Guest Post: The puzzle of China’s rising household saving rate

Yves here. I thought this post from VoxEU was worth featuring because it provides concrete support for one theory about how to reduce US/Chinese trade imbalances. As long as China has a high savings rate and low domestic consumption, it will have to also show a high level of exports, which in turn means other countries or countries wind up showing high levels of consumption and rising debt levels. And worryingly, China’s consumption as a percent of GDP has been falling, a very unusual pattern for a developing economy.

One common prescription is for China to improve its social safety nets. This analysis indicates that might have merit. Admittedly, there are practical obstacles to implementing it, one of the large ones being the level of corruption in provincial governments.

By Marcos Chamon,Senior Economist, Systemic Issues Division, Research Department, IMF, Kai Liu, Ph.D. candidate, Department of Economics, Johns Hopkins University, and Eswar Prasad, Tolani Senior Professor of Trade Policy at Cornell University, Senior Fellow of the Brookings Institution and Research Associate, NBER. Cross posted from VoxEU

In an effort to reduce its sizeable current-account surplus, the Chinese government has made it a priority to “rebalance” growth in China by stoking private consumption. This column examines the determinants of the high household saving rate that keeps Chinese consumption so low.

Economists have repeatedly warned policy-makers about imbalances in the global economy, particularly those caused by the actions of China in running up a colossal current-account surplus. During the global financial crisis and the following global recession, this surplus shrank from 11% in 2007 to an estimated 5% in 2010, but many analysts view this as a temporary respite related to the contraction in trade and expect China’s current-account surplus to rise again (Baldwin 2009). Chinese government officials, meanwhile, have argued that the current-account surplus is driven by structural factors and that the exchange rate has little role to play in influencing the saving-investment balance. They have also made it a priority to “rebalance” growth in China by stoking private consumption. As part of this debate, we ask what determines the high household savings that have been keeping China’s consumption so low.

The facts

Gross domestic saving in China has surged since 2000, climbing to over 50% of GDP in 2005 (Figure 1). In particular, enterprise saving – including that of state-owned enterprises – has risen sharply in recent years. Government saving has also increased. Over this period, the share of household saving in national saving has not changed much, but this is mainly because of a fall in the share of household income in national income rather than a decline in the household saving rate (Prasad 2011).

Figure 1. Gross saving rates by sector

PrasadFig1(1)
Source: National Bureau of Statistics (Flow of Funds data).

Figure 2. Household saving rates

PrasadFig2(2)
Source: National Bureau of Statistics, Flow of Funds data and Urban and Rural Household Survey. Saving rate from national accounts is significantly higher than that from the household surveys. This discrepancy is common (it is present in most countries), and can be due to differences in definitions of income and consumption, methodology and sample coverage.

Chinese households save a large share of their disposable incomes and their average saving rate has increased over the last decade and a half (Figure 2). This pattern is particularly pronounced for urban households, which account for about two-thirds of national income. After remaining relatively flat during the early 1990s, the average saving rate of urban households relative to their disposable incomes rose from 18% in 1995 to nearly 29% in 2009.

This increase took place against a background of rapid income growth and a real interest rate on bank deposits that has been low over this period (and even negative in some years, as nominal deposit rates are capped by the government). This pattern of a rising household saving rate at a time of high income growth seems inconsistent with a certainty-equivalent life-cycle hypothesis model, which would imply that future high income growth should cause households to postpone their savings.

New explanations: Evidence from survey data

In our first paper (Chamon and Prasad 2010), we use data from the annual Urban Household Surveys to characterise household saving patterns. These are large annual cross-sectional surveys conducted by the National Bureau of Statistics.

We document that saving rates have risen across the board in urban China, but especially among households with relatively younger and older household heads. That has led to an unusual “U-shaped” age-saving profile (see Figure 3), where the saving rates are higher at the two ends of the age distribution of household heads. Typically, one would expect saving rates to increase with the household head’s age, peaking prior to his or her retirement, and then turning negative in retirement.

