Opinion & Commentary
Capital flows the wrong way in China
China has recently indicated that it intends to move away from an investment-driven growth strategy toward a consumption based one in order to sustain the next stages of its economic growth. This was reiterated by President Hu during the current five-yearly congress of the Communist party in Beijing where the President told us that China’s “development pattern will be significantly transformed.”
Hu’s prescription is spot on and economic experts have generally applauded the sentiment. China desperately needs to implement a successful consumption based strategy for both economic and social reasons. But words and action are two very different things, especially in China. Reforms needed to substantially lift consumption are unlikely to occur due to overriding political priorities.
Let me first explain China’s two decade old growth strategy. It involves a very inefficient and wasteful recycling of money.
About three-quarters of Chinese growth come from capital investment. State-owned-banks offer cheap capital to mainly state-owned-enterprises who in turn pour money into investment projects. There is ample evidence that this state-directed forced-feeding strategy is unsustainable.
First, World Bank findings indicate that about a third of all recent investments are wasted, and it is rising. In the 1980s and 1990s it took $2-$3 of new investment to produce $1 of additional growth. It now takes about $5 invested for $1 of additional growth. Incidentally, this is worse than even during the Mao period in which it took $3 of investment for $1 of growth.
Second, China is suffering the effects of massive and chronic “overinvestment”, over-capacity, and declining productivity. Chinese companies keep pumping money into making goods, building roads and infrastructure, and erecting buildings that are not used or needed. No wonder achieving growth is becoming less efficient. The Chinese are clearly getting less and less bang for their buck.
How has consumption growth fared in contrast?
In the first half of the 1980s, consumption constituted around 55 percent of China’s GDP. In 2006, the figure is closer to 30 percent. In other words, despite almost 25 years of growth around the double digit mark year-on-year, the proportion of consumption as part of GDP has almost halved.
How do we move away from the investment-driven strategy and raise domestic consumption?
There are a few things the Chinese could do. They could raise the cost of capital in order to curb reckless investment. By all measures, capital for SOEs is too cheap and readily available. They could also simply stop ‘policy lending’ – instructing state-owned-banks to offer so much credit to a relatively small number of inefficient SOEs. Instead, capital would go to those companies that are most likely to make a profit.
All evidence suggests that private companies in China when given the chance thrive. The Chinese domestic sector is stunted because it is not given adequate access to capital and is barred from operating in the dozen or so ‘key industries’ that are currently reserved just for SOEs. In 1985, the private sector received about 85 percent of capital. The figure is now about 30 percent.
China needs to encourage a ‘virtuous pro-consumption circle’: create more jobs, raise across-the-board disposable incomes for the many rather than just the politically connected, and develop private companies and sectors within the Chinese economy that can actually compete in the global economy and stand on its own two feet without regime support.
Bear in mind that the leadership first flagged the need to move toward a more domestic consumption-driven strategy in 2004. Since then, investment as a proportion of GDP has increased from about 40 percent to 55 percent. Monies loaned to SOEs have increased around 20 percent year-on-year since 2004. Despite all the talk, about boosting consumption, the regime has overseen policies that have done the exact opposite.
Why? It all comes down to overriding political priorities.
To placate and co-opt its supporters, and preserve its support base: money is directed from the banks to keep SOE workers, and the Party insiders who run them, happy. The most important sectors are off limits for domestic private businesses since SOEs would not be able to compete.
Will Hutton calls this the greatest theft in human history. The hard-earned savings of its people deposited in banks is effectively being used by the regime as part of its fiscal arm. It is probably the greatest illustration of sustained pork-barrelling of all time. The political costs of changing this strategy are unacceptable for a regime already in serious trouble with its own people. A thriving and powerful private sector that is independent and not reliant on the regime combined with a shrinking state-owned sector would heighten the irrelevance of the Party.
This is why talk about moving toward a consumption-driven strategy is still likely to remain just talk.
Dr John Lee is a Visiting Fellow at the Centre for Independent Studies. His book, Will China Fail?, was released by CIS on Saturday.
