China Center Chart of the Week: China’s falling returns on capital will cause slower growth or higher leverage (or both)

This chart shows The Conference Board’s estimation of the Marginal Product of Capital (MPK) for various countries, broken into two groups: lower income and higher income. MPK refers to the amount of output created from one additional unit of capital to a country’s capital stock (assuming the contribution of labor is constant). In the macro sense, the MPK measure is a proxy for an economy’s aggregate real return on new investment. The chart illuminates several things about China’s MPK: 1) It has fallen rapidly in recent years; 2) China’s MPK is significantly below that of countries in its income peer group; and 3) the overall return on capital compares to the levels seen in advanced countries, which is abnormal as emerging markets tend to exhibit higher MPKs. Taken together, these observations suggest that more investment is required to achieve the same rate of output growth, which may not be sustainable.

This China Center members-only snapshot shows that investment needs to slow down or capital efficiency needs to rapidly rise (through innovation or productivity enhancement). Otherwise, the economy risks becoming overly indebted, which would suppress long-term growth potential even further. Please download the full document for more details.