COMMENTARY

------By Daniel Inman

China and America, two of the world's economic heavyweights, have consumption behaviour that couldn't be more different. In recent years, Americans have embarked on a spending spree of unprecedented proportions, whilst China's savings rate, which historically has always been high, has reached even greater heights.

The figures make the differences clear. In 2005, America saved US$1.6 trillion, 13 percent of its national income. Compare this to China, a country whose economy is just one-sixth of the size of America's, which in the same year managed to save US$1.1 trillion. If government and business savings are left out, focusing on savings at a household level, the contrast is even greater: Chinese individuals are saving about 30 percent of their income, whilst American households have gone below zero, saving a perilously low -0.4 percent.

America and China are spending at two extremes of the consumption spectrum, and as is the case with most extremities, this behaviour is neither desirable nor sustainable. America's consumption drive has been fuelled by a willingness of the American people to borrow in order to keep on spending, often using as collateral houses that have sharply risen in value due to a recent property boom. This is a trend that cannot continue indefinitely.

The fact that Chinese people consume less than any other major country, is detrimental in different ways. Since the Chinese aren't consuming, it means that there is plenty of money going into fixed investments, and the country's economic growth focuses on making goods for export, rather than for the domestic market. The rapid rise of Chinese exports has provoked protectionist grumbles across the developed world, most notably in America.

America and China aren't acting in isolation: the interconnected nature of the global economy is such that nations' actions constantly feed into each other. Because the Chinese are saving so much, they have a massive excess of capital, a large chunk, which goes into American debt. The existence of large amounts of capital in America keeps interest rates low, which in turn makes borrowing more attractive. Americans borrow to consume and in their spending frenzy, they purchase copious amounts of Chinese goods. The Chinese profit from these purchases, save the profits, and so the circle continues.

Since the contrary spending habits of America and China help to perpetuate each other, if one link in the circle were to be broken, then more moderate habits would come about. In America there are obvious solutions that are difficult to enact: increasing consumption tax would be effective, but suicidal at the ballot booth. The most beneficial solution for all would be to get the Chinese people to take a bit more out of their pockets. The more the Chinese spend, the more the domestic market will develop, which would mean the focus on exports could be reduced slightly. There would also be less excess capital to fling into American debt. But before you can get the Chinese to start spending, it needs to be determined why they are so adverse to it in the first place.

Why the long pocket?

High savings in China are nothing new. They've been steadily rising for nearly thirty years. In 1981, China saved 20 percent of its GDP. By 1988, that figure had risen to 30 percent, and in the last few years it has stood well over 40 percent. One explanation of this rise is that it corresponds to a growth in concerns that the employees of state-run enterprises have towards their future. The privatisation of state-owned enterprises and the subsequent lay-offs mean that people are saving for a rainy day that they think may just be round the corner. These worries, and their associated savings, are compounded by the gradual diminishment of state benefits.

But there are a number of reasons that this explanation is unsatisfactory on its own. First, the shrinking of state benefits is a global phenomenon. It's not as if in America people aren't worried about the future of the state pension and the state's provision of healthcare, but it hasn't stopped them from spending.

Secondly, as economist Wing Thye Woo points out, for the theory about state-owned enterprises to be correct, the concentration of savings would have to be amongst the urban population, where the bulk of state-owned enterprise employees are located. To the contrary, the high saving rate is shared across both urban and rural populations. Woo makes a plausible case for the idea that people aren't only saving to support themselves in the future, but in addition, they're saving to invest. In rural areas, where individuals are unable to raise capital from banks, people have to raise the capital themselves, through self-finance. Whereas twenty years ago, when rural industrial development was in its infancy, setting up a workshop was relatively cheap; now, however, as the market has become more competitive, it is necessary to setup more advanced facilities in order to make it profitable, which requires greater capital, and therefore more saving. Woo goes on to say that as the regulations against setting up a private business have weakened, the amount of investment has risen.

If Woo is correct, that a prime motivation for the Chinese saving so much is to invest, then it makes getting the Chinese to spend all the more difficult since their eyes are towards the future, not on satisfying short-term needs. Maybe breaking the cycle of American overspending and Chinese over-saving cannot be achieved by getting the Chinese to spend more.

Evolution to equilibrium

What is mostly likely to happen is that the Americans and the Chinese are going to evolve out of the cycle. It's not really the case that America should stop spending so much, but that it will have to, simply because there is a limit to how much can be borrowed. Whether America is able to slow down its borrowing before it reaches that limit - or once it has passed it - will have serious consequences for the country's economic health.

If America is going to gradually evolve out of its overspending habits, can something analogous occur in China, in light of the fact that the Chinese are consummate spenders? Probably, but over some time. Young Chinese people are growing up in what is becoming more and more a consumer society. They are being exposed to a greater range of goods than ever before. As affluence increases, younger Chinese people will feel the need to save less of their income. They'll still save to invest and they'll still put money aside for a rainy day, but not in the same proportions.

This change in attitude will be a generational shift that will start in the richer, developed areas, and slowly filter inland with economic growth. And as it does, it shall bring benefits to both China and abroad. As the Chinese begin to consume, it will develop the availability of goods for the domestic market, and eventually there will be Chinese products, sold under Chinese brands, for Chinese people. In the meantime, foreign companies can import into China to fill the gap, whilst the Chinese brands develop - a relationship that will please the countries that feel that their trade imbalance with China is detrimental. When China starts to spend a little more, it will have a big impact on the rest of the world.