Lazy thinking at the Economist

The Economist mounts a defense of Chinese capex today. They start with a study from last year:

Western leaders often shake their heads in disbelief at the sums China spends on its huge projects. And some analysts question how much of it has been wisely spent. In a widely circulated study published last autumn, Atif Ansar of Oxford University’s Saïd Business School and his co-authors say the world’s “awe and envy” is misplaced. More than half of China’s infrastructure projects have “destroyed economic value”, they reckon. Their verdict is based on 65 road and rail projects backed by the Asian Development Bank (ADB) or the World Bank since the mid-1980s. Thanks to the banks’ involvement, these projects are well documented.

The Economist then goes on to address the issues with some of the report’s assumptions and picks a particular “failed” project from 1999 that since recovered, concluding:

The authors also assume that any traffic shortfall persists throughout its life. That is not always the case. Traffic on Yuan-Mo, for example, has rebounded, according to the road’s operator. By 2015 it was 31% higher than the ADB projected back in 1999. Around last year’s lunar new-year holiday the road handled record numbers. Some white elephants turn grey with age.

My point of contention is not about 18-year-old projects that eventually came good over a period where the Chinese economy averaged over 10% nominal GDP growth.

My contention is that China is spending more now than they did in 1999 on capex, and so much more of it is debt funded.

CapexToGDP

If China struggled to find beneficial projects in 1999 when they were spending “only” 35% of GDP on capex with sky-high GDP growth, what hope do today’s projects have of being profitable with 45% of GDP being spent, more of it debt fueled, and GDP growth much lower?

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  1. GunnamattaMEMBER

    If China struggled to find beneficial projects in 1999 when they were spending “only” 35% of GDP on capex with sky-high GDP growth, what hope do today’s projects have of being profitable with 45% of GDP being spent, more of it debt fueled, and GDP growth much lower?

    Completely agree, almost none would be the normal answer.

    But one of the things I find myself wondering about the Chinese situation is if they really do think they ‘need’ to take massive investment ‘punts’ (ie they are not really about financing projects for the viability or financial return of the project but taking very speculative positions on the future – almost regardless of the financials in the here and now).

    Things like this from last week China to plow $361 billion into renewable fuel by 2020 http://www.reuters.com/article/us-china-energy-renewables-idUSKBN14P06P and this The Limits of China’s ‘Silk Road’ to Europe http://thediplomat.com/2017/01/the-limits-of-chinas-silk-road-to-europe/ and some of this sort of stuff 33 giant Chinese infrastructure projects that are reshaping the world http://www.businessinsider.com/chinese-infrastructure-projects-reshaping-the-world-2016-9//?r=AU&IR=T/#110-million-the-pingtang-telescope-was-finally-turned-on-in-september-2016-and-is-now-the-worlds-largest-radio-telescope-its-dish-measures-1640-feet-across-1 have me (at least) wondering about the dynamic as they see it. For mine there is no way they are all ‘value’ not in any sort of economic sense.

    I have strong doubts about whether they can actually pull themselves out of a middle income trap, and my guess would be they will be seeing a world where the high watermark of ‘free trade’ (which I see them as deploying a mercantilist approach to) is past, and leaving them with massive capital outflow issues, while sitting atop a pile of UST they need to be real careful in how they use.

    I find myself wondering if they have decided that f they cant deploy themselves in an economic sense then maybe a giant speculative spread of projects is what they are thinking is likely to be better value in terms of giving them traction on the future.

  2. Never thought I would hear the old meme about destroying economic activity by wasteful infrastructure development.
    To adopt the usual stance, on the one hand it may be practically wasteful but on the other hand it engages productive capacity which trickles through the economy. Something about being better to dig a hole and fill it in again rather than have idle capacity ……. sounds like something an economist said some seventy years ago. Anyway, the folks at the Eco like to pull out charts of capex compared to GDP to titillate the masses, even though it’s a bit passé these days.
    Sometimes I feel like we’ll never get wake from this neoliberal nightmare ….sigh!

    • Malcolm I’m posting this as a reply to you only to get your thoughts. Not an argument (at this stage 🙂 )
      As per Mike below!!!! Well said!!!! To actually see China is to stand in awe. To have watched the process ongoing since I first visited in 1985 is really a standout event in my life.
      China has been trying to alter its economy for at least 15 years that I know of. It’s a huge ship that is slow to turn. However have they done such a terrible job? Anyone who saw the place prior to 1985 and who sees it now will know the answer to that is a resounding ‘no’! There are lines of division in prosperity in China however it is a pretty simple fact that the benefits of their economic success have benefited everyone. Let nobody be under any illusion. Their people are proud of China and its achievements and back currrent moves to make themselves more and mre independent of the West particularly in the technology field.
      Two points I’d make
      1. The Chinese economy is productive. They can spend wildly on infrastructure because the benefits of the expenditure remain mostly in China. That’s what a productive economy does for you. Their monstrous capex, as compared to us not necessarily in absolute terms, does not result in massive foreign debt (massive Current Account Deficits). It’s laughable that western economists, who have presided over and produced these debt laden economies especially foreign debt ladedn, criticise the Chinese.
      Then the stupid US Economists et al rant on about Chinese Capital outflows – would that we had an economy where there was so much foreign saving that had massive capital outflows. Note also that much of the criticism come out of the US where they have been priniting the Reserve currency by the Trillion…China capital outflow? Bwahahahahaaaaa!!!!