Figure 3. Urban household saving rates by age of head

PrasadFig3(1)
Notes: Based on a 10 province/municipality subsample of the National Bureau of Statistics Urban Household Survey. Saving rates smoothed by a moving average with 4 neighbouring age averages. For details on the data, and how saving rates are defined, please refer to Chamon and Prasad (2010).

We test a number of conventional theories and find little evidence that they can explain these patterns. For instance, the data suggest a limited role for demographic shifts in explaining saving behaviour. The cohorts most affected by the one-child policy are not among the highest savers.

Instead, the declining public provision of education, health, and housing services (the breaking of the “iron rice bowl”) appears to have created new motives for saving. This can contribute to rising savings as younger households accumulate assets to prepare for future education expenditures and older households prepare for uncertain (and lumpy) health expenditures.
The inefficiency of “self-insurance” contributes to higher aggregate savings (as many households save in order to protect against a shock while relatively few may actually be hit by one). We estimate that the motive of saving for health expenditures accounts for an increase of more than 5 percentage points. The extensive privatisation of the housing stock has also contributed to savings. We estimate that saving for house purchases increased average saving rates by 3 percentage points relative to the 1990s, with the effect concentrated among households with younger household heads (that are less likely to own their dwellings).

While cross-sectional household data can help evaluate the importance of competing channels, it is less informative when saving rates have risen across the board, as is the case in urban China. If indeed rising uncertainty and the related increase in precautionary saving is an important driving force behind the trend in saving rates, the availability of panel data on household income could help quantify that uncertainty and gauge its potential impact on savings.

In a second paper (Chamon et al. 2010), we use a panel dataset from the China Health and Nutrition Survey. That survey does not provide information on consumption or savings but does have data on incomes that allows us to quantify the rise in income uncertainty and decompose the variance of income into components attributable to permanent versus temporary income shocks. We find strong trend growth in both the mean and the variance of total household income. Interestingly, the variance of permanent shocks to household income has remained relatively stable, while the variance of transitory shocks trends upwards. This result is in line with a large literature on how technological and sectoral shifts and the associated labour reallocation can generate higher transitory uncertainty even though some of these shifts themselves are permanent in nature.

Based on these results, we calibrate a simple buffer-stock/life-cycle model of savings to evaluate the implications of rising uncertainty on household saving rates. Under plausible parameter values, the rising transitory variance of income can explain about 4 percentage points of the increase in the saving rate among the households with younger heads.

Households with older household heads that have already accumulated significant savings can more easily accommodate transitory shocks and this factor does not add much to their savings.
On the other hand, households with older heads are more affected by the pension reforms in 1997, which transferred urban pension obligations from employers (predominantly state-owned enterprises) to provincial governments. We estimate that a decline in the pension replacement rate from 75% to 60% of pre-retirement income (in line with estimates for the transition generation under the reform) can explain a 6-8 percentage point increase in saving rates for households with heads in their 50s. The initial effect is more muted for younger households, who have a longer time to adjust to the pension reforms. Thus, we are able to trace much of the increase in savings, concentrated among households with relatively young and relatively old household heads (the “U-shaped” pattern described above), to higher income uncertainty and pension reforms.

Conclusions

Our analysis based on cross-sectional and panel data sheds light on different motives that drive the saving behaviour of Chinese households. While the combined effect may be smaller than the separate estimates from the two independent approaches, the results are able to account for a substantial portion of the increase in average saving rates of urban households as well as the U-shaped age-saving profile of savings.

We find that motives of saving for precautionary purposes due to rising income uncertainty and for housing purchases explains the rising saving rates of households with young household heads.

Pension reforms and rising medical expenditures account for much of the rise in the saving rates of households with older heads.

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12 comments

  1. purple

    But consumption is growing strongly in China; auto sales now dwarf the U.S. and that is unlikely to change.

    What is happening is that investment is going up even more, therefore the ratio of consumption is declining. A similar pattern happened in the US during the Second World War.

    There is reason to believe that the investment is unsustainable, but it’s not an open and shut case. China is a huge country with many developmental needs.

    1. Yves Smith Post author

      What matters is not the gross level of consumption but consumption as a % of GDP. That’s been falling since 2002.

