By Raman Ahmed, Heleen Mees
China’s monumental savings rate is a popular topic of for policy discussion.1 It has been blamed for the global financial crisis, currency wars (Portes 2010), and the ensuing Great Recession (Mees 2012). But what explains the high savings rate?
The growing body of work on this question has put forward many answers, ranging from the one-child policy to the role of marriage and the weak welfare state (see for example Horioka and Wan 2007, Wei and Zhang 2009, Chamon and Prasad 2010, Jin et al. 2010 and Ma and Yi 2010).
In recent research (Mees and Ahmed 2012), we use a dataset that is more recent and covers a longer time span (1960-2009), including the periods with the most important economic reforms, to find the determinants of the household savings rate in China. To that extent we combine Modigliani and Cao’s data with our data, and subsequently use a dummy to account for a level shift in the data for the regressions (see Figure 1). For the analysis, we make use of an error-correction model. Within this specific regression framework we include other exogenous variables next to the variables in the cointegration equation to find the effects on the savings rate. To investigate the presence of cointegration between the variables, we follow the method set out in Boswijk (1994) and use his critical values for the significance of the cointegrating factors.
We find that the main determinants of China's household savings rate are disposable income (measured by its reciprocal) and the old-age dependency rate. The coefficient of the old-age dependency rate is positive rather than negative, as the life cycle hypothesis would predict. Individuals approaching the age of 65 presumably save a higher percentage of disposable income than they did before, while the group of 65+, which are supposed to be dissavers, is still relatively small in China.2 The average income growth rate and the young-age dependency rate play a limited role in explaining the household savings rate. Our findings support the Keynesian savings hypothesis instead of Modigliani’s life cycle hypothesis, although precautionary saving motives are also important. For the full results see Mees and Ahmed (2012).
Figure 1. Modigliani-Cao savings rate and Mees-Ahmed savings rate (%)
Source: Modigliani and Cao (2004), China Compendium of Statistics 1949-2008, Statistical Yearbook 2010.
Comparing our results to previous studies
Our findings for China support the Keynesian savings hypothesis instead of the life cycle hypothesis (LCH), which is in stark contrast with Modigliani and Cao (2004). The analysis that Modigliani and Cao performed considers only the long-term effects, as they have not used an error-correction model (ECM) to account for the unit root in the level of the savings rate (S/Y). In contrast, we have implemented a single step estimation of the long-run and short-run relationships present through the use of the ECM, after establishing the presence of the cointegration relationship. This provides a more accurate analysis of how the variables actually affect the savings rate, while the measure of fit (R2) is informative about the part of the variation explained.
Chamon and Prasad (2010) also dismiss the findings of Modigliani and Cao, pointing out that in 2005 the savings curve by age group was u-shaped: younger and older generations (measured by the age of the head of household) saved a higher percentage of their income than the generations in between, while the LCH would predict a hump-shaped savings curve. This methodology is obviously flawed. After all, one has to observe the savings rate of a certain generation over its lifetime to establish what the curvature of the savings curve is, instead of comparing the savings rate of different generations at a certain point in time as Chamon and Prasad do. In 2005 average disposable income plotted over generations is also u-shaped, with the trough of the curve being the generation born in 1960 (head of household aged 45 in 2005). This 'U-shaped' income curve provides a straightforward explanation for the U-shaped savings curve that Chamon and Prasad find. It suggests that the generation born around 1960 – during the Great Leap Forward and at the onset of the Cultural Revolution – has markedly less earning capacity than preceding and following generations. We show that the household savings curve in China is neither hump-shaped nor U-shaped but positively sloped for the years under consideration (see Figure 2).
Figure 2. Savings rate of different generations (by year of birth) over time
Source: National Bureau of Statistics of China, Chamon and Prasad (2010).
We do not find evidence that China’s one-child policy is responsible for the high household savings rate as Wei and Zhang (2009) argue. The sex ratio (that is the number of men per woman in the pre-marital cohort) does not have a significant impact on the household savings rate. More notably, urban households with a daughter have a fractionally higher propensity to save than urban households with a son. This undercuts the entire premise of Wei and Zhang’s exercise, which holds that households with a son increase savings in order to improve their son’s marital status. The fact that rural households with a son have a higher propensity to save than rural households with a daughter is of little solace. The rural household savings rate is hardly indicative for the overall household savings rate in China (see Figure 3).
Figure 3. China’s household savings (in billion 1978 RMB)
Source: China Statistical Yearbook.
