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Economic Report
ER-681 June 2009
China’s Future Growth:
Savings, Investment, andIts Rebalancing Goal
By:Yingying XuEconomistyxu@mapi.net
The Alliance promotes the technological and economic progress of the United States through studies and seminars on changing economic, legal,and regulatory conditions affecting industry. Copyright © 2009 Manufacturers Alliance, All rights reserved.1600 Wilson Boulevard, Suite 1100, Arlington, Virginia 22209-2594 Phone: 703.841.9000 Fax: 703.841.9514 mapi.net
 
MAPI 1 ER-681
China’s Future Growth: Savings, Investment,
 and Its Rebalancing Goal
Introduction
 
In 2008, China celebrated the 30
th
anniversaryof its historical economic reforms. Over the pastthree decades, expanding at an average annualgrowth rate of 10 percent, China has made itselfthe second largest economy in the world, based onthe purchasing power parity (PPP) standard. Themajor driver of growth has been a significantincrease in the rate of capital accumulation in theindustrial sector, which has been fueled by therapid rise in the national savings rate. Thecontribution to growth from household consumptionhas been declining steadily to a low level not seenin any major economy in the world. Instead,exports have been a strong source of growth anddestination for the increased production from risingfixed asset investment.Only in recent years has it become more and
more obvious that China’s industry
-led, capital-intensive growth model with high savings andinvestment rates, comes at a price. Increasinglyconcerned with the negative impacts of relyingheavily on investment and exports, In 2004,
China’s top leaders f 
ormally called for a
rebalancing of the country’s sources of growth and
made one of the top priorities in its eleventh five-year plan (2006-2010) to promote householdconsumption, expand the service sector, and growat a more sustainable and equitable pattern. If thiswere to be accomplished, fixed asset investmentand (related) exports would be a lesser factor inChinese economic growth. However, despite the
government’s efforts to stimulate consumption and
constrain investment spending in recent years, theshare of savings in GDP has continued to rise,although the investment share has edged downsomewhat, leading to a widened saving-investment
gap. China’s policy initiatives have been criticized
for being too modest to change its underlyinggrowth dynamics.
China’s real economy has been hit hard by the
continued global turmoil and economic crisis,mainly through the freefall in global demand andthe resulting weakness in market-based investmentand sentiment, notably in the manufacturing sector.Therefore, boosting domestic demand anddomestic consumption is key not only for themedium-term objective of rebalancing, but also isimportant in helping to dampen the alarmingslowdown and to prop up economic growth in theshort term. International interest, especially fromchronic trade deficit nations like the United Statesand the United Kingdom
, is high in China’s
rebalancing, because one key to move sustainablegrowth in deficit countries is the ability tosupplement domestic demand from exports to highgrowth countries such as China and India.Recently, there is much talk that China should usethe crisis as a broad catalyst to accelerate the paceof reform, and there already have been somepositive changes. However, the progress of thetransition will not likely be fast and smooth, not onlybecause of the resistance from many vestedinterest groups who benefit from the old growthmodel and thus push for the status quo, but alsobecause of the complexity of tasks lying ahead.During this transitional period, multinational firms,which have made significant contributions inhelping China to produce products for the globalmarket, will need to cooperate with Chinese firms
in more creative ways to meet China’s huge and
growing domestic demand when they both arefacing a tougher business environment in China.The structure of this report is as follows. Thenext section will explain the necessity for China torebalance toward a more sustainable and equitable
economy. Then a detailed analysis of China’
s highnational savings rate will be presented. The lastsection reviews the progress that has been madeduring this transition process and gives someexplanations why China still has a long way to goto achieve its rebalancing goal.
China’s Past Econo
micGrowth Pattern
Several studies have analyzed the sources
behind China’s rapid growth and largely agree that
a significant increase in the rate of capitalaccumulation in the industrial sector has been themajor driver. As shown in Figure 1, fixed assetinvestment averaged 36 percent of GDP in the1980s before trending up quickly in the 1990s, andthe share has exceeded 42 percent since 2003.On the contrary, the contribution of domesticdemand to economic growth has been decliningsteadily, with the share of household consumptionin GDP dropping from more than 50 percent in theearly 1980s to only 35 percent in 2007, the lowestshare of any major economy in the world. Mirrored
to China’s low consumption
-to-GDP ratio is its highdomestic savings, which outpaced investmentgrowth and reached an unprecedented 50 percentof GDP in 2007. Economic theory proves themutual reinforcing relationship between savings
 
MAPI 2 ER-681
and growth, and normally argues that a rise in thesavings rate is necessary in order to finance risingdomestic investment and thus support economic
“takeoff 
.
” What has been surprising is the extent of 
the increase in both the savings and investmentrates in China, which even surpassed what itsneighbors in East Asia had experienced at thepeak of their era of rapid industrialization(Figure 2).
1
 Only in recent years has it become moreobvious that the industry-led, capital-intensivegrowth model characterized by high saving and
1
Newly Industrialized Economies (NIEs) have showna common pattern of rising saving rates during theirtake-off periods.
investment rates, comes at a price. First,with investment booming, excess capacityand overinvestment emerged in a numberof important industries.
2
The resultingoverproduction has not only driven downproduct prices and eroded industrial profitmargins, but has also made Chineseproducers more vulnerable to externalshocks as they become increasinglydependent on international markets. Takethe steel industry as an example. Chinabecame the world's largest steel maker in1996, and at the end of 2008, its excesscapacity in crude steel production reached160 million tons, exceeding the 118 millionmetric tons of annual output in Japan, thesecond largest steel producer in the world.After the global financial crisis intensifiedin September 2008, however, the averagesteel price contracted by more than 30percent, and exports dropped from 20percent of total output in August 2008 toonly 5 percent in February 2009. As aresult, annual profits in 2008 for theindustry as a whole declined by 13.7percent, while in 2007 a 45 percentincrease had been observed. Someresearchers believe that this excesscapacity has contributed at least partly to
the slowdown in China’s Total Factor 
Productivity (TFP) growth,
3
a critical factor
in explaining China’s fast growth. TFP
slowed from nearly 4 percent per annumduring the first 15 years (1978-1993) of
China’s rapid industrialization period to
only 3 percent thereafter.
4
 Second, the industry-led growth patternis particularly intensive in the use of energyand raw materials, which will not only
threaten China’s energy security but also
contribute to harming domestic and globalenvironmental sustainability and publichealth
. China’s energy consumption growth rate
 jumped from an average 3.5 percent in the 1990s
2
According to the most recent estimate from China'sindustry ministry, about 30 percent of the nation'saluminum production capacity, 20 percent of cementand plate-glass capacity, and 70 percent ofsemiconductor capacity is in idle.
3
Growth in TFP represents output growth that is notaccounted for by the growth in inputs, such as capitaland labor.
4
Jianwu He and Louis Kuijs,
“Rebalancing China’s
Economy
—
Modeling A Policy Package,
” World Bank
China Research Paper No. 6, September 2007.
30405060
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Gross National SavingsGross Capital FormationHousehold Consumption
Sources: United Nations and MAPI Calculations
Figure 1Evolvement
of China’s Domestic Savings, Investment and
Household Consumption
ER-681June 2009
Figure 2Gross Capital Formationin East Asia
Sources: United Nations and IHS Global Insight
Household ConsumptionIn East Asia
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   P  e  r  c  e  n   t  o   f   G   D   P
Hong KongSouth KoreaJapanSingapore
1020304050607080
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   P  e  r  c  e  n   t  o   f   G   D   P
Hong KongSouthKoreaSingaporeTaiwan
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