Asia’s Corporate Saving Mystery

By Anoop Singh

As Asia starts down the path to recovery, it is going to have to tackle two issues which are constraining its long-term growth potential: firms that save but do not invest and wealthy households that are reluctant to consume.

At first glance, such behavior seems inexplicable and counter-intuitive.  Let’s imagine for a moment you are an investor—you may well be— you put quite a bit of money into a company to back its expansion plans. Initially, these plans prove successful, and the company makes quite a bit of money. But then the firm ran out of investment ideas. What would you expect them to do?

Surely, you would expect them to return the money you provided, for example by paying it out as dividends. But in the past, prosperous decade before the current downturn this hasn’t been happening in emerging Asia. Firms have been sitting on their profits, not investing them, but not paying them out in dividends, either. That is a puzzle, and a problem.

It’s a puzzle because it’s not obvious why firms should sit on money when they don’t have any need for it. When firms initially started doing this after the Asian crisis of the late-1990s, they had a ready rationale. They wanted to pay down their excessive levels of debt, which during the crisis had brought some of Asia’s largest companies low. But as the years went on, and debts fell, first to safe and then to low levels, it was clear that something else must be going on.

There’s a further puzzling aspect. Economic theory states that households can “pierce the corporate veil” and extract value from a company even if it doesn’t actually pay out profits as dividends. That’s because the retained earnings would increase the firm’s net worth, which would be reflected in its share price. Households could then sell the shares, or borrow against them.

Either way, they could spend more. This theory has been tested in empirical research and found to hold in advanced countries, and some emerging markets. But it doesn’t hold true in China or the rest of emerging Asia. Households simply do not consume more, despite holding valuable financial assets.

Why does this matter? It matters because Asia’s corporate savings puzzle lies at the heart of its economic imbalances. It is precisely the substantial and growing excess of savings over investment in the corporate sector, coupled with subdued household consumption, that over the past decade has produced the region’s large external current account surpluses.

We tried to analyze this mystery in Chapter III of the Asia-Pacific Regional Economic Outlook.

We discovered two vital clues:

  • Corporate governance. The higher the level governance, the more shareholders are able to exercise their rights and prevent firms from hoarding cash.
  • Financial sector development. The more liberalized the financial market, the less firms hoard cash, because they have easier access to funding and are less worried about being shut out of financial markets. Financial liberalization also allows households to consume against their corporate wealth, because they can borrow using their financial assets as collateral.

These finding have profound implications for policy. For example, the econometric estimates imply that if Asia were to reach the average level of corporate governance in advanced economies, it would be able to lessen corporate savings by as much as 2½ percent of GDP. Similar advances in financial sector liberalization could reduce savings by 5 percentage points.

Resolving the conundrum of firms that save but do not invest, and households that hold this wealth but cannot consume may enable Asia to finally catalyze domestic demand.  It could help to  restore rapid growth, even in a “new world” of softer advanced country demand. Improved corporate governance and further financial sector development may be two remedies worth exploring.

9 Responses

  1. I really don’t understand why this is a bad thing. It’s not as if companies are literally piling away paper in vaults. When Chinese companies save, this goes into bank deposits which the banks can lend out for infrastructure improvements.
    At first glance, this behavior seems inexplicable and contrary to intuition. Imagine that you are an investor who can save some money in a company to support its expansion plans. Initially, these plans are successful, and the company made a little money. But the company ran out of ideas for investment. What do you do? Certainly, one would expect to repay the money that you have provided, for example, by way of dividend payment.
    But in the last ten years of prosperity before the current slowdown in output this was not going on in emerging Asia. The companies were sitting on their profits, not investing, but do not pay dividends, either. a puzzle and a problem, a puzzle, since it is not clear why companies should sit on the money when not needed. When companies started doing this after the Asian crisis of late the 1990′s, they had a reason–to be ready.

  2. [...] (mostly corporate) lending. This phenomenon underpins large corporations’ profitability and high savings rates, but is the root of much of the economic waste and environmental damage so common in [...]

  3. The savings glut theory in asia fails to factor one very crucial item — the sociological mindset of people in the East. We have always been a savers’ society. The West always belived in consuming and the East always saved.
    You cannot teach the man in a village not to save, but to consume. He will look at you bewildered and will be cursing you for thinking ‘bad’ about his future. This is part of the reason why gold is next to God for Indians. It’s their ultimate savior.
    Economics theories are very funny, they never consider the ground reality and never take into consideration the socio aspect of things.

