Does China over invest and under spend?

One of the fundamental truisms in analysis of the Chinese economy is that the country invests too much and consumes too little. This line has been repeated so many times that it has become axiomatic.

It is the official verdict of the International Monetary Fund, which estimates the level of over-investment in China is equal to about 10 per cent of GDP and possibly as high as 20 per cent. Paul Krugman, a celebrated Nobel economics prize winner, certainly thinks that is the case. China’s household consumption is only 35 per cent, or about half the level in the United States.

In a way, Beijing has more or less accepted this line of argument. When Wen Jiabao delivered his final speech as the premier, he famously said the domestic economy was “unbalanced, uncoordinated and unsustainable.” 

The ambitious reform program launched last year aims to address the structural imbalance in China’s economy. However, there are some serious analysts who are starting to question some aspects of the orthodoxy and are worried about the impact of the prevailing assumption on the future development of China’s economy.

Cai Hongbin, dean of Guanghua School of Management at Peking University, the country’s most prestigious educational institute and a former economics professor in the United States, argues the rampant assumption that China over-invests and under consumes is flawed.

He explains that the differences in statistical calculation and methodology between China and other countries contribute to the underestimation of Chinese consumer spending and overestimation of investment.

He believes that China’s consumer spending has been under-reported by as much as 10 per cent of GDP and overlapping and repetitive calculations are responsible for about overestimating investment by as much as 10 per cent of GDP.   

If that is indeed the case, China’s imbalanced economy starts to look a lot better. For example, household consumption as a share of GDP stands at 50 per cent last year and the average for developed economies is about 80 per cent. If you add 10 per cent to that, the gap looks a lot more reasonable.

Chinese investment as a share of GDP is about 47 per cent and the average for the developed world is 20 per cent. Again, if Cai’s estimate is correct, China’s investment level is more aligned with the historical peaks in Japan and Korea.

The single biggest factor contributing to the underestimation of Chinese household consumption is the cost of housing and he thinks it has been “seriously underestimated” at a conference after the recent annual gathering of the Chinese parliament.

The cost of housing accounts for 20 per cent of the US household spending and 14 per cent of GDP. In comparison, housing only accounts for 8 per cent of Chinese spending or 3 per cent of the GDP, according to the official statistics.

Hold on, that can’t possibly be right. Housing is arguably the single most expensive item in Chinese family budget. The cost of apartments and rents are going through roofs, especially in mega-cities like Beijing, Shanghai and Guangzhou. Cai explains the way Chinese statisticians calculate household spending is based on historical prices, which are much cheaper than current market prices, which have risen rapidly in recent years.

As a result, he argues that if China uses the accepted international standard to calculate the true cost of housing consumption in China then household consumption as a percentage of GDP could increase by at least 5 per cent.

The existence of a large and flourishing informal economy in China also contributes to under-reporting of consumption. For example, millions of nannies in Chinese cities have never been included in the official statistics, Cai told Caixin media, a leading Chinese financial publication.

One of the most interesting points he suggests is government spending, which is under the spotlight in China due to rampant corruption. Government spending on cars, hospitality and overseas trips is currently classified as operational costs and not as consumption.

This is a significant point and also a very sensitive one. There are various estimates that put official spending in these three areas at 900 billion yuan or about one third of the total government expenditure.

A deputy head of Hubei’s statistics bureau told the state media that the government spent a staggering 400 billion yuan a year on government cars. No wonder German auto-makers love China and there are so many black Audis on the streets.

On the investment side, China’s local statistics bureaus often exaggerate as well as double account on many projects. For example, if you tally all provincial GDPs in 2013, they exceeded the national total by more than 6 trillion yuan. Underestimation of depreciation and other factors also lead to over-calculation of investment.

Cai, who sits on the boards of China Unicom and Sinopec, two of China’s largest companies, warns that the skewed understanding of the true state of consumption and investment could lead to serious consequences.

For example, he says artificial stimulation of consumer spending could be more dangerous than investment -- and bear in mind that the 1997 Asian financial crisis and the global financial meltdown of 2008 happened as a result of reckless consumer spending.

The simple prescription of ‘spend more and invest less’ will not re-balance China’s economy, he argues. The key is to not to invest less but focus more on the quality of investment and to invest in things that would enhance the country’s overall productivity, like technology and education. 

China needs to improve the efficiency of its investment and foster better growth through deepening institutional reform. Cai’s insight will add much to the current prevailing received wisdom on China -- and we should pay a bit more attention to analysts from China, rather than relying on doomsayers all the time.