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National saving and macroeconomic imbalances in China

Weifeng Larry Liu, Ligang Song and Yixiao Zhou

China has experienced rapid economic growth since its economic reforms began in 1978. This strong growth has been accompanied by high national saving rates and persistent current account surpluses. These patterns were most pronounced during the 2000s after China’s accession to the World Trade Organization (WTO) in 2001. China’s current account surpluses have significantly contributed to global structural imbalances, drawing considerable international attention, especially after the Global Financial Crisis (GFC) in 2008 (McKay and Song 2010). The patterns in national saving and current account balances reflect internal and external imbalances in China’s macroeconomic landscape.

Whether high saving rates and large current account imbalances are problems depends critically on their underlying causes (Blanchard and Milesi-Ferretti 2009). If the patterns arise from optimal intertemporal choices such as those driven by demographic changes or temporary productivity gains, they can be desirable as mechanisms for smoothing consumption, financing investment and sharing risks. However, if they result from domestic distortions such as market friction, financial repression or fiscal misbehaviour, they may reflect deeper structural problems that warrant policy intervention.

China’s persistently high saving rates and current account surpluses can be traced to longstanding structural issues in its economy. High saving rates are symptomatic of low consumption, suggesting that rapid economic growth has not fully translated to consumption-based welfare improvement. Low consumption, combined with substantial trade surpluses, suggests that China’s economic growth has heavily relied on domestic investment and external demand. This growth strategy is not sustainable in the long run when investment efficiency wanes and external demand declines. Also, as China moves towards high-income status, its consumption remains markedly low relative to GDP compared with its high-income peers. At its current scale, China can no longer rely primarily on investment and external demand. Instead, it must shift towards domestic consumption as the main engine of economic growth. The structural problems have also exacerbated the economic challenges China has faced in the aftermath of the Covid-19 pandemic.

This chapter presents a long-term retrospective on the dynamics of China’s macroeconomic imbalances over the past five decades and explores the prospects for rebalancing the economy in the current context of population ageing, the energy transition and geopolitical fragmentation. While there are numerous studies of China’s economic growth, much less attention has been paid to its macroeconomic imbalances. Yang (2012) provides an excellent account of China’s saving and external balances from the 1980s to 2010, arguing that the high saving rates and current account surpluses are primarily attributable to a set of policies, institutions and structural distortions. This chapter extends his analysis to the present, with a particular focus on the period since 2000, when China’s accession to the WTO marked a significant step in its integration into the global economy.

Many factors can shape the dynamics of saving, investment and current account balances. This chapter focuses on long-term structural factors, including demographic change, institutional frameworks (such as social welfare systems and state-owned enterprises), market regulations (related to production factors) and key policies (such as exchange rate, trade and fiscal policies). The analysis abstracts from short-term cyclical factors such as commodity price shocks, monetary policy shifts and changes in inflation, with the aim of providing a deeper understanding of the enduring forces at play in shaping macroeconomic balances.

China’s economic development since 1978 has occurred in several episodes, each characterised by distinctive economic reforms and transformations. For narrative convenience, we divide the entire period into six episodes: initial reform and opening-up (1978–91), accelerated market reforms (1992–2000), accelerated global integration (2001–08), economic rebalancing (2009–19) and the post-Covid era (including the Covid period beginning in 2020).

The remainder of this chapter is organised as follows. Section two outlines key macroeconomic accounting relations for an open economy and presents data on major macroeconomic variables, including saving, investment and current account balances. Section three examines saving, decomposed into household, corporate and government sectors, while section four focuses on investment with a similar sectoral breakdown. Section five examines the role of institutions, regulation and policy. Section six explores prospects in the context of population ageing, the energy transition and geopolitical fragmentation, while section seven concludes with policy suggestions for economic rebalancing.

Macroeconomic accounting and data

This section starts with macroeconomic accounting. The balance of payments comprises the current account, the financial account and the capital account. The current account includes the trade balance (goods and services) and the income balance. The financial account covers direct investment, portfolio investment, other investment and reserve assets. According to the balance of payments identity, the current account balance must equal net international capital flows.

From the perspective of national income accounting, the current account reflects the difference between national saving and investment. National saving can be further divided into household saving, corporate saving and government saving. Similarly, investment can be divided into three sectors: household, corporate and government. Thus, the current account is jointly driven by the saving–investment gaps in the household, corporate and public sectors.

Therefore, the current account can be analysed from three complementary perspectives: the goods market, the asset market and the national income identity. It is important to stress that they are accounting identities, and do not imply causality by themselves. A current account imbalance can originate from a trade imbalance, which then necessitates a corresponding saving–investment gap. Alternatively, it can be driven by a domestic saving–investment imbalance, which subsequently manifests as a trade imbalance. Trade flows and capital flows are two sides of the same coin, and determining which side is driving the imbalance requires a deeper understanding of economic fundamentals and policy frameworks. For example, if a country allocates a portion of its domestic saving to purchase safe assets from abroad such as US Treasury bonds, it must run a current account surplus to finance those capital outflows. Conversely, if a country exports more than it imports, it accumulates a current account surplus and builds up foreign asset holdings.

