China should worry about its high savings

Financial Express, 26 September 2006

A striking difference between India and China, that has been widely commented upon, is the higher Chinese savings rate. While India has total domestic savings of 28% of GDP, China is at 42% of GDP. In recent months, new insights have been uncovered about the sources of this difference, in a pair of papers ( The first paper is by Louis Kuijs of the World Bank (Beijing), and the other is by David Li of Tsinghua University.

The high Chinese savings rate has often been attributed to a sense of economic and political insecurity on the part of Chinese households. However, a careful examination of the data shows that India and China have similar household savings rates - if anything, the Indian household savings rate (22%) is higher than that seen in China (16%). Government savings in China constitute 6 percent of GDP while in India they constitute 1.5 percent of GDP. The major source of the difference between the two countries, however, is enterprise saving. In India, this is around 5% of GDP, while in China it is a full 20% of GDP. This is the most important source of the difference between the savings rate of the two countries.

Why is the enterprise saving rate in China so high? First, firms in China appear to be quite profitable, reflecting three phenomena. The simple arbitrage that has been setup with good Chinese firms, which are able to participate in global markets without trade barriers, infrastructure frictions or restrictive labour law, is an enormously profitable one. Second, many loss-making PSUs have been closed down and many PSUs have sacked workers on a large scale. Third, the share of private firms, which are more profitable than PSUs, has risen. Putting these three factors together, Chinese firms have gained profitability on an enormous scale in the last decade.

Why are Chinese firms holding so much retained earnings? The behaviour of the PSU manager in China appears to be one of empire building. The manager of the PSU tries to have a very high investment rate, so as to grow the firm, and be able to do favours and win importance within the Communist party. The prevailing dividend policy is that of never paying dividends to the government. Only a small share of Chinese companies are held by the public so there is very little pressure from the public to pay dividends.

High profits coupled with low dividend payouts has led to an enormous upsurge of fixed investment by Chinese firms. Enterprise savings have risen with the rise in profits of enterprises. As a share of value added, profits in industry rose from 11 percent in 1995 to 22 percent in 2005. Enterprise retained funds, which were roughly nothing in 1983, have risen to roughly 60% of the total fixed investment in the period from 1990 to 2004. In other words, what seems to be happening is that when SOEs make profits, they are not obliged to give them to the government and they try to invest them one way or another. So, instead of flowing back to households as income, and being partly consumed and partly saved, profits must be saved and invested by the enterprise, thus raising the savings to GDP ratio.

The most recent Regional Economic Outlook for Asia and Pacific of the IMF says that some are concerned that the saving-investment imbalance in Asia, especially China, where the national saving has risen sharply and is a major contributor to the global savings "glut". The report then goes on to discuss how household consumption in China can be increased.

But, as these two papers clearly bring out, the macroeconomic problem of high savings in China does not arise from too much savings by households but by government ownership and bad corporate governance in Chinese firms. The ownership of assets by the government rather than by the public has created a system in which investment projects that would not pass the market test of attractive returns still get undertaken by the management. This policy, when scaled up to the level of the country leads to a macroeconomic imbalance of too much savings and investment and export of capital from a poor country. The market does not play the role of allocating resources efficiently.

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