Chinese National Development and Reform Commission Estimate of Over Investment at Probably less than $10.8 trillion sine 1997
A recent study performed by two economists affiliated with the Chinese National Development and Reform Commission (NDRC), Beijing’s powerful economic planning and regulatory agency, offered a revealing glimpse into this puzzle. The economists examined two indicators: the delivery rate of completed fixed-asset investment projects and the incremental capital output ratio (ICOR), which measures how much additional capital is required to generate an extra unit of GDP growth. The researchers concluded that both measures show an alarming increase in wasteful and ineffective investments in China.
The delivery rate of completed capital projects, which was 74-79% in the late 1990s, has now fallen below 60%. This implies that nearly 40% of Chinese investment projects are either not finished on time or not completed at all.
The even more alarming figure, which made headlines around the world, is that ineffective investment has cost China $10.8 trillion since 1997. Sixty-two percent of the wasteful investment—$6.8 trillion—was made after 2009, when China went on an investment binge to stimulate its economy.
The two scholars reached this startling conclusion by noting that China’s ICOR has risen 50%, from 2.6 (for the period of 1979-1996) to 4 (for the period of 1997-2013). In practical terms, this means that before 1997 China needed $2.60 in investment to generate one dollar of GDP growth; today, China needs $4 to produce a dollar of GDP growth. The rise of ICOR, according to the researchers, indicates that China’s investments have become less efficient.
To be sure, one can raise technical questions about using ICOR to estimate investment efficiency. A country’s ICOR can rise as its economy becomes more capital intensive. Obviously, agriculture requires less capital than manufacturing. In China’s case, ICOR was 0.3 for agriculture but 5.9 for manufacturing during 2001-2007. Therefore, in all likelihood, the estimate that China has flushed $10.8 trillion down the drain since 1997 should be taken with caution.
In the 10 years after September 11, 2001 the USA spent more than $7.6 trillion on defense and homeland security. A trillion per year for defense and security in 2012, 2013 and 2014 would be about $10.6 trillion.
China’s capital-to-output ratio is within the range of other emerging markets. China’s 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. However, because its 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.
While a crisis appears unlikely when assessed against dependency on external funding, potential strains from financing high investment still exists and could be quite large. Assuming the conditions that prevailed in other emerging market economies during their pre- and post-crisis periods also apply to China, the probability of a crisis in China would mechanically be about one in five. However, because of the differences in the modality of financing of investment, an external crisis of the kind experienced by many other emerging market economies appears very unlikely to occur in China. But this does not mean that the cost is also absent. Rather, it is distributed to other sectors of the economy in the form of a hidden and implicit transfer of resources. In China, a large burden of the financing of over-investment is borne by households, estimated at close to 4 percent of GDP per year, while SMEs are paying a higher price of capital because of the funding priority given to larger corporations.
Going forward, the challenge is to engineer a gradual reduction in investment to a path that would maximize social welfare. Since that path is not identifiable, the norm estimated using a large sample of emerging markets could provide some guidance. Based on cross-country regressions, lowering China’s investment by 10 percentage points of GDP over time would bring it to levels consistent with fundamentals. Otherwise, vulnerabilities will continue to build. To the extent that elevated levels of investment during the post-crisis period in China were somehow abnormal and necessitated by the sharp external slowdown, the challenge now is how to return to a more “normal” level of investment without compromising growth and macroeconomic stability. Obviously, reaching the level itself should not be the only goal, but it should be accompanied by reforms that would raise productivity and efficiency, while ensuring that the fruits of China’s remarkable growth are shared more equitably across different economic agents, in particular ordinary Chinese households. International experience shows that these are prerequisites for sustainable growth in any country.
Brian Wang is a Futurist Thought Leader and a popular Science blogger with 1 million readers per month. His blog Nextbigfuture.com is ranked #1 Science News Blog. It covers many disruptive technology and trends including Space, Robotics, Artificial Intelligence, Medicine, Anti-aging Biotechnology, and Nanotechnology.
Known for identifying cutting edge technologies, he is currently a Co-Founder of a startup and fundraiser for high potential early-stage companies. He is the Head of Research for Allocations for deep technology investments and an Angel Investor at Space Angels.
A frequent speaker at corporations, he has been a TEDx speaker, a Singularity University speaker and guest at numerous interviews for radio and podcasts. He is open to public speaking and advising engagements.