Chapter 7. Origin and Development of the High
7.9 The First-generation Effect of Savings
Savings and consumption are a union of opposites. If the rapid eco- nomic growth lasts for several years, the savings rate will face two aspects of influence. First, the increase in the national income will allow people to save more money. Second, the purpose of the eco- nomic development is to improve people’s standard of living. To stim- ulate the production enthusiasm, people’s standard of living should be gradually improved in the process of economic growth. However, the increase in people’s level of consumption will certainly reduce the savings ratio. The combination of these two aspects of influence may cause the savings rate to first rise and then drop. The gap between the periods of the rise and the drop of the savings rate is relatively broad, during which the savings rate is maintained at a high level without the influence of other variables.
Rostow’s theory of stage of economic growth explains the occur- rence and change tendency of a high savings rate.36 He divides
36See Rostow (1990). The Stages of Economic Growth.
Origin and Development of the High Savings Rate 225
economic growth into five stages, namely, traditional society, pre- conditions for take-off, take-off, drive to maturity, and age of high mass consumption. In the traditional society, people have very low income and level of consumption; therefore, solving the problem of food and clothing, especially saving money, is difficult. The high sav- ings ratio is impossible to occur at this stage. Before the take-off, the savings ratio is most likely at a low level. In the take-off period, the savings rate gradually rises with the per capita GDP growth. In other words, savings grow faster than consumption. The economic take-off (rapid growth) requires a large number of investments for the large-scale construction of factories and infrastructure and the improvement of traffic and communication. These funds must come from savings. Only a high savings rate can ensure the large invest- ment necessary for the economic take-off. Therefore, the high savings rate is a necessary condition for the take-off.
The savings rate reaches its peak during the take-off stage. Savings and consumption almost grow at the same speed, and the savings rate remains unchanged. The savings rate highly fluctuates for a period of time, which is the basic characteristic of the drive to maturity stage. The high savings rate will remain constant for approximately 20–25 years. Finally, consumption grows faster than savings, and the savings rate begins to drop year after year. The age of high mass consumption follows. Afterwards, the savings rate gradually returns to the normal level.
Rostow’s theory of the stages of economic growth does not pro- vide the quantitative concept of each stage. This book attempts to quantitatively divide Rostow’s stages of economic growth according to the changes in savings rate. In the take-off stage, the savings ratio increases with the per capita income; therefore, the savings ratio is positively related to the per capita GDP growth rate. In the drive to maturity stage, the savings rate is not related to the changes in the per capita GDP and is always maintained at a high level. When entering the age of high mass consumption, the savings ratio becomes negatively related to the change in the per capita GDP. With the per capita GDP growth, the savings rate gradually declines and tends to remain at a relatively stable level (Figure 7.2).
226 From Trade Surplus to the Dispute over the Exchange Rate
GDP per capita
Saving rate
Time GDP per capita
and saving rate
The Preconditions for take-off The Traditional
Society
The take-off stage
The drive to maturity stage
The high mass consumption stage
Figure 7.2: Rostow’s five development stages.
The introduction of the results of psychology and sociology into economic research may explain why the savings rate rises first and then drops in the process of economic growth.
A person’s values are formed in his/her youth. People’s consump- tion habits are closely linked to their household living conditions when they were young. Children from poor families are generally thrifty, whereas those from rich families are often lenient with money.
Therefore, the social and family environment contributes to a per- son’s life habits. During adulthood, people’s consumption behaviors still have a large inertia. Whether in modern or ancient times, the entrepreneurial generation starts from scratch and struggles hard.
Even if these people become rich, they remain hardworking and thrifty. This kind of phenomenon is known as the first-generation effect in welfare economics.
A large number of statistical data have proved that people usu- ally form their consumption behavior in their youth. Once formed, most people will maintain their consumption behavior regardless of whether their income or wealth changes. A luxurious lifestyle does not necessarily increase their enjoyment or improve their qual- ity of life. Although several exceptions can be considered, from the
Origin and Development of the High Savings Rate 227
perspective of a social group, the great inertia that people maintain on consumption prompts them to choose their way of life.
For example, the oil magnate John Davison Rockefeller is usually asked why he prefers staying in a cheap motel while his son stays in a five-star hotel. Rockefeller replies, “. . . because my father is poor, but his father is rich.”
People aged 16–60 years comprise the majority of the social labor force and are the main depositors. Before take-off, majority of the residents in developing countries live in a poor state. With limited purchasing power, they are used to living a simple life. However, along with the economic take-off, they have acquired an increasing amount of wealth and their income increases gradually. People who simply disregard poverty are satisfied with the gradually improving living standard. Although their income has been enough to support their high living standard, inertia prompts them to retain their orig- inal consumption behavior. Second, most residents still recall their poor life in the past and are thus more inclined to increase their savings to avoid experiencing the same difficulties again.37 Third, in countries where the economic take-off has recently started, the service industry is still too undeveloped to provide high-grade and diversified consumption choices, which are conducive to the maintenance of a simple lifestyle in the society. Therefore, during the take-off stage, the proportion of consumption in the GDP is maintained at a low level, and the savings rate of the entire society is remarkably high.
All parents are admirable. They are willing to do everything for their children and hope for them to live happily. The entrepreneurial generation remains thrifty when buying things for themselves, but they are generous when spending money for their children. This sit- uation is common in almost all families. With the rapid economic growth, people are able to provide more comfortable living conditions for the next generation. However, the consumption behaviors of the
37Several studies propose that consumption lags behind income growth because people easily adapt from a life of frugality to that of extravagance but experience difficulties in adapting from a life of extravagance to that of frugality. They would rather maintain their original consuming habits to avoid being forced to reduce their consumption level one day. See Carrollet al.(2000).
228 From Trade Surplus to the Dispute over the Exchange Rate
new generation, who grew up in the process of take-off, are different from those of their parents. They do not worry about food and cloth- ing and have more money to dispose. With the development of the economy, a large number of foreign goods and consumption patterns are introduced to China. The rapidly developing service industry provides more consumption choices for the young generation. With the common phenomenon of “keeping up with the Joneses” in con- sumption in developing countries, the new generation has a higher propensity to consume. As a result, when the first entrepreneurial generation maintains their low consumption, the next generation gradually lives from paycheck to paycheck or lives off their parents.38 Over time, the first generation gradually retires, and the second gen- eration grows and gradually becomes the main body of the society.
Eventually, the savings rate of the entire society will decline.
This effect has been confirmed by Japan and the four Asian eco- nomic giants. Historical data show that residents’ marginal propen- sity to consume varies across different economic development stages.
The level of consumption of the young generation is generally higher than that of their predecessors. During the economic take-off stage, the savings ratio is always remarkably high. However, this situation lasts only for 20–30 years, which corresponds to the period of a gen- eration, and then falls gradually to reach nearly the same level as that of other countries.
In fact, Chinese residents’ marginal propensity to consume is improving. The Chinese people do not necessarily change their con- sumption habits, but the composition of the residents changes. The proportion of the young generation that has not experienced eco- nomic difficulty progressively increases in the society, resulting in the increasing marginal propensity to consume of the entire society.
Based on the development trend, the situation of high savings and
38The former refers to those who spend all their wages every month, and the latter refers to some young people who not only spend their own income but also ask for money from their parents. In 2012, many graduates working in the cities earned less than 3,000 yuan per month on average but lived in a house in Beijing and Shanghai with a rental fee worth nearly 2,000 yuan. Therefore, the graduates usually spent all their wages every month.
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low consumption will not last, and the savings rate of China will most likely gradually drop.