By Michael Baltensperger, a research assistant at Bruegel who previously worked for the Economic Research and Statistics Division of the World Trade Organization and as an external collaborator for the International Labour Organization. Originally published at Bruegel
China’s current account is projected to be balanced within the next few years. Observers disagree whether this is due to structural factors or Chinese policy. We review their assessments of the Chinese saving and investment situation and what this implies for the future.
A country’s current account balance can be seen from different perspectives. From a trade perspective, the current account balance is positive if the sum of net exports and net income from abroad is positive. The current account balance is positive also if a country saves more than what is spent on domestic investment.
The IMF’s spring edition of the World Economic Outlook projects the Chinese current account balance to be around 0.5% of GDP in 2019, enter negative territory in 2022, and stand at minus 0.2% by 2024. But during the last 15 years, the current account balance of China, the world’s manufacturing powerhouse, has been consistently positive and before the great financial crisis as high as 10% of GDP in 2007. As a result, there is a considerable debate whether and how quickly the Chinese current account will be falling below zero.
A report by Morgan Stanley, an investment bank, argues that such projections are too conservative as China’s current account will already be negative for 2019 and grow in the coming decade to reach 1.6% of GDP by 2030. The report notes that this deficit is relatively small, especially when taking into account China’s large net foreign asset position. Nevertheless, the authors conclude that China should take steps towards opening up its financial markets to foreign investors to facilitate the inflow of foreign capital, which will be needed to finance the new normal of current account deficits.
Two articles in The Economist take a closer look at the underlying forces and implications of a negative Chinese current account. The articles highlight that the negative drift in the current account is due to cyclical but also structural forces. The cyclical aspects are best seen from the trade perspective: the currently high prices of Chinese imports, for example oil and semiconductors, drag the trade balance downwards. Once these prices come down to their long-term average, China’s import bill will shrink and the current account balance will increase again. The structural shifts are best seen from the finance side as they affect Chinese saving and investment rates. While investments in China have remained at around 40% of GDP for a while, the share of domestic income that Chinese households (and some firms) save has fallen from 50 to 40% of GDP. From that perspective, the current account balances should now be close to zero.
There are several reasons for the observed decline in the (still high) Chinese savings rate according to The Economist. The first is that China is ageing: there are less young people saving for later days and more old people drawing from their savings. The second reason is that as Chinese residents are growing richer, they consume a larger share of their income. Importantly, from a trade balance perspective, consumption spending by Chinese tourists abroad (which counts as imports of goods and services) has skyrocketed since 2013. The Economist argues that current account deficits are the inevitable new normal for China given those two reasons. Very much in line with the report by Morgan Stanley, the authors conclude that “China will need to attract net capital inflows—the mirror image of a current-account deficit“, which is only possible if China opens up its capital markets to foreign investors.
Brad Setser sees the situation differently by pointing not only to the importance of savings, but also to investments. First, he disagrees that structural factors are pushing the current account into deficit. Drawing on an IMF study, Setser argues that ageing will reduce saving by a mere 6 percentage points of GDP by 2030, therefore saving rates will remain very high. Furthermore, he argues that China’s level of investment, which is one of the highest among large economies, is likely to decline as well, which then balances the current account again. What, then, has caused the observable decline in the current account so far? Setser argues that “[China has] the same level of national savings as Singapore. Singapore runs a 20% of GDP current account surplus. My guess is that without a 10% of GDP (or more) ‘augmented’ fiscal deficit, China would also run a substantial surplus.” Hence, if the Chinese government would stop directing investments to the extent it is doing currently, for example in the case it starts fiscal tightening, China’s current account would bounce back into surplus territory. In fact, he argues that “[t]he turn back toward stimulus in 2016 is the main reason, together with the partial recovery in the price of oil, why the surplus has come down in the past couple of years—not any structural change in China’s savings.”
The second point where Setser disagrees is the urge to liberalise China’s financial account. Setser argues that it is unclear whether a financial sector liberalisation would increase efficiency, since there are many implicit guarantees, and risky, under-capitalised financial institutions around. “What seems more likely is that a more open financial account would lead to a more rapid reallocation of Chinese savings out of China—e.g. more capital flight.” Therefore, a reduction of capital controls would likely lead to capital outflows, which would then put downward pressure on the renminbi. Finally, a depreciated renminbi would immediately lift the current account balance back up.
Zhang Jun evaluates the Chinese investment and saving rates from a future growth perspective. High investment rates, financed by a high domestic saving rate, have allowed for rapid growth in the last decades. However, Zhang argues that China has arrived at a point of development where it is necessary to reduce its high saving rates because investments are oversaturated. He argues, similar to Setser, that the current account balance is close to zero because of policy rather than structural factors. Due to pressure from trading partners over its large export surplus, China decided to “expand substantially its spending on investment in domestic infrastructure and housing and let the renminbi appreciate”. The higher investment rate lowered the current account balance but also reduced marginal returns on capital and total factor productivity. To avoid asset price bubbles and further deterioration of productivity, Zhang argues that Chinese saving rates have to fall, and the thus far protected service sectors should be opened to competition. Such a scenario implies a transformation of the Chinese economy from export-led growth to consumer-led growth, which is much more focused on the domestic market. Providing more consumption opportunities for the Chinese, especially domestic services, will reduce excessive saving. Zhang does not envision China opening its financial accounts, but rather envisions a purely domestic transformation of the economy.
