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China’s High Saving Rate:A shock absorber born of inefficiency

Traditionally, the economy of the People’s Republic of China has been characterised by an administration-controlled business cycle known as “grasp” (shou) and “release” (fang). This characteristic developed as a result of suppressed financial markets under the constraints of the planned economy. Until the mid-1990s, it was still believed that administrative regulation of the business cycle continued to be a distinctive feature of China’s economy. Indeed, it is considered that the economic boom which began in the early 1990s was successfully tamed thanks to the rigorous austerity policies of the then Vice Premier, Zhu Rongji. I believe, however, that the integrity of the vice premier is not the only factor to have influenced the outcome of this economic boom; equally noteworthy is the effect of institutional changes in the macro economy, ie, the development of monetary and non-monetary financial asset markets. This development of financial markets has actually affected household decisions about consumption and saving, and stimulated the latter during this period since the 1990s.

In addition to this institutional change, the increasing uncertainty of future income prospects and the immature insurance market and social security scheme have also produced precautionary motive saving since around 1996. Increased saving has simultaneously reduced consumption, and this phenomenon, in combination with overproduction in manufacturing industries producing television sets, air conditioners, etc., has induced a recent deflationary situation in the macro economy of China. This is manifested in the negative growth of consumer price. Fortunately this development has reduced pressure to devaluate the yuan. The overproduction in the manufacturing industries is also attributable to the inefficient financial system that hindered smooth adjustment of capital allocation.

Almost 20 years have passed since China started its “open door and reform” policy in 1978. Because the reforms were necessitated by poor productivity reaching an impasse under the socialist economy’s public ownership, their focus has been on the supply side: the dissolution of collective farms, the growth of township enterprises, and, the current hot topic, the reform of state-owned enterprises (SOEs). Consequently, institutional reform in order to facilitate the effective demand control has lagged behind, with only stop-gap measures being taken. Also in the background to this is the fact that the reforms were implemented at a gradual pace so as to enable enterprises to adapt smoothly to the “shock” of being faced with the market; control of the money supply itself did not become an urgent issue. By contrast, the shock policy which was employed by Russia and other East European economies—“First, control the money supply and then liberalise prices” (1)—is premised upon a system for control of the money supply being in place. Had China attempted to use a shock policy, this prerequisite would not have been there.

It was not until the early 1990s that a reform calling for the introduction of a market-informed macro-control system emerged. In 1994, inflation, the prime indicator of an imbalance in supply and demand at the macro level, reached its highest level since the reforms started, then in 1996 it suddenly abated, stabilising at single digit growth. In addition to the government’s austerity policy, development of asset markets and the concomitant asset accumulation cannot be overlooked as factors which contributed to curbing inflation. In the following sections, I would like to outline how the development of the financial market has kept the saving rate level during the course of China’s reforms, referring specifically to the diversification of savers, and to policies in favour of household saving (ie, income sustaining policies and the promotion of housing ownership).

Changing savers, constant high saving rate

The Chinese economy has narrowly avoided serious economic collapse during its transitional process. Among a number of factors at play in China’s managing to maintain macro-economic stability with a high rate of economic growth, there is no doubt that the consistently high saving rate has played an important role as a shock absorber against the painful process of economic reform. First of all, I would like, therefore, to consider trends in the domestic saving rate. Figure 1 shows changes in the domestic saving rate (ratio of GDP less consumption to GDP) and investment rate (ratio of investment to GDP) since 1978. It also shows estimated rate values and the composition of savers and investors by sector—state, non-state, and household—as a ratio of the GNP (2). From this table, we can see that since the Open Door and Reform started, a high domestic saving rate has been maintained, and this rate has approximately mirrored the investment rate.

Figure 1 — Saving and investment rates, and main savers

Source : China statistical yearbook (Saving and investment rates), Barandiaran (1996) (structures of main savers)

Who are the contributors to this high saving rate? We can see in Figure 1 that the profile of savers changed in 1990. In the latter half of the 1980s, state sector saving slightly exceeded household saving, and investment and saving rates in the non-state sector were approximately equal. However, from 1990, household sector saving rates have consistently reached over 20% of the GNP while the proportion of state sector savings has fallen slightly. Non-state sector savings, moreover, have also started to increase since 1993. This chart shows that the main saver is shifting from the state-run sector to the household. Unfortunately, neither the extent of the oft-cited losses of state-run enterprises nor the degree to which the state finances, or central bank, are shoring up these losses, can be inferred from the information here, because the non-state sector is assumed to comprise mostly firms while the state sector includes both firms and government in the classifications used here. However, we can at least see that the main saver in the economy has diversified from the state—a single decision maker—to individual households and firms—multiple decision makers.

