China will slow

In this week’s China post. I want to direct readers to some interesting recent reports on the Chinese economy.

The first report, entitled China’s Empty Apartments, is a fascinating two-part series of posts on China’s housing market, written by freelance writer Michael Gsovski, who is a New Yorker that recently spent a year living in Kunming China. The posts are from the China Beat blog. Part I is called “How the real estate market got stir-fried” and part II is called “What happens when the party ends?“.

I cannot recommend these articles enough. But for the time poor, here are the key extracts:

Southeast of Kunming, a new city has risen from the earth, so new that it is literally called the “Chenggong New Area.” Giant complexes of towering, modern apartment buildings line the wide, recently built streets, broken every few kilometers by parks as large and as well-designed as any in Kunming proper. Every block of apartment buildings has a police sub-station, and some have functioning schools. Along the recently constructed highways linking the new city to the old, it seems as if farmland has been transformed into a high-rise commuter suburb like those on the outskirts of Hong Kong and Tokyo in less than a decade.

But something is off. Traffic passes through at a languid one to two cars a minute, about one tenth the rate of less densely built urban districts in Kunming. Unlike residential neighborhoods in most Chinese cities, no clothing stores or noodle shops are open for business. Instead, the vast majority of operating storefronts are either real estate offices or furniture stores, and their keepers only report an average of one or two paying customers a week. Most strikingly, the expected throngs of pensioners practicing tai chi and dance in the parks are nowhere to be seen.

A closer inspection explains this eerie quiet. In almost every building, anywhere from ten to sixty percent of the windows lack curtains or any other visible signs of habitation. Chenggong is a fully built city that lies half-empty. It is a modern ghost town. Yet, there are practically no “for sale” signs. The town is both fully built and fully sold.

Similar reports are coming in from all over China…

All this begs the question: in a rapidly growing nation where Yao believes 140 million urban housing units are serving 200 million urban households, how can so many high-quality apartments be built and sold, but then left unoccupied?…

Buyers pay more than the market value, while the people living on the land receive less, with the surplus going to local governments. If there is a problem with the government, the courts will be of no help because the judges owe their jobs to the same local officials who depend on that money. Real estate companies therefore are composed mainly of individuals well versed in negotiating with the government but with little skill and even less interest in building housing that fulfills the needs of the average person.

Mr. He has himself invested in an apartment in Chenggong, not in spite of this government interference, but because of it.

“The government wants to increase their revenue, so they have to make sure the price of land increases constantly,” He said. “Under these conditions everyone must choose to invest in real estate.”

This is the “stir-fried apartment,” a phrase that describes apartments bought by wealthy individuals as investments, yet left empty because nobody they know is willing to pay the high rents. Many buyers understand that the market for apartments does not conform to consumer demand, but invest anyway, for two reasons. First, they need a place to store savings outside either the sclerotic banking system, which delivers returns far below the rate of inflation, or the Chinese stock market, which is notoriously volatile.

Second, they are confident that local governments will continue to drive land prices upwards as a way to raise land lease revenues.

Since only the government can own land, all individuals or corporations seeking to build on it have to pay fees to the authorities. In the absence of a real estate tax, these fees constitute the sole way for local governments to make money off real estate development. According to a report by Caixin magazine, they account for an average of 46 percent of all local government revenues…

The question almost asks itself: Is the Chinese government doing anything about this?

To go by public statements, it is. Beginning in 2010, numerous price control measures were issued against property speculation and the central bank raised reserve requirements and interest rates to rein in investment. In addition, local governments were required to construct millions of additional low-cost housing units to relieve pent-up demand for them, requirements that have only been expanded for future years.

However, economists like Tsinghua University’s Patrick Chovanec are doubtful that local officials are going to comply with the central government policies to slow the pace of development due to the financial incentives they face to continue encouraging high levels of construction.

“They have every incentive to just say, ‘well, our real estate market is very sound,’” Chovanec said. “Because the alternative would be to pull the plug on growth and that would be committing professional suicide.”