Figure 11.1a presents the current account balance since 1980. From 1980 to the mid-1990s, the current account fluctuated significantly, reflecting a period of economic opening, trade liberalisation and investment-driven growth. In the late 1990s and early 2000s, the current account shifted into consistent surpluses, gradually increasing in line with China’s integration into the global economy and its export-oriented development strategy. The surplus peaked just before the GFC in 2008, reaching nearly 10 per cent of GDP. This period coincided with China’s accession to the WTO and strong global demand for Chinese goods. After 2008, the surplus began to decline sharply, falling below 2 per cent of GDP by the mid-2010s. The current account has since stabilised at moderate surplus levels—generally between 1 and 2 per cent of GDP—suggesting a more balanced external position amid a transition towards consumption-driven growth and changing global trade dynamics.

Figure 11.1: China’s current account and related variables, 1980–2023 (% of GDP): a. Current account balance; b. Exports and imports; c. Savings and investment; d. Consumption

Source: World Bank, World Development Indicators (databank.worldbank.org/source/world-development-indicators).

The current account pattern mirrors both the difference between exports and imports (Figure 11.1b) and the gap between saving and investment (Figure 11.1c). Saving as a share of GDP rose steadily, moving from just over 30 per cent in the early 1980s to about 40 per cent by the early 2000s. It then surged rapidly, peaking above 50 per cent of GDP around 2010, followed by a gradual decline in the 2010s. In recent years, saving has stabilised at about 45 per cent of GDP—still high by global standards. On the other hand, investment hovered about 30 per cent of GDP before 2000, with volatility during the early 1990s reform period. A sharp increase in investment began in the early 2000s, peaking around 50 per cent of GDP in 2010. After 2010, investment gradually declined, remaining slightly above 40 per cent of GDP in recent years. In addition, the pattern of consumption mirrors that of saving (Figure 11.1d). Consumption as a share of GDP followed a declining tread over the first several decades, falling to 50 per cent before the GFC, and then slowly increased throughout the 2010s.

Saving

China has maintained one of the highest saving rates in the world over the past several decades, with the national saving rate exceeding 50 per cent of GDP in the 2000s. In contrast, the United States has experienced a relatively stable saving rate of about 20 per cent over the past several decades. China’s exceptionally high saving rate has been recognised as the major driver of its current account surpluses. To understand the drivers of China’s saving rate, it is essential to distinguish between household, corporate and government sectors, as their saving behaviours differ significantly. In particular, the prominent role of state-owned enterprises (SOEs) and the strong economic influence of the government set China apart from many other economies. China’s high saving rate has been driven not only by household saving, but also by substantial contributions from the corporate and government sectors (Ma and Wang 2010). Figure 11.2a presents saving by households, corporations and the government, while Figure 11.2b shows the breakdown of consumption across households and the government.

Household saving

Household saving is defined as the difference between disposable income and household consumption, so it is closely linked to household consumption behaviour. There is a broad consensus that individuals tend to smooth consumption over time. The degree of consumption smoothing depends on factors including income expectations and uncertainty, borrowing constraints, the availability of saving vehicles and so on. At the national level, aggregate consumption—the sum of consumption across individuals—further depends on age structure and income inequality, as the propensity to consume varies across age groups and income levels.

Figure 11.2: China’s saving and consumption by sector (% of GDP): a. Saving; b. Consumption

Sources: Authors’ compilation from Chinese Statistical Yearbooks, various years (data.stats.gov.cn/english/).

Many studies examine household saving from different perspectives, including demographic change, underdeveloped social welfare systems, the transition from public to private provision of essential services (such as housing, health care and education), income inequality and precautionary motives related to income uncertainty. These explanations are not mutually exclusive but rather complementary.

Demographic change

Demographic change has been an important driver of China’s household saving rates. Declining fertility, particularly driven by the One-Child Policy, along with increasing longevity have resulted in China’s population ageing—a long-term transition that is expected to intensify over the coming decades. According to the lifecycle hypothesis, individuals tend to smooth consumption over their lifetime by saving during their prime to support their consumption in retirement when their income declines. As the population ages, aggregate saving may increase as more prime-age workers save for retirement. Increasing longevity requires individuals to accumulate more savings to support longer retirements, while declining fertility allows households to save more by reducing the financial burden of raising children. Also, income growth across generations can influence aggregate saving as a young individual would save more than an old individual spends because young generations tend to have higher lifetime incomes.

Some empirical studies show that demographic factors significantly contributed to China’s high household saving rates. For example, Modigliani and Cao (2004) argue that China’s demographic structure, of which the working-age population makes up a large share, significantly boosted aggregate saving. Bonham and Wiemer (2013) highlight that demographic change, including population ageing and declining dependency ratios, is key to shaping China’s household saving. Curtis et al. (2015) show that demographic structure with a rising share of middle-aged savers can explain much of the increase in China’s saving rate. Similarly, Ge et al. (2018) suggest that demographic change accounts for a substantial portion of the rise in household saving. Choukhmane et al. (2023) find that the One-Child Policy reduced expected old-age support from children and thus increased household saving, accounting for at least 30 per cent of the rise in China’s household saving rate. Zhang et al. (2018) suggest that rising household saving resulted from a combination of factors, including demographic change and the transformation of social welfare and job security. He et al. (2019) find that demographic change and pension reforms have contributed significantly to the rise in China’s household saving rate.

Social welfare

Social welfare can affect household saving through several channels.¹ A strong welfare system reduces household risk and shapes expectations, thus reducing the incentive for precautionary saving. Social welfare also raises disposable income through transfers, subsidies and public services, especially benefiting lower-income households who have a higher propensity to consume. A comprehensive pension system further reduces the need for retirement saving. In addition, a social welfare system redistributes income, increasing aggregate consumption by shifting resources to low-income groups.

