July 16, 2012 7:32 pm
China: The road to nowhere
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©AP
Up in the air: with a span of more than 42km, the bridge at the eastern city of Qingdao is an engineering marvel – but it has yet to meet usage targets, and stands as a symbol of high investment levels some say are blighting China’s economy
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For China, a country with monstrous traffic jams, the world’s longest sea bridge is a success on at least one front: it has no delays. The problem is that it also has few cars.
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The bridge, which opened a year ago in the eastern port city of Qingdao, traces a wide arc across a bay, from the bustling core to farm fields far from the offices and homes it is supposed to serve. Six lanes wide and 42.5km long, enough to span the English Channel with room to spare, it raises an unsettling economic question: has China, in spectacular fashion, reached its “bridge to nowhere” moment?
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That the world’s second-largest economy could be wasting money on unproductive investment is a controversial claim. Many officials and investors are convinced the country needs to add significantly to its capital stock – roads, airports, factories and apartment blocks – for years to come in order to catch up with more developed economies.
This sanguine view is now being put to the test. The concern is not that China has run out of good investments to make, but rather that it has already made too many bad ones, especially in the property sector, and must pay the price in the form of a sharp economic slowdown.
“It’s actually possible to get ahead of yourself and overinvest along the way. Investment has now been more than 40 per cent of gross domestic product for nine continuous years, and no other country has ever done that,” says Nick Lardy of the Peterson Institute for International Economics in Washington. “Unwinding the whole thing becomes very difficult.”
The government has been trying to do just that – to unwind the excesses of the past decade by reining in the pace of investment. The results of its efforts were seen on Friday when it announced that economic growth in the first half slowed to 7.6 per cent, the weakest since early 2009. Domestic policy was the biggest drag. Construction activity has suffered as Beijing has put the brakes on runaway property investment.
This, many analysts believe, is a good thing. For a fragile world economy, tepid Chinese growth might seem unwelcome but the alternative scenario is more frightening. If Beijing does not induce a mild downturn now, the prospect of a big collapse as bad investments pile up would loom ever larger in a few years.
“We are at a critical stage. We need to balance short-term growth and long-term growth. That is, we can’t only worry about the short-term slowdown,” says Peng Wensheng, chief economist at China International Capital Corp, an investment bank.
Beijing has so far kept its nerve. Wen Jiabao, the prime minister due to step down this year, first said in 2007 that the economy was on an “unsteady, unbalanced, uncoordinated and unsustainable” path, though he then did little about it. The Rmb4tn ($627bn) stimulus programme of State media today vow that there will be no relapse. “The old way will not be repeated,” the Xinhua news agency said in an editorial in May.
There are limits to this toughness, however. Senior leaders do not want to see an abrupt downturn that leads to unemployment and, potentially, unrest. They are particularly determined this year, when a once in-a-decade leadership transition occurs, to minimise any trouble.
So in the past two months, amid signs of economic weakness, Beijing has cautiously shifted to a pro-growth position. It has cut interest rates twice, encouraged banks to lend more, especially to small businesses, and introduced subsidies to induce consumers to spend.
Analysts say this shift must be handled with the utmost delicacy. If the government stimulates too much, investment will again take off, saddle the country with yet more empty apartment blocks, deserted industrial parks and bridges to nowhere. This year’s recovery would come at the cost of serious trouble down the road.
“The worst scenario would be to ease monetary policy and at the same time to relax control measures on the property sector,” says Mr Peng. “If the easing is not carefully managed, we run the risk of making the economy more unbalanced.”
Zhuhai, which lies next to Macau in the south, is the latest city to try to force an end to the crackdown on the property sector. At the weekend, word leaked that it would relax the toughest of the government’s measures to cool the market – a ban on buying more than one home. Like other cities that tried similar tactics, Zhuhai was quickly slapped down by central authorities. It dropped its plan.
But while the leadership has surprised many with its determination to keep a lid on the property sector, there is good reason to believe it has not kicked its addiction to investment. This was reflected in comments last week by Mr Wen that could prove momentous. Expressing his concern about the slowdown, he ordered the government to focus on supporting the economy in the second half of the year. “Policies to stabilise growth include promoting consumption and diversifying exports, but currently the main task is to promote reasonable investment growth,” he said.
These words were an important signal that Beijing was ready to fire up the investment engine once more, to approve large-scale capital expenditure, especially on infrastructure, and to use state-owned banks to provide the financing. Mr Wen insisted the government would stand firm on its property controls. Short of that, though, anything of “quality and efficiency, which makes people’s lives better” would be encouraged.
The government has consistently talked about its objective of reining in investment and encouraging consumption to make growth more sustainable. In practice, though, investment grew from about 32 per cent of GDP in 1990 to about 49 per cent last year, a record high. In the 1970s, during its high-growth era, Japan barely hit 40 per cent.
“It just so happens that every time there is a need for stimulus, the most common channels are still investment oriented,” says Louis Kuijs, formerly a World Bank economist in Beijing, now based at the Fung Global Institute, a Hong-Kong-based think-tank. “These patterns have a momentum and only with very bold reform measures would we expect to see this pattern shifting substantially. We have seen some reform measures, but not truly very major ones.”
