Here is one of the best papers on the Chinese economy I’ve read in a long time–and I read a lot of papers on the Chinese economy. Currently in draft, “A Rebalancing Chinese Economy: Challenges and International Implications” is a systematic explanation of most of the big macro questions about China. The authors are Guonan Ma, an eminent Chinese economist recently retired from the BIS, and Ivan Roberts and Gerard Kelly of the Reserve Bank of Australia.
While there’s a lot to digest in this paper, for this post I want to pull out some of the thoughts about housing. I ranted a while back about how academic economists were ignoring the role of the housing market in driving economic developments in China. This paper by contrast puts housing front and center, and very effectively too. From the conclusion:
We find that conventional analysis understates the role of the household sector in contributing to the high investment share of the economy. Our explanation for the imbalances emphasises the role played by housing market deregulation as one of multiple prolonged positive productivity and demand shocks to the Chinese economy that simultaneously sustained returns to capital, lifted investment and boosted both private and public saving. While recent discussions stress the need to reform financial markets to foster rebalancing, we argue that rebalancing will probably happen anyway as a natural outcome of dwindling income windfalls from worsening demographics, fading positive productivity shocks and maturing housing markets, all of which helped drive the imbalances in the first place.
And some more details from the body of the piece:
The role played by the deregulation of housing markets in China deserves special emphasis. In 1988, the Chinese constitution was amended to legalise the transactions of land use rights, laying the foundation for private home ownership. Throughout the 1980s and 1990s, most of the housing provided by SOEs to their employees was privatised at a discount to the replacement cost. Mortgages were introduced in 1997, and official mortgage rates were cut five times during 1998-2002 to counter the negative consequences of the Asian Financial Crisis.
The deregulation of housing markets saw residential investment rise sharply starting in the early 2000s to almost 16% of GDP currently. This housing boom stimulated huge capacity-building in many related upstream and downstream industries, including steel, cement, glass, household appliances and financial services. Using data from the 2010 input-output tables and more up-to-date data on value-added, Xu et al (2015) estimate that, directly and indirectly, residential housing accounted for 29.4% of GDP growth in 2013.
It is likely that the housing boom simultaneously boosted growth, investment and saving in China while subtracting from net household income (through higher mortgage payments). The rise of private home ownership in the late 1990s boosted incentives to save by households strongly motivated to upgrade their housing and to build up private assets, while generating higher investment. As discussed, the rise in household investment mostly reflected individual investment in residential construction. The property investment booms in the 2000s further boosted land sales proceeds accruing to local Chinese governments, helping to fund investment in infrastructure. At the same time, the steady rise of mortgage loans as a share of total credit (reaching 12% in 2014) implied larger interest payments by home-buyers to financial institutions and a corresponding fall in households’ net property income. In turn, this contributed to the decline in the household share of income in the 1990s and 2000s.
The housing boom increased both sales volumes and prices, lifting corporate earnings and the return to capital across many related industries and helping to underpin strong corporate saving and investment until the late 2000s. In sum, the opening of the housing market can be viewed as a prolonged positive demand shock to the Chinese economy, sustaining returns to capital, boosting investment and lifting both private and public saving at the same time.
The paper is long and somewhat technical in parts, but also conceptually very clear, and the whole thing is very much worth reading. The draft was presented at the Reserve Bank of Australia’s annual conference last week; other draft papers from the conference have also been posted online.