  2. RSDallas

    Maybe it’s a lot simpler than you are making it. I mean think about it. It seems logical that the Chinese population would save more than usual because of where they have come from. They have come from the depths of poverty where they couldn’t save. Now they can save some. Generations to come will be reminded of what it feels like to have nothing; henceforth, their savings rate will be higher than usual for years to come.

  3. ron

    i don’t understand what the economists want. do they want free market or controlled market or both. on one hand they say that imbalances correct themselves. so if china is exporting too much, one day it will have to correct and there will be a recession there. so, its good for the market. yet the economists preach that we use socialistic policies like govt managed pension, social security, education, health so that the people of china can spend on discretionary stuff. free market theory says, that people save and spend on health, education, retirement from that saving and not depend on govt. what do the economist want? or they just want to bash china because its a threat to usa?

  4. Valissa

    This post is a classic example of what is wrong with economics today, and why I find trying to study it so incredibly tedious and frustrating. X should be doing Y so we can achieve Z. Economics is desparately in need of epistemological innovation. Tying economics to the REALITY of the human condition might be a good start.

  5. mjm123

    The reason for high Chinese savings rates can be explained through relatively simple accounting identities.
    A) Through various capital controls, China forces themselves to run a capital account deficit (and therefore an equivalent current account surplus).
    B) A simple accounting identity tells us that: Capital Account = Investment – Savings
    C) So, if you run a capital account deficit, Savings must be greater than Investment.
    D) The Chinese/Asian Development Model creates massive Investment.
    E) But the capital account deficit means that Savings must be higher than Investment

    Therefore, it is China’s policies that control their capital account that create high savings.

  6. AR

    Here’s another possible reason:

    4:2:1

    Four grandparents.
    Two parents.
    One child to take care of them.

    Thus, more savings for old age will be required.

  7. Cedric Regula

    It’s clear to me from the charts that the government savings rate is too high. This place would be MMT heaven. We could re-locate our MMT types to China and China’s problems would be gone in 5 years.

    Harping about decreasing the personal savings rate in China is a bunch of BS. Take the large migrant work force. Their version of unemployment insurance is they show up for work one morning, find the front door padlocked, then they realize it’s time to make that long walk back to the rural farm, provided the farm wasn’t flooded by that big dam the People’s Party built.

    Here’s an interesting article on BYD in China. Towards the end of the article it gives some insight into what “working” means in China. Bennies, bonuses, pensions ,heathcare not mentioned at all!

    “Deploying the armies of laborers at BYD is an officer corps of managers and engineers who invent and design the products. Today the company employs about 10,000 engineers who have graduated from the company’s training programs – some 40% of those who enter either drop out or are dismissed – and another 7,000 new college graduates are being trained. Wang says the engineers come from China’s best schools. “They are the top of the top,” he says. “They are very hard-working, and they can compete with anyone.” BYD can afford to hire lots of them because their salaries are only about $600 to $700 a month; they also get subsidized housing in company-owned apartment complexes and low-cost meals in BYD canteens. “They’re basically breathing, eating, thinking, and working at the company 24/7,” says a U.S. executive who has studied BYD. ”

    http://money.cnn.com/2009/04/13/technology/gunther_electric.fortune/

  8. Lune

    I think the authors underplay the political forces that are a huge factor (a common mistake for economists…).

    Firstly, the authors do make mention of the dismantling of the iron rice bowl, but this is a *huge* factor, not to be underestimated. I traveled in China a few years ago, and admittedly, my evidence is anecdotal, but speaking with young (20s-30s) Chinese, I get the sense they’ve gotten an incredibly raw deal. While the living standards have improved, Chinese society has gone from typical communist cradle-to-grave assurances to one more ruthless than America. People who came of age before the economic reforms (i.e. people in their 40s-50s) were guaranteed education, jobs, health care, an apartment, pension, etc. Now, all of that is gone. Young people migrate to cities, face brutal competition for uncertain jobs, and no longer can afford any of the social net that the previous generation took for granted. It’s therefore no surprise that people are saving huge sums given their government’s stated policy and previous actions of completely destroying their safety nets. (To be sure, most young Chinese don’t want to go back to the old way, and for the ones that are successful, the rewards can be spectacular; but there’s no denying the need to compensate for a social net that has disappeared in less than a generation.)

