Fraud and China

We all know it's a tough time right now - record budget deficit in peacetime, rising unemployment, sliding house prices and an economy teetering on the brink of the double dip recession.

But you may be surprised to know that China may well be in the same boat.  How can that be you may ask?  The only problem China seems to have right now (apart from the usual summer floods) is what to do with all the money from its exports which by the way hit a record in May. Beneath the stirring figures of growth rates that would make our politicians positively salivate are some uncomfortable economic realities which are going to make the going a lot tougher in the next few years. 

Here are three reasons why:

Employment

The release of surplus farming labour from the countryside is swelling the ranks of urban labour market by 24 million a year (that is not far short of the UK's total labour force). The Government formally needs to create 10 million jobs a year and needs growth close to 10% to do it. The official unemployment figure hovers around 4% nationally but in reality the ILO forecast it at more than double this. 

It also disguises a major problem with college graduates. The number of college graduates increased by 6 times in the past decade to reach more than 6.3 million by this year. It will come as no surprise that many of them are struggling to find jobs especially ones that meet their expectations. And the complaints of respective employers sound pretty much like those of UK employers - lack of practical experience, key soft skills like communication and problem solving and so on. At the same time there is emerging evidence of labour shortages in the key manufacturing hubs as both migrants and better educated college students turn their back on blue collar work.

An ageing population

The employment problem is complicated by a second major problem and similarity - the ageing phenomenon. China's population is expected to reach 1.4 billion by 2015 with the number of elderly people over 60 reaching 200 million at the same time. Currently China is the fastest ageing major economy in the world with the ageing rate increasing at 0.5% per annum and the numbers of elderly over 80 growing at 1 million a year. Apart from the pension system which is creaking, the medical insurance system offers incomplete coverage and inadequate benefit levels and the social care needs of the elderly are barely starting to be addressed.

Savings

The third phenomenon is different. China - unlike the UK and the US - is a nation of savers. The level of consumption as a share of national income is just over half that in Europe. The volume of savings drives cheap credit which in turn leads to misallocation of investment into large low return projects and has also fuelled speculative bubbles on the housing and stock market. The Chinese Government is desperate to get consumption and wage share rising as a share of income but are nervous about the impacts on China's global competitiveness, particularly in the light of the Renminbi's appreciation against other currencies.

China's policymakers are beginning to see that many of these issues have one important common factor both as a cause and possible solution - the improvement of the nation's social protection and social security system. The EU-China Social Security project led by the British Council in Beijing has been providing policy advice on the improvement of the social security system since April 2006.

"We have been providing advice on a wide number of areas from the use of unemployment insurance funds to support employment, and training initiatives, transferability of benefits and improvements to the design of the three major insurance schemes" says Grayson Clarke Fund Management Expert on the EUCSS project and resident in Beijing for the past 4 years.

"We are of course only one input out of many to the policy debate but in many respects we are starting to see our opinions sought out and appreciated."

Fraud is a problem

One problem China faces that is also common to the developed world is that of fraud. Three months after the project started in July 2006 the Politburo member for Shanghai, Chen Liangyu, was sacked and subsequently jailed for 18 years for overseeing the illegal lending of social security funds to construct among other projects (so it is rumoured) the Formula 1 motor racing circuit.

"The Shanghai Scandal brought home to the Government how vulnerable the system was to misappropriation and fraud. And the Government started to take it more seriously because they understood it undermined people's confidence to pay contributions from low wages to a system that was potentially corrupt".

Clarke believes that better supervision and control has made some inroads into internal fraud although problems remain at county levels where local governments are often cash strapped and controls on individuals very weak.

External fraud

But an even bigger problem is the emerging issue of external fraud relating both to avoidance by enterprises of tax and social insurance and also to fraudulent claims by individuals and medical institutions for payment. Recently, Jim Gee, Head of Counter Fraud Services at Macintyre Hudson, was asked by the Project to provide expert input into the development of a new China State Council Regulation on Fund Management Supervision which is intended to support better central oversight of the system.

"One of the basic problems at the present time is that the funds have been growing very fast and that nationally, unlike many countries in Europe all have big surpluses" Gee says. 

"But that is largely illusory. Much of the pension fund surplus is actually held by only a few local governments and both the pension and medical insurance fund will face severe pressure from rising costs and a deteriorating contributor retiree ratio."

Subsidies to the pension system from central and local governments already stand at USD 25 billion and much more may be needed in the future.

Tackling fraud is one way in which large savings can be released to deliver higher levels of benefits and reduce pressure on the fund. Everyone knows fraud exists and it is on a big scale. Every day, even in the English language press, there are stories about fake invoices, fake residential status, fake medicines and even fake cooking oil. 

"Of course the social security system is very vulnerable too" Clarke says. "It is run at a highly decentralized level in most provinces with low levels of staff, the IT systems are locally developed and not joined up and the legal foundation to take action against fraud is lacking. But it is also a problem that while people are happy to acknowledge the problem in general terms they don't want to move beyond 'there's quite a bit of it going on'."

"This is a problem in many countries that we have worked" Jim Gee comments.

"In China it is brought into sharper focus by the loss of face culture.  But as the system grows bigger the potential loss of resources to fraud will continue to multiply. The medical insurance for example is almost self-administered. We have therefore been urging the benefits of measurement. Yes there's a potential problem about face when the exercise is first done but the good news is that once measured the amount of loss can be brought down quickly and the savings channeled back into providing higher pensions, and benefits and reducing employer contributions."

Despite the growth of China's economy there has been much talk of indebtedness of some China's local governments. Victor Shih of Northwestern University in the United States has estimated potential local government indebtedness at potentially 50% of total GDP.  So the answer for China may not be so far different to the UK. The easiest cuts are those that can be made in the largest unofficial business expense - fraud.

By Grayson Clarke, Fund Management Expert, EU - China Social Security Reform Project and Jim Gee, Director of Counter Fraud Services, MacIntyre Hudson LLP and Chair of the Centre for Counter Fraud Studies, University of Portsmouth