China is too rich to splurge on infrastructure

How much more stimulus can the Chinese economy take?

It’s a question of crucial importance after Beijing unveiled its 2020 economic policy plans Friday. China’s 4 trillion yuan ($562 billion) stimulus package in the wake of the global financial crisis paved the way for its transformation over the past decade. In the 2000s, the country was a low-cost assembly room for the world’s supply chains. Now it’s an increasingly confident middle-income power, with a burgeoning consumer class and world-beating infrastructure.

In trying to establish a path out of the current economic slump, those gleaming high-speed rail lines, metro systems, apartment buildings and electricity networks pose a problem. China has invested so lavishly in infrastructure over the past decade that its endowment of public capital is now richer on a per-person basis than that of Germany, Spain, South Korea or the U.K. — despite economic output that remains many times lower.

Further spending is unlikely to deliver the same kick to gross domestic product as it did in the past. Indeed, it’s most likely to reduce the rate of return on future investment. If it ends up distracting from the problems of a shrinking labor force and lackluster productivity, it could sow the seeds of an economic stagnation that may take decades to escape.

That’s one reason why the policy announced Friday —  issuing 3.75 trillion yuan of local government bonds, and an additional 1 trillion yuan to deal with the coronavirus — looks so modest. While the aggregate amount is a little more than the 2008 stimulus, China’s economy is about three times bigger, so the impact will be comparatively slight. 

To see how much China’s physical infrastructure has changed over the past decade, it’s worth looking at the International Monetary Fund’s global investment dataset. In the eight years through 2008, China’s public capital stock increased by $7.58 trillion, lifting its share of the global total to 26% from about 19%. In the subsequent eight years, that pace nearly doubled: $13.39 trillion was added, giving China about 35% of the world’s public capital.

This matters because standard models see long-run economic growth as the sum of labor, capital and productivity. In the early stages of industrialization, a country’s labor force is boosted by migration from the countryside and improving life expectancy, while the building of physical infrastructure allows workers to generate output more effectively. The result is a headlong rate of economic growth like that seen in 19th century Europe and America, mid-20th century Japan and Russia, and China over the past few decades.

That model starts to come apart as countries grow richer. The growth in the workforce slows down as rural areas empty out, people begin having smaller families, and the population ages. China lost 2.5 million workers in 2019, three times more than Japan and the European Union put together. Meanwhile, capital investment becomes less productive over time, because more spending is needed to keep up with depreciation, and the return on new investment declines as the stock of infrastructure grows. If societies fail to use their resources more productively, the result is relative or absolute stagnation — the middle-income trap that for decades has stopped countries such as Mexico, Russia, Malaysia and South Africa from joining the ranks of rich nations.

China’s willingness to invest aggressively in upgrading its infrastructure in recent decades is a welcome lesson to countries such as the U.K., where run-down public assets have put a brake on economic growth. At the same time, developed countries aren’t entirely wrong in demanding that such spending should pass some sort of cost-benefit analysis. Capital growth pursued without an eye to improving productivity will fail to deliver the wanted boost to growth, while the attendant debt and costs of servicing it crowd out more worthwhile investments. That can turn glistening infrastructure from an economic boon into a burden, as my colleague Anjani Trivedi has argued.

China’s reluctance to pull the trigger on industrial stimulus in recent years is a welcome sign that policy makers are well aware of this risk. Total debt is running at more than three times GDP, and while the central government accounts for a relatively small portion of that sum, it’s ultimately on the hook thanks to the intermingling of its own borrowing with that of provincial and local governments. 

That means any ambitious plans for 5G networks, artificial intelligence and other high-tech stimulus should be taken with caution. China has ridden the tide of aggressive public investment to turn itself from a poor country to a middle-income power. If it doesn’t learn to restrain that habit, though, a middle-income power is all it will ever be.