China: Investments that stimulated fast economic growth may be problematic later

HONG KONG — It’s getting hard even for the bulls to pretend something isn’t off about China’s breakneck growth story.

On the one hand, as everyone knows, China’s GDP is said to have expanded by an incredible average 10 percent per year for 30 years, according to the IMF, bringing millions of people out of poverty, and making it the second largest economy in the world behind America’s.

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On the other hand, much of this growth has been fueled by investment — in innumerable highways, airports, apartment complexes, and trains — so much so that some experts say China’s economy is not only imbalanced, but may actually be smaller than previously thought, due to waste and environmental destruction.

In fact, according to a new “Inclusive Wealth” index revealed by the United Nations at the Rio+20 conference this week, by some measures China’s economy still trails Japan as the third largest in the world. The UN’s metric weighs economic growth against other factors, including environmental resources, and the value of “manufactured, human and natural capital stocks.”

The top economy in the “Inclusive Wealth Index” is the US with $118 trillion in total wealth, followed by Japan with $55 trillion. Germany ranks nearly the same as China, with $20 trillion.

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The aim of the report is to give governments a more holistic — and accurate — way to plan their policies. Instead of simply aiming to boost GDP — which measures the “stuff” a country produces — this new metric intends to reflect the total well-being of a society. In China’s case, that means accounting for the rampant pollution of rivers, land and air due to modernization.

In this view, China’s growth story changes. Instead of 10 percent annual growth, its economy has grown at a more modest — but still impressive — 3 percent, the report says.

But that's not the only factor casting doubt on China’s GDP growth story. Experts say that subsidies in the form of cheap energy, cheap credit, cheap land have grossly distorted the economy — particularly the state-owned businesses that dominate China’s landscape. Some studies estimate that the subsidies are responsible for 500 to 800 percent of the profits of state-run businesses. In other words, without the subsidies, they would be operating with massive losses.

As a result, some experts estimate that China’s GDP may be overstated by as much as 20 percent.

Michael Pettis, a finance professor at Peking University’s school of management, points out that part of the challenge in getting a hard figure is that many of China's construction projects may not actually add value to the economy.

“The problem is that when you look at the GDP numbers, they really represent the number of inputs, and really don’t measure the value of the outputs,” he says. “If you spend $100 million building an airport, but its economic value is less than that, it still shows up as a $100 million increase in GDP."

China's GDP numbers are now under particular scrutiny following reports that economic data have been fudged.According to the New York Times, many economists believe that Chinese officials are deliberately misreporting electricity consumption in order to mask the extent of the downturn. Electricity usage is typically seen as one of the more reliable indicators of economic activity in China.

While officials are deeply aware of the need to fix China's imbalanced economy — Premier Wen Jiabao has repeatedly warned of the need to “rebalance” the economy, going back to 2007 — the need for political stability now seems to be trumping everything else.

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And because China’s political elites benefit so much from these same problems — the big-ticket construction projects, the favoritism toward state-owned corporations — reining them in is only becoming harder to do.

“If you introduce distortions into the economy, the economy builds itself around those distortions, and the beneficiaries of those distortions do extremely well," Pettis says. "Every country that has had an investment driven growth miracle has had a very difficult period … There’s no historical precedent of managing this transition well. It’s always been very difficult.”