What role does China play in the global savings glut hypothesis? - Finance Dissertation Example
What role does China play in the global savings glut hypothesis?
2.2.1 The productivity boom and investments in the US and Asia (1996–2000) 5
2.2.2 Declining savings in the US and declining investments in countries with surpluses (2001–2004) 7
2.2.3 Asset prices increase, oil prices and reserve accumulation (2005–2008) 7
2.3 Low real interest rate. 9
2.4 Domestic view of causes of global imbalance – “twin deficit” or “saving glut” from abroad.. 9
3 Global savings glut hypothesis. 12
3.1 Global saving glut in relation to long-term capital flow in neoclassical growth model, Heckscher Ohlin Model and intertemporal trade. 12
3.2 Causes of global saving glut in models of global imbalance. 16
3.2.1 Financial friction of assets shortage. 17
3.2.3 Precautionary savings. 19
4 The role of China in the savings glut hypothesis. 20
4.1 High savings rate. 20
4.1.1 corporate savings. 22
4.1.2 Household saving. 23
4.1.3 Government saving. 27
4.2 Domestic investment – financial friction.. 30
4.3 Trade policy, foreign reserve accumulation. 37
5 China’s policy to correct the imbalance.. 40
5.1 Financial development. 40
Appendix 1: Global Current Account Imbalances. 50
Appendix 2: Global Net Financial Assets Imbalances. 50
Appendix 3: Global Imbalances. 51
Appendix 4: Capital Inflow.. 51
Appendix 5: Savings and Investment trends. 52
Appendix 6: Savings and Investment in percent of World GDP. 53
Appendix 7: US Portfolio.. 54
Appendix 8: World real interest rate. 54
Appendix 9: Interquartile Ranges. 55
Appendix 10: Savings and Investment in China.. 56
Appendix 11: Household, enterprise Savings. 57
Appendix 12: Savings as percentage of GDP. 57
Table 1: Household savings in China for last 14 Years. 24
Fig 1: The household saving over the time.. 24
Fig 2: Labour compensation and divident structure distributed to houseolds (1992-2007) 25
Fig 3: Saving Rates by Income Level 1988-2007. 25
Fig 4: Household saving rates and demographcis (1988-2007) 26
Table 2: Demographics structure of the household, 1988-2007. 27
Table 3: The sources of government disposal income and saving.. 28
Fig 5: Gross National Saving Rates of China vs Major Country Groups by Income.. 29
Fig 6: Gross National Saving Rates of China vs Developed Economics. 29
Table 4: Source of funds for fixed asset investment -percentage (Source: Yang, 2012) 31
Table 5: Gross domestic investment (% of GDP) 33
Fig 7: Gross domestic investment from 1960 to 2014 (% of GDP) 34
Fig 8: Current Account Balance.. 34
Fig 9: Real Interest Rate.. 35
Fig 10: China’s trade balance over time.. 36
Fig 11: Chinese foreign direct investment.. 36
Fig 12: Exchange Ratios. 38
Table 6: Bound and applied MFN tariffs. 38
Fig 13: Foreign reserves and the difference between deposits and loans. 39
Fig 14: Interest Rate in China.. 41
Fig 15: Prime Lending rate in China.. 42
Fig 16: Banking related investment flows and capital flows. 42
Fig 17: Consumer spending in China.. 43
Fig 18: Consumer saving in China.. 43
Fig 19: Chinese foreign reserve.. 44
The economic recession and effects were not a consequence of once incident, but an integrated effect of many causes such as the global interest rate stagnation, the insecurity because of the economic stagnation, and the housing crises. In this context, based on the arguments that have been made, the key cause of the deepening economic issue was China. It was said that in the case of the Chinese growth, there was such a level of excesses in global savings and this in turn led to the situation of the interest rates being low. The low interest rates were what fueled the housing bubble situation. Therefore, according to Greenspan’s response, it was stated that China was the reason behind most of this happening and that the Fed only had control over short term rates in the United States.
Now the global savings Glut hypothesis seems to state that the economic down spiral was caused because of the savings exceeding investment. Now traditional imbalances were considered to be caused by means of difference in national level savings and the amount that was invested. Usually, there are three forms of sources for savings which are the household sector, the business sector and also the government sector. Now in order to consider that other countries’ saving is the root cause of problems, the United States’ over consuming cannot be accepted in its entirety. Now although there is some truth to the argument that the Chinese economy is a high saving economy and seems to have led to some imbalance in exports, considerations have to be made for fiat money as well. Fiat money is money that is legally tendered and might not have physical commodity to backup it. China also had a growing economy with GDP increase at 46 percent as recorded in 2009 and has attractive investment opportunities as well. Therefore, much of saving will be absorbed into these opportunities and it cannot really be said that Chinese were surplus saving. This is the basic argument made in the research work.
In 2005, Ben Bernanke, the former chairman of the United States (US) Federal Reserve firstly proposed a well-known hypothesis called the “global savings glut hypothesis” (Bernake, 2005). The hypothesis explained the ongoing, long-lasting, current account deficit and low interest rates in the US. Bernanke’s hypothesis claims that a global imbalance in trade and capital flow, which began in the late nineties, was related to the US financial crisis of 2007 that later spilled out into the rest of the world (Bernanke, Maurice Obstfeld & Rogoff, 2009), and long-term low interest rate could boost the assets bubble, along with the risk of financial system fragility and further cause the financial crisis (Bernanke, 2007). To shed light on the savings glut hypothesis and China’s role in these matters, it is important to explicitly define the global imbalance, the consequences of global imbalance, and the causes of global imbalance.
Global imbalances, often denoted as global current account (CA) imbalance, describe the countries’ persistent current account surplus or deficit (Gourinchas & Rey, 2015). When measuring current account balances, they are the fundamental account within balance of payments according to the IMF data mapper. This refers to the sum of international transactions, and it includes the trade balance of goods and services, income balance, and net unilateral transfers occurring in a country between residents and non-residents within a specific time period. That is to say, CA=Export (EX)- Import (IM) and in addition for an open economy, national income of a country can be expressed as the sum of domestic consumption(C), investment (I), government purchase (G) and net export income (EX-IM). Therefore, when A is denoted as domestic absorption, as sum of domestic consumption investment and government purchase, current account surplus can be expressed as net national income, CA=Y-A; Current account displays also change in net foreign wealth or in the other word, net international investment position; If S denoted as the national saving and for a closed economy, S=I, in a open economy, S= I+CA. Thence, in saving and investment views, current account can be understood as the difference between the national saving and investment. Thus, the current account balance of a country can be expressed in different ways according to macroeconomic aggregates using trade balances, the accumulation of foreign assets, the gap between savings and investments and income-absorption balance (Krugman, Obstfeld & Melitz, 2012, pp. 300-303).
Since 2005, the International Monetary Fund (IMF) has been discussing the global imbalance. This phenomenon existed for decades prior to becoming a hotly debated issue. Global imbalance is often understood as a current account deficit found in advanced economies; it simultaneously causes substantial capital inflow from countries with surpluses, especially emerging Asian countries and oil-exporting countries (Gourinchas & Rey, 2015). Gourinchas and Rey (2015) observed the global imbalance as stylized facts that increased from 1996 and became sustainable by 2008. Bernanke contends that China, as a country with a surplus, was a leading contributor to the US current account deficit. Based on nominal gross domestic product (GDP) data from the World Bank (2016), the US has the largest economy in the world (Source: IMF). However, over the past twenty years, the US experienced its deepest ever current account deficit starting in 2006 as 5.8% of the GDP. Conversely, China experienced a minor surplus in their current account balance prior to 1996, which dramatically increased in 2007 to reach a peak of +10% of the GDP (Source: IMF). In examining the largest international trading partners, it seems that China’s current account surplus made the US an international net importer. Whatever the case may have been, global imbalance remains a crucial issue for policy makers. This bilateral or multilateral trade and financial friction has led to heated debate among economists (Obstfeld & Rogoff, 2009).
