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).
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.
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