To gain some clue as to the distribution of the total amount of savings throughout the household, industrial, and financial sectors, I would like to look next at bank deposits and depositors (Figure 2). Up until now, the majority of savings in China have been held in the form of bank deposits. Consequently, the distribution of depositors is presumed to reflect to a certain degree the trends of savers throughout the whole economy. From the change over the four years (1978, 1986, 1991 and 1995) illustrated in Figure 2, we can see that: 1) industrial deposits are decreasing, and, filling that gap, personal deposits are increasing; 2) since 1990, deposits at other financial institutions have come into existence, and their extent is growing.

Figure 2 — Structure of depositors

Source : Almanac of China’s Finance and Banking, various issues

From the above observations, we can conclude that throughout the “open door and reform” period of China’s economy, the saving rate has been maintained at a high level, but the main saver has diversified from the state to individual households and firms. The fact that the actual savers and depositors have each evolved away from the single agent of state finance and towards multiple actors like the household and firm sectors (the latter including a high proportion of the state-owned sector, which is separate from state finance) has necessitated the growth of the financial market as an arena that links savers and investors.

Thus we come to the next question: what factors have enabled the high saving rate to be maintained in spite of the change in savers? The theories state that a high saving rate is attributable to a number of specific factors. Firstly, income growth in real terms. Normally, saving rates tend to increase following an increase in earnings. We can certainly assume that in China too, the high growth rate has been accompanied by increases in the earnings of the individual. However, in addition to this, we should consider the influence of institutional changes made under the reforms, transforming individual income from goods to cash. This monetisation of income is the second factor. Thirdly, it could also be assumed that the emergence of the financial market has contributed to the sustaining of a high rate of saving, since emergence of asset markets should raise the expected rate of income on the savings of individuals. Thus the third factor contributing to keeping the saving rate high can be assumed to be the growth of the financial market. Fourthly, increase in uncertainty would induce precautionary motive saving under the condition that the household or individual is not fully insured. Finally, the fifth factor to be considered is government policy, which can institute forced savings through, for example, provident funds or home ownership promotion. Keeping the above factors in mind, I will review the historical process of China’s reforms to explore which factors account for the high saving rate.

A history of financial reform in China

Before the reforms, the sole source of funds in the Chinese economy was state finance. Funds circulated only between the government fiscal body and state-owned enterprises. In other words, the flow of funds was enclosed within the one-dimensional body of state finance, and there was no such thing as a market for fund transactions between independent bodies. However, with the introduction, by reforms, of rural and urban-level responsibility systems, farms and firms in villages and cities became independent investors while households emerged as the main savers. This separation of investor and saver gave rise to the need for financial markets where funds are supplied from the depositors to the investors, thus supposedly guaranteeing considerable returns on the savers’ assets.

Table 1 — Overall reforms and financial market development in China

Source : Yuan Dong, an Analysis of Capital Markets in China, in Chang Qing ed., Capital Markets and Labour Markets in China, Institute of Developing Economies, March 1997.

Table 1 shows the history of China’s economic reforms since 1978, highlighting the development of the financial system. Here, I have tried to trace the flow of China’s reforms along with the trends in reforms of the banking system, bond markets, stock markets, and land and housing ownership. This flow is divided into three phases: 1978 to 1984, 1988 to 1991, and 1992 onwards. During Phase I of the reforms, from 1978 through 1984, the main objectives were the introduction of the responsibility system in rural areas and the liberalisation of foreign trade and investment. In general, this period remained strongly flavoured by the flexible application of the planned economy system, but the monetisation of farmers’ incomes progressed. This, no doubt, served to raise village sector savings. There was no effective system in place at this point in time, however, for the intermediation of savings to the investor.

