CHINA´S OVER-INVESTMENT IS ITS ACHILLES´ HEEL / THE FINANCIAL TIMES ( RECOMMENDED READING )

China’s over-investment is its Achilles’ heel

November 30, 2009 2:38am

China’s export-led growth strategy has been very successful in providing employment for people moving from the countryside to cities, and has provided strong GDP growth, but it has weaknesses that have become more apparent since last year’s financial crisis.

That was the impression I got on my recent visit there, as noted in my column a couple of weeks ago, and it is reinforced by reading the European Chamber report on severe over-capacity in Chinese industries such as wind power, steel-making and oil refining.

A Financial Times editorial today discusses the “disturbing” report and concludes:

China’s trading partners have to engage with the rising giant. They must explain that they cannot – and will not – absorb the surplus capacity its heavily distorted model of development is creating. But they can point out that this pattern also damages the standards of living of ordinary Chinese. China has to shift income from its corporations to its households and spending from investment to consumption. What is needed for that is a massive structural reform. This must start now. Indeed, it may already be too late.

The report itself blames factors such as incentives on local officials to promote GDP growth at all costs, and the fact that state-owned enterprises do not pay dividends, for the glut of low cost capital in China and a rampant level of over-investment, particularly in heavy industries.

It is not only European observers who think this. The report quotes China’s State Council, which two months ago released a statement complaining of local governments continuing to expand capacity “blindly” and to make “duplicated” investments without thinking of the consequences.

The result is huge over-capacity in heavy industries that soak up excess capital, which was hidden until last year by strong export demand for steel and the other affected products. But it also makes Chinese industry vulnerable to shocks such as the financial crisis.

The Chinese government itself accepts - at least in theory - the need to switch away from a pure reliance on exports to fuel growth, to boost domestic consumption and to make growth more balanced.

However, whether anything will be done in the medium-term is another matter. Jonathan Fenby, the head of China research at Trusted Sources, a research group, argued recently that Hu Jintao and Wen Jiabao, the two senior Chinese leaders, will “muddle through” until the change of leadership in 2012.