Current account of a country as an important part of the balance of payment, reflects not only the pattern of international trade, but also national savings and investments. When countries run surpluses or deficits, it is often not considered a negative, though clear facts concerning trade and financial friction (Yu, 2007). Countries with surpluses can benefit by conducting international trade using specialized goods production and by using the comparative advantages that they obtain from trade. In the intertemporal view of current account balances, it is often efficient to trade across time in the long run. For instance, in 1990s, the emerging Asia and post war period in Germany, resulted in to deficit FDI. Under the condition that current income of a country is less than the permanent income or borrowing from foreigners. This indicates the lower cost on capital, with the consideration of consumption and saving decision, the current account imbalance would be beneficial (Obstfeld & Rogoff, 1995). For instance, trading wine and machines between two countries make the maximum utility often but not necessarily on same time, while we calculate the trade balance during a year. For countries with deficits, consumption smoothing, like buying wine in advance and trading machine later, may be advisable when a country is trapped in a state of shock, provided that this deficit is not persistent. If capital flows freely in a complete market, with the premise of taking an intertemporal approach toward current account, imbalances should expand for good reason, driving the economy growth. For instance, USA current account deficit extension from 1998 to 2001 owing to its private investment reflected its economy attractiveness (Bernanke, 2007). From the perspective of the savings and investments, when looking at the current account imbalances, there may be a good motive to extend current account imbalances. Assuming that a country has a rapidly aging workforce, their problems may be alleviated by raising the current account surplus through additional national savings. For countries with better investment environments that attract more foreign savings, a deficit may be a positive feature, as mature financial markets are attractive to foreign investors. This could be a good reason to increase imbalances because these imbalances are associated with optimal assets allocation, which increases international capital flow. In other words, the excess savings can flow into areas where investment is most desirable and where there is a low risk for returns on capital. This in turn means that these assets are portable in deeper financial markets (Blanchard & Milesi-Ferretti, 2009). However, taking a look back, soaring imbalances largely imply that domestic and systems risk exists, which leads to inefficient outcomes. For instance, Dutch disease caused domestic distortion because of the adverse impacts caused by the rapid success experienced in some sectors (Corden, 1984). Concerning systemic risk, there is a failure to make adjustments in the financial market because of investor positive demand shock (Blanchard & Milesi-Ferretti, 2009). Regarding mid-term economic development, Blanchard & Milesi-Ferretti (2009) illustrated three stages in the evolution of the imbalances. These stages existed from 1996 to 2008 and actually led to the crisis. These stages include the different factors behind the resulting imbalance.
In appendix, Figure 1 illustrates the global imbalance distribution of different groups of countries from 1996 to 2014. Taking an overview of the current account balance of the whole world from 1996 to 2008, countries with surpluses may be divided into oil-exporting countries, Japan, China, emerging Asian countries, and core European countries. Countries with a deficit include the US and countries on the periphery of Europe[1] In the first two stages, the imbalances were relatively stable and moderate. However, from 2005 to 2008, current account imbalances surged, which led to an increased number of groups with deficits and surpluses. After the global financial crisis, there was significant shrinkage and the US deficit decreased by more than half. Since then, the global current account imbalance has fluctuated mildly and declined slightly. Regarding the evolution of the imbalance between countries and how these countries interacted, the causes and consequences are all observable and shed light on the global savings glut theory, which is where the imbalance originated.
2.2.1 The productivity boom and investments in the US and Asia (1996–2000)
From 1996 to 2000, investment in America increased at a relatively fast pace as compared to the rest of the world. In particular, the foreign direct investment (FDI) and portfolio equity shares of the US current account balance grew dramatically (see Figure 5a) ((Blanchard & Milesi-Ferretti, 2009). People expected US investments to be perceived as part of a high-tech development boom in the dot-com industry. This created a sustainable boost in the world economy with the high productivity. The Asian financial crisis began in Thailand and resulted from the policy response of emerging Asian countries. In 1996, this crisis began to set the stage for the global imbalance that was experienced prior to 2000 (Bernanke, 2005). Before the crisis, Thailand had a pegged exchange rate to dollar and an open financial market. Additionally, the credit expansion had built up asset prices. Currency speculation led to an attack against the Asian vulnerable financial system. In a short period of time, because of the lack of currency reserves for the US dollar, the baht could not hold its value and began to depreciate. This depreciation spread to all of Asia except China (Maurice Obstfeld & Rogoff, 2009). After 1997, emerging Asian stock prices had fallen and relative dollar appreciation was reduced in US net foreign assets. Since current account and exchange rate adjustment reflect also the net foreign asset positions. This remained the valuation changes from exchange rate adjustment and made the capital flow reversal. Consequently, the emerging Asian markets began to run current account surpluses instead of deficits. After the Asian financial crisis, as a result of the currency depreciation and economic recession, diminished imports also helped to reverse the imbalance (Adams & Park, 2009). The economic growth of these emerging countries relied on exports, so export-led policy prevailed. After the crisis, the emerging Asian countries preferred to engage in the precautionary behavior of foreign reserve accumulation, as this was a strategy that they had learned from the economic crisis (Yu, 2007). Unfortunately, this strategy made domestic investment in Asia less attractive. Meanwhile, Japan had the largest surplus in the world with 0.3% of the world GDP. On a whole, investment tended to decrease as a result of the recession (O Blanchard & Milesi-Ferretti, 2009). During this time period, the global imbalance embodied a surging demand for investments in efficient means of production and technical progress. The capital flow reflected an optimal allocation. Countries with surpluses had excess savings that were not excessive while countries with deficits had acceptable levels of debt. Bernanke (2005) hold the view that the imbalance during this period set the stage to the global saving glut hypothesis. Financial crisis in Asia during this period declined the investment significantly, and hurt the domestic import demand.
2.2.2 Declining savings in the US and declining investments in countries
with surpluses (2001–2004)
From 2001 to 2004, the savings and investments of countries with surpluses and deficits declined. However, the driving factor was essentially different. With the dot-com bubble in the US bursting, investment remained weak and the equity investment and FDI’s share of the capital that was flowing into the US declined abruptly (see figure 1). Blanchard & Milesi-Ferretti (2009) observed that this savings decrease was the primary cause of the deficit found in many countries. The Federal Reserve reduced the funds rate gradually from 2000 to 2003 considering of adjust to the recession (Bernanke, 2010). Low interest rate encouraged people to invest in housing market. This trend increased real estate prices. People preferred to spend rather than save (Krugman et al., 2012). The deterioration of both public and private savings not only reflected the domestic imbalance, but also influenced the external balance. During this period in the US, as seen in Figure 1 and 2, the treasury and corporate bond shares of the total current account deficit were over 40% of the US GDP and 20% of these bonds accounted for financing by foreign official investors from countries with surpluses like Japan, emerging Asian countries, and oil-exporting countries (Obstfeld & Rogoff, 2009). In USA, it demanded more desired saving abroad.
