Breaking China’s Investment Addiction

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China’s economic growth model is running out of steam.According to the World Bank, in the 30 years after Deng Xiaoping initiatedeconomic reform, investment accounted for 6-8 percentage points of the country’s9.8% average annual economic growth rate, while improved productivitycontributed only 2-4 percentage points. Faced with sluggish external demand,weak domestic consumption, rising labor costs, and low productivity, Chinadepends excessively on investment to drive economic growth.
Although this model is unsustainable, China’s over-relianceon investment is showing no signs of waning. Infact, as China undergoes a process of capital deepening(increasing capital per worker), even more investment is needed tocontribute to higher output and technological advancement in various sectors.
In 1995-2010, when China’s average annual GDP growth ratewas 9.9%, fixed-asset investment (investment in infrastructure and real-estateprojects) increased by a factor of 11.2, rising at an average annual rate of20%. Total fixed-asset investment amounted to 41.6% of GDP, on average, peakingat 67% of GDP in 2009, a level that would be unthinkable in most developedcountries.
Also driving China’s high investment rate is the decliningefficiency of investment capital, reflected in China’s high incrementalcapital-output ratio (annual investment divided by annual output growth). In1978-2008 – the age of economic reform and opening – China’s average ICOR was arelatively low 2.6, reaching its peak between the mid-1980’s and the early1990’s. Since then, China’s ICOR has more than doubled, demonstrating the needfor significantly more investment to generate an additional unit of output.
As the accumulation and deepening of capital accelerategrowth, they perpetuate the low-efficiency investment pattern and stimulateoverproduction. When production exceeds domestic demand, producers arecompelled to expand exports, creating an export-oriented, capital-intensiveindustrial structure that supports rapid economic growth. But if externaldemand lags, products accumulate, prices decline, and profits fall. Whilecredit expansion can offset this to some degree, increased production based oncredit expansion inevitably leads to large-scale financial risk.
Thus, a combination of investment, debt, and credit isforming a self-reinforcing risky cycle that encourages overproduction. In thewake of the global financial crisis, Chinese banks were instructed to extendcredit and invest in large-scale infrastructure projects as part of thecountry’s massive monetary and fiscal stimulus. As a result, China’s credit/GDPratio rose by 40 percentage points in 2008-2011, with most of the lendingdirected toward large-scale investment by state-owned enterprises (SOEs). Inthe last two years, bank credit has become the main source of capital in China– a risky situation, given the low quality and inadequacy of bank capital.
Meanwhile, strong currency demand has led China’s M2 (broadmoney supply) to increase to 180% of GDP – the highest level in the world. Themassive wall of liquidity that has resulted has triggered inflation, sentreal-estate prices soaring, and fueled a sharp rise in debt.
Given that it is in local governments’ interest to maintainhigh economic-growth rates, many are borrowing to fund large-scale investmentin real estate and infrastructure projects. The active fiscal policy adoptedduring the financial crisis enabled the rapid expansion of local officialfinancing platforms (state-backed investment companies through which localgovernments raise money for fixed-asset investment), from 2,000 in 2008 to morethan 10,000 in 2012. But, as local-government debt grows, Chinese banks havebegun to regard real estate and local financing platforms as a major creditrisk.
Likewise, with key industries facing overproduction andslowing profit growth, firms’ deficits are growing – and their debts arebecoming increasingly risky. Indeed, the proportion of deficit spending amongenterprises is on the rise, and the accounts-receivableturnover rate is falling. By the third quarter of 2012, industrial enterprises’receivables totaled 8.2 trillion renminbi ($1.3 trillion), up 16.5% year onyear, forcing many to borrow even more to fill the gap, which has driven up debt further.
According to GK Dragonomics, corporate debt amounted to108% of GDP in 2011, and reached a 15-year high of 122% of GDP in 2012. Manyheavily indebted companies are SOEs, and most of the new projects that theyinitiate are “super-projects,” with the return on investment taking longer thancreditor banks expect. Indeed, some highly indebted firms’ capital chains maywell rupture in the next two years, when theyreach their peak period for debt repayment.
As a result, China’s financial system is becomingincreasingly fragile. The expansion of infrastructure investment – which,according to some reports, exceeds 50 trillion renminbi, including highway andhigh-speed railway construction – will lead to the expansion of banks’ balancesheets. The investment loans and massive debts among local financing platforms,together with the off-record credit channeledthrough the “shadow” banking system, areincreasing the risk that non-performing loans will soon shake the bankingsector.
To reach the next stage of economic development, Chinaneeds a new growth model. Reliance on investment will not enable China toachieve stable, long-term growth and prosperity; on the contrary it may wellinflict serious long-term damage on economic performance.

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关键词：Investment Addiction investmen Breaking Invest only Investment investment percentage

According to the World Bank, in the 30 years afterDeng Xiaoping initiated economic reform, investment accounted for 6-8percentage points of the country’s 9.8% average annual economic growth rate,while improved productivity contributed only 2-4 percentage points. Faced withsluggish external demand, weak domestic consumption, rising labor costs, andlow productivity, China depends excessively on investment to drive economicgrowth.
as China undergoes a process of capitaldeepening (increasing capital per worker), even more investment is neededto contribute to higher output and technological advancement in varioussectors.
Also driving China’s high investment rate is thedeclining efficiency of investment capital, reflected in China’s highincremental capital-output ratio (annual investment divided by annual outputgrowth)
As the accumulation and deepening of capitalaccelerate growth, they perpetuate the low-efficiency investment pattern andstimulate overproduction.
When production exceeds domestic demand, producers arecompelled to expand exports, creating an export-oriented, capital-intensiveindustrial structure that supports rapid economic growth. But if externaldemand lags, products accumulate, prices decline, and profits fall. Whilecredit expansion can offset this to some degree, increased production based oncredit expansion inevitably leads to large-scale financial risk.
Thus, a combination of investment, debt, and credit isforming a self-reinforcing risky cycle that encourages overproduction.
Meanwhile, strong currency demand has led China’s M2 (broadmoney supply) to increase to 180% of GDP – the highest level in the world. Themassive wall of liquidity that has resulted has triggered inflation, sentreal-estate prices soaring, and fueled a sharp rise in debt.
Given that it is in local governments’ interest tomaintain high economic-growth rates, many are borrowing to fund large-scaleinvestment in real estate and infrastructure projects. The active fiscal policyadopted during the financial crisis enabled the rapid expansion of localofficial financing platforms (state-backed investment companies through whichlocal governments raise money for fixed-asset investment)
According to GK Dragonomics, corporate debt amountedto 108% of GDP in 2011, and reached a 15-year high of 122% of GDP in 2012. Manyheavily indebted companies are SOEs, and most of the new projects that theyinitiate are “super-projects,” with the return on investment taking longer thancreditor banks expect.
The expansion of infrastructure investment – which,according to some reports, exceeds 50 trillion renminbi, including highway andhigh-speed railway construction – will lead to the expansion of banks’ balancesheets. The investment loans and massive debts among local financing platforms,together with the off-record credit channeledthrough the “shadow” banking system, areincreasing the risk that non-performing loans will soon shake the bankingsector.

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