8. Decline of China's Investment Efficiency and the Aggregate Characteristics of Capital Formation

Qin and Song (2002).

But in many research literatures, the contribution of trade growth to China's economic growth is often seriously underestimated. The fallacy stems from the “net export” project in the national income accounting equation. “Net exports” is the difference between exports and imports, equal to the balance of trade. In general, this balance accounts for only 1–2% in China’s GDP; therefore, if one tries to calculate its contribution to economic growth, not only is the “net export” not worth mentioning, it will actually make the growth rate of GDP decrease in the economic trade deficit. For this reason, most studies agree that trade growth is almost negligible in China's high rate of economic growth. Some studies have even concluded that in the 20 years of economic growth in China, exports are not the main driving force, and that China's economic growth is mainly driven by domestic demand. Especially after the financial crisis in Southeast Asia in 1997, the “introversion” of China's economy has actually become a “consensus”. Because the total consumption and investment accounted for 90% of China’s GDP, it seems to be a common sense to claim that Chinese economy and its growth are mainly driven by domestic demands. Unfortunately, however, this common sense may lead to a fallacy.

It should not be hard to imagine that consumption, investment, import and export are interrelated. Moreover, the contribution of import and export to other sectors of economy is likely to be greater for a manufacturing economy like China. Theoretically, if we simply calculate the contribution of “net export” to economic growth from the identical GDP equation before we ascertain the impact of export on other items of expenditures that constitute GDP, we will naturally neglect “indirect contribution” of exports to other items of expenditures. Therefore, using the national income identical equation to directly calculate the contribution of net exports to GDP would seriously underestimate the importance of trade to China's economic growth. One of the correct estimation methods is to estimate the impact of export on consumption, investment and import before estimating the contribution of exports to GDP. And that requires economists to do research in a serious way.

We have noticed that this issue has attracted the attention of Chinese economists, and some people have begun to use similar methods to re-estimate the contribution of China's exports to GDP. For example, Lin and Li (2002) first estimated the positive effects of export on consumption, investment and import, then, they estimated the contribution of export growth to GDP growth. They found that, on average, 10% export growth can boost 1% of GDP growth. Lo (1999), on the other hand, studied the contribution of imports to China's economic growth. Although we need more empirical studies to determine how much exports and trade contribute to China's economic growth, the new conclusions seem to be closer to our intuition. For details, see Lin and Li (2002), Lo (1999).

It is worth noting that the geographical difference in Chinese economic growth has become one of the major issues for economists in recent years and there have been a lot of research literature on this issue as well (for example, Wei 1997; Liu et al. 1994; Demurger et al. 2001; Liu et al. 1999). See Wei (1997), Liu et al. (1994), Demurger et al. (2001). Liu et al. (1999).

Young (1994) in his paper titled Lessons from East Asian NICs: A Different View, provided a simple and technical approach for the East Asian economic growth pattern. His conclusion is more straightforward: “The most important feature of the newly industrialized countries in East Asia is not their unusual quick growth of manufacturing industry, but their success in expanding investment in manufacturing and employment, so they enjoy the reputation of “industrialization”. Krugman (1994) commented on the growth model of the “East Asia miracle” in nontechnical language in a playful article. Felipe (1999) provided us with a very beautiful literature review on economic growth and efficiency change in East Asia. See A. Young, Lessons from the East Asian NICs: A Different View, NBER working paper, No.4482 1994. Krugman (1994). Felipe (1999).

Lau and Kim (1992), Kim and Lau (1996).

Young (2000).

Yuan (2002).

Blanchard and Fisher (1998).

Krueger (1984).

Note: This is because the output elasticity of capital \((a)\) equals the ratio of marginal product of capital \((\mathrm{d}Y/\mathrm{d}K)\) to average output \((Y/K)\). The marginal product of capital \((\mathrm{d}Y/\mathrm{d}K)\) is equal to the reciprocal of the incremental capital output ratio \((\mathrm{d}Y/\mathrm{d}K=I/\mathrm{d}Y)\).

