China over investing by about 10% of GDP
China’s capital-to-output ratio is within the range of other emerging markets, but its economic growth rates stand out, partly due to a surge in investment over the last decade. Moreover, its investment is significantly higher than suggested by cross-country panel estimation. This deviation has been accumulating over the last decade, and at nearly 10 percent of GDP is now larger and more persistent than experienced by other Asian economies leading up to the Asian crisis.
Investment financed by domestic savings and a 4% of GDP transfer from households to corporations
China’s investment is predominantly financed by domestic savings, a crisis appears unlikely when assessed against dependency on external funding. But this does not mean that the cost is absent. Rather, it is distributed to other sectors of the economy through a hidden transfer of resources, estimated at an average of 4 percent of GDP per year.
In other countries the high cost from excess investment has been exposed in the form of bank stress or foreign exchange market crisis, in China, it will likely be captured in, or triggered by, any one of the weak links of this implicit subsidy system.
China’s investment level should be lowered over time by 10 percentage points of GDP. This will help to get to more macroeconomic stability.
This should be accompanied by reforms that would raise productivity and efficiency, while ensuring that the benefits of growth are shared more equitably across different economic agents.