Investment Boom Unsustainable

The Chinese fixed-asset investment boom of the past decade has been, in a word, unprecedented. All low-income countries have required outsized capital stock additions to make the leap to middle-income status, but China’s boom is unmatched by anything on the record books. In fact, by some measures of physical capital, China looks more like one of the world’s leading developed economies, rather than the middle-income economy it is.

As a consequence, we see very little reason to believe China can continue to rely on building ever-more skyscrapers, highways, and manufacturing plants to sustain the kind of GDP numbers to which Chinese citizens and global investors have grown accustomed. In the next 10 years, the onus for growth will rest squarely on Chinese households and their willingness and ability to consume. If consumption fails to grow at a rate well above historical norms, the economy may be able to muster only 5% growth at best, a far cry from the 10% it averaged from 2001 to 2010.

A Decade of Growing Imbalances
The macroeconomic facts of the story provide a sense of just how dramatic China’s fixed-asset investment boom has been (Exhibit 1).

In 2000, before the boom kicked off in earnest, gross capital formation (the GDP accounting term for investments in physical capital, otherwise known for its abbreviation, GCF) accounted for 35% of Chinese economic output. While large by developed economy standards (the U.S. 10-year average is 19%, Japan’s is 23%), it wasn’t terribly atypical for a high-growth emerging economy. Nor was it unusual for China: A decade prior, GCF also had a 35% share. The consistent share of GCF reflected the balanced growth China enjoyed in the 1990s. By 2000, the Chinese economy was 170% larger than it was in 1990, driven by a 173% increase in investment and an only slightly lower 156% increase in consumption.

Chinese GDP expanded at a similarly impressive rate in the 2000s. By 2010, the Chinese economy was 171% larger than it was in 2000. But by then, the sources of growth were anything but balanced. A massive share came from a surge in fixed-asset investment. China was spending 273% more on physical capital than it was in 2000, with GCF accounting for a staggering 49% share of output by decade’s end. Yet households were "only" consuming 97% more than they were in 2000, depressing the share of household consumption of total GDP to 34% in 2010, a paltry share by any standard and the lowest level seen in China since the founding of the People’s Republic.

Unprecedented Intensity
The extreme imbalance between investment and consumption is striking in and of itself. After all, the ultimate purpose of any investment is to consume (eventually). But it appears even more exceptional in the context of the three biggest investment-led success stories of the past 50 years: Japan, Korea, and Taiwan (Exhibit 2). By any measure of fixed asset investment intensity--growth rates, share of cumulative GDP growth, or share of GDP--China has far surpassed the precedents set by these three countries in their boom years. We estimate that, relative to the starting size of the economy, cumulative additions to Chinese capital stock in its boom decade have been 43% greater than Japan’s, 33% greater than Korea’s, and 49% greater than Taiwan’s.

Just as striking is the relatively feeble contribution of consumption to Chinese growth rates. While GCF grew faster than consumption in the boom decades of Japan, Korea, and Taiwan, consumption still accounted for at least half of total economic expansion in each case, versus the paltry 26% share we see in China. Somewhat shockingly, while the investment share of Chinese GDP has exceeded the consumption share in every year since 2003, this feat was not achieved in any year by Japan, Korea, or Taiwan.

China’s Capital Needs
Various "hard" measures of GCF confirm the outsized role of fixed-asset investment in the Chinese growth story. As noted, the Chinese economy is roughly 170% larger than it was a decade ago. But the economy now consumes 383% more aluminum and 393% more steel. Total expressway mileage is up 354% over the past decade, the number of tunnels is up 338%, and floor space under construction, a concrete measure of real estate activity, is up 337%.