Field of Dreams
The construction industry has played decisive role in the grand plan to push the Chinese economy forward. In the past 30 years there has been unabated construction of new residential buildings, office towers, highways, bridges, railways, and factories. However, there is now enough overbuilt in China to make an easy statistical eye-ball observation that supply grossly over represents utilized demand. In fact, it is becoming quite clear that much of the current construction will never see the day when it is used. There are many residential units in the city peripheries that have been unoccupied for more than a decade. This can be verified by walking in almost any city in China and counting the number of apartments without lights on (at night) or without air conditioner units installed. The new office towers in Central Business District of Beijing, Chongqing, or even Shanghai are also vastly under-occupied. For example, perhaps more than 50% of the office tower space in Beijing doesn’t have occupying tenants. And while city roads are clogged with traffic, new toll highways are a joy to ride because they are almost without cars. New airports and other recent infrastructure projects are vastly underused. As well, it is documented that manufacturing capacity in China is well ahead of itself and already has enough overcapacity in many industries (i.e., PV solar panels, shipbuilding) to easily supply any substantial growth from a world economic recovery (that seems now to be a distant likelihood). Yet all this begs the question as to why developers and manufacturers all over China continue to build and construct even more? Fixed investment accounts for more than half of the overall GDP growth in China and consumption accounts for only about 34% of the overall GDP (Y = C + I + G + NX). This means that consumption as a percentage of overall GDP continues to steadily decline (it was about 55% in the early-1980s and 37% in 2008).
Consumption depends far too much on the purchases from a small rich elite class concentrated all within the urban cities, and not nearly enough on a middle class. The middle class in China remains relatively diminutive, and undersized, and it is doubtful that it will significantly grow under the current scenario (of corruption favoring the elite; a misallocation of capital resources; subdued service sector; uncertainty about peoples' financial needs for the future; and a lack of white-collar jobs for recent university graduates - all of which will be discussed later). And it is even more unrealistic to believe in the near future that the migrant working-class will be added to the middle class, or those who remain in the smaller cities and the rural regions will be lifted out of grinding poverty.
Investment Overhang
Without an adequate market to signal when to stop construction, the asset prices have inflated well beyond the market fundamentals. Residential units are listed at prices in the major cities at many multiples above peoples’ incomes. It costs 20 or 30 times a household’s annual income to buy a modest apartment in any major city. But property prices still haven’t even leveled off. Why?
Let’s begin by dispelling some of the common reasons given. Some people have argued that Chinese people are particularly adept at saving their income over an extended time using discretionary income that is often underreported for tax avoidance reasons in the grey market. And while this reason is partly true, this still means that the average citizen in China would have needed to save more than half their income for the last 20 years solely for the purpose of being able to put down the first payment (at least 30% required) on a lease (for 70 years) for their new property. This reason neglects to account for the fact that incomes are much higher today than 20 years ago, and that many people in China are also saving for their own child’s education, and the need to put their own money aside for unplanned sickness and their retirement. A better provided reason given by Arthur Kroeber, a Beijing consultant, argues that lots of people in the major cities already had property (prior to the sharp property price increases), and were then better positioned to trade up despite income being insufficient to support the overdone property prices. But the main problem with this argument is that it still doesn’t explain why so many of the properties remain empty - many of the residential units have been left unoccupied for many years. A more likely, and thorough explanation is that without a property tax and with few alternative investments, the rich investors are motivated to stockpile apartments on an assumption that property prices will continue to go up. If these residential units haven’t been rented out for income (which is mostly the case), then they can only give a positive return to the investor on the notion that the next buyer will pay more. However, because the prices are well beyond the household incomes that first time buyers will ever be able to afford, the residential properties are being traded among these rich investors (who are often the property development companies themselves) on the premise of continuing to find another investor to pay an even higher price. This leaves anyone in the middle class that are without property out of the market. The only reasonable conclusion is that this is nothing other than a Ponzi scheme, in which someone in the game of musical chairs will be left without a seat. The famous short-seller, James Chanos has described it as ‘a treadmill to hell’ and ‘Dubai X 1,000’ for justified reasons.
China’s growth has and will still be for some time coupled to the export sector. China’s labor force and economic strength are largely dependent on being an intermediary for final processing in a value chain. China imports semi-processed products from neighboring countries (i.e., Japan, South Korea, and Taiwan) and exports final assembled products around the world, with the dominant markets in the United States, the EU, and neighboring Asian countries. However, these markets have reached near import/consumption saturation in the current economic cycle, and with weak growth are unlikely to substantially increase their purchases in the near future. This leaves China in a quandary as to how to maintain current levels of economic growth from something that will no longer work like it did for the past 30 years.
Thus, to summarize, the Chinese economy is far too dependent on fixed investments and a flawed export model that have squeezed consumers out of the market. The government despite saying the opposite are clinging even harder to supporting more investment and exports. This is causing the imbalances to get larger. This then leads us to the next part of the series on how this is unsustainable.
Export Dependence
China’s growth has and will still be for some time coupled to the export sector. China’s labor force and economic strength are largely dependent on being an intermediary for final processing in a value chain. China imports semi-processed products from neighboring countries (i.e., Japan, South Korea, and Taiwan) and exports final assembled products around the world, with the dominant markets in the United States, the EU, and neighboring Asian countries. However, these markets have reached near import/consumption saturation in the current economic cycle, and with weak growth are unlikely to substantially increase their purchases in the near future. This leaves China in a quandary as to how to maintain current levels of economic growth from something that will no longer work like it did for the past 30 years.
Thus, to summarize, the Chinese economy is far too dependent on fixed investments and a flawed export model that have squeezed consumers out of the market. The government despite saying the opposite are clinging even harder to supporting more investment and exports. This is causing the imbalances to get larger. This then leads us to the next part of the series on how this is unsustainable.