"Life Cycle" Hypothesis of Saving: Aggregate ... - Arabictrader.com

6
THE CHINESE SAVING PUZZLE AND THE LIFE-CYCLE
HYPOTHESIS
Franco Modigliani and Shi Larry Cao
1 Introduction
With today’s world economy plagued by recession and sluggish performance,
China stands out with its sustained high growth, perhaps due to market-oriented
economic reforms that began in 1978. The growth has been accompanied by an
explosion in China’s household saving ratio, which has reached an impressive
level in recent years, just when there has been a worldwide reduction in the
private saving ratio. In 1994, for example, our estimate of the household savingto-income
ratio in China was close to 34 percent, rivaling the Japanese experience
in the 1960s, even though the level of China’s per-capita income remained
well below those of the industrialized nations (see figure 6.1). More surprisingly,
looking back at the postwar history of Chinese household savings, one finds that,
from the 1950s through the mid-70s, the “thrifty” Chinese were not so thrifty
with an average household saving ratio below 5 percent. In this paper, we attempt
to explain the apparent paradox of the sudden spurt in the saving ratio’s magnitude
by using the framework of the life-cycle hypothesis (LCH) developed by
Franco Modigliani and R. Brumberg (1954).
The LCH was initially thought to be relevant for developed market economies
only. China’s per-capita income in 2002 is still ranked below 100th in the world,
according to the World Bank. 1 In the middle of our sample, there was a sharp
regime shift from a highly planned economy to a market-oriented economy.
Therefore, testing the explanatory power of the LCH for China is not only relevant
in endeavoring to offer a plausible explanation of the drastic changes in the
personal saving ratio of that country, but also has theoretical implications as to
the applicability of the LCH model to a more general environment, including
developing countries.
Reprinted with permission from Journal of Economic Literature 42 (March 2004), 145–170.