Assessing the CPF
Investment Performance of the CPF Board
According to statutory requirements, CPF funds must be invested in government bonds and in advanced deposits with the Monetary Authority of Singapore, which eventually converts the monies into bonds. With the exception of the early years following independence, the government has consistently been running budget surpluses so the amounts borrowed are not used to finance infrastructure. Instead, CPF balances are invested by the government through the Singapore Government Investment Corporation (GIC) and other channels. Investments are mainly in external and real assets. However, very little information is available on either the investment portfolio or the returns earned.
As mentioned earlier, CPF members receive a market-related interest rate on their savings, based on the average of the 12-month deposit and savings rate of four major local banks. The rationale for paying short-term interest rates on long-term funds is that Ordinary and Medisave Accounts operate like a current or savings account and can be withdrawn on demand for approved uses. As such it is justifiable to pay short-term interest rate on them. The market-related interest rate paid on the Ordinary and Medisave Accounts is calculated based on 80% Fixed Deposit and 20% Savings Deposit rates. This is already generous given their short-term nature, a floor rate of 2.5% paid on these funds and that the accrued interest income is tax-exempt. If the returns to CPF balances invested by the government are higher than what is paid to the members, then the difference is an implicit tax on members, although this may be offset by subsidies. Asher suggests that the implicit tax is likely to be regressive, as those with low balances have a greater proportion of their (forced savings) assets with the CPF.
Achievements of the CPF Scheme
To date, the CPF scheme has provided a solid and sustainable base for financing an affordable social security system. Indeed, it has expanded from an old age savings scheme to a multi-purpose savings program. The most important achievements of the scheme are as follows.
As a mandatory scheme for all public and private sector employees, it ensures that the majority of the population will set aside some savings for old age and contingency purposes. Partly owing to this fact, public assistance benefits to the destitute constitute less than 1 percent of budget outlays (Carling and Oestreicher).
The self-funding scheme, adjusted periodically for inflation, has enabled the scheme to weather changes in demographic trends, longevity, higher costs of medical care. Individuals finance their own retirement without creating funding problems for the government and future generations.
It encourages family members to help one another and allows transfers from members to their children, spouses and parents. This, in turn, binds the family structure.
CPF contributions are portable; contributions are made to individual accounts such that worker mobility is allowed and more efficiency is generated than when workers are tied down by pension plans.
CPF contributions helped to promote savings especially in the early years and CPF balances invested in government securities provided an important source of funds for government projects, particularly the HDB housing program. In later years, when deficit financing turned to budget surpluses, CPF accounts enabled members to finance the purchase of their homes.
Qualifications of the CPF Scheme
Despite the advantages of the scheme, there are some important qualifications:
Although efforts have been made to liberalize the use of CPF funds over the years, the regulations still prevent members from having access to the full range of investment opportunities. For instance, CPF cannot be withdrawn for investing in members own business for fear of failures wiping off old age savings (Aw).
Furthermore, intentionally or not, the scheme encourages certain ways of investing, especially in housing. Purchase of housing and the push to upgrade to bigger, better homes have led to inflation and speculation in real estate (Aw).As mentioned earlier, CPF balances are invested in government bonds, which carries lower risk but also brings relatively low returns. The government does not need the proceeds of these bond issues for funding purposes as the budget is routinely in surplus, and so the funds are invested in external and real assets by GIC. CPF members are sheltered from investment risk and are believed to earn a commensurately lower rate of return, while the GIC aims to maximize the total rate of return and to manage risk. The merits of such an arrangement are evident but its desirability is debatable.
Comparison between the CPF Scheme and Social Security in the U.S.
Social welfare has traditionally been thought of as one of the goals of development, a view that has been reinforced by recent emphases on the importance of providing for the basic needs of the populations of developing countries. Such needs typically include adequate nutrition, health care, clothing, housing, utilities, education, employment and social security. By any absolute or comparative standards, Singapore has excelled in providing for these needs of its population over more than a quarter century of development. Although its per capita income is still below that of most developed nations, Singapore has comparable or superior standards of social welfare by most indicators. In 1985, 77 percent of employed persons held forced savings in for retirement and medical expenses in the government-run CPF, which has helped give Singapore the highest rate of personal savings in the world. Singapore also has probably the best public-housing programme in the world, with 84 per cent of the population (including middle- and upper-income professional) in 1985 living in government built and administered housing units, 64 per cent of them owner-occupied. It is tempting to regard this high standard of social welfare as simply the outcome of more than two decades o rapid economic growth, industrialization, and urbanization, reflecting the successful achievement of developmental goals.
In 1935, President Franklin D. Roosevelt signed the Social Security Act into law. While private and public pensions were becoming increasingly common in the U.S. in the early part of the twentieth century, the economic devastation brought about by the Great Depression threatened the survival of these schemes. Social Security, therefore, was borne out of the need to provide for old age insurance in the aftermath of a massive economic depression. Today, Social Security provides a variety of benefits, the major ones being retirement benefits, including spousal benefits, disability, and survivors benefits. Over the years, contribution rates have been raised from 2 percent of wages (1 percent each from the employee and employer) in 1935 to the present 12.4 percent (6.4 percent each from the employee and employer).
