Comparing China Versus the United States on Misallocated Investment

Michael Pettis describes the issue of misallocation of resources. This is a charge that has been made frequently that China is misallocating resources. The example is then brought up about ghost cities as overbuilding in real estate.

Michael describes what matters as far as economic misallocation is concerned is

1) Whether the total economic costs of investment are less than the total economic benefits, and

2) Whether there is a mismatch in the timing of costs and benefits.

The first point determines whether the investment is ever wealth enhancing, and the second determines whether or not in the medium term there is a worsening of the underlying imbalance.

Kurt Shrout provides some data which shows that China’s construction industry makes up 18% of its economy in 2010 versus a world average of 12%. China is still developing and urbanizing so having a somewhat larger construction industry is not out of line.

Total Factor Productivity is increasing at a fast rate in China

These figures undermine a common claim—that China’s rapid growth has been based solely on overinvestment. Sceptics like to compare China with the Soviet Union, where heavy investment also produced rapid rates of growth for many years before it collapsed. But the big difference is that TFP in the Soviet Union actually fell by an annual average of 1% over 30 years to 1988. In contrast China’s productivity has been lifted by a massive expansion of private enterprise, and a shift of labor out of agricultural work and into more productive jobs in industry. China’s average return on physical capital is now well above the global average, according to Goldman Sachs. A decade ago it was less than half the world average.

The United States has total federal, state and local government spending of $6.3 trillion in 2012

Total Spending  $6.3 trillion  
Pensions        $1.0 trillion  
Health Care     $1.1 trillion  
Education       $0.9 trillion  
Defense         $0.9 trillion  
Welfare         $0.7 trillion

It is well known that the US spends more on health care per person and more on education per person with average results that are often not superior to those of other developed countries.

Are the US investment in defense going to provide greater economic benefits ? It would in scenario where the defense was needed to fend off an invader or if the military gains provide more geopolitical economic returns.

China has corruption and the US has lawyers (legal industry about $250 billion) and more bureaucracy and incompetence on large construction projects.

Michael Pettis declined my bet on whether China’s GDP will be larger than the US in 2018

Michael Pettis believes that China’s GDP measures ignore capital misallocation, Non-performing loans and environmental degradation, which together may mean that Michael believes that Chinas GDP is actually 20-40% smaller than the nominal GDP numbers suggest (and much smaller than the PPP estimates, which are almost worthless anyway).

I agree with the higher purchasing power parity estimates and getting into what should or should not be in GDP means coming up with a different metric which would be irrelevant to a discussion of the current GDP metric.

I will still track China and US GDP closely. We will see which is higher as we get towards 2018 and 2020.

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