## _wp07181

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---

### I. Introduction: Puzzle and focus
- Chinese government calls for rebalancing toward consumption away from investment and external trade.
- Decline in the share of household consumption in GNP to below 40 percent in 2005.
- Quantitative observation:
  - Rise in the household saving rate of 5 percentage points since the early 1990s can only explain 1 percentage of the 9 percentage points decline in the share of consumption that has occurred since then.
  - Concurrently, the share of household income in GNP declined by 8 percentage points.
- Declines occurred across income sub-categories, particularly in wages (the largest component); investment income and government transfers also fell.
- Labor-market explanation challenged:
  - Despite 100-150 million workers either unemployed or underemployed, employment growth could plausibly have been faster; increased labor supply and potential employer monopsony power do not fully account for the persistent decline in the wage share.

### II. Hypothesis and mechanism: borrowing constraints and labor share
- Core argument:
  - China’s underdeveloped financial sector and persistent difficulty for average firms to obtain financing played a major role in co-movements of employment, household income, and consumption.
- Mechanism (firm-level borrowing constraints -> macro outcomes):
  - Firms rely on bank financing for working capital to pay wages and other current expenditure and are credit constrained.
  - Borrowing constraints act like taxes on labor input, creating a wedge between the market wage rate and the marginal product of labor.
  - The larger the borrowing constraint, the larger the wedge and the lower the labor share.
  - Since the mid-1990s, pressures to reform forced banks to be more conservative, tightening borrowing constraints and contributing to the decline in the wage share.

### III. Firm-level evidence (World Bank Enterprise Survey and regressions)
- Survey design and sample:
  - World Bank Enterprise Survey on Productivity and Investment Climate (2002) covering 1,500 Chinese enterprises from five cities.
  - Firms rated financing obstacles on a five-point scale (0 to 4). About three-fourth of the firms surveyed were fully private.
  - Degree of obstacle — Number of Firms — Percent in total:
    - None 537 35.8
    - Minor 323 21.53
    - Moderate 298 19.87
    - Major 250 16.67
    - Very severe 92 6.13
    - Total 1,500 100
  - World Bank 1999 survey finding cited: 80 percent of private firms face financial constraints in China.
- Employment and financing (1998–2000, averages):
  - Average employment growth by financing obstacle:
    - None or minor: 5.36 (1.11) — Number of firms 676
    - Moderate: 0.81 (1.76) — Number of firms 236
    - Major or very severe: -0.97 (1.69) — Number of firms 261
  - Investment growth by financing obstacle (1998–2000):
    - None or minor: 282 (57) — Number of firms 436
    - Moderate: 555 (181) — Number of firms 172
    - Major or very severe: 347 (98) — Number of firms 183
- Regression evidence (selected reported coefficients and diagnostics preserved as in source):
  - Financing Obstacle (1=none or minor, 2=modest, 3=major or very severe): coefficients roughly in the range -2.45 ... -3.08 (t-statistics shown in brackets); negative and statistically significant effects on employment growth across ownership groups.
  - Firm's age in 1998: coefficients around -0.52 ... -0.68 (highly significant).
  - Small/Medium Sized Firms (1 if employee number <500): coefficients around -13.15 ... -14.29 (highly significant).
  - Government Ownership (1 if there is government share): coefficients include -6.35, -11.00, etc.
  - Investment Growth: positive coefficients 0.02, 0.01 with significance.
  - Increase in Capacity Utilization: coefficient 0.3 (highly significant where included).
  - Observations and adjusted R-squared examples (as presented in source):
    - Observations: 1172 885 827 1147 863 805 774 594 542
    - Adjusted R-squared: 0.14 0.14 0.13 0.16 0.15 0.14 0.19 0.19 0.18
- Interpretation:
  - Enterprise-level data provide strong support that borrowing constraints were important in holding back employment growth.
  - The negative impact of financing difficulties on employment growth is statistically significant and robust, including in the sample restricted to private firms.
  - Little statistically significant impact of borrowing constraints on firms’ investment was found.
  - Firms tend to keep a stable level of investment given adjustment costs while adjusting working capital (and thus employment) to cushion against shocks.

