Most people point to the rapid growth in China’s capital spending and its unusually high share of GDP. Fixed-asset investment (the most widely cited figure, because it is reported monthly) has grown at a breathtaking annual rate of 26% over the past seven years. Yet these numbers are misleading. They are not adjusted for inflation and they include purchases of existing assets, such as land, that are inflated by the rising value of land and property. A more reliable measure, and the one used in other countries, is real fixed-capital formation, which is measured on a value-added basis like GDP. This has increased by a less alarming annual average of 12% over the past seven years, not that much faster than the 11% growth rate in GDP in that period.
The level of fixed-capital formation does look unusually high, at an estimated 48% of GDP in 2011 (see left-hand chart). By comparison, the ratio peaked at just under 40% in Japan and South Korea. In most developed countries it is now around 20% or less. But an annual investment-to-GDP ratio does not actually reveal whether there has been too much investment. To determine that you need to look at the size of the total capital stock—the value of all past investment, adjusted for depreciation. Qu Hongbin, chief China economist at HSBC, estimates that China’s capital stock per person is less than 8% of America’s and 17% of South Korea’s (see right-hand chart). Another study, by Andrew Batson and Janet Zhang at GK Dragonomics, a Beijing-based research firm, finds that China still has less than one-quarter as much capital per person as America had achieved in 1930, when it was at roughly the same level of development as China today.
Some claim that a rise in the ratio of China’s capital stock to GDP is evidence that new investment is becoming less efficient: a given increase in capital leads to a smaller increase in GDP. But a rising capital-output ratio is perfectly normal when a poor country shifts from agriculture to more capital-intensive industry. GK Dragonomics estimates that China’s ratio of 2.4 in 2010 is well within the range of 2 to 3 seen in most countries.
Another yardstick is the return on capital, which should be falling if there is huge spare capacity. Yet average industrial profit margins and the rate of return on capital of listed firms have been fairly steady over the past decade after adjusting for the cycle. Although many firms, particularly state-owned ones, benefit from cheap loans, the average real cost of borrowing across the whole economy is much higher, so this distortion is more likely to lead to a misallocation of investment than to excess overall investment. The growth rate in China’s “total factor productivity” (TFP), a measure of the efficiency with which both labour and capital are used, has also been one of the fastest in the world.
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