Pettis + Sumner v FE
Some of China's unbelievably high investment can be thought of as "quasi-consumption"
by S.C. | HONG KONG
MICHAEL PETTIS and Scott Sumner disagree about China. But they both agree that a recent Free Exchangecolumn about China's investment spending is bunkum. To be honest, I'm having my doubts about the column too.
Mr Pettis, a finance professor at Beida's school of management, thinks China's investment-led growth model is impossible to sustain and yet hard to replace. It cannot go on. Yet without it, China's high-speed growth cannot go on either. As a consequence, he argues, China's growth this decade will "barely break 3%". Bet on it.
Mr Sumner, on the other hand, is more relaxed about China's heavy capital spending. China, he points out, needs to build a lot more of almost everything, even if it doesn't always build everything in the right order. He invokes a deep theorist--the only Westerner to understand China--to buttress his case. Much of China's investment, he concludes, is a prelude and complement to consumption.
Isn't all investment a prelude to consumption? It should be. But Mr Pettis thinks China's investment is mostly a prelude to further investment. The Chinese dig fresh iron-ore mines to supply new steel mills, which serve the grand designs of property developers, who sell their flats to speculators. The fruit of this long chain of investment is supposed to be "housing services" in this example. But that is not what property speculators are buying. If China's capital spending appears profitable, it is only because each stage of investment creates artificial demand for the products of the previous stage.
So Mr Pettis and Mr Sumner are divided on China. But they are united in their criticism (see here and here) of the recent Free Exchange("Hayek on the Standing Committee?"). That column reported on research by two economists at Goldman Sachs, Yin Zhang and Michael Buchanan (who has just left the firm). They argue that some of China's unbelievably high investment can be thought of as "quasi-consumption". Once this is taken into account, China's investment rate doesn't look quite so excessive.
"Quasi-consumption" is a slippery concept. It's possible it serves to obscure more than it reveals. (Certainly, it drove two of Mr Sumner's commenters to distraction.) I may try and tease out what it might mean in a subsequent post. But as a first pass, let's make a familiar distinction between investment by households, the government and firms. This three-fold distinction is quite common in discussions of investment, or gross fixed capital formation (GFCF), among statisticians. For example, in their very readable guide to the national accounts, François Lequiller and Derek Blades write the following:
The gross fixed capital formation of "pure" households... consists of the purchase of dwellings...The GFCF of general government consists mainly of road infrastructure but also of office buildings, schools, hospitals, etc. However, what economists are mainly interested in is the gross fixed capital formation of the business sector... This is the largest single component of investment and its movements trigger off the beginning and the end of economic cycles.
The easiest way to convey the gist of the Goldman Sachs research it to say that they have divided China's investment into these three categories, more or less*. And they have noticed that a disproportionate amount of it falls into the first two: the purchase of dwellings, and investment by the government (in what they call "social infrastructure"). Together, these two kinds of investment account for about 18% of GDP, the economists calculate, or almost 40% of China's overall investment in fixed assets. In Russia, by comparison, investment in dwellings and infrastructure accounts for less than 30% of gross fixed capital formation.
I think this is an interesting observation, even if quasi-consumption is not the right way to describe it. At the very least, their finding helps to allay two specific fears about overinvestment: the fear that China's heavy capital spending is creating excess industrial capacity, and the related fear that China will resolve its overcapacity problem by dumping excess goods on world markets. Those are not the only worries that China's high investment inspires. But they are the two that most disturb the sleep of rival producers overseas.
*It's more complicated than it sounds, because China's National Bureau of Statistics does not provide a neat breakdown of GFCF into these categories. The Goldman Sachs economists must instead use an alternative series on Fixed-Asset Investment (which is not the same as the GFCF reported in the GDP figures). The FAI figures are broken down into about 20 categories. From these 20, the Goldman Sachs economists pick out seven elements of "social infrastructure". They then assume that social infrastructure's share of GFCF is the same as its share of FAI. To social infrastructure, they then add (non-commercial) housing. If that sounds fiddly, welcome to my world.
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