I have to confess to some frustration with some of the recent commentary on China coming from academic economists. Usually I value the perspectives from the academy as helping draw some needed attention to longer-term issues and away from the short-term noise that dominates the media and financial-market debates. But I think on China there is a tendency for some people to look past “simple” issues like the business cycle and housing in favor of discussing only complicated structural issues. Again, usually I’m all in favor of complex, historically nuanced explanations–but you can go too far with this stuff. Sometimes it’s really not that complicated.
Exhibit A is a survey of “top UK-based macroeconomists” about their expectations for China’s future growth. Many of the economists surveyed expect China’s GDP growth to be lower than 6% for several years, I view I agree with. The survey also asked for economists to give the reasons why they expect this slower growth, and here is what they came up with: “less space for catch-up growth,” “adverse demographic dynamics,” “problems in the financial sector,” “diminishing flows of rural-urban migrants,” “the ‘intentional’ rebalancing from high-growth industry to moderate-growth services,” “risks from ‘secular stagnation’ in developed economies.”
Exhibit B is a recent piece by Jeffrey Frankel, in which he lists no fewer than six economic forces behind China’s slowdown. Like the respondents to the UK survey, he also cites less space for catch-up growth, adverse demographic dynamics, diminishing flows of rural-urban migrants, and the rebalancing to services, while adding “diminishing return to capital” to the list (he leaves off secular stagnation in developed economies).
What I found amazing about these analyses is that they fail to even mention the most straightforward and direct explanation of why China’s growth is much slower today than it was in say, 2010 or 2007. It’s not like it’s a secret. From about 2003 to about 2010 China had the biggest construction boom of modern times and probably in all of human history. Then in 2011-12 the construction boom ended. That’s it. Really, that’s all you need to know. Well, you might need one more fact: housing and construction account for as much of a third of China’s GDP, once all their indirect linkages to other sectors are considered. I think a housing downturn explains very well the timing, severity and distribution of the economic slowdown that has actually occurred.
The long-term structural explanations favored by many academic economists–like the “middle-income trap,” demographics, etc–by contrast simply do not explain what China has been going through over the past few years. It’s possible that the diminishing return on capital argument is intended as a fancy way of accounting for the obvious downturn in housing investment. But here I have to agree with Michael Pettis when he says that “the deceleration in Chinese growth moreover has been far too rapid to be explained by any normal decline in marginal returns on capital as investment rises.”
As I have previously argued on this blog, the regional pattern of the slowdown is in fact very important. If China were really falling victim to the exhaustion of catch-up growth potential, then it would be experiencing a gradual slowdown, and the provinces slowing down would be those who had caught up the most. And this is not true; the high-income provinces are doing well while low-income provinces are hurting.
I have never really believed in the idea of the middle-income trap, and I increasingly feel that it is actually counter-productive in current discussions about China. If you think China is succumbing to the middle-income trap (in any of the various manifestations mentioned above) then you think China’s problems are complex and long-term in nature, and the proper response is a set of carefully calibrated structural and institutional reforms. If growth ends up worse than expected, you put the blame on the government for not taking the right policy prescriptions.
But if you agree with me that China is experiencing a lengthy downturn in housing construction that followed a lengthy boom in housing construction, then current rates of GDP growth are not primarily the result of the government’s failure to do structural reforms. That’s not to say structural reforms are not important–I do think the government should be liberalizing service sectors and taking other measures to improve the growth potential of the economy. The benefits of those reforms will however only show up further down the line, once the cyclical pressures from the downturn in housing have let up somewhat. None of the various structural reforms being debated today will do anything to change the fact that in the near term, China does not need to build a lot more housing. And that therefore business for companies related to housing construction (and there’s lots of those) will be poor.
According to Standard Chartered, housing and construction account for about half of China’s GDP slowdown. So housing is the most important explanation but not the only one (see report, November 2015: https://www.sc.com/BeyondBorders/wp-content/uploads/2015/11/2015-11-XX-BeyondBorders-Report-Asian-housing-Ride-the-cycle-Final.pdf)
China is also under reporting its GDP. They don’t use the same methodology to tally up their economy as others.
The above Rhodium CSIS report posits, China’s GDP is 10% bigger than officially stated.
Isn’t the previous housing boom a form of catch up growth? Wouldn’t this imply that the slowing down of the housing boom is a reduction in the potential for catch up growth?
After all, most industrialized countries don’t have such a high percent of GDP in housing…
That’s an excellent question, thank you. We could indeed view modern housing as one kind of “technology” that is diffusing through the Chinese economy, in the same way that 4G mobile phones or automobiles or the limited liability company have been. In fact in the research produced by my firm, this is exactly how we analyze Chinese housing.
If you were able to somehow sum all the diffusion curves of all these various technologies, you would be able to see how far China along had progressed in its adoption of global technologies and how far its “catch-up” growth had left to go. We can’t really do that of course, so people end up looking at per capita GDP etc instead as a measure of catch-up potential. And since the change in relative per capita GDP in any given year is not that great, catch-up potential changes only very gradually. So my issue with the argument that the current slowdown is all about “less space for catch up growth” is not that it’s wrong exactly, but that it’s not very helpful. At any time in the last 10 or 20 years (or 20) you could say that China’s potential for future catch-up growth is lower than it was in the past (simply because China has been growing) and therefore that future growth is likely to be slower. This is of course true but it also doesn’t explain very much–if we want to explain why China is slowing down now, why some industries are slowing more than others, why some regions are slowing more than others, then the generic “less space for catch up growth” does not in fact answer these questions. What I’m trying to say here is that “less space for future housing development” is a better and more specific explanation. I hope that makes sense.
I confess I did not really understand the suggestion from another commenter that if China had floated its currency and undertaken political reform that people would be buying more housing than they are now. I don’t think that’s how it would work out.
Why can’t Chinese construction be falling because they’ve entered the middle income trap, limited by their current oft-deplorable institutions? If they were floating their currency and embarking on a series of political reforms to bring them in line with South Korea and Taiwan, continued >5% real growth would be a lot more plausible. Unfortunately (particularly for the Chinese citizenry) they seem to be imposing more capital controls and cracking down on dissidents.
The regional argument is unpersuasive because it relies on official RGDP data (which is not even comparable year-over-year according to its source) and an uncertain model.
Right now the best description of the Chinese economy seems to be inscrutable.
Ireland fell over when Housing Construction surpassed 25% of GNP. Good Luck to China.
Andrew what is your thoughts about current housing boom in China? It seems like the government is trying to prop up the economy by encouraging housing demand.
Yes, I think that’s exactly right. Real estate as a sector is sensitive to interest rates and credit, and so cuts in interest rates and a dramatic expansion of mortgage lending are having a significant effect on property sales and investment. It’s interesting, though not very encouraging, that investment outside of real estate has hardly responded at all to lower rates and faster credit growth. It’s also significant I think that the biggest increases in property prices have been in fairly small number of markets, and that the bounce in property investment has been very modest; it seems like a lot of the new money is bidding up prices of existing assets rather than leading to new construction. So I think China can get some cyclical boost from housing this year, but I still think housing is over as a major economic growth driver.
I wonder how much of the excess capacity and ghost apartments have been consumed during the housing boom. Like you said, the majority of the gain has been in T1 megalopolises. Did this trickle down to the T3/4 cities with large inventories?