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Andrew Batson recently pushed back a bit against my attempt to frame one of China’s core macroeconomic problems as “too much savings.” He argues that policies to bring down savings have been tried in China – spending on social insurance rose in the ‘aughts – and it didn’t bring down national savings:
“the hypothesis that stingy social welfare policies are the main culprit, because they induce lots of precautionary savings behavior, was conventional wisdom around 2003-04 but has not held up well.”
Andrew characterizes my concerns (laid out in detail in my recent paper) about high Chinese savings fairly.
I worry that if investment dips and savings stays high China will suffer from a cyclical shortfall in demand. I think that is a good explanation of what happened in China in late 2014 and early 2015, when residential investment was weak (there was a glut of supply at the time thanks to over-building, especially in tier 3 and tier 4 cities) and China tried to curb local government investment. The cyclical short-fall in demand creates pressure for China to look to exports to support growth—rebalancing away from both investment and exports is actually quite difficult. And the cyclical short-fall in demand also creates pressure on Chinese policy makers to loosen curbs on credit to support the economy, creating the stop-go pattern we have observed recently.
And I worry that the combination of a structurally high level of savings and a structural fall in investment will re-create a large current account surplus. Or to be precise, an even larger current account surplus.
So is there no hope?
Will China’s savings fall naturally with investment, either as a result of lower business profits and less business savings, or because – as Andrew argues, drawing on work from Guonan Ma, Ivan Roberts and Gerard Kelly *– the rise in household savings was in part a function of the need to save to make a down payment on an apartment and household savings will fall naturally as more and more Chinese urban residents own their own homes (assuming prices stabilize).
I hope so, but wouldn’t want to bank on it—in part because home prices are now rising and in part because I am always leery of arguing that rising home prices have one effect on surplus countries and another on deficit countries.**
And more importantly, is there any scope for other policy reforms to bring China’s saving rate down?
Here I am more optimistic than Andrew is, even with data from the expansion of social insurance in the ’aughts, for three reasons:
• There is significant evidence that higher spending on public health in particular lowers savings
• There are still significant gaps in China’s social safety net that could be filled in and thus there is scope to make China’s system of social insurance more generous.
• Many of China’s social insurance programs seem to take in more in contributions than they pay out in benefits. That is part of the reason why it isn’t a surprise that the expansion of social insurance, as they were designed, didn’t lower national savings. And it is also suggests there is scope to change the way social insurance is funded and in the process lower national savings.
Let me take each point in turn.
China has increased its spending on public health over time. But the absolute level of public health spending is still quite low – around 1.5% of GDP. China intends to increase this over time to about 2% of GDP. But that is also still quite low absolutely, and relative to other major economies.
The IMF’s cross country research on the causes of current account surpluses (call them savings surpluses) finds that public spending on health care is a significant determinant of national savings.* Raising public spending on health care by a percentage point (and financing that with taxes) reduces national savings, on average by about 0.5% of GDP. (data here, table 4)
And there is evidence that result holds for China. A study by Barnett and Brooks (of the IMF) found a yuan of spending on public health raised household consumption by two yuan.
China plans to raise public spending on health to around 2 percent of GDP (see paragraph 25 of this IMF working paper). It could easily do much more.
Two, there are still gaps in China’s system of social insurance that could be filled in.
Employers do not always make contributions. Many benefits are managed at the municipal and provincial level, and thus are not in practice fully portable across China (impeding labor mobility, among other things). Basic pension benefits are small. The benefits from unemployment insurance are also relatively low, in part because of a desire to keep unemployment insurance payments below the minimum wage. The co-payments on even the best public health plans are very high. And so on.
A couple of concrete examples, drawing heavily from the China Labor Bulletin and the World Bank’s China 2030 report.
A relatively small share of the work force has access to an “urban” pension, thanks to China’s large informal labor force, and a large rural labor force. China Labor Bulletin reports:
"Official figures from the Ministry of Human Resources and Social Security show that in 2015, only 262 million workers, about one third of China’s total workforce of around 775 million, actually had a basic urban pension."
And pension benefits available to those who are in the informal labor force are small.
"To supplement this shortfall, the government has been promoting a basic pension for urban and rural residents who are not necessarily formally employed …. The fund is subsidized by the government but monthly pay-outs, especially in rural areas, are generally very low. Indeed, official figures show that the average pay-out for the 148 million people receiving benefits in 2015 was just 1,432 yuan for the whole year. The average annual pay-out from the basic urban pension fund by contrast was 28,363 yuan in 2015. The individual residents’ scheme has the potential to grow and provide more extensive benefits in the future but it currently has little real impact."