### IV. Finance patterns and sources of investment funds
- Fixed asset investment sources (selected years):
  - "Self raised" share rose from 45.3 (1999) to 51.3 (2004).
  - "Domestic loans" share around 22.9 (1999) to 20.4 (2004).
  - "State budget" share around 7.1 (1999) to 4.2 (2004).
- Average shares of capital from sources (World Bank Enterprise Survey):
  - Retained Earnings/Internal Funds: 52 (All firms), 52 (Private Firms)
  - Personal, Family, Friends: 7 (All firms), 9 (Private Firms)
  - Bank Loans: 20 (All firms), 17 (Private Firms)
  - Other External Financing: 10 (All firms), 11 (Private Firms)
  - Other sources (supplier credit, etc): 10 (All firms), 10 (Private Firms)
  - Number of firms: 132 (All firms), 1951 (Private Firms) — as presented in the source table.
- Short-term credit dominates enterprise borrowing:
  - Short-term credit (less than one year) accounted for more than half of bank loans in 2005.
  - Average term of long-term loans in a 2003 World Bank survey was about 2 years.
- Firms respond to financing constraints by accumulating internal funds (retained earnings/self-financing); more than half of China’s investment is financed by self-raised funds and for private enterprises more than 60 percent of private enterprises’ capital is from self-raised funds.

### V. Macroeconomic embedding and model results
- Model setup (neoclassical growth model with borrowing constraint, following Aziz (2006) with endogenous employment):
  - Representative household values consumption and leisure; labor indivisible (h=40 hours).
  - Production: Cobb-Douglas Y = A K^{α} L^{1-α}.
  - Firms pay wage bill in advance and must borrow working capital; borrowing constrained by collateral (capital) via parameter θ with 0<θ<1.
  - When the borrowing constraint binds (η>0), labor share and household income fall below α; tighter borrowing constraint (θ declines) reduces wage share and household income share of GNP.
- Calibration parameters (as in source):
  - α = 0.35; β = 0.97; δ = 0.06.
  - From household problem steady state: m pinned to 1.25 using average values for 1980-2005.
  - θ chosen as 0.35 in 1980-95 and 0.25 from thereafter in baseline calibration to match data patterns; an alternative fixing θ=0.25 is noted but considered inferior to declining θ.
- Comparative steady-state implications highlighted:
  - A decline in θ -> smaller wage share, larger profit share, lower household income-to-GNP, lower consumption-to-GNP, higher corporate investment-to-GNP and total investment-to-GNP, and higher capital-output ratio.
- Model fit and caveats:
  - Simulated paths for consumption share, investment share, capital-output ratio, wage-to-GNP, and household income-to-GNP closely follow observed data for 1980-2005 with chosen θ sequence.
  - The simulated wage share is about 5 percentage points of GNP lower than that in the data in around 2005 while household income share matches reasonably well.
  - Labor market deregulation likely had only a limited impact on wage share; borrowing constraints on working capital have a much larger effect in lowering wage and household income shares.
  - Rational consumers in the model choose consumption behavior consistent with a falling share of consumption in GNP when household income share declines, matching observed data.

### VI. Aggregate context, trends, and measurement issues
- Growth and composition:
  - Over the last two decades, China grew at an average rate of around 8-10 percent.
  - Growth driven by high savings, high investment, and high external demand.
- Consumption and income shares:
  - Consumption share fell from 48.2 percent of GNP in 1992 to 39.6 percent of GNP by 2005.
  - The consumption ratio declined by over 10 percentage points since the early 1980s.
- Household savings and related accounting facts:
  - Household saving rate: "first declined from around 33 percent in 1992 to 25 percent in 2000-2001, before rising back to 33 percent in 2005."
  - If household disposable income had remained at its early 1990s level and the saving rate followed observed behavior, consumption share would have declined from 48.2 percent of GNP in 1992 to 46.9 percent of GNP — roughly only 1 percentage point. Instead actual fall was 9 percentage points, implying nearly 8 percentage points more than explained by the rise in the saving rate alone.
  - Decline in wage share: estimated drop from about 67 percent of GNP in the mid 1980s to the current level of 56 percent.
  - Corporate and government saving each rose by around 4 percentage points of GDP in the past five years, now representing around 19 and 10 percent of GDP, respectively.
  - Other aggregate growth facts:
    - Urban employment growth averaged a little more than 3 percent each year since the early 1990s.
    - Urban employment grew over 100 million since the early 1990s.
    - Real consumption grew at an annual rate of 8 percent.
    - Household income increased at a similar pace; average annual GDP growth was around 10 percent.
    - Employment growth in the tertiary industry averaged less than 5 percent while the wage rate grew averaging 15 percent each year.
- Measurement issues that could understate the decline in labor share:
  - A large percent of employment in the primary sector can reduce aggregate labor share.
  - A large share of self-employed workers leads to understatement of labor share in standard accounts because income of self-employed is often attributed to capital; in China, however, all of the income of self-employed workers is attributed to labor compensation, implying the labor share may actually be overstated in official series.
  - Given large movements of workers from agriculture into manufacturing and services over the past twenty years, the decline in labor share is likely more significant than aggregate data indicate.

