Digital Financial Inclusion and Consumption Smoothing in China

• Published date: 01 January 2020
• Date: 01 January 2020
• Author: Hao Zhang,Xingjian Yi,Jennifer T. Lai,Isabel K. M. Yan
• DOI: http://doi.org/10.1111/cwe.12312

©2020 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 64–93, Vol. 28, No. 1, 2020

64

Digital Financial Inclusion and Consumption

Smoothing in China

Jennifer T. Lai, Isabel K. M. Yan, Xingjian Yi, Hao Zhang*

Abstract

In this paper, we investigate the effect of digital nancial inclusion (DFI) on household

consumption smoothing in China. We use four waves of the biennial China Family Panel

Studies from 2010 to 2016, during which time DFI has signicantly developed alongside

nancial technology across China. We split household income shocks into permanent

and transitory components, and evaluate if DFI may help households to buffer against

these shocks. We nd that households are not able to insure against permanent shocks to

income, but they can smooth approximately 70 percent of transitory shocks to income.

We also find that DFI has diminished households’ ability to insure against transitory

income shocks. This is partly because online purchase may lead to the oversensitivity of

consumption to income. In addition, we nd that contrary to DFI, traditional nancial

sector development contributes to better household consumption smoothing against

transitory income shocks.

Key words: consumption smoothing, digital nancial inclusion, insurance, permanent

income shock, transitory income shock

JEL codes: D14, E21, F61

I. Introduction

This paper empirically evaluates the effect of digital financial inclusion (DFI) on

household consumption smoothing in China. We use four waves of the China Family

*Jennifer T. Lai, Associate Professor, School of Finance, Guangdong University of Foreign Studies, China.

Email: econlai@gmail.com; Isabel K. M. Yan, Associate Professor, Department of Economics and Finance,

City University of Hong Kong, China. Email: efyan@cityu.edu.hk; Xingjian Yi (corresponding author),

Professor, School of Finance, Guangdong University of Foreign Studies, China. Email: yxjby@163.com;

Hao Zhang, Associate Professor, School of Finance, Guangdong University of Foreign Studies, China. Email:

haozhang@gdufs.edu.cn. Jennifer T. Lai gratefully acknowledges nancial support from the National Science

Foundation of China (No. 71403061), the Fund Projects of Guangdong University of Foreign Studies (Nos.

18ZD01 and HW2018012) and the Foundation of Southern China Institute of Fortune Management Research.

Xingjian Yi gratefully acknowledges nancial support from the National Social Science Foundation of China

(No. 15ZDA013).

©2020 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Digital Financial Inclusion and Consumption Smoothing 65

Panel Studies (CFPS), namely 2010, 2012, 2014 and 2016, to assess whether the

development of DFI at both extensive and intensive margins helps to mitigate the pass-

through of income shocks to consumption at the household level in China.1

Our paper is motivated by two facts. First, starting from the late 2000s and early

2010s, DFI, an important part of nancial technology (ntech) development in China,

has signicantly progressed. The DFI general index compiled by the Peking University

Institute of Digital Finance reects both the extensive and intensive margins of nancial

service usage by individuals through the ntech company Alibaba Ant Financial Service

(Guo et al., 2020, forthcoming). It shows that from 2011 to 2013 the overall index has

increased almost three-fold.2 By denition, ntech covers digital and technology-enabled

business model innovation in the nance sector, which democratizes access to nancial

services (Philippon, 2017). The World Bank denes nancial inclusion as individuals

and businesses having access to useful and affordable nancial products and services that

meet their needs – transactions, payments, savings, credit and insurance – delive red in a

responsible and sustainable way. DFI is a combination of ntech and nancial inclusion

that measures access and usage of nancial services through ntech. Second, although

ntech development in China has revolutionized how people conduct transactions and

use other nancial services, such as saving, credit and insurance, the overall impact of

ntech on household welfare has yet to be fully investigated. As households are usually

assumed to be risk averse, higher consumption smoothing indicates higher household

welfare. This paper empirically investigates the effect of DFI on household consumption

smoothing in China, in order to ll this gap.

Following the general practice in the literature, we rst split household idiosyncratic

income shocks into permanent and transitory shocks based on assumptions of household

income process (Blundell et al., 2008, 2013; Jappelli and Pistaferri, 2011). We then

estimate the sensitivity of household consumption in response to the two shocks in the

baseline model. Furthermore, we add the DFI index to the baseline model to assess its

impact on this sensitivity and evaluate how it affects household consumption smoothing

1In our paper, consumption smoothing is used interchangeably with consumption risk sharing and consumption

insurance. Usually consumption smoothing pertains to households smoothing consumption across time, while

consumption risk sharing pertains to households smoothing consumption across different states of nature,

and consumption insurance summarizes the combined effect of the two. In our paper, we follow Jappelli and

Pistaferri (2011) and use consumption smoothing to represent smoothing across time and states.

2The data used to compile the index was obtained from Alibaba Ant Financial Service Group, which provides

products such as Alipay (“Zhifubao” in Chinese, for online and offline payments), Yu’E Bao (for online

investment in money market funds and other investment products), etc. They account for a signicant portion

of the overall digital nancial service market in China.