2.2.3 Asset prices increase, oil prices and reserve accumulation (2005–2008)
During this period, the global imbalance led to tremendous discrepancies between countries with surpluses and deficits. The current account surpluses from central Europe and China burgeoned rapidly. O. Blanchard & Milesi-Ferretti (2009) observed that the current account surpluses in European countries remained stable and broadly balanced. The German account surplus was to some extent offset by peripheral European countries like east Europe (Blanchard & Milesi-Ferretti, 2009). Therefore, the current account balance of the US, China, and oil-exporting countries made major constitutional changes during this period. It is possible to compare the saving investment behaviors exhibited by China and oil-exporting countries. In spite of the high savings in China, domestic investment also remained high. In contrast, oil-exporting countries had rates that were under 25% of their domestic GDPs for longer than 10 years, and their savings rates increased rapidly to 40% of their GDPs. This occurred because of the oil price shock that impacted one large oil importer—the US—and increased deficits and favored the oil-exporter by increasing trade income. According to Obstfeld and Rogoff (2009) calculations, the growing deficits of advanced countries also reflected the higher costs of commodity imports. As the world deficit was growing, increases in the demand for total savings also grew. In 2007, the world annual savings rate climbed to 24.4%, and savings by oil-exporting countries and developing Asian countries dominated (See Figure 3 and 2). The financial market was also facing more “irrational exuberance” than expected (Chinn, Eichengreen, & Ito, 2011). The amount of capital flow among advanced countries grew rapidly from 2002 onward. This growth quickly formed a straight linear path, peaking at around 20% of the world GDP in 2007. Asset price inflation, especially US housing prices, increased the demand for more borrowing.
Residential investments and mortgage debt growth in the US were accompanied by the worsening quality of mortgages, and they increased to more than 1% of the US GDP. Up until 2006, securitized subprime shares and the origination of nonprime and subprime mortgages reached over 80%. The rapid development of US financial markets, financing from foreign banks, and easy lending conditions led to the real estate boom (Obstfeld & Rogoff, 2009). In addition, foreign investors made huge debt purchases of US treasury bills and corporate bonds, which served as a major source of liability for the US (Blanchard & Milesi-Ferretti, 2009). In 2008, a crisis ensued accompanied by a sudden drop in capital flow emphasized that unacknowledged in 2008 threats “typically involving hedge fund and other non-banks, impossible to track by national regulators”. This impacted the underlying equilibrium, which is very similar to the Asia crisis in late 1990s (Obstfeld & Rogoff, 2009). This financial system risk could not withstand the rapid changes in the credit market and served as a trigger for the crisis. Furthermore, the dollar served as a vehicle currency and was held by many countries as their official reserve, which added to the external liabilities faced by the US. China in particular was and remains the largest purchaser of US bonds. China had already accumulated substantial reserve assets from 1 trillion US dollar in 2006 to 3.9 trillion US dollar in 2014 (Chen, 2012).
2.3 Low real interest rate
As stylized facts besides global imbalance, many economists also concerned about he long lasting low real interest rate since worrying about “secular stagnation” (Blanchard, Furceri, & Pescatori, 2014). Because the natural real interest rate denote for the level of output expectation since late 2008, the Federal Reserve has kept the effective funds rate close to zero (Blanchard & Johnson, 2013). The US economy fell into the liquidity trap, and there was little room for conventional monetary expansion for policy maker to coordinate the economy in short run, low real interest rate. This is to say that low expectations on the future output growth could give rise to higher spending but inadequate to recovery (Blanchard & Johnson, 2013). As the figure shows that the world real interest rate was about 5% in 1980s, in 1990s average to 2% and recently down to zero. But after financial crisis in 2008 the interest rate stayed close to 0%. Not only in USA the long term yields of Treasury Note fell, but also in the other advanced countries is observed the down pressure trends of real interest rate(Blanchard et al., 2014).
2.4 Domestic view of causes of global imbalance – “twin deficit” or “saving glut” from abroad
A summary of the evolution of current account imbalances in different countries indicates that several unique, country-specific features cause these imbalances. This may have led to the deficit in the US, with the resulting policy reaction depressing interest rates globally. Below, it is analyzed the possible causes arising from domestic and external factors.
Because the US current account deficit remained substantial for decades, economists debate whether it arose from the US national saving. This drought particularly government budget balance or the “global saving glut” abroad.
In an open economy model, when we consider the government budget, a country’ s national saving comprises private and government savings. This is mainly the difference between the government’s tax revenue and expenditure:
This equation suggests that the twin deficit theory is valid. If a country runs a current account deficit, it must be a result of a joint determinant variable of private saving, investment, and government budget. If private saving related to investment stays stable, then the current account deficit will be attributable to the government budget deficit. Strong evidence of the same was observed in the US in the early 1980s. Because of tax cuts and increased military spending, the government budget deficit increased to 5% of GDP in 1986, and the US current account turned to deficit from 1982, to the extent of ~3.3% of GDP (Cavallo, 2005). M. D. Chinn & Ito (2008), found that in industrial countries, budget balance is a more essential factor in current account changes. They investigated data for industrial countries from 1971 to 2004, tested it in a model by controlling for institutional factors, and found that “1 percentage point increase in the ratio of budget balance to GDP relative to the weighted world average should lead to a 0.10 to 0.49 percentage point increase in the current account to GDP ratio.” However, “twin deficits” are often not consistent with natural facts. For instance, if the twin deficit hypothesis is valid, a reduction in the budget deficit should have narrowed the current account deficit. Nonetheless, from 2003 to 2006, the US budget deficit decreased from -5.2% to -2.6% of GDP, but the current account balance widened further from -4.7% to -6% of US GDP (Source: IMF and Whitehouse). The Ricardian equivalence suggested that the government deficit would not affect the current account, because any private saving and investment will make adjustments to neutralize government dissaving such that changes in private investment would have no effect on the current account (M. Chinn et al., 2011). However, this was proved to be critical in practice (Krugman et al., 2012). There is more empirical evidence providing loosely connection with the twin deficit hypothesis. Cavallo (2005) found that during the postwar period, when US government expenditure was dominant in non-trade services like labor cost, the budget balance showed an even weaker correlation with the current account and trade. Chinn et al. (2011) have also critiqued that the “twin deficit” hypothesis doesn’t hold always owing to its assumption that budget balance was affected by exogenous shocks, despite the reason that current account balance could be attributed to other types of shocks. Therefore, the current account deficit reflected not only in the U.S but also domestic demand on saving was inadequate for investment. This could suggest that external imbalance rather than government budget issues.
Globally, saving should equal investment. However, this balance could not be maintained in each country in a given period (Bernanke, 2005). The global saving glut hypothesis claims that the origin of this global imbalance, especially the US current account deficit, was financed by countries with a major trade surplus, such as the emerging countries in Asia and oil-exporters that have excess saving relative to domestic investment. This implies another current account approach, which is to say: in global view.
This excess saving was channeled to investments in the US, leading to large capital inflows into the US. Simultaneously, less-developed countries have a less-developed financial system; therefore, they cannot invest efficiently domestically, leading surplus countries to search for investments abroad (Bernanke, 2005). In around 2000, the US financial market was one of the most attractive investment destinations because of technological development and a mature financial system, resulting in desired investments reaching very high levels. Further, strong evidence consistent with the global saving glut hypothesis is the fact that real interest rates worldwide have shown a decreasing trend for decades (see Figure 6) (Bernanke, 2005). In around 2005, the low interest rates led to the housing bubble bust. In the US, people preferred to borrow more to invest in the housing market. Therefore, the demanded investment increased. This should have led to a rise in the real interest rate; instead, the rate continued to fall. This is indicative of the fact that, as mentioned above, the lenders came from outside the US. Based on these findings, the “global saving glut” is considered more reasonable rather than the “twin deficit” hypothesis.
