DEVELOPMENT ECONOMICS II

ESSAY

Estimate budget sustainability of Pension Reform Policy in Vietnam:

Extending the retirement age

Trang Phuong Nguyen Hanken

Anh Quoc Nguyen University of Helsinki

Introduction

Since 1990s, there has been a common concern about increasing trend of population aging and

dependency rate in both developed countries and even in developing countries, where most of

elderly people live (Lawson et al, 2012). This phenomenon has potentially lead to instability in

of the government public pension budget as majority of the support for the elderly is provided by

public pensions and by government health care, based on redistribution principle from younger

working-age population to older generations. (OECD, 1998; World Bank, 1994).

Similar to the global trend, Viet Nam, one of the most promising economies in East Asia, is

forecasted to experience the deficits by 2021 and even depletion by 2034 in government pension

fund if no pension reform is made by International Labor Organization. This paper, therefore,

aims to both analyze the planned extended-retirement-age policy, as one of the most effective

remedy implemented in numerous countries, in the end of 2015 in case study of Viet Nam with

detail estimating the changes of pension budget in the next 15 and 30 years.

The structure of this paper is divided into 6 main sections. After literature review in section 2,

some theoretical framework will be introduced with mainly focusing on mechanism of potential

impact of extended retirement age on public pension budget. In the next section, methodology

used in this paper and dataset will be illustrated. Finally, the two final sections deal with main

results and conclusion.

1. Literature review

This growing recognition of the potential consequences of this issue has leaded to several

discussions on the need for appropriate public policies and impact evaluation of numerous

policies applied to deal with this problem around the world.

John Bongaarts (2004), for example, mentioned about the unsustainability of the pension system

as the raising dependency rate and population ageing and the need to identify and implement

reforms of public pension systems under these changing demographic conditions. Projections to

2050 in demographic trends and pension expenditures in the absence of changes in pension

system were also provided in the context of G7 countries.

Additionally, Van den Noord and Herd (1993), by researching the pension liabilities in the seven

major OECD economies, estimated the likely changes of public pension budget in the seven

OECD countries under new threat of population ageing and concentrated on the urgent needs to

reform the current system to remedy this problem. By using the generational account approach,

combining with a number of assumptions, the liabilities of pension fund was forecasted in case

with and without the implication of the extended retirement-age policy in next coming year, with

the conclusion being that raising retirement ages would make a particularly significant

contribution projected pension liabilities in all OCED industrial countries researched.

Similarly, Leibfritz et al (1995) examined the economic costs of demographic rapid

transformation on government budgets, public pensions budget, and healthcare system by using

quantitative methodology in OECD countries. Some policy options were suggested by them to

cope with all there raising threats, following the finding that further increasing in retirement age

could create stability of the economic system both in the first decade of the 21st century and in

long run. Noticeably, there were a large number of practical evidences of the effectiveness in

extended retirement age policies in many countries. In USA, for instance, the retirement age will

raise from 65 to 67 by 2022. In UK, retirement age for women, which was 60, will be increase to

65 by 2020. In Japan, retirement age will be extend from 60 to 65 for both men and female. In all

these mentioned countries, the policy has significant impact on the budget.

2. Theoretical framework: Mechanism of potential impact of extended retirement age

on public pension budget.

Increasing in the retirement age will lead to the growth in the pension tax as treated employees of

the policy pays more for the budget and the decline in the pension spending, which would have

been paid to the treated employees of the policy without the policys implication, will be saved.

There have been many manners to estimate the impact of increasing retirement age policy to

national pension budgets.

Net pension liabilities is seen as one of the most effective manner for assess the changes in

pension budget in case the extended retirement age policy is implemented, according to Leibfritz

et al (1995), Van den Noord and Herd (1993). It is defined as the gap between the cash flow of

pension tax, which refer to the potential money formal employees pay for the pension insurance

before retirement age, and the pension payments, which is the money that pension return to

payers after retirement age yearly. If net pension liability is estimated to be negative in coming

year, the pension fund is seen as financial instability in coming year and vice versa.

Additionally, public expenditure ratio, which is measured by percentage of current total annual

spending on public pension divided by current total pre-tax annual earnings of workers, is also

reliable index. (John Bongaarts, 2004). This indicator presents how many percentage of income

is spent on retired people annually.