      2. If we were to spend money on infrastructure in this country as it is now structured we would have to spend that money on projects that, on an economic analysis in A$ terms, would be uneconomic. We need to look into our future some distance to assess the real and lasting benefits. We would need to alter our long term horizon from 12 months to 30 years. We would need to assess the spending in those terms – not how many people will get on a train to go to work to make coffees for lawyers and government employees in the Sydney city centre!
      So the Chinese with a project that pays after 18 years? What is wrong with that? I suppose we would ask how many coffee shops and drug-selling tattoo parlours could we have opened in Sydney and Melbourne for the money! Much more instant return on GDP!!!

      Now China faces problems…huge problems! Those problems will affect Australia in ways that the morons who rule us have not even yet begin to think about. However our, including most western societies, mocking China for its economic performance has got to be the inanity of the year.

      • Interesting post Flawse.
        My last trip to China was just after the HKG hand back so I never witnessed the fruition of the miracle, although we hosted many trade visits from China Light Industrial subsequently. IMO the Chinese did exactly as they said they would when Deng laid out the manifesto for for modernising China. The observations I’ve made since then is that the massive and rapid development of infrastructure led to the rapid urbanisation of what was previously a subsistence economy outside of the major centres. Of course this hasn’t been perfect, but for the majority of the population their quality of life has vastly improved. There has been environmental damage and social dislocation together with ethnic issues which we can all observe and my take is that the Chinese are aware of these externalities and are seeking to redress them as we speak, but it will take time. What has been provided is the capacity building of the population to compete with products anywhere in the world and they are now rebalancing their economy by developing the services sector which is why many westerners continue to live and work in China as this skilling goes forward.

        In doing justice to your observations, I need to generalise so this is going to be a bit of a ramble, but anyway here goes.
        A cluster of coincidental have helped to achieve the miracle. The primary one is that their system of Government is totalitarian and is essentially what would be termed a planned economy so they faced little resistance from their citizens as the Party moved their agenda forward. The other incidental is their vast population which was seen by Westerners as a captive market for goods and services, but the Chinese insisted on technology transfer agreements with trade, hence they were able to open their market and attract investment at the same time to balance and pay for their early development until they built their own manufacturing capacity. That second stage then saw the transfer of manufacturing from the West to China which resulted in a massive trade imbalance in their favour with which they urbanised their country. During this period their currency was fixed by the PBOC so they were able to manage their capital flows under the noses of western governments because the global corporates held their respective governments to ransom.
        This has changed in recent years as China needs the status of a reserve currency to advance their services sector and the fools at the IMF unwisely permitted the Yuan as a reserves and we’ve seen the fiddling the Chinese have done to rebalance the basket of currencies to suit their purpose whilst soft fixing the Yuan. The West is now aware of the game they are playing but are captive to the markets built over this period of development although this could dramatically change if Trump initiates a trade war. China are readying themselves which is why they are running down their foreign reserves to avoid a collapse of the Yuan otherwise they will be unable to prevent a currency devaluation which will stall their economy. That’s my potted version which I needed to outlay before I came to your points.

        The miracle would not have been achieved without their totalitarian state, greedy western global corporates and their rigging of the currency. Now the world is experiencing slow growth, China will need to float their currency or their miracle will start to unwind. They probably won’t be too fussed if some manufacturing is shifted and they are actually doing that themselves anyway with the Silk Road objective, but if the US clamp tariffs on Chinese products their hand is going to be forced. It depends on how aggressive Trump will be to force the issue but there is every indication that he won’t mess about so we are in for some interesting times.

        In essence what I’m saying is that while China developed the world prospered and turned a blind eye to the Chinese gaming the system but how could they be blamed for wanting to modernise their society and emulate the free world success? The game is changing now and their next challenge will be monetary policy that will be acceptable to the West, trade relations which provide a level playing field, pressure from their own citizens who have tasted the West and will want to modernise their political system and some agreement between the US, Russia and Europe about shared military objectives. So I agree we should learn from the Chinese experience, but I’m not convinced the Chinese approach is possible or appropriate for Western developed nations. Short of conflict, for China to take the next step they will need to move in concert with the West and that means monetary policy and fiscal policy needs to be modernised and their currency at some stage will need to be floated. They need to help of the rest of the world to do this and as there is every indication that Trump wants a new relationship with Russia, they will need to do it sooner rather than later.
        So in response to your question in 1 I suggest the circumstances were very different which allowed the Chinese development whereas we are at a different stage, with a different political system and a very small population. I don’t think we can copy the Chinese investment/infrastructure patterns.
        With respect to 2, China will have to play under World rules or their economy will crunch. When their currency is truly fiat with a float then they will adjust but essentially we don’t really understand the real productive capacity in China so whether the adjustment is negative or positive is in the wind.

