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Many important stats from China today:

Fixed-asset investment in urban areas rose 26.6% in the January-February period from a year earlier. That’s the slowest growth rate in a year, and down from the 30.5% expansion for all of 2009.

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US personal income rose 0.1% in January, following average monthly gains of 0.33% in the previous 3 months. During the last 3 and 6 months, personal income growth hovers around 3.0% annualized. Year-over-year, personal income is up 1.1%, the first positive YoY growth rate since December 2008.

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China recorded its widest rural-urban income gap last year since the country launched its reform and opening-up policy in 1978.

The urban per capita net income stood at 17,175 yuan ($2,525) last year, in contrast to 5,153 yuan in the countryside, with the urban-to-rural income ratio being 3.33:1, according to the latest figures from the National Bureau of Statistics.

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A wave of disappointing economic news is beginning to hit. We have been warning for quite some time that the February blizzards would depress activity during that month. Even the consumers’ mood was impacted by the weather. According to the Conference Board, the index of consumer confidence fell more than 10 points in February, the worst decline in a year.  Why is the impact so large?

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Volatility remains elevated. ICSC says that last week’s 1.4% jump was weather and Super Bowl related.

Heavy weather tripped a stock-up effect for groceries…

…was given a boost by a calendar shift for the Super Bowl.

Single-copy sales declined 9.1% (during the 2nd half of 2009) at the 472 publications reporting to the ABC. Those results follow 18 months during which newsstand sales tumbled at a quickening pace—6.3% in the first half of 2008, 11% in the second half of 2008 and 12% in the first half of last year.(…)

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For many economists and observers China is an accident waiting to happen. They argue that the Chinese government has created huge imbalances with policies favoring short-term economic measures such as infrastructure spending at the expense of longer-term, more lasting, policies aimed at boosting domestic consumption.

To the contrary, Chinese officials have planned it almost perfectly. In addition, Chinese personal savings rate is peaking and will be declining steadily in coming years, providing policymakers with another powerful tool to manage the economy exactly at the time when China’s export clients are entering an extended period of subdued growth.

China’s economic stimulus has helped save the world in 2009. China may have accounted for as much as 2 percentage points of annualized growth in world output in Q2 2009 alone. In effect, more than 70% of China’s 2009 $585B stimulus package was  earmarked towards infrastructure expenditures. For many, this will only exacerbate imbalances,  eventually leading to economic catastrophe.

With proper perspective, however, we must admit that China’s economic performance during the last 15 years has been nothing but remarkable, particularly its achievement of strong and stable economic growth coupled with reasonably low and stable inflation rates.

There are two main reasons for this achievement. First, the Chinese government has a very strong and quick hand in most levers throughout the economy. The elephant has been able to turn on a dime. Secondly, policymakers have simply been outstanding in choosing the right policies at the right time. This cleverness, combined with the ability to rapidly and effectively implement decisions have made it possible for the government to pilot the country’s economy with great stewardship.

Chinese Savings

Chinese officials know that Chinese people are big savers. Contrary to the US, where the savings rate is near zero, Chinese workers save nearly 30% of their income and, surprisingly, this proportion has been growing even as income rose. It would therefore have been totally inappropriate and futile to base the 2009 stimulus efforts on policies aimed at throwing money to the Chinese consumer like the US and most Western countries have done.

The other thing that Chinese officials know is that this propensity to save, although rooted in confucianism, is actually highly pragmatic and can thus be changed. An IMF working paper on this matter sums up the reasons behind Chinese savings habits:

China’s low household consumption, or equivalently high saving, is often linked to precautionary motives. Government health, education, and pensions systems are underdeveloped, leaving individuals to bear a large share of the costs. As a result, households build up saving to cover these expenses, as well as to self-insure against uncertainty, especially regarding future health and pension needs.

The authors of the paper conclude that

government spending on health, but not on education, has an impact in reducing urban household saving. The impact, moreover, is large. A 1 yuan increase in government health spending was associated with a 2 yuan increase in household consumption.

Health vs Education

Yet, the Chinese government has strongly favored spending on education is recent years. While this may initially appear ill-advised, I see it as very clever planning.

Health is strongly correlated with economic well-being which, in turn, is powerfully influenced by education. Favoring education over health in the early years should meaningfully increase the health of the Chinese people in coming years. Not only will Chinese live in better material conditions, their higher education will help promote better eating and living habits.

Wensheng Peng, head of China research at Barclays Capital, makes the point:

Many Chinese residents heat their homes with gas canisters because there are no pipelines. Some have no sewerage or running water. Much else, beyond such basic needs, can be built. Take the high-speed railway now strung across the nation. Within a few years, it will connect 70-80 per cent of Chinese cities with a population over 500,000. In terms of travel times, the entire country will shrink by three-quarters. Shanghai and Beijing will be five hours apart. There will be potentially enormous productivity gains.