Of course Morgan Stanley would say that. Zhang Jun sounds much wiser advocating for a purely domestic transformation of the economy. And I betcha he knows that China can float its budget and do it’s own fiscal expenditures. No need to pervert economics by asking for foreign capital while creating some bizarre austerity by scarcity in a nation the size of China. This post was very refreshing because it gave the usual Morgan Stanley pitch and then the more sensible ones.
The article confuses trade balance with current account balance. which diminishes its credibility. The current account balance consists in the trade balance in goods and services + net factor payments + unilateral transfers. Also no mention of Michael Pettis? He’s been arguing for the need to switch from investment/export led growth to domestic consumption led growth, which means reduced domestic saving to go with avoiding inefficient malinvestment, and thus a decline in growth to 3% or less to realign the factors for years now. Whether China can manage such a realignment is really the key question as to whether it will continue to prosper or go bust in a crisis.
I anticipate that the chance of capital controls being relaxed by the current Chinese regime approximates to zero.
They are smarter than that. They also have no need for FDI and are unlikely to be foolish enough to take on foreign denominated debt of any description.
China was just as clueless as everyone else and fell for the neoliberal ideology hook, line and sinker.
China has made all the classic, neoliberal mistakes.
They have inflated both real estate and stock markets with bank credit. They really got taken in by all that price discovery and stable equilibrium stuff.
Their stimulus since 2008 has gone into all the wrong places that didn’t grow GDP; the private debt soared, but GDP didn’t. It’s a classic, neoliberal mistake.
At 25.30 mins you can see the super imposed private debt-to-GDP ratios.
Japan, the UK, the US, the Euro-zone and China.
They have already learned the private debt-to-GDP ratio and inflated asset prices are indicators of financial crises.
The West’s “black swan” is a Chinese Minsky Moment.
As the Chinese understand the problem they are not going to try and cure a debt problem with more debt as we have been doing in the West since 2008. In the West, central banks dropped interest rates to the floor to squeeze more debt into our economies.
Chinese bankers had inflated the Chinese stock market with margin lending in 2015.
Set the scale to 5 years to see what happens to the Chinese stock market as their bankers inflate it with margin lending.
The wealth is there one minute and gone the next, it wasn’t real wealth. GDP measures the real wealth in the economy.
The Chinese wanted increased domestic consumption, but let housing costs soar.
It was that silly neoliberal ideology again, but they have now learnt that high housing costs eat into domestic consumption by reducing disposable income.
Disposable income = wages – (taxes + the cost of living)
Once they have sorted out the mess left behind by the neoliberal ideology they will be ready to start growing again, but it could take a while.
I don’t really think your analysis is a good one, even though I don’t really have the sources to back up my dubiousness,
China may have undergone some sort of neoliberal economic catastrophe, but also expanded social services and reduced poverty steadily and consistently throughout each of the past several five-year plans. It’s hardly the sort of neoliberal austerity that you see under smaller nations that are forced to capitulate to Western capital and with it austerity demands from the IMF.
Maybe they are going to experience some recession, but the wealth they’ve created within the country (in terms of infrastructure, greatly increased home ownership, reduced poverty etc.) *is* real wealth.
Just my two cents
Any sources you can cite regarding expansion of social services in China?
The bulk of the dramatic uplift in average living standards since 1994 seems to derive directly from China becoming the world’s workshop, and more recently from screentech (Wechat Alipay etc., yeah double edged sword of course).
It’s unclear to me though how much of that “jerbs” wealth effect trickles down to public goods and services: health clinics, city buses, wet markets, etc. Do local officials care much about that unglamorous stuff, or are they too busy with land peculation? Are company towns growing up, providing these services to workers and their dependents? and creating a 2+ tier society?
Hi speed rail, 12 lane elevated highways and dense forests of luxe towers may look good from the crumbling West right now, but they don’t do much for the typical grandma unless they (a) yield local tax revenues that (b) are spent well. In a nation of 1.2 billions there’s probably some variation, but hmm.
Morgan Stanley are just publishing their assumptions from the recent trade position of China ( call it a wet finger in the air …… a guess!) and the Economist’s journalists couldn’t find their arses with both hands.
See https://tradingeconomics.com/china/gold-reserves ……………. which are held in their current account balance which is an aggregate from consecutive trade balances. And this is what we know about. Like Russia, China has been stashing away bullion all over the globe which never finds it’s way into published figures. And who would believe their trade numbers anyway?
They’ve been practising their own version of MMT for yonks so all the salivating over a collapse of their domestic economy from a suspected trade imbalance is just a neoliberal’s wet dream. Trumps tariffs are hurting like hell, but I imagine they are more stressed about lost face than the recent trade imbalance. The West will pay eventually when China and Russia float their own version of reserve currencies with their hooks well and truly into Europe as the EU collapses under their own monetary incompetence. China is just marking time. Their into the long game unlike Western politics. Just keep digging those bunkers!
A couple of days late, but…
The US dollar is the world’s de facto currency. This requires that the US have a big trade deficit- if you want someone to request your currency, you have to make your currency available to them!
So… if China wants to push the dollar out of its catbird seat, China will have to export RMB at a steady but massive pace- they will need a negative balance of trade. I suspect this is part of the Belt&Road project- economic hegemony will sooner or later require currency hegemony.