        I know this all sounds obtuse, but the short answer is that nobody knows.

    • Thanks Malcolm I pretty much agree and I wasn’t saying that Aus could now copy what China did – probably quite the opposite as per your post. I do question Western economics which makes a rundown in Chinese reserves necessary. This for a country with a very strong external trade account running massive surpluses. Yet we allow the USA to abuse the privilege of being the Reserve Currency and run massive CAD’s for 30 years.
      (Of course China and Russia are both busily working to undermine that status somewhat and in that regard i was not opposed to the yuan being included in the basket.)
      Re the planned economy – of course but is it worse than the stupidity that we have managed to create, incorporating totally false precepts, over, especially, the last 30 years. We’ve arrived at some conclusions to teh idiocy and still it is not questioned except by a few such as Paul Romer and a collection of rag-bag non-entities such as pfh et al!! 🙂

      Cheers and thank you for the thoughtful reply. Around the topic of China as you say Who Knows? But one thing I can say – the next 30 years are going to look nothing like the last 30 years despite our ruling clowns and academics thinking that it will be so.

      • The amazing thing to me is that primarily US based and owned multinationals undermined US hegemony after the collapse of the USSR in their quest to open the Chinese market for greater profits. They totally undermined US manufacturing and its employees wages and job security in their quest to get the China market opened to themselves.
        We now have the situation where the US has permitted China to take de facto possession of the whole South China Sea and the Pratley and Paracels against the interests of Phillipines and Vietnam in particular.
        On the other side those same multinationals have done god’s work in lifting 3 or 4 hundred million Chinese out of abject poverty, greatly increasing equality between nations.
        As to whether capex projects have been destructive of wealth I would vehemently disagree in a particular way. Those projects have laid foundations for the modernisation of China and the lifting of at least 200 million to international middle class standards of living. The benefit to the population at large is considerable and the projects had to be done over time for resource and budget reasons. It is similar to a lot of nation building work done in Australia after the Second World war. Units of fiat currency converted to present value are not the way to measure the value of such projects in the context of nation building. In fact PV as a measure would proceed with a project that made the present population rich even if it meant the death of everyone on the planet in 100 years as the costs of their demise is worth virtually nothing in present value terms. And of course GDP has such omissions and anomalies that it is also not a great measure of the value increase of a society over a short period of time such as a year or even 5 years.
        This does not mean that China does not face problems of backlash (reduced free trade, currency wars, defeat of mercantilism and demographics (size, gender imbalance, dependency, ethnic rivalries) and I expect those problems to be clearly manifest to all within about 5 to 10 years, and potentially much shorter if Trump provokes change through use of executive power.

  3. I’m in awe of Chinese infrastructure. Massive projects, build the road and they will come mentality, lifting millions from abject poverty, improving miserable housing and living conditions. Jesus, we struggle to build a second airport in Sydney or genuinely needed urban and inner urban road links, or dams, or develop the North.

    If as a nation you’re going to incur massive debt, which is better, the Chinese model or US QE?

  4. Well, when the whole thing falls apart – you don’t have to give the freeways to someone else so who cares ?

    When Australia falls to bits, who are those houses going to belong to ?

  5. Too many words and wasted time spent debating this topic.

    A child of five can see that China’s debt-funded expansion is the most incredible case of mal-investment in all history. An epic reckoning is baked in the cake and no amount of ‘management’ of the situation is going to rectify the situation. It is simply a matter of when, not if.

    • I’d like to meet this prodigy. No doubt autistic to boot. Sure, China has an unbalanced economy, but most of this infrastructure- railways, roads, power stations, hospitals, schools, sewers, etc,- will be needed. Sure there probably is a financial shock or shocks coming and a long term slowdown in growth as the gap with the rich countries narrows but that physical capital will not disappear, nor will the industrial knowhow China has acquired. Compare that with Oz, where the investment is predominantly speculative, where the infrastructure is lagging and being used for rent seeking, where the breadth and depth of industrial capacities and knowhow has shrunk precipitously. When the financial shock hits Oz, we’ll find ourselves with little to show for the huge “investment”, except for overworked and ageing infrastructure and services, discounted property and lots of unwonted dogboxes.

      • Hello St Jacques ..
        Two things: I accept that the China point is not worth arguing over. I believe China is in a far worse state than the Japanese managed to get themselves into in the roaring 80’s (they’ve never recovered from their own epic credit boom). Time will tell whether their issues are major or minor and all those who win bragging rights can exercise those if they can be bothered. I suspect, nobody will as the consequences will be sufficiently dire that they’ll have better things to concern themselves with.

        I definitely wasn’t defending Australia (by attacking China). I agree with all the points you make regarding Australia’s descent into a nation of speculators and actually heading down a rather dark road as a result. This situation will eventually resolve itself, with or without a China bust. The real issue for us all is that there is no single nation on the planet (or economic bloc) that is capable of bailing us out when the next economic/financial crisis arrives.