[MUSIC] One of the challenges that has been facing the Chinese economy for some time is the difficulty of rebalancing the structure of economic growth. There was a famous quotation by Wen Jiabao in 2007, when he said China's economic growth is unsteady, unbalanced, uncoordinated, and unsustainable, which really reflected grave concern on the part of China's leaders, about the structure of GDP, and whether it could produce sustainable growth. If we consider the national identity, income identity equation which is basically how GDP is defined in national accounts, we can present the equation where GDP is the sum of four components. The four components are investment, consumption, government expenditure and net exports. The desire to rebalance is to shift away from the investment component and increase the consumption component. In China, investment has always been very high, and consumption has been very low compared to the typical experience of most countries. Here is a look at the data. You can see that investment has been around 40% or so for much of the reformed period. And since 2007 when Wen Jiabao made this quotation, expressing a desire for rebalancing, the percentage of investment of GDP has actually increased somewhat, and is now hovering at a remarkably high percentage of 44% of GDP. In contrast, household consumption, which the government has been trying to increase, has actually declined somewhat in recent years and is now at 38% of GDP. In most economies, the consumption share would be well over 50%. The other two components are government consumption, 13%, and net exports, 5%. If we look at the Chinese structure of GDP, and compare it to other countries in the world, here you can see that China is very much an outlier. So the blue lines represent China's consumption share of GDP on the left, and investment share of GDP on the right. And compared to other countries, the consumption is very much on the low end and declining over time as China has become richer or moved to the right along the X axis. And investment has actually increased over time, and is very much an outlier compared to the typical pattern of other countries. Many people have pointed to the high savings rate in China as explaining why there is not enough consumption and there is so much investment. In closed economies, in terms of capital flows, typically, investment is closely related to savings because those are the funds that are being supplied typically through deposits in the banks, that are then lent out to finance investments in the economy. And of course, if we also think about the relationship between savings and income, we know that if you have a certain amount of income, for instance households or firms, and if they're saving a lot, it means typically that they're consuming less. So, a high savings rate also explains relatively low rates of consumption. Here, you can see that even compared to other Asian countries, all of which tend to have high saving rates, the saving rate in China is even higher. So again, very much an outlier in terms of international experience. Now why might there be high savings in China? There's been quite a lot of research that has tried to examine this issue. There are many potential reasons, let me describe a few of them. The first one that's emphasized by many macroeconomists is demographics structure. People typically are dissaving when they're young, then saving during their prime working years, and then dissaving again when they're old. So, if the country tends to be dominated by an active workforce, then you have more savers and thus a higher aggregate savings rate. And although China has had a pretty large share of the workforce in the population, in recent years, China is becoming aging. So that actually the labor force has shrunk as a share of the population, which means we should have seen a decline in savings rather than an increase in savings. Another important potential factor is uncertainty, uncertainty over income, uncertainty over future policy changes, uncertainty over one's health or needs in retirement. All of these uncertainties can lead individuals to save in case something bad happens or in case they're going to really need their money in the future. They may want to save more and consume less. And this can contribute to high savings rates. This makes sense in a transitional economy where many things are influx, and in an open market system where things can change very rapidly from year to year, employment, agricultural incomes due to rainfall and weather shocks, etc. A third potential reason for high savings is liquidity or borrowing constraints. Obviously if people cannot borrow easily, for instance, to pay for their college or to pay for other needed expenditures, it may lead them to save more so that they can self-finance those investments. That is also going to be true in the corporate sector. If firms have difficulty getting access to funds through the banks, etc., they may feel they need to save more of their profits to finance investments later when they want to expand their business. A fourth possible explanation for high savings is that there may be a high economic return to saving. And this will typically be true if there are lots of high return investment projects that yield a high return and thus, if you save your money, it can be invested and you can get a high interest rate or rate of return on an equity investment. Of course in China, the problem is that most people are putting their money in banks, where the deposit interest rates are kept at pretty low levels by the government, at least during most of this period until recently. And the other concern of course is, with such a high investment rate, over time, one might expect that the economy starts to run out of high return projects. If you are investing 40% of GDP every year, it may be hard to continue finding high-return projects that would create an incentive for continued savings and investment. Another possible explanation is a behavioral explanation, wherein people form habits. And especially when incomes are growing fast, people may tend not to adjust their consumption as quickly as their income is going up. So if you have gotten used to a fairly frugal lifestyle and suddenly you find incomes growing fast, you may resist the temptation for a while of really changing the level or nature of your consumption. And this could lead to higher savings rates. And finally, sometimes people attribute high rates of savings to cultural factors, although it's hard really for this explanation to distinguish why cultural aspects of saving would be different in China than in some of the other Asian countries. Now, what can the government do to promote a more consumption-driven growth path? Well, one thing they can do is avoid the temptation of trying to stimulate the economy, especially when growth starts to slow by just flooding the economy with new credit through the banks. So this is a very common response in China to try to make sure that growth does not slow down too much. The problem is when there's a stimulus package that goes through bank credit, oftentimes the money ends up in inefficient investments or ends up in the housing market, which just fuels a real estate bubble. And this just prolongs this reliance on an investment driven growth model. Another set of actions the government can undertake is through the fiscal system. First, they can try to reduce personal taxation to encourage individual consumption spending, and they can perhaps transfer the tax to the corporations. Secondly the government can spend more on services, social insurance. So protection programs that put real resources into the pockets of households, and thus will encourage them or give them the means to spend more. If households who are poor are given money, they're very likely to spend that to increase their consumption. And that will stimulate the consumption side of the economy. And this also by promoting a better social insurance system, for instance, through a better health care insurance system or pension program, people may feel more confident that they don't need to save now for precautionary reasons in the future, and so they might increase consumption as well. Now on the financial side, of course, the government can try to support greater lending for consumption. It's already been the case that banks are now lending quite a bit for housing loans, for real estate purchases, but you can also imagine other types of consumer finance for automobile purchases or durables, or for credit cards or other things that will support consumption, which still has some scope for increase. And finally, to try to make it cheaper for domestic consumers to purchase imported goods, you could try to support an exchange rate policy that would lead to appreciation of the exchange rate. That, of course, would make foreign goods cheaper and promote consumption. But of course, that could be at odds with the desire to make the exchange rate more market determinant, depending on what the market equilibrium exchange rate is.