Overheated Chinese dragon

Based on 'A reheated economy' (The Economist)

China’s economy re-accelerated again in the last quarter of 2004 despite huge efforts to curb rampant investment. Is it growing too fast to keep its balance? Is the Chinese dragon being overheated?

The Chinese economy grew strongly by 9.5% as it finished strongly at the end of 2004, growing at a pace of almost 13% annually, according to JP Morgan. This would be a cause for great celebration anywhere else but for China this may spell bad news.

There has been a lot of worry among economists that the Chinese dragon may be “overheating” and are hoping for a “soft-landing”. This has been a result of Chinese banks lending freely, investing blindly and rising prices. This concern has been voiced among the Chinese as the prime minister, Wen Jiabao, said that China would take “very forceful measures” to cool down the overworked economy. Curbs were placed upon various sectors such as steel, aluminium and cement. For the first time in nine years, the interest rates were raised a minutely to battle rising costs.

Nevertheless, last year’s pace of expansion was not such a surprise as the average rate of growth as been 9.4% annually since China embraced market economies in 1978. Why should a country with vast reserves of labour and no shortage of capital worry that it is growing too fast?

However, economists are not only worried about the pace at which the Chinese economy is growing but are equally anxious about the balance of the economy. No matter how fast it is growing, it is certainly investing insidious amounts. Investment accounted for 42% of China’s GDP in 2003. It is not possible for an economy to withstand that colossal rate of capital accumulation. At some point, China’s investment must run into rapidly diminishing returns. Are two cement factories better than one?

Suppose China can sustain a rate of investment at about 35% of GDP rather than their current rate of 45%. But the question is how they can get from 45% to 35%. Such a sharp contraction in investment will not be consistent with a soft landing and will result in a huge plummet of the economy as a whole. As with all developing countries that experience such boom-and-bust cycles of investment, China is no exception.

China’s economy is still sprouting vigorously but some still fear that too much of this growth will turn out to be dead wood. The rampant investment is overheating the Chinese dragon and it is common fear among economists that China will eventually feel the effects.