Aggregate Savings and External Imbalances in China (Digest Summary)

The author documents the trends in China’s balance of payments, including dramatic changes in its current account balance and net foreign asset position, as well as the significant buildup of foreign exchange reserves. This balance of payments imbalance is mirrored by China’s savings less the investment imbalance—that is, the X – M = S – I national accounting identity (where X is exports, M is imports, S is savings, and I is investment), which equates the current account balance with the savings–investment balance. The author believes that these imbalances are the result of government policies that encourage saving across the corporate, government, and household sectors; investing in foreign assets; and promoting exports. The government has not yet ameliorated these imbalances with policies increasing social welfare spending or encouraging domestic spending. The author suggests seven reforms to reduce the imbalances.

After China joined the World Trade Organization (WTO) in 2001, which reduced trade barriers, China recorded persistent surpluses in its current and capital accounts, producing a buildup in foreign exchange reserves. This buildup was reflected in a large savings–investment gap arising from an increased aggregate savings rate, constraints on investment growth, and limited public spending.

The aggregate savings rate is composed of the savings rates of firms, the government, and household sectors.By the late 1990s, China completed a series of economic reforms that increased the efficiency of firms. But these policies also involved the suppression of wage increases, low-interest payments on loans, and low land rentals, leading to sharply increased profits. Corporations retained a large share of these profits because the Chinese government did not ask state-owned enterprises to pay dividends until 2008. One reason private enterprises retained profits was that state-owned banks have an intrinsic bias to grant credits to state-owned enterprises. As a result, the aggregate enterprise savings rate increased.

Government savings in China rose from 3.3% of GDP in 2000 to 8.4% in 2008. The increase in tax revenues from production was the largest contributor to the higher savings rate as higher taxes and fees far outpaced the government’s increase in spending. The growth of government revenues and lag of public spending are related to the “Nation Rich, People Poor” view that is widely discussed in the public media in China.

The aggregate savings rate in the household sector also increased. It can be explained partly by a decrease in the pension-to-wage ratio—that is, workers have to save more for their retirement. The policies to control population growth have also contributed to the increase by prompting people to save more for old-age security, as opposed to relying on offspring, and to support aging parents given the limited public old-age benefits. Finally, an imbalance in the gender ratio and an incomplete transition from public to private provision of social welfare are also reasons for the rising household savings rate.

Although the investment rate climbed rapidly between 2000 and 2005 (the period immediately after China joined the WTO), the investment rate plateaued afterward. In 2005, in an effort to avoid an overheated economy, the central government imposed investment controls for a set of industries. Moreover, the state-owned banks are essentially incapable of providing effective investment loans to the growing and more-efficient private firms because of various legal and political problems.

China practices a combination of export-promoting and import-restricting policies. Policies include self-balancing regulation, which requires that foreign direct investment be oriented toward export industries. The rule states that exports must exceed 50% of the total annual output of foreign firms. Other policies, including export tax rebates, limits on certain imports, and exchange rate policy, may also contribute to the large trade surpluses.

The author documents, using government and IMF data, the trends in China’s balance of payments, including the dramatic changes in its current account balance, net foreign asset position, and foreign exchange reserves. He then proposes a unified framework for understanding the joint causes of China’s high savings rate and external imbalances.

After analyzing the causes, the author suggests that the government (1) provide credit preferences to private enterprises, (2) reduce distortions in the cost of production inputs, (3) enforce existing labor protection laws, (4) reduce import duty drawbacks and export tax rebates, (5) remove preferential policies toward export-oriented foreign direct investment in special policy zones, (6) encourage the private sector to invest abroad, and (7) review population control policies.

The Chinese government could increase spending in retirement pensions, education, and social welfare, as well as provide incentives for domestic investments. Encouraging consumption and investment could boost domestic demand and long-term productivity, eventually reducing the reliance on exports and the trade conflicts with external economies.