Consumer-Based Growth: Reorienting Investment and Enhancing Efficiency
IMF experts review
China should increase the efficiency of its investments, with a less direct and less transient link with corporate and household income. Thus, investment may generate a more permanent and higher income. Consumption could become more self-sufficient. Therefore, the investment should not be indiscriminately directed towards urbanization and industrialization of western regions, but focused on areas with greater and more lasting side effects on income and household consumption
There seems to be a growing consensus that China’s growth model heavily reliant on exports and investment may have run its course. Not many challenge that China will have to adjust to slower global trade growth over the next decade. However, views differ on the role of investment. On one side, it is argued that huge infrastructure needs particularly in less developed non-coastal areas and ongoing urbanization will require still ample investment. In the other camp, there is some skepticism about whether China can continue to invest at the current rate due to limited absorptive capacity, increasingly inefficient investment and tightening financing conditions.
Assessing which of these views is more appropriate is very important at the current juncture, as China searches for alternative growth engines amid structural changes to its economy, and an external landscape transformed by the global crisis. If some investment is excessive, that part will only raise output at the time of implementation, with little impact on future growth. If continued, large deadweight losses will arise that could become increasingly difficult to resolve. On the other hand, cutting investment, even if it is excessive, will inevitably slow growth. The only way to maintain relatively robust growth in this case would be to raise capital efficiency.
Acknowledging this issue, the Chinese government for the first time called for a reduction in “redundant” public investment during its most recent Economic Work Conference. So what kinds of investment should be curtailed? Another way of describing this challenge is how to ensure consumption does not slow too much as investment declines to a lower steady state growth path. Excessive investment will likely raise corporate income, and to a lesser extent household income as the share of labor cost is usually low, during the implementation phase and then falter quickly thereafter as it will not contribute to effective capital accumulation. On the other hand, more efficient investment that contributes to the productive capital stock should have a less direct and less transitory link with corporate and household income. Instead, investment will be associated with a more permanent and higher income, and consumption would be more self-sustaining.
This analysis, made by IMF experts, proposes a possible framework for identifying excessive investment. Based on this method, it finds evidence that some types of investment are becoming excessive in China, particularly in inland provinces. In these regions, private consumption has on average become more dependent on investment (rather than vice versa) and the impact is relatively short-lived, necessitating ever higher levels of investment to maintain economic activity. By contrast, private consumption has become more self-sustaining in coastal provinces, in large part because investment here tends to benefit household incomes more than corporate ones.. If existing trends continue, valuable resources could be wasted at a time when China’s ability to finance investment is facing increasing constraints due to dwindling land, labor, and government resources and becoming more reliant on liquidity expansion, with attendant risks of financial instability and asset bubbles.
Thus, investment should not be indiscriminately directed toward urbanization or industrialization of Western regions, but shifted toward sectors with greater and more lasting spillovers to household income and consumption. In this context, investment in agriculture and services is found to be superior to that in manufacturing and real estate. Financial reform would facilitate such a reorientation, helping China to enhance capital efficiency and keep growth buoyant even as aggregate investment is lowered to sustainable levels