How is China now planning its economy?

Since 1978, China has undergone a fundamental and very successful reform from a planned economy towards a market economy. But one should still keep in mind that this is still an autocratically governed country where technocrats call the shots at all levels. China is still working with five-year plans and the economy is still tied to administrative goals. SO how does economic planning work in China nowadays?

Gregory Chow offers some insights, in particular on how this planning has recently become more important due to the global economic crisis. Administratively, policy is guided by the five-year plans, which interestingly have recently included new sections on welfare and management of society, making apparent some worries about the adverse effects of market economies and rapid development (or democracy when people can complain?). The remarkable part of these plans is that explicit targets are set, and policy is in a major way oriented towards these targets. Of course, the government still controls directly a considerable number of state-owned enterprises. And it has the traditional tools of policy in a market economy at its disposal to influence the rest of the economy. These policies are coordinated at all levels thanks to the very central nature of government.

In some sense it would also be good for market economies to also set some targets for policy. In fact, this is what politicians should be arguing about and then let technocrats put policy in place to achieve these targets. I would not mind targets like putting a man on Mars by 2020, making sure everyone in covered by health insurance by 2015, get 50% of commuting kilometers on public transportation, or defense expenses being completely dedicated to defense (and not attack) by 2015, for example. In fact, the World Bank has well-defined targets for developing economies. In do not see why this should not be applicable for developed ones. At least it would make governments capable of rallying support for some goals and be explicitly accountable.

Why is the Chinese savings rate so high?

The current global imbalances, at least those between the US and China, are only possible because China is currently saving a historically high share of its income. Various theories have been advanced to explain this surge in the savings rate: 1) Economic reform has increased household-level uncertainty and thus precautionary savings. 2) Forces have shifted from consumption-oriented households to savings oriented businesses. 3) Demographics and the life-cycle combined with the growth in income lead currently to high savings rates because savings change through the life cycle and thus fluctuations in the dependency ratio become important.

As Carl Bonham and Calla Wiemer point out, the savings rate has not been uniformly high and is in fact consistent with the changes in the dependency ratio. The savings rate increased through the 1980s to peak at 41.9% in 1995, then "bottomed" at 37.7.% in 2000, before surging back to 51.4% in 2008. The current global imbalance occurs in part because, unlike before, investment rates are restricted by policy, and stand at 43.5%. A modest decrease in the savings rate can rebalance things.

To test the three theories against these staggering numbers, Bonham and Wiemer use a structural VAR and determine the latter one is the most important, while the others cannot be dismissed. I am not particularly fond of VARs to test theories, they should rather just describe the data, but the evidence is quite compelling in this case. Of particular interest is that one can forecast the savings rate, as the dependency ratio is quite predictable. And this forecast shows that Chinese savings rates have peaked last year and will decrase quite significantly over the next decade. If true, this should reduce considerably the pressure on China to do something about current imbalances.

Lords, bondage, Hegel, and ... the US-China current account balance

Current global imbalances are mostly the mark of what is happening in the United States and China. And how the two are interacting, one could argue, is all that is going to matter. Pessimists view the current imbalances as the result of large domestic distortions and problems in international financial and monetary markets. Optimists consider the situation to be part of a normal adjustment and everything will automatically be fine.

Célestin Monga tries to reconcile both views using Hegel's approach of self-consciousness and the lordship-bondage relationship. Yes, we can apparently understand global imbalances using philosophy. The idea is the following: The Unites States and China have become largely interdependent and cannot ignore each other. Even if one has dominating position on the other, it can exploit the situation. Think of a fight to death between two adversaries. The winner becomes the master, but there is nothing left to dominate as the other is dead. The same would happen with the other winning. Both realizing that they so reliant the other, the solution is not to kill the loser, but to enslave him. But over time, the slave adapts and makes the master totally dependent on him and becomes more powerful.

How does this brings us to US-China relations? First ignoring each other, the US takes center stage with the Industrial Revolution, and China's 5000 year history takes a back seat. But since China has regained economic power and is on the verge to become the second economy in the world, both economies wage a battle for economic supremacy, best visible on the position with respect to the "manipulated" renminbi/dollar exchange rate (US position) and the "concerns" about the US dollar (China position). But both cannot ignore how intertwined they are, just have a look at the trade and capital accounts. This implies that they cannot unilaterally take policy decisions without considering very seriously how they other would react. They are locked in a Nash equilibrium, and at this point both are masters and slaves.

Should we not use philosophy and psychology instead of macroeconomics to understand global imbalances? Is this an example of behavioral economics going too far? We tend too often to think that countries act like a representative agents, and this analysis takes it to the extreme. One cannot ignore that some factors here are solely dependent on government decisions (exchange rate, monetary policy), that make it look a country acts as one, and is thus locked in a two player game. But this hides considerable heterogeneity of agents within, but while they face the same prices, their impact varies a lot: some are exporters, some importers, some directly, some indirectly. And government policies are a reaction to all this heterogeneity. I think our macroeconomic models are still more useful than Hegelian conjectures.

Growth leads to savings, not vice-versa

Fast-growing countries, like currently China, have very high savings rates. Data indicates that causality runs from growth rates to savings, and not the reverse. In theory, this is puzzling. Such high growth rates originate in rapid productivity improvements. This leads to high returns for capital and thus one should see high investment (and savings). However, returns for savings in such countries are very low. Why are people savings so much then?

Yi Wen finds one way to justify this: precautionary saving. We know that whenever there is a motive for precautionary savings, this can be rewarded with interest rates below the discount rate. And this is triggered by borrowing constraints. And it is well known that the Chinese financial sector is still severely underdeveloped.

The actual mechanism at play is obscure to me. The paper reasons that when permanent income increases, it is savings that increase instead of consumption, because of the borrowing constraint. The only way I can see this happening is when the uncertainty increases faster than incomes, or if utility is twisted in some way. But I do not seem to see either. While the author claims to have made a model that is tractable and analytically solvable, it does not appears to help in any way to understand what is going on. And Yi Wen does not seem to offer any explanation either.

Savings rates and public pensions in China

Chinese savings rates are very high and increasing, which have allowed the current paradoxical situation that an emerging economy is massively lending to industrialized economies, in particular to the most advanced, the United States. But why is this savings rate so high? While the popular opinion seems to be that Chinese households just cannot consume fast enough given the very high growth rates of their incomes, closer inspection of household level data reveals a very different picture.

Take for example Jin Feng, Lixin He and Hiroshi Sato, who find that changes in the pension system can explain all of the increase in the savings rate from 17% in 1995 to 23% in 2004. The pension system has been reformed to become less generous, prompting households to compensate with their own savings. Add to this that precautionary savings is not only motivated by retirement, but also by the fact that economic uncertainty has significantly increased with the liberalization of labor markets, you have the perfect storm for a massive increase of savings rates as household try to reach an acceptable buffer stock. Public appeals for them to consume more will do nothing.