Why Has China's Current Account Balance Converged after the Global Financial Crisis?

• DOI: http://doi.org/10.1111/cwe.12367
• Date: 01 January 2021
• Published date: 01 January 2021

©2021 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 109–129, Vol. 29, No. 1, 2021 109

*Jianwei Xu, Professor, School of Economics and Business Administration, Beijing Normal University, China. Email:

xujianwei@gmail.com; Panpan Yang (corresponding author), Senior Research Fellow, Institute of World Economics

and Politics, Chinese Academy of Social Sciences, China. Email: pamelapanda@126.com; Guangrong Ma, Professor,

China Financial Policy Research Center, School of Finance, Renmin University of China, China. Email: grma@ruc.

edu.cn. The authors thank Bin Zhang and other attendees at the Second China–Japan Youth Conference on Trade,

Exchange Rate and Labor and anonymous reviewers for their helpful suggestions. The authors acknowledge f‌i nancial

support from the National Natural Science Foundation of China (Nos. 71773125, 71973142, and 71673028) and

Important Projects in the Scientif‌i c Innovation of CASS (Research on the Major Risks of China in the Next 15 Years).

Why Has China’s Current Account Balance

Converged after the Global Financial Crisis?

Jianwei Xu, Panpan Yang, Guangrong Ma*

Abstract

China’s current account surplus declined signif‌i cantly from its peak of nearly 10 percent

of GDP in 2007 to less than 1 percent in 2018. The new pattern offered fresh evidence

for our understanding of China’s current account dynamics. In this paper, we used f‌l ow

of funds data to gauge its underlying driving forces. Specifically, by employing index

decomposition analysis, we decomposed the current account from the perspective of

savings and investment into three sectors: the household, corporate, and government

sectors. We found that the decline in China’s current account ratio was f‌i rst driven by

cyclical factors, i.e. weak corporate saving growth induced by the economic slump in

2009 as well as the following massive corporate investment bolstered by the government

stimulus plan. However, such cyclical factors quickly subsided, and the subsequent

current account balance reduction was later supported by structural factors, i.e.

household savings declined enduringly and the Chinese government switched to a more

expansionary fiscal policy. There are three possible explanations for the structural

movement: reduced precautionary saving due to higher social security coverage ratio,

lower corporate prof‌i ts as a result of economic slowdown, and a twin def‌i cit due to the

government’s more relaxed f‌i scal stance. The new facts, however, were not consistent with

other current account theories focusing on long-term aspects of the saving–investment

account puzzle, especially those relating to China’s special demographic characteristics.

Key words: current account, f‌l ow of funds accounts, investment, saving

JEL codes: E21, E22, G21

I. Introduction

Debate over China’s current account surplus has often featured in the global news.

However, the once seemingly unstoppably growing current account surplus ended

Jianwei Xu et al. / 109–129, Vol. 29, No. 1, 2021

©2021 Institute of World Economics and Politics, Chinese Academy of Social Sciences

110

with the global f‌i nancial crisis and then experienced a drastic reversal, with the current

account surplus share of GDP shrinking signif‌i cantly, from nearly 10 percent in 2007 to

less than 1 percent in 2018. What’s more, according to the IMF 2018 External Sector

Report (IMF, 2018), there could even be a possible current account def‌i cit in the future.

Thus, the question is why and how China’s current account balance embarked on such a

diminishing trajectory over the past 10 years.

The literature trying to explain China’s current account balance can be traced back

to the 2000s when it started to accrue, reaching a peak in 2007. Most of the studies

focused on the particular pattern of China’s high household saving rate, producing

a number of novel theories highlighting special features such as the demographic

transition, precautionary saving, and gender imbalance (Modigliani and Cao, 2004;

Horioka and Wan, 2007; Du and Wei, 2010; Zhou, 2012). Several theories also emerged

focusing on the particularly high corporate saving rate and linking it with China’s

special institutional characteristics (Song et al., 2011). All in all, these explanations

associated China’s increasing current account surplus with structural characteristics of

its economy and fitted them with the intertemporal open macroeconomic framework

(Obstfeld and Rogoff, 1995).

However, most of the evidence used to support the above theories was based on

China’s pre-2007 current account balance movement. There has been a sharp reversal

of the situation ever since then. After the global f‌i nancial crisis, China’s current account

ratio (as a proportion of GDP) slumped from about 9.1 percent in 2008 to less than

1.8 percent in 2011, and then remained at a low level and continued decreasing (Figure 1).

This seemed to cast doubt on the validity of some of the previous theories focusing

on long-term structural factors, such as demographic characteristics, which actually

only experienced a very gradual change after the crisis. Extending the evidence to the

post-2007 period thus offers novel opportunities to reassess the validity of the above

theories.

To account for the new pattern, a few studies examined the recent movement of the

current account balance in China. For example, The Economist (2019a, b) highlighted

that the negative drift in the current account was due to the cyclical shift of the high

prices of Chinese imports, such as oil and semiconductors, and the rising labor cost,

which led to lower exporting capacity. Furthermore, the service trade sector deficit

also offered an important channel that offset a large amount of the goods trade surplus,

contributing to the worse current account def‌i cit following the global f‌i nancial crisis.

That said, to the best of our knowledge, there seemed to be little evidence to revisit the

theories proposed earlier.