Is China's Real Estate Market a Risk to the Global Economy? - "China's Housing Market Is Plagued by Massive Overcapacities"

The rapid growth of the Chinese economy since the 1980s has driven up real estate prices in the People's Republic. In some of China's big cities, housing prices have seen annual double-digit growth ten years running. Now, however, the market is cooling off appreciably, with some markets falling as rapidly as those in the United States before the subprime mortgage crisis erupted in 2007. Is China's housing bubble about to burst threatening the still fragile global economy? According to the economist Oliver Lerbs, the situation is comparable to the one in th US, but there are also differences.

Chinese leaders spurred on urbanisation for years, boosting domestic spending and growth. Is the real estate and construction sector playing its intended role for China’s economy?

In the past years the real estate and construction sector has indeed been a decisive pillar of Chinese growth. For instance, new housing investment accounts today for some 15 per cent of output. Even for an emerging country like China, this percentage is worrisomely high. This is especially true because local municipal funding in China relies less on taxes and fees than on the sale of state land for new construction. Generally, real estate investments are not per se less productive than investments in machinery or patent development - they raise production capacity in the form of housing services - but right now it is doubtful whether further investment will yield a healthy real interest rate in the long run. In many places vacancy rates are already enormous - a clear sign of capital misallocation.

Land and housing in China’s metropolitan areas are becoming increasingly scarce, with sharp rises in prices. At the same time, entire satellite cities, newly built, remain empty. How do we account for this incongruity?

China's housing market is plagued by massive surplus. It is also very fragmented due to high transaction costs and greatly varying property values depending on location. Some settlements lack the infrastructure needed for a good living standard. The vacancy levels, however, do not always reflect a surfeit of supply, leading to lower prices. Many Chinese have invested in second homes and, banking on a near-term sale, have decided to keep them empty. Vacancy is also caused by China's institutionally weak rental market. Different experts have tried to estimate the number of vacancies but no one knows the exact figures.

Housing prices in China seem to be going the way of those in the U.S. shortly before the subprime mortgage crisis. Are the Chinese about to endure a similar collapse?

Unfortunately, homebuyers tend to project their experiences with past growth into the future. With the current housing surplus, however, we can hardly expect that real estate prices in China will continue to grow. A depressed housing market like the American one would have extremely negative effects on China's private spending and the domestic economy. But considerably less foreign capital went into leveraging real estate sales in China than was the case for the U.S. What’s more, the Chinese banking sector is strongly regulated. We have here after all two very different economic systems. In the event of a crisis, the Chinese central government would likely take quick and decisive action as the country's "lender of last resort". Nevertheless, we know from Japan that a housing bubble collapse can paralyze the economy for years even with massive state interventions in the banking sector.

How is the year shaping up for China's housing market, the economy, and the global economy in general?

According to our China Economic Panel (CEP), forecasts for housing prices in key regions are surprisingly optimistic, but overall economic growth is projected to slow. If politicians slacken their efforts to cure China's housing market ills, economic expectations will continue to dampen, particularly given China's enormous expansion of cement and steel production. Hanging in the balance are many jobs and, by extension, demand for foreign goods. Hence, a prolonged real estate malaise in China would negatively affect the global economy as well as its own.