China's economic re-balancing challenge

From an excellent article by Yu Yongding,

Currently, the most severe problem confronting Chinese authorities is over-capacity. For example, China's annual production capacity for crude steel is one billion tons, but its total output in 2012 was 720 million tons - a capacity utilization rate of 72%. More strikingly, the steel industry's profitability was just 0.04% in 2012. Indeed, the profit on two tons of steel was just about enough to buy a lollipop. So far this year, the average profitability of China's top 500 companies is 4.34%, down 33 basis points from 2012...

Despite China's lack of a comparative advantage for steel production, it has built approximately one thousand mills, with output accounting for roughly half of the global total. As early as 2004, China's government tried to clamp down on over-investment; and yet output increased dramatically, from 300 million tons that year to a billion tons in 2012, owing to strong demand generated by investment in infrastructure and real-estate development...

With per capita income at less than $6000, home ownership in China is roughly 90%, compared to less than 70% in the US... China has 696 five-star hotels, with another 500 on the way. Five of the ten tallest skyscrapers under construction worldwide are in China... China's economy is being held hostage by real-estate investment... currently running at 10-13% of GDP, is already far too high.

Going forward, China's biggest problem is in re-balancing its unsustainably high investment rate...


... which has underpinned its physical capital accumulation based economic growth model.

There are lot of things going on here. The rulers in Beijing realize that their investment-driven model is critical to sustain the high growth rate, which is the glue that maintains economic, political, and social stability in the country. It keeps creating the jobs required to employ a large and growing workforce rapidly transitioning out of agriculture. The high property prices gives the provinces and local governments the required resources to sustain their grand infrastructure and real-estate projects. In turn these projects provide the demand to keep manufacturers with their high capacity factories working full-time. Besides, it also helps cover-up the strains on heavily exposed (to construction-intensive sectors) bank and debt-laden corporate balance sheets. A rapidly expanding economic pie provides the officials and leaders with ample to nibble at the margins and thereby keep the ruling establishment satisfied. Finally, the high growth rates provides the Communist Party with the credibility to continue the political status quo.

Any talk of re-balancing invariably involves unsettling this tenuous equilibrium. But given the complexity of the situation, any prospects of calibrated government policy maneuvers to re-balance the economy by shifting consumption and investment trends, does not look promising.