In this paper, the net pension liabilities will be used to estimate the impact on the budget.

3. Methodology and data

4.1 Methodology

We examine the effect of the reform by estimating pension improvement from status quo.

(keeping the current retired age). People who are effected by the reform are workers that work in

formal sectors and reach the age of 55-60 for female and 60-65 for male.

Net pension improvement is driven by two main forces: (1) the gain in social pension tax due to

more people staying in the labor force and (2) the reduction in pension payment due to the

decrease in pension beneficiaries. These two effects together will improve the pension fund. In

this paper, we will estimate the magnitude of these main forces based on the past data and some

assumptions about the labor force structure.

=

Pension tax is a certain percentage of the anual salary of former workers. Pension payment is a

transfered money which is determined also by a certain amount of anual salary. These two

percentage is set by law so it is expected to be unchanged in the estimated time. Therefore, in our

analysis, annual salary of workers in extended age, which is determined by the number of

workers in extended age and the average salary for these people, is the core of our estimate. For

the following parts, we will discuss how to estimate these indices and the prediction multipier for

the future.

4.2. Data and measurement:

We will briefly discuss our data source and measurement of some important indices.

4.2.1. Demographic data and the overview of the economy and labor market:

Vietnam population

At the moment, Vietnam finds itself in a demographic golden age with 54% the population in the

working age with only 10,6% people over 65 years old1. However, the population has been aging

due to the decreasing birth rate and increasing life expectancy. Until 2030, Vietnam is expected

to have 20.3% population over 60 years old2. Therefore, in our analysis, the number of people

affected by this policy will increase over the time. We use the prediction data of World Bank as

the index for number of people in extended age.

Labour market structure and the portion of labor in formal sector

Vietnam has undertaken Doi Moi reform to liberalize the economy and attract trade and

foreign investment. The reform and integration into world economy have been taken place since

1990s by some agreements with the neighbor countries and United States. However, the boom in

foreign trade and investment only started since Vietnam joined WTO in 2007. 3 This movement

has changed the labor structure dramatically. Vietnam has moved from agriculture economy to

manufacturing - service economy (with 53.2% the labor force in manufacturing and service

sectors in 2013). The proportion of labor force in formal sector takes up around 70 -80% of total

labor force (2013) but this rate slowly increases with 0.34% per year from 2009 -2013.

In our analysis, we need to estimate the portion of labor in formal sector in order to find out the

number of treated people. As mentioned above, Vietnam is in the process of international

intergration, the economy will change over time and so do the structure of labor market and

portion of formal labor force. Therefore, for the accuracy of our analysis, we will estimate the

rate of labor in formal sector in two scenerios: (1) this rate will remain unchange over time and

(2) increase with the average speed of 0.34% annually.

1 The 1/4/2013 time - point population change and family planning survey - Major findings- General Statistics

Office of Vietnam 2 Population Pyramid of the world 1950 - 2100, Vietnam: http://populationpyramid.net/viet-nam/2045/

3 The distributive impact of Vietnam's accession to the WTO article,

http://www.cairn.info/zen.php?ID_ARTICLE=ECOI_118_0043

With the predicted number of population in the future and the estimated portion of labor in

formal sector, we could find out the number of treated people for our analysis.

4.4.2. Average salary for workers in the extended retirement age:

Average salary for workers in the extended retirement age in 2009-2013

We could access to average salary for workers in the labor force in Report on labor force survey

2013, General Statistics Office of Vietnam. However, the average salary in the labor force

overall cannot reflect the salary of workers in the extended retirement age. The older workers

tend to have more experience and earn more than younger cohorts. Therefore, workers at the end

of their career life are expected to earn more than the labor forces average salary. We,

unfortunately, do not have data on the distribution of salary across age groups. To solve this

problem, we use the labor experience and average salary increase rate to calculate the average

salary on different age group. The average salary increase rate is the average number of salary

increase rate in the last 3 years by Vietnam Total Reward Survey Report. So the average

salary at age groups i (e.g. i = 0 of age group 15-20, i=1 for age group of 21-25 and so on) in

year x is expressed by this formula:

Six

[0,11]= 0(1 + )

Where is the salary in year x of age group i, 0 is the average starting salary for workers, g is

the average salary growth rate, is the average experience of age group i.

