Is Growth in China Investment-Led?



The general confusion, in both the mainstream and some heterodox groups, about the Asian development model is surprising, to say the least.  Martin Wolf, in a recent column (subscription required or here for free), says regarding the Chinese growth prospects that:

"Happily, China has close cultural and economic similarities with these east Asian successes. Unhappily, China shares with these economies a model of investment-led growth that is both a strength and a weakness. Moreover, China’s version of this model is extreme. For this reason, it is arguable that the model will cause difficulties even before it did in the arguably less distorted case of Japan."

The notion is that high rates of savings, associated to repression of consumption, and the absence of a social welfare net, lead to high rates of investment, which explain the incredible performance of Asian economies over the last 60 years or so, starting with Japan, followed by the Tigers, and then China.  The danger would be that, as the share of consumption grows, and:

"this pattern of growth is to reverse, as the government wishes, the growth of investment must fall well below that of GDP. This is what happened in Japan in the 1990s, with dire results."

Although, it is not quite expelled out, one would imagine that the problem is that with higher levels of consumption not enough savings would be left to 'finance' investment.  Further, the argument in the column suggests that as a result of the high levels of investment, returns "at the margin" are low, and "much of the investment now undertaken would be unprofitable."

In heterodox circles there used to be talk about an investment-profit nexus in the Asian development model. This was the main point of a famous paper by Akyuz and Gore (subscription required). The idea was that government policy accelerated the process of capital accumulation by creating rents and pushing profits over and above those that could be attained under free market policies, and higher profits generated incentives for investment and economic growth. Also, Asian economies displayed an ability to upgrade exports continuously through the "flying geese" path, and to their ability to generate the high levels of savings and investment required for this upgrading.

Further, Gabriel Palma, a well known heterodox economist at Cambridge University, argued that savings in an economy, necessary for capital accumulation and investment in his view, is not voluntary or spontaneous but needs a governmental role and that the general failure in Latin America to grow as fast as East Asia results, in part, to the fact that domestic savings have gone into consumption and not in investment. In other words, while the frugal Asian elites invested like ants, the spendthrift Latin American elites emulated the patterns of consumption of the developed world, like the grasshopper (see for example his paper on the Chilean bourgeoisie here; subscription required).

There are problems with both the neoclassical and the heterodox accounts of the Asian development model.  The conventional model suggests that the flow of savings somehow funds, investment.  Somebody should show this people the System of National Accounts (SNA-2008), which shows that savings are a residual.  Further, if the model shifts from export-led to domestic demand-led, in particular with higher levels of consumption, investment will continue to react, through the accelerator, and will not stop growing.  If consumption grows faster than output, and its share increases, either investment, government consumption or net exports, as shares will have to fall, but that would not signal any particular problem to the growth process.  Investment is the result of growth, in Asia as in any other part of the globe.

One possible danger is that if net exports become negative, an external constraint may become binding.  However, the Chinese have maintained a closed capital account, and manage their exchange rate, which suggests that there is is clear awareness that external constraints should be managed.  Also, they aggressively have searched sources of inputs, trying to secure favorable trading terms, so that access and ability to pay for imports will not force a slowdown of their economy. So a likely outcome is simply that the consumption share will increase while the investment will shrink, with no significant effect on growth.  The Japanese stagnation has nothing to do with a fall in the share of investment in total GDP, and is related, in part, to the collapse of a financial bubble.

For the heterodox story I suggest reading my post on whether the United States is profit-led. The problem is essentially the same with the general profit-led argument.  The problem is that investment is derived demand.  High profits do not lead to investment if demand growth is sluggish.  The central element in the Asian development model was the growth of exports, and their privileged access to American markets.  Carlos Medeiros (reading in Portuguese here) and Franklin Serrano have referred to this as "development by invitation."  Both the Chinese have benefited from access to American markets, as the Americans, with cheap consumption goods. More importantly for American corporations (besides access to the Chinese and other Asian markets) is the use of relocation as an effective threat against labor at home.

In sum, not only China is not investment-led, but additionally there is no significant risk from a Chinese development strategy that is more reliant on domestic sources of demand.  Consumption is not inimical to growth, particularly if it results from sustained increases in real wages, rather than the accumulation of private debt, as in recent American booms.  That is the Chinese challenge, to incorporate an increasing number of workers into the formal economy with higher real wages.