China's growth has been extremely reliant on investment in recent years. Investment as a share of gross domestic product (GDP) has risen above 50 percent, fueling the expansion of housing stock, local infrastructure and manufacturing capacity. The problem with this pattern of growth is that after some years excess capacity starts to build up and the return to further investment falls. The best evidence for these diminishing returns is the fact that while China's investment rate has been rising, its growth rate has been slowing—by more than three percentage points. It takes more and more investment to grow at a slower and slower rate.
For this reason, China's new leaders are trying to implement reforms that would rebalance the economy. On the supply side they aim to generate more innovation and productivity growth while reining in wasteful investment. On the demand side they would like to see increases in household income and consumption that would lead to a more sustainable balance between consumption and investment.
In Finance and Development I argue that this Sino-shift creates opportunities and challenges for other developing countries through three mechanisms.
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