China’s bubbling economy

The way capital is allocated in China makes investment there inefficient, say analysts.

  • In developed countries, $1 of investment eventually yields $1 in increased output, but in China the ratio is more like $7 invested for $1 in output.

  • It's only because of China's high savings rate (40 percent) and foreign investment that it can waste capital while at the same time growing.

  • India, for example, has a growth rate lower than China's and its savings rate is only about 20 percent, but its banks are in much better shape.

    Capital is being misallocated. Local branches of China's big banks have lent mainly to state-owned enterprises (SOEs) or those run by politically well-connected managers.

    Thus companies that already tended to be inefficient because of their ownership have had access to large amounts of cheap capital. Meanwhile, the rest of the private sector was starved of credit.

    Zhou Xiaochuan. head of the central bank, is deregulating interest rates. On Jan. 1, 2004, banks will be allowed to widen the range of interest rates they charge on commercial loans. The benchmark lending rate is 5.3 percent, and in the new year banks will be allowed to charge as much as 70 percent more – up to 9 percent.

    Although China's banks have a load of bad loans, loan growth is running at 20 percent. Fixed-asset investment was up 29.6 percent in the first 11 months of 2003, and November consumer price index figures show inflation year-on-year hitting 3 percent, up from 1.8 percent in October.

    The government is building infrastructure, banks are giving out loans to expand production capacity and property developers are building new office buildings and villas.
    But analysts fear that the demand simply won't be there, and there could be a recession as unneeded investments are liquidated.

    Source: Hugo Restall,China's Not Overheating, It's Wasting Capital, Wall Street Journal, December 22, 2003.

    For text (WSJ subscription required),,SB10717914656193200,00.html
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    FMF Policy Bulletins/30 December 2003
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