    Secondly, while it may seem strange to us in the U.S. who are indoctrinated to believe in the free market uber-alles, the mentality of countries like China is that the economy is primarily a tool to advance political goals by other means. The goal of China is to become a world power, and to prevent the perceived abuse and humiliation of their colonial era from ever happening again. Trade policies that strengthen their hand and weaken their competitors’ is not merely a byproduct, but the intended goal of their economic policy.

    Thirdly, command economies (in which capital is directed by politicians) necessarily puts political goals ahead of economic ones. Thus, it’s no surprise that the major thrust of China’s economy is in “prestige” industries that contribute to nationalistic pride such as heavy industries, massive construction and infrastructure projects, electronics, export oriented manufacturing, etc. Much of the output of China’s economy is not designed for consumption by local Chinese. Will this change? Not while the controllers of the state’s purse function in a political system which responds very well to pressure from leaders above and very little from pressure by citizens below.

    So in summary, China’s savings rate is puzzling only if you disregard China’s political environment. With a broader analysis of the economic consequences of China’s policy decisions, the savings rate becomes easily understandable.

  9. gmanedit

    Excellent comment, Lune: China wants to guard its geopolitical future, and people who have the safety net stripped away try to build a cushion.

  10. Richard

    If I may interject here to share some anecdotal experiences from my peers and I out on the west coast in the SF Bay Area. We are all 1st generation Chinese immigrants to the US, most often the children of Chinese and Taiwanese businessmen and engineers. Our parents grew up solidly middle class (enough money to immigrate but not enough vested interest to stay put). All of us have 50%+ individual savings rates.

    Why do we do it? Well, we just have to look around at the irresponsible people all over the US and how much they suffer due to failure to prepare for adverse circumstances. To us, it is unthinkable to operate without 1-2 years of buffer to guard against sudden unemployment, time spent in higher education, sudden illness, etc.

    Of course, one can’t prepare for every minute possibility, but by saving, one can avoid becoming reliant on capricious government aid policies. After all, how are we going to pay for university when we make too much to qualify for financial aid but don’t really make all that much once cost of living is factored in? Also, there is a *huge* community stigma against being dependent on gov’t aid. It basically marks you as a failure among the East Asian community.

    In addition, we’re quite pessimistic in our outlook for the future. Most of us work in finance, engineering, or health care. Engineers worry about wage arbitration and falling salaries and outsourcing in the future. Doctors worry about changes to the health system and declining salaries. Bankers worry about widespread hostility and reining in of bank bonuses as well as lacking connections that would allow them to make partner. There’s also the coming collapse of the US dollar and the US’s superpower status. When you constantly worry about your job, even if it’s in actuality quite secure, you save.

    Another reason we all save so much is that we have to plan for huge expense in the future. Housing around the Bay Area is expensive ($500K for a 2 bedroom). One also needs to amass a sizable nest egg to attract a spouse (probably a problem limited to we males) and support a family down the road. Finally, there are expenses associated with taking care of one’s parents in their old age (we don’t expect social security to be there).

    Perhaps the most important thing is that we just don’t care very much about luxury consumer goods. Aside from high-ticker items like car/home/wife and everyday grocery and utility expenses, there’s nothing in the middle that we really care about. Thus, we save (or better yet, invest in productive financial assets to guard against inflation and to hopefully replace our incomes so we can retire early!).

    This mode of thinking generally holds true for my cousins back home in China. Thus, I submit that a large portion of China’s savings rate is due to cultural reasons (lack of desire for middle-ticker items and almost paranoid fear of ever being on gov’t assistance).

  11. Pete

    Chinese people and many of american people behave very similar in regards their savings, when the time is uncertain. But the system designed by the economists usually screw all the savers anywhere in the world. Chinese inflation is running much higher than reported, and the savers don’t get much from their savings either, just like here in america. presently the time is really uncertain, people worry about their future. so they save regardless what the central bankers do.

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