The Life Cycle Model and Household Savings: Micro Evidence from Urban China∗

This study investigates the extent to which China’s high household savings rates can be explained by the life cycle theory. First, we document that Chinese parents depend on their children for support when elderly and that sons provide more support than daughters. Second, we test the two predictions of a simple life-cycle model that account for these two facts: 1) parents will increase savings when they have fewer children; and 2) the reduction in fertility will increase savings more for parents who have only daughters. To establish causality, we exploit the plausibly exogenous decline in fertility in China caused by family planning programs which began in the early 1970s and the fact that there was no sex-selection for our sample of urban Chinese households that had children during the 1960s and 70s. Our results show that for parents who have a daughter as the eldest child, having one child less increases the savings rate by over 14,000 RMB, which is approximatley 27% of average income; for those who have a son as the eldest child, there is no effect. Finally, we apply our estimates to a simple life-cycle model of savings to predict the level and rates of savings, and thus assess the extent to which the life-cycle model can explain the data.