Most economists seem to think China invests too much. In previous posts I’ve argued that if China wants to consume more, they first need to invest more. If they want more restaurant meals and vacations, they must first build more restaurants, hotels, airports and train stations. If they want more health and education, they must build more schools and hospitals. If they want more housing services, they must build more housing. Free Exchange just published a piece that offers an odd perspective on this issue:
Others are less convinced about Hayekian risk. Francis Cheung of CLSA, a broker, argues that China suffers from excess capacity in some parts of infrastructure, but not all. Cities like Beijing and Shenzhen are congested, faring worse on IBM’s “commuter pain” index than Delhi or Nairobi (see left-hand chart). That would suggest China has scope to invest in Shenzhen’s metro, one of the projects announced last week. Infrastructure demand will eventually catch up with supply, Mr Cheung concludes, as long as infrastructure spending remains disciplined.
Moreover, investment that adds little to a society’s stock of productive assets is not necessarily malinvestment. Michael Buchanan and Yin Zhang of Goldman Sachs say that some Chinese investment is best seen as “quasi-consumption”. In this category they place things like earthquake-proof schools and more comfortable metro lines. Instead of adding to the economy’s productive capacity, these assets provide a flow of services (such as reassurance to parents and relaxed travel) directly to consumers. In this respect they are more akin to consumer durables, like washing machines or cars, than to iron-ore mines or steel plants.
As a rough gauge of the size of quasi-consumption, the Goldman economists add up China’s investment in house building and “social infrastructure”, such as utilities, transport, water conservation, education and health care. Reclassifying this spending as consumption would increase China’s household consumption to 53% of GDP last year, compared with only 35% in the official statistics (see right-hand chart).
I’m not quite sure how the Goldman economists reached this conclusion. Perhaps it was as follows:
1. Everyone knows that China invests too much.
2. Common sense says that certain Chinese investments are desirable.
3. Hence those desirable investments must be consumption, not investment.
Investment is the construction of capital goods. Period, end of story. Capital goods are highly durable assets, such as subways, airports, apartment buildings, hospitals, schools, etc. Factories are also capital goods, although they tend to be less durable (at least in America) than the other items that I listed.
An economic “miracle economy” is simply an economy that has been horribly mismanaged by the government, before the miracle occurs. This mismanagement causes their GDP to be far below potential. With somewhat more sensible government policies (but not necessarily sensible in an absolute sense) the country will engage in a period of catch-up growth. Fast growth tells us almost nothing about the effectiveness of the current government; it tells us that the previous government was incompetent. When fast catch-up growth occurs, the level of investment will be necessarily high, because one must first build the capital goods required to produce developed country levels of consumption. This theory has several implications:
1. During the 2020s it’s quite possible that North Korea will grow at a faster rate than any other country in history (outside of small countries whose data is distorted by huge natural resource discoveries.) That’s because its GDP per person is probably farther below potential than any other country in history. If it does set a record, no other country will ever surpass its record. North Korea is the last of its kind. Other poor countries are poor for much more complex (and hence hard to overcome) reasons that North Korea is poor. Vietnam is probably most similar, then Cuba.
2. During this super growth spurt, North Korea will invest at an extremely high rate, perhaps even higher than in China. If it is able to maintain a fairly high level of consumption, it will be through imports, not domestic production of consumer goods. It’s not clear that China has this option.
PS. For the purposes of this post, I define “potential” as the steady state per capita GDP level (as a fraction of US GDP/person) achievable with a new and moderately competent central government. I’m claiming that a group of technocrats put in charge of the central government in North Korea could achieve higher growth than the same government in Afghanistan. I’m not assuming identical economic policies, as it’s more difficult to implement policies in some countries than others. Governability is endogenous.
PPS. My North Korea prediction is based on the assumption that economic reform will occur. If it doesn’t, then obviously growth will be less impressive.