Zhang and Shi (2003).

Ohkawa (1984), Toh and Ng (2002).

For example, Toh and Ng (2002) explained the changing patterns of TFP in Singapore based on this hypothesis. He also mentioned that this view of development cycle was also expressed in a similar way by Ohkawa (1984).

He (1992).

Jefferson et al. (1996).

The capital data we use here is the data after the original value of fixed assets has been deflated, which, of course, will only affect the absolute value of capital-labor ratio but not its pattern of changes. See Zhang et al. (2003).

Chen (1999).

Keijiro et al. (2000).

A recent study by Qin and Song (2002) also confirmed the Chinese economic growth in the past 10 years was mainly driven by excessive investment demand, and the rapid growth of capital formation has led to the loss of investment efficiency. They used Chinese provincial investment data of 1989–2000 to calculate the excessive demand for investment and the loss of investment efficiency. Clearly, excessive investment demand and loss of investment efficiency are responsible for the decline of China's economic growth.

During 1981–1985, the rate of fixed asset investment in Singapore was as high as 46%, which may be related to the rapid growth of Singapore's infrastructure investment at the time. According to Toh and Ng (2002), more than half of the investment was on residential and factory buildings.

For example, the author noted that the rate of investment in 1981–1985 rose sharply, half of which was caused by the expansion of investment in construction projects. The boom in the property market and the government housing schemes all raised the rate of fixed capital investment in Singapore (Toh and Ng 2002).

The proportion of investment in housing construction in mainland China is lower than that in Hong Kong, but is close to that in Taiwan. The average proportion in Hong Kong in 1966–1998 was 12.6%, while that in Taiwan was 6.8%. The data of proportion of housing construction investment in GDP in Singapore, Hong Kong and Taiwan Ch are from Toh and Ng (2002).

“Other investment” refers to economic sectors outside the joint venture economy, share-holding economy, foreign-funded economy, economy invested by China’s Hong Kong, Macao and Taiwan regions, as well as state-owned, collective and individual economies.

For example, if broken down according to sources of funding, in 1998, among the total investment in capital construction, the state budget funds accounted for only about 10%; and out of the investment of 451.675 billion yuan in renovation projects, the state budget funds only accounted for 6.1 billion yuan. See The State Bureau of Statistics (2001).

According to the data provided by Toh and Ng (2002), the rate of public investment in Hong Kong in the same period was relatively low, only 3.7%.

As everyone knows, the scale of accumulated non-performing assets in the banking sector (currently estimated value is $700 billion by other countries, accounting for about 60% of Chinese GDP. However, the assistant to the governor of the People's Bank of China publicly corrected this estimate claiming that the ratio of non-performing loans in the four major Chinese banks is 28%) is becoming one of the most serious problems facing the financial sector in China. The accumulation of excessive non-performing loans essentially reflects the problems of China's investment decision making system itself. Moreover, in recent years, the capacity of China's economic growth to absorb labor force has been weakened, which has attracted the attention of labor economists. See Liu and Liu (1995) and Yuan Zhigang (2002)’s discussions on this issue. For details, see Liu and Liu (1995).

The so-called “classical competition” is an adjustment process whereby zero profit equilibrium is achieved by free entry and increase of the number of producers. Although this process realizes the static efficiency, there is a lack of sustained, dynamic efficiency improvement mechanism, thus it is not conducive to economic growth.

Sun (1998), Song et al. (2001).

See Lin (1992).

For the relationship between FDI, trade growth and economic growth in China, see the point of view of Yao and Zhang, Lin and Li (2002).

Since 1998, the government deficit has increased sharply from less than 1% in GDP to about 3%, and increased government spending is almost entirely supported with the government’s debt. The net treasury bonds each year (the amount of the treasury bonds issued minus the balance of capital and interest repaid) are almost equal to the fiscal deficit of that year.