In the latest example of what we have dubbed “the most over-hyped theme in emerging markets,” the Carnegie Endowment’s Yukon Huang defends China’s imbalanced growth model as a natural consequence of rapid urbanization in an FT Alphavile guest post. He writes, “urbanization largely explains both the decline in labor’s share of income and the increase in savings rates, which together explain the decline in consumption as a share of GDP.” At best, this is an incomplete explanation for the shift in China’s growth model.
The charts below plot the change in urbanization against the change in national savings and private consumption as a share of GDP for 32 major emerging markets from 2000 through 2010. Directionally, Huang seems to be correct, but the relationships are very weak and China is a major outlier on both metrics. (Neither is statistically significant in a linear regression, though the sample size is probably too small. If you remove the two largest outliers from the sample, China and Kazakhstan, the fitted line flattens.)
The logic behind Huang’s argument is an extension of Arthur Lewis’s model, in which surplus labor migrates from the agricultural sector to manufacturing as an economy modernizes. Initially, labor is plentiful and capital is scarce, and capital earns higher returns than labor until the surplus is exhausted. Huang’s argument is that China is near this tipping point and that economic rebalancing will be a natural consequence of the demographic trend. Therefore, policy makers are likely to make a mistake if they target rebalancing. Instead, China should simply focus on “improve[ing] the efficiency of its urbanization process and develop more appropriate financing sources.”
However, as the charts above indicate, the rise in Chinese savings and the decline in private consumption cannot be empirically explained as a natural byproduct of urbanization-industrialization. Instead, specific policy decisions that transferred wealth from households to government-linked corporates appear to be the more likely culprit. As we’ve argued previously, negative real deposit rates, RMB undervaluation, changes in fiscal policy and weak land rights have all effectively taxed household incomes since the early 2000s. These policies better explain the decline in wages as a share of GDP than the increase urbanization. After all, consumption as a share of GDP was largely stable until 2001, even though the pace of urbanization was roughly the same in the 1990s as it was in the 2000s. These policy distortions, as well as the sharp decline in the dependency ratio that began around 1998, largely explain the increase in China’s savings rate as well.
A closer look at China’s history suggests that policy decisions are more important in determining the national savings rate and private consumption’s share of GDP. For example, between 1995 and 2000, China’s savings rate fell and consumption increased as a share of GDP. This was a period of significant financial sector liberalization, state owned enterprises were privatized and households were granted titles to their homes. However, after China’s accession to the WTO in 2001, this reform momentum weakened, and state-owned enterprises reasserted their political power throughout the next decade. National savings shot up and private consumption lagged behind the rest of the economy in the following decade, partially because of this.
Going forward, we expect China’s savings rate to fall by about 10 percentage points over the next decade as the dependency ratio rises, financial liberalization is gradually rolled out and corporate profits decline as a share of GDP. Failure to act would leave China with either a very large current account surplus or a growth model in which savings were perpetually wasted through unproductive investment. This would only be sustainable to the extent that bad debts could be hidden with even more aggressive financial repression. China’s policy makers would do well to ignore Huang’s comforting advice.
A version of this post was previously published by Roubini Global Economics on September 5.