Toward the end of last year, 97 Beijing-based food delivery drivers sued a number of takeout platforms and two dispatch companies for wage arrears and nonpayment of social insurance. Not long after, one of the dispatch companies settled with the disgruntled workers, collectively paying them over 700,000 yuan (about $100,000) in compensation.

While the numbers in this particular case were eye-popping enough to make headlines, the reality is that companies engage in such unscrupulous behavior every day all across China’s booming “informal economy.” According to a 2018 estimate from the International Labour Organization, more than half of the country’s urban workforce participates in the informal sector, ranging from freelancers and private contractors to migrants working without formal employment contracts and proprietors of small-scale private enterprises.

Informal work is well known for being less regulated and offering fewer labor protections than formal employment. But as the informal sector continues to expand, the state must confront another problem: The current social insurance scheme, designed with the formal sector in mind, is not keeping pace with the needs of the country’s informal workforce. This not only leaves many informal workers living without a safety net, but also endangers the long-term viability of the welfare system at a time when the country’s rapidly aging population threatens to send costs soaring.

Two or three decades ago, the young delivery drivers we see weaving through traffic every day would likely have found jobs at one of the country’s state-owned enterprises, or SOEs. Prior to the 1990s, most urban workers in China were affiliated with a work unit, known as a danwei, which provided employees with a comprehensive set of social welfare services including health care, education, and pension benefits.

When SOEs were the dominant economic actor, the private and informal sectors were still small enough that they could be ignored. It wasn’t until the ’90s, when a significant number of SOEs were restructured and a large portion of their workforce laid off, that the informal sector began to explode in size. That same decade, China initiated a new urban employee social insurance scheme comprised of five elements: a pension plan, health insurance, unemployment insurance, reproductive insurance, and workplace injury compensation.

Yet this new scheme continued to target formal employees only, requiring contributions from both enterprises and individual employees in proportion to their payrolls and wages, respectively. Even though informal sector workers and rural migrants were theoretically allowed to sign up for urban residence-based social insurance from the mid-2000s, many opted not to do so, as benefits for residents not enrolled in the full urban employee scheme were much lower.

As a result, although recent statistical data suggests that the informal sector has provided the majority of new urban jobs in China since 2010, most of these workers are not enrolled in or protected by the country’s social insurance scheme. Looking at nationwide survey data, my colleagues and I found that, among workers in the informal sector, the pension enrollment rate is below 47%. In contrast, 90% of formal sector workers have enrolled in the state pension scheme.

With many workers lacking health and unemployment insurance, they are in real danger of falling into poverty if they are laid off or experience a serious medical emergency. Indeed, the problem of urban poverty is attracting increasing attention from policymakers as more urban workers are left exposed to these risks.

Interestingly, however, my colleagues and I also found that many informal sector workers are intentionally choosing not to enroll in social insurance, largely because of low benefit payouts and continued difficulties in actually accessing local welfare services.

China’s welfare programs are run at the prefectural level, and we have found that in smaller, poorer regions, as well as those with larger informal sectors, benefit payouts are generally lower than in richer areas. This incentivizes workers from poor areas to save their money and risk going without insurance.

In addition, the country’s hukou system of household registration poses a problem for many informal sector workers. For individual workers and the self-employed, enrollment in the social insurance system is not a very attractive option, since in many cases they can only claim benefits from the city or region where their hukou is registered, and payouts there may be lower than in their city of residence.

Our research also points to another problem: the scheme’s payment structure. We found that many high-earning members of the informal sector — including some self-employed workers and those who run small, private companies — expressly choose not to enroll in social insurance. Although contribution rates are progressive and tied to income, the benefits of some social insurance programs, such as unemployment insurance, are fixed. Hence, high-income workers sometimes prefer to simply buy private insurance instead.

Low social insurance enrollment rates among the informal labor force not only leave many workers without a safety net, but also pose a long-term threat to the viability of the entire welfare system.

Broad-based enrollment in social insurance is especially crucial as China’s population continues to age. The share of those aged 65 and above has increased from less than 6% in 1994 to over 10.9% in 2018, according to the World Bank. In provinces where the population is starting to gray, local authorities have already been forced to plug holes in pension funding with transfers from their general budgets. In 2017, these transfers accounted for roughly 15% of the 3.35 trillion yuan the country spent on urban employee pensions that year.

Looking forward, it’s important to increase informal sector participation in social insurance. One possible option is for policymakers to reduce the high compliance costs of China’s welfare system, including by optimizing its management and reducing the burden on users.

In particular, the government should consider upgrading the management, control, and disbursement of pension funds from the prefectural level to the provincial level. This would equalize benefit payouts across a given province and assuage the concerns of workers still registered as living in poorer areas but who have migrated to the provincial capital or another major city.

Policymakers should also give thought to adjusting payouts for unemployment insurance to take into account either total contributions or income brackets. This could potentially bring more high-earners back into the system and boost overall contributions.

My colleagues and I realize that these reforms will take time to implement. But if the alternative is a social insurance system that’s unable to address the needs of a broad and growing segment of the workforce, then the rewards will be worth it.

Editors: Cai Yiwen and Kilian O’Donnell.

(Header image: Construction workers in Shenyang, Liaoning province, May 17, 2010. Sun Hai/VCG)