Free exchange | China's economy

Stimulation without edification

Malinvestment adds little to the capital stock or national well-being. But idle workers add nothing

By S.C. | HONG KONG

THIS week's Free Exchangecolumn in print wonders whether China's policymakers are increasingly slave to the ideas of Friedrich Hayek, the Austrian economist who fretted about "malinvestment". The column echoes a piece in The World in 2012, a sister publication of The Economist published last autumn, which pointed out that many economists in China now regret the excesses of their country's very Keynesian response to the 2008 financial crisis and seem reluctant to repeat it now that the economy is once again slowing sharply. Chinese policymakers want to avoid the "'Hayekian' risks of capital misallocation and wasted investment", according to Andrew Batson of GK Dragonomics, a Beijing consultancy, even if that increases "the "Keynesian" risk of a shortfall in aggregate demand".

The danger of capital misallocation has increased, argues Mr Batson, because investment has reached such a high share of China's GDP. I agree. No country that invests 46% of its GDP in fixed assets can hope to invest well. The government's reluctance to push that ratio even higher is one explanation for its inhibited response to the slowdown. The pace of infrastructure investment has quickened, but not by enough to offset the slowdown in homebuilding.

Extra investment is a peculiarly effective form of stimulus in China. It is quick: local governments and state-owned enterprises always have lots of grand expansion plans up their sleeves, which they scramble to implement whenever Beijing gives the nod. It can also be labour-intensive. The construction boom in 2009 employed lots of people laid off from export factories.

But extra investment is not the only possible kind of stimulus. There are a host of other ways China could revive spending. The government could cut taxes further. It could multiply spending on rural pensions and di bao handouts to the poor. Such measures would offset the Keynesian risk of weak demand, without raising the Hayekian risk of capital misallocation.

The best stimulus plans both revive aggregate demand and enhance aggregate supply. They create assets of lasting value, adding to society's productive potential, even as they spur the economy to make full use of that potential. But sometimes crisis-fighting governments have to make do with less than the best. They have to settle for a demand boost, without a supply-side gain; stimulation without accumulation. Malinvestment adds little to the capital stock or national well-being. But idle workers add nothing.

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