Will Financial Liberalization Help China to Invest More Efficiently? Evidence from China’s Saving and Investment from 1993 to 2017

Abstract China has enjoyed high saving and high investment ratios by international standards. However, mainstream economists argue that China suffers from inefficient investment due to excessive state interventions. The mainstream argument is in conflict with the observed high output-capital ratios and rates of return on capital in China before 2008. China’s investment efficiency has deteriorated since 2008 despite the progress of financial liberalization. In this essay, we used provincial-level panel data from 1993 to 2017 and the technique of General Method of Moments to examine how China’s saving and investment respond to output-capital ratio, gross profit share, and real interest rate. We find that output-capital ratio has positive effects on saving and investment in all three periods (1993–2000, 2001–2008, 2009–2017); gross profit share has positive effects on saving; but gross profit share has negative and significant impact on investment for the period 2009–2017. We find that real interest rate has significant and negative impact on China’s saving for the period 1993–2000, a result that is inconsistent with the neoclassical theory of saving. On the other hand, real interest rate has a significant and negative impact on investment and a significant and positive impact on saving for the period 2009–2017, consistent with what should happen in a liberalized financial market according to neoclassical economics. These findings suggest that China’s financial market may have become sufficiently liberalized to induce the “correct” behavior from businesses and households but the “correct” behavior has not yet led to improvement in China’s investment efficiency.