Microsoft Word EcRefChina Oct06. doc

III:2 Income Transfers and Social Insurance 
In urban areas, China has recently started to build up mandatory systems of income 
insurance akin to social arrangements in developed countries in the west (“social 
insurance”), combined with elements from to the so-called “provident funds” in Singapore 
and Malaysia. The main programs comprise unemployment benefits, social assistance, 
pensions and health-care insurance (the latter will be discussed in section III:3).
115
The 
fairly high generosity of these programs, although confined to a small part of the 
population, is reflected in the large social security contributions required to finance them: 
payroll taxes amounting to about 40 percent of the wage bill for those involved (30 
percentage points being paid by the employer).
116
By comparison, in today’s developed 
countries figures around 30 percent are more common. In a short and medium-term 
perspective the high payroll taxes may also have retarded the expansion of employment in 
manufacture, since it often takes time before such taxes are fully shifted onto 
correspondingly lower pre-tax wages. 
We would expect that social insurance in China, as in other countries, will be designed 
not only to provide income smoothing and income insurance, but also to assist individuals 
with low life-time income, hence mitigating long-term poverty. In today’s developed 
countries, this is usually brought about by benefit floors in various social insurance 
systems, such as basic (or guaranteed) unemployment benefits, sick-pay benefits or 
pensions. In developed countries, social insurance often also contributes to an 
overall 
redistribution of lifetime income (across the entire distribution of income). In addition to 
the benefit floors, this is brought about by also having benefit ceilings, without 
corresponding ceilings for the contributions. Of course, since such non-actuarial 
arrangements weaken the link between contributions and benefits, they are bound to 
create implicit tax wedges, which tend to distort labor supply and investment in human 
capital.
115
See, for instance, China’s Social Security White Paper (2006) and World Bank (2003a, Section 5). 
116
China’s Social Security White Paper, 2006. 

---

59
Today, 
unemployment insurance
in China,
 
initiated in 1986 and revised in 1999, covers 
about 105 million urban individuals (in 2004).
117
The maximum duration is high by 
international comparisons, between 12 and 24 months (depending on how long premiums 
have been paid for a particular individual). The replacement rate (the ratio of the benefit 
to previous wage) is fairly generous for many “urban insiders” – both compared to income 
security for workers in many other developing countries and (of course) to the income 
level of unemployed workers not covered by the system. The OECD (2002, pp. 566-567) 
reports a replacement rate of about 50 percent for a large fraction of those insured, 
although there are also reports of lower levels (about 30 percent) for others.
118
Presumably, the rationale for this relative generosity towards some urban workers is to 
create an acceptable substitute for the receding job guarantees by state-owned enterprises. 
The system may, however, run into financing problems in the future, since structural 
unemployment in China is likely to be high during coming decades.
119
A financially and 
socially safer approach might have been if China, at its present stage of economic 
development, had chosen a less generous system for the most favored groups, and instead 
tried to cover a larger share of the labor force. Since unemployment insurance is difficult 
to extend to the farm population, for which unemployment is even difficult to define, 
improved crop-failure legislation, and/or improved natural-disaster relief, might be 
substitutes for unemployment insurance for this population.
There is also a “bottom level” safety net in urban areas in the form of means-tested