Farmers' Behavior in Investing Children's Human Capital Under the New Rural Old-Age Pension
Pension Income, Liquidity Constraints and School Attainment: Impact of the New Rural Pension Program in China
Tao Xiang
School of Business Administration
Northeastern University,
Shenyang, China
(Preliminary)
2
The authors thank Gang An, Jin Feng, Guangzhen Guo, Yi Huang, Xinhai Lu, Haifeng Tian and participants in seminars and conferences in Wuhan (MASS, 2011), Shenyang (NEU) and Beijing (Renmin) for their comments and suggestions. The help from CCAP on questionnaire design, the work of enumerators from Northeastern University (Shenyang) and the help from the local officials are gratefully acknowledged. This research was financially supported by the National Natural Science Foundation of China (Project 71103031).
Abstract: Students from poor rural households have less chance to continue their study when they graduate from lower secondary schools due to liquidity constraints. The Chinese new rural pension program, piloted in 2009, has been dumped into a lot of fund by governments and may relax liquidity constraints for poor students. This paper proposes a basic two period household model to analyze human capital investment with and without liquidity constraints when the pension program is implemented. The derived propositions show that when there are no liquidity constraints, the pension program has no impact on human capital investment; and under complete liquidity constraints, net positive pension income will increase human capital investment as it increases household income.
In the empirical part, we use a survey data set that we designed and implemented, and use parametric survival models to overcome bias due to the nature of right censored data. Results show that pension income increases school duration significantly. We also find that the impact of the pension program is heterogeneous, with higher impact on those households more seriously constrained by liquidity. The results support the view that one reason why the participating households are more likely to invest in human capital is because the pension income is relaxing households’ liquidity constraints.
Keywords: Liquidity constraints; School attainment; New rural pension program; Two-period household model; Survival analysis
I. Introduction
China has become a middle-income country, which induced continuous worry whether China will drop into the middle-income trap (Cai，2012). In the literature, scholars have analyzed reasons for middle-income trap, such as the impact of import substitution strategy (Leung, 2010), the role of science and technology (Nallari et al., 2011) and the importance of infrastructure (Nag, 2011). However, the most important reason may lie in income inequality (Kanbur and Zhang，1999；Khan and Riskin，1998；Wan and Zhang，2012) and its byproduct, lack of human capital investment (Galor and Moav, 2004). As upper-income countries have advantages in knowledge-intensive industries, developing countries have to compete in these industries in order to cross the middle-income trap and join the club of upper-income countries. If developing countries want to gain advantages in these industries, human capital accumulation is necessary. However, income inequality reduces human capital investment of poor people and hence deters development.
Human capital investment in China has also been heavily impacted by income inequality (Zhang et al., 2012). Even though the returns to human capital investment increase (Wang et al., 2009; Heckman 2003) along with the continuous transition of the Chinese economy, the share of college students from rural areas is very low (Wang et al., 2011). If markets are efficient or if households have enough resource to invest, households will invest in human capital when they find that the returns to the investment are high. However, if credit markets are not perfect and households are poor, households can not effectively invest in human capital (Galor and Moav, 2004; Kane, 1994).
As far as liquidity constraints in rural China is concerned, Park and Wang (2000) find that 12 percent of informal loans to households are used to pay school fees, which implies that credit constraints may be important for poor households. Brown and Park (2002) use household data to explicitly prove that liquidity constraints limit education investment of Chinese rural households. Wang et al. (2011) find that the impediments keeping the rural poor from pursuing a college education arise long before high school and liquidity constraints may be one of the impediments. Even though there were three sequential reforms undertaken between 2000 and 2006 on tuition of primary and lower secondary schools for poor, rural families, which had statistically significant effect on school enrollment (Chyi and Zhou, 2010), the tuition in the upper secondary schools is still the highest all over the world and keeps poor students out of school (Liu et al., 2009).
