Peterson Institute publications
The Peterson Institute for International Economics is a private, nonprofit, nonpartisan
research institution devoted to the study of international economic policy. More › ›
RSS News Feed Search

Op-ed

Don't Hail China's Soft Landing Too Soon

by Morris Goldstein, Peterson Institute for International Economics
and Nicholas R. Lardy, Peterson Institute for International Economics

Op-ed in the Financial Times
October 6, 2004

© Financial Times


You can almost hear the popping of champagne corks. In recent months, growth of China's real fixed investment, industrial value added, broad monetary aggregates, and bank lending all slowed from the breakneck pace of last year and the first quarter. But the growth of private consumption increased, so second-quarter gross domestic product growth was only a little below the figure for the first quarter and somewhat higher than growth for 2003 as a whole. Many observers have thus concluded that China's desired "soft landing" is imminent.

Based on China's experience in the unwinding of the last investment boom, we say: not so fast.

Capital investment as a share of GDP in 2003 hit 43 per cent—virtually the same as the peak in 1993 during the last investment boom. Fixed-asset investment apparently continued to grow more rapidly than GDP in the first eight months of this year. So the investment share has probably risen to an all-time high. There is nothing in the last 25 years to suggest that an investment share above 38 to 40 per cent of GDP is sustainable.

From the peak of the last cycle, real fixed investment growth slowed dramatically over a period of about five years. Likewise, from the trough of 1999 it has taken four to five years for investment growth to reach the overextended levels of 2003–04. Creating and unwinding investment booms in China is a multiyear phenomenon.

Faster growth of private consumption could potentially offset slowing investment. But when investment growth was declining from its 1993 peak, there was no sustained, upward movement in consumption. The record shows a positive correlation between growth of real fixed investment and real household consumption. We doubt that a big increase in real household consumption could be induced without creating other problems.

Government consumption has less than one-third the weight of investment in GDP, and the Chinese authorities have been reluctant to run budget deficits beyond a few percentages of GDP. Net exports have the smallest weight, and the rest of the world would no doubt call for a correction if China's net export balance climbed too sharply.

In the last cycle, from the peak investment share in 1993 to the trough late in the decade, the growth of real GDP dropped by 6 percentage points—a substantial decline, even if did take five years to occur.

Some argue that China's rapid industrialization and urbanization mean the sustainable rate of investment is likely to be much higher than it was a decade or so ago. Yet industrialization was well under way during the unwinding of the last boom, and both the investment share and overall GDP growth fell. True, housing in most cities is now private. But last year property investment as a share of GDP was already 50 per cent higher than the previous peak in 1993, suggesting future adjustment is more likely to be down rather than up. Neither the unprecedented aggregate lending boom in 2003 nor the investment excesses in steel, aluminum, cement, and property suggest to us that banking reform has progressed to the point where an investment share of 43 per cent can be profitable.

Taking a medium-term perspective also makes it clear why policy levers that produce impressive short-term results may not work over a period of several years. Continued use of the administrative controls introduced last year will bring mounting difficulties that can diminish their effectiveness. Provinces and ministries may complain that controls limit their ability to pursue "good" investment opportunities, thus reducing growth and job creation. Companies are likely to turn to unregulated sources of finance to evade the impact of tighter bank credit on investment. In addition, detailed instruction from Beijing on the pace and subsector allocation of bank lending is inconsistent with efforts to reduce state interference in lending decisions and with plans to privatize two of the four largest state-owned banks. But if "victory" on overheating is declared soon and administrative controls are relaxed, overheating could reappear quickly.

Administrative controls look less appealing in the medium term because they fail to address two other key factors of disequilibrium: real interest rates that are too low and a real renminbi exchange rate that is still significantly undervalued.

The necessary unwinding of the current investment boom has barely begun, and it is premature to herald the arrival of a soft landing. Better to put the champagne back in the fridge until the mission really is accomplished.


RELATED LINKS

Policy Brief 13-16: Preserving the Open Global Economic System: A Strategic Blueprint for China and the United States June 2013

Working Paper 12-19: The Renminbi Bloc Is Here: Asia Down, Rest of the World to Go? October 2012
Revised August 2013

Policy Brief 12-7: Projecting China's Current Account Surplus April 2012

Book: Sustaining China's Economic Growth after the Global Financial Crisis January 2012

Book: Eclipse: Living in the Shadow of China's Economic Dominance September 2011

Op-ed: For a Serious Impact, Tax Chinese Assets in the United States October 13, 2011

Op-ed: Taxing China's Assets: How to Increase US Employment Without Launching a Trade War April 25, 2011

Op-ed: Why the World Needs Three Global Currencies February 15, 2011

Policy Brief 10-26: Currency Wars? November 2010

Op-ed: Obama Has to Tell Beijing Some Hard Truths November 29, 2010

Testimony: Correcting the Chinese Exchange Rate September 15, 2010

Policy Brief 10-20: Renminbi Undervaluation, China’s Surplus, and the US Trade Deficit August 2010

Book: China's Strategy to Secure Natural Resources: Risks, Dangers, and Opportunities July 2010

Op-ed: Chinomics: Yes, China Does Need that Infrastructure June 23, 2010

Policy Brief 10-16: Deepening China-Taiwan Relations through the Economic Cooperation Framework Agreement June 2010

Testimony: China's Exchange Rate Policy and Trade Imbalances April 22, 2010

Op-ed: New Imbalances Will Threaten Global Recovery June 10, 2010

Policy Brief 10-7: The Sustainability of China's Recovery from the Global Recession March 2010

Testimony: Correcting the Chinese Exchange Rate: An Action Plan March 24, 2010

Paper: Submission to the USTR in Support of a Trans-Pacific Partnership Agreement January 25, 2010

Peterson Perspective: A Growing US-China Rift January 6, 2010

Book: China's Rise: Challenges and Opportunities (hardcover) September 2008

Paper: China Energy: A Guide for the Perplexed May 2007

Speech: Is China a Currency “Manipulator”? January 28, 2009

Testimony: China's Role in the Origins of and Response to the Global Recession February 17, 2009

Book: US-China Trade Disputes: Rising Tide, Rising Stakes August 2006

Book: Debating China's Exchange Rate Policy April 2008

Working Paper 11-14: Renminbi Rules: The Conditional Imminence of the Reserve Currency Transition September 2011

Testimony: A Muscular Multilateralism to Engage China on Trade September 21, 2011

Peterson Perspective: Legislation to Sanction China: Will It Work? October 7, 2011

Book: The Future of China's Exchange Rate Policy July 2009