Lu Zhongyuan Research Report No 043, 2003

IV. The Main Factors Affecting the Changes in China’s Investment-Consumption Relationship

Analyzing the factors affecting the changes in the investment-consumption relationship is absolutely necessary to interpreting the causes and mechanism of this relationship and forecasting the future trend of its changes.

1. The rise in residents’ income and the upgrading of consumption structure constitute the fundamental starting point for a rational adjustment of the investment-consumption relationship.

Since the initiation of reform and opening up, residents’ income in China’s urban and rural areas has risen rapidly, and the growth rate of consumption has been among the fastest in the world. The structure of consumption has moved from the type that the needs for food and clothing were met by farm produce to the type that the needs for a well-off life are met by industrial products. In addition, some people have moved to the type of consumption that the needs for a wealthy life are met by services. The focus of personal consumption has also shifted from the quantitative increase in consumer goods to the qualitative improvement in life. From 1978 to 2000, the Engel coefficient of the urban and rural residents dropped respectively from 57.5 percent and 67.7 percent to 39.2 percent and 49.1 percent. Overall, the coefficient was below 50 percent. This is a unique feature of a well-off life. In recent years, the Engel coefficient has been declining at an accelerated pace in both urban and rural areas. It is an indication that upgrading the structure of residents’ consumption has quickened. The rise in the level of residents’consumption and the upgrading of the structure of consumption have posed an objective demand that the rate of end consumption should be increased appropriately and the rate of investment should be reduced accordingly. This will help maintain a relatively coordinated proportionate relationship between investment and consumption. An unduly high rate of investment coupled with an unduly low rate of consumption for a long time is inconsistent with the growing demand of the people’s consumption and not conducive to the end consumption to push economic growth. The potential of China’s residents’ consumption growth is still enormous and the space for residents’ consumption needs to be further expanded.

2. The high savings rate has for long supported China’s relatively high investment rate, while the declining disposition of residents’ consumption has constrained a sustained rapid growth of consumption demand.

China is a country noted for a tradition of high savings. From 1992 to 1998, China’s overall savings rate (the proportion of total savings in the total disposable income of all citizens) stayed steadily around 40 percent, far higher than the world’s average level of 20 percent. This situation was in sharp contrast with the low savings tradition in the developed countries in the West. For example, the overall savings rate in the United States was 15 percent, but the residents’ savings rate there was only 5 percent. High savings constitute a foundation for high investment. Therefore, China’s investment rate during the same period was also about 40 percent on average, which was also far higher than the world’s average level of 20 percent. China’s overall savings come from residents’ savings. Of the overall savings during the 1992-1998 period, the household sector accounted for 53 percent, the non-financial enterprises accounted for 32.2 percent, the financial institutions accounted for 1 percent and the government departments accounted for 13.8 percent. With regard to China’s total investment, the non-financial enterprises were the leading player. Of the total capitalization, the household sector accounted for 14.4 percent, the non-financial enterprises accounted for as high as 77 percent, the financial institutions accounted for 0.6 percent and the government departments accounted for 7.9 percent1. A comparison between the composition of China’s total savings and that of its total investment shows that the household sector was the largest funding surplus sector, which constituted the most important funding source of the investment by the corporate sector and provided the most elementary support for the total capitalization. International comparisons indicate that one important cause of China’s high investment rate is the high level of domestic savings, especially the high residents’ savings. Many other Asian countries also have the tradition of high savings. In the newly emerging industrial countries like the Republic of Korea and Singapore, the investment rate in 2000 was also as high as 31 percent. As a developed country, Japan also had an investment rate of as high as 26 percent. This cannot but have a close relationship with the high levels of their domestic savings.

When residents’ income is at a given level, the higher the disposition of savings (namely the proportion of savings in disposable income) is, the lower the disposition of consumption (namely the proportion of consumption in disposable income) will be. This will lead to a decline in the rate of end consumption. If the residents’ disposition of savings declines and their disposition of consumption rises, the investment rate will fall, which will lead to a relatively high rate of end consumption. Since the 1990s, the Chinese people’s disposition of consumption has gradually declined, resulting in a slower growth of consumption. During the 1999-2001 period, the average consumption disposition of China’s residents in cities and towns dropped respectively from 0.847 to 0.774 and from 0.85 to 0.74. During the same period, their disposition of savings constantly rose. The average annual growth rate of personal savings was 23.7 percent and that of personal consumption was only 12.9 percent2. If the disposition of residents’ consumption continues to fall and the growth of consumption spending continues to slow down, the disposition of savings will be inevitably too high, which will have a negative impact on a rational change in the relationship between investment and consumption. Therefore, a coordinated change in the disposition of residents’ savings and consumption is of vital importance to rationalizing the relationship between investment and consumption.

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1 Guo Hao: An Analysis of China’s Capital Flow, Science of Finance and Economy, Issue 4, 2001.

2 Qi Jingmei: 2003: China’s Consumption on Fast Track, Economic Daily, January 21, 2003.