Blame game over giddy China savings takes a twist

Greece's big budget deficit has plunged the eurozone into crisis, while rating agencies wonder whether Washington's fiscal profligacy could one day cost the United States its AAA rating.

China has a different problem: its government is under attack for conservative spending policies that, critics say, are damaging long-term productivity prospects and contributing to the economic imbalances underlying the global financial crisis.

The International Monetary Fund and World Bank have long called for China to ramp up social spending so its citizens have less need to save for a rainy day and can consume more. Still, recent advice to Beijing from the Organisation for Economic Cooperation and Development was remarkably blunt.

"Looking ahead at the exit from the ongoing fiscal stimulus programmes, it will be important not to revert to budget surpluses," the OECD said in a report this month. "China's public finance position is remarkably strong and can readily accommodate a permanently high level of government spending."

The OECD reckons that China, which is not a member of the Paris-based forum of industrial democracies, entered the economic slowdown with a general government surplus in 2007 of more than five per cent of GDP, reflecting buoyant tax revenues and tight-fisted spending policies.

China may have rapidly increased outlays on welfare pensions and health, but it has barely scratched the surface. "Greater public spending on education in particular can help both to boost productivity and to reduce inequality," the OECD said.

Despite implementing a four trillion yuan stimulus programme, the government's budget deficit last year was just 2.2 per cent of GDP, below its target of three per cent.

If spending slows as the pump-priming ends, the OECD fears that surpluses could return and lead to a renewed widening of China's current account surplus, a sore point with the United States and Europe.

Just how far the government is to blame for a surge in China's national savings rate last decade is controversial.

Many economists had attributed the increase to higher corporate profits as enterprises, feasting on cheap loans and labour, made the most of a boom in global demand.

But recently revised statistics showing the flow of funds through China's economy between 1992 and 2007 have reopened the debate.

Calla Wiemer with the Centre for Chinese Studies of the University of California, Los Angeles, says a leap in the national savings rate to 51.4 per cent of GDP in 2008 - by far the highest of any major economy in the world - largely reflected increased household savings due to changing demographic and income patterns.

The flow of funds also shows government saving surged to 10.6 per cent of National Disposable Income in 2007 from just 4.5 per cent in 2004. Big increases in revenue were either saved or used to pay off debts to the neglect of social welfare spending.

"For the sake of the long-run health and well-being of the Chinese people, government needs to spend much more on public consumption," Ms Wiemer wrote in the most recent edition of the China Economic Quarterly journal. "The scale of the increase in government spending that is called for is enormous, and the resulting stimulative effect on the economy could thus be substantial."

Stephen Green, head of Greater China research at Standard Chartered Bank in Shanghai, arrives at a similar conclusion.

Mr Green says a rise in total government income to 35 per cent of GDP in 2007 from 25 per cent in 1995 was necessary given the parlous state of state finances in the early 1990s.

"But the problem is that the government is also keeping more of the benefits of growth, rather than spending them. And this amounts to a significant, but hidden 'unbalancing' of the economy. It has to be among the diagnoses of China's imbalances and its low consumption problem," Mr Green wrote in a recent note.

Interpreting Chinese statistics, however, is tricky. Louis Kuijs, a World Bank economist in Beijing, says he cannot reconcile the purported leap in government savings with other fiscal data and surveys of Chinese households and industry.

And UBS economist Jonathan Anderson says the flow of funds breakdown is particularly inconsistent with China's well-regarded survey of industry. Both he and Mr Kuijs remain of the view that corporates explain the lion's share of the jump in national savings.

"I don't want to rule out anything, but it doesn't feel right to me. When we look at the way China was growing - this capital-intensive, industry-led growth - I don't have the sense that that pattern of growth was already starting to change in 2005," Mr Kuijs said, referring to the apparent shift in the structure of the economy around mid-decade.

Despite the disagreements, China-watchers concur that the government must refocus its spending from physical capital to human capital to sustain long-term growth.

Whereas the OECD advocates more education spending, a new IMF study concludes that, to reduce precautionary savings, the priority should be on public health care.