There has no doubt about the fact that the Chinese economy is one of the largest economies in the world today.

Theoretically, China is the second-largest economy in the world. It is widely believed that the Chinese economy will surpass the American economy to become the largest in the world.

However, many economists believe that the Chinese economy is already the largest one in the world if we consider purchasing power parity.

The fact that China has grown at such a remarkable pace has made it a case study for the world. As a result, a lot of scholars are carefully studying the pension system in China as well.

The Chinese system is quite different as compared to the western world. In this article, we will explain how the Chinese pension system works.

How Does the Chinese Pension System Work?

• Unlike the rest of the world, the Chinese do not have a homogenous pension system. They have a system where there are various layers. The contributions, as well as benefits, are governed differently in the different layers.

  The Chinese have created this system because they believe that the financial habits and investment preferences of investors can be very different from each other.

• The Chinese pension system is not made up of one scheme. Instead, it is an array of schemes. Many of these schemes are voluntary whereas others are compulsory.

  The high number of schemes has caused some confusion amongst the citizens. Many citizens have complained that they are not able to fully comprehend how the system works and how they can gain benefits out of the same.

• The Chinese have a three-layered pension system. The first layer of the system has been created to provide a social security net to the entire population of China. This layer is funded by the government and provides welfare payments to every citizen once they reach a certain age. These payments are made irrespective of whether the recipient was ever employed and if so, what income did they earn while being employed.

• The second layer of the pension system is largely funded by employers. Both government employers, as well as private employers, are required to fund this pension of their employees.

  Many employers have complained that these rates are prohibitively high when compared to other countries of the world. However, China being a communist country tries to focus more on the social welfare of its workers.

• The third layer of the Chinese pension fund system is a pay-as-you-go system. This system requires households to make periodic contributions toward their retirement funds. Such contributions are often voluntary. Hence, they are generally made by the middle class and wealthy investors in China.

Urban Vs Rural Divide

• It is important to note that one of the biggest differences between the Chinese pension system and other pension systems is the fact that the Chinese pension system is managed at the local level.

  In most parts of the world, pension funds are managed at the central level. Hence, the rules governing pensions can vary even within different parts of China.

• The Chinese pension system is composed of two different types of schemes. There is one pension scheme that is applicable in the urban areas of China whereas there is another scheme that is applicable in the rural parts of China.

• Another important consequence of this rural-urban divide is the fact that rural workers who migrate to urban areas are generally not covered under this scheme. They have the option to participate voluntarily but neither the employer nor the employees are keen on doing so. This is because the employers want to avoid the high cost whereas the employees are more concerned about getting the money immediately rather than waiting for pensions.

Private Employee Pension Vs Government Employee Pension

• The Chinese pension system can also be subdivided based on whether the employee is employed in a public sector undertaking or whether they are employed in a private sector firm.

• The employees of private companies in China are expected to contribute 8% of their salary towards their pension. However, when it comes to government employees, they are not required to pay any amount toward their pension fund contribution

• The government is trying to change this situation because of the huge subsidy bill. However, they are unlikely to be able to do so. Even if they do mandate contributions by government employees, the government will have to increase wages by an equal amount effectively rendering the entire exercise pointless.

Tax Treatment of Pensions

In most parts of the world, governments encourage their people to invest in pensions by providing them with tax relief. However, this is not the case in China.

In China, there is small tax relief for the employers who make a contribution on behalf of their employees. However, there is no direct tax benefit for employees who make contributions to their pension funds.

It seems like the government is not interested in ensuring higher pension contributions which is strange given the fact that China still has a large population that is close to the poverty line.

The fact of the matter is that the Chinese system is quite complex. There are several schemes and variations which apply differently to different sets of workers. This is in sharp contrast to the largely homogenized pension systems of western democracies.