Those thrifty Chinese companies (and households)

chinaflag.gifA lot has been and is being said about the Chinese economy's overheating and the pressure on the rmb(the Yuan) to appreciate. In the past week I have indulged myself in the question of whether the Chinese economy in fact was overheating and also I have mused about the pressures on the rmb. For this one, let us re-coup the source of this almost gravity defying growth rates in China ...

(From the FT) 

'The key driver of the economy remains investment, which rose by 30.8 per cent in the second quarter year-on-year, as companies ploughed their earnings back into new projects and local governments spent funds in search of grassroots growth.'

In economics we know that investment can only come from postponing consumption - i.e. savings. So let us look a bit more closely here ... luckily this week's edition of the Economist has a thoughtful article on this (walled for non-subscribers).

Companies don't pay dividends ... particularly the state-owned enterprises (SOEs) are under the loop.

'Imprudent banks, aggrandising officials, avid foreign investors; many culprits are blamed for China's overheating economy. Yet those most responsible are rarely fingered: Chinese companies. The country's firms' investment in fixed assets was up by a cracking 35%, year-on-year, in June. This pace does much to explain the country's rapid GDP growth, of 11.3% in the year to the second quarter.

This investment is largely financed by companies' retained earnings: indeed, firms, not China's thrifty households, are now the country's biggest savers (see chart). Both the rate of retention and the furious pace of investment could be cut if companies were made to pay dividends. At the moment, China's state-owned enterprises (SOEs), which most of the biggest still are, do not pay dividends to their main shareholder, the state.'

Chinese state owned enterprises (SOEs) are making money again and as the article reports ... 

'Extracting some of that profit in the form of dividends would force these firms to be more circumspect in how they spend the remainder, improving capital allocation and cutting back the wasteful investment and overcapacity so prevalent in China.


In fact, the World Bank points out, if even half of SOE's 2004 profits, estimated at 6.5% of GDP, had been spent on education and health, government spending in those areas would have been 85% higher. Such a boost—enough to waive all school fees, nationally—might persuade ordinary citizens to save less and spend more, leading to the rebalancing of consumption and investment that policymakers have long sought.'

Breaking up the measures of thrift thus tells an important story here I think but apart from the companies lack of dividen payout the households' relatively high savings should not be neglected here as they also are part of this interesting equation which makes up the Chinese economy.