Pause for thought

China's GDP growth appears to have accelerated substantially in 2002. The Asian Development Bank, whose estimates closely track Beijing's official figures, puts full-year GDP growth at 8 percent, up from 7.3 percent in 2001. Even allowing for anomalies in the official data (which point to a significant exaggeration of growth rates over the past decade), the picture of relatively faster growth last year is consistent with reliably measured indicators, such as the rapid increase in the Mainland's foreign trade.

Some recent figures, however, imply that concerns over China's 'growth quality', which became widespread in the late 1990s and then receded with Beijing's accession to the World Trade Organisation, may still be justified. The sharp decline after 1998 in policy lending to state enterprises, which had been recognised as a threat to the stability of the banking system, has probably improved the efficiency of capital allocation. But other signs point to a continuing problem of misdirected investment and suggest that current growth trends are unsustainable.

Part of the difficulty in assessing China's performance last year reflects internal inconsistencies in the data. For example, the National Bureau of Statistics reports that in January-November 2002, fixed-asset investment rose by 23.4 percent over the same period the previous year, while retail sales of consumer goods rose by 8.8 percent and net exports by 53.2 percent. Although the sum of these three components is only roughly equal to GDP (China has no recent published statistics that effectively track government consumption, the missing fourth category), their weighted average must fall well above 8 percent, indicating that at least one of them – almost certainly the reported growth rate of retail sales – has been exaggerated even more severely than reported GDP growth.

This seems to confirm a fact about China's economy since the Asian financial crisis: growth has been driven largely by investment spending and export demand, while domestic consumption has lagged far behind. Whether this is a feasible growth strategy in the long run will depend on the quality of investment, in particular its ability to support continued export growth.

Since 'fixed-asset investment' is a very broad category, it can be risky to draw conclusions from trends in the data. The classification will include, for example, profitable export manufacturing projects undertaken by foreign capital, socially productive state investments in infrastructure and misguided capacity expansions at inefficient state enterprises. One way to disentangle these elements, however, is to compare the economic performance of China's provinces, which have been affected very unequally by the investment boom.

Although hardly conclusive, the two charts shown suggest that the efficiency of fixed-asset investment last year may have been rather low. The chart below plots the relationship for each province between growth in investment and growth in the value added of industrial output. The strongly positive correlation suggests that much of the investment of the past year may have benefited the industrial sector; provinces where investment spending rose rapidly also saw sharper rises in output.

Higher output alone, however, is an unreliable indicator of efficiency, particularly if state-led growth in demand is responsible for the increase. A more market-sensitive variable may be provincial exports, which are wholly dependent on private overseas demand. China's exports surged 21.6 percent year-on-year for the January-November period of 2002, and the regional profile of export production saw a modest diversification: on average, the provinces whose economies were less export-based in 2001 experienced slightly higher export growth.

However, there is no apparent relationship between the provinces' rate of investment growth and their success in boosting exports last year; the chart at the top of the opposite page suggests that there may even be a slight negative correlation. Jiangxi province, for example, saw a phenomenal 52 percent rise in fixed-asset investment in this period, but it was one of the few provinces where exports actually fell year-on-year, by 2.6 percent.

The most likely explanation for this result is that fixed-asset investment in China is dominated by two components: private, market- directed business investment, which is concentrated in coastal regions; and state-led infrastructure spending, which has been intentionally focused on underperforming inland provinces and which has helped boost demand for the output of state enterprises in those regions.

Investment in road building or other infrastructure projects is not necessarily misguided, of course; in fact it almost certainly offers greater social benefits than does issuing credits to state enterprises. Nevertheless, the provinces affected most by the recent infrastructure boom seem to have been unable to convert these infrastructure improvements into export growth, despite starting from a below-average level of export intensity.

The indications are, then, that fixed-asset investment – by far the largest component of recent GDP growth – may still contain a substantial non-productive element, even after Beijing's success in choking off credit to weak state-owned enterprises. Since this investment is financed by deficits at the central government level and (probably to a much larger extent) by bank lending to local governments and the real estate sector, this suggests that China's financial risk profile is continuing to deteriorate.