### VII. Financial markets, investment income, and government transfers
- Investment income to households:
  - During the past decade, less than 8 percent of households’ disposable income came from investments.
  - The share declined to below 3 percent in 2005.
- Stock market and financial intermediation indicators:
  - Market capitalization: China accounted for 18 percent of GDP as of 2005.
  - Comparators: US 136 percent, India 75 percent.
  - Individual investor accounts of exchanges averaged about 5 percent of the population.
  - Household holdings of equity around 15 percent of total financial wealth (rose in 2006 to around 30 percent after equity price surge noted in source).
- Bond market: corporate bond market accounts for about 3 percent of total bond market; overall bond market small relative to GDP.
- Bank deposit rates and returns:
  - Deposit rates have been averaging around 2 percent in real terms.
  - Banks enjoy a margin about 4 percentage points between floor of lending rates and ceiling of deposit rates.
  - Investment income share has declined as the margin between deposit rate and nominal GNP growth widened.
- Government transfers and SOE profit distribution:
  - Government transfers to households declined since the early 1990s, standing at around ½ percent of GDP in 2005.
  - Government spending on health and education at around 3 percent of GDP is one of the lowest in the world.
  - SOEs have made net profits around 6½-7 percent of GDP since 2003 (for which data is available) but the government has not received profit transfers at least since 1994.
- Implication:
  - Ownership of Chinese firms is not widely held directly or indirectly by households; weak corporate governance and depressed equity prices limited household capture of rising profits.
  - Bank deposit interest rate caps and high bank interest margins effectively resulted in transfers from households to corporations.

### VIII. Key findings and quantitative conclusions
- Primary quantitative conclusion:
  - The fall in consumption share between 1992 and 2005 is predominantly explained by falling household income share rather than the rise in household saving rate alone (consumption fell 9 percentage points vs. 1 percentage point explained by saving-rate behavior holding income fixed).
- Firm-level constraints matter for employment:
  - Financing constraints at the firm level are empirically associated with lower employment growth; smaller and younger firms report more severe constraints.
- Financial structure and income distribution:
  - Underdeveloped financial markets (small stock market, limited corporate bond issuance, low direct household investment income, weak pension/mutual fund channels) and reduced government transfers have limited households’ ability to share corporate profits and smooth income, contributing to weak consumption share.

### IX. Policy recommendations (as presented in source)
- Improve banking practice and risk-management:
  - Strengthen internal risk-management and risk-pricing practices in banks to enable better client differentiation and ease borrowing constraints, especially for small and medium enterprises.
- Remove cap on deposit rates:
  - Lifting the cap would permit smaller banks to compete more effectively, potentially increase deposit rates, and help improve household incomes.
- Equity market reforms:
  - Continue conversion of non-tradable shares and promote secondary market trading; encourage large, well-known corporations to list and expand mutual and pension funds to widen household shareholding.
- Reintroduce and institutionalize dividend payments by SOEs:
  - The government has focused on reintroducing dividend payments; some form of dividend payment scheme is expected to be in place by 2007, which would provide budget revenue for social spending and transfers.
- Reorient public spending:
  - Increase public spending on education and healthcare and transfers to households to support higher private consumption.

*Source: _wp07181 (IMF working paper content provided in the source PDF).*

### References..............................................................................................................

### _wp07181 - References

### I. Introduction: Puzzle and focus
- Chinese government calls for rebalancing toward consumption away from investment and external trade.
- Decline in the share of household consumption in GNP to below 40 percent in 2005.
- Common explanations focus on rising household saving; cited studies include Blanchard and Giavazzi (2005), Kujis (2005), Modigliani and Cao (2004), Prasad and Rajan (2005).
- Quantitative observation: the rise in the household saving rate of 5 percentage points since the early 1990s can only explain 1 percentage of the 9 percentage points decline in the share of consumption that has occurred since then.
- Concurrently, the share of household income in GNP declined by 8 percentage points.
- Declines occurred across income sub-categories, particularly in wages (the largest component), with investment income and government transfers also falling.
- Labor-market explanation challenged: despite 100-150 million workers either unemployed or underemployed, employment growth could plausibly have been faster; increased labor supply and potential employer monopsony power do not fully account for the persistent decline in the wage share.