Kunming-based commercial real estate developer Zhang Hanqing (name changed) agreed with this belief that local politicians will not be willing to reduce the cost of real estate. As an example, Zhang brought up the fact that for him leasing 1 mu (1/6th of an acre) of land in Kunming costs anywhere from 1 million RMB to 5 million RMB in payments to the government.

When asked if it was possible that the government would reduce the rate of new construction, Zhang was unequivocal.

“Personally, I think it is impossible,” he said. “The local government’s income is land income. The more land they sell, the more money they get. It’s difficult to say how much they can reduce it even if they have to.”

Additionally, there is the common off-the-books patronage that real estate companies are required to give their government contacts for permission to build. According to Hanqing’s son, Zhang Yun (name changed), his father’s associates in residential real estate have had frequent experiences with government officials who demand massive discounts on investment-grade apartments before approving deals.

“If he is the [real-estate] authority, he visits the real estate company,” the younger Zhang said. “The real estate company then has to give him a set of apartments that have no profit or even a slight loss.”…

To make matters worse, Northwestern University political science professor Victor Shih said his research indicates that low-cost housing is not being constructed at nearly the rate that the central government wants, due to the reluctance of local governments to use land for less than maximum profit…

Property analyst Roselea Yao agreed that the affordable housing numbers are being greatly exaggerated to calm citizen concerns about rising prices. She doubted Vice Premier Li Keqiang’s claim in November 2010, that 5.8 million million units of affordable housing were under construction, and that half of those would be completed by the end of that year.

“I would give them a pretty heavy discount on those 5.8 million units,” she said. “Probably something like half. And for completions, I think even lower, like 20 to 30 percent.”.

Shih said that government’s response had been tepid because he did not think the government was truly worried about the prospect of popular resentment over inflation and corruption in the housing market. He cited the government’s heavy investment in censorship and policing—which for 2011 exceeded official spending on the military—saying that as a result, officials did not believe themselves vulnerable to popular protests, only to the interest groups that Kunming lawyer He Haojun had cited as being influential in society: the wealthy and the developers.

“They believe in their coercive capacity,” Shih said. “The government isn’t elected, so why should they care? They have to care about the interests of a small number of elite, including real estate developers. So as long as the developers don’t face a declining real estate market, they’re able to sell the real estate and the local government is able to sell the land, it’s fine for now.”…

Shih said he believes that the bubble in real estate threatens to have more wide-ranging effects in the long term. For if land values are currently overpriced and therefore fall in the future, the value of all loans backed with land as collateral would be called into question, and many, extended hastily in the wake of the financial crisis to prop up the economy, would not be repaid. After a year’s research, Shih concluded that excessive lending had led to 11 trillion RMB in debts assumed not only by local governments, but also by the local investment companies established by them.

“If the land value plummets, many local governments will not be able to repay these loans, and the banking system is in big trouble,” he said…

According to academics like Shih, the party will have to end sometime. “There’s no such thing as a real estate boom that goes up forever, anytime in the world,” Shih said. “And this will not be an exception.”

The second report is entitled: China’s S-Curve Trajectory: Structural factors will likely slow the growth of China’s economy and comprehensive national power (h/t Bernard Hickey).

This is an incredibly detailed report covering many facets of China’s political economy. Below are some key extracts:

China is likely to follow an S-Curve-shaped path of slowing growth as key internal and external challenges—including pollution, corruption,chronic diseases, water shortages, growing internal security spending, and an aging population—feed off of one another and exact increasingly large costs…

Demographic Issues:

China will start aging to such a degree as to call any straight-line projections of its economic growth and other national power trends into serious doubt.

As demographer Nicholas Eberstadt relates, “China has been a sub-replacement society for perhaps twenty years [with a] current net replacement rate (NRR) [of] just 0.77, and some authoritative estimates suggest that it could be even lower than this.”China’s population of young male manpower (ages 15-24) has already begun to decline.Its total working age population is poised to start decreasing in 2015. This trend is exacerbated by traditions of early retirement, e.g. in clerical jobs, particularly for female workers. Already, the proportion of older, sicker, and less educated workers is starting to rise.

