Great ci­ties and ghost towns

Financial Mirror (Cyprus) - - FRONT PAGE -

Many ob­servers tend to re­gard the rise of un­oc­cu­pied mod­ern “ghost towns,” funded through risk-laden lo­cal­go­v­ern­ment fi­nanc­ing ve­hi­cles (LGFVs), as symp­toms of China’s com­ing col­lapse. But this view un­der­es­ti­mates the in­evitabil­ity – in­deed, the ne­ces­sity – of such chal­lenges on the path to de­vel­op­ment.

In 2012, the ven­ture cap­i­tal­ist Wil­liam Janeway ar­gued that eco­nomic de­vel­op­ment is a three-player game in­volv­ing the state, pri­vate en­tre­pre­neur­ial in­no­va­tion, and fi­nan­cial cap­i­tal­ism, with in­evitable cycli­cal over­shoots that cre­ate the con­di­tions for the next wave of in­ven­tion and out­put growth. The United States had ghost towns and lo­cal bank busts once it be­gan in­vest­ing in rail­ways, min­ing, and in­dus­tri­al­i­sa­tion in the mid-nine­teenth cen­tury. But it ex­pe­ri­enced no sys­temic cri­sis that spilled over its bor­ders.

With­out large-scale in­fra­struc­ture in­vest­ment, es­pe­cially in trans­port, the pro­duc­tiv­ity gains that en­abled Amer­ica’s emer­gence as an in­dus­trial power would have been im­pos­si­ble. Though the process in­cluded sig­nif­i­cant cre­ative de­struc­tion, rapid eco­nomic growth off­set losses re­sult­ing from ex­cess ca­pac­ity.

Sim­i­larly, when viewed through the long lens of his­tory, China’s ghost towns will prove to be pot­holes on the path to de­vel­op­ment. China’s mas­sive in­fra­struc­ture in­vest­ment, funded largely through LGFVs, will most likely be re­mem­bered for its crit­i­cal con­tri­bu­tion to the coun­try’s eco­nomic mod­erni­sa­tion.

Of course, the trans­la­tion of in­fra­struc­ture in­vest­ment into eco­nomic progress is not guar­an­teed. The new in­fra­struc­ture – to­gether with on-the-job train­ing that en­ables Chi­nese work­ers to man­age it ef­fec­tively – must boost the coun­try’s pro­duc­tive ca­pac­ity suf­fi­ciently to off­set the value de­struc­tion from ob­so­lete fixed as­sets and un­der­em­ploy­ment.

In this sense, China’s prospects are promis­ing. As it stands, the to­tal value of in­fra­struc­ture in­vest­ment in China amounts to only about 240% of GDP, less than half of Ja­pan’s 551% – and with a much younger pop­u­la­tion. China’s cap­i­tal stock re­mains be­low $10,000 per capita; that fig­ure is above $90,000 in the US and more than $200,000 in Ja­pan (at 2011 prices).

More­over, roughly 1% of China’s pop­u­la­tion – about 12 mln peo­ple – is mi­grat­ing to ci­ties each year. Un­re­lent­ing de­mand for mod­ern, in­no­va­tive in­fra­struc­ture that sup­ports cit­i­zens’ liveli­hoods, im­proves en­ergy ef­fi­ciency, and min­imises pol­lu­tion can­not sim­ply be ig­nored – es­pe­cially given ur­ban­i­sa­tion’s cen­tral role in driv­ing eco­nomic mod­erni­sa­tion and pro­duc­tiv­ity gains.

Though LGFVs carry some in­trin­sic risks, stem­ming from rel­a­tively low lev­els of trans­parency and gov­ern­ment su­per­vi­sion, they have been in­te­gral to China’s in­dus­tri­al­i­sa­tion process so far. In­deed, they emerged in the early 1990s to en­able Shang­hai and Guang­dong to up­grade their in­fra­struc­ture in prepa­ra­tion for their in­dus­tri­al­i­sa­tion drive.

Both ci­ties suf­fered from weak tech­ni­cal and in­sti­tu­tional ca­pac­ity and lit­tle for­eign ex­change or do­mes­tic credit. By work­ing with the World Bank and the China De­vel­op­ment Bank (CDB), Shang­hai and Guang­dong cre­ated an in­no­va­tive in­sti­tu­tional struc­ture to fa­cil­i­tate the co­or­di­na­tion of stake­hold­ers to de­liver spe­cific in­fra­struc­ture projects, em­ploy­ing the le­gal and ac­count­ing tools of mod­ern cor­po­ra­tions. In other words, the LGFV is, at its core, a ve­hi­cle for lo­cal mod­erni­sa­tion.

This in­sti­tu­tional in­no­va­tion en­abled the re­con­struc­tion of hun­dreds of Chi­nese ci­ties, con­nected by air­ports, high­ways, high-speed rail, and ad­vanced telecom­mu­ni­ca­tion sys­tems. Sup­ported by th­ese struc­tures and link­ages, one-third of Chi­nese ci­ties have at­tained per capita GDP of more than $10,000.

More­over, the orig­i­nal LGFVs were not sub­ject to ma­tu­rity mis­matches, be­cause they were funded through long-term CDB loans, with lo­cal gov­ern­ments us­ing the fees and taxes they ac­crued from the com­pleted in­fra­struc­ture to cover op­er­at­ing costs and ser­vice their debt. In this way, LGFVs also helped to cre­ate the net­work link­ing lo­cal mar­kets to global value chains.

But, as is of­ten the case, suc­cess led to ex­cess. Mas­sive gov­ern­ment stim­u­lus in the wake of the global fi­nan­cial cri­sis spurred lo­cal gov­ern­ments to take loans from Chi­nese banks to re­alise dream in­fra­struc­ture projects, with re­mote ci­ties at­tempt­ing to im­i­tate ur­ban showcases like Shang­hai or Shen­zhen.

In a sense, this was a pos­i­tive de­vel­op­ment. After all, lev­el­ing the in­fra­struc­ture gap en­larges the range of op­tions from which peo­ple and com­pa­nies can choose when de­cid­ing where to live or es­tab­lish fac­to­ries and of­fices.

But the in­fra­struc­ture boom was un­der­pinned by the belief that lo­cal gov­ern­ments would al­ways have ac­cess to easy credit, cheap land, and ris­ing de­mand. When the mar­ket tight­ened in 2011, many projects’ prospects di­min­ished, spurring LGFVs to seek credit in the shadow bank­ing sec­tor, which has caused their bor­row­ing costs to rise and in­tro­duced new mar­ket-based chal­lenges to the re­form process.

Nonethe­less, be­cause China is a net lender to the world, LGFV debt has no global sys­temic im­pli­ca­tions. While China’s out­stand­ing lo­cal-gov­ern­ment debt to­taled CNY 29 trln ($4.7 trln) at the end of 2011, its land and fixed as­sets are worth some CNY 90 trln, mean­ing that even if as­set val­ues were writ­ten down by half, lo­cal gov­ern­ments would re­main sol­vent.

This leaves only the is­sue of debt ser­vic­ing. To re­solve it, the gov­ern­ment has an­nounced fis­cal re­forms to split rev­enues be­tween cen­tral and lo­cal gov­ern­ments and en­able lo­cal gov­ern­ments to is­sue long-term mu­nic­i­pal bonds.

China’s ghost towns and lo­cal-gov­ern­ment debts are not har­bin­gers of doom. They are bumps on the road to a de­vel­oped econ­omy, in which ex­cesses will have to be re­solved by the state or the mar­ket. In fact, over­com­ing th­ese chal­lenges will make for a more re­silient econ­omy in the long run.

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