OECD sees endless China boom

By Leith van Onselen

Over the weekend, the OECD released a detailed 161-page economic survey on China, which provided a rosy assessment of China’s economic prospects.

The OECD notes that China’s economic performance has been spectacular, with its rate of growth over the past 30-years being the fastest in history (see next chart).

A key driver of China’s strong economic growth has been its high rate of capital investment, which accounted for around two-thirds of Chinese growth in the five years to 2011 (see next chart).

But unlike many other commentators, such as Professor Michael Pettis and Professor Patrick Chovanec, the OECD is not concerned by China’s high dependence on capital investment, which it believes is justified overall based on high marginal returns and likely to continue:

The quality of investment appears quite good insofar as marginal returns to capital are quite high. There is also evidence that investment is allocated to areas where profits are highest, at least in industry, where the growth of the capital stock correlates well with the rate of return in previous years (Simons, 2013). The only exception is in electricity generation where the capital stock has continued to grow despite poor returns, presumably as producers expected regulated prices to be raised eventually…

Growth will also continue to be underpinned by capital deepening… capital per head in China remains well below levels in advanced economies, though above those in some other large emerging economies (Figure 15, Panel B). In key infrastructure segments capacity lags behind. By the late 2000s the total length of paved roads in China was around half that in the United States, despite a comparable land area and a population more than four times larger. The total length of the railway network in China is even further behind, at around one third of the United States. Accordingly, returns to infrastructure investment may still be high. Despite strong investment in the property sector, per capita residential living space is still just only 20 m² (and lower on an internationally comparable basis), while large sections of the rural and urban populations live in sub-standard buildings. In sum, large unmet demand in a number of areas will require continued strong investment.

Similar sentiments were expressed in the media conference pertaining to the report, whereby the OECD argued that China’s investment was well founded and likely to continue:

“The level of investment in the private sector is well-founded by the rates of return, and in infrastructure, we still think there are tremendous needs,” Richard Herd, the head of the OECD’s China desk, told a media conference.

“We’re positive on investment in the sense that we see rates of return remaining quite high,” he added.

The report also plays down widespread concerns about heavily-indebted local governments and the shadow banking system, noting that the central government has big cash reserves, significant fiscal flexibility, and the ability to take control of troubled assets put it in a strong position to absorb potential trouble and prevent a financial crisis.

Looking forward, the OECD expects the strong growth to continue, with China’s economy forecast to expand by 8.5% in 2013 and by more in 2014, with growth to average 8% over the decade. This is well above the government’s official growth target for 2013 of 7.5% and 7% on average over the five years to 2015:

China’s growth performance since the sharp acceleration in the early 1980s has been exceptional and has propelled it to become the world’s second-largest economy. While trend growth is bound to slow gradually over time, China’s rapid catch-up can continue during the coming decade… Indeed, the Chinese economy is on course to become as large as that of the United States around 2016, when allowance is made for differences in price levels between the two countries by using purchasing power parity (PPP) rather than market exchange rates. However, China’s income per head will be only one-quarter that of the United States in 2016. Even so, by 2020, China may have become a moderately prosperous society and a high-income country on the World Bank definition (around USD 12 500 in 2011 prices). For growth to be sustainable and to contribute as much as possible to citizens’ wellbeing, however, it needs to become more inclusive and greener…

If the OECD is correct in its assessment (of which I have great doubts), then it is great news for Australia, given that China accounts for around two-thirds of global seaborne iron ore demand (Australia’s biggest export commodity), not to mention being the key marginal buyer of coking coal used in steel production (Australia’s second biggest export commodity):

Moreover, China is a major user of thermal coal for electricity generation, which is also a major Australian export:

One potential roadblock to China’s development, identified by the OECD, is its excessive levels of pollution, which is high by global standards:

Another key potential roadblock, which receives only scant attention by the OECD, is China’s rapidly ageing population (in part due to its One Child Policy), which is on track to follow Japan’s trajectory since the 1990s and threatens to stifle economic progress, making it grow old before it gets rich (see next chart).

Overall, the OECD lays out the bullish case on China well, but provides too little assessment of the downside risks associated with China’s over-dependence on fixed asset investment, its rapidly ageing demographics, as well as the Chinese authorities own desire to slow and re-balance growth away from unsustainable fixed asset investment towards more sustainable consumption-led growth.

The summary report can be downloaded from here, whereas the full report can be viewed by clicking on the below icon.

[email protected]

www.twitter.com/leithvo