These trends threaten the core of China’s current labor-intensive growth model, which is built on manufacturing conducted by large numbers of extremely low-salaried workers. While China’s technological capabilities have improved in many respects, it has not yet succeeded in moving far up the added value chain. For the first time since China’s economic boom started in the 1980s, large numbers of factories in the industrial heartland of Guangdong’s Pearl River Delta have closed and others have struggled to find workers even after raising wages significantly…

“By any yardstick one cares to select,” explains Eberstadt, “Chinese society overall will be graying at a tremendously rapid, and indeed almost historically unprecedented, pace over the next generation.”] By 2040, “China’s projected proportion of senior citizens 65 years and older would be far higher than that of the United States or Europe today—indeed, possibly higher than any level yet recorded for a national population. In urban China, fertility today is extraordinarily low, with TFRs [Total Fertility Rates] averaging perhaps 1.2 and TFRs of barely 1.0 in the largest metropolitan areas such as Beijing, Shanghai, and Tianjin.” Meanwhile, albeit in part because of an exodus of young workers to cities, China’s countryside—envisioned to be the location of China’s next wave of low-cost growth to reduce inequality—is graying even more rapidly than its cities…

Chronic health and pollution:

China faces growing internal challenges from regional income disparities and rising incidences of chronic health problems such as cancer and diabetes that will require very significant financial resources to address while still trying to maintain economic growth. These health challenges are exacerbated by the rapid aging of Chinese society described above. World Bank studies have estimated that air pollution caused damages that could be worth as much as 4.6% of China’s GDP in 1995 and nearly 4% in 2003, while a recent MIT study estimates that the damages may have been as much as 6% of GDP in 2005.[22] Water pollution is also a serious problem. The bottom line is pollution has likely kept China from producing at its full economic potential…

Debt-fuelled growth:

Chinese economic growth has relied heavily in recent years on fixed asset investment in roads, rails, bridges, and airports, among other things. To finance these projects, many local governments took out bank loans, creating a local government debt burden that China’s National Audit Office estimates to be worth US$1.65 trillion, or roughly 27% of China’s 2010 GDP. The People’s Bank of China has estimated that the real figure could be closer to US$2.1 trillion, according to Minxin Pei.

Pei’s work points out that many of the local infrastructure projects are highly leveraged, meaning that the borrowers are likely to face substantial debt service costs. This will be a major problem if Pei’s analysis holds true, as he cites a local banking regulator as claiming that only 1/3 of the investment projects will produce cash flows large enough to cover their debt service burden.

Beijing’s decision to increase interest rates as it fights inflation may help slow the pace of debt accumulation in China, but with the existing burden, if China’s growth slows—driven by the factors we discuss, or possibly others—non-performing loans could quickly become a major problem. In turn, the diversion of state financial assets to resolve bad debt problems would exact opportunity costs by keeping the money from being used for more productive purposes.

Fixed Asset Malinventment:

China’s rapid buildout of roads, rails, ports, airports and other physical infrastructure in the past several decades has been amazing in terms of its speed and scale. However, events such as the tragic July 2011 high speed train crash near Wenzhou raise three very important questions:

1.  What is the quality of this shiny and quickly-built new infrastructure?

2.  Are there large hidden future costs of having to demolish and rebuild infrastructure that was built for speed and sparkle rather than quality and safety?

3.  Will China be able to bear the longer-term costs of maintaining it in good, safe, working order?

With proper supervision, Chinese construction firms can build world-class infrastructure at competitive prices. However, in practice, the potent cocktail of politically-induced time pressure, corruption, and a safety culture that remains lax for a country with China’s aspirations have combined to yield an infrastructure base that far too often literally kills.

