Breaking China’s investment addiction
China’s economic growth model is running out of steam.
According to the World Bank, in the 30 years after Deng Xiaoping initiated economic reform, investment accounted for 6 to 8 percentage points of the country’s 9.8 per cent average annual economic growth rate, while improved productivity contributed only 2 to 4 percentage points.
Faced with sluggish external demand, weak domestic consumption, rising labour costs and low productivity, China depends excessively on investment to drive economic growth.
Although this model is unsustainable, China’s over-reliance on investment is showing no signs of waning. In fact, as China undergoes a process of capital deepening (increasing capital per worker), even more investment is needed to contribute to higher output and technological advancement in various sectors.
In 1995-2010, when China’s average annual gross domestic product (GDP) growth rate was 9.9 per cent, fixed-asset investment (investment in infrastructure and real-estate projects) increased by a factor of 11.2, rising at an average annual rate of 20 per cent.
Total fixed-asset investment amounted to 41.6 per cent of GDP, on average, peaking at 67 per cent of GDP in 2009, a level that would be unthinkable in most developed countries.
Also driving China’s high investment rate is the declining efficiency of investment capital, reflected in China’s high incremental capital-output ratio (annual investment divided by annual output growth), or ICOR.
In 1978-2008 — the age of economic reform and opening — China’s average ICOR was a relatively low 2.6, reaching its peak between the mid-1980s and the early 1990s. Since then, China’s ICOR has more than doubled, demonstrating the need for significantly more investment to generate an additional unit of output.
VICIOUS CIRCLE OF OVERPRODUCTION