China’s social welfare system has undergone significant changes over the past several decades. The 1990s marked a turning point, as the government dismantled the system of lifetime employment and SOE-provided welfare. As SOEs restructured or downsized, millions of urban workers lost access to job-based welfare benefits such as housing, health care and pensions. In the 2000s, China began to significantly expand its social welfare programs, including the basic pension system for both urban and rural areas, the New Rural Cooperative Medical Scheme for health insurance and various unemployment insurance schemes. Despite these improvements, China’s social welfare system remains constrained in both coverage and generosity, particularly for rural areas and informal sectors. This underdeveloped welfare system has been a key driver of households’ high saving and low consumption.

Also, the expansion of social welfare benefits has been accompanied by a rapid rise in the cost of living. The increasing cost of essential services, such as health care, education and aged care, have continued to drive precautionary saving behaviour. On the other hand, housing has been moved away from the social welfare system, making homeownership a major financial burden, further increasing household saving incentives, as discussed later.

Some empirical studies highlight the role of income uncertainty and social welfare in shaping household saving. Blanchard and Giavazzi (2005) argue that China’s high household saving rate stems from weak social welfare, limited public services and underdeveloped financial markets, which drive precautionary saving. Demographic shifts further reduce reliance on family support, reinforcing the need for households to save for future uncertainty. Feng et al. (2011) find that weaker pension coverage and reduced expected benefits after the SOE reforms in the late 1990s led to significantly higher household saving rates. Chamon et al. (2013) attribute China’s high household saving rates primarily to income uncertainty and inadequate social welfare. Ma and Yang (2013) also identify inadequate social welfare and limited pension and healthcare coverage, among other factors, as key drivers of household saving. He et al. (2018) find that the increased unemployment risk from the SOE reforms significantly increased precautionary saving among affected households, accounting for 40 per cent of their wealth accumulation between 1995 and 2002. İmrohoroğlu and Zhao (2018) suggest that the combination of increased long-term care risks for the elderly and the weakening of traditional family insurance due to the One-Child Policy accounts for half of the rise in China’s saving rate between 1980 and 2010.

Housing reform and prices

China’s housing reform in the late 1990s marked a transition from a welfare-based to a market-based system, leading to significant housing price surges in the subsequent two decades. Figure 11.3 shows housing price trends between 2000 and 2021 across different city tiers. This reform had profound impacts on consumption and saving. The expansion of homeownership was a key driver of household wealth accumulation. Households needed to save significantly for down payments and prioritised saving for future home purchases over non-housing consumption. Parents often saved aggressively to help children afford homes. The high cost of homeownership reduced expenditure on non-housing consumption, slowing China’s transition to a consumption-driven economy.

Several empirical studies explore the impacts of China’s rising house prices on household saving. Chen and Yang (2013) show that housing price increases drove households to save more, accounting for 45 per cent of the overall increase in the household saving rate between 2002 and 2007. Wang and Wen (2012) find that rising housing prices increased the saving rate by 2–4 percentage points. Chen et al. (2020) find that after China’s 1998 urban housing reform, households significantly increased their saving rates to meet housing purchase needs, especially young and middle-aged households.

Figure 11.3: China’s housing prices, 2000–21

Note: The National Bureau of Statistics of China classifies cities into four tiers: there are four first-tier cities (Beijing, Shanghai, Guangzhou and Shenzhen), 31 second-tier cities, 35 third-tier cities, and all other cities fall into the fourth tier.

Source: Qiu and Liu (2024).

The recent housing market crisis has strong implications for household saving. Housing prices have started to decline, and young generations have weaker preferences for homeownership compared with previous generations. These changes helped reduce the incentives for young generations to save. Local governments face revenue challenges as land sales slow, affecting public spending and saving.

Income inequality

Income inequality has widened significantly over the past several decades. While economic growth has lifted millions out of poverty, income disparities between urban and rural areas, between social classes and across regions have persisted (Zhou and Song 2016). The Gini index rose from 0.3 in the 1980s to 0.45 in 2010 and then gradually declined. The top 10 per cent income share rose from 27 per cent to 41 per cent during the period 1978–2015 (Piketty et al. 2019). This inequality influenced national saving because saving behaviour differs across income levels.

High-income households save excessively for investment rather than increased consumption. On the other hand, low-income households have limited access to health care, pensions and education benefits and must self-insure against risks through saving. Job instability, especially in the private sector, also leads to high precautionary saving to prepare for periods of unemployment. The growing middle class faces strong homeownership pressure, leading to high saving for deposits and mortgages. Rising education costs require substantial saving.

Several empirical studies examined the relationship between income inequality and household saving in China. Jin et al. (2011) show that wealth disparities drive precautionary saving behaviour among lower-income groups based on urban household survey data from 1997 to 2006. Chu and Wen (2017) also suggest that income inequality significantly shapes saving behaviour at both individual and aggregate levels using both household survey data and macro data.

Corporate saving

Corporate saving—defined as the value added for financial and non-financial companies minus labour compensation, production taxes, net asset payments and net transfer payments—captures firms’ retained earnings. In China, understanding corporate saving requires distinguishing between SOEs and private firms, as their behaviours differ significantly.