Liquidity constraints due to market failure or poverty can be resolved through household wealth accumulation, like remittances (Calero et al., 2009), or through redistribution by government (Benabou, 2002; Uchida et al., 2009). Social welfare represents the largest redistribution program among many countries. These programs can help children enjoy chances to get education more equally (Roemer, 2002).
After fast increase of financial revenue, the Chinese government is able to increase the amount of redistribution (MOF, 2011). In 2009, the most ambitious rural pension program in the history of China and all over the world according to the potential number of beneficiaries was initiated (CCG, 2009). The fund of the program is composed of individual contribution and subsidies from local and central governments.
Even though the program’s main objective is ‘to solve the problem of support for old rural residents’ (CCG, 2009), the impact of the program on human capital investment determines the economic value and sustainability of the program (Leisering et al., 2002). The reason lies in the fact that the income loss due to redistribution has disincentive on the rich so that they may not work as hard as before. As a result, the taxable income decreases. Such effect may result in unsustainability of the program. The traditional welfare states have already suffered from this effect. For example, probably due to high tax rates in France, French actor Gérard Depardieu changed his nationality from French to Russian (Miller, 2013). If many rich people migrated to avoid high tax rates, host countries will have less and less resources to tax on for redistribution. Hence, the overall sustainability of the pension program depends on whether the inefficiency effect is able to be countered by the efficiency effect resulted from increased human capital investment.
Furthermore, even for the pension program, it may have opposite impacts on human capital investment. Of course, the increased income due to subsidies may relax liquidity constraints. But since the pension program requires pension premium for participation, limited resource of poor households may become more limited when they pay premium. These two effects may simultaneously influence parents’ decisions to invest in children’s education in the opposite direction — the former implies an increase in the investment, but the latter may lead to a decline. The ultimate effect depends on which effect dominates.
Therefore, this paper analyzes the impact of the rural pension program on human capital investment under liquidity constraints. It is the first study to assess the intergenerational impact of the expansion of a very special rural pension program on children’s human capital investment.
In the empirical analysis, we take into account the character of right censored school duration for school-age children as most of the children have not finished their schooling, and apply a parametric survival analysis to analyze school duration of the children aged 15 - 18. To avoid endogeneity due to reverse causality, i.e., parents decide on participation in the program by taking into account children’s status of enrollment, we use an instrument variable, number of family members aged 60 or above.
This paper contributes to the knowledge of impact of liquidity constraint on human capital investment in rural China. There is a tremendous literature on this topic. Ten years ago, Brown and Park (2002) proved that liquidity constraints limit education investment of Chinese rural households. Hannum (2003) found that village poverty levels affected enrollments for rural youth. Poverty also limited households’ source to correct children’s bad vision and hence impact academic performance of those children (Hannum and Zhang, 2012). Even though these researches provide evidence on impact of poverty on education, they mostly focus on children enrolled in primary and lower secondary schools, the tuition for which has been waived (Chyi and Zhou, 2010). Hence, impact of poverty on these children may be mitigated. However, impact of poverty on children ready to enter upper secondary schools is still important (Liu et al., 2009; Chen et al., 2012). Therefore, our research focuses on the children aged 15 - 18, who are more affected by the current education system.
This study also relates to the literature on the intergenerational effects of welfare system on education. Studies of changes in the U.S. national welfare system in the 1990s, aimed at promoting adult employment and reducing long-term dependence on public assistance, have generally yielded positive findings with regard to educational attainment in adolescents (Miller and Zhang, 2011) and young children (Duncan and Chase-Lansdale, 2001; Morris et al., 2005, Zaslow et al., 2002). The impact of pension program on investing in human capital in South Africa also got enough attention in the literature (Yanez-Pagan, 2008; Duflo, 2003; Edmonds, 2006). Mu and Du (2012) provided evidence on this issue from urban China. Different from the above researches, our research focuses on impact of the largest rural pension program all over the world with Chinese characteristics.
