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Who is winning the battle of economic ideas in China?
Sep 15th 2012 | from the print edition
WEN JIABAO, China s prime minister, this week gave one of his last big speeches
before retiring from the Politburo s powerful nine-member standing committee.
He vigorously defended China s bold response to the 2008 financial crisis and
conspicuously failed to promise anything similar in reaction to the economy s
present woes. Mr Wen described China s 2008 stimulus as a scientific response
to that year s crisis, which prevented factory closures, job losses and return
of migrant workers to their home villages . It would have delighted John
Maynard Keynes, an economist once denounced as anti-science and anti-people
by China s Communists.
Some people claim that China paid an undue price for this stimulus, Mr Wen
noted. He rejected their criticism. But even he seems reluctant to pay that
price again. Despite the sharpest slowdown in the Chinese economy since 2009,
Mr Wen did not announce anything spectacular. Instead, he emphasised the
government s existing adjustments and fine-tuning , including some tax reform,
and a couple of cuts in interest rates and reserve requirements. That was in
keeping with two recent announcements by China s planning body, which briefly
raised hopes of a second stimulus. The announcements highlighted a number of
infrastructure projects that will add over 2,000km to China s road network and
multiply the length of China s subway systems. But most of these projects were
conceived and approved months ago. Only the announcement was new.
Rather than Keynesian economics, a different economic science seems to be
governing China s response to this slowdown. Whereas Keynes feared shortfalls
in investment spending, his intellectual antagonists worried about
misallocations of that spending. Inadequate investment, Keynes argued, would
leave the economy deprived of demand and workers bereft of employment. But
malinvestment, argued Friedrich Hayek, an Austrian economist, would leave the
economy poorly co-ordinated and workers stranded in the wrong jobs.
In the past year, the spirits of Keynes and Hayek have done battle for the
minds of China s policymakers. This month Andrew Batson of GK Dragonomics, a
research consultancy in Beijing, argued that Hayek seems to be winning. China s
leadership is now keen to avoid the Hayekian risk of wasted investment, he
wrote, even if that increases the Keynesian risk of inadequate demand and
weak growth.
This Hayekian risk looms large, some argue, because China has already invested
heavily in everything it normally stimulates when trouble looms. They point to
disturbing examples of ghost cities, white elephants and bridges to nowhere.
One example is the Jiaozhou Bay Bridge, which connects the Huangdao district of
Qingdao with the rest of the city, two locations already connected by a tunnel.
The bridge is the longest overwater bridge in the world, but only because it
does not follow a straight line.
Others are less convinced about Hayekian risk. Francis Cheung of CLSA, a
broker, argues that China suffers from excess capacity in some parts of
infrastructure, but not all. Cities like Beijing and Shenzhen are congested,
faring worse on IBM s commuter pain index than Delhi or Nairobi (see
left-hand chart). That would suggest China has scope to invest in Shenzhen s
metro, one of the projects announced last week. Infrastructure demand will
eventually catch up with supply, Mr Cheung concludes, as long as infrastructure
spending remains disciplined.
Moreover, investment that adds little to a society s stock of productive assets
is not necessarily malinvestment. Michael Buchanan and Yin Zhang of Goldman
Sachs say that some Chinese investment is best seen as quasi-consumption . In
this category they place things like earthquake-proof schools and more
comfortable metro lines. Instead of adding to the economy s productive
capacity, these assets provide a flow of services (such as reassurance to
parents and relaxed travel) directly to consumers. In this respect they are
more akin to consumer durables, like washing machines or cars, than to iron-ore
mines or steel plants.
As a rough gauge of the size of quasi-consumption, the Goldman economists add
up China s investment in house building and social infrastructure , such as
utilities, transport, water conservation, education and health care.
Reclassifying this spending as consumption would increase China s household
consumption to 53% of GDP last year, compared with only 35% in the official
statistics (see right-hand chart).
Less tofu
Hayek thought that badly conceived investment would only result in a worse bust
later. This belief is shared by many bearish commentators on China s economy.
But China s high investment is backed by even higher saving. As a consequence,
China does not need its investment to generate high returns in order to pay
back external creditors. China has, in effect, already set aside the resources
that will be lost if its investments turn sour.
The real cost of malinvestment lies elsewhere. It squanders the hard-earned
saving of China s citizens, leaving them with empty malls rather than
much-needed clinics; vacant villas alongside overcrowded dormitories; sewers
that cannot cope with downpours; and buildings that collapse like tofu. If
China is to limit this waste in the future, it will have to improve the way it
matches savers and borrowers. It will have to liberalise its financial system
further, and allocate a bigger share of credit to private entrepreneurs rather
than state-owned enterprises.
This points to a different, better lesson to take from Hayek, who never won his
battle against Keynesian stimulus in the 1930s. His later works praising the
price mechanism and fretting about economic planning are what turned him into
an intellectual star. Mr Wen s successors will inherit an economy less
susceptible to planning and ever more in need of deregulation. The later Hayek
is the one China s policymakers would do well to heed.
http://www.Economist.com/blogs/freeexchange
from the print edition | Finance and economics