May 30, 2012 / 7:38 PM / 6 years ago

Analysis: Geography, not economy, counts in China's rebalancing

XI’AN, China (Reuters) - A gleaming new $1.4 billion airport extension, a $5.2 billion bullet train and Samsung’s planned $7 billion electronics plant, touted as the largest single high-tech foreign investment in China, are sure signs of economic intent in ancient Xi’an.

Along with a $1.4 billion subway, a crane-cluttered skyline and rapidly rising tower blocks shrouded in industrial smog that cloaks the 3,000-year old former dynastic capital, they show that fixed asset investment remains the main route to growth for China - trod for three decades and likely for decades to come.

For all of China’s talk of economic rebalancing to shield it from internal and external risks, the only real re-orientation in the medium term is geographic - shifting infrastructure spending west to replicate rewards reaped by 30 years of coastal development.

That is likely to stoke concerns already voiced by the International Monetary Fund about China’s unprecedented rate of investment spending and confound investor expectations that rebalancing would be a swifter shift towards the consumption-driven growth of developed economies - not 20 more years of inland infrastructure creation.

“There are experiments everywhere in China. Some good points emerge and the best points are what the centre tries to identify and encourages others to learn from,” Zhang Wei Wei, a leading scholar of China’s development model who was translator to its architect - Deng Xiaoping - told Reuters.

China’s rise, in Zhang’s analysis, depends on a conscious effort by Beijing to perfect an urban development model that eases rural poverty and cements power in the capital.

It implies fixed asset investment on a scale as enormous as that which has generated around half of China’s growth in the last decade - when it amassed a foreign reserves fortune of $3.3 trillion, became the world’s second-largest economy, the biggest exporter and the most important driver of global growth.

Indeed, intensive urbanization is the only way Xi’an and dozens of similar cities can grow fast enough for the Communist Party to make good on pledges to raise incomes for the poor and achieve social stability, thereby justifying its grip on power.

During the 2005-2010 five-year plan, average annual urban income in Xi’an roughly doubled to 22,244 yuan ($3,530). The plan is to double it again by 2015. But that still leaves wages way behind Shanghai’s 71,874 yuan average - China’s highest.


China’s ‘Go West’ development strategy, in its second decade after generating $325 billion in investment since its launch in 2000, is the manifest example of the China model in action and ample evidence to long-term investors of its durability.

“It is a conscious strategic objective,” said Gang Zou , general manager in Xi’an for Applied Materials, the world’s largest chip-fabrication equipment maker and an investor so important it is mentioned by name in the municipality’s latest five-year plan - the cornerstone of government policy.

“The first 10 years of the ‘Go West’ policy helped Xi’an build the infrastructure to be ready to take more opportunities in the second 10 years,” Zou told Reuters on a tour of Applied’s $300 million research, development and training facility - and the world’s biggest privately-owned solar cell R&D laboratory.

Applied, which has operated in China for 28 years, generated $2.5 billion of its $10.5 billion global revenues in the country in 2011 - a cool $1 billion more than it billed there in 2010.

No wonder Samsung is following suit with an investment in a plant to make memory chips that will total $7 billion over several years - or 11.5 percent of Xi’an city’s entire 2011 GDP.

Samsung, like Applied, cites clear-planned, infrastructure-led urban development as a key reason for investing in a city that boasts one of the highest research institute and university campus concentrations in China.

Sustained spending though risks a further increase in internal economic imbalances already at levels that worry the IMF.

“Our fear is that China continues to invest so heavily as a share of GDP over the next four or five years that vulnerabilities begin to emerge,” said Murtaza Syed, the IMF’s chief representative in China.

World Bank data shows gross fixed capital formation, which covers in investment in things like buildings, roads, bridges, railways, airports, industrial equipment and machinery, rose to 45.4 percent of GDP from 36.3 percent between 2002 and 2010.

No economy of China’s size has ever maintained investment at such a rate for such a sustained period before. The IMF believes it could stay around 45 percent for the next five years.

“What concerns us is how this capacity is absorbed. Either it goes into the global market, or it is absorbed domestically, or it leads to non-performing loans,” Syed said.


The composition of the investment is key.

That’s why Beijing is determined to keep curbs on property speculation that it imposed two years ago after 4 trillion yuan ($635 billion) of fiscal stimulus injected in the wake of the 2008-09 global financial crisis sparked frenzied development.

It’s a lesson in how fixed asset spending can go wrong. The determination to avoid a repeat is so strong that growth is being sacrificed short term, with analysts citing property curbs as the main reason why 2012 is set to see China’s slowest economic growth since 1999 - albeit at 8.2 percent.

Productive, efficient assets like essential infrastructure and globally competitive factories are welcome. Building too much speculative capacity, particularly real estate, could backfire if they lead to bad debts and the recapitalization of the banks left holding them.

Xi’an plans to increase fixed asset investments by 26 percent in 2012. Between 2005 and 2010, the value of such spending rose four-fold compared with the previous five years.

Wolfgang Weil, chief operating officer at Xi’an Xianyang International Airport, reckons his new 20 million passenger-capable terminal and second runway - able to accommodate the Airbus A380 superjumbo jet - is part of a virtuous cycle.

“I’m pretty sure in the case of Samsung, one factor helping their decision was that there is now a runway available at Xi’an airport without any limitation to aircraft type and payload,” he told Reuters a couple of weeks after the official opening.

Weil says sustainable passenger potential in Xi’an - home to 8.5 million people and the least developed, but fastest-growing city in China’s four main metropolitan deltas - appealed greatly to Germany’s Fraport, the airport’s joint venture partner.

Sustainable is a key word for those concerned that China’s intensive urbanization is dangerously unbalanced development.

While investment has soared, final consumption fell to 48.3 percent of GDP in 2010 from 59.6 percent in 2002.

Economies of scale, however, mean that factories dwarf the household contribution to GDP and, by definition, a fall in investment spending in coastal provinces will naturally raise consumption’s share of GDP there.

Meanwhile shifting investment inland to where workers are cheaper allows China to squeeze another decade or two from a development model pushing its maximum potential on the coast.

The apparently unbalanced development is China’s greatest economic strength, according to Yukon Huang of the Carnegie Endowment for International Peace in Washington, who says the last major economy to develop in such a skewed way was the United States - the most powerful nation on Earth.

That means the key question for investors is how Beijing can manage the investment and political risks generated by another two decades of development spending, when China’s urban population is expected to swell to 66 percent by 2030 from 51 percent in 2011.

“China is large and disparate enough for industry to shift and take advantage of comparative advantages and cheaper labor elsewhere in the country,” said Eric Fishwick, head of economic research at brokerage CLSA.

“But China’s scale implies continuing friction as policymakers in developed nations have a wrong-headed view of what China’s rebalancing means.”

Editing by Neil Fullick

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