Good sentences about China

by on April 6, 2013 at 3:51 pm in Uncategorized | Permalink

From Karl Smith:

China at some points has had investment rates of in excess of 40% of GDP. For super-geeks this exceeds the Ramsey Rule at a zero discount rate. For non-geeks it means that there is no investment strategy under which this is the profitable thing to do.

Its always hard to tell but on balance I think the Chinese government is aware of this, yet is willing to lose money on its capital investments in order to provide jobs for people moving to the city. This is a smart move if you think cities produce agglomeration effects.

With apologies to the less wonkish, China is using physical capital as a loss leader in order to grow cities that will produce network effects will in turn foster the human capital that really makes a country rich.

In this way China has become like Amazon’s Jeff Bezos, a Destroyer-of-Worlds.1 You can’t win a physical capital accumulation battle against someone whose plan is to overinvest and lose money on the physical capital.

That is speculative of course but nonetheless worth a ponder

1 mw April 6, 2013 at 4:31 pm

I wonder what Ramsey suggests for a developing country if that country has reason to believe ex ante, based on the experience of ‘certain’ other nations, that when it becomes an “advanced country” its government will cease to be sufficiently functional to make investments in physical capital regardless of profitability?

2 JW April 8, 2013 at 5:04 am


3 Bill April 6, 2013 at 4:34 pm

And, they will make water flow uphill.

You can look at it a different way: elites are compressing the wage rates of its citizens, and bureaucrats are siphoning off the differential through corruption:

Here’s a telling story of corruption:

4 asdf April 6, 2013 at 5:44 pm

Yes, I think the fact that someone is getting rich off these “investment” contracts is all the explanation we need.

5 Yancey Ward April 6, 2013 at 5:51 pm

I find myself in rare agreement with Bill. Karl Smith is way over-thinking this.

6 FC April 6, 2013 at 6:05 pm

Sounds like China is in what Lenin called a revolutionary situation.

7 JW April 8, 2013 at 5:07 am

Of course there’s corruption. But of the BRICs, arbitrary of course, China is on a par with Brazil for corruption. Russia and India are much worse.

More importantly, there’s no wage compression, indeed, labour does much better than private capital in China. China’s data says so, but more importantly western manufacturers in China are saying the same thing. Wages are growing with GDP. Not a bad outcome versus most other economies developed and developing.

8 Spencer April 6, 2013 at 4:48 pm

On the other hand, when economic growth is dependent on large scale capital spending it an reverse with amazing speed.

So Chinese growth is still dependent on exports and capital spending, two of the most volatile components of any economy.

9 dearieme April 6, 2013 at 5:28 pm

You don’t understand; they spend some capital and in just a few hours they feel the need to do it again.

10 Yancey Ward April 6, 2013 at 5:50 pm

Sounds like Keynesian Pork.

11 TMC April 6, 2013 at 7:04 pm

+1 to both of you!

12 Joe Smith April 6, 2013 at 5:53 pm

“China is using physical capital as a loss leader in order to grow cities that will produce network effects will in turn foster the human capital that really makes a country rich”

So they are investing in physical capital as an indirect way to invest in the network effects. This may make little sense in a free market but in a controlled market like China it makes sense because the Communist Party will be able to capture the returns on the network effects.

13 JW April 8, 2013 at 5:08 am

+1. Yes.

14 JW April 8, 2013 at 5:36 am

I don’t know the details on Amazon’s network effects though I suspect they’re huge. For Amazon to be like China it needs to be creating some pretty significant network externalities in the form of tax revenues through third parities. In the case of China, tax revenues have risen from 10ppt of nominal GDP to 20ppts of nominal GDP in 16 years.

This is my issue with the original analysis, including the Ramsey rule citation. Yes, the returns on the direct assets in China are often very low, but the wider impact is huge. This must be accounted for when it’s the government investing.