Examples in recent years include the increased death toll in the 2008 Sichuan earthquake due to shoddy buildings constructed by corrupt contractors who cut corners to pocket the difference between the cost of high and low quality materials; and the July 2011 Wenzhou train crash, which killed 40 people when lightning allegedly stopped a bullet train that was then rear ended by another. In contrast, Japan, which has operated its bullet train system for decades through major earthquakes and other events, has only experienced one fatal accident (when a passenger was caught in a door).A key difference is that Japan spent the time and resources required, not only to build in both physical safety features (“hardware”) but also to train operators (“software”) to a very high standard…

Implications for commodity exporters:

Disruptions to China’s growth would hit mineral exporting countries particularly hard, as demand for iron ore, copper, oil, soybeans, machinery, and other good and resources has come to drive much of the economic growth enjoyed by Brazil, Chile, Russia, Australia, Indonesia, and other resource producers…

On the microeconomic level, companies—particularly in the natural resources sector—are making multibillion dollar investments predicated on assumptions of strong Chinese growth for decades to come. Lower economic growth rates in China would still produce substantial annual increases in mineral demand due to the country’s massive economy, but a mining firm that uses 7-8% Chinese growth as a base case for developing a project could face difficulties if the longer-term growth rate turns out to be ‘only’ 4% per year.

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Leith van Onselen


  1. The Chinese construction boom is the cause for Australia’s mining boom. Not Asia’s demand for our resources. So much for the RBA and the treasury allowing the destruction of every non mining related sector in Australia to make way for the supposed Boom Mark 2.

  2. I hadn’t thought of that – due to the one child policy their demographics are going to be staggering in the future. How can you be the dominant economic superpower when you have to support a half billion old retirees?

  3. I’m sure you’ve all heard of the ‘Tulip Mania’ that overcame the Netherlands in the 17th century. To quote Wikepedia “At the peak of tulip mania, in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman”

    This goes to show that:
    1) The human race never changes
    2) It’s still in the late mid stage in China, but it’s already irreversible.

    To quote from Apocalypse Now – Keep your heads down, it’s gonna be a big one…

    • And what is taking place is little different from the property driven credit/consumption fever that recently afflicted many developed economies – including ourselves.

      • While I agree we’ve seen property prices soar due largely to the availability of credit (and increased debt fueled consumption due to the wealth effect), I think what is happening in China is an order of magnitude more serious. The fact that:
        1) negative real interest rates have forced virtually everyone with any earning capacity to speculate to try to save;
        2) no-one can pay the rent on any of these (64 million so far) empty apartments so borrowers are under increasing pressure; and that
        3) huge interest rates are now being imposed by shadow banks (almost certainly with the connivance of CP officials)
        means the social fallout will be far greater than that Australia will feel (though I do sympathise with first home owners trapped by reckless FHOG policies etc). Add food price inflation to the mix and now what for China’s citizens?

        • Cant remeber where i saw it but with the new female leader of Thailand in place, one of her policies was to increase wages for the people of Thailand. One way she is doing this is by increasing the price of a tone of rice exported to countries in asia. The price they used to sell was 9999 thai per tone but the minimum will now be 15,000 thai. Thailand being the biggest exporter of rice in Asia means more pressure’s on inflation in China.

        • I was being little general! On the basis that we have had a credit boom and as a result are now heavily indebted and softening economic conditions may result in a growing number unable to pay, most of our debt foreign sourced, potential pressure on our banks – which in a worst case scenario may lead to the government stepping in.

          “Huge interest rates by shadow lenders” – yesterday there was a post indicating that these interest rates were around 24% – yes high, akin to Australian credit card rates and nothing on Wells Fargo payday rate of 120%. I think inflation the greater immediate risk in terms of social cohesion. Curious that when the Chinese government tightens to limit inflation growth, which experts advise, the barrage of China critics point to the slightest slowdown as imminent collapse.

          Chinese debts are largely domestic, the Chinese government may well implement unconventional solutions. Who knows?

  4. On the issue of S curves, investment booms and the like.

    China’s FAI per capita – even at near 50% of GDP – remains one of the lowest in the world, even adjusted for GDP per capita. On the banking / governnment debt issues, China has been here before and “muddled through”. Why should we think this won’t happen again?

