Capital and Chinese growth
Rapid production and ghost cities
One of the most notable features of China’s rapid growth over the last 30-40 years has been the rate of capital accumulation. This has gone hand in hand with massive urbanization, and the scale of Chinese cities has become staggering. These satellite overheads give you some idea of how big certain Chinese cities have become.
Recall that most of the capital stock consists of buildings and structures, so the construction is visible evidence of capital accumulation. The of $K$ in China grew along with the cities.
Building this kind of capital in that short of a time required incredible effort. This next video is one of a host you can find online showing rapid Chinese construction projects. In this case, an entire train station was built in about 9 hours, overnight.
This is pretty amazing to watch. But it should also serve as a reminder that the amount of capital accumulation, $K_{t+1} - K_t$, or the growth rate of capital, $g_K$, don’t necessarily mean that much without being put in context.
One thing to note in the prior video is the number of workers involved. Yes, the train station represents new capital, and that capital will presumably add to the capacity to produce GDP in the future. But note that the labor productivity - which is GDP per worker - is quite low to begin with. Building capital using massive labor forces doesn’t mean you are rich, it means you are able to organize lots of low-productivity labor into projects.
A second things to note is that capital has a diminishing marginal product. Accumulating a bunch of new capital does not ensure that the addition to GDP will be large. This is especially true as an economy acquires more capital. We model this with the elasticity $\alpha$, which says that if you double capital only, you do not double output. To be more precise, the derivative of GDP with respect to capital, the marginal product of capital, is
\[MPK = \frac{dY}{dK} = \alpha \frac{Y}{K} = \alpha \left(\frac{AL}{K}\right)^{1-\alpha}\]and so as the amount of capital goes up, the marginal product of capital falls. The only thing that would offset this is an increase in people, L, or productivity, A. But those come from different processes, not from accumulating capital.
You can see the real-life diminishing marginal product of capital by looking at the “ghost cities” of China. Over the last several decades, China has built out massive cities for hundreds of thousands if not millions of people, but many of them remain empty.
These cities all represent a larger stock of K. But what are they contributing to GDP? Nothing. The marginal product of capital in these ghost cities is zero. Simply building more and more structures does not, by itself, ensure that more economic activity will take place. The Chinese government has lured some employers to these cities, but note that it is a company like Foxconn (who makes iPhones) which would already have been producing elsewhere. It is simply shuffling around existing economic activity, not necessarily adding new economic activity.
Third, these examples of Chinese capital growth are a good example of how we need to separate the effect of gross capital formation from the effect of capital on GDP. When a new structure is built, that is part of gross capital formation, and that is part of GDP in that year. But once that structure is built, it’s contribution to GDP depends on the economic activity that takes place in that structure. If you have a ghost city situation, that contribution is zero, and all that capital is producing nothing.
You can compare this to the situation of constructing a house (in China, in the US, wherever). When there is new construction of an apartment building, which would include a tear-down and rebuild, then this construction activity is part of gross capital formation and is directly a part of GDP that year. If the building cost 1,000,000 dollars to build in 2019, then that was 1,000,000 that was part of GDP in 2019. But in 2020, when the apartment building was complete, the contribution it made to GDP consists only of the rents that it earns from tenants. That might be 200,000 dollars, perhaps. Don’t confuse the value of the apartment building (one million-ish) with the flow of GDP. Same with the Chinese cities. Don’t confuse the value of the construction of those cities (millions and millions) with the flow of GDP from them (zero).
Last, the Chinese capital accumulation reminds us that economics is all about opportunity costs. What did the Chinese not do because they were building these cities? What did they not do because they were putting up a train station in 9 hours? Remember from the Solow model that gross capital formation requires us to spend some fraction of GDP, $s_I$, on new capital goods. That is a fraction of GDP that we cannot use for something else: healthcare, education, entertainment, food, clothing, TVs, cars, beer, doughnuts, etc. The cost of building out all this capital has been a sacrifice of consumption goods in the Chinese economy.
This could well be a worthwhile trade-off for China. Building up a big stock of capital today could produce a huge stream of GDP and ensuring high consumption levels in the future. It remains to be seen if this capital accumulation will do that.
And keep in mind that if in 2040 you are still seeing videos of Chinese construction projects taking 9 hours using 1000’s of workers, then something has gone wrong. The whole point of the capital accumulation is to raise worker productivity. If it still takes that many people to do these projects, then what was the point?
Capital accumulation is definitely part of the story of economic growth, but don’t jump to the conclusion that it is the only part of economic growth that matters.