15 liberalarts April 6, 2013 at 5:58 pm

I have never been to China, but everyone I know that has is struck by the very low quality of their capital investments. Concrete that crumbles in a decade, bathtubs installed without calking them in, etc., etc. Thus, perhaps they or we are overvaluing the capital and the problem is not too much capital but overpaying for a smaller amount of capital.

16 Dismalist April 6, 2013 at 6:01 pm

I have vague memories of West Germany’s investment share of GDP in the 1950’s being around or in excess of 30%. [Please correct me if I’m wrong.] If the investment translates into consumption growth quickly, that’s OK.

17 Sbard April 6, 2013 at 6:43 pm

The peasants are coming to the cities whether the cities are ready for them or not. If there isn’t enough for the peasants to do when they get there, you have social unrest. There are enough single, young men from the countryside causing trouble in the cities as is, you don’t want to make the problem worse.

18 anon April 6, 2013 at 10:12 pm


It is another way of paying “unemployment” and “disability” but getting lousy infrastructure as a bonus.

And it is “investing” in the same way the US government is putting more money into the higher ed bubble with student loans and encouraging “everyone should go to college”.

19 steve April 6, 2013 at 11:37 pm

I agree as well. Chinese governments well before the arrival of the communists have spent much of there efforts on avoiding social unrest. Basically, with their vast numbers, the peasants are capable of becoming a threat to the ruling regime at any time. This is coupled with a history in China of blaming any and all problems on the government. Floods, droughts, disease, inflation, deflation have all been likely sources of peasant revolt in the past. Is it still true today? I don’t know. My guess is the Chinese leaders don’t know either, and aren’t taking any chances.

20 Sbard April 7, 2013 at 1:26 am

The Chinese government’s number one goal is keeping the economic engine running so as to provide jobs for the populace. The tacit bargain between the Chinese government and the Chinese people is that the government keeps the jobs and money flowing and the people keep quiet and let the government do its thing. For the most part this works: the urban political machine is mostly competent and mostly works to improve the economy and quality of life of its subjects.

This also has the result of emptying the countryside of working age people as they realize that they can triple or quadruple their income by working in a big city sweatshop. Unfortunately, for a lot of these migrant workers, the big city isn’t all that has been promised to them. Relatively poor regional centers like Hefei (capital of impoverished Anhui province) are flooded by rural migrants looking for jobs that don’t exist. Rapidly increasing housing prices leave a lot of the men from these areas unlikely to ever marry (wedding expenses in China typically include an apartment for the newlyweds and the expenses are mostly borne by the groom’s family). Unmarriageable young men from the countryside are already a source of petty crime and trouble-making in the cities. It should also be noted that a majority of the “mass incidents” that occur in China happen in rural areas, thanks to the rampant corruption of the out-of-sight-out-of-mind local bureaucrats in those areas.

21 Mike H April 7, 2013 at 1:15 am

Saying that Chinese peasants revolt because of the lack of work in the cities is an oversimplification of the real problem. China has a Hukou system that basically functions like the internal passport system Soviet Union had. If your Hukou is issued by a district in the countryside, you are effectively a second-class citizen in every city. You can’t go to a hospital in the city, your children can’t go to school, you can’t get a real (registered) job even if someone wants to hire you. The only way to change Hukou is by buying a large parcel of land or a house in the city (which most peasants can’t afford) or by bribing party officials.

Of course you can always buy into the official party line that Hukou exists to prevent rural migrants from overwhelming urban infrastructures. Still you have to wonder if this is just a deliberated institution set up to preserve the privileges of the established urban residents (where 99% of the party members come from).

22 Sbard April 7, 2013 at 1:40 am

The ordinary urban residents of China don’t have too much sympathy for rural migrants; they see them as socially backwards troublemakers who cause problems in their daily life: they crap in the streets, they clog the sidewalks with their illegal businesses, they crowd the buses and the trains. Most of the urban residents are quite fine with the current arrangement even if they have no chance of ever becoming a party leader.

Interestingly, the current inflation problems in China have actually hit the urban residents much harder than the rural ones who can eat the fruits of their labor.

