Brett Stoughton ECON 236 Course Paper

The Negative Impact of China's High Savings Rate on its Economic Growth Outlook

This past September, the U.S. Department of the Treasury revised its 2015 GDP growth

target for China from its original 7% estimate in January down to 6.8% (15). While this small

modification is blamed on a short term reduction in China's investment activity, there is

evidence that this investment slowdown and consequently sluggish economic growth is not just \

ri ~ i~' te~ary. Economists predict that the nation's astounding average annual GDP growth of 9%

for the past 30 years (U.S. Dept. 15) is coming to an end. This slowdown may be partially", ~~ ~ I~ (...V: "('t... ();_?"" r-' .. ¡.,

caused by China's high household savings rate. [ r rs bue; I"" ~ s) ¡AI\ ò d...rd ) ,.-- ---_ Ever since capitalist reforms in 1978, the Chinese people have had a history of saving

much of their income. Contributing factors for this include their institutional voids of social

security and health care, as well as the growing issue of an aging population for the future. Since L~(I)~ ¡.: Dí:') household savings translates into how much investment is available to an economy, especially in

China's case as the government limits the private savings to mainly domestic investment

vehicles, China has had an excess supply of savings relative to the amount of investment needed.

The demand for investment is declining because of factors including a shift in the Chinese

economy towards services rather than manufacturing, the limited future growth for new housing

construction and infrastructure projects, and downward pressure on Chinese manufacturers due

to slowing export growth. The great supply of savings from households and the decelerating

demand for investment in the Chinese economy is leading to a shrinking marginal return on

investment. Smaller returns make it harder for China to maintain its historically high GDP

growth in the future.

Conventional wisdom says that a high savings rates within developing and emerging

economies is beneficial for their long run economic growth. When households save more of

their income, the domestic economy has more access to capital which also decreases the cost of

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acquiring such capital. This cheap supply of financial resources can spur greater economic

activity and increase overall output. Thus, high savings can result in high GDP growth (Lean

and Song 5). Yet in China's case, the savings rate may be so high that it is in fact hindering

growth.

Regarding China's rate specifically, Chinese households have had a history of saving ., ~r of the e¿~nomic freedom that begin in 198~ Their commitment to save much of their

income has only increased over time with a 2013 savings rate of 49 .9% of GDP. This is more

than double the global average of 22.6% and is also well above the other BRIC economies , eL.'c.._;¡... '""'-

(World Bank). While it is true that China has tremendous grOwthter the past 30 years can)

partly be attributed to its high savings rate, there is most likely a limit.

One of the main reasons why the savings rate is so high in China is because of its

institutional voids and aging population. Furthermore, the savings rate could continue to climb if

the Chinese government does not take the necessary action to meet the needs of its people. With

regards to institutional voids, the Chinese people do not have much in terms of social security

(Perkins 6). The absence of post-retirement financial provision and security from the

government motivates the Chinese to save as much as possible beforehand on their own.

Additionally, healthcare in China is expensive, and with a newly implemented but still

insufficient government- rovided health insurance program, the Chinese again need to save even

more for unexpected and long-term health needs. These two voids in China's government has

led to great precautionary saving by the Chinese, and consequently, low consumption rates.

Additionally, the Chinese will only have an even greater motivation to save in the near

future because of the aging population. Generally speaking, aging populations tend to increase

the savings rate of a nation. This is because of two reasons, especially if an aging population is

partially attributed to an increased life expectancy @, greater life expectancies ~courage

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those who currently in the labor force to save more. With a longer life span, people have to save

more than previous generations in order to provide for more years of life (Li and Zhang 199).

~reater life expectancies motivate people to continue working, even if they are old

enough to retire according to law. Because people's incomes generally rise with age due to their

accumulated work experience, having more elderly people in the workforce leads to higher

incomes devoted towards more saving. These two trends in the elderly population will increase

the aggregate savings of the nation as a whole (Li and Zhang 204). In an empirical study

analyzing the historic savings rate and the dependency ratio of China from 1978 to 2012, Li and

Zhang found that for every 1 % increase in the old-age dependency ratio, there was a 0.37%

increase in the overall savings rate (Li and Zhang 204). When the overall population of China is

only expected to age further along with the institutional voids that still exist, the savings rate of

the Chinese people are expected to remain high with the possibility of increasing even further.

The great supply of household savings is currently met with a limiri-emand for

investment. This is due to trends including a shift in composition of the Chinese economy, a

decreasing future need for new housing and infrastructure, and a slowdown in export growth.

Regarding the structure of the Chinese economy, it is becoming more services-based rather than

its historic orientation around manufacturing. In China's manufacturing-dominated past, the

government emphasized in heavy industry, such as steel, which needed large amounts of

investment. Yet, this has been changing over the past few years. As of 20 13 the services sector

makes up 50% of the economy compared to 40% by manufacturing and construction (U.S. Dept.

