The economic threats of the Chinese real estate bubble

How serious is the threat to the Chinese economy for the difficulties of Evergrande, the most indebted real estate company in the world, and now Fantasia, Become? The answer is not that China will experience a catastrophic financial crisis. On the contrary, the economy’s dependence on the demand for real estate investments must end. It imposes major adjustments and creates a major headache for the authorities: what to replace real estate investment with to generate demand?

From a macroeconomic point of view, the most important fact about the Chinese economy is its extraordinary savings. In 2010, it reached 50% of gross domestic product. Since then, it has dropped a bit. However, it was 44% of GDP in 2019. Household savings are very high, with an average of 38% of disposable income between 2010 and 2019, representing just under half of all this savings. The remainder is mainly made up of the company’s retained earnings.

If the economy does not collapse, investment and net exports must match savings if the economy operates close to potential output. Since the global financial crisis, net exports represent a small percentage of GDP and the world will no longer accept. The average fixed investment from 2010 to 2019 was around 43% of GDP. Surprisingly, it was 5 percentage points higher than between 2000 and 2010. On the other hand, the growth rate has declined considerably. This combination of high investment and low growth shows a significant drop in return on investment (directly illustrated by the rise in “incremental productivity of capital”). (See table.)

However, there is an even bigger problem than it suggests. First, large investments are associated with large increases in debt, especially in the household and non-financial corporate sectors. The first rose from 26% to 61% of GDP in the first quarter of 2010-2021, while the second rose from 118% to 159%. Second, a significant portion of that investment is wasted. Xi Jinping himself spoke of the need to shift to “pursuing real growth rather than increasing GDP growth.” That must be a big part of what he meant.

This combination of high and unproductive investments and peaks in debt is closely linked to the size and rapid growth of the real estate industry. 2020 article by Kenneth Rogoff and Yuan Chen Yang The Chinese real estate sector claims to represent 29% of GDP in 2016. In high-income countries Only Spain before 2009 reached this level. Additionally, nearly 80% of that impact comes from investment, and about a third of China’s very high investment is in real estate.

Many strong indicators show that this investment is driven by unsustainable prices and excessive leverage, creating huge overcapacity. The price / income ratio in Beijing, Shanghai and Shenzhen is much higher than in other major cities in the world. Real estate represented 78% of China’s total wealth in 2017, compared to 35% in the United States. The household debt ratio is equivalent to that of high-income countries. Vacancy measures and other excess capacity are high. In 2017, home ownership reached 93%. In addition, family formation is slowing down, the Chinese population is aging, 60% of which is already urbanized. All of this indicates that the real estate boom must end.

The government controls the Chinese financial system, which can prevent a financial crisis. House prices can fall sharply, which can have a significant negative impact on household wealth and spending, but it can be avoided. The most likely threat is the collapse in real estate investment. This has a major negative impact on the finances of local communities. Most importantly, it will leave a big gap in demand. “A 20% drop in real estate activity could lead to a 5-10% drop in GDP without taking into account the amplification of the banking crisis and the importance of real estate as collateral,” said Rogoff and Yang. Insist. It might be worse.

Between 2012 and 2019, investments contributed 40% of the growth in Chinese demand. If investment in real estate collapses, it will leave a great shortage. However, tolerating this painful adjustment is ultimately desirable. This should improve the well-being of the population: after all, building unnecessary goods is a waste of resources. The slowdown in the pace of recent real estate investments is also a natural consequence. “Three red lines For real estate developers imposed by the state last year. ”: Strict restrictions on a company’s debt ratio, debt ratio and short-term debt ratio.

The main current policy is to redirect spending towards consumption and away from the most wasted investments. This will require a redistribution of income to households, especially poor households, and an increase in public consumption. Such changes are also part of recent attacks on Otomi’s privileges. It will also require major reforms, especially in the structure of taxation and public spending. In addition, investments must shift from real estate to high carbon emissions. This too will require major political changes.

The crisis is also an opportunity. The Chinese government is well aware that the great boom in real estate investment is far beyond its reasonable limits. The economy needs a driving force for various demands. The country is still relatively poor, so a long-term economic slowdown like Japan is not necessary, especially given the room for improvement in the quality of growth. But a model based on wasted investments is coming to an end. Must be replaced.

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