Tuesday, July 27, 2010

Getting East Asia to save less, spend more

Jul 20, 2010
By Linda Lim

AFTER recovering from the Asian financial crisis of 1997-98, East Asian economies began running consistently large current account surpluses.

The accumulated foreign exchange reserves served as a buffer against potential speculative attacks on their now-floating currencies, and allowed management of those currencies to reduce volatility and maintain the international competitiveness of their heavily export-oriented economies.

Because the United States was the largest final destination market for their exports and home of the world's reserve currency, a large proportion of these Asian reserves were invested in US dollar assets - especially US Treasuries but also corporate assets via Asia's sovereign wealth funds.

The resultant capital inflow into the US and global markets, together with the US Federal Reserve's easy money policy, kept US and world interest rates low, funding ever-increasing US and some European budget deficits and household debt.

Cheap money fuelled 'financial innovations' such as sub-prime mortgages and risky assets, which led to a crisis.

The capital flow from Asia (and other commodity-exporting economies) also propped up the US dollar and depressed Asian currencies, maintaining Asian export competitiveness, current account surpluses, and reserve accumulations, while expanding US current account deficits and national indebtedness.

US Fed chairman Ben Bernanke identified a 'global savings glut' as the cause of these global macroeconomic imbalances. With only a few exceptions, excess public sector savings in the form of persistent government budget surpluses are not the source of the high savings in East Asia, leading to the observed current account surpluses.

Japan notably runs large government budget deficits and has a huge national debt, but still exports more than it imports, due to high savings in the private sector. The basic question is: Why do East Asians save so much, particularly at low levels of income?

Demographic profile is a major reason. With the bulk of the population in the prime working-age years, and high rates of female labour force participation, dependency ratios have been relatively low, leading to high household savings and low shares of consumption in gross domestic product (GDP).

With few descendants to support them in retirement (and high life expectancy in many Asian countries), as well as weak or non-existent social safety nets, there is a high rate of precautionary savings not only for retirement, but also for health care and children's education.
Some economies - Singapore, Malaysia, Hong Kong - have forced-saving schemes or national 'provident funds' with high rates of mandatory contributions out of earned income.

Some researchers have also identified the high cost of residential property - as measured by ratios of housing prices to years of annual income that are much higher than international norms at given per capita income levels - as a contributing factor to high savings and low current consumption rates.

Underdeveloped and inefficient financial sectors in many Asian countries cause low returns for savers, requiring more savings to yield the income required for retirement.

Widening income inequality, with China, Hong Kong and Singapore now at the US levels of the Gini coefficient, also concentrates income among high-income earners who tend to be high savers.

Finally, high corporate savings are a major contributor to high aggregate national savings. In Asia, these result from a number of structural features of the corporate sector. Large, low-income China and small, high-income Singapore represent the two extreme cases, with the lowest shares of labour (wages) in national income, and consumption ratios at or below only 40 per cent of GDP, versus the Asian average of 55 per cent.

Moreover, in each case, these shares have steadily declined over the past two decades. Malaysia ranks a close third.

Both China and Singapore are characterised by high and rising shares in GDP of state-owned enterprises or government-linked corporations, and of multinational corporations - neither of which have built-in incentives to distribute corporate income where it is produced, preferring reinvestment for growth.

Multinationals are often beneficiaries of host country tax breaks or other investment incentives that reduce local income distribution, and are obligated to remit income overseas to their predominantly home-country shareholders.

Elsewhere, the private sector is dominated by closely held public companies or family-owned conglomerates, both of which have little shareholder pressure or motivation to distribute rather than accumulate and reinvest corporate income for growth and expanded market share.
Most of the causes of high Asian household and corporate savings are structural rather than policy-driven, and cannot be easily or quickly unwound by government policy.

Demographics obviously take a long time to change but have an impact when they do. As a population ages and large cohorts retire, they dissave.

Financial sector reform should help rebalancing by increasing the efficiency and diversity of financial instruments, so that less savings are required to earn a target return for the investor.

