China’s Slowing Fixed Asset Investment

The slowdown will have repercussions for a number of other sectors. Can Beijing find a new source of growth? 

By Sara Hsu

March 24, 2014

China’s rate of growth in fixed asset investment is declining, and while this technical measure of infrastructure, property, and plant and machinery is not as eye-catching as say, consumer sentiment, this particular indicator has been bolstering GDP since the global financial crisis hit China. Its decline means not only that GDP will have to come from other sources in the near future, but that there will be knock-on effects in a number of sectors, including infrastructure, real estate, construction, metals, and machinery, that will compound a slowdown in growth.

China’s investment in infrastructure and real estate has been enabled by a large increase in funding through non-traditional means—i.e., not through bank loans, but through, rather, the shadow banking sector, which includes funds from a number of under-regulated, under-monitored sources such as trust companies. A surge in liquidity stemming from trust companies and other shadow banking entities fueled China’s infrastructure and real estate boom. What is more, stimulus provided by the Chinese government for construction of infrastructure helped to maintain China’s high rate of GDP growth, but returns to both infrastructure and real estate have declined, and shadow banking loans have soured, revealing weaknesses in productivity of these sectors. But that’s not all.

First, declining growth in infrastructure and real estate will have a direct impact on the construction sector, as fewer individuals are employed to work either on government or privately owned projects. The construction sector consists of building, planning and management services, and material provision and installation. Most of the sector is occupied by private enterprises that will lose business as fixed asset investment growth falls off. This sector is labor-intensive and will result in unemployment if its decline is unchecked.

Second, the metals sector will also suffer fallout from a decline in the infrastructure and real estate sectors. The metals sector was boosted by growth, particularly in the infrastructure stimulus packages put through by the government in recent years. Production of steel and aluminum are expected to turn downward as demand for these materials for use in construction declines. Smaller metals producers will face potential bankruptcies as the sector experiences a slump in growth.

Third, China’s machinery sector is expected to decline; production of construction machinery was the most lucrative component of the machinery sector in recent years, and as construction slows, so will domestic demand for construction machinery. High levels of competition in the machinery market due to high fixed costs may result in potential failures of less profitable machinery producers, while machinery producers that remain in business will have to turn to other sources of revenue.

What all of this means is that a shift in China’s source of growth will have to come soon, since reliance on fixed asset investment has buoyed the economy in a number of essential sectors. Rebalancing will indeed have to take place, and a policy focus on other sectors such as retail or environmental services will have to be made rapidly to maintain the current economic growth rate.

A strong policy focus will hopefully result in a knock-on effect in other sectors, while a weak policy focus will have a shallower impact. For example, a focus on growth in retail products will have a larger impact if it is accompanied by policies that promote consumption, perhaps with a consumption subsidy, or an increase in available jobs (and therefore incomes) during the urbanization process. Large-scale growth in the retail sector may also enhance consumption of food and beverages, e-commerce, and transportation/logistics, as retail products are marketed and produced. By contrast, a more limited policy that promotes consumption of retail products without ensuring the means to purchase the products would have a more short-term and limited effect.

As China’s existing sources of growth slow, new sources will become exponentially more important. How well they can replace fixed asset investment and its knock-on industries as a source of growth will depend, in turn, on how widely the impacts of new growth sources are felt. Given the large size and heterogeneity of China’s economy, the domino effect resulting from a policy shift away from focus on fixed asset investment will determine whether GDP growth can be sustained. The hope is that China’s leadership has taken into account the repercussions of the coming policy shifts and that they are sufficient to maintain its economic expansion.

Follow Sara Hsu on Twitter @SaraHsuChina.