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I keep reading that China must switch to consumption-led growth or productivity-led growth, that investment-led growth is 'dangerous.'

I understand that it is probably not sustainable in the sense that returns on capital will start to fall after awhile. But what else is the danger?

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  • $\begingroup$ Consumption is base on unlimited population growth. Urbanization will cause population shrink over time. Also higher income will demands better quality of goods/services. $\endgroup$ – mootmoot Jun 8 '17 at 12:43
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From the Chinese perspective, it's "dangerous" because high investment for so many years, particularly when driven by state incentives or by state-owned firms might induce mis-allocation of resources, high indebtness levels and excess capacity (some might say even voluntary, for example dumping in steel to hurt developed countries' industries). For instance, this paper states that:

The main objective of management in Chinese state-owned and state- dominated firms has been to maximise not profits but the growth of investment and output. The reward to such bureaucrats takes the form of prestige, power and the accompanying perks of commanding an organisation; the reward being greater the larger the organisation.

Another reason is that investment is more volatile than consumption. However, if investment is supported importantly by state-owned enterprises, this might not apply well to China, which by the way have not had a recession in decades).

From a western perspective, high investment (and low consumption) contributes to a high trade balance surplus and therefore to a high current account surplus, which might be good for the central bank of China (accumulation of reserves) aiming to keep the Yuan relatively low to foster the competitiveness of the export sector, but is bad news for the rest of the world. The latter would benefit from higher consumption of the Chinese population (via Chinese imports and rest of the world's exports). The same story is told of Germany, which would help other countries (mainly European partners, because of same currency) by rebalancing its economy from exports toward more consumption.

Additionally, note that some economists have blamed China (among others) for the Great Recession (e.g. here or here), partly because of their voracious reserve accumulation policies, a core element in the export-led Chinese development strategy. Thus, a more rebalanced global economy might be good for the world economy as a whole, decreasing the likelihood of another recession.

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Some economists argue that China should head towards a consumption-led and especially a productivity-led growth because their investment-led growth is not sustainable (as you stated), at least not in the long run. China already relies heavily on exports, plus they produce more than the rest of the world can consume which obviously leads to certain difficulties in the future.

Although China's growth in the last quarter of a century has been impressive, some experts assert that China's growth rate could be much higher if the resources would be used more efficiently. This inefficiency is - according to them - due to the enormous investment projects that China has carried out. In addition, China's workforce will shrink in the future which makes relying heavily on investments more difficult to achieve.

I hope my explanation is helping, I know it is far from the only way to look at China's economic growth.

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  • $\begingroup$ [re: inefficient investment projects] I know their state owned enterprises are not efficient and propped up. But that does not seem to be a pitfall of investment-led growth in general: that's a criticism of what, specifically, China invested in. Or is the idea that allocating resources to investment will always be less efficient if you are monomaniacial about it? $\endgroup$ – thewhitetie Jun 10 '17 at 21:50
  • $\begingroup$ It is dangerous because they can hardly keep up the investment-led growth (on its current level) in light of their demographic situation and because they highly depend foreign demand. Because of that, many experts point to the inefficiency in the state-owned enterprises. If the owner of these firms (i.e. the Communist party) manages to make these firms productive (e.g. by privatizing them), China would not have to rely as much on investments as they do now. $\endgroup$ – Kuma Jun 11 '17 at 9:14

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