Savings and consumption choices for long term growth for China

Comments on Louis Kuijs “China: what long-term policies and reforms are needed to sustain growth?” 3/07/2009, http://www.eastasiaforum.org/2009/07/03/china-what-long-term-policies-and-reforms-are-needed-to-sustain-growth/

This is my first comment on this article. It is likely that I will make another comment on the point of deregulation later on.

Louis Kuijs has made a number of interesting points in his article on what policies China should pursue. Most of them may be correct. However, I would like to argue two points of policy of development, in the Chinese current context.

The first is about savings and consumption and their role in long term growth. It is mostly natural to assume a country like China should increase consumption in the face of the current great global recession and the much talked point of international imbalance in savings and consumption between the US on the one hand and some other countries including China the other.

China has had until recently current account surplus and has high savings. Exports have fallen due to the global recession. Saving rate is going up in the US, mainly because of the burst of housing and equity markets bubbles, rising unemployment and the difficulties in credit and financing. So if international consumption is falling, an increase in consumption in China may be able to offset that. But is that the correct and most optimal action to take for China? That is the most important question for China’s policy makers.

I am not sure to change savings and consumption is the best course of action for China to take. The main reason for my doubts is that China is still a low income country with low physical capital per capita and it has huge potential for rapid growth. Unlike most industrialised countries where the marginal return for investment may be naturally lower due to the fact that they are mostly in the world production possibility frontier, the return to investment in China may be much higher due to the potential of rapid growth in the catching up phase. So, there is an alternative to increase in consumption, China can increase investment in infrastructure and physical capital for even faster or at least sustained rapid growth.

So most people / economists with the view for China to increase its consumption as a long term policy to sustain growth may be misguided. China has more options than most industrialised countries in terms of savings and consumption trade off. It also has a much greater feasibility set in terms of investment than most countries. So it is not good enough to simply argue for an increase in consumption and a reduction in savings. It is a much short-sighted view. It reflects a poor understanding of development processes and the important role of domestic savings in those processes.