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China’s Wasted Capital

China has been criticized for being both a miser and wantonly in global trade circles. Its critics bash it both for careless over-investing at home and for depressing world demand through excessive thrift. In fact, it is not the size of Chinese domestic capital investments that stands out, but rather the misguided content of the investments. Considering the size of its economy, China actually needs to create much more capital than it currently possesses in order to reach levels comparable to those of the U.S. or Japan (see Graph 1).

China’s capital stock amounted to about 2.5 times China’s GDP in 2008, according to the APO, which was the same as America’s figure and much lower than Japan’s

Forty-four percent of China’s economic growth is due to brute accumulation of capital. The fact that much of this capital is useless contributes to the fact that Chinese growth model does not increase the living standard of Chinese citizens as well as it could. For one thing, Chinese citizens’ money in bank deposits is deprived of growth because of government-capped interest rates. In terms of trade, the renminbi’s low exchange rate suppresses consumption (by making imports expensive) and supports production of exports. Sadly, the proceeds that the government extracts from its citizens by capping the interest rate and stifling consumption gets malinvested “in speculative assets or excess capacity.”

The ones responsible for the malinvestment of Chinese citizens’ capital are local governments and SOEs (State-Owned Enterprises). It is their doing that 30 per cent of China’s GDP has become driven by demand from the property and construction centres. The officials have made revenues by buying cheap land from farmers who cannot sell directly to developers and who have to accept what the government is willing to pay. They have built cities, expecting urbanization to push people into them, before creating job opportunities for them. The city of Kanbashi, which was designed for 300,000 people, is today occupied by less than 30,000. Its Genghis Khan Square, comparable in size to Beijing’s Tiananmen Square, is utterly desolate.

The urban center of Kangbashi (Ordos, Inner Mongolia) is swept by a single woman every day

Models of housing at the Noble City development sits on display in the new Kangbashi section of Ordos

In a paper called “Das (Wasted) Kapital”, David Dollar and Shang-Jin Wei “reckon that two-thirds of the capital employed by the SOEs should have been invested by private firms instead” mainly because so much of the capital used by SOEs has been left to rot outside. The SOE justify their investments by their incredibly high “profitability”. But the investments are only profitable because of the lack of competition in the markets that the SOEs occupy. What’s more, the SOEs’ input of land, energy and credit are artificially cheap. It is not surprising then that Unirule, a Beijing think-tank, has shown that “the SOEs’ profits from 2001 to 2008 would have turned into big losses had they paid the market rate for their loans and land.”


Old houses are demolished to make space for construction projects of local governments and SOEs

Miles and miles of empty houses in Huaxi village

China needs to change its growth model as quickly as possible because its economic growth itself is growing. Thus, as China acquires more know-how, better technology and development techniques, it produces more and more capital, which the government squanders. A good solution was proposed by Premier Li Keqiang, who urged “the introduction of a property tax, the reduction of local governments’ over-reliance on land auctions, the construction of housing in rural land designated for commercial development, and a change in education, welfare and household registration rules to reduce distortions – to ‘stamp out the phenomenon of families spending tens of thousands of dollars on unlivable pigeon-coop-sized houses near elite schools’.”

Still, there are scholars who believe that China’s priority should not be better efficiency in economic growth or raising the living standard, but growth itself. Scott Sumner of Bentley University argues that even if it does not produce “everything in the right order”, China ought to “produce lots more of almost everything”. These more optimistic scholars argue that China should produce as much as it can, until its capital per capita ratio and GDP level reach those of the U.S. and Japan. Xi Jinping’s announcement of a huge new economic zone in Xiongan, with the infrastructure build-out intended to cover 2000sq km (a size similar to the city of Shenzhen with 12 million people), indicates that his economic conviction belongs to the same boat. While he is president, China will have to deal with being called a miser and a wanton.

The Economic Impact of Brexit

It’s been four months since the Britons decided to leave the EU and the reactionary sentiment in Europe couldn’t have been more mixed. While many aspects of the vote have been contested, one thing remains sure – the EU has lost an important free-trade advocate, whose voice will be missed in a future, which looms with rising protectionism and nationalism. But the focus of Downing Street has now shifted from the EU’s concerns toward Britain itself and its future. The new prime minister, Theresa May, plans to turn Britain into “the Great Meritocracy” together with her Conservative “party of workers”. Her initially pro-EU rhetoric has changed in order to reflect the will of the people of UK, which they manifested in the Brexit referendum.

“We applaud success. We want people to get on. But we also value something else: the spirit of citizenship. A commitment to the men and women around you who provide a service. A social contract which says you take on local people before cheap labour from overseas. But today too many people in positions of power behave as if they have more in common with international elites rather than the people they employ, the people they pass in the street.”