In Phase II of the reforms, commencing in 1985, we see the beginning of the separation of businesses from state finance. Accordingly, a framework was established, at this time, whereby the one-dimensional circulation of funds within the state finance system could be converted to multi-dimensional fund circulation incorporating household, firm and state finance. First, the source of capital supply to state-owned businesses, hitherto the state coffers, was transformed into bank loans. Also, labour wages in urban areas were reformed to reflect the performance of workers, with the aim of providing an incentive to work hard. This led to an increase in earnings as a whole. In 1984 and 1985, the issue of corporate bonds and shares was implemented and surplus household income—savings—started to be absorbed in the form of securities. The introduction of private ownership of housing was also attempted from the beginning of the reforms as another means of intermediation that would absorb a part of household income back into the financial system. This last measure suffered several initial failures because household income levels still remained too low for the large burden of house purchase. Eventually, promotion of home ownership was introduced successfully in 1988, however, as I will describe later, and this has since also entered the fast lane. Phase II of the reforms thus saw progress in the separation of savers and investors, and in the formation of the fund and capital markets where these two kinds of actors are linked.

Following a period of adjustment lasting from 1988 through 1991, the path towards a “socialist market economy” became definitive after Deng Xiaoping’s tour of southern China in early 1992 (3). The watershed marking the conclusive break with the old system had been passed. State-owned enterprises began listing on the stock market, mergers and acquisition or bankruptcies were urged, and in the process, stocks and bonds were issued and the supply of securities assets increased. In addition, a public provident fund was introduced in Shanghai in 1991 as part of a system to encourage investment in housing. This scheme became nationwide in 1994.

To what extent has China’s accumulation of assets progressed under the processes outlined above? Table 2 shows the sizes of outstanding financial assets, (money, bonds, shares) as a ratio of the GNP. In addition to these financial assets, it would be interesting also to confirm the degree to which real estate, which hitherto had virtually no value but suddenly gained high value, has now come to be owned as an asset. Unfortunately, real estate-related data could not be included here due to lack of aggregate data for the whole nation. From the table it can be ascertained that: 1) monetary assets (M0, M1 and M2) account for by far the greatest proportion of the asset total; 2) notwithstanding point no. 1, the accumulation of non-monetary financial assets is also growing. Among these non-monetary assets, state bonds account for a considerable percentage; 3) despite the fact that stocks (4) are relative newcomers to the security markets in China, their popularity is gaining rapidly. As a result, in 1993, the total of non-monetary financial assets has reached approximately the same level as that of cash (M0). As I will explain below, this has implications for the control of inflation.

Table 2 — Accumulation of financial assets as percentage of GNP

Source : Peoples’ Bank of China, China financial statistics (1952-91), China Finance Publishing; Peoples’ Bank of China, Quarterly Bulletin, January 1997

In most economies, financial markets are expected to also fulfil another function in addition to asset management and the provision of portfolio opportunities, which have been the focus of this paper thus far. That function is liquidity supply. In market economies, the banking system is expected to provide this function, but under the planned economy in China, the function had been severely suppressed. As a result, a dysfunctional settlement system appeared in the economy. A good example of this dysfunctional settlement system is the triangular debt problem, whereby the bankruptcy of one company causes the knock-on effect of deterioration of payment abilities in other companies. In an attempt to solve this problem in China, short-term money markets were established in the mid-1980s, and the use and circulation of bills was promoted by the government.

The short-term money markets not only provided an arena for the transaction of liquidity; simultaneously, they signified the development of an infrastructure for controlling macro-economic balance. As we observed in Table 2, when the only assets in existence are monetary, instruments for controlling the money supply are very limited. In such a case, inflation cannot be controlled simply by restraint of the money market in the form of exchanging money for non-monetary assets. In China, in order to resolve the sudden economic boom of the mid to late 1980s, it was believed that throwing goods onto the market by increasing production and imports would encourage the withdrawal of the cash in circulation among the public. In the economic environment with only money and goods and an immature asset market, the volume of recycled cash on the market became an important index for the People’s Bank of China to watch (5). With the enactment in 1995 of the Central Bank Law, the People’s Bank of China has been able to begin establishing a system for control of the money supply. In 1996, the short-term money markets were unified on a national level, and open market operations were started. At the present moment, however, it would seem from the extent of savings on the market that it is the secondary market of state bonds, rather than the money market, that has become the arena for market intervention (6). Thus the two functions of the financial market, asset management and liquidity supply, are developing parallel to one another.

