China’s debt-fuelled infra model
With stagnant growth and a poor, aging population, Deng Xiaoping’s Chinese dream may been unravelling
In my column “China’s statist turn II: The ‘development’ bank” (19 July 2013), I had outlined how the Chen Yuan converted the bankrupt China Development Bank (CBD) into the main instrument for channeling China’s infrastructure spending through the off-balance sheet localgovernment financial vehicles (LGFVs), which leveraged the future value of land into large upfront loans. This, I argued, represented a huge gamble that the infrastructure created would raise growth and incomes to pay for the debt, which had financed the infrastructure. If it failed, as in effect the ultimate financiers were households with deposits in commercial banks which had bought CDB bonds, these savers would have been robbed.
We now have some answers on how this gamble is paying off from a recent paper by economists from the Saïd Business School in Oxford (Atif Ansar, Bent Flyvbjerg et al: “Does infrastructure investment lead to economic growth or economic fragility? Evidence from China”, Oxford Review of Economic Policy, 32(2):360-90). They examined the documentary evidence on 74 road and 21 railway projects built from 1984 to 2008 across China contained in the loan documents of the ex ante planning and ex post evaluations of the World Bank and the Asian Development Bank. The portfolio was worth $65 billion in 2015 prices. They compared the planned benefit-cost ratio (BCR) with the realised BCR. For the latter, whilst the actual costs were readily available, for the benefits they used the actual traffic on the railways and roads. Because they argued the other broader benefits such as value of time savings or an increase in land values do not come about unless the forecast of traffic volume materialises.
They find that 55 per cent of the projects in their sample had an ex post BCR less than one, implying that they were unviable from the outset and were destroying economic value. A majority suffered from both a cost overrun and benefit shortfall. Only six projects showed benefits which greatly exceeded costs. They comment: “Venture capital investors not governments are meant to take on endeavours with such risky payoffs.” Thence their general conclusion that “generalising from our sample, evidence suggests that over half the infrastructure investments in China made in the last three decades have been NPV negative. Far from being an engine of economic growth, a typical infrastructure investment has destroyed economic value in China.”(p. 377).
The second bow in Chen Yuan’s CDB debt model was to extend it to developing countries. After the global financial crisis in 2008, he extended his collateralised land-based model to the Third World. He gave large loans to state-enterprises owning natural resources in Africa and Latin America, collateralised on future deliveries of these natural resources to Chinese state-owned companies. The loans were used by the borrowing country to buy Chinese goods and services. There were no strings attached to the loans.
Venezuela was one of the major recipients of these CDB loans. The Wall Street Journal (13 September 2016) reports that China lent Venezuela $60 billion of which $20 billion still remains to be repaid. If President Nicolás Maduro falls, though the Opposition says it will honour the Chinese loans in the hope of keeping Chinese credit flowing, they may be tempted to invoke the emerging international norm of “odious debt”, as Iraq’s government did after the fall of Saddam Hussein to win forgiveness of the debt he had incurred. With over 100,000 Chinese engineers and workers on Venezuelan infrastructure projects paid for by shipments of 600,000 barrels of oil a day, there are serious concerns about their safety, as Venezuela has the second-highest murder rate in the world after Honduras. Since 2014, more than 30,000 Chinese have left the country. Another CDB gamble is unravelling.
The macro-economic consequences of the CDBled debt-fuelled infrastructure model are equally serious. Messrs Ansar and Flyvbjerg rightly note that the official government debt to GDP ratio of 55 per cent understates the actual official debt burden, as the corporate borrowing, and financial institution borrowing is dominated by state-owned or state-controlled enterprises. Their liabilities are in effect those of the government. Adding these to the official figures they estimate that China’s true government debt is 190-220 per cent of GDP, only surpassed by Japan’s. A third of China’s $28.2-trillion debt load is accounted for by its infrastructure gamble.
But this huge debt overhang is unlikely to trigger a typical debt crisis, for as in Japan – as Nicholas Lardy (“China’s economic reforms and growth prospects”, China Economic Journal, 2015) has pointed out – most of it is domestically held; it is financed by domestic deposits and not the wholesale market so is not subject to “sudden stops”, nor financing through the interbank market. Also, China has a high savings rate of about 50 per cent. Ultimately, however, the costs of this unproductive debt overhang will have to be borne by Chinese savers.
This would be a replay of the Japanese story after its period of rapid “catch up” growth ended with the oil shock of the 1970s. Thereafter, Japanese corporations with access to household savings through Japan Post overinvested in low-return investments. This led to very high capital-output ratios and a real capital loss for Japanese investors of 380 trillion yen between 1970 and 1998. (A Ando, NBER Working Paper, no. 8033, 2000). Worse, the bursting of its asset bubble in the late 1980s was followed by little or no growth, with per capita GDP (in constant $) in 2009 no higher than 1991. To counter this economic stagnation Japan undertook massive infrastructure investments. “Between 1991 and 2008 the country spent $6.3 trillion…. No one can look at the Japanese numbers and conclude that the money has ramped up the growth rate”. It has only led to Japan’s crushing debt burden of 230 per cent of GDP. “Japan is less, not more dynamic, after its infrastructure bonanza” (Edward Glaeser: “If you build it…”, City Journal, 2016).
China is on a similar Japanese path because of the inefficient debt-fuelled infrastructure model its leaders have followed over the last few decades. Unlike China today, the Japanese had a high per capita income before their economic stagnation set in. With stagnant growth and a still poor and rapidly aging population, the implicit contract Deng Xiaoping made with the Chinese population of rising incomes underwriting their support for the CCP is coming unstuck, because of Chen Yuan’s infrastructure delusions.