China’s Addiction to Unproductive Infrastructure

China’s impressive infrastructure projects have been the subjects of both international praise and criticism. A recent New York Times article about the debt-ridden Chishi Bridge seems to have rekindled longstanding concerns about the future of China’s economy. The country’s infrastructure feats are often afflicted with corruption, debt, and poor construction. The collapse of a $12 million Chinese-built bridge in Kenya and the “straddling bus” investment scam this week are just two recent examples. Other varieties of China’s infrastructure resource misallocations include China’s modern ghost towns and unused airports and factories.

Two major causes of China’s inefficient infrastructure investments are systemic corruption and an attachment to an increasingly unviable development model. The resulting inefficiency, debt, and unproductivity paint a grim picture of China’s future economic and political stability. As China increasingly takes the lead in international projects like the Belt and Road Initiative (BRI), political fragility and stymied growth in China could have global consequences.

Infrastructure investment as a hotbed of corruption

Literature on China’s infrastructure and other fixed-asset investments often discuss the country’s rampant corruption. Infrastructure investments continue despite low returns because “construction has become and end unto itself.” Government-backed loans and close ties with construction companies provide incentives for local governments to undertake construction projects for private gain, feeding a cycle of corruption and misallocation. According to a 2014 party report, “officials in the provincial transportation office, high and low, racked their brains for ways to get their claws into expressway projects.” Chen Mingxian, a Hunan transportation official who led the highly praised Chishi Bridge project, received $4.4 million in kickbacks in two years for giving construction contracts to favored companies.

In reaction to the collapse of a bridge in Harbin in 2012 (which was one of many of China’s countless and constant infrastructure failures), local residents immediately pointed to corruption. Zeo Niu, a college junior in Harbin, noted that the practice of using substandard materials while charging for high-quality materials is commonplace. Niu quotes an analogy from her uncle, who runs a construction company: “If the central government wants a steel bar, it should be 10 centimeters. When it comes to the province, it will be 8 centimeters, and when it comes to the city, it will be 5.”

China’s deeply embedded system of corruption, which is reinforced by its heavy state hand in the economy, may be to blame for its addiction to unproductive infrastructure projects. In his influential book China’s Crony Capitalism: The Dynamics of Regime Decay, Minxin Pei reveals that crony capitalism—an economic system in which capitalists gain rents from politicians—is endemic to China’s purposefully-crafted institutional environment. According to Pei, the Communist Party of China (CPC) embarked on reforms in the 1980s that sought both greater economic efficiency through partial liberalization and the preservation of party loyalty. The resultant administrative decentralization and partial property rights reforms became the necessary conditions for Chinese-style “collusive corruption.” The former provided government officials with an environment safe for corruption and the latter provided opportunities to privately benefit from state-owned property.

The large contracts and the abundant opportunities for cost inflation and skimping on quality materials make infrastructure projects easy targets for rent-seekers. Of the fifty cases of “Outsider-Insider Collusion” (in which both officials and private businessmen are involved) that Pei investigated, twenty-eight cases were in the infrastructure and construction sector and thirty-four were in the real estate sector.

Unproductivity in infrastructure investment

China’s post-1978 development model has primarily relied on two growth drivers: (1) fixed asset investment mostly in infrastructure and (2) low-wage manufacturing for exports. China’s infrastructure investment is the highest in the world. According to a 2016 McKinsey report, China’s rate of infrastructure investment (about 8.6% of its $11 trillion GDP) is nearly twice as much as India, the next largest spender, and over three times as much as the US and Canada. “It’s very important to improve transport and other infrastructure so that impoverished regions can escape poverty and prosper,” President Xi Jinping stated in 2013.

But are China’s infrastructure and other fixed asset investments actually productive drivers of economic growth? Researchers at the University of Oxford find that in over half of China’s infrastructure investments, the costs of the projects have been greater than the benefits generated. Only 28% of the infrastructure projects were “genuinely economically productive.” Economists at the Chinese National Development and Reform Commission (NDRC), China’s top economic regulatory agency, have also observed high waste and inefficiency in China’s fixed asset investments.

In the short run, a construction boom contributes to growth. But when projected benefits fail to materialize, the debt accumulated leads to economic and financial problems. The University of Oxford researchers estimate that China’s economic losses in infrastructure projects have equaled about one third of its $28.2 trillion debt. A careful analysis of the economic data of China’s infrastructure projects reveals that China’s rapid economic growth may instead be a result of economic competition generated by the liberalizing reforms of the 1980s.

Why China’s infrastructure investment strategy isn’t working

According to developmental economists, when a NIE reaches a middle level of per capita income (usually about $11,000), the benefits that the country has been reaping from the typical developing-economy growth strategies of capital accumulation, low-wage manufactured exports, and rural-urban migration begin to run out. This phenomenon is known as the middle-income trap.

