September 2003

China’s rapidly aging population, strong economic growth, and high return on capital mean that a funded pension system would be more efficient than a state-directed system. Yet, there are many problems in implementing a new privatized pension system. The root problem is the lack of a well-designed transition plan that bridges the old system and the new one. The paper analyzes the transition problem and argues that the combination of Chinese families’ emphasis on education, strong economic growth into the foreseeable future, and the current lack of income smoothing at the individual level makes borrowing now and taxing future generations a fairer and more cost-effective way to finance the transition cost. many problems in implementing the new Chinese pension system. The root problem is the lack of a well-designed transition plan that bridges the old system and the new one. In this study, we analyze the transition problem and provide a simple solution. We argue that the combination of Chinese families’ emphasis on education, strong economic growth into the foreseeable future, and the current lack of income smoothing at the individual level makes borrowing now and taxing future generations a fairer and more cost-effective way to finance the transition cost.