems that will substantially improve their economic efficiency. While the social insurance system includes a variety of programs, this study focuses on old-age insurance and health insurance. …