Thursday, January 13, 2011

Analyzing China's savings paradox

The persistent reluctance of Chinese consumers to spend their incomes, especially when they are experiencing unprecedented prosperity (average annual household income almost tripled from 1989 to 2006) has been puzzling.

Consider these - private consumption in China has fallen precipitously from 46% of GDP in 2000 to a measly 35%, the lowest among all major economies; urban Chinese household savings have doubled from 15% in the early 1990s to over 30% in recent year.

Rectifying these imbalances in the Chinese economy is critical to addressing the global macroeconomic imbalances that are atleast partially responsible for the current global economic crisis.

Economists Marcos Chamon, Kai Liu and Eswar Prasad studied Chinese statistical surveys of household incomes dating back to the 1980s and attribute the Chinese savings trend to the uncertainty Chinese feel about their income and the market-oriented nature of Chinese reforms. The heightened uncertainty forces the Chinese into saving a larger proportion of their income even in a rapid-growth economy.

They argue that the new nation-wide contributions-based pension scheme ('individual accounts' that hold retirement contributions from both employer and employee), introduced in 1997, replacing the companies' (mostly state-owned) based pensions scheme, has increased uncertainty among employees. Further, the economic reforms and the entry of multi-national firms have made the life of the average young Chinese worker riskier - private sector jobs do not guarantee job security. The proportion of workers employed in the state-owned companies fell dramatically from 81% in 1989 to 64% in 2006. And even for the state-employees, the terms of employment are not as secure as they used to be.

Accordingly, a U-shaped savings pattern has emerged - younger people save more to create a 'buffer' against greater income uncertainty and older folks save for their retirement. They write,

"Higher income uncertainty and pension reforms can together explain much of the rise in average savings among urban households in China…Moreover, the calibrated response to saving rates implies changes to the cross-section of savings over time that are sharper among households at the two ends of the age distribution of household heads. Even 10 years after the initial increase in uncertainty and pension reform, we estimate the youngest and the oldest households save 5 percentage points more than before those changes, compared to only 2.5-3.5 percentage points more for those in their late thirties-early forties."


KP said...

Dear Gulzar,

Some themes here that make any conclusion from these statistics...difficult

- Savings is good? makes you a stronger economy?

- Savings is bad? don't know why - apart from the argument that if everyone saves - who will spend?

- Savings invested by governments into infrastructure - are virtuous?

- Savings rerouted into the economy through markets - private initiative - (infrastructure / education/ health etc.,) - is even better?

- Does citizen savings allow better prioritization of government spending - larger pie? ( assuming that the leakage through the system is low)

- Since private savings only represent non-utilized wealth accumulation from the standpoint of the individual, and governments invariably access these through banks/ bonds etc.,

>> Is this a critique of governments inability to encourage individual spending

>> A lack of confidence in the future?

>> Governments inability to spread the wealth around to those parts of the population that need support. ( Is that a socialistic idea and in the way the current markets based debate is framed - and a bad idea .. )

"Rectifying these imbalances in the Chinese economy is critical to addressing the global macroeconomic imbalances that are atleast partially responsible for the current global economic crisis."

Is this an implicit recommendation that the chinese economy expand / alter its consumption characteristics to revv up economies that are slowing down?

And will expanded chinese consumption be met only through imports?

Where does the notion of imbalance stem from?


gulzar said...

china's problem has a problem with its over-reliance on exports and under-playing of its domestic consumption. domestic consumption as a share of GDP at 37% in 2010 is easily the lowest among all the major economies (US is 70%, India is 57%). given this reality, economic growth policies center around keeping the export engine humming - and the resultant incentive to manipulate exchange rates, keep costs (and hence wages and interest rates low) down.

consumption is made by governments, households and businesses, and for trade (GDP = C+I+G+NX). in China's case, NX, G, and I are strong, whereas C is weak. in a typical country, C forms the major share (see examples of the US and Indian GDP's share of consumption). for all its worth, investments of governments and private firms (in China's case, even this is indirectly by government, since state-owned entities are effectively government itself), can only do so much.

if the chinese government removes artificial restrictions on wage increases, establishes social safety nets, and takes measures to lower uncertainty, then people will naturally start spending and the 'C' imbalance will be rectified. (see this

if all these things happen, then the larger global macoreconomic imbalances will automatically get addressed. chinese trade surpluses will be balanced - both by greater imports (by increased consumption) and lower export growth (domestic consumers will take up a large share of domestic growth).