23 Edward Lambert April 6, 2013 at 7:01 pm
24 TallDave April 6, 2013 at 9:55 pm

“This is a smart move if you think cities produce agglomeration effects”

I think people forget sometimes why free markets work. If the agglomeration effects don’t produce a profitable investment, it was a bad idea.

As liberarts notes above, China’s building codes are atrocious and the infrastructure investment is a boondoggle of epic proportions — much of it will last only a decade or so. They are squandering the immense economic gains of moving 1.3B billion people from basket-case Communism to dysfunctional banana republic. The smart elites are buying gold and getting out while the getting’s good.

25 asdf April 7, 2013 at 10:43 am

Yes, one thing you get from talking to people in China is that their goal seems to be to get rich enough to get out of China.

26 Steve C. April 6, 2013 at 10:47 pm

So, they are going to “make it up on the volume”?

27 Ape Man April 6, 2013 at 11:06 pm

You wins the Internets. At least, if you are referring to the joke I think you are.

28 Michael Smitka April 6, 2013 at 11:47 pm

Loren Brandt and Xiaodong Zhu include a calculation on returns to infrastructure investment [theirs? World Bank’s?] that suggests returns similar to private investment; it’s the investment of SOEs (state-owned enterprises) and local governments that have access to bank credit that is truly excessive (and at zero or negative real rates, the standard developing country financial repression story). So yes, lots of waste, but starting from a disequilibrium (misallocation & underinvestment under Mao) and with fast depreciation [what was done in the 1980s is obsolete]. [B&Z do this in the context of a 3-sector growth model; see a Song, Storresletten & Zilibotti 2011 AER paper for a somewhat different multisector model that focuses on international flows rather than purely domestic.]

However, this ignores political economy. Maintaining macroeconomic control is a challenge. The financial sector remains “shallow” and repressed, so conventional monetary policy focused on interest rates is ineffective. [Plus central government budget surpluses to date mean there’s no bond market…] Meanwhile, provincial and local government exercise great autonomy – Beijing is not in control, and can only through concerted effort use “window guidance”, pushed down to the provincial and city level, to slow credit creation. Now cities finance their projects through land development schemes; as urbanization slows, that will become harder to do. But banks don’t yet have enough human capital and management experience to lend to smaller companies. So there’s considerable irony (tragedy?!) that in an economy that is still in relative terms capital scarce, smaller firms have no access to capital markets, and even at zero or slightly negative real interest rates (in an economy that was growing at 10% pa real!!) big (inefficient) firms and local governments simply can’t borrow fast enough to soak up all savings; instead they lend capital to us, the U.S. Rebalancing will require not only shifting macroeconomic flows, but building up the micro-level institutions needed to better allocate capital.

A quick summary: yes, investment is too high, but that is not true of the private sector (and even less true of the agricultural sector). There’s also a catch-up component, which can de-accelerate rapidly.

29 JW April 8, 2013 at 5:42 am

I’ve never understood why local government financing through land sales is such a problem? It’s clearly matching assets and liabilities. The land’s been improved so its only right to finance improvement with land sales to capture the created surplus. Inevitably land will run out but so will the need to develop it.

30 Ray Lopez April 7, 2013 at 1:32 am

Asians always oversave and over-invest. Recall the Japanese in the late 1980s. “This too shall pass”.

31 Brian Donohue April 7, 2013 at 11:44 am

+1. Both are interesting demographic stories too. Japan old, China rapidly aging. High savings were always a good idea, but it’s a shame how both countries have managed these massive savings.

32 Barry J April 7, 2013 at 2:50 am

I guess I’m missing what is remarkable about this; though I would love to be enlightened. Simplistically, if an investment in building a bridge were profitable, then (in a free market economy at least) private enterprise would do so.
Government should only spend when it is “unprofitable”; governments are not households, etc…

33 Shane M April 7, 2013 at 3:52 am

When benefits are diffuse / difficult to capture by a single company wouldn’t it be expected to _not_ be provided by free market? The reported pollution issues in China come to mind, but perhaps high pollution levels are possibly efficient. Difficult to buy clean outdoor air / water if I have to pay for the clean air / rivers of others who will pollute. Agglomeration effects may be similarly difficult to capture by any single party.

