China Economy

China's spending could cause crisis, IMF experts warn

A report by IMF experts warns China is overinvesting at a speed that could plunge it into crisis and burden its SMEs and households

PUBLISHED : Wednesday, 05 December, 2012, 12:00am
UPDATED : Monday, 30 May, 2016, 5:00pm


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Economists from the International Monetary Fund have joined critics in warning that China may be overindulging in its investment binge, with potentially dangerous consequences, economically and socially.

The authors estimate that China's overinvestment in the past few years could amount to as much as 20 per cent of gross domestic product, though they settle on the figure of 10 per cent.

The authors claim: "Now, with investment to GDP already close to 50 per cent, the current growth model may have run its course … In China, a large burden of the financing of overinvestment is borne by households, estimated at close to 4 per cent of GDP per year, while SMEs are paying a higher price of capital because of the funding priority given to larger corporations."

The three authors are ultracareful and sensitive in handling the topic. Their working paper, entitled Is China Over-investing And Does it Matter?, contains the caveat that the views in the paper "do not necessarily reflect those of the IMF".

Two of the authors, Il Houng Lee and Murtaza Syed, are, respectively, the senior and the deputy resident representative of the IMF's China office, so it is hard to get more authoritative or officially close to the IMF's informed thinking.

The third author, Liu Xueyan, is a senior fellow in the institute of economic research of the National Development and Reform Commission of China, whose contribution carries the caveat that the paper does not reflect NDRC's views, either.

As they note, other reports have questioned China's investment levels. The novel approach of the latest working paper is that it looks at China in the context of other countries that have also seen their economic take-off boosted by high levels of investment. Other Asian nations blazed a trail of high growth backed by investment, good savings rates and exports.

But, as the paper points out, "high investment has also proven to be costly", both in other parts of Asia and previously in Latin America in the 1980s. High investment ratios, fed by foreign financing, allowed countries to achieve faster growth, but then led to disastrous banking or foreign exchange crises.

They estimate that, based on a cross-country regression, China's over-investment gives it a one-in-five chance of an economic crisis, but they say that may be overstating the risk because of China's low reliance on foreign capital.

But the working paper points out: "While a crisis appears unlikely when assessed against dependency on external financing, it raises concerns about the underlying domestic strain associated such a high level of investment, which appears to be implicitly borne by households."

It says: "China requires ever higher investment to generate the same amount of growth."

With prospects of export growth subdued because of the sluggish global economy, unless there is an unexpected surge in China's productivity, "the contribution of investment to growth will need to reach 60 to 70 per cent to support the same amount of growth".

The authors warn "the cost of financing such an elevated level of investment could undermine overall economic stability". They conclude: "The challenge is to engineer a gradual reduction in investment to a path that would maximise social welfare."

That path is not clear, they say, but China could lower its investment by 10 percentage points of GDP "over time" without compromising growth and macroeconomic stability.

But they also plead - carefully, as if not wishing to offend anyone - for "reforms that would raise productivity and efficiency, while ensuring that the fruits of China's remarkable growth are shared more equitably across different economic agents, in particular ordinary Chinese households".

It is easier said than done. Lynette Ong, an associate professor at the University of Toronto, is more direct in pointing out how construction has driven and taken a grip of China's economy, with attendant risks.

She notes that in an area of Anhui province officially designated an "impoverished county", "the government office block looks exactly like the White House, only newer and whiter".

Potential social problems are exacerbated by the raw deals ordinary Chinese suffer at the hands of government officials. Under Chinese law, which states that collectively owned farmland must be converted to state ownership before being released to private developers, local governments can make huge profits in expropriating land from villagers. About 300,000 peasants are evicted from their villages each year.