Too Much of a Good Thing

A typical Chinese infrastructure investment suffers a double whammy of cost overruns and benefit shortfalls so large that it destroys economic value. There is an even more detrimental boomerang effect of infrastructure over-investment. Unproductive projects carry unintended pernicious macroeconomic consequences: sovereign debt overhang; unprecedented monetary expansion; and economic fragility.

Low-quality infrastructure investments pose significant risk to the Chinese economy. Unless China shifts to fewer and higher-quality infrastructure investments, the country is headed for an infrastructure-led national financial and economic crisis, which is likely to spread to the international economy.

We reached these conclusions based on an analysis of 95 large Chinese road and rail transport projects and 806 transport projects built in rich democracies, the largest dataset of its kind. Our China study is part of a larger on-going investigation of large-scale projects around the world at the University of Oxford’s Saïd Business School. We were thus able to report valid international comparisons between China and many of the rich democracies in the Americas, Europe, and Asia Pacific for the first time.

The salient findings are fivefold.

First, China is now the world’s biggest spender on fixed assets in absolute terms. The scale and speed of China’s investment boom are staggering. China spent $4.6 trillion in 2014 accounting for 24.8 percent of worldwide total investments and more than double the entire GDP of India. By way of comparison, China’s total domestic investment was merely 2.1 percent of the world total in 1982. Undoubtedly, China has been in the grips of the biggest investment boom in history for over 15 years.

Second, in line with global trends, in China actual infrastructure construction costs are on average 30.6 percent higher than estimated costs, in real terms, measured from the final business case. The evidence is overwhelming that costs are systematically biased towards underestimation.

Third, in terms of absolute construction time schedule overrun, China performs better than rich democracies. In democracies, politicians seem to have an incentive to over-promise and then under-deliver. China has built infrastructure at impressive speed in the past but, it appears, by trading off due consideration for quality, safety, social equity, and the environment.

Fourth, with respect to traffic performance, demand in China represents two extremes. A majority of the routes witness paltry traffic volumes but a few routes are highly congested. Too little and too much traffic of this magnitude both indicate significant misallocation of resources.

Fifth, 55 percent of the projects were economically unviable at the outset of their operational lives. Another 17 percent of the projects generated a lower-than-forecasted benefit-to-cost ratio. Any future risks, such as greater-than-expected operation and maintenance costs, can impair the future economic viability of these projects. Only 28 percent could be considered genuinely economically productive.

The pattern of cost overruns and benefit shortfalls in China’s infrastructure investments is linked with China’s growing debt problem. Cost overruns have equaled approximately one-third of China’s $28.2 trillion debt pile. China’s debt-to-GDP ratio stands at over 280 percent; exceeding that of many advanced economies, such as the United States, and all developing economies for which data are available. Because many corporations and financial institutions in China are state-owned, our revised calculation of China’s implicit government debt as a proportion of GDP suggests that China’s is the second-most indebted government in the world after Japan’s. Extraordinary monetary expansion has accompanied China’s piling debts: China’s money supply, broadly defined, grew by $12.9 trillion in 2007–13, greater than the rest of the world combined. The result is increased financial and economic fragility.

The infrastructure policy implications of our research are three-fold. First, China’s high-octane investment programme in infrastructure is not a viable strategy for other developing countries such as Pakistan, Nigeria or Brazil. Instead, China’s is a model to avoid. It is a myth that China grew thanks largely to heavy infrastructure investment. It grew due to bold economic liberalisation and institutional reforms, and this growth is now threatened by over-investment in low-grade infrastructure. The lesson for other markets is that policy makers should place their attention on software and orgware issues (deep institutional reforms) and exercise far greater caution in diverting scarce resources to large-scale physical infrastructure projects.

Second, less is more when it comes to infrastructure investments. Infrastructure supports economic development if the investments are productive. This big ‘if’ is all too often ignored in policy debates leading to the predicament in which China now finds itself. Our findings suggest that had China focused on about a third of its most productive investments it would have reaped lasting economic benefits without the debt overhang it is currently suffering.

Finally, incurring huge piles of debt to fund infrastructure is a destabilising strategy. New-Keynesian arguments that see public debt in a benign light are misguided at the level of debt we see in China. Negative macroeconomic impacts include: volatile movements in interest, exchange, and inflation rates; unpredictable movements in asset prices, such as house prices and listed public equities; adverse growth outcomes; rising unemployment from deleveraging; and lack of capital to finance productive investments. Several of these negative consequences are already materializing in China in 2016.

Dr. Atif Ansar is Programme Director of the MSc in Major Programme Management (MMPM) at the Saïd Business School of the University of Oxford. Dr. Bent Flyvbjerg is the first BT Professor and inaugural Chair of Major Programme Management at Oxford University’s Saïd Business School.

This essay is part of our Big Questions series.