“Growing Pains” in China's Social Security System


This paper investigates the puzzles in China’s social security system. First, given the relatively low benefit rate and still relatively young demographic structure, the statutory contribution rate is surprisingly high and the social security fund is already in deficit. Second, despite the low statutory retirement ages (50 for women and 60 for men), early retirement is prevalent. We develop and calibrate an overlapping generations model of optimal social security featuring wage compression relative to workers’ productivity, which we micro-found by older workers’ fairness concerns. The theory provides a novel and unified explanation for these facts, focusing on the labor demand side forces: firms are not willing to hire older workers who have lower productivity relative to the younger cohorts but demand wages that rise with those of the younger cohorts. We find that, paradoxically, the rapid inter-cohort productivity growth, a phenomenon we documented in Fang and Qiu (2022), is at the root of these puzzles, leading to “growing pains” in China’s social security system. Our quantitative analysis reveals that surprisingly, the “growing pains” in China’s social security system will be “cured” when the inter-cohort productivity growth slows down to the levels in more developed economies.

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