Microsoft Word EcRefChina Oct06. doc

Party Congress in early 
2006.
What, then, can China learn from developed countries in the sphere of income insurance?
When discussing this issue, it should be noted that in their early phases of economic 
development, today’s rich countries relied mainly on (modest) safety nets – rather than on 
arrangements for income protection (i.e., benefits in some proportion to previous 
earnings). It was only after those countries had become rather well off, mainly after World 
War II, that comprehensive arrangements for income protection (social insurance) became 
common.
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Moreover, it was not until the 1970s that these arrangements became so 
generous that aggregate social transfers in Western Europe reached the interval of 20-30 
percent of GDP. As a result, during the early phase of building up income security in 
today’s developed countries, previous informal systems of income transfer – connected 
with relatives, or run by so-called “friendly societies” – survived until new, more formal 
transfer systems had acquired solid financial and administrative bases.
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So much for lessons from the 
early
development of income insurance among today’s 
developed countries. Some experiences from 
contemporary, 
highly ambitious systems of 
income protection in these countries are also of interest for China (as well as for other 
developing countries). I refer, for instance, to the importance that such systems are 
financially robust to various types of “unfavorable” exogenous shocks, such as in 
demography, productivity growth and macroeconomic instability. One conceivable way 
of achieving this could be to make the benefits automatically contingent on the 
development of certain variables such as the rate of growth of the tax base, the number of 
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Such experiments are underway in eleven provinces, with the explicit (ultimate) purpose of 
eliminating the differences in income security between urban and rural areas (
China Daily
, Nov. 2. 
2005). 
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Germany under Bismarck introduced social insurance for industrial workers earlier than other 
countries, and the United States built up universal social security, mainly in the form of old-age pensions 
as early as the mid-1930s. 
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This point is developed in Lindbeck (2002).

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individuals above retirement age, and the number of individuals living on various benefit 
systems (Lindbeck, 2006). Indeed, social insurance in some developed countries is today 
heading in this direction. The basic idea is to relieve politicians from the necessity to take 
unpopular policy measures from time to time for the purpose of guaranteeing the financial 
sustainability of various social insurance systems. 
Another lesson from developed countries is that the consequences of income-security 
arrangements and redistribution policies for economic efficiency and economic growth 
depend crucially on exactly how the arrangements are designed. Therefore, it does not 
make sense to ask whether there is a trade-off between income security and redistribution, 
on one hand, and economic efficiency and growth, on the other hand, 
without first 
specifying how the arrangements of income security are actually designed
. For instance, 
undesired disincentives effects of the taxes required to finance such systems may be 
mitigated by establishing a rather tight “link” between contributions and benefits for the 
individual – although this naturally reduces the redistributional effects across individuals. 
Moral hazard in the connection with various benefit systems (such as increased leisure 
financed by the general tax payer) may also be mitigated by making benefits distinctly 
lower than the after-tax wage. Otherwise, there is a risk that individuals develop a 
gradually more “liberal” interpretation of their rights to live on various types of benefits, 
such as unemployment benefits, sickness absence pay, and early retirement benefits. Such 
a weakening of attitudes and social norms towards benefit dependency would accentuate 
the problem of moral hazard. Indeed, I have hypothesized elsewhere that contemporary 
welfare-state problems in several developed countries are partly due to such changes of 
attitudes and social norms (Lindbeck, 1995; Lindbeck, Nyberg and Weibull, 1998).
These lessons from developed countries may seem self-evident at first, but experience 
shows that they are not easily learned and adhered to. Contemporary experience in several 
countries in Western Europe also expose the political difficulties in cutting back the 
generosity of welfare-state arrangements even after both experts and many politicians 
have become convinced that existing arrangements are not sustainable. It is, therefore, 
important that China watches out for problems of disincentives and moral hazard in the 
future when expanding its social insurance system – preferably before the problems have 
become severe.

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