Zhou (2009) argues that China’s high saving rate was closely linked to its unique pattern of income distribution across sectors, where a large share of national income accrued to the corporate sector and the government, both of which tended to have higher saving propensity than households. For example, household saving remained stable at about 20 per cent of GDP over the period 1992–2007. In contrast, corporate saving surged in the 2000s following China’s accession to the WTO and reached 23 per cent of GDP by 2007, roughly doubling the level in 1992. SOEs—particularly in energy, finance and heavy industry—benefited from state support and monopolistic advantages and accumulated substantial retained earnings, reflecting a combination of high profitability and low dividend payouts.

The high profitability of SOEs was attributed to productivity improvements and market distortions of production factors. SOE reforms in the 1990s increased their competitiveness (Garnaut et al. 2006). Accession to the WTO removed trade barriers and introduced better technologies and management. Meanwhile, SOEs benefited from access to cheap production factors due to market distortions arising from China’s asymmetric market liberalisation (Huang and Tao 2010). The relaxation of worker mobility restrictions in the 1990s resulted in massive flows of migrants from rural to urban areas, creating a large pool of low-cost labour. SOEs enjoyed cheap credit due to low interest rates set by state-owned banks, which prioritised lending to SOEs over private firms. Since land is state-owned in China, SOEs could acquire land at artificially low prices—for example, in special economic zones. Also, price controls on coal and electricity kept energy costs low, further reducing production costs for SOEs, particularly those in heavy industry. In short, the combination of productivity-enhancing and cost-constraining policies increased profits, especially for SOEs.

On the other hand, SOEs were subject to weak dividend distribution requirements, which allowed them to retain a large share of earnings instead of returning them to the state or funding public spending. The excessive corporate saving of SOEs in the 2000s was thus a structural feature of the economy, rooted in institutional and governance factors rather than standard firm-level behaviour (Bayoumi et al. 2010). Corporate saving contributed to macroeconomic imbalances and highlighted the need for institutional reforms of SOEs, including taxation, social security and corporate governance, to support economic rebalancing (Ma and Wang 2010).

Private firms also accumulated savings, but for different reasons. Without equal access to credit, given the dominance of state-owned banks, private firms had to rely more on internal saving to finance investment or borrowing from the informal financial sector, paying much higher interest rates than in the formal financial sector, pushing up the economy-wide opportunity costs (Song 2005).

After the GFC, corporate saving began to moderate for several reasons. The global economic slowdown reduced China’s export growth, which was a major driver of corporate profits and saving. The demographic dividend was vanishing and wages increased quickly (Cai and Lu 2013). Land prices, particularly in urban areas, increased rapidly during the housing boom. This increased costs for firms, especially in industries reliant on land for production or development, constraining their ability to accumulate savings.

Government saving

In China, government income comes from multiple sources: value added from SOE production, returns on state-owned assets, taxes on production and income and net revenues from social insurance funds. In the 1990s, government saving stayed around 5 per cent of GDP. However, it declined sharply in 2000 due to large-scale SOE reforms, which reduced profitability and the fiscal contributions from the state sector.

In the 2000s, after China’s accession to the WTO, rapid economic growth significantly increased government revenues, particularly through increased corporate tax income. SOEs in key sectors such as energy, banking and heavy industry regained profitability, contributing to a rebound in public saving. As a result, government saving returned to approximately 5 per cent of GDP during this period. Despite increased government revenues, government saving remained relatively stable because the government increased spending on public infrastructure—in particular, a massive fiscal stimulus package in response to the GFC reduced government saving.

In the 2010s, public saving as a share of national saving continued to decline. Slower economic growth led to a deceleration of fiscal revenue growth. Also, government spending increased significantly, driven by increases in investment in infrastructure and rising social welfare spending, including pensions, health care and poverty alleviation programs. The combination of slower revenue growth and expanding social spending placed downward pressure on government saving, raising a big issue about governments’ fiscal sustainability (especially at the local level), which continues today.

Investment

China’s investment landscape has significantly transitioned from a state-dominated model in the early reform period to a mixed system in which private enterprises play an increasingly important role. China’s investment as a share of GDP has been high compared with many other economies including major East Asian economies such as Japan, South Korea and Singapore, reinforcing the earlier point that it is the high saving rather than low investment that has primarily driven China’s current account surpluses. The topic of investment has received far less attention than saving in the literature. But the role of investment is also important, especially given China’s unique economic system, in which SOEs and the government at both the central and local levels play prominent roles in shaping investment dynamics. China’s investment-to-GDP ratio was consistently lower than its saving-to-GDP ratio, leading to a pattern of excessive saving, which underscores the continued current account surpluses in China vis-a-vis the rest of the world. Figure 11.4 presents China’s investment by sector: private investment, government and SOE investment and foreign direct investment (FDI).

Figure 11.4: China’s investment by sector (% of GDP)

Source: Authors’ compilation from Chinese Statistical Yearbooks, various years (data.stats.gov.cn/english/).

Private investment

During the 1980s and 1990s, the Chinese Government gradually allowed private firms and FDI to play a limited role in investing in the economy. Special economic zones were established to attract foreign capital and private investment. In the 2000s, following China’s accession to the WTO, private investment (both domestic and foreign) surged, particularly in the real estate, manufacturing, technology and services sectors. Real estate investment became a dominant form of capital allocation for both households and businesses throughout the 2000s and 2010s, until the housing market crisis of 2021–22. The rapid increase in housing prices over the two decades fuelled further investment in housing and spurred local government investment in public infrastructure. Figure 11.5 presents housing investment in absolute terms and as a share of economy-wide investment.

