Issue: 364
Sent: 24-11-2009 10:32:01
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Another Transiton to Worry About
John Robertson
China's transition from an economy dominated by investment spending to one oriented more toward consumption will be another test for the global economy.
We have all marvelled at how quickly the Chinese economy has been growing for nearly two decades. Its average 10.3% per annum GDP growth rate since 1990 has turned a centrally planned agricultural economy into an economic powerhouse.
Western commentators, continually concerned about infrastructure inadequacies in their own countries, might have viewed this performance too uncritically. From that perspective, a government commitment to bridges, roads, airports and new, more efficient factories seems an unquestionable good.
However, there is evidence that Chinese investment spending has been excessive insofar as there is now widespread excess capacity and fading investment returns.
According to the Asian Development Bank, gross domestic capital formation accounted for 44.4% of Chinese GDP in 2008. The proportion of capital spending in GDP had been running above 40% since 2003. In 2008, consumption spending made up just 36.1% of GDP. In the current year, the contribution of capital spending could exceed 50%.
In India, Asia's other large developing economy, consumption accounted for an estimated 55% of GDP in 2008 and investment spending was equivalent to just 34%. In Indonesia, the capital spending ratio was 28% in 2008 and 15% in the Philippines.
Under almost any circumstances, China's investment program was likely to outstrip anything among either the advanced or the developing economies. However, there has been some evidence of Chinese provincial authorities opting for investment as the easiest way to meet centrally imposed growth objectives. Similarly, there has been evidence that spending has been maximized, even as the return on investment began to decline, to ensure that subsequent allocations of capital funds would not be lost.
Superimposed on these already high levels of capital spending in the last 12 months has been a highly capital intensive government stimulus program.
Chinese policymakers were always going to have a tough job rebalancing the respective contributions of investment and consumption. One of the consequences of these artificially high levels of investment will be a more rapid curtailment of investment spending in the coming two years than would otherwise have been needed.
China's policy makers will have to manage the transition from an economy driven by investment spending to one driven by consumption spending in such a way that consumption growth accelerates fast enough to adequately compensate for a likely fall in investment.
This puts the Chinese authorities in a severe bind if they wish to target a 10% growth rate any longer. The maths confronting them is quite stark.
Let's say investment in 2009 is 50% of GDP and consumption is 35% leaving the remaining 15% to be contributed from other sources.
Let's also say that investment spending is unchanged at its currently elevated level in 2010. If GDP growth is to approach 10%, consumption spending would have to grow at a rate near 30% in a single year. This would be nearly unimaginable.
If, in 2011, investment spending drops back toward an already very high level of 40%, consumption spending would have to rise by another 45% to get us close to a 10% growth target.
We might be inclined to give the Chinese authorities the benefit of the doubt. After all, haven't they done an outstanding job so far in managing a transition to a vibrant market based economy? Nonetheless, these would be extraordinary outcomes if they were achieved.
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