### II. Hypothesis: Borrowing constraints and their mechanism
- Core argument: China’s underdeveloped financial sector and persistent difficulty for average firms to obtain financing played a major role in co-movements of employment, household income, and consumption over the last two decades.
- Mechanism:
  - Firms rely on bank financing for working capital to pay wages and other current expenditure and are credit constrained.
  - Borrowing constraints act like taxes on labor input, creating a wedge between the market wage rate and the marginal product of labor.
  - The larger the borrowing constraint, the larger the wedge and the lower the labor share.
  - Since the mid-1990s, pressures to reform forced banks to be more conservative, tightening borrowing constraints and contributing to the decline in the wage share.

### III. Firm-level evidence
- Empirical approach:
  - Firms’ access to financing measured by perceived obstacles of financing to business operation as reported by enterprise managers in industry surveys.
  - Effect on labor measured by employment growth of individual firms.
- Key empirical findings:
  - Enterprise-level data provide strong support that borrowing constraints were important in holding back employment growth.
  - The negative impact of financing difficulties on employment growth is statistically significant and robust, including in the sample restricted to private firms.
  - Little statistically significant impact of borrowing constraints on firms’ investment was found.
- Interpretation:
  - Firms tend to keep a stable level of investment given adjustment costs while adjusting working capital (and thus employment) to cushion against shocks.

### IV. Macroeconomic embedding and comparative policy experiments
- Model approach:
  - Borrowing constraint embedded in a neoclassical growth model following Aziz (2006), with modification to allow endogenous employment determination.
  - Model used to assess impact of borrowing constraints on labor demand and household income and to simulate the impact of labor market deregulation.
- Model results (qualitative summary from source):
  - Labor market deregulation likely had only a limited impact on wage share.
  - Borrowing constraints on working capital have a much larger effect in lowering wage and household income shares.
  - In response to a declining household income share, rational consumers choose consumption behavior consistent with a falling share of consumption in GNP, in line with observed data.

### V. Why rising profits did not raise household income
- Reasons listed in the source:
  - Ownership of Chinese firms is not widely held directly or indirectly by households.
  - For listed firms, weak corporate governance and minority shareholding rights allowed firms to accumulate profit instead of distributing dividends.
  - A protracted period of depressed equity prices and limited transactions reduced household benefits from capital gains.
  - Government retains considerable ownership of the corporate sector but SOEs do not pay dividends to the government; the usual conduit of transferring corporate profit to households was closed.
  - Bank deposits are the main vehicle of household savings, but deposit interest rates have been capped by the government; the share of interest earnings has declined.
  - Higher bank interest margins, in the context of a banking sector burdened with high non-performing loans and under-capitalized and under-provisioned institutions, effectively resulted in transfers from households to corporations.

### VI. Aggregate context and trends
- Growth and composition:
  - Over the last two decades, China grew at an average rate of around 8-10 percent.
  - Growth driven by high savings, high investment, and high external demand.
- Consumption and income shares:
  - In 2005, Chinese households consumed less than 40 percent of GNP.
  - The consumption ratio declined by over 10 percentage points since the early 1980s.
- Household savings:
  - Since 1992, household savings averaged around 19 percent of GNP, falling from 22 percent of GNP to [text truncated in source].

*Source: _wp07181 - References; canonical source URL provided with the content unit.*

### 15.8 percent of GNP in 2001 and then

### _wp07181 - 15.8 percent of GNP in 2001 and then

### Household income, saving, and consumption trends
- Consumption share fell from 48.2 percent of GNP in 1992 to 39.6 percent of GNP by 2005.
- Household saving rate: "first declined from around 33 percent in 1992 to 25 percent in 2000-2001, before rising back to 33 percent in 2005."
- If household disposable income had remained at its early 1990s level and the saving rate followed observed behavior, consumption share would have declined from 48.2 percent of GNP in 1992 to 46.9 percent of GNP — roughly only 1 percentage point. Instead actual fall was 9 percentage points, implying nearly 8 percentage points more than explained by the rise in the saving rate alone.
- Decline in wage share: estimated drop "from about 67 percent of GNP in the mid 1980s to the current level of 56 percent."
- Corporate and government saving each rose by "around 4 percentage points of GDP" in the past five years, now representing "around 19 and 10 percent of GDP, respectively."
- Other aggregate growth facts:
  - Urban employment growth averaged "a little more than 3 percent each year since the early 1990s."
  - Urban employment grew "over 100 million since the early 1990s."
  - Real consumption grew at an annual rate of "8 percent."
  - Household income increased at a similar pace; average annual GDP growth was "around 10 percent."
  - Employment growth in the tertiary industry averaged "less than 5 percent" while the wage rate grew "averaging 15 percent each year."