In the 2010s, the private sector continued to drive investment in the manufacturing, technological and service industries. In particular, private investment in green technologies has grown rapidly due to a combination of policy support and market demand. Private companies were increasingly leading in solar energy, electric vehicles and battery storage. Meanwhile, as production costs, especially wages and housing prices, increased continuously, many low-end manufacturing industries began relocating to other developing countries, such as Vietnam and Bangladesh. The recent housing crisis after the Covid pandemic marked the end of the two-decade-long housing boom. With already high homeownership rates and unaffordable housing prices, housing demand declined sharply and private investment dramatically shifted away from real estate.

Figure 11.5: China’s housing investment: a. Investment level (RMB trillion); b. Investment share (%)

Source: Authors’ compilation from Chinese Statistical Yearbooks, various years (data.stats.gov.cn/english/).

Private investment was generally constrained by financing capacity due to the fragmentation of the financial markets (formal versus informal financial sectors) and non–market-based interest rate determination—a typical feature of financial repression (Song 2005), as the state-owned financial system was not efficient in funnelling vast savings into private firms. Despite high national saving rates, much of the capital was allocated to SOEs and public infrastructure projects, while private firms faced significant barriers to accessing credit although they were generally more productive. This financial repression limited the scope for private investment and innovation, hampering the development of domestic entrepreneurship (Son and Song 2015). As a result, excess domestic saving was not fully absorbed by the domestic economy and instead flowed abroad. These capital outflows contributed to persistent current account surpluses and the rapid accumulation of foreign exchange reserves. A significant part of these reserves was invested in low-yielding safe assets, particularly US Government bonds, which was not an optimal use of national saving.

SOE investment

SOEs have been a central topic in China’s economic transition and policy debate as ownership reform constitutes a key part of the transition to a market-oriented economy. The evolution of SOE investment was largely shaped by a combination of policy directives, financial advantages and structural reforms.

The share of SOE investment declined during the 1980s and 1990s due to economic reforms and privatisation. Many inefficient SOEs were either closed or restructured (Garnaut et al. 2005). In the 2000s, SOEs regained momentum in heavy industries such as metals, materials, machinery, automobiles and chemical products as well as infrastructure, energy and finance, as promoted by the government. The investment boom after China’s accession to the WTO was mostly driven by SOEs and FDI. As mentioned earlier, SOEs benefited from preferential access to capital through state-owned commercial banks and often operated under soft budget constraints, especially at the local level, where SOEs became tools for regional development under the auspices of local governments.

In the 2010s, SOE investment remained stable and maintained its dominant role in strategic sectors. SOEs increasingly aligned investment with national initiatives. In 2015, the government launched ‘Made in China 2025’ to boost investment in semiconductors, automation, advanced manufacturing and green technologies, with a focus on industrial upgrading and innovation. Meanwhile, the government introduced its ‘Supply-Side Structural Reform’ policy to reduce overcapacity in heavy industry. Investment in these areas was a combination of government, SOE and private sector investment, with SOEs central to the strategy and the private sector also playing an essential role, supported by government policies and financial incentives. Moreover, investment was also guided by ongoing urbanisation and environmental targets such as air pollution and climate policies, with SOEs taking the lead in areas such as high-speed rail expansion, space technology, the green energy transition and smart city infrastructure. China has now become the world’s largest investor in renewable energy products. The government also encouraged SOEs to become more efficient and competitive through mixed-ownership reforms and overseas expansion through the Belt and Road Initiative and other overseas investments that generated some positive impact on domestic structural reform as SOEs investing abroad must comply with the rule-based market environment for their operation (Song et al. 2011). At the local level, governments increasingly relied on SOEs to carry out development projects and stimulate regional growth. The developments over the past decade have reinforced the enduring and complex role of SOEs in the economy.

Government investment

The government shifted away from direct control over investment to guiding investment through policies and incentives during the 1980s and 1990s. In the 2000s, the government heavily invested in infrastructure such as highways, railways including high-speed trains and urban development—all of which were key drivers of China’s rapid economic growth. In response to the GFC, the government launched a massive stimulus package to boost investment, targeting infrastructure development.

In the 2010s, the government gradually shifted investment priority from large-scale infrastructure projects to strategic industries. Guided by initiatives such as ‘Made in China 2025’ and ‘Supply-Side Structural Reform’, public investment increasingly targeted technological innovation, advanced manufacturing, green energy and high-tech industries. This transition was also driven by growing concerns about diminishing returns from infrastructure investment, industrial overcapacity, environmental degradation and debt sustainability. Over the past decade, the government primarily acted as a facilitator rather than a direct investor, encouraging SOEs and private firms to invest in strategic industries through a range of policy tools such as subsidies, tax incentives, research and development grants, preferential access to credit and public–private partnerships.

Institutions, regulation and policy

This section examines how China’s institutions, regulations and policies have shaped the patterns of saving, investment and external balances. We begin by extending the details of our earlier discussions of social welfare systems and factor market distortions, and then turn to other key policy areas, including exchange rate policy, trade policy, fiscal policy and financial regulations. Policies and regulations in these areas were not necessarily intended to promote external surpluses but were aimed at broader economic objectives such as sustained growth, full employment and financial stability. However, large trade surpluses emerged as a by-product of these policies (Song 1996; Goldstein and Lardy 2006; Fan 2008; Corden 2009; Huang and Tao 2010).