3 Global savings glut hypothesis
3.1 Global saving glut in relation to long-term capital flow in neoclassical growth model, Heckscher Ohlin Model and intertemporal trade
Under the assumption of the “global saving glut” hypothesis, the main reason for the low interest rate and current account deficit in U.S. is that the trade net income in surplus countries resulting from excess saving relative to weak domestic investment caused an increase in the capital and financial account surplus in the US. That is to say, trade pattern between USA and rest of the world could give rise to the saving glut (Lucas, 1990). However, according to that the theory of international trade patterns depends on resource, the Heckscher- Ohlin Model, which predicts free trade towards of factor-price equalization. Krugman et al. (2012) share the belief for the other way around. If home country is capital abundant, then capital will tend to flow to the country where capital-labor ratio is lower. While USA is considered that its capital-labor ratio is still higher than the emerging countries, but saving glut hypothesis indicates capital flow upstream.
Heckscher-Ohlin model doesn’t explain this puzzle but if allows international borrowing and lending then in the view of intertemporal trade the countries that have intertemporal comparative advantage for specialization in production for future goods will borrow in the capital market to invest for present production. This implies that high return on capital, associated with high real interest rate (Krugman et al., 2012, p. 130). These trade pattern reflects that current account in deficit sheds light on the huge success of the emerging Asia countries in 1990. However, later since Asia crisis, many emerging Asia countries become capital exporter (Krugman et al., 2012, p. 639). Neither of the trade motive could explain the current capital flow puzzle.
Normally, according to neoclassic theory, if the two countries have the same level of technology in capital share and depreciation, then the capital flows to the country with high return on capital, namely, the one that is capital scarce such as developing countries. Under this set-up, the US is a mature advanced economy with higher capital stock level and lower marginal product of capital (Gourinchas & Rey, 2015; Lucas, 1990). Lucas (1990) approximately calculated the marginal product of capital by assuming that both countries could acquire the same technology and productivity. He compared the US with India in 1988 under the assumptions that the average capital share α is 0.4 and production per person in the US is 15 times that in India. He used the Cobb Douglas production function y = A*kα (where y and k are the income and capital per worker, respectively) and marginal product of capital r = A*α*kα-1. Then, he replaced the capital factor per person with the production output per person, that is, r = α*A1/α*y1-1/α. As a result, the marginal product of capital in India was found to be around 58 times that in the US. However, substantial net capital inflow from developing countries to USA, particularly from emerging Asia is found due to global imbalance, while the developing emerging Asia should be considered to have higher return on capital (Gourinchas & Rey, 2015). Below, the factors driving this allocation puzzle are analyzed.
Lucas’s tentative calculation is obviously unrealistic. His assumption is under the ideal consideration that two countries produce the same good, have the same relation of capital and labor input to production output, and capital flows freely internationally; he also ignored the productive difference per worker (Lucas, 1990). Lucas (1990) opined that by correcting for the human capital difference, the value would change from 58 to 5. This implies that the difference in productivity per worker is a fundamental factor that explains capital converges to high productivity, which associated with high capital-labor ratio. First, advanced rich economies provide more inputs for education and training of human capital; this induces capital flows to rich countries and, to some extent, offsets the return on physical capital (Lucas, 1990). Second, government policy and institution quality affect the return on capital through, for instance, government tax, capital control, or protection for property rights by preventing stealing of new technology that would otherwise reduce the return on capital (Alfaro, Kalemli-Ozcan, & Volosovych, 2008). Another factor affecting capital allocation is capital market imperfection. Alfaro et al. (2008) noted that although capital flows to a country with high return on capital, it does not flow to countries where the capital market has failed. Asymmetric information and sovereign risk are considered the main barriers to foreign investment in developing countries. Therefore, return on capital does not actually provide a sufficient explanation for the direction of capital flow.
Gourinchas & Rey (2015) provided a comprehensive model to predict capital flow in the neoclassical growth model under an intertemporal approach to the current account, in which the autarky interest rate determines the direction of capital flow.
According to the set-up of the model[2], first, under the assumption of a country in financial autarky in a closed economy, the Euler Equation gives the optimal saving and investment decision[3] as
where γ is the elasticity of intertemporal substitution; δk, the constant depreciation rate of capital; ρ > 0, the time preference; and α, the capital share of income (0 < α < 1). The autarky rate rta equals the marginal product of capital, which means that a household must give up a unit of consumption per capital at present to obtain the return of additional saving later. Capital always tends to flow to a country with high autarky returns (Adams, & Park, 2009). Therefore, if the capital share and depreciation is the same, the higher autarky interest rate should correspond to a low level of capital stock. Another factor influencing the autarky interest rate is productivity growth. In a steady state, capital accumulation no longer changes. Then, the consumption per capita increases in proportion with the productivity growth g. Then, in the steady state,
In a closed economy, capital scarcity and long-term productivity growth in the steady state are two important elements that determine the autarky interest rate. As explained above, capital scarce countries have a higher autarky interest rate; in the steady state, countries with higher productivity growth rate also have a higher autarky interest rate (Chen, 2012).
In an open economy, which allows trading and international borrowing and lending, the autarky real interest rate is by definition the interest rate “prevailing in an economy barred from international borrowing and lending,” (Obstfeld & Rogoff, 1995). Gourinchas & Rey (2015) derived the relation of the world’s real interest rate and autarky interest rate to a country’s long-term external position as
In the steady state, is the capital per efficient unit in relation to the world’s interest rate, where the optimal investment world interest rate equals the marginal product of capital; , the constant output of capital; , the non-capital income; , the world’s average productivity growth; g, the country’s productivity growth; and , the household initial wealth per efficient capita. Thus, the net external wealth given in the first equation is related to the world’s interest rate and country’s steady state autarky rate. Furthermore, because the current account reflects the change in net foreign claims, the second equation shows how the current account is related to the interest rate. Gourinchas & Rey (2015) summarized that if a country’s autarky interest rate in the steady state is lower than the world’s interest rate, it must be the reason for the lower productivity growth; capital then flows out of the country, and the country has a positive net foreign claim and runs a current account surplus. Thus, in the long run, capital flows to advanced countries because of their high productivity growth. However, China, as an emerging country, has shown relatively higher productivity growth, and it is nonetheless experiencing its strongest capital outflows (Gourinchas & Jeanne, 2007). Therefore, productivity growth is perhaps not the motive for capital flows in this puzzle. High productivity growth means that investment in China is high. The reason why China exhibits strong capital outflow must then be its even higher national saving rate. These large savings were not fully channeled to domestic investment; instead, they were channeled to positive net foreign claims. Bernanke (2005) explained this current account movement and capital flow as follows: excess desired saving in surplus countries with huge foreign reserves and holding large amounts of foreign assets was used to acquire large amounts of American bonds; moreover, the long term yield American bonds also reflect the world’s real interest rate, pushing down the world’s real interest rate, which is referred to as equilibrium international borrowing and lending in the external balance. Next, I explain the causes of the global saving glut in the model of global imbalance and how constraining the autarky interest rate in emerging countries relative to advanced countries lowers the world’s interest rate.
3.2 Causes of global saving glut in models of global imbalance
Bernanke opines that GSG (global saving glut) countries’ excess desired saving is the cause of global imbalance. However, from the perspective of the neoclassical model, the global imbalance accompanied by capital flow owing to inhomogeneous productivity growth does not explain China’s strong growth over the last 20 years (Chen, 2012). By observing the following models of global imbalance, the reason for the low autarky rate and, in turn, the world’s low equilibrium real interest rate could be clarified. The following sections show how models of global imbalance could explain theoretically the causes of the global saving glut and how these affect capital flows (Adams & Park, 2009).