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It remains clear, from one perspective, that China still needs more investment. Its capital stock per worker is just 8 per cent that of the US, giving it plenty of room to invest more, according to HSBC, the UK bank. This is obvious to anyone who has been to its sprawling cities from Shenyang in the north to Guangzhou in the south, which have clogged roads and little in the way of underground train lines.
But the rush to catch up has been unseemly. Although its capital stock should be expected to converge with that of more developed economies, this should happen over many decades, not overnight, Mr Lardy says. Nearly two-thirds of capital stock has been created since 2003. Simply put, China has built too much, too quickly.
Back in Qingdao, officials privately admit the world’s longest bridge was a mistake. The idea of a local Communist party chief, since sacked for corruption, it serves a suburban district that is also connected to the city centre by an undersea tunnel, several ferry routes and a highway that runs along the water’s edge. Though it was designed to carry 30,000 vehicles a day, an executive in a government-backed construction company says it is registering just 10,000.
More positively, some senior officials are now prepared to speak out about the issue – in public. Guo Shuqing, China’s chief securities regulator, seen as one of the most reform-minded officials, laid out the country’s problems in stark terms in a speech at a financial conference last month. “Infrastructure used to be our bottleneck, but now we are already beginning to see partial overcapacity, some roads and rail lines that are idle,” he said.
The waste has been more severe in the property sector, where construction has been speedy but shoddy, even in the richest coastal regions. “Homes have to be rebuilt on average every six or seven years,” Mr Guo said.
He is not alone. An increasingly common refrain among senior policy makers this year has been the need to change the foundations of the growth model. “Reform should be implemented unswervingly or there will only be a dead end,” Mr Wen said in February.
His words have been followed by an array of reforms in the past few months, part of a multi-pronged attempt to steer China away from its over-reliance on investment.
Cheap capital has been a leading cause of excessive investment, and the central bank has started to correct this by increasing the influence of market forces on interest rates and the exchange rate. At the same time, seeking to direct financing to more productive uses, regulators have ordered banks to lend more to smaller businesses and less to state-owned enterprises. There has also been progress in changing the fiscal system to make local governments less dependent on land sales and hence less gung ho about new investment projects.
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That the reforms are being pushed through just months before Xi Jinping is expected to be installed as president is a strong indication that the next generation of leaders backs the changes.
Yet they are so far best characterised as a series of small steps, not a thoroughgoing overhaul. Both the current leaders and their successors are wary of doing anything too radical – unless it is absolutely certain that the system is broken, why fix it?
“People are betting on the incoming leadership taking up the reform challenge. But that’s far from guaranteed. As an economy matures, it becomes harder to reform,” says Ben Simpfendorfer, founder of Silk Road Associates, a Hong Kong-based consultancy.
One adviser to the cabinet says there has been significant progress on at least one front. Five years ago, it was hard to persuade officials that overinvestment was a concern. “Now they all agree. Implementing the necessary reforms is a different issue, though,” says the adviser, speaking on condition of anonymity.
As the economy slows and Mr Wen talks more about the need for investment than structural reform, China is at risk of once again going down the same old road – the one he called a dead end just a few months ago.
The temptation to keep the economy racing along in the short term, heedless of longer-term pitfalls, is hard to resist.
Financial system: A boom driven by distortions
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Severe distortions in China’s financial system are seen by many analysts as the biggest single factor behind the country’s runaway investment boom.
Large corporations and state-backed entities are able to borrow money from banks at artificially cheap levels, fuelling reckless spending decisions. Meanwhile smaller businesses – the lifeblood of the economy, generating about 80 per cent of jobs – are seen as risky borrowers since they lack government backing and so have little access to the state-run financial system.
“Money flows to the state-owned enterprises in the end and they can use this to get into real estate or to provide financing for others, so asset bubbles get more and more serious,” says Zhang Jun of Shanghai’s Fudan University.
The government has ordered state-owned companies to stop investing in real estate if it is not one of their core businesses in a bid to halt a development that officials feared was driving up property prices and increasing balance sheet risks. But many companies ignored this edict and continued to pile into property until the market soured last year. For example, COFCO, the country’s top grain trader, is also one of its biggest shopping mall developers.
“Our major concern is making a profit, not quitting the housing market,” an unnamed official at a state-owned firm was quoted as saying by China Business News, a local paper.
Ordinary people subsidise such largesse by stuffing their savings into bank accounts with exceptionally low interest rates. Deposit rates in real terms have averaged 1.5 per cent since 2004, despite the economy growing 10 per cent a year.
Chinese people have few other choices for their money. The country’s stock market is riddled with insider trading and rotten corporate governance; it is extremely difficult for individuals to invest abroad; and the mutual fund and insurance industries remain under-developed.
Outside of banks, savers have one other viable investment option: property. A study by China’s Southwest University of Finance and Economics recently found that city dwellers owned on average 1.2 homes.
With many in the middle class struggling to get a foot on the property ladder, the implication is that wealthier citizens often own multiple homes and do not mind allowing them to sit empty in the expectation that they will appreciate.
“It’s very common for officials with power and with money to have four or five homes,” Zhang Zulin, the mayor of Kunming, a southwestern city, said in a speech last month.
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