Larger labor force not a panacea for pension woes

China may raise the country's retirement age by the second half of this year, according to an announcement from the Ministry of Human Resources and Social Security, the country's labor authority, amid concerns about a ballooning deficit in pension funds and dramatic increases in the nation's elderly population.

If China takes no action to change its pension system, by 2013 the country's retirees will leave a 18.3 trillion yuan ($2.87 trillion) gap between the liabilities and assets of its pension fund, up from a shortfall of 1.76 trillion yuan in 2010, according to a joint study by Bank of China and Deutsche Bank.

By keeping more people in the work force, the government undoubtedly hopes to expand the country's pension fund pool and thus downsize what it pays out to retirees. Such a move would, if anything, only provide a short-term solution to what is in fact a systemic problem. The most pressing issue facing China's pension system is not a lack of incoming funds, but the low returns on pension fund investments.

Actually, China has a large number of potential funding sources for its pension system, thanks to support from the central and local governments, which have been subsidizing pensions since 1997.

New fiscal subsidies for pensions have been growing consistently since 2007 and hit 227.2 billion yuan last year, according to the Chinese Academy of Social Sciences.

Over the past decade though, investments made with pension funds have yielded returns well under 2 percent, much lower than the 10 percent or higher returns seen in many developed countries, said Dai Xianglong, chairman of the National Council for Social Security Fund, in December.

The majority of China's pension funds have been channeled into low volatility, fixed income investment products whose returns have failed to keep pace with inflation gains.

A lack of competition in the pension fund market and limited information disclosure regarding how the government invests pension funds, have also failed to push the managers of these funds to seek higher returns. Currently, there are only 11 fund management companies in China allowed to handle pension funds, five of which control 85 percent of the total funds.

The government should strengthen its oversight on pension fund investments, encourage competition within the industry and diversify investment vehicles to improve risk management, with an eye toward beefing up returns from pension funds, rather than just forcing workers to delay retirement.