by Ascha Lychett Pedersen
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The world economy is experiencing changes in both saving and investment behavior that are having implications for the configuration of current account imbalances. China has experienced a tremendous increase in its saving rate especially during the last decade, and has emerged as a significant capital exporter. The international economic and financial consequences of this development is highly debated. However, the emphasis on the significance of the aging Chinese population is still somewhat downplayed, argues Ascha Lychett Pedersen The standard theory for analyzing the impact of changes in the age structure of population such as aging on aggregate savings is the lifecycle income theory of consumption. This theory, formulated by Modigliani in 1963, argues that people will take their lifetime income into consideration when deciding their consumption level. In a nutshell: An average consumer has a lifetime income pattern of a very low level of income prior to employment, a rise in income level during adult years due to earnings from employment, and a lower level of income in late life when earnings decline after retirement. Despite such age-related changes in income, consumers desire to maintain generally stable consumption over the lifetime. As a result, the savings and the saving rate of each consumer will likely maintain a lifecycle pattern similar to the lifecycle pattern of income. In particular, the saving rate during the post-retirement late life will be very low compared to that of adult years when money must be saved in preparation for consumption after retirement. Ultimately, such a lifecycle income theory forecasts a decline in the overall saving rate when the proportion of elderly population increases. Therefore, the continuous aging of the Chinese population will presumably lead to a sharp decline in domestic savings rates and help rebalance the global economy. China became an "aging society" in 1999 after the composition of people over 60 years within its entire population broke the 10 percent benchmark. The roots of population aging in China are the same as many other aging societies: a low fertility rate, rising life expectancy, and age structure dynamics, i.e. the cumulative effect of past changes in birth and death rates. The elderly share of the Chinese population has been increasing rapidly and is set to form a continuously growing share. According to UN projections, over 30% of the population is expected to be age 60 or more in 2050. In absolute numbers, this corresponds to approximately 540 million people by 2050, whereof 100 million will be age 80 or more. In part as a consequence of Chinas process of population aging to date, the ratio of individuals age 15-64 to those younger and older, which grew rapidly during the last few economic boom decades, has reached its peak and is slated to decline rapidly in coming decades. This ratio indicates the dependency ratio in the Chinese society. Even though 37% of Chinas population ages 60+ are employed, more and more Chinese cease working before or in the years soon after they reach age 60. If the implications of the life cycle hypothesis are aggregated over individuals, a negative relationship should exist between aggregate domestic savings and the share of the non-working-age population. National savings and net capital formation decrease as the size of the elderly population with low or negative prosperity to save increases. This suggests that the Chinese high savings rate is a temporary phenomenon, and that the global imbalances will begin to decline as a large share of the Chinese population enters retirement age in the decades to come. In a best case scenario, the large current account surpluses will be reduced without any need for government intervention The demographic tendencies leave some grounds for optimism (good for the global balance, bad for China). The demographic factors supporting extraordinary high savings rates in China will not persist indefinitely. The share of working age individuals in total population will peak as early as 2010. The dependency ratio will then rise rapidly more rapidly than has been the case in virtually any other country as members of the workforce begin to retire and are succeeded by the smaller cohort bequeathed by the countrys one-child policy. Thus, the growth of labor force will decline, possibly along with a declining household saving rate and a slower pace of investment spending. However, it can also be argued that forced will pull in the other direction. As life-expectancy continues to increase, the propensity to save among people of the age 60 or more might increase. In these considerations, we have to remember that China is unique in the sense, that the country has become an aged society, while still being a developing country. Even though the average Chinese has experienced a large increase in wealth during the last decades, fact remain that the median income per capita driven by the very large rural population is low. The West was fortunate: Europe and the US first became rich and then they grew old. Most people in China will grow old before they grow rich; a fact which inevitable partly drives the saving mentality of the population. Given these projections, the current account surplus of China can be expected to remain high in the years to come, although declining. The fact that China will account for more than 50 percent of the GDP of emerging Asia by 2020, means that the trajectory of saving and investment rates in emerging Asia will be heavily influenced by its development. Hence, decisive action by the Chinese government would help to rectify global imbalances. Taken together, a key implication from these forces is that Chinas saving rate is likely to plateau before long and may ease off noticeably from the current 53% or even higher levels over the next 10 years. Prevailing projections for future saving rates in China, such as a study by Shioji-Vu, conclude that China (as well as the rest of emerging Asia) will continue to show increases in per capita capital accumulation during the next 20 years but at a slower pace than earlier. The current and projected demographic trends lead towards a decline in the future Chinese savings rate, although the level will still be high. In effect, this will, ceteris paribus, contribute to an increasing balancing of the global current accounts. Nevertheless, Chinas special and major structural alterations remain to be carried through in the years to come, which inevitably will have an impact on the saving behavior of the Chinese households.