After the Asian financial crisis, this did occur in some countries, most notably South Korea. Elsewhere, banks remained dominant, becoming more conservative in their lending practices after the Asian financial crisis. Furthermore, the experience of the crisis made China reluctant to pursue capital account liberalisation.

Still, demographics and financial sector reform are probably responsible for the increased share of private consumption in GDP between 1990 and 2008 in the largely domestic private sector economies of Japan (rising from 53.2 per cent to 57.8 per cent), Taiwan (54.6 per cent to 61.4 per cent), South Korea (50.9 per cent to 54.5 per cent) and Hong Kong (57.1 per cent to 60.5 per cent).

Consumption also increased (41.6 per cent to 45.2 per cent) but remained low in Malaysia over this period.

The difference between Hong Kong and Singapore is striking, with private consumption in the latter declining from 46.3 per cent of GDP in 1990 to 38.6 per cent in 2007. This is surpassed only by the decline in China from 50.6 per cent to 36.4 per cent.

Besides the practice of running surplus government budgets in Singapore compared with Hong Kong, the decline in the wage and consumption share is probably due to the rising share of foreign labour - which, like multinationals, has an expected higher propensity to save its income for repatriation rather than domestic consumption.

The lack of a social safety net might partly explain high savings in relatively low-income China, but cannot explain continued high savings in high-income Singapore and Japan, where safety nets are adequate and financial markets relatively well-developed.

[I question the conclusion that the safety nets in Singapore are adequate. If my "safety net" is my CPF, then that safety net is based on savings. If my medisave (savings) and medishield (insurance bought with savings) and eldershield (also insurance) are part of the safety net, again they are from savings. Then it is clear why savings in Singapore is still high - because the safety nets are funded by savings.]

What about currency appreciation? In theory, this should reduce the relative share of export to domestic market production, while increasing the share of imports for consumption, thus shrinking current account surpluses and foreign exchange reserve accumulation.

However, this has not happened despite the near-continuous appreciation of Asian currencies against the US dollar over the last three decades, particularly in Japan and Singapore.

The last two decades in East Asia have seen savings' high share of GDP decline in the 'more democratic' economies of Japan, South Korea and Taiwan, but also in non-democratic Hong Kong. This is probably mostly due to demographic reasons largely beyond the control of government policy, with the exception of Singapore's migrant labour policy.

But the inevitable acceleration of ageing and retirement will eventually lead to lower savings and thus to macroeconomic rebalancing away from export production and towards domestic consumption.

Financial sector liberalisation has helped rebalancing, but is still incomplete and likely to continue being retarded by a combination of post-Asian financial crisis and post-global crisis risk aversion and ideological scepticism, nationalist objections, and resistance by domestic financial institutions to increased competition.

Witness, for example, Japan's backtracking from the proposed privatisation of its postal savings institution, South Korea's legal attacks on foreign transactions in its financial sector, and the continued dominance and even expansion of China's state-owned banks.

There is no evidence from East Asia to date that expanding social safety nets will significantly reduce savings, given that they have not done so in Japan and Singapore. There may also be governmental hesitation to do so, given ageing populations and the recent negative demonstration effect of fiscally unsustainable safety nets in Europe.

[I suspect social safety nets may have to be expanded completely in order to induce spending. People save for their homes, for unemployment, education (their own and their children), for medical and other emergencies, and retirement. If we expand the safety net to cover just medical, there is still housing, employment, education, etc. If we cover medical and education, there is still the rest to save for. Only when the safety net covers everything will people have no reason to save and every reason to spend. In other words we have to be a welfare state and then things may become unsustainable.]

Corporate restructuring necessary to reduce high corporate savings rates is likely to prove most politically intractable, requiring governments to relinquish state control of economic resources and activity.

On the other hand, the experience of the global crisis and international pressure to rebalance to prevent further crises provide a political stimulus and awareness of the need for multilateral collective action as well as national rebalancing.