34 guest April 7, 2013 at 1:42 pm

Yeah, I think Barry J missed Econ 101.

35 Andao April 7, 2013 at 6:29 am

Urbanization was critical when it meant moving closer to the factory, or when you literally had to take a piece of paper from bank A to bank B to get a loan processed. Nowadays living in a city is more a lifestyle decision than an economic one. As China becomes a service economy, are the mega cities going to stay relevant? If I was a young person from a farming family, why move to Shanghai when the county seat might have similar job offerings (with lower wage/cost of living)?

It’s also funny how the gov seems to know which cities people will move to and can wisely direct funds accordingly. I wonder if China had a Detroit, would they just keep dumping money into it? Or would they go with the flow and move on to the Chinese Austin or Phoenix? They probably won’t have to make this choice for many years, but someday.

36 JW April 8, 2013 at 5:19 am

Yup, young people aren’t moving to Shanghai anymore. But of course Shanghai is just one city in China, about 1.5% of the population, maybe slightly more. The east coast is full and the no vacancy sign has gone up. But there,s a whole country out there that’s still pretty big.

As you say, instead they’re staying at home, which suggests a productivity improvement at home. County towns are a lot better than they used to be, and probably need to be a lot better again, given the stink of raw sewerage in the last one I visited. Infrastructure plays the biggest role in this productivity improvement.

I don’t think there’s evidence that cities are being planned centrally. Cities get more money as they raise more taxes- it’s demand led.

37 Andao April 7, 2013 at 6:41 am

Everyone’s the first to crack the “Japanese investment boom-bubble” economic model, until they aren’t.

38 vlade April 8, 2013 at 5:16 am

Urbanization is irrelevant if the wages are depressed. See Brazil, Mexico and quite a few other countries for good examples. If China was really that keen to throw cash at something, minumum wages would be a much better thing. Low-cost labour can work for long time, but then the implication is that it stays low cost – ergo little to no domestic consumption. Higher wages are profit destroying, but that’s good in a perverse sense. If you want to profit with higher wages, you have to be more innovative – but at the same time, the higher wages mean your consumption base is wider. I’m not mentioning protectionism, as that already is in place in China, and to an extent it’s questionable whether that is overall plus or not (as in sometimes it probably is, sometimes it isn’t).

39 KGJ April 9, 2013 at 9:10 pm

Consider South China Mall, by far the largest shopping center in the world, twice as big as the previous record holder, built by a “local boy” undeterred by the absence of airports or freeways or bustling cities nearby. Here workers clean the water canals every day, janitors sweep the dust, shopkeepers read and listen to music, and teletubby mascots run around with no children to entertain, for the entire complex is eerily empty. Instead of filing for bankruptcy, the mall has merely changed hands and is now owned and run by the government.

(PBS: Utopia, Part 3 1/2: The World’s Largest Shopping Mall)

40 Brandon H April 11, 2013 at 12:35 am

This seems like a very brave strategy for china to use. Almost half of their GDP has as some point been put into investments they know won’t be profitable. This at first makes no sense to me. I consider myself a “non-geek”, so I took this statement at face value at first.
However, after some consideration, this strategy seems to me like the same kind of logic that explains why it can be beneficial for a government to spend and create a (large) deficit during a recession in order to grow the economy. While at first these types of strategies seemed backwards to me, this article clears things up. China is definitely taking a loss with these investments, but with the end goal of growing the economy by investing in the cities. This in turn makes up for the initial loss of capital, akin to the U.S. government spending its way out of a recession.
Chinas strategy seems akin to the Roosevelt’s New Deal and its many programs such as the Tennessee Valley Authority and the Civilian Conservation Corps; helping citizens by employing them while simultaneously using this labor to build stronger infrastructure (in China’s case its cities) and grow the economy.

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