The Asian Wall Street Journal
Op-Ed piece
July 22, 1998

Hong Kong Tempts Providence

by Bretigne Shaffer

Hong Kong pinned high hopes on its first compulsory retirement scheme when the Provisional Legislature passed it into law on April 1. "Hong Kong's hard-working work force finally can look forward to the certainty of retirement protection," Secretary for Financial Services Rafael Hui pronounced after the vote approving the Mandatory Provident Fund. One local paper even hailed the MPF as a sign Hong Kong was joining the rest of the developed world with a state pension scheme of its own.

Little has been said, however, about the effects the MPF will have on the economy, or about the fact that much of the population does not even stand to benefit from the scheme. The MPF Office has admitted that implementing the scheme will result in a drop in annual consumption of 0.4% during its first year. More worrying is the way it will change the incentives for businesses to hire workers.

The plan gives the impression that employees are somehow getting something for nothing: Employees are required to contribute 5% of their wages to the fund, and employers contribute another 5%. But while employees may feel like their employer's contribution is a gift on top of their normal compensation, in fact treating the two contributions separately is a distinction with little difference. Employers' contributions will eventually be passed on either to consumers, in the form of higher prices, or to employees.

Depending on the degree of elasticity in the labor market, the MPF will impact workers in one of two ways. Employers will pass on as much of their 5% contribution as they can to their employees, by actually reducing wages, or by raising wages less than they would have without the MPF contribution. The employees' 5% wage cut will put pressure on wages to rise. To the ext4ent that employers are not able to reduce wages, or are even pressured to raise them, they will simply cut back on employment.

"There may be job losses," says Steve Butler, board director of the consulting firm Watson-Wyatt, "or it could actually lower wages. Employers may just say the whole 10% is coming out of your salary."

The potential for job losses is very real. Extensive studies in the U.S. have shown that a 10% increase in that country's minimum wage results in a 1% to 3% reduction in entry-level employment. While minimum wage increases in the U.S. affect only the lowest segment of the work force, primarily those in entry-level jobs, Hong Kong's MPF will effectively mean a 10% tax on employment across the economy. This could very easily translate into an economy-wide increase in unemployment.

Apart from the direct impact of the contributions themselves, the MPF will also introduce a new burden to businesses, in the form of administrative procedures necessary to implement the scheme. For some companies, this burden will not be substantial, as it will simply mean adjustments to a payroll system that is already in place. However, for the vast majority of companies in the Special Administrative Region the cost will be significant. According to Watson-Wyatt's Butler, some 90% of Hong Kong's companies do not have computerized payroll systems. Most perform only rudimentary payroll calculations - often on a daily basis, and often paying employees out of cash on hand.

Because businesses in Hong Kong do not withhold tax from their employees' paychecks, and until now there has been no state-mandated pension plan, many companies here are not set up to perform the complex administrative tasks that are routine in other developed countries. Making the transition to a system that reliably tracks each employee's earnings and both parties' contributions to a pension fund promises to be a costly undertaking. "It sounds to me as if it's a huge administrative burden," says Dr. David Henderson, adjunct fellow for the Center for the Study of American Business. "They will have to do a lot of things they didn't have to do in the past. The incremental costs will be very high."

Of course, all of this does not even take into account the cost to Hong Kong taxpayers of the HK$5 billion (US$647,668,000) Mandatory Provident Fund Authority, the seed money of HK$600 million for the MPF Compensation Fund, or the HK$500,000 consultancy study to determine how much the MPFA board members should be paid. These expenses alone amount to nearly half of the anticipated HK$12 billion in MPF contributions for the first year.

For such a costly scheme, one would expect substantial benefits for society as a whole. Under the MPF, however, such benefits are highly questionable.

At approximately 30% of GDP, Hong Kong's savings rate is already one of the world's highest. For those in the middle and upper classes, the effective 10% of wages put into the MPF will not have much effect on spending and investment, other than forcing people to save in ways they might not otherwise have chosen. In fact, says MPF expert Francis Lui of the Hong Kong University of Science and Technology, this MPF scheme won't help the middle class at all. Mr. Lui says that economically it may make sense to exclude the middle class from the scheme, but that politically it would not be feasible.

Even the SAR's population of elderly poor will not be helped by the MPF. Most of Hong Kong's poor were in the work force at a time when well over half the territory's population lived in abject poverty. Workers at that time were more concerned with day-to-day survival than saving for retirement. Ironically, this group will not benefit from the MPF at all, as it will be many years before participants start receiving payments, and those who are not currently in the labor force will never receive any payments at all.

Nevertheless, the working poor in Hong Kong do stand to gain from the scheme, at least in the distant future. Low-income workers will benefit, not only from the promised security of retirement funds, but also from the opportunity to invest in diversified funds - something they might not be able to do as individual investors. However, these are also the people for whom the MPF will cause the greatest hardship. Even the MPF Office acknowledges, in its report to the Provisional Legislative Council, that "[T]he move towards increased savings and reduced consumption is likely to be more discernible for the low-income group with a low savings ratio."

The MPF will be most burdensome to those who can afford it the least: employees in low-income brackets, to whom even a 5% cut in wages each month could actually eat into basic necessities; and the smallest of small businesses, like the noodle shop that won't be able to afford a dishwasher. The working population will also be affected by any decrease in job opportunities stemming from the additional cost to business.

According to MPF supporters, the initial drop in consumption will eventually be balanced out by payments to retirees who have paid into the scheme. However, with the conservative nature of the MPF requirements, it is hard to imagine the returns being dramatic enough to compensate for the problems caused by increased unemployment, or the ongoing administrative burden to businesses. Nor is it clear why such significant costs should be imposed on the entire economy when only one group stands to benefit. As some in Hong Kong have suggested, it might be less costly to simply make direct payments to those who cannot afford to save on their own.

The irony of the scheme is that while its purpose is to provide economic security for the SAR's work force, it may actually accomplish just the opposite. By imposing substantial new costs on the territory's businesses and a 10% disincentive on hiring, the MPF inadvertently puts workers at even greater risk of economic uncertainty. Indeed, the only clear-cut beneficiaries of the scheme seem to be those in the fund management industry itself. Given the potential damage to the economy and the dubious advantages the scheme offers to the bulk of those it covers, Hong Kong's MPF is hardly a model for other Asian countries to follow.

Ms. Shaffer is an editorial page writer of The Asian Wall Street Journal.

Copyright Dow Jones & Co. 1998