Strategies of Japanese pension reform

Japan now is the state with the highest elderly share in the world. While life expectancy increased to 83 years (highest in the world), TRF (total fertility rate) remains in a very low level (1.4), that is one-third lower than the replacement rate (2.1). As the biggest generations (born 1947-49) started retiring in 2007, the elderly share will continue to increase. So, Japan’s support ratio continues to decline, and that becomes an issue for the state, that has a necessity to support elderly by providing adequate life conditions. In order to do that, the state needs to reform social institutes aimed to support elders. The evidence is that adaptation of pension institute to new demographic reality is one of the main issues. The burden of old-age support has become the responsibility of the relatively smaller young age cohorts, creating a situation that is very difficult for the society to correct. Here, main actions are connected with increasing efficiency in social spendings through an increase in the pension eligibility age, reduction in state’s share in the pension benefits and an increase in contributions paid by non governmental agents (employers and employees).

As well as the role of government as a main regulator, the role of employers in providing retirement should be overviewed. Special social role of Japanese conglomerates (keiretsu) affects pension system as well. They provide special retirement programs for its lern-term employees in order to increase their loyalty to the company and achieve long-term planning [6, p. 50].

Context

With the demographic transition and fastening population aging, the burden of old-age support has become the responsibility of the relatively smaller young age cohorts, creating a situation that is very difficult for the society to correct. Japan, as a country where traditional (primary Confucian) social norms are still very strong, traditional respect for the elderly does affect individual and public behaviour, governmental as well. This means that taking resources away from the old is socially unacceptable; it is also politically difficult, because the older generation forms a very large voting bloc. [1, p. 100] So that, containing social security spending is a key fiscal policy challenge in Japan. During the 1960–2000 period, there is a significant increase in the generosity of the social security program. In particular, the social security replacement rate which is 17% until 1973 increases to 35% between 1974 and 1979 and to 40% after 1979. Social security spending (mostly pension, medical, and old-aged care spending) now takes up nearly 55 percent of the total non-interest spending by the general government, reflecting the rapid population aging.

Japan has the highest debt-to-GDP ratio among advanced economies. In addition, recent government plans call for a continuation of primary deficits at least through 2020, renewing concerns over whether the Japanese government bonds (JGBs) may become a global problem. [4, p. 117]. Pension deficit contributes about 4% of GDP each, and, after about 25 years the pension deficit starts to rise again, eventually stabilizing at about 5% of GDP. [4, p. 134]

Although the increase in this spending will be moderate compared with other advanced countries, Japan needs to reduce its fiscal deficit, which calls for more cost-effective social security policy. Moreover, large intergenerational imbalances (where younger generations take a heavier fiscal burden than older generations) could result in deep system crisis if reforms are delayed. At the same time, building balance between achieving fiscal savings and providing social safety nets can be named critical for Japanese social security institutes [5, p.4]

While considering employers’ role, they are still oriented for permanent employment that is deeply connected with long-term planning. HRM systems of many companies include high spendings into the workforce training and prefer to hire new graduates ahead of more experienced employees in order to perform better integration in the company’s structure [6, p. 51]. As well as that, Japanese companies in order to increase employers’ loyalty provide special conditions for permanent employees, such as the retirement allowance and the increase of salary during the later stage of the career [6, p. 51].

Japanese pension system overview

State role

Japan’s public pension is, in principle, a pay-as-you-go system. The normal retirement age for the basic pension was 60 for both males and females, but it has been rising to 65 for both. [4, p. 127].

All Japanese citizens aged 20 or older are obliged to participate in the system and are grouped into three categories. First category includes students, farmers, self-employed individuals, some nonregular workers that are not offered employees pension insurance, and all others not in second or third categories. They are covered by National Pension program. Second category consists of regular workers in establishments with more than five employees and third category includes non working spouses of category 2 workers, who essentially are housewives married to regular workers [3, p. 127].

