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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.


  1. I think you're misreading why people think that China is investment-led and possibly due for a nasty recession. most of the argument revolves around the absurdly high level of fixed investment relative to gdp, there being a very large housing bubble and accelerating inflation which limits the amount of policy options available. an example article from naked capitalism here:

  2. Hi Nathan:
    Nope. If you check the article there is nothing about a bubble, and yes Wolf is very clear that he follows the neoclassical story. Conventional boiler plate on savings are necessary to grow. Also, the Chinese inflation has nothing to do with the traditional full employment of neoclassical lore. It is normal for a developing country doing a structural transformation of its economy, to have significant misalignments of relative prices. Those force readjustments and inflation follows. Further, the increase in home prices, particularly in metropolis like Shanghai that grow crazily are normal, and different in nature from the stuff that took place in the US where the middle class was borrowing because wages didn't grow, and banks were betting on a collapse. So no risk of slowing down even if your argument was the one being pushed. Further, the heterodox story is completely different, but also wrong. The problem is that some people think that consumption is bad for growth, because somehow it precludes investment, when it actually, through the accelerator it stimulates it. The problem with the Latin American elite is not that they didn't save like the Asian, but that they often bet on a model of development that is based on a subordinate integration to the world economy (not recently at least in some countries of the region). That is not a danger in China either. Hope this clarifies the points you raised.

  3. I should have been more clear. I didn't mean to make a claim about what Martin Wolf thought or didn't think. i wanted to disagree that his narrative was the general narrative about China today. I also didn't mean to claim that China's problems were from full employment. I am confused however, on why you think that the incredible price increases in housing and other assets "are normal" rather then credit driven and fueling maladjustment and excess debt. it seems to me that the major difference is the authorities could enact policies preventing housing prices from declining significantly in the hopes of preventing a recession and subsequently more riots and protests. it seems that your position on china here is very different from Minqi Li's position in this article: if you had the time, i would appreciate hearing where and why you disagree with him (if you do at all)

  4. Higher inflation is normal in countries that shift from being fundamentally agrarian to being industrial. The whole Industrial Revolution was an inflationary period. But of course it took 100 years rather than the 30 it has taken China so far. That's why China grow rate is so high. If you are going to incorporate hundreds of thousands of people into the formal economy, then you have to provide houses, and among the several things you will have is a housing boom. Note that in China real wages have been growing, interest rates are low, and debts are in domestic currency, because they keep a closed capital account. So that other story of why China may collapse is also fundamentally flawed.

  5. By the way, American elites know that the risk is not a slowdown in China, but the competition for resources. This is Hillary this week:

    "We saw that during colonial times, it is easy to come in, take out natural resources, pay off leaders and leave," Clinton said in Lusaka, the Zambian capital, before flying off to Tanzania. "And when you leave, you don't leave much behind for the people who are there. We don't want to see a new colonialism in Africa."

    An American Secretary of State complaining about Chinese neo-colonialism! The whole thing is here:

  6. Hi Matías:
    It was my understanding that China responded its collapse of net-exports in 2008-2009 by increasing fixed-investment. Consequently, China is suffering from immense overcapacity along with the problem of non-performing loans. If so, to ease this glut in capacity and potential deflationary pressures, they would eventually have to transition to a macroeconomic set-up that is biased in favor of consumption.

  7. Hi Zain. Public spending increased. They did a massive fiscal package, and that included public investment. Private investment always reacts to increasing demand. But nobody buys equipment if their demand is not increasing. Hence, overcapacity is a strange term. Demand may fall, and you may have excess capacity, but the problem is the fall in demand. The capacity was not built in excess of the demand prospects. And China certainly does not suffer from lack of demand. This notion of a problematic transition to domestic consumption does not make much sense. Note also that all the non performing loans are in domestic currency, so there is nothing that prevents Chinese authorities to rescue their own banks.


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