Social Security in Ageing Asia: Editors' Overview

• Date: 01 July 2015
• Author: Takatoshi Ito,Shujiro Urata,Kazumasa Iwata,Colin McKenzie
• Published date: 01 July 2015
• DOI: http://doi.org/10.1111/aepr.12097

Social Security in Ageing Asia:

Editors’ Overview

Takatoshi ITO,1Kazumasa IWATA,2Colin MCKENZIE3and Shujiro URATA4

1Columbia University, 2Japan Center for Economic Research, 3Keio University and 4Waseda University

JEL codes: F21, G11, G23, J26, H53, H55, H75, I11, I18,I38, J1, J26

1. Social Security in Ageing Asia

Social security is a main pillar of social policies toward eliminating the misery of the

elderly in a mature society where the number of children has decreased and multigenera-

tional families are becoming rare. It is often viewed as a part of a welfare program where

the government taxes the rich and subsidizes the poor. The poor includes the elderly in

the case of the pension system, the sick and physically frail people in the case of the

medical and long-term care insurance system, and the unemployed and the handicapped

in the case of the employment and disability insurance system. Once policies are consid-

ered to be an income transfer program, political and social causes dominate economics.

Although many consider welfare programs have a political and social priority when

markets fail to work, economic factors are still important in at least three respects. First,

an insurance program can be provided in the private market. Life insurance and nonlife

insurance (e.g. insurance for house owners and renters, auto insurance) are all provided

by the private sector. Even the pension system can be provided by a private annuity

market. Why should the government mandate the program to all its citizens, that is,

require universal coverage? It has been shown that mandatory pension and insurance

systems can be justified when the market fails due to information asymmetry, adverse

selection, and moral hazard.

Second, if the social insurance is provided on a purely actuarially fair, balanced-

budget manner, it is easy to understand and debate using the microeconomic theory

of insurance. However, in many cases, general tax revenues are used to subsidize these

programs. The programs tend to become larger with more generous benefits, without a

painful rise in contributions, especially when politicians want to garner votes by promis-

ing more benefits without additional burdens. Then, the macroeconomic impact of taxes

has to be considered. A larger welfare program can only be feasible with subsidies from

higher general taxes, such as value-added taxes (VAT). Typical welfare states have rela-

tively high VAT rates. Sweden’s generous medical and pension system is only possible

with a 25% VAT. But, in some countries, politicians pursue more generous benefits

without higher taxes by increasing issues of government debt. Mounting government

debts that result from increased government spending on the consumption of services

and pensions rather than spending on infrastructure pose both macroeconomic and

intergenerational questions.

Third, social security in many countries is becoming a source of generational con-

flicts, although many casual observers do not realize that this is the case. When income

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doi: 10.1111/aepr.12097 Asian Economic Policy Review (2015) 10, 179–198

© 2015 Japan Center for Economic Research 179

grows and the population increases from one generation to the next, a pure income

transfer from the young to the old, that is, a pure pay-as-you-go pension system, may

increase the welfare of all generations. This can be understood as an infinite Ponzi game

that continues indefinitely into the future. If we know with certainty the growth rates of

per-capita productivity (income) and the population into the infinite future, we can cal-

culate an efficient and fair transfer program from the young to the old, in the name of a

pension system. However, a generous program based on optimistic forecasts of growth

rates of income and the population often runs into problems when productivity gains

slow down, the fertility rate becomes lower, and/or average life expectancy becomes

longer. When the government realizes that the current pension system is unsustainable

with new estimates of growth and demographic changes, then the system should be

changed to reduce the benefits to the old and to impose higher contributions on the

young. Instead, the government often turns to issuing more government debt to prolong

an unsustainable pension system. This is only shifting the burden to the young who will

be liable for paying the government debt in the future, exacerbating the generational

inequality.

One way to mitigate the generational conflict when ageing is expected to affect

the pay-as-you-go pension system is to accumulate a public pension fund. During the

decades when there are relatively large number of people in the working-age population,

the young’s contributions can be only partly transferred to the then old, and the rest can

be accumulated as reserves for the future. The public pension funds can generate returns

higher than the growth rate of wages if invested wisely. In fact, Japan has built up such

public pension funds. An efficient investment strategy is expected to slow down the

speed of benefit cuts and/or the contribution rate hikes, when demography turns against

the system.

Japan, which is at the frontier of the global “ageing society” trend, faces all of these

three problems in an acute manner. Japan’s well-known mounting government debt is

mainly supporting ever-expanding social security expenditures. The forecasts for the

debt dynamics are pessimistic unless the pension system and the medical and long-term

care insurance systems are reformed.

Asian emerging-market economies are quickly adopting modern institutions such as

a pension system and other social security programs. The lessons from Japan should be

learnt carefully by those countries, since their once high economic growth rates are

coming down (i.e. growth convergence), and their societies are ageing quickly either due

to government policy (e.g. the one-child policy in China) or the natural outcomes of

economic growth. When the social security program is designed, it should be built with a

sustainable social insurance framework alleviating, not aggravating, informational asym-

metries and moral hazard. The revenue and expenditure of the social insurance system

should be determined in an actuarially fair manner for the pension system, and a statis-

tically fair manner for the medical and long-term care insurance system. Japan provides

an example that includes successes and failures. Subsequent adjustments, as well as the

initial design of the systems are important, as demography changes. In the case of the

pension system, adjustments become necessary in the age for qualifying for a retirement

Social Security Ageing in Asia Takatoshi Ito et al.

© 2015 Japan Center for Economic Research180