Two types of pension have been introduced. First one, Basic pension ( kosei nenkin ), is co-paid by state and non govermental programmes to which a beneficiary belongs to as well as by a drawdown from a reserve fund if contributions are temporarily insufficient to cover the payment. This type is received by members of all three categories. The second type, earned-linked pension, is received be members of the second category and financed only by contributions paid by them during working life. Category 1 participants pay flat rate contributions, while Category 2 participants contribute by paying payroll taxes (the payment is equally shared between an employee and an employer) [5, p. 6]. The maximum annual benefit of the basic pension would be reach by an individual who has contributed for the maximum of the 40 years.The benefit is reduced proportionally according to the number of months that the individual was not covered and did not contribute [4 127].

Employer role

Most Japanese companies have unique retirement systems. Regular employees receive a portion of their wage when they retire, the retirement allowance accounts for around ten per cent of lifetime earnings. The retirement allowance is not linked to age but directly to the tenure; it means that employees who worked for a long time until retirement age can get a larger amount of retirement pay. The amount of retirement allowance may be very different in the case of retirees of the same age due to the different length of continuous employment. So that, the allowance increases sharply in the case of those who can claim more than 30 years of service. Retirement allowance has always been considered as a reward compensation for distinguished service [6, p. 57].

Japanese Pension Strategies

First Japanese pension system was introduced in 1961: it was the basic pension, mainly targeted, as described before, on the members of the first group of pension beneficiaries. Reforms in Japanese pension system were introduced in

1970s, when the replacement ratio was boosted sharply from 40 per cent to 60 per cent of gross wages and problem population aging has occurred [2, p. 4]. For instance, the retirement age was gradually risen. However, the system was reformed substantially in 2004. This reform affected benefit levels (so that aggregate pension benefit expenditure will not increase as a percent of GDP in the long run) as well as increased state’s share in paying pension benefits (from 1/3 to ½).Moreover, pension benefits are expected to be indexed to the price level, however, there was made an addendum not to apply it for deflation. As result, pensions have been overpaid in terms of purchasing power since 2005. A law was finally passed in 2012 to correct the overpayment, however, it was unpopular measure between elderly electorate. [1, p. 105] Moreover, several other acts that reglament pension system were introduced in 2012, however the were not likely to decrease social security spendings. Reforms affected minimum number of years for which contributions need to be paid (from 25 years to 10 years); extend the coverage of the EPI to part-time workers; and consolidate the EPI and the MAAs [5, p. 8].

Pension benefit spending totaled 10.6 percent of GDP in FY2010 including 8.9 percent old-age pension share. [5, p. 5]. To avoid pension crisis several measures could be undertaken. Some of them have been already implemented, however future development is possible as well (for example, the retirement age had been risen from 55 to 65 years, and the rise is expected to continue). Through them, there are three main ones: already mentioned raise of eligibility age, than, decrease in benefits paid by state (mainly for wealthy retirees) and increase in contributions paid by employees themselves during working life as well as collecting contributions from dependent spouses of the EPI-eligible employees [5, p. 9].

Raise Pension Eligibility Age

Raising the pension eligibility age is one of the most discussed measures, and usually named most acceptable. Age rising could encourage continued participation in the labor force by older-aged workers, resulting in higher lifetime income and consumption. The retirement age for basic pension was gradually rising from 55 to 65 (for age cohorts born later than 1965), and the eligibility age for the employees’ pension insurance has been rising from 60 (male) and 56 (female) and will reach 65 for a cohort born in 1961 (male) and 1966 (female) [4, 127].

This measure is rather cost-effective: increasing the pension eligibility age for the basic pension to 67 for all categories of participants by 2020 would reduce the government subsidy to the basic pension by ¼ percent of GDP by then (compared with the base case projection included in the 2009 actuarial review). If it were raised further to 69 by 2030, the fiscal savings could reach ¾ percent of GDP in 2030. Taking into consideration that fact, that the gap between life expectancy and the pension eligibility age is larger in Japan than in most other countries. While Japan continues to take the global lead in life expectancy, the pension eligibility age remains capped at 65 [4, p. 20].

So that, there is an objective necessity in age-rising: it will positively affect both Japanese economy (through increased productivity and consumption) and individuals’ wealthfare; also it provides a possibility for better HRM through using experienced workforce in their old ages. The financial burden will be shared more equally between younger and older cohorts, decreasing intergenerational imbalances. If to compare with other measures that can be undertaken, an increase in the pension eligibility age does not likely to raise old-age poverty.

