Chinese Malinvestment

Former White Elephant Investment: Pudong 1990 vs. 2010

We're in the midst of another round of Chinese 'Ghost City' malinvestment chatter in the news. Most recently, it was a report out of China citing an eye catching $6.8 trillion figure as the amount squandered.

The paper came from a couple of Chinese academics (Xu Ce and Wang Yuan) at the National Development and Reform Commission. As usual, I couldn't find the source material so I'll run through a couple of summary pieces in our media.

Here's  Jamil Anderlini at FT:

“Ghost cities” lined with empty apartment blocks, abandoned highways and mothballed steel mills sprawl across China’s landscape – the outcome of government stimulus measures and hyperactive construction that have generated $6.8tn in wasted investment since 2009, according to a report by government researchers...

Misallocation of capital and poor investment decisions are not the only explanation for the enormous waste in China’s economy. A significant portion of China’s post-crisis stimulus binge was simply stolen by Communist Party officials with direct responsibility for boosting growth through investment, according to separate estimates by Chinese and overseas economists. 

From Mike Bird at Business Insider:

The Chinese economy has wasted $6.8 trillion (£4.3 trillion) in investment during the last four years...

Even in the enormous Chinese economy, that's practically half of the investment between 2009 and 2013, the period covered by the investigation. This is likely to have pretty grim effects on Chinese economic growth in the years ahead.

This is sort of one of those sniff test statements. Does it really seem plausible? Recall this study that made the rounds a year or so back. The media typically summarized a summary of the study that they didn't bother to, or couldn't understand the nuances of; and drove conclusions far beyond the scope of the paper (which to my eye had already stretched their conclusions a bit given their own numbers).

In that paper, the authors make a claim (based on some weak assumptions) that 5.5 years of life were being lost, to Chinese living in the northern parts of the country, due to air pollution.

Again, an eye catching number. It seemed to fit the dominant China narrative. But the sniff test should have been, if you add 5.5 years to the life expectancy of northern Chinese how old would they then live? Beijingers would be living to 87+ years if they had the same air pollution levels as southern Chinese. Again, does that make sense? Of course not. Unless you're comfortable with the assertion that besides air pollution China does better at maximizes life expectancy then pretty much everywhere else in the world (in 2012 Japan's overall life expectancy was 1st in the world at 84.6 years).

So with this huge malinvestment number, the questions should be: what data were they using? and compared to what? And do two factors combine to produce the type of clear conclusions being drawn in the media?

The economist picks this apart pretty well here:

So how exactly do Mr Xu and Ms Wang arrive at their numbers? Their method is to compare China’s capital efficiency in the 1980s and 1990s with the past decade; they treat any decline in efficiency as evidence of wasted investment.

So, at a glance we can see that this is a fairly dubious way to seek the conclusions we're reading in the popular media. It's not to say that this study isn't useful. Measuring the diminishing returns to capital, or even parsing apart the theoretical divide between malinvestment and the more secular diminishing returns to capital you'd expect, would be incredibly useful. However, using the number derived from this method as a measure of malinvestment seems beyond an overreach.

At which point I notice that Paul Krugman has addressed this on his blog, better than I was going to.

What the paper does is look at the ratio of capital added to economic growth — the so-called incremental capital output ratio. It finds that the ICOR has been lower in recent years than it was in the past, and attributes all of the shortfall to waste. 

But what if there were no waste at all? What if China were simply engaged in capital deepening? What would we expect to see in that case? The answer is, exactly what we do see. The ICOR data say nothing at all about waste.

So again, this paper is looking at the capital efficiency in a more esoteric sense. The news papers a more literal sense. Playing on the ghost city, communist country narrative is all to easy. Which isn't to say that all investment is done 'efficiently'. Surely it is not. But the Chinese know that, and have been methodically going about remedying that over the past year.

Once again, I think Xi and the Communist Part of China have earned the benefit of the doubt on managing this process.