Financial Repression and the One-Child Policy
I recently left a comment on Paul Krugman's blog post on financial repression in China. Krugman wrote:
I have no idea whether this John Hempton piece on China is at all right, but it’s a terrific read, and provides food for thought.
Hempton basically argues that China has turned financial repression—controlled interest rates on deposits, which ensure a negative real rate of return—into a giant engine of kleptocracy. The banks extract rent from depositors, transfer those rents on to state-owned enterprises in the form of cheap loans, and then the Party elite essentially embezzles the money. Underlying the whole system is a high savings rate that Hempton attributes to the one-child policy.
China certainly has financial repression, which imposes a massive tax on the household sector. But negative real deposit rates began after 2003 and the household savings rate turned up at about the same time. If the savings rate was truly linked to the one-child policy the uptick in household savings should have occurred long before the middle of the last decade.
More likely, financial repression is explained by China's currency policy; the exchange rate was significantly undervalued by 2003. As Barry Eichengreen has pointed out, countries with undervalued exchange rates typically have low interest rates.
Krugman finishes the piece with the following thought:
Actually, if he’s right about the demographic underpinnings, there’s a time bomb lurking in the system quite aside from his concerns about inflation running too hot or too cold: eventually, and as I understand it fairly soon, those older Chinese who have been frantically saving because they don’t expect enough grandchildren to support them will become net dissavers, pulling money out of the banks to live on. And then, if his basic story is right, the whole system implodes.
This is likely to be a nonissue. While the aging trend in China is rapid, changes in the savings rate will be much less so. The savings rate will likely fall in the future as the proportion of retirees increases, but this process of adjustment will occur over years and decades rather than through a sharp decline.
For more detailed discussion of financial repression in China see the introduction [pdf] to my latest book, Sustaining China's Economic Growth after the Global Financial Crisis.