To estimate the average experience for each group, we use labor participation rate across age

groups. We observed the participation rate across age groups in Report on labor force survey

in five years from 2009 to 2013 and this rate is stable over time (Graph 1). Therefore, we get this

ratio as the constant term for our measurement. The average experience of a certain age group is

the difference between their group age and the average age that this group joins the labor

participation. Demographically, the age that a worker joins the labor force varies from 15 to 25

years old. The explanation for this fact is that some people go to work right after their

compulsory secondary school and some continue to pursue higher study and join labor force later

than their cohorts.

Graph 1: Labor Participation by age group

(Source: Report on labor survey, General Statistics Office of Vietnam 2009 - 2013)

For more of the calculation, see Appendix A.

The growth rate of average salary for treated people:

In order to estimate the average salary for people in effect in the future, we need to have an

average growth rate of salary over time to be the multiplier for our estimate. In order to do that,

we look at the trend of real average salary for treated people in the last 5 years. Then we compare

this trend to the trend of real GNI per capita4 which is considered to be the representative for

salary.

The data shows us a sharp increase both in the norminal average salary for treated people and

norminal GNI per capita from 2009 2013. However, during this period, Vietnam has faced a

high inflation rate. Therefore, after adjusting the inflation rate, these two indices fluctuate around

the starting number in 2009 leading to the growth rate of salary is approximately zero in this

period (Graph 2).

4World Bank, GNI per capita, Atlas method, http://data.worldbank.org/indicator/NY.GNP.PCAP.CD

0%

20%

40%

60%

80%

100%

Female

Male

Graph 2: The trend of real average salary and GNI per capita 2009 2013

(Source: World Bank Development Indicators, our estimate)

For these evidence that we have colleted, we assume that the average salary is stable over time.

4.2.3. Data summary and estimate coefficient:

Here is the summary of some basic indices that we would use in our estimate. Besides, we set up

two scenerios for ratio of labour in formal sector. As mentioned above, in scenerio one, we will

assume that this ratio is constant over time and grow over time in the other case. Therefore, our

result will give a range of the pension changes responding to these scenerios.

Table 1: Data summary and annual growth rate of index

Female(55-59)

in 2013

Male (60-65)

In 2013

Estimated growth rate

per year

Min Max

Average salary per year (million

VND)

40,561 48,904 - -

Ratio of labour in formal sector 71.4% 80.7% 0% 0.34%

Labour participation 75% 72% - -

% Retirement pension/salary 75% 75% - -

% Social pension fee/salary 8% 8% - -

50%

60%

70%

80%

90%

100%

110%

120%

2009 2010 2011 2012 2013

Salary for treatedfemale

Salary for treatedmale

Real GNI per capita

4. Result

Table 2 and table 3 indicate the estimated changes in pension tax, pension payment and net

pension liabilities in 2030 and 2045. In general, if extended retirement age policy was

implemented by the end of 2015 as planned by the government, it would impact significantly on

the pension fund, leading to financial stability over time and, in addition, this boost in net

pension liabilities is mostly due to cash pension payment saved (90%), rather than from the cash

pension tax received from the treated people.

In case of minimum pension gains, it is forecasted that the net pension liabilities will increase

considerable by 117 billion VND, with approximately 57 billion VND and 60 billion VND being

come from Male aged 60-65 and Female aged 55-60, respectively by 2030. Moreover, this net

pension liability is expected to witness a far more impressive growth to nearly 150 billion VND

after 30 year till 2045. When it comes to maximum pension gains, due to the larger forecasted

number of both male and female affected by the policy, all pension tax, pension payment and

pension liability are forecasted to larger than those in minimum pension gains. By 2030, for

instance, total expected pension payment in maximum pension gains will be approximately 114

billion VND, comparing to 105 billion VND in minimum pension gains. This results in expected

pension liability of about 126 billion, about 9 billion VND higher than this figure in minimum

pension gains. Similarly, 170 billion VND will be the pension liability expected by 2045, in

comparison of only 150 billion in minimum pension gains.

5. Conclusion:

In conclusion, it is clear that the extended retirement age policy lead to financial stability in

government pension fund in 2030 and 2045 at significant rate, based on some different

assumptions on average salary of treated people and demographic changes by gender and age-

groups.