The writer, a Singaporean, is professor of strategy at the University of Michigan's Ross School of Business. This is an edited excerpt of an article that appeared in Rebalancing The Global Economy: A Primer For Policymaking, edited by Stijn Claessens, Simon Evenett and Bernard Hoekman.

Jul 26, 2010
Save or spend? Two sides of the coin

We published an article by Linda Lim, a professor of strategy at the University of Michigan's Ross School of Business, last Tuesday arguing that Asian economies should save less and spend more. The article spawned an e-mail exchange between Professor Lim and Professor Tommy Koh, chairman of the Centre for International Law at NUS. We carry today edited excerpts of their exchange.

DEAR Linda,
It is with some trepidation, as I am not an economist, that I write to register my disagreement with several points in your essay.

First, you state 'Cheap money fuelled 'financial innovations' such as sub-prime mortgages and risky assets, which led to a crisis'. I beg to disagree. It is greed that led Wall Street to deceive investors with those unsound instruments.

[These two explanations are not mutually exclusive. The greed of Wall Street would have no no expression without the availability of cheap money. Cheap money lying idle were the "fuel" for financial innovations motivated by greed.]

Second, you quote United States Federal Reserve chairman Ben Bernanke as saying that a 'global savings glut' was the cause of these global macroeconomic imbalances.

Mr Bernanke's argument is self-serving and disingenuous. He is trying to blame America's creditors when the fundamental problem is America's unsustainable deficits.

Third, you argue that the reason why East Asians save so much is demographic. I do not agree. East Asians save because of our culture of thrift and out of prudence.

During the 1997-98 Asian financial crisis, if Hong Kong had not had very substantial reserves, speculators would have succeeded in bringing down the Hong Kong dollar and stock exchange.

Fourth, I agree that East Asia should spend more - but not in the way that US consumers spend.
East Asia should spend more of its savings on education and training, housing and health care, on alleviating poverty and ensuring that every Asian has access to safe drinking water, basic sanitation and a decent standard of living, on improving our environment and upgrading our infrastructure and cities.

DEAR Tommy,

Thanks as always for your careful reading of my article.

On cheap money: Its contribution to the financial crisis is not at all controversial, though both former Fed chairman Alan Greenspan and Mr Bernanke have indeed said self-servingly 'It wasn't us' - the title of an Economist magazine commentary on the tendency of central banks to deny that monetary policy had any role in the financial crisis, a patently absurd suggestion.

Greed, we have always had with us. But when interest rates are low, first, it is hard to make money via conventional means so the greedy look for extraordinary innovations; and second, the cost of capital is cheap, encouraging people to risk it playing for higher stakes.

Cheap money always leads to asset bubbles, everywhere. There was also the lack of regulation which permitted excessive risk-taking. Greed may be necessary but it is not sufficient to explain a financial crisis of such magnitude.

On the 'global savings glut': Mr Bernanke came out with this notion well before the crisis. It was an attempt to explain why the US current account and fiscal deficits - which should have been unsustainable long ago - did not prove to be so. Even today, savers around the world plough their money into US assets, which perpetuates the deficits. Why do they do this?

Because the money has to go somewhere. There is so much of it and in times of uncertainty, there is still a 'safe haven' preference for the US dollar.

On the demographic explanation for savings rates: It is uncontroversial, with a great deal of empirical research behind it.

Culture may have a marginal effect but so far this has not shown up in the research. It turns out that East Asian cultures (diverse among themselves) have savings rates that vary over time and are strongly correlated with demographic profiles and real interest rates. The same is true of other countries.

Culture is neither necessary nor sufficient as an explanation for high savings. When the Japanese and Germans age further, they will not be able to avoid drawing down on their savings to survive. The same will be true for Singaporeans.

On what Asians should spend more on: The bedrock of a market economy is consumer sovereignty, so Asians should spend on what they want. For some, it will be more food, clothing, a home of their own. For others it will be better services - health, education, etc.

