Last week I had the opportunity to give a lecture about China's economy at the English Chamber of Commerce. I took great pains in its preparation, as I was perplexed over the recent popularity of a phrase used to describe China’s economic model-- the “Three Horse Drawn Carriage” (investment, consumption, and exports -Ed.). I am specifically concerned over the government’s adoption of the term in its own economic research, as the “Three Horse Drawn Carriage” concept is oftentimes misleading and misused.
Surely there is a better, less pandering way to analyze the Chinese economy. If we look to recent international dialogue for hints, we notice that there is worry over China’s investment and savings rates. Within the country, most people equate the country’s savings to bank deposits; the great majority them interpret this as a phenomenon of the banking sector.
When investigating macroeconomic problems, economists define savings as national revenues minus total consumption. This includes families, governmental organizations, and corporations. Thus, if we want to discuss a country’s savings rate, we need to be quite familiar with its revenues, and effectively, the country’s cash flow statement. We cannot just look at the banks.
Interestingly enough, if we employ China’s national accounting information to calculate the national savings rate, then it is indeed constantly increasing. Ten years ago the savings rate was approximately 36 percent of GDP; today it is around 46 percent. This would seem to parallel the growth in the savings rate recorded by banks. In fact, this is not the case. If we take family income and subtract consumption from it, we are left with a decline in savings over the past ten years that does not match up. Ten years ago families saved 20 percent of GDP; today they save only 16 percent.
But the government also saves. Using the above methodology, the government currently saves around 6 percent of GDP, up one percentage point from ten years ago. The reason is obvious: although government revenues have increased, spending has also skyrocketed.
As a frugal consumer, however, industry has been saving all along. Ten years ago, industry savings accounted for 12 percent of GDP. Today that number has gone beyond 20 percent, even exceeding the savings rate of families. This is similar to Japan, but in stark contrast to India where industry saves only 5 percent of GDP.
Because consumption by Chinese industry is so negligible and profits have grown so much, savings have also ballooned. This is controversial; for many years we had been used to dismissing many Chinese businesses, especially nationally owned businesses, as unprofitable entities. Over time we developed an unwillingness to recognize their massive growth in profit.
If the profitability of Chinese firms has substantially increased, then can’t we say that they are becoming competitive? Actually, we can’t. Profit, profit margin, and productivity increases are all different. This is economics.
In the early nineties economists could not understand why China’s economy was worsening. Despite reform, Chinese industry experienced a wave of financial losses. Why, as soon as economists concluded that Chinese firms were becoming more productive, did their performance begin to dip? It had to do with changing market conditions. The market understands the critical connection between profit margins and productivity. It might have been that more businesses were reporting losses, or that single businesses were losing more. The latter has to do with productivity; the former is tied to market conditions.
What we see now is the opposite; a large-scale increase in profits that reflects new policy-influenced advantages in the market and the expansionist track taken by the government since 1998. In order to fight back the effects of the 1997 asian crisis, the government implemented an aggressive economic policy that included heavy governmental borrowing in order to jump-start investment and consumer demand. This was a turning point in the Asian crisis. Consumer credit stimulated demand in the housing market. Meanwhile, large-scale infrastructure construction projects attracted even more investment.
According to Shi Zhengfu, a veteran corporate investment consultant, Chinese businesses for the past five to six years have been experiencing what they call a “blowout” in profits after being exposed to new market opportunities, with many dark horses arriving as well. It was also during this period that China’s external economy emerged.
Clearly these are all the results of new economic policy. But we must ask ourselves, how long can it last?