16). Less state intervention in the economy promoting heavy industry and the growing services

sector has resulted in declining importance for manufacturing (Perkins 11). But as services-

oriented businesses require less financial and physical capital than the manufacturing industry,

the overall need for investment in the Chinese economy as a whole is slowing down. Industries

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such as wholesaling, retailing, education, health care, and financial services are more labor-

intensive and require human capital instead (Perkins lO). - Combined with China's growing services sector, which will require less capital

investment, the demand of manufacturing for the housing industry and the nation's infrastructure

is expected to level off in the foreseeable future. Regarding the housing industry specifically,

/new construction has been a major factor in the need for Chinese investment since 2007. This is

because of the still great need for new housing construction by China's huge population due to

years of "neglect" before 1978 (Perkins 11). This need is being fulfilled through an exploding

housing construction industry since 2007, especially since real estate is one of the few

investment vehicles in which the government allows the Chinese to store their vast savings

(Perkins 16). But after a few years of the immense housing construction and the recent

considerations of the Chinese government to allow its people to invest in more types of assets,

reducing the nee'1f0ntinued fast growth in new construction. Perkins estimates that China's

demand for new housing in the future will remain between 700 million and one billion meters/

annually when new housing over the past 5 years has already been averaging 910 million rrr' (14-

16) each year. Thus, the growth rate of housing construction should level off eventually since

the supply of housing will soon surpass the demand.

Regarding infrastructure, the Chinese government has increased its already heavy

/ investment of its transportation and telecommunications networks since 2004 at a growth rate of

14.3% each year (Perkins 19). However, the Chinese's diminishing need for more infrastructure

cannot continue to justify its high investment growth for the long run. Regarding roadways for

example, one can compare China and the United States because of their similar geographical size

and corresponding miles of roadways. Yet, China has less than half as many passenger vehicles

as the United States (Perkins 18). Perkins estimates that the growth of investment for

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infrastructure will eventually fall to the growth rate of GDP due to a shrinking needs, and not

remain at 14.3% (19).

Additionally, the need for investment will continue to decline because of the slowing

export growtl:!:.. This problem for China has been exacerbated by the high household savings rate. - Since income can either be consumed for personal use or be put into savings, the Chinese by

definition have a corresponding low consumption rate. This low domestic consumption of goods

and services, mainly from the capital intensive manufacturing sector, has structured the economy

towards producing things for foreign markets as 47.1 % of China's GDP is exported (Perkins 9).

Low consumption rates in China cause an "undesirable over supply of production and services in

the market" (Lean and Song 15) which forces Chinese producers to export globally. Yet, as

China's wage rates rise and labor-intensive manufacturing is outsourced to countries with even

lower wage rates, the Chinese export sector has slowed down. Before 2008, China had an annual

export growth rate of20%. Since 2008 though, China's export growth has averaged only 6.6%.

(Perkins 7-8). The manufacturing sector's heavy reliance on exports and the corresponding

decline in export growth will reduce the future growth outlook for Chinese manufacturing in the

years to come. This will further reduce the demand in the long run for investment since the

dwindling manufacturing sector requires the most investment.

In all, the vast supply of household supplied savings and the slowing demand of

sustainable investment needed in the economy each have their own impact on future GDP

growth. However, it is essentially the intersection of these two trends that makes China's

historic growth rates unsustainable for the future. This is because where the supply level of

savings meets the demand level for investment is the interest rate in the economy. This assumes , r_/lr~

that the savings of a nation primarily stays in that said nation's economy, which is the case for '( ( l

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China since the Chinese have a limited array of mostly domestic assets in which they can put

their savings. ~~

If'" Yet, if the interest rates are low, this usually spurs economic development because the

C, f ~ conomy has access to cheap capital. So why isn't this the case in China? The reason is that

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~ -. ,..:years, such internal stimulus cannot be maintained forever. Again, the reason is that the savings ) . ,I)' 'O tL,S rate is too high. In 2014, the investment-to-GDP ratio was 46% (U.S. Dept. 15), which is less

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while the high savings rate has certainly had an impact on China's stellar growth over the past 30

than the 49.9% savings-to-GDP ratio. This has created the key issue of decreasing marginal

returns on investment because there is more savings that are being made available to an economy

that is demanding of it. Empirically, China's incremental capital output ratio, which is a measure

of how much additional capital is needed to provide an extra unit of production, has grown from

2.4 to 5.3 in just the past IO years (U.S. Dept. 15). This signals the decreasing rate of return on

investment in China or the "rising inefficiency" of investment (Perkins lO).

