The world seems to think China is doing too much saving and not enough consuming. As a result, many are suggesting China should boost its consumption in order to reduce its dependence on external demand and achieve sustainable long-term economic growth. Otherwise, it will always need exports for growth.
The Chinese government appears convinced and has started taking aggressive action to discourage domestic savings by boosting consumer demand. However, while these policy recommendations may appear intuitive, BCA Research warns that they are both misleading and downright dangerous.
The firm’s managing editor, Chen Zhao, notes that while China’s gross national savings rate has risen from 36% of GDP in 1990 to 50% in 2007, the household savings rate has remained much more steady, ranging from 20% to 25% during the past 20 years. That puts China below even India and into the range of Israel and Malaysia.
As a result, it is incorrect to say that Chinese consumers have “over-saved and under-consumed,” Mr. Zhao tells clients.
China’s real private consumption growth has outpaced any other major country in the world over the past two decades at an average annual rate of 15.2%. Corporate savings, which currently stands at 23% of GDP, has been a key factor keeping the country’s gross savings rate at elevated levels. The government sector has also contributed a net 4% to gross savings.
“Corporate savings, in essence, are retained earnings, and the very high savings rate suggests that Chinese companies have kept a large portion of their profits at the company level,” Mr. Zhao explains.
He feels China should not begin to focus on reducing the national savings rate by encouraging domestic consumption while discouraging investment. Why? It is imprudent for a large developing nation like China.
“History has repeatedly shown that capital spending is the single most important element for a poor and rural-based economy to industrialize itself,” he said. “No developing country has ever consumed its way to economic prosperity. Quite the opposite, industrialization is all about saving and investment.”
China has outgrown all other developing nations during the past 30 years because of its high savings rate, which has allowed it to sustain a very rapid expansion of its capital stock while still maintaining a current-acount surplus, Mr. Zhao noted. As a result, policymakers both inside and outside of China should be greatful for China’s plentiful domestic savings that can be used to finance its own industrialization process.
The Latin American debt crisis of the 1980s and the Asian economic crisis in the late 1990s demonstrated showed that sustained consuption booms and capital spending binges can fail.
And while the pace of credit expansion in China is alarming, which has prompted a consensus to form that massive bubble has been inflated, it is important to note that Chinese bank loans represent certain distortions created by fiscal stimulus.
Mr. Zhao explains that one of the real challenges for steady expansion in China is the government’s tendency to adopt economic policies targeted at boosting political popularity of the ruling party, even at the expense of efficiency. For example, the introduction of minimum wage policies and the promotion of labour unions may protect workers, but they inevitably lead to economic rigidity, Mr. Zhao explains.
“Chinese authorities need to change their habit of relying on administrative measures to regulate the economy,” he said, adding that China‘s foreign exchange-rate policy is another area with many potential problems. ”Without further economic restructuring and financial-market reforms, the resilience of the Chinese economy will decrease and the ability to avoid boom-bust cycles will be reduced.”
It remains unclear whether the current government will pursue any refroms, particularly because incumbent leaders are due to step down in 2012. The incentive to maintain the status quo increases the odds of the current economic boom turning into some kind of bust in the next two or three years.
Photo: An employee counts yuan banknotes at a Bank of China branch in Changzhi, Shanxi province on January 13, 2010. China recently took its strongest step towards tightening monetary policy as the world's third-largest economy roars ahead, surprising investors with an increase in banks' required reserves that rocked global financial markets. (REUTERS/Stringer)