### Labor share, measurement issues, and structural shifts
- Aggregate statistics may understate the true decline in labor share because:
  - A large percent of employment in the primary sector can reduce aggregate labor share.
  - A large share of self-employed workers leads to understatement of labor share in standard accounts because income of self-employed is often attributed to capital; in China, however, "all of the income of self-employed workers is attributed to labor compensation," implying the labor share may actually be overstated in official series.
- Given large movements of workers from agriculture into manufacturing and services over the past twenty years, the decline in labor share is likely more significant than aggregate data indicate.

### Firm-level financing constraints and employment (World Bank Enterprise Survey evidence)
- Survey: World Bank Enterprise Survey on Productivity and Investment Climate (2002) covering "1,500 Chinese enterprises from five cities."
- Survey structure: firms rated financing obstacles on a five-point scale (0 to 4). About "three-fourth of the firms surveyed were fully private."
- Summary table snippet (as presented in source):
  - Degree of obstacle — Number of Firms — Percent in total
    - None53735.8
    - Minor32321.53
    - Moderate29819.87
    - Major25016.67
    - Very severe926.13
    - Total1,500100
- World Bank 1999 survey finding cited: "80 percent of private firms face financial constraints in China."
- Employment and financing (1998–2000):
  - Average employment growth by financing obstacle:
    - None or minor: 5.36 (1.11) — Number of firms 676
    - Moderate: 0.81 (1.76) — Number of firms 236
    - Major or very severe: -.97 (1.69) — Number of firms 261
  - Investment growth by financing obstacle (1998–2000):
    - None or minor: 282 (57) — Number of firms 436
    - Moderate: 555 (181) — Number of firms 172
    - Major or very severe: 347 (98) — Number of firms 183
- Regression evidence (selected coefficients reproduced as in source tables):
  - Financing Obstacle (1=none or minor, 2=modest, 3=major or very severe): coefficients roughly in the range "-2.45 ... -3.08" (t-statistics shown in brackets); negative and statistically significant effects on employment growth across ownership groups.
  - Firm's age in 1998: coefficients around "-0.52 ... -0.68" (highly significant).
  - Small/Medium Sized Firms (1 if employee number <500): coefficients around "-13.15 ... -14.29" (highly significant).
  - Government Ownership (1 if there is government share): coefficients include "-6.35", "-11.00", etc.
  - Investment Growth: positive coefficients "0.02", "0.01" with significance.
  - Increase in Capacity Utilization: coefficient "0.3" (highly significant where included).
  - Observations and adjusted R-squared shown in table (examples): Observations "1172 885 827 1147 863 805 774 594 542"; Adjusted R-squared "0.14 0.14 0.13 0.16 0.15 0.14 0.19 0.19 0.18" (values presented as in source).
- Key interpretation: firms reporting greater financing difficulties had significantly lower employment growth, while evidence that financing obstacles slowed investment is limited; financially constrained firms often use retained earnings/self-financing and reduce working capital rather than fixed investment.

### Finance patterns, sources of investment funds, and short-term credit
- Fixed asset investment sources (selected years):
  - "Self raised" share rose from "45.3" (1999) to "51.3" (2004).
  - "Domestic loans" share around "22.9" (1999) to "20.4" (2004).
  - "State budget" share around "7.1" (1999) to "4.2" (2004).
- Average shares of capital from sources (World Bank Enterprise Survey):
  - Retained Earnings/Internal Funds: "52" (All firms), "52" (Private Firms)
  - Personal, Family, Friends: "7" (All firms), "9" (Private Firms)
  - Bank Loans: "20" (All firms), "17" (Private Firms)
  - Other External Financing: "10" (All firms), "11" (Private Firms)
  - Other sources (supplier credit, etc): "10" (All firms), "10" (Private Firms)
  - Number of firms: "132" (All firms), "1951" (Private Firms) — as presented in the source table.
- Short-term credit dominates enterprise borrowing: short-term credit (less than one year) accounted for "more than half of bank loans in 2005." Average term of long-term loans in a 2003 World Bank survey was "about 2 years."

