Page 124 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 6: Investment

Notes
it will end in tears. To assess that risk you need to ask two questions. How much excess
capacity was there already? And where is the new investment going?
There is certainly excess capacity in a few sectors (steel and some export industries, such as
textiles). But the best measure of spare capacity for the economy as a whole-the difference
between actual and potential GDP, or "output gap"-is probably only about 2% of GDP,
compared with an average of almost 7% in the rich world.
The large role played by state-owned banks is bound to have resulted in some misallocation
of capital, but a recent study by Helen Qiao and Yu Song at Goldman Sachs argues that
concerns about overinvestment are exaggerated. A successful developing economy should
have a high ratio of investment to GDP. And a rising rate does not mean that the efficiency
of capital is falling; capital-output ratios are supposed to increase as economies develop.
America's capital stock is much larger relative to its GDP than China's, with 20 times more
capital per person than in China.
A better measure of capital efficiency is profitability. Profits have indeed slumped over
the past year, but taking the past decade to adjust for the impact of the economic cycle,
profit margins have not narrowed as one might expect if there were massive spare capacity.
The argument that the average cost of capital is ludicrously low is also no longer true.
China's real interest rate is now 7%, which is among the highest in the world.
Where is the new investment going? There has been little new spending in industries with
overcapacity, such as steel and computers. But the surge in state-directed investment has
fuelled fears about its quality. In its latest China Quarterly Update, the World Bank calculates
that government-influenced investment so far this year was 39% higher (on a national-
accounts basis) than a year earlier, while "market-based" investment rose by a more modest
13%. This implies that government-influenced investment accounts for about three-fifths
of the growth in investment this year, up from one-fifth last year.
The usual assumption is that government investment is less efficient and will therefore
harm long-term growth. But the fastest expansion in spending has been in railways (up by
111% this year). As a developing country, China still lacks decent infrastructure; railways,
in particular, have long been an economic bottleneck. Investment in roads, the power grid
and water should also yield high long-term returns by allowing China to sustain rapid
growth.
And the government is focusing its infrastructure stimulus on less developed parts of the
country where the benefits promise to be greatest. According to Paul Cavey at Macquarie
Securities, fixed-asset investment in western provinces was 46% higher in the first four
months of this year than in the same period of 2008, almost double the rise in richer
eastern provinces.
Some of the money being spent in China will inevitably be wasted, but it is wrong to
denounce all government-directed investment as inefficient. In the short term it creates
jobs, and better infrastructure will support future growth. It is certainly not a substitute
for the structural reforms needed to lift consumer demand in the longer term, but it could
help. After all, without running water and electricity, people will not buy a washing
machine.
Question:
Do you think that China's investment spending could soon be bigger than US? Justify.

Source: www.economist.com

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