Social welfare system

As discussed earlier, social welfare plays an important role in shaping household consumption and saving. China dismantled its system of lifetime employment and job-based welfare in the 1990s as part of its broader transition from a planned to a market economy and began expanding a modern social welfare system in the 2000s. Figure 11.6 presents China’s spending on social security with and without health care from 1990 to 2023. Spending on social security not including health care increased from 0.3 per cent to 3 per cent of GDP between 1990 and 2023 and, in absolute terms, rose from RMB5.5 billion to RMB3.9 trillion over the period. Meanwhile, healthcare spending grew from 0.73 per cent to 1.73 per cent of GDP from 2007 to 2023, bringing total spending on social security to 5 per cent of GDP in 2023.

Figure 11.6: China’s social security spending (% of GDP)

Notes: Social security spending includes spending on pensions and social welfare, social security subsidies and expenditure for retirees by the government and other institutions. Healthcare spending was not separately reported in China’s statistical yearbooks until 2007.

Source: Authors’ compilation from Chinese Statistical Yearbooks, various years (data.stats.gov.cn/english/).

Despite significant improvements, China’s social welfare system remains incomplete and faces significant challenges. Total social spending as a share of GDP was far below the Organisation for Economic Co-operation and Development average of 21 per cent in 2023 (OECD Statistics: www.oecd.org/en/data.html). Another major issue is the significant gap in welfare provision between urban and rural areas, which is maintained by the household registration (hukou) system. Migrant workers contribute to urban economic growth but have limited access to urban social welfare benefits, which discourages their consumption in cities (Song et al. 2010). Pension coverage is not yet universal and benefit levels remain relatively low, particularly in informal sectors and rural areas (Cai and Cheng 2014; Fang and Feng 2018). Many rural residents also lack access to adequate health insurance. The benefits of health insurance are often limited in scope and depth. Out-of-pocket health expenses remain high for rural residents, particularly for serious illnesses or treatments requiring travel to urban hospitals. These issues contribute to high financial vulnerability and reinforce precautionary saving behaviours by households.

Factor market regulation

Huang and Tao (2010) argue that China’s current account surplus arose from the asymmetric liberalisation of product and factor markets. While China has significantly liberalised its product markets, with most goods and services priced by market forces, the government has retained strong regulations and distortions in factor markets, including labour, capital, land and energy. These distortions effectively repressed factor costs, particularly through low land prices and inadequate social welfare contributions for workers, which in turn reduced production costs, boosted corporate profits and saving and contributed to trade surpluses resulting from improved international competitiveness.

Despite some gradual reforms in the 2010s, factor markets in China remain significantly more regulated and distorted than product markets—a structural problem that still holds today. Labour mobility continues to be constrained by the hukou system, which limits migrant workers’ access to public services and social protection in urban areas. Social welfare contributions are not uniformly enforced, particularly for informal and migrant workers. Capital markets, although increasingly open to foreign participation, are still influenced by state-led financial intermediation, with SOEs often enjoying preferential access to credit and financing at below-market rates. Land markets remain under government control, with urban land allocated administratively and rural land locked in collective ownership structures that prevent free transfers and market pricing. While energy pricing has become more market-based in recent years, subsidies and regulated prices continue to affect energy-intensive sectors. These enduring distortions continue to suppress factor costs, bolster corporate saving and indirectly support China’s external surpluses.

Financial market regulation

As mentioned earlier, China’s financial system is highly regulated and overwhelmingly dominated by state-owned institutions, which are inefficient in channelling saving into private investment. Generally, firms finance investment through external debt or equity financing. In terms of debt financing, firms can borrow money from banks or issue corporate bonds. But China’s banking system is mostly state-owned and primarily lends funds to SOEs and government-backed projects. SOEs dominate the corporate bond market, while private firms face higher borrowing costs. In terms of equity financing, China’s initial public offering (IPO) market is highly regulated, with government control over listings. As a result, it is difficult for small and medium-sized private firms to access funding, although China has made important progress in establishing platforms at both the Shanghai and the Shenzhen stock exchanges to attract investment for small and medium-sized enterprises and high-tech start-ups.

Also, China has not fully liberalised the capital account and its financial system has strict controls on international capital flows. This regulation limits the private sector (households and private firms) from investing abroad. Saving accumulates within the domestic financial system, mainly in the state-dominated banking system. Excess saving must be invested elsewhere—often abroad—primarily through government channels such as foreign exchange reserves, sovereign wealth funds and state-led overseas investment, although overseas investments by private firms have been steadily increasing over time. Figure 11.7 presents China’s foreign reserves since 1980. Reserves grew modestly until the early 2000s, and then surged rapidly after China’s accession to the WTO, peaking at nearly US$4 trillion in 2014. A sharp decline followed, after which reserves stabilised slightly above US$3 trillion.

Figure 11.7: China’s foreign reserves (US$ trillion)

Source: State Administration of Foreign Exchange of China (www.safe.gov.cn/en/).