Although the savings rate varies significantly per income group, with the lowest income group’s savings rate in urban areas in the single digits and the highest income group’s savings rate at almost 40% of disposable income, we do not find evidence that income inequality as such is a motive for households to save a larger portion of their income, as Jin et al. (2010) have suggested. It would have been the Chinese version of ‘keeping up with the Joneses’, albeit that ‘keeping up with the Wangs’ would not have involved conspicuous consumption but rather conspicuous saving. This would have instigated higher savings rates across the board of deciles of savings rates, with the strongest effect on low-income households. However, using urban data on household savings rates and income inequality from 1985-2009, we do not find this effect present.
There is no evidence that the household savings rate in China is high because of low deposit rates, as Michael Pettis (2012) has asserted time and again, which would indicate that the income effect of lower deposit rates trumps the substitution effect of lower deposit rates. The coefficient of the deposit rate has alternating signs, but is insignificant in every single estimate.
Horioka and Wan (2007) conclude that variables relating to the age structure of the population do not have a significant impact on the household savings rate, while we find in all samples that the old-age dependency rate has an impact on the household savings rate, and in some samples the young-age dependency rate has an impact as well. A possible explanation for the difference with Horioka and Wan lies in the fact that the time span of their panel analysis is quite limited (1995-2004) and the age structure probably does not exhibit sufficient variation in such a short time interval to find relevant effects on the savings rate.
The concept of ‘forced savings’ in relation to household savings is generally understood to be (1) expansionary monetary policy to stimulate investment at the expense of higher inflation that curbs households real purchasing power, or (2) an undervalued currency that depresses households real purchasing power, or (3) the government imposing taxes on households to subsidize national industry. Since we measure household savings as a share of real disposable income (that is, after tax), forced savings can’t account for our findings.
We started this article by noting that China’s national savings rate was remarkably high by most standards. The high national savings rate reflects high savings in all three sectors – corporate, household, and government (Ma and Yi 2010). China is however not unique, as Carroll and Weil (1994) and Modigliani and Cao (2004) have pointed out before. China's trajectory over the past 30 years is actually quite similar to the experiences of – for example – Singapore and Malaysia, which also have average national savings rates of about 45% of GDP.
There are fewer data on household savings rates compared to national savings rates. Italy (1960-1970) and Japan (1971-1980) had average household savings rates of 24.5% of disposable income, while the average household savings rate in China (2000-2009) was 24.6% of disposable income. The household savings rate in India was – at 32% of disposable income in 2008 – even five percentage points higher than in China. China’s national savings rate (expressed as a percentage of GDP) is nonetheless 20 percentage points higher than India’s, due to much higher corporate savings (retained earnings) and higher government savings.
Weak corporate governance structures, with many enterprises being (formerly) state-owned enterprises, and underdeveloped financial markets are often cited as reasons why in China few dividends get distributed (Song 2010). Another reason for high corporate savings may lie in the capital controls that are still in place, because of which foreign money has to be held at the People’s Bank of China. The capital controls result in forced savings, although we suggest that these forced savings are rather the byproduct than the aim of capital controls.
Studies that treat China as a unique case of a deviation from the textbook model seem off the mark. In case a unique feature of China is used to explain China’s high household savings rate, the studies are (a) unscientific, in the sense that essentially one data point is being used, and (b) not very interesting even if true because they have no obvious applicability to any broader understanding of how the world works. China is only different than other emerging economies because its economy is vastly larger, and has received much more scrutiny because of its role in the years leading up to the 2008 financial crisis and ensuing economic recession (Mees 2012).
The fact that the conventional Keynesian saving model, which implies a long-run tendency for the savings rate to rise with income, may largely explain China’s household savings rate in the past three to five decades, is best understood against the background of China as an emerging economy. There is evidence from developed countries that when income growth slows, savings rates decline. Since the high household savings rate is in part prompted by precautionary savings motives, especially for old age, the successful implementation of credible retirement plans – as announced in The Twelfth Five-Year Plan (2011-2015) – may reduce the household savings rate. However, as many Chinese fear that their country will grow old before it grows rich, precautionary motives may continue to fuel household savings as a share of disposable income in the years to come.
Raman Ahmed is an intern at Goldman Sachs.
Heleen Mees is Adjunct Associate Professor, New York University Wagner Graduate School of Public Service; Assistant Professor in Economics, Tilburg University.
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1 Although household savings declined as a share of China’s total savings as the growth of corporate profits outpaced the growth of household income, the household savings rate nonetheless climbed robustly over the past decades, from a mere 12% in 1978 to 27% in 2009. This compares with (gross) household savings rates in OECD countries ranging from 6% to 16% of GDP (OECD 2009).
2 The age group 65+ is a very close proxy for the age group approaching 65.
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