Lower Replacement Ratio

If to compare Japan’s replacement ratio with other OECD countries, Japanese pension benefits (about 50 percent) on average are on the low side. The replacement ratio for a representative couple, of about 50 percent, is below the median. However, a reduction in the replacement ratio targeted on wealthy retirees would be appropriate, instead of across-the-board benefit cuts. For example, a 10 percent cut of the pension benefit for 10 percent of the wealthiest retirees would reduce the government subsidy by ¼ percent of GDP in 2020. In reality, a reduction could be applied more broadly, for example, to the wealthiest one-fourth of retirees.

Higher contribution rates

A higher contribution rate would help to decrease budget burden and generate fiscal savings. Raising the contribution rate for the basic pension by 1 percentage point would increase contributions by ½ percent of GDP in 2020, which could be used to reduce the government subsidy to the basic pension. This option, however, would have a detrimental effect on growth and aggravate intergenerational imbalances. Social burden for younger generation is already quite high, and is expected to increase. It is noticed that higher pension contributions rate has a negative effect on labor supply. A higher contribution rate also increases the burden on younger generations because pension contributions are paid by the working-age population [5, p. 11].

However, according to the research made by Bei, Mitchell and Piggott, for Japan, it would be more suitable, and actually fairer to change the whole system of paying contribution rates from Pay-as-you-go to NDC (Notional defined contribution). This system is defined as non-pre-funded contribution system, where notional individual accounts accumulate at a notional interest rate linked to the system return. Benefits are annuitized at retirement based on each cohort’s expected mortality patterns and system returns [2, p. 6]. By this, each age cohort pays contribution for itself, and the burden for younger cohorts does not increase with population aging. Every participant receives actuarially fair benefit. There, the only risk of the NDC system is connected with issues faced by each cohort: for instance, the may be connected with economic depression and lower earnings received by the whole generation. In order to avoid such risks, better social security nets for poor should be developed; moreover, some local adaptation methods can be included as well [2, p. 8]. Generally, it is argued that under the NDC system participants receive higher benefits while enhancing system financial sustainability. Moreover, the wholy system is more transparent, as Pay-as-you-go, so the program could possibly reinforce participants’ trust [2, p. 17]. So that, in contrast with increasing contribution rates under the Pay-as-you-go system, implementation of NDC provides a possibility to increase the level of elderly participation in active labour force. Positive effects provided by implementing NDC system are quite similar for that's given by rising eligibility ages.

Taking into consideration all measures discussed before, they can significantly decrease government spendings, as well as provide positive effect on country’s economic growth, and reduce intergenerational imbalance. Through combining different measures, effect could be maximized. For instance, raising the retirement age to 70 and cutting pension benefits by 10% significantly reduces the pension deficit [3, p. 118]. However, some reforms, as age-rising are more desirable, because they provide a positive effect on economic growth in the long run by helping to raise labor force participation, than others (as, for instance, cut in replacement ratio).

Conclusion

Japan, being a pioneer in global aging, more than other states need in costeffective social spendings policy. Japanese pension consumers are devoted into three groups according to their occupation. And, there are two types of pension introduced: basic pension, that is paid for all three groups and the earnings-linked pension, that is paid only for working population.

Pension burden for budged is high and continues to increase. In these conditions, several measures were undertaken by Japanese government to reform pension institute. The options are, firstly, increasing in Pension Eligibility Age, and this option is considered to be the most desirable one, because it, firstly, does not increase elderly poverty risks, but, oppositely, provides a positive effect on the individual’s welfare as well as on economic growth (by increased consumption and productivity) generally. Then, discussing decreasing in replacement rate, this measure provides a possibility to reduce social spendings, but increases elderly poverty risks as well. The third option discussed in the paper - higher contribution rates - on the one hand, does not affect on elderly financial security, and, on the other hand, reduces budget burden. However, it affects working population that pays contribution, so that this option could result in decrease of labour market supply as well as increase the intergenerational imbalance.