Both the CPF scheme and the Social Security system in the U.S. share the basic philosophy that the government should help individuals achieve some form of protection in society, but the similarities end there. The two programs operate on different systems, represent different stances on redistributive and equity issues, accord the individual with different degrees of economic freedom, and enjoy different levels of financial health. The following section highlights the main differences between the two programs.
Pay-As-You-Go vs. Fully Funded
The most fundamental difference between the CPF Scheme and Social Security is that the former is a system of fully-funded individual accounts while the latter works on a pay-as-you-go (PAYG) basis. For a PAYG system, almost all the in-coming funds are immediately paid out to current beneficiaries, instead of being saved and invested in individual accounts for workers future benefits. The future benefits of todays workers will then be similarly financed by taxes from the next generation of workers.
An advantage of a fully funded system over the PAYG system is that the former is wealth-producing whereas the latter is merely a redistribution of health (Ferrara and Tanner, 60). CPF balances are invested in government bonds, which generate positive rates of return. Under the Social Security system, no funds are saved and invested, thereby adding nothing to production. This implies that workers under Social Security forego the amount of increased production and associated returns that they would have received if their money were invested. Each retiree gets no more out of the program in benefits than the simple amounts paid in taxes, unless the government raises the amount of taxes it collects from the next generation of workers.
A possible advantage of the PAYG system is that it provides better protection against inflation. It is relatively easy for a PAYG system to protect purchasing power of benefits: inflation tends to increase in tandem with benefits. Under the fully-funded system, the rate of return on members balances in their accounts acts to protect the savings against inflation as opposed to having to revise the contribution rates constantly. The Minimum Sum is to be increased to $80,000 in 2003, which is in 4 years time. All of the members savings, i.e. those withdrawn at age 55 and the Minimum Sum disbursed from retirement age is for old age.
Redistributive element and equity issues
Social Security is an important channel through which income redistribution is carried out. To determine an individuals Social Security benefits, the administrator looks at all the contributions an individual has made over his lifetime and calculates his Average Indexed Monthly Earnings (AIME). From this amount a progressive formula is used to determine his Primary Insurance Amount (PIA). For people turning 65 in 1997, the formula was 90 percent of the first $455 of the AIME, plus 32 percent of the next $2,286, plus 15 percent of the remaining AIME. Therefore, low-income workers receive a larger percentage of their pre-retirement income than do high-income workers. The rationale is that low-income earners will presumably retire with less wealth and assets than their high-income counterparts. It follows that Social Security benefits would constitute a larger portion of their retirement income.
The CPF scheme, on the other hand, does not exhibit this strong redistributive element. Since members have individual accounts, their retirement savings are a direct function of their contributions.
Choice and Control of Contributed Funds
In an ideal world, each individual would be free to make his own decision over how to provide for his retirementhow much to save and how to use those savings. However, under the PAYG system, American workers have no control over the one-eighth of their wages that are now consumed by Social Security. In Singapore, while use of CPF savings is limited to government-approved purposes, workers still enjoy a greater degree of freedom over how they want to invest their savings.
Financial Health of the Two Systems
By nature of fact that the CPF scheme is fully funded, it is in sound financial conditions. As a matter of fact, the governments emphasis on asset enhancement in recent years aims at generating higher retirement savings for its members.
In contrast, Social Security is facing impending trouble. According to the 1998 Report of the Social Security Systems Board of Trustees, the Social Security system will begin to run a deficit in 2013. That is, the system will give out more benefits than the taxes it will receive.
This is the result of several factors. Over the years, Social Security has expanded considerably as politicians successively raised benefits in order to win elections. Greater benefits may have been sustainable during times of economic growth. However, with todays declining birth rates, falling worker-to-retiree ratios and increasing life expectancy, the system can only be sustained by benefit cuts, tax hikes or a combination of both. As Ferrara and Tanner argue, Social Security is "a program that was flawed from its initial design, an unsustainable pyramid scheme that places ever higher burdens on young workers while making promises for the future it cannot keep."
The impending crisis has led to calls for privatisation of Social Securitythat is, the switching over from a PAYG system to a privately-run one with fully-funded, individual accounts. Policymakers and academics are studying Social Security models from other countries, of which Singapore is one. However, concerns have been raised over the adoption of a CPF-style approach whereby the government controls the investment of Social Security balances. According to Ferrara and Tanner, having the government invest directly would give the government enormous control over the U.S. economy and would have potentially disastrous consequences. Such an arrangement, they argue, would result in the socialization of a large part of the U.S. economy, putting ownership rights over much of the American economy in the hands of the U.S. government. This argument highlights the difference between the two societys attitudes towards government intervention in the economy.
PART FIVE - Conclusion