3.2.1 Financial friction of assets shortage
Asymmetric development of the financial sector in different countries could be a fundamental reason for the global saving glut. When a country cannot raise sufficient funds for investment, the demand for investment reduces and further widens the gap between saving and investment. According to the model of asset shortages, because the emerging countries lack financial assets, they face a shortage of stores of value (Chen, 2012). Thus, the ability of the undeveloped financial system to channel future income to assets is weak (Gourinchas & Rey, 2015).
This asset short model assumes a risk-free economy with breakeven wedge rate of per unit of wealth for a life insurance company in light of the natural mortality risk, and the household future consumption preference changes to owing to mortality risk. Thus, the aggregate consumption and total wealth are given as and , respectively, where Wt is the total wealth; rt, the risk-free interest rate; and Zt, the non-financial income. In financial autarky, where capital is equal to wealth, regardless of the depreciation of capital, it is assumed that the share of non-financial income to total income is , where is the financial value rate and the capital output ratio is for constant interest rate r, and the autarky interest rate in the steady state is expressed as This implies that when a country has low financial development, it could depress the autarky interest rate. In the global economy, taking the interest rate as a weighted average to the output could also depress the world’s interest rate. Gourinchas & Rey (2015) used this model to explain how the low share of future income pledge is attributable to capital market imperfections such as taxation, property rights protection, and corruption, which are major problems in developing countries. Capital flows into the US and not to other industrial economies because the US has higher stable productivity growth and the US dollar remains the major global reserve currency.
Strong growth in emerging countries requires growing investment. However, the asymmetric development of the financial market, undeveloped capital market, and shortage of assets owing to a shortage of stores of value lead to even larger savings to invest. Furthermore, the inadequate supply of financial assets reduces the investment need, further widening the saving-investment gap (Chen & Imam, 2013). Therefore, excess savings flow to well-developed financial asset markets with high autarky interest rates.
In Bernanke’s (2005) GSG hypothesis, demographic factors also matter. He argues that population aging in mature economy also caused excess saving. Since less share of workforce and high capital-labor ratio in advanced countries, the excess saving for need of retirees flows out of country instead spend domestically due to lower return on capital in the country and Gourinchas & Rey (2015) have explained a simplified model under the condition that when the population remains constant, the possiblity of retired state is and possibility of dying is . The consumption of retirees is , because by simplifying the model, households consume when they are about to die. Thus, the accumulated wealth of workers and retirees can be expressed as
Their induction implies that wealth increases with the interest rate rt, and retirees’ wealth decreases with consumption and increases with new retirees; On the other hand, workers’ wealth increases with saving from nonfinancial income and decreases when they retire. In the steady state, wealth accumulates in proportion with productivity growth, and the autarky interest rate is determined by . (P. O. Gourinchas & Rey, 2015). This implies that the demographic factor of population aging reduces the autarky interest rate (Gourinchas & Rey, 2015). As Gourinchas and Rey (2015) showed the distribution of demographic structure in advanced countries with current account surplus for Germany and Japan, the population of retired share much higher than US, which in 2010 the retirees- workers ratio for each takes 33.4%, 38.3%, 21.8%. Thus here demographic factor plays a role for external balance for the source of excess saving from advanced economy.
3.2.3 Precautionary savings
Precautionary savings are savings that are made in anticipation of a bad state of future income, unexpected risk or uncertainty, or lack of social insurance, In such cases, a household would like to save rather than consume to overcome risk (Adams, & Park, 2009).
Gourinchas & Rey (2015) presented a Bewley model, in which a household and agents face purely idiosyncratic risks that trigger precautionary saving. When this risk can be well diversified, a country has lower idiosyncratic risk and relatively high level of financial development. In this model, the more idiosyncratic the risk, the lower is the autarky interest rate. Furthermore, in an open economy, when domestic investors face higher uninsurable risk, they demand more riskless bonds rather than investing in risky capital (Adams, & Park, 2009). This is reflected in safe cross-border flow of assets. Precautionary motivations result in financially less-developed countries having a positive foreign asset position (Chen, 2012). Excess savings flow from GSG countries to the US resulted as global demand to invest in US assets safely. In particular, the period from 2003 to 2007 saw a surge in GSG countries’ foreign holdings of US Treasury, agency debt, and mortgage-backed securities. These also pushed down real interest rates (Bernanke, Bertaut, DeMarco, & Kamin, 2011). Financial friction owing to a lack of financial assets and potential for more uninsurable risks in GSG countries prevented them from investing sufficiently in their own country; instead, they searched for safe assets in advanced countries.
The role of China in the savings glut hypothesis
The previous sections have explained that global imbalance embodies that the huge U.S. current account deficit sustained financed by the current account surplus countries since late 1990. In particular GSG countries for emerging Asia and oil exporting countries’ accumulated excess saving has flown to the U.S (Yang, 2012). Among the trade surplus countries, oil- exporter countries and Japan also played a part in the contribution of global imbalance, but Japan’s domestic saving has significantly declined since 1991(source World Bank). Thus, excluding the oil-price arising before in Bernanke (2005) has claimed that China played a leading role in the GSG hypothesis, as well as Fergusonw & Schularickz, (2007) described the capital flow between two major economy China and U.S. in the world has huge influence in the global assets market. They both hold the view that China’s excess saving has contributed to depress the global real interest rate (Bernanke, 2005). If China plays an important role in GSG theory, China’s current account surplus caused its saving- investment gap, then excess desired saving should consist with capital inflow into US and correlate to long term low interest rate. In order to find which role China has played in the GSG hypothesis, It will elaborate by summarizing the empirical findings why China exhibits such high savings rate and how this savings failed to channel to investment in the country and instead flow abroad. In addition, China’s exceptional “twin surplus”[4] of current account and capital and financial account end up with huge foreign exchange reserve has also contributed to the GSG hypothesis.
Initially, there is no doubt that currently the savings rate of China is one of highest in the world.[5] Since its large scale of economy, this high savings rate has attracted plenty of attention, particularly, China’s high saving of GDP above 35% since 1978[6] is significantly far over the world average level under 25%. Even among the GSG countries[7], China’ s saving rate has been ranked to the top for resent years (Yang, Zhang & Zhou, 2012). Ma & Yi (2010a) have compared the long-term savings rate with different country groups, China’s high saving rate also account for long-term fact and have been sustained increased like the other economy takeoffs Asia countries (Bernanke, 2005) According to the IMF world economic outlook database updated in 2016, in 1990’s China’s gross domestic saving rate was average below 41% of the gross domestic product (GDP) and from 2000 it continued increased dramatically as of 36.9% to 53% in 2008. But the Investment growth was not in pace with the saving rate and the saving investment gap was increased from 1,7% to the peak 10% of GDP. And since then the saving rate has remained to be almost stable at the level around 50%.
Chinas high savings rate could have been addressed to the rapid economy growth. In Solow model, when a country stay blow at the level of capital in steady state, the increase of savings rate will lead to higher output growth. Reversely, high output growth could also positive relate to the high saving rate in the medium-term. (Carroll & Weil, 1994). Yang (2012) find the evidence that the rapid accumulation of saving in China in early 2000s could be mainly consequence of acceleration in economic growth and their model predicted that during the same period GDP growth in China caused 11% increase of saving rate, while the real observation is 13%. Nonetheless, for long term China’s high saving rate exhibits causation of other features (Bernanke, 2005). Demographic distribution, financial constraints, precautionary motive and institutional reforms affect the nature of China’s national saving.
