time preference rate, and fiscal policy in the long run gradually approaches that of developed countries, but especially if this adjustment is delayed and successive cohorts of Chinese “continue to save like current cohorts.”<sup>12</sup> After 2050, this is reversed, so that capital will again flow from the US, EU, and Japan to China.

In contrast, Dollar and Kraay (2005), using a normative approach, suggest that China should be a significant net borrower. They investigate what net foreign asset (NFA) position China would have in 20 years or so if international capital flows, and economic behavior more generally, were in line with (i) open economy theory and/or (ii) other emerging markets. Calibrating a theoretical model of international capital flows on China data, this model would predict a NFA position of -17 percent of wealth. They also estimate non-structural cross-country regressions of NFA, in which China is always an outlier with 5 to 7 percentage points higher NFA relative to wealth than is predicted by its characteristics. They explain the difference with the actual NFA position by China’s extensive capital controls. Without these controls, China’s residents would have borrowed more from abroad. Looking ahead, it is likely that capital controls will be liberalized. This should lead to a lower, significantly negative, NFA position in the future, and negative current accounts along the way.

These 2 papers indicate the range of possible outcomes for the future path of the current account balance and capital flows, depending on several factors, including the relative speed of the decline in saving and investment and the impact of capital controls.

# **IV.2 Our analysis looking ahead**

The forward looking work in this paper consists of 2 elements. First we look at crosscountry data (over time) to find relationships for saving and investment on the one hand and “structural” variables on the other hand, in order to gauge what would happen to China’s saving and investment in the decades if China would behave like the average country. In this, we build on the existing literature. But we extend the set of variables in order to say more about the impact of structural changes on saving and investment. The key finding here is that, purely on account of projected structural developments, saving and investment decline only mildly in the decades ahead, with ambiguous impact on the net external surplus.

Second, we look at the potential effect of several policy adjustments. These adjustments are the ones identified as necessary to rebalance the composition of demand and to rebalance the pattern of growth. As elaborated below, two types of policy adjustments will tend to reduce both saving and investment. A set of reforms, largely macro economic in nature, to change the composition of demand would in addition have a significant negative impact on the saving-investment balance. A second set of reforms, largely of microeconomic nature and meant to change the pattern of growth would, through changes

> 12 In their base case, future cohorts gradually adopt Western (i.e., US) saving behavior so that the Chinese born in 2050 and thereafter have the same time preference as Americans in 2004 (the US time preference rate is assumed time-invariant). The difference between their 2 scenarios starts to kick in after 2020.

12