Exchange rate policy

A country’s exchange rate policy directly affects its current account balance. An undervalued fixed exchange rate increases export competitiveness and supports current account surpluses, while an overvalued currency can lead to deficits. China’s exchange rate policy has been a focal point of public debate about its external imbalances. China maintained a dual (official and market) exchange rate system until the government unified the two rates in 1994 and then pegged the renminbi to the US dollar from 1994 to 2005 (Figure 11.8). The fixed exchange rate over the decade helped support trade surpluses, especially after China’s accession to the WTO. Increasing trade surpluses led to concerns over the renminbi’s undervaluation. The G7 and the International Monetary Fund (IMF) in 2005 called for revaluation of the renminbi and urged China to allow greater exchange rate flexibility. In response, China moved towards a more flexible exchange rate system, allowing the currency to appreciate gradually against the US dollar (or a basket of major currencies). This shift aimed to address trade imbalances and respond to international pressure. After the GFC, China allowed greater flexibility in the exchange rate, with more market forces in the exchange rate markets. China has also moved towards internationalising the renminbi, which became part of the IMF’s special drawing rights basket in 2016. The government has also implemented reforms to open its financial markets (including both equity and bond markets) to foreign investors.

Figure 11.8: China’s nominal exchange rate (RMB per USD)

Source: State Administration of Foreign Exchange of China (www.safe.gov.cn/en/).

China’s exchange rate policies are often aligned with broader economic objectives. While promoting exports is frequently highlighted in public debates, the policies also aim to balance multiple goals, including maintaining short-term financial stability, managing inflation and capital flows, supporting renminbi internationalisation and reducing trade tensions.

Some studies argue that it is not realistic to expect a more flexible exchange rate regime to automatically correct the current account imbalance. Yu (2007) cautions that exchange rate reform alone is unlikely to lead to significant reductions in China’s current account surplus, arguing that structural factors play a more decisive role than currency appreciation. Chinn and Wei (2013), using a panel dataset of 170 countries over the period 1971–2005, find no strong, robust or monotonic relationship between exchange rate regime flexibility and current account reversion. Woo (2006) argues that trade surpluses are more effectively addressed by the establishment of an efficient financial intermediation mechanism than by currency appreciation. Similarly, Goldstein and Lardy (2008) argue that exchange rate policy alone is unlikely to be effective in solving external imbalances. Similarly, Ma et al. (2013, 2016) argue that while appreciation of the renminbi can help rebalance the economy by reducing net exports, exchange rate adjustment alone is insufficient. Rather, sustainable rebalancing requires structural reforms such as improving the social safety net, reforming the financial system and encouraging household consumption to address the underlying causes of China’s high saving rate.

Trade policy

China has pursued export promotion policies since its economic reform. Before its accession to the WTO in 2001, China practised a combination of export-promoting and import-restricting policies through tariffs, quotas and import licences (Yang 2012). After China’s accession to the WTO, trade barriers fell dramatically, increasing the profitability of firms. A large fraction of profits was either saved in the corporate sector or collected by the government as revenue.

China’s export policy has evolved through three stages, reflecting its economic development and integration into the global economy. Before 2000, China promoted exports by establishing special economic zones, reducing tariffs and trade barriers, attracting FDI and joint ventures, providing export tax rebates, low-interest loans, subsidies, preferential land deals and infrastructure support, alongside exchange rate polices. China’s accession to the WTO further liberalised its trade policies by systematically reducing trade barriers, leading to significant increases in trade surpluses during the 2000s. After the GFC, China gradually moved away from low-cost manufacturing and rebalanced its economy from international trade to domestic consumption and technological innovation. The Belt and Road Initiative, launched in 2013, expanded China’s trade network and infrastructure investments in developing countries. More recently, initiatives such as ‘Made in China 2025’ enhanced exports in high-tech industries like semiconductors, automation and green technology products (solar panels and electric vehicles).

International trade has shifted from traditional simple exchanges of final consumption goods to more complex global value chains (GVCs), in which production is fragmented across countries, thanks to technological advancements and trade liberalisation, among other factors. China plays a central role in GVCs. A significant fraction of China’s trade surplus over the past two decades came from processing trade, in which intermediate goods are imported, assembled and then exported as finished products. This export model inflated China’s gross trade surpluses, while much of the value added originated from other countries. China’s move up the value chain increased the trade surplus and strengthened its net export position.

Rising geopolitical tensions and supply chain disruptions during Covid-19, together with rising labour costs, have diverted some low-cost manufacturing firms away from China, resulting in a slowdown in exports of low-cost manufacturing products. But China’s exports of high-value manufacturing goods have increased in recent years. China’s manufacturing exports have continued to account for about one-third of the world total.

Fiscal policy

Fiscal policy comprises two components: revenue and expenditure. In China, tax and land-related revenues have been the main sources of government income, with local governments heavily reliant on land sales and fiscal transfers from the central government. Government expenditure includes public investment, social welfare and transfer payments, debt servicing and policy instruments such as subsidies, grants and incentive programs.

The current account balance is the sum of the private sector balance and the public sector balance. The longstanding twin-deficit hypothesis suggests that a fiscal deficit is often associated with a trade deficit. If the government borrows more, it will increase domestic demand, which can increase imports and worsen the trade balance. If the deficit is financed by international capital flows, it can appreciate the domestic currency, further widening the trade deficit. This relationship is not always one-to-one but depends on the dynamic changes from exchange rate policy, monetary policy and international capital flows.

Fiscal policy can influence national saving and current account balances through expenditure. Government investment, as discussed above, is a key component of fiscal policy. An increase in public investment directly reduces public saving and thus national saving, which in turn reduces current account surpluses. Higher spending on social welfare can boost domestic consumption and thus reduce household saving and further narrow trade surpluses. In addition, fiscal instruments such as subsidies and tax incentives (including those targeting international trade and broader distortions in factor markets) change the relative prices of exports and imports, thereby influencing the current account balance.

