Why a property crash could be good for China

Since China started tightening lending restrictions for property developers, to rein in debt, there have been headlines about impending doom for the real estate sector. We have since seen major Chinese developer Evergrande file for bankruptcy protection in the US while Country Garden, the country’s largest developer until last year, flirts with a default. Despite property prices across China struggling to recover, the day of reckoning has yet to come for the sector. However, participants and onlookers must ask whether there is any benefit to delaying a correction. China’s real estate sector accounts for 25-30 per cent of its economy, compared to just 15-18 per cent in the US. China’s massive investment has resulted in some 50 million empty flats, sold but unoccupied. What is surprising is that this surplus has not dampened prices further. In Shanghai, a city with a per capita gross domestic product of about US$25,000 last year, the average property price per square metre is US$18,400. In comparison, the average price in New York is just US$16,500, against a much higher GDP per capita of over US$100,000. This stark difference in housing affordability underscores the distortions and imbalances in China’s real estate market and its broader economy. Several domestic headwinds pose challenges to the Chinese economy. These include low consumption and a growing reliance on unproductive investments fuelled by a perilously high savings rate and an increasing debt burden. The challenges stem from what former premier Wen Jiabao labelled in 2007 as “unbalanced” growth. This results from the unequal distribution of income generated by GDP. Ordinary households, which should allocate most of their income to consumption rather than savings, retain too small a share of the national GDP. Meanwhile, businesses, local governments and wealthy households claim an oversized portion of GDP, leading to a significantly elevated rate of savings and investment. When real estate prices drop, wealth is transferred from those heavily invested in the sector – such as developers, local governments and wealthy households, particularly those with multiple properties – to those less involved, namely ordinary households and the younger generation. This occurs because, in China’s case, young people, less-affluent households and prospective first-time homebuyers would have a greater opportunity to buy property, increase their wealth and spend less income on rent. China needs to achieve more sustainable and balanced economic growth. One could argue that a real estate crash would benefit the country by redistributing wealth from entities in the real estate sector, local governments and rich households to ordinary families, thus helping to rebalance the economy. But what would such a crash in China look like? For one thing, it would not be China’s “Lehman moment”. The US and Chinese financial sectors cannot be compared. For starters, the Chinese government has significant control over banks, which mitigates concerns about moral hazards and makes it easier for the People’s Bank of China to ensure the solvency of the country’s banks. There would, however, be significant short-term disruptions to China’s real economy, given that its real estate sector and related activities account for a substantial portion of national GDP. Beijing would not be powerless to act but its response is likely to differ from that in other economic downturns. It should focus on demand-side stimulus and other measures to boost wages. This would enable households to allocate a larger portion of their income to consumption, thereby increasing consumption’s share of the economy. China’s consumer spending puzzle is missing a key piece But an emphasis on demand-side stimulus does not preclude the possibility of supply-side policies. In this, the government should support China’s service industries and hi-tech manufacturing. A growing service sector could absorb a rising number of university graduates, while an expanding hi-tech manufacturing sector would enhance national income and increase national security by reducing reliance on foreign technology. Before America’s Great Depression in the 1930s, the economy was extremely unbalanced. The economic depression, while devastating, had a greater impact on US GDP than on household incomes, which eventually led to corrections to this imbalance. The Chinese government possesses a broader set of tools. It can ensure that a property price drop does not result in the same level of economic pain, while still achieving income rebalancing. Anthony William Donald Anastasi is an American PhD candidate at the School of Politics and International Relations at East China Normal University