Unbalanced growth in China inevitably prompts questions about the country’s economic strength. Even premier Wen Jiabao sees it as a problem, although he remains adamant that adjusting the exchange rate is not part of the solution; forcing Beijing to do so, he warned this week, would be “a disaster for the world”.
Investment as a share of gross domestic product is now well over 40 per cent, while private consumption has fallen to 36 per cent. Some observers believe that this imbalance can only lead to economic collapse; others see it as China’s underlying source of power. The truth is in-between: while there is nothing fundamentally wrong with the country’s economic strategy, China needs to move slowly towards more sustainable growth.
By definition, economic growth is driven by consumption, investment and net exports. No country has achieved rapid growth over extended periods with a consumption-driven approach. In China’s case – contrary to popular belief – net exports have accounted for only 10-15 per cent of growth over the past decade. Realistically, a country of China’s size could not have sustained double-digit growth for three decades without an unusually high investment rate.
As noted by the World Bank’s Growth Commission, the 13 countries that enjoyed growth rates exceeding 7 per cent for several decades all had high investment rates and kept consumption down early in their development. However, against this group of mainly east-Asian countries, China stands out with its unusually high and steadily increasing rate of investment, and its success in avoiding any major economic slowdowns. Growth in GDP never fell below 8 per cent over the past two decades and the investment rate increased steadily from about 35 per cent to well over 40 per cent of GDP. Stimulus programmes also helped China navigate unscathed through both the Asian and recent global financial crises.
While investment has been encouraged by subsidies and interest rate policies, this is also true for other countries. There is another explanation for China’s high investment rates. As a former centrally planned economy, China continues to rely much more on the banking system and retained corporate earnings to finance investments, especially for infrastructure, that would normally be funded out of government budgets. Since all major banks are state-owned, any future loan write-offs are not private losses but absorbed by government and can thus be considered “quasi-fiscal deficits”. The likelihood of a financial crisis emanating from these deficits depends on China’s creditworthiness. A low debt-to-GDP ratio and high foreign reserves give it a comfortable cushion.
China’s vulnerabilities stem more from whether or not such high levels of investment are being used efficiently. A worst-case scenario is the former Soviet Union, where high and largely wasteful expenditures led to economic collapse. But China’s situation bears no resemblance. There is little evidence that China’s investments are producing unusually low rates of return and the country is not operating in a closed environment. Chinese companies face competitive pressures – both domestically and globally – that limit inefficiencies.
Nor should China’s low ratio of consumption to GDP be confused with anaemic increases in living standards. Private consumption and wages have actually been growing by an impressive 8-10 per cent annually. An easy fix would be to mandate higher dividends out of the surging profits of state enterprises, which have been pushing up investment and channelling funds to consumption.
With both GDP and consumption increasing rapidly, why should China give up its unbalanced growth approach? The major concern is rather whether its high levels of investment will continue to generate adequate returns or are sustainable in a broader sense. While there have been misgivings about possible wasteful spending in the recent stimulus, it was designed with demand rather than efficiency in mind and any negative results are likely to be short-lived. The bigger fear is over the sustainability of an investment-driven industrialisation strategy increasingly challenged by environmental concerns and the social implications of widening income disparities.