On the revenue side, the tax system plays an important role in shaping income distribution, which in turn influences income inequality, aggregate consumption and national saving. A more progressive tax system can reduce income inequality by redistributing income from high-income to low-income households, who tend to have a higher marginal propensity to consume. This redistribution boosts overall consumption and may reduce household saving rates. At the same time, corporate tax policies affect firms’ retained earnings and investment decisions, thereby influencing corporate saving. The structure of both personal and corporate taxes has important implications for the composition and level of national saving, as well as for broader macroeconomic imbalances.

Prospects

China’s national saving and current account balances are expected to continue shrinking over the coming decades. The decline in the saving rate reflects structural shifts in the economy, including population ageing, evolving consumption patterns, less public investment and rising public debt. As the saving rate declines, the current account surplus will likely narrow further.

A major factor contributing to the projected decline in China’s national saving is its rapid population ageing. According to the United Nations’ 2024 World Population Prospects (population.un.org/wpp/), the elderly dependency ratio in China is expected to increase dramatically, from about 15 per cent today to nearly 50 per cent by 2050. This demographic shift implies that a shrinking share of the working-age population will support a growing elderly population. As more people enter retirement, they will begin to decumulate their savings to finance consumption, leading to a structural decline in aggregate saving. Also, the ageing population will place increased pressure on public pension and healthcare systems, raising the fiscal burden on the government.

China has been expanding its social welfare system. If the government continues to move towards levels of social welfare like those in advanced economies, rising expenditures will place upward pressure on fiscal balances and thus reduce government saving. On the other hand, as social welfare improves, households may reduce precautionary saving, leading to a decline in household saving rates as well. Such structural increases in public spending may also necessitate tax reforms or reallocation of fiscal resources, given that China has already accumulated significant public debt, particularly at the local level (Wong 2024).

Shifts in the consumption–saving preferences of young generations are also expected to reduce household saving rates. Unlike previous generations, young Chinese are more inclined to spend than save, driven by improved access to credit and changing lifestyles, and less concern about old-age security due to expectations of social safety nets. This behavioural shift will reinforce the downward trend in national saving.

The housing market, which has long been a cornerstone of household wealth and saving behaviour in China, has been experiencing dramatic structural change in recent years. With homeownership already near saturation and housing prices peaking around the 2021–22 housing market crisis, the role of real estate as a store of value and a saving vehicle is diminishing. Future declines in property prices would further weaken household saving incentives. In addition, government revenues, particularly at the local level, have been heavily reliant on land sales and housing-related taxes. As the real estate sector contracts, this revenue stream is shrinking, thereby reducing government saving.

China’s ‘dual circulation’ strategy, introduced in 2020, emphasises strengthening domestic consumption (internal circulation) through building an integrated domestic market while maintaining openness to global markets (external circulation). This strategic pivot aims to rebalance growth drivers by reducing reliance on external demand and investment-led growth. Over time, this shift could reduce the trade surplus and change the composition of exports and imports.

Ongoing geopolitical tensions, particularly with the United States, may have long-term implications for China’s trade relationships and supply chain integration. These disruptions may lead to a more fragmented global trading environment, further constraining China’s external balances and reducing its reliance on export-led growth.

Nevertheless, China remains well positioned to expand in high-value export sectors such as green technologies. As the world transitions to low-carbon energy systems, demand for Chinese electric vehicles, solar panels and battery technologies is expected to grow. This could partially offset the decline in traditional manufacturing exports and support external balances, even amid broader headwinds from rising trade protectionism.

Conclusion

China’s persistently high national saving rates and large current account surpluses have long reflected underlying structural imbalances in the economy, particularly the low levels of domestic consumption as a share of GDP. While China’s rapid economic growth over the past few decades has lifted millions out of poverty and transformed the country into a global economic powerhouse, this growth has not been fully translated into consumption-based welfare improvements for households. Instead, a disproportionate share of income has been directed towards investment and net exports, rather than household spending.

The long-term macroeconomic imbalances stem from deep-rooted institutional, policy and structural distortions. Factors such as incomplete social welfare systems, constrained labour mobility, distorted factor markets and underdeveloped financial markets have suppressed consumption and encouraged excessive precautionary saving. Traditional macroeconomic policy tools have become increasingly less effective and less sustainable as mechanisms for promoting balanced growth.

Going forward, more sustainable and inclusive long-term growth in China must be driven mainly by domestic consumption and should aim to enhance household welfare more directly. This transition will require a strategic rebalancing of the economy from investment-led and export-led growth to consumption-led development. Such a shift is not only necessary for improving the quality of growth and the welfare of people, but also for ensuring economic resilience with an ageing population and growing global uncertainties.

Achieving this transformation will depend critically on broad-based policy and institutional reforms. These should focus on reducing structural distortions, better integrating domestic markets and fostering a more equitable distribution of income. Strengthening social welfare systems, including pensions, health care and unemployment insurance, can reduce the need for precautionary saving, while policies that boost household income, particularly for rural and low-income populations, and urbanise migrant workers will directly support consumption. Together, these reforms are essential for building a more balanced, welfare-enhancing and sustainable economic model for China’s future.

Acknowledgements

Weifeng Larry Liu acknowledges financial support from the Australian Research Council Centre of Excellence in Population Ageing Research (CE170100005) and the Australian Centre on China in the World.

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1. 1 Various terms are used in the literature to refer to state-provided support systems, including social welfare, social safety net, social security, social insurance, social protection, etcetera.