    Also, on China’s demographics/labour force issues. 3 points:

    1. Easing of the 1 child policy is being trialled in a number of cities now.

    2. If you’ve been to China you understand that prospective labour productivity growth is massive over coming decades, and

    3. Low value manufacturing IS heading west and continuing to capture cheap labour input (ie: rural workers don’t need to migrate to the coast, the industry is migrating to them…). The car factory I visited in April had NO robots on the line…and paid workers USD 2500 per annum (roughly). Again, prospective labour productivity improvements are ENORMOUS…and will require huge capital deepening even from here over coming decades.

    • China’s FAI per capita – even at near 50% of GDP – remains one of the lowest in the world, even adjusted for GDP per capita.

      That sentence makes no sense. If its adjusted for GDP per capita, then China is spending half its GDP on investment.

      Even on a nominal basis China is spending more than the US, an economy almost three times the size.

      50% of China’s $6 trillion GDP is $3 trillion.
      17% of the US’s $15 trillion is $2.72 trillion.

      On a PPP basis, China’s FAI would dwarf that of the US.

      Basically, you’re talking nonsense.

  5. This is a bit of a niggle, but I just want to take issue with the start of the quoted passage:

    ‘Southeast of Kunming, a new city has risen from the earth, so new that it is literally called the “Chenggong New Area.”’

    Regarding “Chenggong New Area”, this naming convention is very common in China & Japan (because Japan borrowed their written pictographic language from China).

    To wit: Take for example Shin-Osaka & Shin-Kobe stations in Japan. These names literally mean ‘New-Osaka’ and ‘New-Kobe’ station. That’s not a reflection on their ‘newness’ or otherwise, it’s just how naming conventions work there.

    I think either the author of the quoted blog has presented the name “Chenggong New Area” in a deliberately disingenuous way, or he doesn’t really understand the culture he’s commenting on all that well. Either explanation leaves me discouting the article’s analysis somewhat.

  6. Given what we know about the LAST “Asian Crisis” and the role of urban land price inflation in it, WHY is ANYBODY making their plans for the future around the assumption “China will anchor the Australian/ regional/ world economy”?

    • people have short memories

      “we are different”

      “this time its different”

      we are “moving forward”

  7. Great article Leith. I have just sent the link to my friend who is in China now. He has set up a small engineering factory with a Chinese family as his family’s engineering business started 40 years ago in Sydney has shut down due to cheap Chinese competition. He is in the Ningbo area and sees the empty kilometres of residential units that were not there 18 months ago.
    BTW, can I ask a question about the American economist Harry Dent and his views, on the world economy….do you have an opinion on his outlook?

    • Dent has a few tricks of predictive analysis that others have not had. There is something in it.

      My own hobby horse, is that the behavior of urban land markets is “THE” major tool for predictive analysis, yet it is ignored by most economists. Harry Dent does not seem to be any exception.

      I think tacking the “demographic spending patterns” analyses of Dent, onto the “Geo-Austrian cycle” analyses of Fred Foldvary, might just be a useful refinement of analysis. I believe that analysis needs to start from “property cycle analyis” as Foldvary does, and then add other refinements from there.

      Foldvary adds Austrian monetary cycle analysis to property cycle analysis, and gets the most stunningly accurate results, even without adding the demographic spending pattern refinements of Dent. Doing this would be well worth considering, though, I think.

  8. Someday China will slow. Maybe tomorrow. Maybe in 2030. Since the identical headline (always welcome in the Western, anti-government press) has been run many times over the past 30 years, we must conclude that nobody knows.
    The principal misunderstanding underlying such predictions is that China is a congerie of capitalist fiefdoms whose overlords bribe the government in order to squeeze out one more quarterly profit (and consequent bonuses for its generals).
    But China is nothing like that and has never been–except during times of civil unrest.
    China is a unitary state. ALL of its resources are at the call of it’s leaders, all the time: banks, army, insurance companies, industries and even the 88% of its citizens, who trustmand admire their government.
    The leaders, 8 remarkably honest engineers (are engineers more honest than the rest of us?) meet every day to reallocate resources. Supported by hundreds of statisticians (a Chinese strength for over 1,000 years) they make adjustments to keep the country on track today, five years hence, and fifty years into the future.
    It’s not rocket science. Any country could do it. But such rationality is anathema to our warlords, who continue tearing their countries apart.