Therefore, as following will be presented the reasons of high saving in China based on the breakdown of components of national saving and along with the causes of GSG hypothesis and China’s policy and government regulations could have helped extend the saving-investment gap.
In general, corporate savings share of GDP fluctuated around 15% before the year 2000. In the surge of total saving rate 13% from 2000 to 2008 corporations saving share counted to 6.1% of GDP.(see figure)(Yang, 2012) Enterprise saving is equals to all the “disposable income”, when the final consumption not occur.(Ma & Yi, 2010b; Yang, 2012) Thus, enterprise savings accumulation depends on the corporations’ finance ability, profitability, the labor cost and other payments. First, state owned enterprises, which have the most market power in China,(IMF Staff, 2011) access the credit market easier than private firms and they pay less than market interest rate for the assets payments.(Ferri & Liu, 2010; Huang & Tao, 2010; Yang, 2012) Private firms, which with high productivity financed more on retained earnings, the barrier of credit loans led to saving increase.(Zheng Song, Storesletten, & Zilibotti, 2014; Yang, 2012) The wage cost reduced because the large supply of rural low-skilled labor in industry sector. (Yang, 2012) Second, the institutional reforms in state owned enterprise between 1995 and 2005, such as reducing the labor force, anticipation of dividends, modest the social welfare benefits reinforced competition with the private firms, these reforms have increased the efficiency and productivity, led to corporate profits arising. (Ma & Yi, 2010b; Yang, 2012) The largest increasing enterprise saving before 2008, to the extent owing to Chinas entry into WTO, trade policy has boost the corporate earnings through export expansion.(Yang et al., 2012) Nonetheless, corporate saving is not the major saving source of Chinas national saving, because in the compared with corporate investment, which exceeds the corporate saving much more, while the immense households excess saving is considered the major source of Chinas national saving.(see figure)
Since household saving is the largest part of China’s national saving and household spending remains stable lower than 10% of GDP before 2008, (see figure) thus, household saving behavior plays important role for China’s excess saving. As in section 3 global imbalance model mentioned that demographic factor of population aging will lower the autarky interest rate and excess saving flows out. China’s high savings rate is positively related to the population of the country (Adams, & Park, 2009). As per the given Fig -2 in appendix, the growth rate of value added per worker have increased which is contributing a lot towards household savings. The savings minus investment over GDP is given as employee share which is given in column 1 & 2, indicates that employee share is 99.64 % over GDP on a confidence level of 95% or significant at 5% level. Generally, household evolves through two distinct stages of life – work and retirement. The Chinese household saving can be interpreted form the given data
Table 1: Household savings in China for last 14 Years
Fig 1: The household saving over the time
The table and graph indicates that from year 2000 to 2013 there is huge growth in savings among Chinese population. It has increased from 28.2457% in 2000 to 38.46141% in 2013. This is clear sign to explain that household savings have increased significantly over the last few years. There are various reasons for increase in household incomes for example increase in wages, reduction in expenditure, and long retirement age etc (Bernanke, 2005). Household saving is computed as the difference between disposable income and consumption expenditures on clothing, housing services, food, entertainment, education, communication, transportation, medical care and other miscellaneous items. The household saving is determined by various factors such as age, wages, demographics, children, elderly people, spending nature and more. In the given figure below the ratio of labor compensation over added value of enterprises (LHS) and the ratio of household dividend income over added value of enterprises (RHS) is given that indicates that the LHS has decreased over time but on the other side the ratio of RHS has increased over time. This helped in raising the enterprise saving capacity (Adams, & Park, 2009).
Fig 2: Labour compensation and divident structure distributed to houseolds (1992-2007)
This is because of the increasing value of household dividend income over the added value of enterprise. This reflects that how the savings are increasing over time with increase in the household income.
Fig 3: Saving Rates by Income Level 1988-2007
The above diagram illustrates how household saving rates are depedent on the income level positively. The four lines shown in the group indicates the four level income groups. The saving rate of lowest income group (0-25%) fluctated between 5-10% in most years and ending at 7% saving in 2007. In contrast the saving rate of high income group (75-100%) started at 10% n 1988 and went up to 34% in 2007 which is 27% heigher than the lower income group (Bernanke, 2005).
Demographics is one of the important factor in defining the higher saving rate. In the below figure the various demographic structure as family with elderly and family with children have been represented. It is observed that on an average the saving in last 20 years has been increased by 21% (Adams, & Park, 2009). After late 1990’s the household saving rate with elderly experienced has increased faster than any other group. This trend is even consistent with the decline in pension income for eldely experienced.
Fig 4: Household saving rates and demographcis (1988-2007)
The below is the data taken from CHUS from 1988 to 2007 based on household size, age of household head, schooling of household head, child dependence ratio and old dependence ratio (Blanchard & Johnson, 2013).
Table 2: Demographics structure of the household, 1988-2007
The conclusion is that household saving has increased significantly over time in China due to the factors as discussed above. This household saving rate increase over time has potential impact on global savings because many students moved to other countries for higher study or job and spending there (Yu, 2007). Major global companies like Apple, Uber, Microsoft, Zara etc. have entered to Chinese market and all Chinese population is spending their savings on these foreign brands (Yu, 2007). This makes lots of sense in increase in economic GDP of foreign countries and hence contributing to global economy.
The saving rate impacts the financial stability and hence finally stabilizes the economy of that particular country with increase in per capita household income. More saving in household, provides access to all requires resources and hence improves the economic stabilization (Yongding, 2013). Over the last 30 years, China has undergone a spectacular economic transformation involving not only fast economic growth and sustained capital accumulation, but also major shifts in the sectoral composition output, increased urbanization and a growing importance of markets and entrepreneurial skills (Bernanke, 2005).
In China, the relocation of labor and capital across manufacturing firms has been key source of productivity growth. The china country has got high foreign net surplus from US $21 Billion in 1992 to US $2130 Billion (Adams, & Park, 2009).
The rate of return over investment has remained well above 20% which was higher than any industrialized and developing economics across the globe (Ferri, et al, 2010).
Table 3: The sources of government disposal income and saving
The share of government saving in GDP fluctuated at a level below 4.4 % percent during the period 1992-1999 and reached at 2.6% at the lowest level in 1999. In 2007, the saving figure climbed up to 10.8% in 2007. As per the given details above, the disposable income of Chinese government jumped from 1608.9 Billion Yuan in 1999 to 6308.4 Billion Yuan in 2007. This indicates how Chinese government has increased its saving by almost 10.8% in last 8 Years (Yu, 2007). The major contribution in the Chinese’s country saving was from the tax increase over the income or revenue. The tax increase was more than 65%.
Fig 5: Gross National Saving Rates of China vs Major Country Groups by Income
Fig 6: Gross National Saving Rates
of China vs Developed Economics
The above graphs indicate that over the period from 1978 to 2008, the China’s gross national saving increased due to increase in average income of the Chinese population and also improvement in its enterprises profit. Similarly, among all the developed economics, the china’s nationals saving rate increased to a very high level as per the world bank data (Ferri, et al, 2010). These facts and analysis indicate that the country’s saving has increased many fields over time and this has impacted a lot on the global platform (Yongding, 2013). The Chinese country has invested in various global companies or in global projects that has sparked the growth for various projects or countries around. China country has evolved as one of the most significant economics in the globe and this is becoming as one of the strongest economy over the coming time. China economy will surpass one of the strongest economy ‘United States of America’ in next few years (Yu, 2007). This shows that Chinese government’s increase in saving will evolve as world’s biggest economy in the world.