### Macroeconomic mechanism: borrowing constraint, wage share, and consumption (model summary)
- Model features:
  - Representative household values consumption and leisure; labor indivisible (h=40 hours).
  - Production: Cobb-Douglas Y = A K^{α} L^{1-α}.
  - Firms pay wage bill in advance and must borrow working capital; borrowing constrained by collateral (capital) via parameter θ with 0<θ<1.
  - When the borrowing constraint binds (η>0), labor share and household income fall below α; tighter borrowing constraint (θ declines) reduces wage share and household income share of GNP.
- Steady-state comparative statics highlighted:
  - A decline in θ -> smaller wage share, larger profit share, lower household income-to-GNP, lower consumption-to-GNP, higher corporate investment-to-GNP and total investment-to-GNP, and higher capital-output ratio.
- Calibration parameters used (as in source):
  - α = 0.35; β = 0.97; δ = 0.06.
  - From household problem steady state: m pinned to "1.25" using average values for 1980-2005.
  - θ chosen as "0.35 in 1980-95 and 0.25 from thereafter" in baseline calibration to match data patterns; an alternative fixing θ=0.25 is noted but considered inferior to declining θ.
- Model matches:
  - Simulated paths for consumption share, investment share, capital-output ratio, wage-to-GNP, and household income-to-GNP closely follow observed data for 1980-2005 with chosen θ sequence.
  - The simulated wage share is "about 5 percentage points of GNP lower than that in the data in around 2005" while household income share matches reasonably well.

### Financial markets, investment income, and government transfers
- Investment income to households:
  - During the past decade, "less than 8 percent of households’ disposable income came from investments."
  - The share declined to "below 3 percent in 2005."
- Stock market and financial intermediation indicators:
  - Market capitalization: China "accounted for 18 percent of GDP as of 2005."
  - Comparators: US "136 percent", India "75 percent" (presented in source figure).
  - Individual investor accounts of exchanges averaged "about 5 percent of the population" (per source, with caveats).
  - Household holdings of equity around "15 percent of total financial wealth" (rose in 2006 to around "30 percent" after equity price surge noted in source).
- Bond market: corporate bond market accounts for "about 3 percent of total bond market"; overall bond market small relative to GDP.
- Bank deposit rates and returns:
  - Deposit rates have been "averaging around 2 percent in real terms."
  - Banks enjoy a margin "about 4 percentage points" between floor of lending rates and ceiling of deposit rates.
  - Historical relation shown: investment income share has declined as the margin between deposit rate and nominal GNP growth widened.
- Government transfers:
  - Government transfers to households declined since the early 1990s, standing at "around ½ percent of GDP in 2005."
  - Government spending on health and education at "around 3 percent of GDP" is one of the lowest in the world.
- SOEs and profit distribution:
  - SOEs have made net profits "around 6½-7 percent of GDP since 2003 (for which data is available)" but the government has not received profit transfers "at least since 1994."

### Key findings and quantitative conclusions
- The fall in consumption share between 1992 and 2005 is predominantly explained by falling household income share rather than the rise in household saving rate alone (consumption fell 9 percentage points vs. 1 percentage point explained by saving-rate behavior holding income fixed).
- Financing constraints at the firm level are empirically associated with lower employment growth; smaller and younger firms report more severe constraints.
- Firms respond to financing constraints by accumulating internal funds (retained earnings/self-financing); "more than half of China’s investment is financed by self-raised funds" and "for private enterprises, more than 60 percent of private enterprise’ capital is from self-raised funds."
- Underdeveloped financial markets (small stock market, limited corporate bond issuance, low direct household investment income, weak pension/mutual fund channels) and reduced government transfers have limited households’ ability to share corporate profits and smooth income, contributing to weak consumption share.

### Policy recommendations (from source)
- Improve banking practice and risk-management:
  - Strengthen internal risk-management and risk-pricing practices in banks to enable better client differentiation and ease borrowing constraints, especially for small and medium enterprises.
- Remove cap on deposit rates:
  - Lifting the cap would permit smaller banks to compete more effectively, potentially increase deposit rates, and help improve household incomes.
- Equity market reforms:
  - Continue conversion of non-tradable shares and promote secondary market trading; encourage large, well-known corporations to list and expand mutual and pension funds to widen household shareholding.
- Reintroduce and institutionalize dividend payments by SOEs:
  - The government has focused on reintroducing dividend payments; "some form of dividend payment scheme is expected to be in place by 2007" (as reported in source), which would provide budget revenue for social spending and transfers.
- Reorient public spending:
  - Increase public spending on education and healthcare and transfers to households to support higher private consumption.