However, the decreasing marginal return on investment is not only caused by the sheer

amount that savings outstrips investment, but the lower total factor productivity that the large

savings are being invested into over time. Total factor productivity is the degree that output

changes in an economy separate from input changes, and it has declined from 3.8% between

1978 to 2005 to 2.1 % between 2006 and 2011 (Perkins and Rawski 852-53). Perkins estimates

that the TFP growth rate will have to stay between 3.6% and 4.9% for the foreseeable future in

order for China to match its historic GDP growth rate of 9% (27).

Total factor productivity has been decreasing and will continue to decrease because of

in China's past was attributed by the high investment in housing and transportation which

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generated great returns. Yet the impact of these high returns on China's overall GDP growth

will fall as the investment needed and the respective returns on such projects in these areas fall. ......,

econd, ,he former central planning system of China was inefficient and did not provide

the growth that the Chinese people demanded. After 1978 when capitalist economic reforms

began, GDP growth rates increased due to privatization. Because of the efficiency provided by

"private entrepreneurial leadership," China experienced "'easy' boosts in productivity (Perkins

29). After years of the privatization of many of the state-owned enterprises, there are few "easy"

boosts still left to be had. Future total factor productivity growth will have to be found

elsewhere.

"- last reason why total factor productivity should decline because of the rising wages

in China. The cost of labor has increased in China because of slowing population growth from - the previous one-child policy and the coming end of the excess labor supply provided by the

domestic migration of low-skilled rural workers to China's urban centers (Perkins 5). With

higher wages, there will be smaller productivity improvements for the overall economy in the

future as it becomes increasingly more expensive for the businesses to help transition migrants to

urban occupations of higher productivity.

Overall, the increasing inefficiency of investment caused by both the harmfully low

interest rates in the economy and China's lower total factor productivity growth will reverse the

typically beneficial impact of a high savings rate on GDP growth. Perhaps China is also

succumbing to the Neoclassical growth theory which says that an increased savings rate only

leads to a temporary boost in output (Van Der Heide); China's extensive economic growth over , oil./" • , 'Y1, .. "i· v the last 30 years from the high savings rate is slowly coming to an end.

Nevertheless, China's GDP growth still has a bright future. There are actionable items

that the Chinese government can implement in order to both decrease the savings rate and

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increase the demand for investment in sustainable ways. Regarding the savings rate, it has

already been discussed that China's institutional voids of socia~rity and health care have

motivated the Chinese to save a large proportion of the income. China's government can reduce

the people's precautionary saving motive through expanding and improving its current health

care system as well as providing more financial security so that the Chinese people consume - more of their income instead.

Additionally, the Chinese government can redirect its public investment on needs other

than housing and transportation. Altneratively, more should be done towards environmental

sustainability. Specifically, China has major water shortages in its southeastern urban centers - and northeastern industrial areas. While China has not publicized how much money they have

spent on water conservation, their largest water project to date was over $70 billion as they

redirected water from the Yangtze River to the north (Perkins 21). Continued investment in

future water projects are needed to meet the growing water shortages of the country.

Moreover, China can also invest more heavily in greener energy sources. The issue of air

pollution in China's major cities is well-publicized. Because more efficient energy sources

require a large amount of initial investment (Perkins 22), China can redirect the large amount of

household-provided savings toward environmental sustainability for both its water projects and

pollution-reducing initiatives. Yet, while environmental investment may not translate directly

into as high GDP growth as housing construction, it will enable China to "fully employ its

resources" for the future (Perkins 22).

By improving China's institutions to decrease the supply of savings and redirecting its

focus on the environment to increase the demand for investment, China can raise its interest rates

to slow its decreasing marginal return on investment in an effort to maintain its high GDP

growth.

Works Cited

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/" "Gross savings (% ofGDP)." The World Bank. The World Bank Group, 2015. Web. 27 Nov.

2015.

Lean, Hooi Hooi, and Yingzhe Song. "The Domestic Savings and Economic Growth ,,---'

Relationship in China." Journal of Chinese Economic and Foreign Trade Studies 2.1

(2009): 5-17. ProQuest. Web. 26 Nov. 2015.

Li, Haiming, and Xiuli Zhang. "Population Aging and Economic Growth: The Chinese

Experience of Solow Model." International Journal of Economics and Finance 7.3

(2015): 199-206. ProQuest. Web. 1 Nov. 2015.

Perkins, Dwight H. "Understanding the Slowing Growth Rate of the People's Republic of

China." Asian Development Review 32.1 (2015): 1-30. ProQuest. Web. 1 Nov. 2015.

Perkins, Dwight, and Thomas Rawski. "Forecasting China's Economic Growth to 2025."

China's Great Economic Transformation (2008): 829-86. China Economic Education

and Research Network. Web. 28 Nov. 2015.

U.S. Department of the Treasury. "Report to Congress on International Economic and Exchange

Rate Policies." Semiannual Report on International Economic and Exchange Rate

Policies, October 2015. Web. 2 Nov. 2015.

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