Zhou Xiaochuan: On savings ratio
Keynote address by Dr Zhou Xiaochuan, Governor of the People's Bank of China, at the
High Level Conference hosted by the Central Bank of Malaysia, Kuala Lumpur, 10 February
2009.
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There are no commonly accepted explanations for savings and consumption behaviors in the
economics and statistics community. With further transmission of the current financial crisis,
discussions on the causes to the crisis intensified. Some believe that the high savings ratio of
the East Asia and oil-producing countries is one major cause for the global imbalance and
the crisis. This paper attempts to explore the factors that affect savings ratio, and examine
the reasons behind the high savings ratios in the East Asian and oil-producing countries and
the low savings ratio in the U.S. It also provides a brief description of savings ratio in China
and the corresponding adjustment approaches, as well as a set of options for adjusting this
ratio. Major views of this paper were discussed at the High Level Conference Hosted by
Bank Negara Malaysia on February 10, 2009.
I. Factors affecting savings ratios
The term "savings" in this paper includes domestic savings, current account surplus and
foreign reserve. As of now, we have not seen sufficient and solid academic studies
illustrating the linkage between the savings ratio and determinant factors, such as the level of
wealth as measured by per capita GDP, foreign exchange rate, the development of financial
intermediation and capital market, tradition, demographic structure and social security
system. While exchange rate is statistically correlated with savings ratio to some degree, the
coefficients are generally low and the correlation usually insignificant. It therefore seems that
savings ratio can't be adjusted by simply adjusting exchange rate.
Identifying the factors determining savings ratio is a major policy challenge for all countries.
We can only come up with an effective policy tool kit after identifying determining factors for
and their impacts on the savings ratio.
II. Causes for high savings ratio in the East Asia and oil-producing countries
Tradition, cultural, family structure, and demographic structure and stage of economic
development are the major reasons for high savings ratio in the East Asia. First, the East
Asia countries are influenced by Confucianism, which value thrift, self-discipline, zhong yong
or Middle Ground (low-key), and anti-extravagancy. Second, we may be able to trace the
cultural differences from a large number of textbooks and literature of different countries. For
instance, the Latin American countries have similar levels of national wealth as the East
Asian countries but lower savings ratios. This can be attributed to the cultural differences in
the region, where people have a higher propensity of consumption and tend to quickly use up
all their salaries. Third, family tie is strong in the East Asian countries, and families shoulder
social responsibilities such as providing for the elderly and bringing up children. Fourth,
according to the Life Cycle Hypothesis by Franco Modigliani, more money is saved to meet
future pension and healthcare needs as the share of working age population increases.
When we study the phases of economic growth, in times of exceptionally high economic
growth, most of the incremental income will be saved, resulting in an unusually high savings
ratio. China fits in the above-mentioned two conditions for a high savings ratio. Japan and
the U.S. can also demonstrate the contribution of these factors in determining savings ratio.
Similar to the U.S., Japan is a developed country with high per capita income. The social
security systems in the two countries have their respective weaknesses. However, Japan's
savings ratio is much higher than that in the U.S. This can be largely ascribed to cultural,
family value and demographic feature in Japan, which are fairly similar to those in other East
Asian countries.
Some argue that an inadequate social security system leads to high savings ratio. Though
logically sound, this argument lacks adequate empirical support. Moreover, it is based on the
assumption that human behaviors are rational and people increase their savings for future
healthcare and pension needs. In fact, such an assumption does not necessarily stand.
High savings ratio in oil-producing countries has different reasons. Endowed with rich oil
resources that far exceed their normal demand, these countries naturally accumulate their
wealth in the form of savings.
The elementary textbooks on economics always start with "supply, demand and prices",
which lead the readers to believe that certain prices (e.g., exchange rate and interest rate)
can determine the behavior of savings and consumption. However, the fact is that the level of
savings ratio is influenced by a wide range of factors, and it can't be adjusted simply by
changing nominal exchange rate. Factors such as national tradition, culture, family
structures, demographics and social security system can't be changed in the short term. As a
result, it may take a long time for policies to yield intended impacts.
III. Implications of the Asian financial crisis for savings ratio in the East Asia
Savings in the GDP are composed of resident, corporate and government savings. If total
savings exceed domestic investment, the surplus will take the form of foreign reserves. To
analyze the drastic increase of imbalance of savings and trade in East Asian countries that
emerged after 1997, we need to examine the impact of the Asian financial crisis on savings
ratio in these countries.