Chinese economists have been arguing for some years that China should be investing its surpluses in health and education services, and not in manufacturing for export to rich foreigners or buying pieces of paper like US Treasuries or BlackRock shares. Unfortunately, since so much of China's savings is in the hands of state entities, this does not happen.

DEAR Linda,

I hope you will not be offended if I were to give a rejoinder to your reply.

First, it is wrong to blame so-called cheap money for the excesses and sheer dishonesty of Wall Street. What happened was a combination of greed and a lack of regulation.

[I believe the author has explained that greed alone cannot explain the excesses of the financial crisis. It was greed fueled by cheap money and lubricated by deregulation. Cheap money had a role. We can debate if a well-regulated sector might have had some defence but I suspect that brilliant greedy minds would have found other loopholes. Maybe.]

Under the regime of former president George W. Bush and Mr Greenspan, 'regulation' became a dirty word and 'de-regulation' a good word. But as Mr Greenspan has recently confessed, he had been wrong to assume the market could always be relied upon to regulate itself.

Second, it is very convenient for Americans to blame others for their problems. It is intellectually dishonest of Mr Bernanke - and, I regret to say, many of my intellectual friends in Washington - to blame Asia for our high savings rate and for lending our savings to America.

If American intellectuals were more willing to confront the truth, they would acknowledge that the fundamental problem is their low saving and high spending habits and their indebtedness.

This is not a new point. Many years ago, economist Henry Kaufman wrote a book warning that American families, companies, cities, states, and the federal government itself, were in danger of drowning in a sea of debt.

It is morally absurd for the world's No. 1 debtor nation to blame its self-inflicted problems on its creditors.

[Of course morally absurd. But money lenders, and casinos do the same things too. So do indulgent parents to free-spending children. The fault lies with both. In this case the fault lies with the free market, the capital market, and the amoral pursuit of the highest returns on investement.]

Third, we Asians save because it is in our culture to do so. Thrift and saving are among the Asian values which my grandmother taught me. Saving is a virtue. Spending and living beyond one's means is not a virtue but a vice.

[Culture may be one factor, but demography trumps culture. If you're old and have no income, you draw down on your savings. Regardless of your culture. If you save in spite of your need for sustenance, that's not culture. That's mental illness.]

I think it is time for Asians like me to stand up and speak the truth (with love) to Americans. They should save more and spend less. They should live within their means. And, if they do not, please do not try to make saving into a vice and spending a virtue.

Fourth, let me raise the issue of the exchange rate of the Chinese currency. The US campaign against China on this issue reminds me of another recent period in American history.

During the mid-1980s, when America was gripped by economic nationalism and protectionism, to appease the protectionists, Washington targeted Japan and the four newly industrialised economies (NIEs) of East Asia - South Korea, Taiwan, Hong Kong and Singapore. Japan was pressured into signing the Plaza Accord which substantially revalued the yen by more than 50 per cent against the US dollar.

Washington also accused the four NIEs of currency manipulation as the justification to graduate us from trade preferences. The representatives of the other three NIEs in Washington kept silent, but I asked to debate the accusers at Peterson Institute.

What are the lessons learnt? The first lesson is that US trade policy is always driven by domestic politics. The second lesson is that though the yen was substantially revalued, Japan continued to enjoy (and still does) a trade surplus with the US.

It is not the exchange rate but the saving rate that is the root cause of America's current account deficit.

DEAR Tommy,
I don't disagree with you at all. But I think you are misunderstanding the thrust and context of my argument.

It was not about the causes of the financial crisis. These have been amply addressed by many, including myself and yourself. But the world has moved on, as it needs to, from the causes of the crisis to its policy solutions.

No one - including the Chinese government - disagrees that global macroeconomic rebalancing is required. Rebalancing is not the only solution to the crisis, but it is one solution - together with financial re-regulation, and international monetary policy and banking rules coordination.

The US must indeed save more and spend less; and China and other Asian countries must save less and spend more.

