BEIJING – China’s economic growth model is running out of steam. According to the World Bank, in the 30 years after Deng Xiaoping initiated economic reform, investment accounted for 6-8 percentage points of the country’s 9.8% average annual economic growth rate, while improved productivity contributed only 2-4 percentage points. Faced with sluggish external demand, weak domestic consumption, rising labor costs, and low productivity, China depends excessively on investment to drive economic growth.
Although this model is unsustainable, China’s over-reliance on investment is showing no signs of waning. In fact, as China undergoes a process of capital deepening (increasing capital per worker), even more investment is needed to contribute to higher output and technological advancement in various sectors.
In 1995-2010, when China’s average annual GDP growth rate was 9.9%, fixed-asset investment (investment in infrastructure and real-estate projects) increased by a factor of 11.2, rising at an average annual rate of 20%. Total fixed-asset investment amounted to 41.6% of GDP, on average, peaking at 67% of GDP in 2009, a level that would be unthinkable in most developed countries.
Also driving China’s high investment rate is the declining efficiency of investment capital, reflected in China’s high incremental capital-output ratio (annual investment divided by annual output growth). In 1978-2008 – the age of economic reform and opening – China’s average ICOR was a relatively low 2.6, reaching its peak between the mid-1980’s and the early 1990’s. Since then, China’s ICOR has more than doubled, demonstrating the need for significantly more investment to generate an additional unit of output.