Michael Pettis, insightful as always:
I can go on but I think my point is relatively clear. The social capital model suggests that there is some amount of investment that is wealth enhancing for any economy, depending on its ability to absorb and exploit the benefits of that investment. Beyond this amount, however, it can be difficult for an economy that scores lower in social capital to take full advantage of investment, in which case the additional productivity generated by higher levels of investment are low, and are more likely to be exceeded by the cost of the investment.
Raising the amount of investment, in this case, is wealth enhancing up to some point, beyond which it can become wealth destroying. At that point it is far more efficient to improve the institutional ability to absorb investment than to increase investment itself (although, because this is intimately caught up in social and political power structures, it can be brutally difficult to do so).
He nails it towards the end:
If you believe, however, that China’s very low level of social capital has long ago made its investment strategy obsolete, the consequences and implications are radically different. It suggests that China has overinvested beyond its capacity to utilize these investments economically, and so there are hidden losses on bank balance sheets created by the failure to write down physical capital to its true value. In this case Chinese growth cannot help but drop significantly as these losses are finally recognized and as investment levels are sharply curtailed.
The real challenges for China, if you believe in the social capital constraint, are not about maintaining high rates of growth in the short term but rather of raising the levels of social capital in China. This is much more difficult and much more likely to be virulently opposed by the elites whose ability to constrain economic efficiency is precisely at the heart of their wealth — which consists of appropriating resources rather than creating resources — and of their power. It is, however, the only real way to sustain growth over the medium and long terms. […]
Not only will China’s real GDP growth drop as China shifts towards a different growth engine, but it will drop even more as China is forced to recognize the hidden losses buried in its debt levels.
While it does, methinks it’ll also face the issue of keeping export-driven businesses alive in a context of rising wages.