In its 11th five-year plan (2006-11), the Chinese government clearly set its goals:

With the implementation of the 11th Five-Year Plan, public services will be further improved. Public services for urban and rural residents, such as compulsory education, public health, social security, public culture, will be improved substantially both in quality and quantity. Average education for citizens will be increased to nine years. Urban citizens covered by basic pension will be increased to 233 million and the penetration rate of new rural cooperative medical care will be over 80%.

The Chinese government is on the ball: central government spending on health care is estimated to have increased 48% in 2009, almost twice the rate for spending on education. A 2009 World bank study agrees with Chinese policymakers’ decisions:

The reorientation of government spending toward the poorer rural areas and increased efficiency in the delivery of public health care will be key factors in improving health outcomes and impacting consumption behavior.

Confucius and Chinese Savings

During a 2004 trip to China, my many discussions with Chinese citizens, businessmen and government officials revealed another aspect of Chinese propensity to save: Chinese children have the obligation to take care of their elderly parents. This dates back to Confucius’ “xiào” which instructed adult children to take respectful care for their aged parents. In modern China, xiào is considered a cardinal virtue of a moral person and an integral part of what constitutes a good citizen
.

This Confucian tradition of seeing one’s taking good care of one’s aged parents as a moral duty has been not only reflected in the Chinese moral life but also in the practice of the Chinese laws from the beginning. For example, according to the Chinese Marriage Law, adult children’s moral duty of taking respectful care of their aged parents is defined as:

Children have an obligation to support and to assist their parents….. When children fail in such duty, parents who cannot work or have difficulty with their living have a right to demand alimony from their children.  (James Wang)

A young Chinese guide said at the time that she was saving some 40% of her income to prepare for this eventuality, and that this was a pretty common behavior among her generation.

As the Chinese government gradually improves and broadens the health care system and sets better safety nets for the poor and the elderly, it will lessen its citizens’ moral duties, thereby freeing savings towards consumption.

Life Insurance and Chinese Savings

Meanwhile, another significant change has been rapidly developing, looping together education, health, savings and consumption: life insurance and institutionalized savings.

Chinese working youth, being better educated and informed, increasingly rely on the rapidly growing life insurance industry to help them procure for their obligations towards elder parents using a much smaller part of their current income. Life insurance products also contribute to rural Chinese decision to move to the city:

The people who leave their villages also leave behind the traditional family roles that call for the family to stay together and the young to care for the aged. Once that tradition is broken, people who have left the village need to find new ways to fulfill their obligations, and insurance is one popular answer.

In all, the stage appears set for the next major leg in China’s economic expansion as domestic consumption will greatly benefit from the forthcoming inevitable decline in savings rates. This will provide Chinese authorities with another powerful tool to manage the economy if, as and when infrastructure spending  and, more importantly, export revenues slow down. China will thus further insulate itself from the vagaries of its trading partners.The next 2 charts from the IMF illustrate the point.

Charts from the IMF

Related post:

CHINA’S COMING CONSUMPTION BOOM

Amid declining employment, work week and hourly earnings and faced with a record debt level, the US consumer was hard pressed to maintain the right balance between spending and saving in order to help sustain the economy while restoring its balance sheet through higher savings. Recent data show that Americans did just that.

Wages and Salaries remain very weak but the apparent improvement in the labor market raises hopes that labor income will soon start rising at a faster pace.

Government safety nets like Transfer Payments and lower income taxes have played their role during the downturn but need to be relieved by rising labor income.

Thanks to the significant government transfers and lower income taxes, PDI has been rising steadily throughout 2009.

The rise in PDI enabled Americans to triple their savings without curbing consumption. In fact, November PCE exceed their June 2008 record level.

This is a pretty remarkable achievement! Here is the math between August 2008 and November 2009:

Wages and Salaries dropped $216B in 15 months, or 3.3%, but higher transfer receipts and lower income taxes totaling $720B enabled Personal Disposable Income to rise by $326B, or 3.0%, during the most severe economic contraction since the Depression.

Americans maintained their expenditures and saved the remaining $340B. Is this the “new normal”, the era of frugality expected by many observers? These numbers suggest not. Americans are not ready nor willing to reduce their standard of living, as long as Congress obliges.

What about 2010?

Employment is the key. The good scenario is that employment levels begin to rise as the bailout money dries up. Savings rates stay around the 2009 average of 4.6%. Higher income taxes, inevitable to pay the 2009 bailouts, are delayed to 2011, enabling PDI and PCE to rise 2.5-3.5% with little inflation.

The bad scenario is… very bad. Employment does not pick up and the bond vigilantes force rates up forcing Congress to focus on the deficit. Higher taxes are announced for 2011 and beyond and consumers increase their savings rate beyond 5.0%. The Fed can’t do much more.