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

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

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

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’

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

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

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

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

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