The economic reform process interrupted the cosy pre-reform social security system, whereby SOEs represented a lifetime of employment and welfare. SOEs are now expected to compete with the private sector in terms of efficiency and profitability. The various social welfare provisions to employees are now seen as a significant burden on production costs. For example, in 1993 retirees comprised 20 per cent of the total number of state sector employees. In some long-established SOEs, the ratio of retirees to total employment was 1: 1 (World Bank 1996). Non-wage welfare benefits also added to the cost of running SOEs. In a case study of one SOE, the average yearly wage was 8,000 yuan, while the average amount of annual welfare expenditure per employee was an additional 12,000 yuan (see Mai and Perkins 1997). The issue of ‘burdensome’ social security provision goes hand-in-hand with encouraging labour mobility. Workers actually still prefer to stay with the already over-staffed state enterprises because they have job security and welfare. The private sector, on the other hand, does not offer either.

It is essential, therefore, that China establishes an external welfare system so as to reduce the financial burden of SOEs and facilitate labour mobility. The importance of social security reform has been recognised since the mid-1980s, but this issue has become urgent since a large number of SOEs were running at a loss in the early 1990s.