4.2 Domestic investment – financial friction
The major contribution to the saving rate in Chinese economy is because of the domestic investment in the country. Financial friction is defined as costs including commission, fee, research time, interest rate, tax implications, time value money associated with transaction, and loan origination fees (Blanchard & Johnson, 2013). A transaction’s friction cost includes all the expenses associated with any transaction (Adams, & Park, 2009).
The government has invested lots of amount in the country to improve the financial strength. The table indicates the sources of funding for fixed asset investments in the period of 1995-2007. The shares of the domestic loans remained below 21% of the total investments throughout the 1995-2007 period. The below table indicates very surprising fact that most of the investments are from self -raised funds and has largest share in total investment (Blanchard & Johnson, 2013). Self-raised funds were below 50% during 1990s to 64.8% in 2008. Due to decline in domestic loans in last decade, the enterprise investment relied mostly on self-retained earnings. This helped specially SEMs to have more saving and hence made difficulty in getting more money from Bank because of lack in required collateral for Bank to provide loan.
Table 4: Source of funds for fixed asset investment -percentage (Source: Yang, 2012)
The table also indicates that there was around 7% of the total fixed-asset investment from foreign direct investment (FDI) and State Budget. Informal and private financing channels accounted for around 13.5% of total investment as ‘fixed-asset investment’. The weak financial sector creates the incentives for enterprise saving. The gross domestic invest (now termed as Gross Capital Formation % of GDP) as per world bank is given in below table and also represented in the chart. The source of the data is from World Bank (2016).
This data recommends that for last years the gross domestic investment has raised up to 46.2% in 2014 from 15.5% in 1960 (Blanchard, O. J., Furceri, D., & Pescatori, A. 2014).
Gross Capital Formation % of GDP
Table 5: Gross domestic investment (% of GDP)
According to macro-economic theory, the supply demand curve indicates that demand refers of a product or service is desired by buyers. This implies that increase in more saving among enterprise leads to domestic investment through self-retained savings.
Fig 7: Gross domestic investment from 1960 to 2014 (% of GDP)
Bank institution interest rate and Financial Friction
The bank institutional rate for money deposit money in to bank accounts leads to increase in more saving for enterprises or individual. The current account balances in Bank is shown in the below diagram (IMF Staff, 1991). This indicates that Chinese economy has run a persistent current account surplus since early 1990s. On the other side, the long run real interest rate has been declining over the last decade. This has declined in spite of enormous efforts from central bank to raise interest rates (Adams, & Park, 2009).
Fig 8: Current Account Balance (Chen, 2012)
Fig 9: Real Interest Rate (Chen, 2012)
Both above figures indicate that current surplus has increase in the country because of high saving by enterprises but on the other side the real interest has been declined over time. This leads of less saving of enterprises through interest rate (Lucas, 1990). The lack of bank and domestic loans in the country will lead to have more surplus in bank accounts and as well as for government. The enterprises are now investing their own money than taking any loan or fund form bank or government (Chen, 2012).
Fig 10: China’s trade balance over time
The china’s trade balance indicates that after 2007-08, there was huge decline in the trade balance. This affects China’s economy as well as on global level. The china’s total import dropped by 10% globally. Less interest rate by banks has led to more saving rate individually or household level (Yu, 2007).
It is argued that global imbalance is the product of credit friction in emerging markets and this have been emerged in recent years (Adams, & Park, 2009).. The financial friction has been most important and critical factor behind both investment and economic development. The financial friction is because of the inefficiency of state manufacturing sector as well as the global imbalances (Chen, 2012).
There has been huge investment in China by cross border countries. There is more than 7% accumulation to the Chinese growth investment. The capital control and regulations of the financial system do affect the key measures of economic performance, such as productivity growth, wage growth and trade surplus (Blanchard, O. J., Furceri, D., & Pescatori, A. 2014).Largely the domestic investment is through self-retained earnings or saving whereas before 2010, there was huge FDI contribution and China also got financial debts to have high growth and investment in the country (Yongding, 2013) (Yu, 2007). The below figure indicates Chinese foreign direct investment over the last decade.
Fig 11: Chinese foreign direct investment
The late retirement age, high wages, local investment, government investment and foreign direct investment has led to increase in saving rate as discussed above. The high saving rate over the time helped Chinese population to get access to better healthcare and social life (Adams, & Park, 2009). The happy lifestyle indicator is the main indicator for Chinese growth and financial wealth over the time. This has made China as one of the top strong economics in the world. This economics has changed the global economics for more income and resources from China in various sectors like technology, manufacturing and investment (Chen, 2012).
4.3 Trade policy, foreign reserve accumulation
China transformed its dual track exchange rate system to a semi pegged regime in 1994. The exchange rate and reach exchange rate id plotted in the below diagram for RMB, USD and REER increase (Gourinchas, P.-O., & Jeanne, O. 2007). The FDI inflow or outflow in China was dependent on the exchange rate too. The exchanged rate declined over time and hence the trade policies and foreign reserve were also get affected during this time because of currency fluctuations or exchange rate (Adams, & Park, 2009).
The dotted and solid lines in Panel A plot quarterly nominal and real exchange rates between RMB and USD, respectively. The dashed line is the real effective exchange rate. We use inflation rates in China and the US to compute real exchange rates. The initial rates are normalized to 100. The dashed and solid lines in Panel B plot annual real effective exchange rate and surplus GDP ratio (%), respectively (Chen, 2012).
Before 2008 crisis the Chinese trade policies were quite different than trade and foreign policies after the crisis. There was enormous external opening in 1990s and mid 2000s with fast and strong global integration but it had high remaining barriers for example services, investment and domestic business climate obstacle. During these trade policies the bound and applied MFN tariffs are given below as per World Trade Organization report (2010).
Table 6: Bound and applied MFN tariffs
The China has imposed high tariffs on trade services during late 2000’s which resulted in high inflow in income to the country as compared to other country. China had multi track trade policy during that time (Huang, Y., & Tao, K. 2010). There was no serious medium term prospect of Asian regional integration. The china has termed stalled liberalization in its trade policies. China released more active industrial policy for SOEs and there was marginal increase protectionism (Adams, & Park, 2009). All these trade policies turned China as biggest economical country in the world after united states of America. The policies were made quite liberal for global access. Because of all these polices and reasons, the foreign reserves in china increased to a great extent. In 1992, the china foreign reserve was less than 10% but after 2006, the foreign reserve increased more than 45% (Huang, Y., & Tao, K. 2010).
Fig 13: Foreign reserves and the difference between deposits and loans
Note: The figure plots China’s foreign reserves (solid line) and the domestic bank deposits minus domestic loans (dotted line), both expressed as a percentage of GDP.
After 2004, there was huge difference between the deposits and loans in China. This means that the deposits increased and loan decreased as because of self-retained earnings increase (Gourinchas, P.-O., & Jeanne, O. 2007). These both facts as increase in foreign reserve and decrease in loans turned china as global economic magnet which attracted all the foreign companies or investors to invest in India. Given these premises, the growth in the share of credit-constrained SME during the 1980s contributed to productivity growth in Taiwan (Cavallo, M. 2005). Interestingly, the timing of reallocation coincides with the massive accumulation of foreign reserves. Chinese foreign reserve accumulates for more than 80% of T-Bill in the country (Adams, & Park, 2009).
China. The personal saving is being invested in the enterprise sector and not being deposited to the Banks and hence it is leading to depress the interest rate in China. how Chinas excess saving depress the interest rate
(Arora, Tyers, & Zhang, 2014).
5 China’s policy to correct the imbalance
Chine has introduced various policies to correct the imbalance which is created through various reasons in the country.
