Capital allocation efficiency has deteriorated in recent years
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A significant common problem: Inefficient allocation of Capital
The two systems, despite their differences, share a significant problem: a majority of funding flows to the economy’s less productive parts, thus making investments less efficient and productive and imposing huge economic costs.
In China, the companies that IPO are often those that can rather than those that should. The majority of China’s quoted companies, including the lar ge caps, are not fully-private companies. They are State-Owned Enterprises (SOEs). Although contributing only one-third of China’s GDP, they still controls much of the country’s capital.
These companies have long enjoyed some significant advantages over purely private-sector companies, including most importantly preferential access to loans from state-owned banks, and an easier path to IPO.
Clearly state-owned enterprises are major cause of inefficiency. Their poor performance has been caused, at least to some extent, by the government to achieve certain social policy goals, but it has also been due to their lack of flexibility caused by extensive government interventions in their economic management. The inefficiencies have lead to low-profits and escalating debts, and this has led to further government interventions to prop the poor firms up by transferring resources from the better performing firms to the bad firms. The SOEs also receive preferential treatment in various forms by the government and are often protected from competition. There is a large spread in returns between the performance of the small number of state firms that do well and the bulk of them that do very poorly.
Another reason of misallocation has been government interventions in economic activities and coincident corruption. The growth-promoting policy initiated by the central government has been interpreted at the local level as growth at any cost. Achievement projects and image projects have run rampant as local governments competed for a nominal share of increased GDP. There has then emerged what Hunt calls China’s trilogy of local company, local government, and local bank. Each has a vested interest in building whatever plant is in vogue, whether a steel mill, power station, air-conditioner factory, copper-tube plant, whatever. Very often these plants have been financed by zero-cost capital, with corrupted officials benefiting financially in the process.
Efficient capital allocation is not a particular strongpoint of India.
On average we find that the elasticity of capital in India is about 0.20, which suggests a weak capital market and significant adjustment costs.
By comparison, corresponding estimates for the US is close to one and for China close to 0.5.
Furthermore, there was no general improvement in capital allocation since 1991 when gradual reforms were initiated. However, the industry variation and ownership matter for capital allocation. For example, institutional investors appear to improve
allocation whereas bank ownership reduces the elasticity of capital. But in economic terms these effects are relatively small. All in all, further improvements in capital allocation need to come from further deregulation.。