The high savings ratio and large foreign reserves in the East Asian countries are a result of
defensive reactions against predatory speculation. During the Asian Financial Crisis, the
rampant speculations of hedge funds caused large capital inflows and subsequent reversal in
these countries, which exacerbated their economic woes. People in these countries were
shocked, and disgusted by these speculative attacks. Afterwards, many suggested that
unregulated predatory speculation caused the crisis, and appropriate international regulation
was needed. However, for various considerations, some countries were against such
regulations, and failed to see the need to adjust the regulatory frameworks. International
organizations also failed to perform their regulatory responsibilities over abnormal capital
flows, forcing the East Asian countries to amass foreign reserves to fend for themselves.
The increase of savings ratio and current account surplus in the East Asian countries is also
a result of the rescue plan designed by international organizations. The rescue plans were
silent on regulating cross-border speculative capital flows, which otherwise should have been
put under scrutiny. Instead, excessive and stringent conditionalities were imposed,
demanding that the crisis-stricken countries adopt tight fiscal and monetary policies, raise
interest rates, cut fiscal deficits and increase foreign reserves. In the decade thereafter, the
East Asian countries learnt the lessons, and increased foreign reserves and domestic
savings in order to beef up their defense against financial crisis.
Of course, there were also vulnerabilities in economic development models, foreign debt
management as well as institutional arrangements of the East Asian countries. Sweeping
structural reforms on the corporate and financial sectors were launched in the wake of the
crisis, social security systems were improved, and education and healthcare systems
reformed. However, it takes time for these efforts to take effect.
IV. Can China adjust its savings ratio effectively?
During the Asian Financial Crisis, China, as a responsible large economy, did not devalue its
currency and paid the price - a fairly slow recovery. The endeavor of the Chinese authorities
to maintain the stability of RMB against all odds contributed to stemming the spread of the
financial crisis.
After the crisis, China intensified efforts to revamp its corporate and government sectors with
the deepening of market-oriented reforms. Profitability of enterprises, especially SOEs,
increased; fiscal position improved and residents' income improved steadily. Starting 2002,
savings ratio began to surge, with steadily rising resident savings and remarkable increase of
corporate savings. China's savings ratio increased from 37.5% in 1998 to 49.9% in 2007.
During the period, the ratio of corporate sector disposable income to the national disposable
income increased from 13% to 22.5%, while the share of government disposable income to
the total increased by only 2 percentage points.
The rate of corporate savings to GDP in China is high compared with other countries in the
world. This is closely related to the unsolved distortion of cost/profit of enterprises during
China's economic transition. Under the planned economy, housing, healthcare, and pension
were provided by the enterprises and the government, and weren't accounted for in wages.
This had dampened people's incentives to save. Savings were even considered "involuntary"
as people had to regularly line up in queues at shops for consumer goods in short supply.
After the reform in the 1990s, the "iron bowl" (lifelong secure job and welfare) system was
smashed and the enterprises stopped providing pension and housing for free. However,
effective social security system had not been in place either. These significantly increased
the incentive for precautionary savings. Nevertheless, the real cost of labor takes time to be
reflected in the cost of the enterprises. As a result, the extraordinary profit from cost
distortion did not find its way to liability accounts of pension, healthcare and housing for
employees, where it should, lead to significant surge of corporate savings. This broadly
explained the increase in household and corporate savings. This is also why some people
suggested that part of the state-owned shares of listed companies should be transferred to
the national social security fund.
The Chinese authorities have a clear policy intention to reduce savings ratio. Since 2005,
boosting domestic demand and encouraging consumption have been important components
of the national economic policies. These policies would eventually bring down the savings
ratio. Yet, in-depth studies are needed to identify factors influencing the savings ratio, its
elasticity with respect to these factors, and the specific adjustment measures to take.
Besides, the incomplete reforms in some areas have affected the adjustment of savings
ratio. Although private enterprises in China are already market-driven and free of cost
distortion, the reforms of the public sector are incomplete despite considerable achievements
in reforming SOEs. The lack of clearly-defined and fully monetized cost structure hampered
the adjustment of savings ratio. It is therefore important to expedite the reform of the public
sector and the transformation of the government functions.