Similarly health care benefits are not especially generous, as one would expect given the low level of overall spending on public health. Sara Hsu writes:
“While in name China has achieved universal health coverage in recent years, benefits remain low and quality and extent of care and coverage vary widely. Copays are often very high, certain drugs are excluded from coverage, and out of pocket expenses are insufficiently reimbursed. The out-of-pocket cost issue is the most pressing, especially in rural areas.”
Co-payments in particular seem high and, at least in some cases, according to the China Labor Bulletin’s summary of China’s social insurance system, patients often make full payments out-of-pocket upfront, and then seek reimbursement.
(One small caveat: generalization from afar is hard; I am totally dependent on secondary sources. Beijing supposedly now prepays for some approved health care, but that seems to be the exception not the rule).
Finally, it is important not just to look at how much is being spent on social insurance, but also look at size of the “contributions” that finance the system. Social contributions (payroll taxes) in China are quite high.
“Income redistribution through taxes, contributions and transfers has so far been ineffective in stabilising the household share of income …. Social welfare contributions made by the household sector tripled between 1992 and 2007, from 1.4% of GDP to 4.2%. As discussed earlier, the 1997 pension reform introduced individual pension accounts funded by mandatory employee contributions, which are deductions to household disposable income”
In many cases current contributions seem to exceed current benefits, meaning that the social insurance system acts as a form of forced savings. (See the China Labor Bulletin’s report for details, as the balance between contributions and current benefit payments varies across provinces)
That is part of the reason why the World Bank’s China 2030 Report suggests reforms to the pension system that would reduce contributions without lowering benefits -- which requires finding new ways of covering the cost of legacy benefits.
“China is a high labor taxation country if all social insurance (SI) contributions are paid …. As part of its overall adjustment of the tax structure, it would be desirable for China to lower the tax burden on labor over time … a win-win solution appears possible for workers and employers that could reduce contribution rates significantly while protecting the replacement rates of pensions. This approach would involve financing the “legacy costs” of the current pension system from an alternative source …”
Bottom line: A broad redesign of China’s system of social insurance seems to offer potential to lower China’s level of savings.
These issues here of course are complex: the balance between social insurance and incentives to work; the balance between a pay-go system and a funded system; and the question of how to split cost and responsibilities between municipality, province and the central government.
Yet it still seems that there is room to reform China’s system of social insurance in ways that would provide stronger and more consistent coverage, with more portable benefits, ideally financed through a more progressive system of taxation.
And in the interim, well, China’s central government has ample fiscal space and could easily pick up more of the tab—allowing contributions to be cut temporarily. That seems like a healthier way of providing short-term stimulus than another round of credit loosening. It does, though, require tolerance of bigger central government fiscal deficits.
*The Ma, Roberts and Kelly paper Andrew cited actually shares my concern that internal and external rebalancing could trade off (in the absence of other policy adjustments). "In net terms, we conclude that a resolution of internal imbalances may well exacerbate external imbalances rather than the reverse. Calculations using global input-output tables further suggest that, without a significant reorientation of international trade flows or prices, the patterns of rebalancing considered in our scenarios will generate substantial headwinds for exports to China by its major trading partners." They also argue that maintaining strong consumption growth as investment growth slows will be a challenge. I agree there too. That is why I am arguing that a range of additional policy reforms are needed to provide a boost to consumption during the process.
** Down payments in China have traditionally been quite high, though this is changing. The need to save for a down payment is central to the argument why rising home prices induce more savings, along with self-financed apartment improvements. In many other countries, of course, rising home prices seemed to lower not raise national savings. The U.S., the UK and Spain for example, pre-crisis. I generally tend to be a bit skeptical of arguments that postulate the same variable -- rising home prices -- has a completely different impact on savings in deficit countries and in surplus countries. Of course, institutions matter. In the U.S. household dissavings was facilitated by home equity lines of credit and the like, which I suspect aren’t as common in China. And China’s high down payment require, as long as it is enforced, differs from the U.S. pre-crisis institutional set up as well.
*** I generally cited the China Labor Bulletin because it provides a relatively straight forward explanation of China’s social insurance system. For those who prefer a different source, the technical analysis in the World Bank’s China 2030 report paints a similar picture of a system of social insurance that still has significant gaps.