Income sustaining policies: stimulants of household saving

Thus, come what may, the financial system in China has managed to avoid collapse of the macro economy. To what factors can this escape be credited? I have described how a high saving rate has been maintained although the saver has changed from government to households. The next question is: why did households, the new savers, manage on their own to divert income to savings rather than simply consuming it?

The first reason must be the rise of income level in both cash and real terms. As we saw above, the reforms began with offering incentives through the responsibility system first in villages, then in towns. The wages of labourers in urban areas, for example, had previously been decided according to their rank, not job; housing, medical care and other important living expenses had been provided in kind or at a low price subsidised by the state. Payment in cash had formed only a very small part of the total wage. This system was converted to a job payment system, however, and wages began to be earned according to the particular job and the contribution of the worker. The impetus this policy gave to productivity was considerable. Meanwhile, converting to cash the proportion of income that had formerly been paid in goods (welfare, etc.) raised cash-income levels and increased the accumulation of cash savings across the economy. At the same time, savings were also increased by the rise in income in real terms caused by the growth of the economy.

Concurrent with these changes, there were also a number of other forces at work keeping household savings within the financial system. Firstly, there was the fact, already detailed above, of increased choice of asset investment afforded by the development of state bonds, shares, and other non-monetary assets. In addition, the government itself also took steps to ensure that household sector savings remained in the financial market. During the periods of economic overheating of 1988 through 1991 and 1993 through 1995, the government took the measure of applying an index-linked interest rate to all fixed-term bank deposits with a term of longer than three years. (The majority of individual savings are held in bank deposits.) The same measure was introduced in the 1990s for state bonds with a term of over three years. With regard to this measure, a researcher at the People’s Bank of China believes that by limiting interest rate adjustment for long-term time deposit savings, the individual’s inflation expectations were lowered and the high saving rate was successfully maintained (7). Indeed it is true that the measure prevented a flow of deposits out of banks and thus averted a crisis in the banking system, which was supporting the slump in state-owned enterprises. In the course of time, the inflation rate finally dropped in April 1996 and an index-linked interest adjustment scheme was cancelled.

These depositor protection policies were introduced at the same time as the austerity policies by Vice Premier Zhu Rongji. The main focus of the austerity policies was to quell overheated investment through control of bank lending, including the setting up of an administrative framework of quotas. In other words, the policies imposed a limitation on the outflow of funds from the banking system. Bank loan capital in the form of the inflow of deposits, meanwhile, was controlled by savings protection measures so that money remained in the banking system or state bonds. Thus these policies, whose aim was to bail out the banking system with its still inefficient management, induced savings and imposed regulations so that savings would stay in the banking system with lower returns than would have been the case without the policies.

It is undeniable that the growth of real and cash income, and the development of the asset market are substantial factors behind the high saving rate. However, there still remain inefficient characteristics such as massive savings in the banking sector, induced by the index-linked deposits, but with the eventual consequence of lower return due to the poor management of the banking sector.

The commodification of housing and the provident fund scheme: forced savings

Further institutional schemes have been set up to keep household savings within the formal finance systems. These were not only transitional measures to respond to short-term business fluctuations like the index-linked deposits, but also more institutionalised schemes. One such new scheme was the provident fund systems, especially for the privatisation of housing. The introduction of privatisation of housing was aimed directly at lowering the state financial burden. The first sale of public housing was attempted as early as 1978, but at that time household incomes were still too low, and the attempt eventually failed (8). Following this attempt, there was a new pilot scheme idea in 1984: the sale of housing at prices reduced to a level that people could afford. The selling prices were fixed at a level that would not even cover the compensation payable to the original inhabitants after the sale, however, so the idea was dropped again. After further study of how to implement the commodification of housing, in 1987 the towns of Yantai, Bangbu and Tangshan submitted draft plans and these became the basis of a new model idea. In 1988, the State Council promulgated the eleventh document on housing reform, and the issue took a big step forward.

In spite of minor differences among the three pilot schemes, the fundamental ideas comprised the following two points: 1) rent charged to the tenants was increased; 2) as compensation for this increase in expenditure, the government issued certificates for housing, equivalent to the amount of increased expenditure on rent. The certificates were only allowed to be used either as payment instruments for the rent, or for the purchase or building of a house. Later, along with increases in income levels, the government decided to buy back the housing certificates in exchange for the tenants giving up their subsidies on housing so far. In this settlement, the government made a payment not in cash, but by bank transfer to the account of the purchaser, with a regulation on the transfer’s cashing. Though this was directly aimed to reduce the fiscal expenditure burden, it was also expected to curb inflation and the inflation expectations of households. The exceptionally low housing expenses before the reform had been a subsidy on purchasing power, which might stimulate consumption and consequently also inflation. The government realised that promotion of home ownership would force household income to stay within the banking sector, and prevent possible inflation pressure.