*Source: _wp07181 - 15.8 percent of GNP in 2001 and then*

### REFERENCES

### _wp07181 - REFERENCES

### References (selected)
- Andersen, Jonathan, 2006, “What Beijing Can and Can’t Do,” UBS Investment Research, Asian Focus.
- Aziz, Jahangir, 2006, “Rebalancing China’s Economy: What Does Growth Theory Tell Us?” IMF Working Paper No. 06/291 (Washington: International Monetary Fund).
- Aziz, Jahangir, and Christoph Duenwald, 2002, “The Growth-Financial Nexus,” China: Competing in the Global Economy, edited by Wanda Tseng and Markus Rodlauer.
- Aziz, Jahangir, Eswar Prasad, and Steven Dunaway, 2006, “China and India: Learning from Each Other,” Washington: International Monetary Fund).
- Blanchard, Oliver, and Francesco Giavazzi, 2005, “Rebalancing Growth in China: A Three-Handed Approach,” CEPR Discussion Paper.
- Brown, David, John S. Earle, and Dana Lup, 2005, “What Makes Small Firms Grow? Finance, Human Capital, Technical Assistance, and the Business Environment in Romania,” Economic Development and Cultural Change, University of Chicago Press.
- Dabla-Norris, Era, 2005, “Issues in International Fiscal Relations in China,” IMF Working Paper No. 05/30 (Washington: International Monetary Fund).
- Einarsson, Tor, and Milton Marquis, 2001, “Bank Intermediation over the Business Cycle,” Journal of Money, Credit, and Banking, pages 876-899.
- Fazzari, Steven M., and Bruce Petersen, 1993, “Working Capital and Fixed Investment: New Evidence on Financing Constraints,” Rand Journal of Economics, pages 328-342.
- Fan, Gang, 2006, “Currency Asymmetry, Global Imbalance, and Rethinking again of International Currency System,” Global Imbalances and US Debt Problems, Should Developing Countries Support the US Dollar? edited by Jan Joost Teunissen and Age Akkerman.
- Gollin, Douglas, 2002, “Getting Income Shares Right,” Journal of Political Economy, pages 456-474.
- Green, Stephen, 2004, The Development of China’s Stock Market, 1984-2002, published by RoutledgeCurzon.
- Hansen, Gary, 1985, “Indivisible Labor and the Business Cycle.” Journal of Monetary Economics, pages 309-327.
- Hayashi, Fumio, and Edward Prescott, 2002, “The 1990s in Japan, A Lost Decade,” Review of Economic Dynamics, pages 206-235.
- Hoffman, Bert, and Louis Kujis, 2006, “Profits Drive China's Boom,” Far Eastern Economic Review, pages 39-43.
- Huang, Yasheng, 2003, “Selling China—Foreign Direct Investment During the Reform Era,” Cambridge University Press.
- Huang, Yasheng, 2006, ”Assessing Financing Constraints for Domestic Private Firms in China and India: Evidence from the WBES Survey Evidence, Indian Journal of Economics & Business.
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### Appendix I: Macroeconomic Data
- GDP and consumption
  - GDP and consumption are from the national account.
  - Official data before the GDP revision in early 2006 are used for this paper for three reasons:
    - The revision only covers the period since 1993, which would complicate historical comparison.
    - Only part of the national accounts has been revised; the flows of funds account (most relevant to this paper) have not been revised, and using revised data would result in a large discrepancy between the two sides.
    - The economic census only covered 2004; historical data were backfilled by a statistical method that assumes a smooth path of increase in services, so the information loss by not using the new data is relatively small.
- GNP
  - Following Hayashi and Prescott (2003), GDP is adjusted for net income on factor services to get GNP.
  - GNP is broken down into private consumption, government consumption, and investment (where investment includes total investment (including inventory), net exports and net factor payments).
  - Capital stock is derived by applying the investment, assuming the initial foreign capital to be zero.
- Household Income and Its Components
  - 1992-2003:
    - Data on disposable income and labor remuneration are directly available from the National Account flows of funds.
    - China’s statistical bureau defines disposable income as income received by institutional sectors on the basis of total income of primary distribution and through current transfers; this income is used for final consumption and savings.
    - Labor’s remuneration refers to whole payment of various forms earned by laborers from productive activities, including wages, bonuses and allowances in monetary form and in kind, free medical services, medicine expenses, traffic subsidies and social insurance fee paid by the laborers’ working units for them.
    - For the individual economy, since laborers’ remuneration is not easily distinguished from operating profit, both are treated as laborers’ remuneration.
  - 2004-2005:
    - Household income is estimated using household survey and population data, adjusting for differences with the national account flows of funds data in previous years.
    - Household survey provides per capita income of rural and urban households; these are multiplied by respective population estimates and added with an estimate of subsistence consumption.
    - These estimates come out about 2-3 percent below the level of total disposable income from the flow of funds data published by NBS for the few years before 2003; they are adjusted upwards by 3 percent to match the flow of funds data.
  - 1985-1992:
    - Household survey data are incomplete; consistent series available are per capita income for rural and urban households since 1985.
    - Kraay (2000) constructed net income from 1978-1994 from the household survey; net income excludes production costs associated with household production for rural population and transfers to family members not residing in households for urban population.
    - As shares of GNP, both gross income and net income from household survey displayed similar decline between 1985 and 1994 and are well below levels recorded in the flows of funds.
    - Rely on data on total wage bill before 1992 to derive the wage share during this period.
      - Total wage bill refers to total remuneration payment to staff and workers in various units during a certain period.
      - Excluded from “staff and workers” are those working in agriculture (unless working in an enterprise related to agriculture) and those working informally.
      - “Labor remuneration” from flows of funds account has broader coverage than total wage bill, as it includes all productive activities of laborers and compensation in the form of social services.
    - Operating surpluses of individual economy (or self-employed) are included in labor remuneration but not in the wage bill.
      - Gollin (2002) notes that in most countries income of self-employed workers is considered capital income, which could underestimate labor share where self-employment is substantial. In China, all income of self-employed workers is counted as labor remuneration, so the wage share may actually be overstated.
      - The share of self-employed workers in total employment rose sharply during the 1990s, before coming down and stabilizing since late 1990s; this may have accounted for some increase in the recorded share of compensation during the 1990s.
    - Compensation for labor from flows of funds includes compensation to farmers and compensation in the form of social services (free medical services, medicine expenses, traffic subsidies and social insurance fee paid by working units), although these elements were unlikely to have increased in the 1990s.
    - The ratio of total wage bill and compensation to labor in 1992 is used and applied to total wage bill data during 1980-1992 to construct wage income consistent with flows of funds definition.
    - The constructed wage series show a remarkably similar decline in the wage share as the income shares from the household survey during 1985-1992, consistent with the view that household income, mostly driven by wage income, declined as a share of GNP between mid-1980s to 1992.