V. Observations on low household saving ratio in the U.S.
The U.S. household savings ratio in recent years went through two phases: before the
mid1990s, it ranged between 7-10%; after 1997, it declined remarkably with pronounced "twin
deficits", especially trade deficit. Some attributed the low savings to the so-called "euphoria"
on the U.S. economic performance since the mid-1990s. Specifically, in late 1980s and early
1990s, after the collapse of the central planning system of the former Soviet Union and
Eastern Europe, growth in those regions steadily slipped. In the 1990s, the Japanese
economy was also trapped in prolonged stagnation, and EU's economic performance was
lackluster due to structural problems including rigid labor market. The U.S., as the largest
economy, boasted the optimal economic system that was seemingly unparalleled in the
world. The only remaining challenge, in terms of economic system, came from Asia; after
1997, the Asian economies suffered heavy blows. In contrast, the US economy
demonstrated strong flexibility and resilience, and recovered rapidly from the 9/11 attack and
the burst of IT bubble in recent years. All these augmented the euphoria sentiment in the
market, which in turn influenced the saving behavior of the U.S. residents. However, the
unprecedented magnitude of the current financial crisis is expected to dramatically dampen
such euphoria sentiments.
The time series show that this round of low savings and high consumption in the US
commenced in mid-1990s. In contrast, the savings ratio of East Asian countries only surged
after the Asian financial crisis and China's savings ratios did not begin to increase until 2002.
The difference in time distribution indicates that there is no significant causal relationship
between the two.
VI. Options for adjusting saving ratio
Global savings imbalance exists for many reasons. It seems inappropriate to link savings
ratio only to exchange rate, and it is also unrealistic to resolve long-term issues in the short
run. One should, instead, adopt a broader and more comprehensive mindset in examining
the imbalance of savings.
First, a comprehensive set of prescription is needed. Although the U.S. can't sustain the
growth pattern of high consumption and low savings, it is not the right time to raise its
savings ratio at this very moment. It needs to strike a balance between stimulating
consumption and facilitating the economic recovery. On the other hand, the East Asian
nations should attend to economic growth model, economic structure, price system and the
like, in order to bring down savings ratio. Of course, reform of the exchange rate mechanism
is part of this prescription. The Chinese government has focused on boosting domestic
demand to sustain economic growth in an effort to tackle the ongoing financial crisis and
conducting economic adjustment. The RMB 4-trillion yuan stimulus package, one of the
largest in the world, is mainly an expenditure program. The program underscores public
welfare, job creation, and income growth for the rural areas and the underprivileged groups.
Second, countries and international organizations should strengthen their cooperation and
intensify the regulation of the international speculative capital flows. The current financial
crisis underscores the necessity of reinforcing the regulation over international capital flows
and enhancing their transparency. International organizations and countries concerned
should help developing countries to establish a robust early-warning system and guard
against attacks from predatory speculation. International cooperation should be strengthened
to improve the aid mechanism. In case emerging markets experience temporary BOP
difficulties, international aid should be swift, and conditionalities attached should be reduced.
This would encourage countries to lower savings including foreign reserves and expand
domestic demand.
Third, appropriate measures should be taken to channel more savings into developing
countries and emerging markets. Savings flowing from emerging markets to the advanced
economies is neither rational nor consistent with the intention of the advanced economies to
increase their domestic savings. However, the adjustment of savings ratio in the East Asian
countries will not see immediate effects. Meanwhile, savings in oil-producing countries may
remain at a high level so long as oil prices don't plunge further. Therefore, global savings
imbalance will remain for some time in the future. The top priority at present is to facilitate the
rational flow of savings and improve their allocation efficiency. One option is to redirect
surplus savings to other developing countries and emerging markets, those with abundant
resources, low labor cost, but lack of capital. These economies are the future growth engines
of the global economy.
Finally, the reform of the international monetary system should be advanced. Currently, U.S.
dollar is used in most international trade and financial transactions, and is also the most
important reserve currency. The IMF data showed that the U.S. dollar accounted for 63.9%
of the total foreign reserves by the end of 2007. When countries increase savings and if
these savings are in the form of dollar denominated foreign reserves, capital will inevitably
flow into the U.S.. In the short run, the U.S. may need more capital inflows to deal with the
financial crisis; over the long run, large capital inflows are not in its best interest of making
adjustments to its economic growth model. Moreover, the over-concentration of foreign
assets in one particular currency may bring about undesired consequences. Therefore, in
addition to upgrading regulatory cooperation and rationalizing savings allocation, the
international community should move forward in reforming the international monetary
system. Efforts should be made to strengthen the surveillance on the economic and financial
policies in major reserve currency countries and to enhance the status of the SDR, so as to
advance the international monetary system towards diversification over the long run.