In previous post (see ‘Thinking about China‘ and ‘What is happening in China?‘) I explored how the Chinese growth model was coming to an end. Like previous ‘miracle growth’ episodes the Chinese model was based on the suppression of internal consumption and the use of external demand for exports, and above all very, very high levels of investment to drive demand in the economy. Although the Chinese model is one that has been used before it is different in both the size of the economy and the scale of the imbalances. Chinese investment levels have been in recent years the highest ever recorded in history and the animated video below depicting the recent metro building program in China is a neat illustration of what is happening.
As I explained miracle growth episodes based on low consumption and high investment eventually always come to an end as the opportunity for productive investment is exhausted. Productive investments are ones that will generate a return that can at the very minimum be used to repay the capital borrowed to fund the investment. As more and more money is borrowed to implement less and less productive investment debt levels begin to soar, even though the economy is apparently growing strongly. Eventually the rising debt forces a slow down in growth and the economy begins the tricky business of rebalancing. It is tricky because it involves shrinking whole sectors of the economy associated with investment (such as heavy goods, cement, steel, infrastructural components, etc) and shifting production to the consumer sector. This process inevitably means enterprises shrinking, closing and going bankrupt and can cause a severe unemployment problem which can lengthen the rebalancing period. Whatever way the transtion period is managed the outcome of the end of a ‘growth miracle’ is inevitably a significant slow down in growth for many years as the debts built up in the growth period are paid down. In the case of China high ongoing rates of growth do not indicate economic health but rather the postponment of the neccessary adjustment, and the longer the postponment the more difficult the transition and rebalancing will be.
This sort of rebalancing is doubly tricky in the Chinese political economy because it will require a shift of income and wealth away from the Party elite who are disproportionality dependent for their very high wealth on the investment sector, state enterprises and cheap capital, and who control the political system.
The problem of over investment is neatly illustrated by this startling animated map below (click the play button to view it). It shows underground metro construction in Chinese cities between 1992 and 2020 (it includes lines still under construction). As you can see the growth is impressive and then explosive. The period after the financial crisis is a period of frenetic metro line building as internal investment in China was ramped up to keep growth going. It wasn’t just metro building that saw frenetic growth, China is now criss crossed by super highways, full of huge airports, networked with high speed train systems and full of half occupied new cities.
But what now? A metro system in every town? In every village? Eventually the metro building binge has to come to an end then what becomes of the enterprises, and their workers, currently making metro trains, digging equipment, cement and rails?