### Appendix II: Firm-Level Survey Data and Variables Used in the Cross-section Regression
- World Bank Enterprise Survey on Productivity and Investment Climate
  - Sample: responses of 1500 Chinese enterprises.
  - Survey asks firms to rate severity of issues related to institutions, policies, and infrastructures on a five-point system ranging from zero to four (zero = no obstacle; four = very severe obstacle).
  - Two financing-related questions:
    - Obstacles to business operation posed by access to financing (e.g., collateral).
    - Obstacles posed by the cost of financing (e.g., interest rates).
  - Other survey items: firm’s line of business, location, number of employment, source and size of investment, share of government ownership, etc.
  - Ownership composition: most of the firms (about three quarter) in the sample are completely privately owned; the rest have government share ranging from 1 to 100 percent.
- Key variables and definitions used in regressions
  - Employment growth between 1998 and 2000: the percentage growth of the average number of total employees (including contractual employees) during the two years, based on reply to question C.1.
  - Investment growth: percentage growth in the value of total fixed assets between 1998 and 2000, based on reply to question B.3.
  - Increase in capacity utilization (manufacturing firms): change in capacity utilization (in percent) between 1998 and 2000.
  - Financing variable:
    - Survey response on financing obstacles is recoded to Financing = 1 if response is no or very minor obstacles.
    - Financing = 2 if response is moderate obstacle.
    - Financing = 3 if response is major or very severe obstacles.
  - Control variables (z):
    - Firm age: difference between year of establishment and 1998.
    - Small medium sized firm: dummy = 1 if total employees less than 500 in year 2000, and 0 otherwise.
    - Government ownership: dummy = 1 if firm is partly or fully owned by state, and 0 otherwise.
    - Regression robustness: estimates are also run excluding state-owned enterprises to account for potential biases from SOE restructuring.
    - External orientation (following Huang (2006)): based on response to question A.12, takes value 1 (with foreign partners) and 2 (no foreign partners).
    - Location and industrial sub-sector controls: dummy variables corresponding to location and industrial sub-sectors (all together 56 dummy variables).

*Source: _wp07181 - REFERENCES (IMF working paper content provided in the source PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2007/_wp07181.pdf_