This paper also contributes to the knowledge of motivation for welfare state. Benabou (2002) has paid due attention to the efficiency effect of redistribution and support the sustainability of welfare states. However, there are also tremendous suspect from the neoliberal economists and the mundane world that redistribution has important disincentive effect on people’s motivation to work (Offe and Keane, 1984; Fieldstein, 2005). Our paper provides evidence that redistribution induces human capital investment in poor households and hence induces healthy development of an economy highly based on human capital accumulation.
The remainder of the paper is organized as follows. In the second section, we introduce the main characteristics of the pension program. Then, we use a two period household model to show possible impact of the program in section III. And in section IV, V and VI, we present data and empirical results. The final section concludes.
II. china’s new rural pension program (nrpp)
The New Rural Pension Program (NRPP) has been rapidly expanded to all counties by the end of 2012 since it was piloted in 2009. The pension program expanded so fast that we can utilize it as a quasi-natural experiment. The basic schemes of the NRPP are regulated by Doc. 32 (Lei et al., 2011), according to which, all rural residents aged 16 or above (excluding students) who are not enrolled in the urban basic pension program and other equivalent pension programs can participate voluntarily[i]. The scheme of the program is shown in Figure 1.
The pension fund consists of two main parts: an individual premium and government subsidies. The individual premium comprises several categories: from 100 to 500 or to 1000 RMB per year per person, depending on local regulations, and is supposed to be adjusted according to rural residents’ increase in per capita net income. Each premium level corresponds to a certain payment schedule. The higher the premium, the higher the nominal payments received in the future.
The government subsidies comprise two parts. One part may be called premium subsidy since it depends on whether the peasant pays the pension premium or not before he/she retires. It is given either by the local government or by the local and the central government, depending on the location of the province. This part is required to be no less than 30 RMB per year per person. The other part is called basic pension benefit, which is at least 55 RMB per month per person and is promised to be adjusted according to economic development and commodity prices. The funding source for the basic benefit mainly comes from the central government, while the local governments can also supplement it so that it is higher than 55 RMB per month. See table 1 to find different schemes in the three sample provinces.
Individual premium and premium subsidy are accumulated in individual accounts according to one-year deposit rate. And the pension benefits a beneficiary can ultimately achieve depend both on the accumulated total funds in the individual account, and on the basic pension benefits from the government.
When a beneficiary turns 60, he/she starts to receive a monthly benefit (1/139 of the total accumulation) from the individual account for a maximum 139 months. At the same time, he/she receives the basic pension benefit funded by the government. Even though the individual account may be emptied 139 months after retirement, the beneficiary can still get the basic pension benefit.
In order to encourage participation, the new system has at least two major merits. The first are the basic pension benefits paid by the central government; the second being the premium subsidy. Both merits reflect the program’s nature as a redistribution mechanism.
Even though the program may deter participation due to its premium requirement, it had successfully been carried out. By the end of March, 2012, the number of participants is 343 million, about 70% of the eligible. The number of beneficiaries is 95 million (Anonymous, 2012a). Subsidies from governments amounted to 262 billion RMB (Anonymous, 2013). As it uses quite a lot resource, its impact on the economy deserves careful evaluation. Meanwhile, the lowest annual pension benefit (660 RMB) is about 30% of the poverty line, 2300 RMB, and hence is more than a quarter’s income of a poor peasant. Therefore, impact of the program on poor peasants may be significant.
Table 2 and 3 show participation situation in the sample villages. The overall participation rate for all the eligible is 72%. The participation rate rises with age and the oldest group, aged 60 or above, has the highest participation rate, 89%. The respondents report reasons for not participating. The most reported reason (52% of the non-participants) is “too young” and the second (31%) “other reasons”. There are still some peasants (14%) reporting the reason is that the premium is too high, reflecting that these peasants are poor and unable to afford even the lowest premium. We can also find from figure 2 that most participants (nearly 90%) only pay the lowest premium. This is also a signal that participants have limited source to allocate to this program.