Even though the referendum has not yet had a markable negative impact on the British economy, the economic projections after its leaving the EU remain unpromising. Officials like Theresa May believe that the success of Brexit will be judged based on more than just GDP and trade figures, but also on the extent to which Britain regains its sovereignty and sustains its national identity. This does not mean, however, that Britain’s economy, especially its future trade-relations, won’t play a significant role in determining the success of Brexit. Let’s look, therefore, at the prospect of these trade relations by examining the effect of the referendum, and of Brexit itself, on Britain’s closest trading partners.

Although the result of the referendum spurred concern and uncertainty in, for example, the automobile industry of the EU, the 14% drop in sterling in about 4 months after the vote caused a rise in foreign direct investment in the EU, as investors fled the sterling. “The referendum has cut off one of the EU’s wings, but the EU keeps flying,” says Jean-Claude Juncker. But Britain keeps flying too – and much swifter than expected for that matter. In fact, its GDP figures in the quarter following the Brexit referendum have seen a growth of 0.5% – higher than the 0.3% growth predicted by many economists. The expansion, nearly exclusively in the services sector and fueled by a higher consumer spending, has been made possible by a weaker sterling. Even though the devaluation of the pound has, surprisingly, failed to stimulate British exports, it may yet bring about a slump in British imports as foreign, mostly primary products become less affordable for Britons. Such a vision is especially gloomy for Britain’s closest neighbour, Ireland.

“The figures show the cost of Brexit to Ireland will be significant, possibly in some areas even worse than in Britain itself.” That is hardly surprising when one considers the tariffs that could be imposed on, e.g., Irish exports of meat and dairy products, were Britain to leave the EU Single Market. These could possibly climb as high as 20-30% and compromise the Irish barrierless cross-border trade with Britain, on which farmers heavily depend.

The imposition of all future tariffs and nontariff barriers depends on the outcome of the negotiations between the British government and foreign economies. Theresa May has already initiated some of these negotiations, not surprisingly, by a visit to India, where she discussed the possibilities of a future trade relationship for the two countries with its prime minister, Narendra Modi.

Not all countries, however, are as welcoming to Britain as India. Britain’s leave of the EU will hugely detract from its lucrativeness as a trading partner. Its most important one, the EU, has signaled that the negotiations between the two actors won’t be initiated until Britain triggers Article 50. As the EU’s Commissioner for Trade, Cecilia Malmstrom, put it, “First you exit, then you negotiate.” The problem is that once Britain triggers Article 50, it will only have 2 years to negotiate a deal with the EU, unless it wants to start operating according to the rules of the WTO and risk the imposition of more than 20% tariffs on certain products. Some pundits say that this time is insufficient to prepare an acceptable trade agreement between the two polities.

This is hardly surprising when one considers Britain’s likely requirements in these trade negotiations: a continuation of the free trade of capital, goods and services; and the abolition of the freedom of movement. In other words, the UK would like to rip out the “four freedoms” of the EU – its most fundamental tenet – and only pick three of them. But EU bureaucrats have never granted such an opt-out, and they are highly unlikely to do so in Britain’s case. Will they let Britain both have its cake and eat it?

After the referendum, EU officials have redirected their attention to a further integration of the EU. They have pushed for policies which are the least common denominator of all its constituents, specifically the establishment of a border-control agency and a push for a closer military cooperation. Furthermore, because it is in their interest to discourage other countries from leaving, they now have an incentive to “punish” Britain for Brexit. The German finance minister signaled what has now become a widespread stance toward granting any opt-out or “special agreement” for Britain: “[Such an opt-out] would require the country to abide by the rules of a club from which it currently wants to withdraw. In is in. Out is out. One has to respect the sovereignty of the British people.”

But the EU also has an interest in keeping the one major global financial center, London, on its continent. If its officials become too obstinate in their negotiations with Britain, they could disrupt London’s prominent status in the world of finance. And even if London’s financial institutions were to resettle in other EU cities like Frankfurt, Paris, or Dublin, these cities lack the potential to fully substitute for London.

As complex and negative as its effect on foreign countries may seem, Britain will not leave the EU for the sake of other countries, but for the sake of its own populace. Brexit will and should be judged by the extent to which it accomplishes to deliver to the British people what they placed before the ideal of a supranational, European identity – British identity and the independence from Brussels. Even though such an aspiration has recently become viewed as a wayward contradiction to prosperity, it is often forgotten what Britain managed to accomplish when it last upheld a very similar worldview during the reign of Margaret Thatcher. Repudiating the concept of a “European reality,” she said: “Europe’ in anything other than a geographical sense is a wholly artificial construct. It makes no sense at all to lump together Beethoven and Debussy, Voltaire and Burke, Vermeer and Picasso, Notre Dame and St Paul’s, boiled beef and bouillabaisse, and portray them as elements of a ‘European’ musical, philosophical, artistic, architectural or gastronomic reality. If Europe charms us, as it has so often charmed me, it is precisely because of its contrasts and contradictions, not its coherence and continuity.” It looks like we’ll be hearing such statements much more often in the upcoming months, as Britain prepares to trigger Article 50.