What I was doing in my article was actually challenging Washington pundits, who believe it's up to China and the rest of East Asia to change their macroeconomic behaviour. I tried to show them how difficult (and perhaps impossible) that change is: Asians will not grow old faster (and thus spend more) just because Washington wants them to; state-owned enterprises and export-oriented multinational corporations have no incentive to retain earnings and distribute them in the host country; and so on. In other words, there are structural and not just monetary-and-fiscal-policy reasons for these persistent global imbalances.

It is very Washington-centric to attribute the global macroeconomic re-balancing argument to Americans only. Many Chinese economists have said the same thing - and more.

I think we need to move beyond the notion that Americans have a monopoly of ideas. They do not - hence the increasing representation of Asian voices in debating such issues. Hope we can agree on that, even if you and I (both Asians) do not agree.

Finally, I think your comments are actually an expression of your frustration with your Washington friends rather than a disagreement with the theoretical and empirical reasoning underlying my article. Or at least I hope so, since I can't do anything to change the facts.

[While I am generally impressed by Prof Tommy Koh, in this instance, I must confess to being a little disappointed in him for debating and defending a rather culturally chauvinistic position. Dr Lee argued her case very well, I thought. And I understand her point that it is structurally difficult if not impossible for the Chinese to do what the Americans want them to do.

That said, that last para was a little personal. :-)

Six months later, we have this article below on how China can spend more. But itis govt spending not private consumption although the expectation is that there will be some knock on effect from private individuals spending on their homes.]

Jan 13, 2011

China has much to gain from a public housing scheme

By Meng W. Tan
AS DEMAND in the developed economies continues to languish, the world increasingly is hoping that a burgeoning Chinese economy will pull the developed economies - and hence the global economy - out of the doldrums. The working of this reverse coupling theory rests on the premise that China, which has grown into the world's second largest economy predominantly by exporting until now, succeeds in building a sustainable internally driven growth.

Much to the world's disappointment, however, domestic consumption in China today remains relatively subdued.

At the height of the global financial crisis, the Chinese government acted decisively by pumping four trillion yuan into the economy. As the crisis evolved and external demand withered, more measures - on both the supply and demand sides - were introduced to stimulate domestic consumption to make up for the shortfall in export.

The bold rescue measures by the government succeeded in staving off widespread business failures and massive unemployment, but fell short of generating internally driven growth. Most of the increase in private consumption over the last two years has been artificially propped up by government subsidies and rebates given to consumers, and is therefore not sustainable.

However, given China's relentless push for urbanisation and economic restructuring in the years ahead, there is certainly room for its domestic economy to grow.

One way it can undergo a sustained expansion is for China to embark on a massive public housing programme.

So far, public housing programmes implemented by many local governments have achieved only limited and varied success. Only 6 per cent of urban Chinese families currently live in public housing, which includes low-rent homes and apartments with controlled prices.

The limited success can be attributed mainly to the government's hitherto emphasis on economic growth, leading local officials to focus on only economic activities that contribute to gross domestic product (GDP) growth. What little motivation left to provide low-cost housing was further eroded by corruption and by vested interests of local governments which depended heavily on land sales and private property development for fiscal revenue.

Things are set to change, however, with the resolute switch from the 'growth-at-all-costs' strategy to inclusive growth strategy as outlined in the recently announced 12th Five-Year Plan (2011 - 2015). Public housing is a key investment area in the new five-year economic plan. With that switch, career advancement of public officials will increasingly be coupled with improvement of living standards rather than growth of GDP. Local governments, for example, have been ordered to set their own goals for the provision of affordable public housing.

Already, many cities have stepped up their efforts. Shanghai's supply of public housing will increase by 25 per cent this year to reach 15 million sq m. For China as a whole, the government is projected to have built 5.8 million units of affordable housing by the end of last year. This figure is set to almost double to hit 10 million units this year. Altogether, the programme is projected to cost the government 700 billion yuan last year and 1.3 trillion yuan (S$253 billion) in the following year.