In 1990, the State Council clearly indicated a policy attitude favourable to home purchase and against rental housing. In order to fulfil targets, a provident fund for housing was set up. In 1991, the Shanghai government announced policies for the introduction of a provident fund, the raising of rents, and the creation of favourable conditions for house purchase. The Beijing government also promoted house purchase by implementing similar policies. The provident fund system is modelled on Singapore’s mandatory pension scheme: a portion of a person’s salary is obligatorily saved for housing purchase. After paying the premium for a fixed period, the person can choose whether to receive the money in the form of house acquisition or a pension.

To summarise, the series of housing reforms took care of maintaining household income level. In practice, the reforms did not make payments in the form of cash or another asset available for household expenditure, but forced money to stay within the financial system in the form of certificates of state borrowing, or later, in accommodation purchase accounts. The introduction of institutionalised forced saving thus kept the saving rate from falling.

Concluding remarks

In the above sections, I have described the development processes relating to financial asset accumulation and saving rates, along with the policies aimed to promote them. In short, firstly, an increase was effected in the income of potential savers - individuals and households. This created saving incentive as predicted by the theory. Secondly, the reform caused an increase in the volume of money throughout the economy, which created the possibility of severe inflation at the same time since increased money is a stimulant to both saving and consumption. Thirdly, however, non-monetary assets—the newly promoted state bond market, stock market, and the private ownership of housing—provided means of absorbing surplus funds and thus played a substantial role in preventing severe inflation.

It is undeniable that it was the growth and development of these asset markets that assuaged the overheating of the economy and brought stability to the macro economy. These developments caused a substantial change in the macro-economic structure of China. This process can also be summarised as follows: by sustaining the increase in household incomes, the reforms succeeded in keeping funds circulating into the financial system. These effects are the outcome of China’s method of gradual reform, frequently described as “increase in flow reform”. Thus, gradual reform appears to have successfully sustained the banking system and a high rate of saving by means of income increases and the creation of compulsory savings schemes and saving-incentive schemes.

Recently, since late 1996, a fairly high saving propensity and sluggish consumption have enhanced deflationary pressures. Precautionary motive saving, due mainly to the liberalisation of the labour system, is frequently cited as one of the causes of the sluggish economy since 1996, in addition to the factors mentioned above, such as the monetisation of income and forced saving for housing, which have not been fully examined in this article. However, the precautionary motive saving explanation of the high saving rate seems convincing for the following reason. As a consequence of the progress of SOE reforms, the probability of unemployment has risen, especially in urban areas. Though it can be assumed that people in China have cash in hand as the high saving rates indicate, they might be reluctant to use up this money, as they are faced with uncertain futures. They may prefer to save the money and invest it in shares, bonds and other non-monetary financial assets. Such motives also contribute to raising the saving rate. The financial market has already achieved a certain stage of development in the sense that the people in China have some confidence in the market. However, in the sense that the financial market and the social security system have not been able to prevent precautionary motive saving, and that the process of reform may have caused anxiety, the high saving rate also indicates that the financial market and overall reform in China are still in the process of development.

Regarding the current situation of the whole financial system in China, Barandiaran points out the following factors as salient features: 1) importance being attached to the function of diverting household savings into business investment; 2) active promotion of resource mobilisation from saver to investor in preference to promotion of financial asset portfolios; 3) strong regulation by the government (9). In this article, I have focused primarily on saving, which is a source of inflow into the financial system, relevant to 1). the resource mobilisation nature of financial intermediation in China, 2) mostly through regulation, might have hindered smooth capital reallocation. In order to manipulate these problems, methods of promoting a high saving rate, such as housing certificate issue or provident funds, were devised through kinds of regulation. In other words, the inefficient financial system passed its problems on to both ends of the financial intermediation system: households, the savers, and firms, the investors. Financial reform, which is the main task of the Chinese government in 1998, is necessary in the sense that it might boost sluggish consumption, which is the reverse symptom of the high inflation of only a few years earlier, both stemming from the same root.