Fixed asset investment yields rapid growth for economies in the early stages of development that lack such physical assets. While China’s infrastructure investment was considered insufficient in 1997, many scholars argue today that China has already accumulated enough physical assets to arrive at a point at which continued infrastructure investment is no longer economically efficient. Atif Ansari, one of the researchers of the aforementioned Oxford study explained that “‘Build it and they will come’ is a dictum that doesn’t work, especially in China, where there’s so much built already.” China is also reaching the Lewis Turning Point, a point during which China’s surplus of rural labor will be depleted and labor wages will increase, eroding China’s competitive advantage in cheap, labor-intensive manufactured exports.

Scholars like David Shambaugh and David Dollar point out that although China’s current development strategy has transformed China’s once-developing economy into a newly industrialized economy (NIE), changes in development strategy are necessary are necessary to escape the middle-income trap and achieve a “developed” economy. The country would need to “rebalance” to a new growth model that would instead rely on domestic consumption, the services sector, and innovation.

Chinese leaders observe escaping the middle-income trap to be a necessary but difficult task. China’s Development Research Center of the State Council finds that only thirteen of the 101 post-1960 middle-income countries were able to move into the higher income club, “including Japan, South Korea, Taiwan, Hong Kong, Puerto Rico, Mauritius, Singapore, and Israel.” The rest faced economic stagnation, recession, or got stuck at middle-income levels.

Stuck between unproductivity and a harder place

The CPC’s prioritization of regime survival has preserved China’s systemic corruption and rigid, capital investment and cheap export-oriented growth model. China’s current growth model allows the CPC to maintain a heavy state hand in the economy and to rely on personal loyalty networks (guanxi). The political willingness of the CPC to take a leap from and possibility reverse its familiar and safe strategy is a determinant of the country’s ability to change its growth model. A new growth model based on consumption, services, and innovation would require changes to China’s existing institutions—institutions that have been demonstrated to be decently effective and comfortably illiberal to leaders who are constantly insecure about the regime’s survival.

China’s biggest challenges may be fostering competition, innovation, and a sense of economic security that would spur consumption. In the seminal book Why Nations Fail, political economists Daron Acemoglu and James A. Robinson show that “inclusive economic institutions” (which truly enforce property rights, create a level playing field, and encourage efficient investments) are key to the economic success that illiberal NIEs like China desperately need.

But inclusive economic institutions require inclusive political institutions, which distribute power widely and establish “law and order, the foundations of secure property rights, and an inclusive market economy.” Both are necessary for the innovation that would allow China to move up the income ladder. According to Acemoglu, China’s current growth is not sustainable because China is reluctant to establish a genuinely inclusive market economy and to move away from informal politics. Such institutional reforms would weaken the party state’s political control—which relies on guanxi and corruption.

But President Xi Jinping does not seem to be inclined toward liberal reforms. Instances of President Xi’s increasingly authoritarian moves in just the past month include the removal of Bishop Peter Shao Zhumin of Wenzhou (who is still missing), the new ban on livestreaming on popular social media sites, and the shutdown of non-government news programs “without licenses.”

Implications for China and the world

Institutional decay could threaten China’s political stability. In Crony Capitalism, Minxin Pei observes that collusive corruption has already spread to China’s judiciary and regulatory agencies. Gloomy economic prospects, corruption, and repressive government policies have led to mass discontentment in the form of protests. In 2010 alone, China saw 180,000 protests, riots, and mass demonstrations. And as China increasingly takes on international leadership roles, political instability in China could impact international cooperation and institutions.

China’s infrastructure investments have grown hand-in-hand with its national debt, and the majority of China’s investments since 2000 have been fueled by debt. The debt build-up and monetary expansion that results from China’s unproductive infrastructure investments puts China at greater risk for a financial and economic crisis. Since China’s economy is deeply intertwined with the rest of the worlds, a crisis in China could lead to a global crisis.

As China tries to export its infrastructure-oriented growth model through the Belt and Road Initiative (BRI), it could be exporting its corruption and development challenges as well. The $12 million bridge that collapsed in Kenya was built by a subsidiary of the state-owned China Railway Group Limited. Infrastructure investments abroad could perpetuate or even expand corrupt practices. Infrastructure investment is not a miracle development strategy. An over-reliance on infrastructure could entrench infrastructure-oriented development at the cost of building strong, inclusive institutions that would sustain long-term growth.

China already knows that it faces significant institutional and strategic challenges. President Xi Jinping commented in 2014, “the tasks our Party faces in reform, development, and stability are more onerous than ever—and the conflicts, dangers, and challenges are more numerous than ever.” President Xi’s focus on cracking down on corruption reflects a sound assessment of the greatest dangers to China’s future stability. But top-down, after-the fact-remedies such as removing corrupt officials cannot change the fact that corruption is endemic to political and economic institutions. While liberalization may be impossible in the foreseeable future, China could experiment with moderate reforms that would formalize political relationships to a greater extent and establish more oversight at the local level. The United States and the other countries could help China by supporting potential reforms with an eye toward maintaining political stability.

(Featured image: Chishi Bridge in Hunan Province. Image credit: 东方IC)

By RUKA WANG JULY 7 2017

Ruka Wang is a Summer 2017 intern at The Carter Center China Program.