Thursday, January 27, 2005
China refuses to cool down
It's been a while since anyone has posted anything from the Economist. So, I figured the new economic numbers from China might be as good an excuse as any. Many of you may have already read that China's economy has grown at a blistering 9.5% in the last quarter. Most countries (India, for instance) would be happy with that sort of growth. Not China, which has been trying desperately to cool its overheating economy and attempting to soft-land it with measures that include increased interest rates, curbs on investment etc. It seemed to be working for a little while during the third quarter, but the economy seems to have returned to overheat mode. Why is this a problem, you might ask. The Economist provides the best known reasons. It's not pretty, especially given how much the world economy has come to depend on China to sustain growth.
China may or may not be growing too fast, but it is certainly investing too much. In the year to the first quarter of 2004, spending on fixed assets—plant, property and infrastructure—grew by 43%. Investment accounted for 42% of GDP in 2003, and perhaps a still greater share last year. No economy can sustain such a colossal rate of capital accumulation. At some point, China’s investment must run into rapidly diminishing returns. Are two cement factories twice as good as one?
If investors were betting their own money, these redundant cement factories—not to mention steel mills, luxury flats and car plants—would probably never have been built. But China’s reckless investment owes a lot to the heedless lending of its banks. Chinese households still save about 45% of their income. They deposit about two-thirds of these savings in China’s four big state-owned banks, which lend about two-thirds of these deposits to state-run firms. The banks pay little attention to risk and do not expect much of a return: perhaps 40-50% of loans are non-performing. In fact, their lending is best seen as a form of state subsidy. If these subsidies were added to the government’s books, China’s budget deficit would balloon to 18% of GDP.
Suppose, says Ms Choyleva, that China can sustain a rate of investment of about 35% of GDP, rather than its current rate of 40-45%. How does it get there from here? Such a sharp contraction in the investment rate is not, she says, consistent with a soft landing. If investment slows, the economy as a whole will plummet. China, she predicts, cannot escape “the natural violence” visited on all developing countries that go through such boom-and-bust cycles of investment.
China may or may not be growing too fast, but it is certainly investing too much. In the year to the first quarter of 2004, spending on fixed assets—plant, property and infrastructure—grew by 43%. Investment accounted for 42% of GDP in 2003, and perhaps a still greater share last year. No economy can sustain such a colossal rate of capital accumulation. At some point, China’s investment must run into rapidly diminishing returns. Are two cement factories twice as good as one?
If investors were betting their own money, these redundant cement factories—not to mention steel mills, luxury flats and car plants—would probably never have been built. But China’s reckless investment owes a lot to the heedless lending of its banks. Chinese households still save about 45% of their income. They deposit about two-thirds of these savings in China’s four big state-owned banks, which lend about two-thirds of these deposits to state-run firms. The banks pay little attention to risk and do not expect much of a return: perhaps 40-50% of loans are non-performing. In fact, their lending is best seen as a form of state subsidy. If these subsidies were added to the government’s books, China’s budget deficit would balloon to 18% of GDP.
Suppose, says Ms Choyleva, that China can sustain a rate of investment of about 35% of GDP, rather than its current rate of 40-45%. How does it get there from here? Such a sharp contraction in the investment rate is not, she says, consistent with a soft landing. If investment slows, the economy as a whole will plummet. China, she predicts, cannot escape “the natural violence” visited on all developing countries that go through such boom-and-bust cycles of investment.