This spending will generate an explosion in demand for building materials, home furniture, and other related products and services - with the ensuing multiplier effect driving the rest of the domestic economy. Given the government's strong financial reserves, there is no doubt that this new impetus for internal growth can continue for at least the next 10 to 20 years, as China gravitates towards its target of urbanising 70 per cent of its population.

Besides generating internally driven growth, the public housing programme also provides policymakers with a powerful counter-cyclical fiscal tool to complement the currently often used monetary tools (open-market operations, interest rates and reserves ratio) to manage the macro economy.

In recessionary times, for example, the government can step up fiscal spending in the construction of public housing. Such investments certainly beat the indiscriminate construction of highways that lead to nowhere by officials keen to report higher GDP figures during the two years when the money from the four trillion yuan rescue package was being hastily dispersed.
Another macro-economic aspect the public housing programme will have an indelible impact on is asset inflation. Despite years of efforts using predominantly monetary policy tools, the runaway property prices continue to scale new heights. Government efforts have been largely unsuccessful because asset inflation in China is more than just a monetary phenomenon and therefore cannot be effectively addressed by using only monetary tools.

Given the rapid pace of urbanisation, there is indeed an insatiable demand for affordable public housing as young urbanites form new families and rural migrant workers continue to flood into the cities. As it is, the majority lower- and middle-income Chinese are deprived of the opportunity to own an apartment while the minority rich invest in high-end units which are then left vacant. Based on estimates from electricity meter readings, such empty apartments are estimated to number 64.5 million in urban China.

The fact is that private housing in China has become an investment asset even before home ownership has become prevalent.

The premature escalation of property from a roof over the head to an investment asset means that a larger proportion of the population are priced out of the market even before they have a chance to own a property. Without government intervention, the pursuit of maximum profits by private developers inevitably results in market failure which causes misallocation of economic resources.

More importantly, an out-of-control private property market polarises the society as the rich are further enriched by property investment while the poor remain poor or become even poorer. Without the government's intervention, profit accumulates in the hands of private developers, speculators and corrupt local officials. By intervening directly as a market player, two goals are achieved.

Firstly, the government provides a critical asset that everybody needs at a reasonable price and profit margin, determined based on wage growth and health of the overall economy. Secondly, the profit is redistributed in the form of housing subsidies so that more can rent or own a house and get to share in the fruit of economic growth.

Hence, the public housing programme not only generates internally driven growth directly, but it also facilitates redistribution of wealth and allows the lower- and middle-income population to spend less on acquiring a house and have more left for other consumptions. Until affordable public housing becomes a prevalent fixture in the Chinese landscape and offers a real alternative for the majority of the wishful home owners, any policy measures to curb rising home prices, redistribute wealth and raise domestic consumption are likely to be met with only temporary and limited success.

Finally, the development of public housing provides an opportunity for policymakers to revalue the yuan and speed up the restructuring of the economy.

Chinese policymakers have been unwilling to let the yuan appreciate - for fear of the social turmoil that can result from massive unemployment arising from the closure of factories whose products are made uncompetitive by a stronger yuan in the international market.

However, if the dislocated labour arising from yuan revaluation can be relocated to the public housing sector, then the government's fear of any impending social turmoil can be assuaged. This creates more room over time for the yuan to appreciate, which in turn helps to speed up structural reforms.

Inefficient producers and businesses still engaged in low value-add or polluting activities can be allowed to fail, so that resources can be re-allocated to more productive and emerging sectors.
The overdue economic upgrading will raise across-the-board wages which, together with the higher purchasing power afforded by the stronger yuan, can further help to boost domestic consumption and substantially improve the quality of living for the low-income masses.
In short, a successful public housing programme in the coming years will underpin Chinese policymakers' efforts in stimulating domestic consumption and setting in motion a sustainable and benign cycle of internally driven economic growth that economists and policymakers all over the world have been clamouring for. This internally driven growth will certainly gather momentum in the coming years. That is when the much-touted theory of reverse coupling will be put to a real test.

The writer, a Singaporean, is a PhD candidate in world economics at Nanjing University School of Business.

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