Do the maths
Consider these two warnings over China’s growth model. “Overinvestment…has given rise to excessive production capacity” says one expert, adding that “investment-induced fast growth…may not be sustainable in the longer term”. Another is more dramatic: “once increasing fixed investment becomes impossible – most likely after 2013 – China is poised for a sharp slowdown.”
The sentiment is timeless. The first quotation comes from a book published in Hong Kong in 1998 and second from a column published two weeks ago by economist Nouriel Roubini.
In between the two gloomy predictions, the Chinese economy has done very well. Real GDP has increased every year by at least 7 percent. That growth has been unbalanced in various ways, but the standard of living of almost everyone in the country has increased massively. Still, the country remains relatively underdeveloped, with around one tenth as much capital stock per person as the United States, according to HSBC.
Spending on investment cannot increase much faster than GDP forever and ever. But overinvestment-worriers predict a sharp slowdown long before China becomes glutted with infrastructure. They say it’s reckless to dedicate 45-50 percent of GDP to investment, as China has done in the last three years, according to official statistics. The share has been more like 30 percent in other fast developing countries. Either China must reduce this share or keep going with investment, much of it debt-financed. The first option could mean unemployment, the second a financial crisis.
There are four reasons this thinking is flawed.
First, Chinese investments overall do not seem to have been particularly wasteful. Yes, there are bridges to nowhere, unused smelters, almost empty airports and millions of empty apartments. But in comparison to the growth, the waste has been relatively small and will mostly be temporary. China can make use of most of these investments, if not now then relatively soon.
Besides, investment is a good thing for China. As academics John Knight and Sai Ding demonstrate out in a new book, “the accumulation of physical capital” and “the level of human capital” account for most of the nation’s growth. Knight and Ding also show that profitability at private companies increased between 2000 and 2007. That suggests better, not excessive, investments. What’s more, the share of GDP produced by inefficient State-Owned Enterprises has been declining since the 1990s.
The crisis-induced export slowdown and the anti-crisis stimulus may have slowed these helpful trends. But the misallocation over the last three years could not have been large enough to make the whole economy unbalanced.
Second, the statistics are untrustworthy. China’s expensive land artificially boosts the investment share. Expensive property adds to the state value of industrial investments, even though straight land purchases are excluded from the count. Also, the under-reporting of consumption falsely decreases the consumption share. Barclays Capital has attempted to adjust. It finds an economy that looks only mildly more reliant on investment than either South Korea or Taiwan were at a similar stage of development.
Also, the economic convention of counting housing construction as investment distorts the analysis. A shift in emphasis from roads and the like to social housing – the current plan of the Chinese government – won’t necessarily change the investment share of GDP, but housing investment is much less likely to lead to overcapacity. China may have almost enough roads to support its fleet of cars and trucks, but the quality of the housing stock is poor and a few hundred million people are expected to move to cities as soon as possible.
Third, the economic logic behind the overinvestment case is questionable. Poor countries are so short of industry, infrastructure and housing that it is almost impossible to overinvest. Of course, inefficiency – suboptimal allocation, poor quality, some totally pointless projects – is rampant. Poor countries are poor in large part because they lack the information, institutions and skilled people which are required for best practice. But inefficient capital is far better than absent capital.
Finally, the government is on the case, and probably has what it takes to deal with any problems. The official line is that the consumption share of the economy should rise. The recent stimulus programmes may have slowed the economic shift, but the social housing programme is a sign that the official intention has not changed. Indeed, if the Barcap analysis of GDP constituents is right, the consumption share of GDP actually stopped falling two years ago.
Predictions of an imminent end to the growth run of the People’s Republic have been around since the county first opened to the world in the late 1970s. Views rarely change. Gordon Chang has just reissued his 2001 bestseller, “The Coming Collapse of China”. A decade of Chinese success has only made the Forbes columnist more confident in the country’s imminent failure.
Chang may eventually be right. And the investment worriers may yet get their hard landing. But each year of growth and supposed overinvestment makes China richer – and more able to deal with a setback when it comes.