Facts suggest China's high investment strategy is most efficient

Levels of investment have taken center stage in discussions over China's economy, with some commentators suggesting they are extravagant and ineffective.

In July, Premier Wen Jiabao stated that for China's economy "currently the main task is to promote reasonable investment growth". The data for that month showed that China's annual growth in fixed asset investment, at 20.4 percent, was the lowest for a decade.

In August, a $376 billion (300 billion euros) energy saving investment program was announced to meet China's key goal of reducing energy use per unit of GDP by 16 percent by 2015 from 2010 levels.

However, China's emphasis on investment has been criticized by some Western commentators on the grounds that it is "inefficient", and that such programs necessarily lead to "overcapacity". But such claims are myths, based on elementary economic errors.

A typical claim that China's investment is inefficient comes from BusinessWeek journalist Brian Bremner's statement that "It takes $5 to $7 of investment to generate a dollar's worth of gross domestic product in China, versus $1 to $2 in developed regions such as North America, Japan and Western Europe".

Others assert that China's investment is inefficient compared with, for example, that of the US, and therefore it should not launch big investment programs.

This argument is logically false in terms of economic growth, as shown by elementary arithmetic. If one country has 20 percent less efficient investment than another, but invests twice as much, the country with less efficient investment will grow far more rapidly than the country with more efficient investment.

It is entirely possible for the quantity of investment to be more important than its efficiency in terms of economic growth. That is demonstrated by Singapore, the Asian economy with the highest per capita GDP.

Various studies show Singapore's investment efficiency is rather low, but it invests such a high proportion of its economy that its GDP per person is even higher than the US when measured in comparable World Bank prices.

China has to invest far fewer dollars for its economy to grow by a given amount than the US, Europe or Japan. Regarding GDP growth, China's investment efficiency is far higher than theirs.

Taking the average of the past five years, China's annual economic growth was 10.5 percent, and its fixed investment was 43.1 percent of GDP. China consequently invested 4.1 percent of GDP for each percentage point of GDP growth.

In the same period, the US economy grew by an annual average 0.1 percent and its fixed investment was 16.9 percent of GDP. Therefore, the US invested 120.9 percent of GDP for each percentage point of economic growth - a far higher figure than China.

Naturally the US trend is distorted by the big recession, but in 2007, the last year before its onset, the US invested 8.8 percent of GDP for each percentage point of economic growth. China's figure was 3.4 percent. Therefore, far from being inefficient, China's investment is more than twice as efficient as the US' from the viewpoint of economic growth.

Comparisons with other countries show the same picture. Again, taking the average over the five years to 2011, Germany invested 16 percent of GDP for every percentage point of economic growth - the 2007 figure was 10.6 percent. The 2011 figure for the UK was 143.3 percent, the 2007 figure was 5.8 percent. The 2011 figure for France was 43.6 percent, the 2007 one 9.7 percent. Taking the five years to 2010, the latest available data, Japan invested 74.6 percent of GDP for every percentage point of annual GDP growth - the 2007 figure was 12.2 percent.

The facts are therefore clear. Far from China having to invest far more dollars for a given increase in GDP than the US, Europe or Japan, it has to invest fewer. In generating economic growth, China's investment is far more efficient.

How does this fit with claims about unoccupied cities and unused convention centers that are habitually thrown around in attempts to prove the inefficiency of China's investment? Because these are anecdotes without statistics, something that should always set alarm bells ringing in studying a serious subject.

Economic variables are averages. Therefore, by definition it will always be possible to find individual cases below the average, be it some ill-judged piece of investment in China or in any other economy.

Individual anecdotes prove nothing as they may be balanced elsewhere by super-efficient investments. Only averaging efficient and inefficient investment proves anything, and the result, as we've seen above, is that China's investments are two to three times more efficient than US, European or Japanese investment in relation to economic growth.

It is because China's level of investment is both high and efficient that its economy grows so fast. Its investment efficiency is not only higher than the US but also higher than most other countries, and it is unlikely that high economic growth can be achieved by increasing it further. It is already near the upper limits of such efficiency in terms of international comparisons.

China's GDP growth, the only possible foundation for sustained growth of its population's living standards, therefore depends far more on a high investment rate than the almost illusory belief that the efficiency of China's investment can be significantly raised.

India also has highly efficient investment, at a level almost identical to China's. The reason China's economic growth averaged 10.5 percent during the past five years, while India's has averaged 7.6 percent, is because China's fixed investment was 43.1 percent of GDP, while India's was only 31.4 percent. Maintaining a high level of fixed investment in GDP is therefore key to China's economic growth.

As illustrated by China's $376-billion energy-saving investment program, it is an elementary economic error to claim new investment necessarily increases capacity and therefore overproduction. Investment may not increase capacity at all, but simply increase productivity, or make production more energy efficient or less polluting. Indeed, China will require more investment to tackle environmental issues, as non-polluting power stations and factories are more expensive than polluting ones.

Finally, while China's investment is efficient in generating economic growth, China's capital stock per person is very low compared with the US. No matter how hard China's population work, it cannot compensate, in terms of output per person and living standards for the lower investment stock in China than in an advanced economy. To narrow the gap with the advanced economies, China will have to continue to invest at a much faster rate for a prolonged period.

China's investment is too important an issue to be subjugated to the level of myth.

The author is a visiting professor at Shanghai Jiao Tong University. From 2000 to 2008, he was the economic adviser to the mayor of London. The views do not necessarily reflect those of China Daily.

(China Daily 08/31/2012 page9)