  4. The Chinese excess savings puzzle, so called, is really an excess profits puzzle. That’s why it is not really a problem for Chinese capitalism — since when has having too much profit been a problem for capitalists?
    There has been strong growth in domestic consumption and investment, but profit growth, particularly since the turn of the millennium has been even stronger. That’s a result of the integration of China into the world market and the reform of the state owned sector in particular.
    In other words the increase in savings is nothing more than an increase in profits. It can hardly be claimed that China invests too much; at over 40% of GDP it already invests more than anyone else in the world. Chinese investment is only really limited by rising inflation itself, caused by raw material shortages, which are in turn a product of the rate of Chinese investment, as was the case in the middle of 2008 for example.
    At present the glut of Chinese savings/profits is underwriting the U.S. recovery. Imagine how bad the world recession would be with interest rates a few percentage points higher?

  5. 1) China doesn’t need policies to increase GDP growth. This is just not a problem right now.

    2) China does need policies (as does everyone else) to give it more stability against financial crashes.

    And in that case, not sure why saving is such a “bad” idea: without savings, you don’t have any cushion to deal with bad situations. If you are dependent on bank loans to survive, then you are in a huge mess when the banks start to crumble.

  6. It’s actually not a mystery why Chinese companies (and households) hoard cash. The problem is that they cannot be guaranteed bank loans when things go bad, so they end up with massive amounts of cash which they can spend if things go bad.

    I really don’t understand why this is a bad thing. It’s not as if companies are literally piling away paper in vaults. When Chinese companies save, this goes into bank deposits which the banks can lend out for infrastructure improvements.

    Personally, I think that given that macroeconomic theory is a mess, when macroeconomists say that China should save less and spend more, and that China is doing an obviously stupid thing by undertaking the policies that it has, then we really ought to question the assumptions of the macroeconomists.

    The problem with discouraging savings is that it assumes that companies will always be able to get funding when they need it, so when funding breaks down, you have a major crisis in the United States that you really don’t have in China. When a company in the US loses bank financing, then it has to immediate lay off workers, whereas Chinese companies have enough cash to keep workers employed while the government figures out what to do and while stimulus starts going on line.

  7. Fascinating article. Does this mean that if the renminbi appreciates, as most countries want, and China quits its peg, then the global imbalances–the ones blamed for this financial crisis–will not necessarily be rectified? The assumption of an appreciated peg is that the Chinese will consume more American goods and services and that Americans will consume less Chinese goods and services; Chinese goods/services will become more expensive and American goods less expensive on international markets. This would ostensibly ameliorate China’s vast current account surplus and America’s tremendous current account deficit. But this inveterate saving on the part of Chinese consumers and companies might very well negate this theory.

    • J. Yelapi is absolutely right. Revaluation won’t correct the global imbalances.

      This was demonstrated in 1985 by the Plaza Accord, under which the United States devalued the U.S. dollar against the Yen in the hope of correcting the trade imbalance. However, for a variety of reasons this could not work (including the fact that Japan’s financial system was set up so that credit mainly flowed to production so that there was a structural demand deficit).

      Comments on the situation (including an outline of a JPRI paper on the nature of Japan’s financial system and system of political economy) are under the section ‘An invisible clash of financial systems’ at:
      http://cpds.apana.org.au/Teams/Articles/competing_civilizations.htm#financial_systems

  8. The accumulation of excess savings (by firms / households) in countries like Japan and China probably reflects culturally-based features of the methods used for organising economic activities. This is explored at:
    http://cpds.apana.org.au/Teams/Articles/AsiaSustainable.htm#Understanding

    Economic activities tend to be coordinated by social relationships amongst elites (and their subordinates) rather than by concern for profitability. This generates substantial cash flows but not profits. So long as the cash is saved, the absence of serious concern for profitability does not matter (because there is no need to demonstrate profitability to outside investors). When there was a need to demonstrate profitability to outsiders, the result was the Asian Financial Crisis of 1997. The countries that avoided that crisis were those with current account surpluses and large foreign reserves (eg Japan and China) and others have learnt the lesson.

    Clearly these practices cause major problems for the world economy as a whole – see
    http://cpds.apana.org.au/Teams/Articles/AsiaSustainable.htm#Impacting

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