Why Do Chinese Households Save So Much?

♠ Posted by Emmanuel in at 6/24/2008 01:08:00 AM
I am currently revisiting the interesting paradox of rising Chinese household savings in recent years. It is indeed curious how household savings rates in the PRC have risen while consumption has dropped as a percentage of GDP. Given the improving economic fortunes of China, shouldn't more exuberant households instead be spending more, albeit not to Americanesque extremes? Chinese household savings rates are in the range of 20-25%, while American ones are in the range of, er, 0-1%. If we are interested in remedying whopping huge global economic imbalances, then finding ways of inducing more domestic Chinese demand will be part of the solution. There are various explanations offered for this pattern, including:

(1) The government does not provide as many health and education services as in the past, necessitating more savings for out-of-pocket expenses on these expenditures;
(2) China lacks a financial infrastructure that permits more to buy on credit;
(3) The Chinese, like many other Asians, are frugal by nature (the cultural explanation);

In this paper, Marcos Chamon and Easwar Prasad use Chinese survey data to come up with some preliminary fundings. The authors find (1) and (2) account for the increased savings, although (3) is harder to use as justification for increasing savings rates as opposed to just high observed savings rates. Here are a few key lines, although the entire article is well worth downloading if you are interested in either China or global economic imbalances. Here is the abstract:
From 1995 to 2005, the average urban household saving rate in China rose by 8 percentage points, to about one quarter of disposable income. We use household-level data to explain why households are postponing consumption despite rapid income growth. Tracing cohorts over time indicates a virtual absence of consumption smoothing over the life cycle. The age profile of savings has an unusual U-shaped pattern, with saving rates being the highest among the youngest and oldest households. We find that financial underdevelopment, as reflected in constraints on borrowing and low returns on financial assets, partially accounts for this pattern. Moreover, overall saving rates have increased across all demographic groups. We argue that this can be explained by the rising private burden of expenditures on housing, education, and health care.
And here is a key passage:
These various strands of evidence suggest that rising macroeconomic uncertainty, coupled with financial repression--which has resulted in the lack of instruments for borrowing against future income, limited opportunities for portfolio diversification, and low real returns on bank deposits--has driven the increase in household saving rates. The appendix provides a simple stylized model (drawing on Jappelli and Pagano, 1994) to illustrate how the interaction of rapid income growth and borrowing constraints due to financial underdevelopment can drive up saving rates.

There are other factors that may be relevant as well. The overall macroeconomic uncertainty associated with the transition to a market economy has contributed to precautionary saving motives, although we do not find strong evidence that this effect has been quantitatively important. Economic growth may affect savings through habit formation considerations (Carroll and Weil, 1994); our results, however, suggest a limited role for that channel in urban China. Finally, cultural factors are often considered an explanation for the high saving rates in many East Asian countries, including China. But they cannot account for the trend in saving rates, which is the primary focus of this paper.