China’s “overinvestment” problem may be greatly overstated
THE IMF says so. Academics and Western governments agree. China invests too much. It is an article of faith that China needs to rebalance its economy by investing less and consuming more. Otherwise, it is argued, diminishing returns on capital will cramp future growth; or, worse still, massive overcapacity will cause a slump in investment, bringing the economy crashing down. So where exactly is all this excessive investment?
"Most people point to the rapid growth in China's capital spending and its unusually high share of GDP. Fixed-asset investment (the most widely cited figure, because it is reported monthly) has grown at a breathtaking annual rate of 26% over the past seven years. Yet these numbers are misleading. They are not adjusted for inflation and they include purchases of existing assets, such as land, that are inflated by the rising value of land and property. A more reliable measure, and the one used in other countries, is real fixed-capital formation, which is measured on a value-added basis like GDP. This has increased by a less alarming annual average of 12% over the past seven years, not that much faster than the 11% growth rate in GDP in that period.
The level of fixed-capital formation does look unusually high, at an estimated 48% of GDP in 2011. By comparison, the ratio peaked at just under 40% in Japan and South Korea. In most developed countries it is now around 20% or less. But an annual investment-to-GDP ratio does not actually reveal whether there has been too much investment. To determine that you need to look at the size of the total capital stock—the value of all past investment, adjusted for depreciation. Qu Hongbin, chief China economist at HSBC, estimates that China's capital stock per person is less than 8% of America's and 17% of South Korea's . Another study, by Andrew Batson and Janet Zhang at GK Dragonomics, a Beijing-based research firm, finds that China still has less than one-quarter as much capital per person as America had achieved in 1930, when it was at roughly the same level of development as China today.
This paper proposes a possible framework for identifying excessive investment. Based on this method, it finds evidence that some types of investment are becoming excessive in China, particularly in inland provinces. In these regions, private consumption has on average become more dependent on investment (rather than vice versa) and the impact is relatively short-lived, necessitating ever higher levels of investment to maintain economic activity. By contrast, private consumption has become more self-sustaining in coastal provinces, in large part because investment here tends to benefit household incomes more than corporates.
If existing trends continue, valuable resources could be wasted at a time when China’s ability to finance investment is facing increasing constraints due to dwindling land, labor, and government resources and becoming more reliant on liquidity expansion, with attendant risks of financial instability and asset bubbles. Thus, investment should not be indiscriminately directed toward urbanization or industrialization of Western regions but shifted toward sectors with greater and more lasting spillovers to household income and consumption. In this context, investment in agriculture and services is found to be superior to that in manufacturing and real estate. Financial reform would facilitate such a reorientation, helping China to enhance capital efficiency and keep growth buoyant even as aggregate investment is lowered to sustainable levels.
In contrast to claims cited above suggesting that Chinese investment levels are too low, among other things the paper argues that although investment levels as measured by capital stock per capita are obviously lower in the poor inland provinces in China than they are in the richer coastal regions, in fact investment in the former areas may be less productive than investment in the latter areas. This implies that the regions with less capital are also less able to absorb additional capital efficiently.
Should this be a surprise? For those who argue that China is poor because capital stock per worker in China is much lower than in the advanced countries, and that China should aggressively increase investment to close the gap, the findings in this paper ought to be surprising. If the further an economy is from US levels of capital stock the more appropriate it is to increase investment, then investment in the poor inland regions should have a higher return than investment in the richer coastal regions".
Source: China Financial Markets M. Pettis
