What caught my eye?v.56:Capital
In our latest issue we compare capital stock of key economies and ask how much and what type of capital is needed (with primary focus on China)
What is capital Despite importance of capital in driving productivity, it might surprise investors that there is no data base providing consistent capital stock estimates, either on a national, regional or global basis. In this note we used a World Bank study (‘93) and extended its estimates across key economies under a consistent set of depletion and FX assumptions. What do these estimates show
On a PPP basis, China in 2016 would have the world’s largest stock of capital ($71trillion) and even on a nominal basis, its stock of capital would be the second largest globally ($39trillion) after the US ($54trillion). We estimate Japan’s capital stock at ~$18-19trillion and Germany’s at ~$12trillion. In Asia ex China, India has the largest stock (~$25trillion PPP and $7trillion nominal).
Does it mean that China is now over invested We believe that the problem is not so much stock of capital (which is average when measured on a per capita basis or against output) but rather pace of investment and its direction. China’s capital stock ratios ($52k/capita PPP; $28/capita nom. and capital stock/output of 3.4x) are only slightly ahead of where one would expect, given China’s stage of evolution. In other words, China has progressed from very low levels of capital in ‘80s-90s to where a lack of capital stock is no longer an issue.
However, a key concern is the pace of incremental investment. China is now in the 4th decade of ~10%+ pa growth in capital stock per capita, with a meaningful acceleration in the last decade. We estimate that between ‘07 (GFC) and ‘16, China’s stock increased by ~162% (constant $). As ASEAN and Korea in the ‘90s and Japan in the ‘70s-80s illustrate, a rapid increase in capital flows, sustained for an extended period (decade or longer), causes significant “indigestion” and misallocation, leading eventually to either a credit crisis, abrupt slowdown in economic growth or combination of the two. China’s pace of capital accumulation and its duration has already been far beyond prior experiences.
Perhaps even more important than pace of investment is its direction. We estimate that ~90% of investment is in traditional manufacturing, infrastructure and real estate. The “soft” areas (such as IT, software, and intellectual capital, social/cultural, health care) are almost a rounding error (for example IT, Software & Information are less than 2%). In other words, unlike US or Korea where “soft” areas are now accounting for ~30% of investment, China adds to physical overcapacity rather than embracing new areas of growth. As the Third Industrial Revolution continues to reduce “returns on humans” and shrink supplier and value chains, China’s vulnerabilities grow, making it one of the most vulnerable economies to radical shifts in manufacturing, trade and services.
What is the solution As discussed here and here, we believe that the only viable solutions are non-capital market domestic structural reforms and a major re-think of investment strategy. Essentially, as an individual who is becoming overweight and is suffering from high blood pressure, China needs a change in diet from meat to “Mediterranean-vegetable” fare, implying lower infrastructure and higher “soft” investment. This would not only reduce the pace of overcapacity but also erode precautionary savings whilst helping to withstand shrinkage of global supply & value chains. However, China seems unlikely to accept a shift to lower multiplier activities, unless there is no choice. We believe that corporates would be a canary in a coalmine and they are already signalling overcapacity, lengthening cash collection & declining ROEs. It probably needs to get worse.