5.1 Financial development
In order to correct imbalance globally due to high saving in China, decline in interest rate, increase in self-retained earnings, increase in domestic sector, changes in polices, exchange rate & foreign reserve, the China government has introduced various programs for financial development (Blanchard, O. J., Furceri, D., & Pescatori, A. 2014).
China has developed various free trade zone to enhance its financial development for example Shanghai free Trade Zone (Chen, J., & Imam, P. 2013). These free trade zone were availed for global as well as Chinese companies to register the companies, licensing, and more access to Chinese economy. These free zones were created for RMB internationalization. The focus of shanghai is to become the global financial sector and the focus of Guangdong free zone province towards more a regional role, and integrating with Hongkong Chinn, M. D., & Ito, H. (2008). With help of these free zones, China has built ecosystem for importing and exporting of all goods and services. The China government has created many such free zones as per the need for internal and external.
Open RMB Assets co-operation with IMF:
In recent, China has moved significantly towards its financial development by getting approval for introducing its Yuan currency to its basket for reserve currencies (Huang, Y., & Tao, K. 2010). This introduction works as fixture in very international monetary system for financial development.
Bank lending rate and loan (Z Song, Storesletten, & Zilibotti, 2011; Zheng Song et al., 2014):
China has reduced is lending and loan rate in the country in order to take more loan and lending from government institutions, banks and state financials. The below chart explains that after 2012, the lending and loan rate has been declined to a greater extent.
Fig 14: Interest Rate in China (Source: Trending Economics, 2016)
The china’s prime lending rate is around 4.35% which is significantly lower than 12% in year 1995. This is a significant move by Chinese government to enhance its financial development as more and more lending and loan will be taken by the population or enterprises of China, the more interest will be gained by the government for its reserve (Chen, J., & Imam, P. 2013).
Fig 15: Prime Lending rate in China (Source: Trending Economics, 2016)
Capital and financial account free gradually:
Chinese private capital flows are dominated by foreign direct investment and banking related flows. The China authorities have liberalized the financial system since 1984 (Adams, & Park, 2009). The capital and financial account liberalization has led for more net income flow through direct investment, banking capital (Obstfeld, M., & Rogoff, K. 1996). The below chart indicates how the capital and financial account process have changed income flow.
Fig 16: Banking related investment flows and capital flows
In the last few years, China has gone under a huge transformation.
Consumption increase –Saving reduce:
The consumer spending in China has increased recently because of higher saving that lead to spending more.
Fig 17: Consumer spending in China (Source: Trending economics, 2016)
The above figure indicates that after 2012, the consumer spending has increased twice in last 5 years.
Fig 18: Consumer saving in China (Source: Trending Economics, 2016)
In last few years, the consumer saving in china has decreased. As from the given figure below, it is observed that after 2010 the consumer saving has declined (Alfaro et al, 2008). This indicates that consumer spending has increased and consumer saving has reduced which is correcting the imbalance globally.
In last few years there happened huge change in foreign exchange reserve. The Chinese foreign exchange reserve has reduced after 2014. All these changes are happening because of financial development in the country.
Fig 19: Chinese foreign reserve (Source: Trending Economics, 2016)
Social health care institutional progress:
The China government has introduced various healthcare reform plans in the country (Alfaro et al, 2008). China has planned to spend more than US $124 Billion in order to provide affordable healthcare for every Chinese citizen that includes establishing or updating laws related to healthcare investment, medical devices and pharmaceuticals.
The Chinese government’s economic and financial strength depends on country’s financial reserve, self-retained saving, trade and foreign policies, consumer spending, enterprise investments, foreign direct investment, and monetary policies. Based on the data analysis with respect to the Chines expenditures and savings before 2010 and after 2010 it has been identified that while the savings did increase before 2010, after the economic crises, there is much better spending impacts seen (Chen, J., & Imam, P. 2013).
It is hence recommended that there be monetary and trade policies in the country that helps the country to balance its savings and its investments. In current times, it is noted that China plans to spend on health care and infrastructural development and this would help absorb the excesses in savings and balance the glut effect.
The second recommendation made is that its financial development must be developed such that it fosters capital outflow as well as in investments in other countries. Project inflow from China to other countries is much lesser comparatively given its economy (Blanchard, O. J., Furceri, D., & Pescatori, A. 2014). Finally, countries with surplus in spending such as the United States must also attempt to balance out by improving their monetary policies so as to plan savings for a long term.
The research attempted to understand the glut hypothesis as argued for from the Chinese perspective and also from the global imbalance theoretical viewpoints. The research analyzed the productivity boom and investments in the US and Asia as opposed to the declining savings in the US and declining investments in countries with surpluses. The cause for the low interest rates is hence not born only because of the high savings done in countries such as China. In addition to the glut hypothesis, it is necessary to also understand the effect of declining savings and increasing investments.
An attempt to understand this was done by means of applying different models such as the neoclassical growth model, the Heckscher Ohlin model (Gourinchas, P.-O., & Jeanne, O. 2007) the intertemporal trade model and more. Financial friction of assets shortage, the demographics involved the precautionary savings effect on global economy and more are analyzed. In specific chapter four attempts to understand the role of China based on its high savings rate and its domestic investments and has identified that there is indeed a necessity to correct the imbalances and the country is indeed focused on increasing investments so as to absorb the excesses in savings.
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Appendix 1: Global Current Account Imbalances
Appendix 2: Global Net Financial Assets Imbalances
Appendix 3: Global Imbalances
Appendix 4: Capital Inflow
Source: (Gourinchas & Rey, 2015)
Appendix 5: Savings and Investment trends
Appendix 6: Savings and Investment in percent of World GDP
Appendix 8: World real interest rate
Notes: world-short real: ex-post 3-month real interest rate for the G-7 countries (GDP weighted). US-long real: 10 year yield on U.S. Treasuries minus 10-year expected inflation. 10-year TIPS: yield on inflation indexed 10-year Treasuries. Source: Global Financial Database, IMF International Statistics, OECD Economic Outlook, Survey of Professional Forecasters 54
Appendix 9: Interquartile Ranges
From Source: (Gourinchas & Rey, 2015)
Appendix 10: Savings and Investment in China
Appendix 11: Household, enterprise Savings
Appendix 12: Savings as percentage of GDP
Fig: 3- Household, enterprise and government saving as percentage of GDP
[1] Here periphery Europe indicates the European countries except Austria, Belgium, Denmark, Finland, Germany, Luxembourg, Netherlands, Sweden, and Switzerland.
[2] The set-up is considered under the production of one good, and the utility function is given by . The population Nt increases with n, and . The labor productivity increases with the rate g. and . See (P. O. Gourinchas & Rey, 2015) section 3.
[3] Here, the model is represented according to (Maurice Obstfeld & Rogoff, 1996). The utility of consumption is .
[4] According the balance sheet of payment, if a country runs current account surplus, it theoretically has spent its capital abroad, it should have the meanwhile a capital and financial deficit, however as many emerging Asia countries suffered from the aftermath the Asia crisis in 1990’s, China builds up its foreign exchange reserve resulting also surplus in capital and financial account. See (Yu, 2007)
[5] According to the data from World Bank, in 2014, China’ gross domestic saving rate of GDP ranked to 9th of the world, albeit the first 8 countries’ saving rate higher then China, the GDP value is much smaller than China.
[6] Data comparison from the year 1978 is because that China’s economic reform is since then taken place, gradually transition from a central-plan-economy to a market-oriented economy. see(Mcmillan & Naughton, 1992)(Yang, 2012)
[7] See figure 2 and 3, GSG countries referred to the current account surplus countries that domestic saving exceeds investment.
