A more detailed look at China’s economic performance in 2012 shows it tipped further off balance, relying more than ever on credit-fueled investment, a trend it had tried to rein in

May 22, 2013, 1:58 p.m. ET

China Tilts Back to Big Spending

By TOM ORLIK

BEIJING—A more detailed look at China’s economic performance in 2012 shows it tipped further off balance, relying more than ever on credit-fueled investment, a trend it had tried to rein in. A further tilt toward capital spending flies in the face of Beijing’s goals to shift to a consumption-driven economic model and threatens to add to a mounting debt problem, exacerbate industrial overcapacity that is dragging down profits, and produce more empty “ghost cities”. The share of fixed investment in China’s GDP rose to 46.1% in 2012, up from 45.6% in 2011, according to National Bureau of Statistics data, published by data provider CEIC. China’s headline GDP data have been available for some time, but the detailed breakdown between the shares of investment, consumption and exports has only been published this week.That data also shows the share of net exports at 2.7%, down from 8.8% in 2007, reflecting the transition from reliance on foreign demand to domestic investment to drive growth.

Meanwhile, the share of household consumption was flat at 35.7%. That figure is particularly disappointing as it comes after government efforts to rebalance growth more toward consumption, which is extraordinarily low by international standards. In 2011, this push appeared to be making some headway, with the share of household consumption in GDP edging up and fixed investment’s share staying flat.

But with growth slowing in 2012, a return to credit and investment to pump up the economy seems to have undone that modest progress.

“Rebalancing the economy is the essential challenge facing the Chinese government but they have not made any progress over the last year,” said Mark Williams, China economist at Capital Economics.

In the first four months of 2013, there were signs that the structure of the economy was moving in the wrong direction. Growth in disposable income for urban households slowed. In addition, a clampdown on official excess dented growth in retail sales. In both cases, the numbers pointed to weak consumption.

Economists say excess reliance on investment as a driver of growth is a key risk for the world’s second largest economy. China’s leaders have long pledged to expand consumption. “We need to focus on expanding domestic demand,” Li Keqiang said in 2011, before being promoted to premier. “The key to expanding domestic demand is increasing consumption”.

For the past decade, a combination of low wages, low interest rates for state-backed borrowers and an undervalued yuan has given businesses a boost and crimped income for households. The International Monetary Fund estimates that low interest rates have transferred around 4% of GDP a year from household savers to big corporations.

The result: Investment has careened higher while consumers have been starved of funds to spend at the shops. The investment share of China’s GDP is substantially higher than in other Asian tigers during their periods of rapid industrialization. By comparison, Korea’s share of investment peaked at 40.1% in 1991, according to the IMF.

The signs of excess investment are evident in China’s steel sector, where overcapacity has futures prices on the Shanghai exchange near record lows. “Even if demand rebounds, the industry won’t recover completely as long as China doesn’t take real actions on overcapacity,” said an official with Anshan Iron & Steel Corp., one of China’s largest steel mills.

In the real-estate sector, excess investment has poured in, with ghost towns of unsold property springing up around the country. There are currently 3.7 billion square meters of property under construction in China, according to the NBS, enough to satisfy demand for almost four years without starting a single new property.

The consequences are clear in slowing growth, mounting debt and reduced corporate profitability. China’s GDP decelerated to 7.8% growth in 2012, down from 9.3% in 2011 and the slowest since 1999. As firms and local governments turned to borrowing to finance investment, the ratio of household, corporate and local government debt to GDP has ballooned from around 123% of GDP in 2008 to about 180% in 2012, according to WSJ calculations. Industrial profits contracted for much of 2012, a reflection of overcapacity denting pricing power.

China’s leaders have made boosting domestic consumption a priority. Private-sector wages rose 14% in 2012, outpacing the economic growth rate as the central government encouraged aggressive increases in minimum wage and changed labor regulations in favor of workers. The government has also loosened control on interest rates, boosting the income of household savers. A stronger yuan has reduced export competitiveness, discouraging investment in low-end manufacturing.

Now, despite those efforts the trend toward consumerism playing a larger role appears to have stalled. “A rapid rebound in infrastructure construction in the second half of last year probably was the major reason for the increasing share of investment,” said Zhiwei Zhang, China economist at Nomura.

Some analysts cautioned that the shift away from investment would take time to materialize. “Investment has already slowed to around the same growth rate as the rest of the economy,” said Dragonomics China analyst Andrew Batson. “Investment growth will keep slowing, but the government wants to avoid a sharp slowdown that would lead to a collapse in overall growth.”