M&G’s Riddell: Booming investment and falling growth bodes ill for China

China is investing scary amounts compared to GDP and is likely to tank as the USSR and Asian Tigers did in the past, M&G macro and fixed income fund manager Mike Riddell argues.

China’s investment to GDP ratio leapt to more than 54 per cent last year, up from 48 per cent a year earlier.

That while its GDP growth fell to 7.7 per cent, its lowest rate in 13 years.

“It should be a concern if a country experiences a surge in its investment rate over a number of years, but has little or no accompanying improvement in its GDP growth rate,” Riddell warns.

“This suggests the investment surge is not productive, and if accompanied by a credit bubble (as is often the case), then the banking sector is at risk.”  

It is even worse when growth is falling, as in China’s case, he adds.

Riddell references a prescient 1994 study by then Stanford economics professor Paul Krugman. which compares the contemporary boom of the Asian Tiger economies with the similarly meteoric rise and subsequent collapse of the Soviet Union.

“Krugman’s paper gained widespread attention at the time (even more so post the 1997 Asian crisis), and succeeded in refocusing attention on the concept of productivity,” Riddell says.

“It mattered not what the growth rate was, but how it was achieved.”

Economic growth is driven through boosts to inputs through increased labour and greater capital stock such as machines and buildings, as well as efficiency gains. The most sustainable long-term growth comes from greater efficiency, mostly through technology, the manager says.

The USSR in the 1960s and 1970s and the Asian economies in the 1990s were simply able to mobilise massive resources, but efficiency gains were poor, he adds.

“These were one time changes; they weren’t repeatable.”

There is a perception today that modern China’s rocketing growth is reliant on heavy investment. Although investment is a large driver, before 2008 the nation’s blooming private sector and technological improvements created strong efficiency gains, Riddell says.

In the past five years, however, China’s efficiency and productivity has plummeted.

Its leaders have spoken of the need for a more sustainable model, but the economy is heading in the wrong direction with state-sponsored investment injected when growth disappoints, he says. 

“China is trying to hit unsustainably high GDP growth rates by generating bigger and bigger credit and investment bubbles,” Riddell says.

“And as the IMF succinctly put it in its Global Financial Stability Report from October 2013, ‘containing the risks to China’s financial system is as important as it is challenging’. China’s economy is becoming progressively unhinged, and it’s hard to see how it won’t end badly.”