However, our estimate has a strong assumption that the economy will happen in the same path as

the last 5 years. The past data is quite short due to a shock of international integration leading to

a dramatic change in Vietnam economy. Therefore, we can only use the data in a short period to

eliminate noise in our estimate. So if any deviation from this economic path will lead to an

increase in the average salary per year and the effect of net social pension liability will be larger.

An extension to this issue is that we could consult the growth path of other developing countries

(e.g. China) to set a model for Vietnam growth path in the next 30 years. Moreover, our essay

only looks at the impact of this reform on the pension fund. There would be some social impacts

in different age groups of this policy that are source for further research. However, in the scope

of this 10-page essay, we choose this approach to shortly examine the impact of the reform and

give a suggestion for policy makers.

Table 2: Expected changes in net pension liability by 2030

2030

Min Max

Female Male Female Male

Number of treated people (person) 1,692,716 1,476,423 1,829,745 1,582,169

Pension tax (VND) 5,492,658,789 5,776,237,604 5,937,302,586 6,189,950,797

Pension payments (VND) 51,493,676,147 54152227542 55,662,211,746 58,030,788,720

Net Pension liability (VND) 116,914,800,082 125,820,253,849

Source: Estimation of authors

Table 3: Expected changes in net pension liability by 2045

2045

Min Max

Female Male Female Male

Number of treated people (person) 2,126,470 1,909,878 2,450,504 2,167,368

Pension tax (VND) 6,900,141,744 7,472,055,492 7,951,591,891 8,479,440,459

Pension payments (VND) 64,688,828,845 70,050,520,240 74,546,173,983 79,494,754,305

Net Pension liability (VND) 149,111,546,321 170,471,960,639

Source: Estimation of authors

Bibliography

1. Paul van den Noord and Richard Herd (1993): Pension Liabilities in the Seven Major

Economies

2. John Bongaarts (2004) : Population Aging and the Rising Cost of Public Pensions,

Population and Development Review 30(1), 1-23

3. Leibfritz et al (1995): Ageing populations, pension systems and government budgets:

How do they affecting saving, OECD studies

4. OECD. 1998. Maintaining Prosperity in an Ageing Society. Paris: OECD Publications.

5. World Bank. 1994. Averting the Old-age Crisis: Policies to Protect the Old and Promote

Growth, Oxford: Oxford University Press.

6. Lawson et al (2012): What works for the poorest, Oxford Publisher

7. World Bank Development Indicator 2015

8. International Labor Organization dataset 2015

APPENDIX A AVERAGE SALARY DISTRIBUTION OVER THE AGE

The average salary of the labor force is:

Sx = Six pi

11i=0 (1)

Where Six is the average salary at the range age i in year x (i.e. i=0 for the range age from 15-19,

i=1 for the range age from 20-24 etc.), pi is the percentage of labor participation at age i over

the whole labor force. The data shows us the average salary of the labor force Sx , the labor

participation at age i pi , the average salary raise per year g.

Labour salary from work increases at the speed g (the average salary raise per year) for each

experienced year. Therefore, the average salary at the range age i in year x is:

Six = S0(1 + g exi) (2)

with S0 is the average starting salary for a fresh employee and exi is the experience that person

has.

The experience at range age i exi is measured in the following way. Demographically, the

starting age that people in the working age join the labor force is between 15-25. The explanation

for the variation of the join time because some portions pursue higher study and spend more time

at school and join the labor force later than the other cohorts. The percentage of labor

participation by age and gender is stable through time and had the value as Graph 1.

With the assumption that people join the labor force and will stay there, the working experience

at the range age i is effected by the labour participation time:

exi = (Startj) 5 (j 1)ij=0 (3)

Where starti is the ratio of new labor participation of the range age i. For example, 40% of

people in the range age i=0 (15-19 years old) start working, therefore, 5 years after, this group is

at age group i=2 (20-25 years old), this 40% participate continues to work and has 5 years

experience in the labor market. At the same time, the labor market also receives new

participation of their age cohorts and these new participation get 0 year experience. Therefore,

the average of experience of this age group after 5 years will be ex2 = 40% 5 + (40%) 5

0 = 2 years. This calculation will give us the value of exi in each age group.

We then substitute the value of Six dependent on S0 to equation (1) given value of Sx and pi to get

the value of S0. Then, we could substitute back to equation (2) to get the average salary for each

age group.