In a recent New York Times article, Paul Krugman suggested that China’s economy could stagnate because of its unsustainably high level of savings and housing bubble. His prescription is that “China really needs to change its economic mix – to save less and consume more.” Both the diagnosis and prescription are very misleading.
China has a large real estate sector and housing prices are high compared to other economies. But Krugman jumps to the conclusion that this constitutes a bubble. However, the high housing prices in large Chinese cities are not signs of speculative demand but, rather, a reflection of the supply shortage relative to real housing demand.
Per capita living space in large Chinese cities is small and new housing supply is well short of demand from young people wishing to live in these cities. Every year, millions of university graduates move into major cities to work, but struggle to afford housing. Moreover, there are hundreds of millions of migrant workers, most of whom can only afford to live in dormitory-type housing.
In the next 10-20 years, there will still be massive demand for urban housing and infrastructure investment in these large cities. China’s urbanisation rate is only about 60 per cent, some 20 percentage points below other typical middle-income economies such as Mexico (79.58 per cent) and Malaysia (74.84 per cent). Another 300 million people are expected to move into cities, especially large cities.
In a recent New York Times article, Paul Krugman suggested that China’s economy could stagnate because of its unsustainably high level of savings and housing bubble. His prescription is that “China really needs to change its economic mix – to save less and consume more.” Both the diagnosis and prescription are very misleading.
China has a large real estate sector and housing prices are high compared to other economies. But Krugman jumps to the conclusion that this constitutes a bubble. However, the high housing prices in large Chinese cities are not signs of speculative demand but, rather, a reflection of the supply shortage relative to real housing demand.
Per capita living space in large Chinese cities is small and new housing supply is well short of demand from young people wishing to live in these cities. Every year, millions of university graduates move into major cities to work, but struggle to afford housing. Moreover, there are hundreds of millions of migrant workers, most of whom can only afford to live in dormitory-type housing.
In the next 10-20 years, there will still be massive demand for urban housing and infrastructure investment in these large cities. China’s urbanisation rate is only about 60 per cent, some 20 percentage points below other typical middle-income economies such as Mexico (79.58 per cent) and Malaysia (74.84 per cent). Another 300 million people are expected to move into cities, especially large cities.
Over the next 20 years that would mean roughly 15 million people potentially moving into cities every year, with each person requiring US$200,000 of investment in housing and urban infrastructure on average, which works out to US$3 trillion a year, or 20 per cent of China’s current gross domestic product.
China’s biggest social problem is its urban-rural divide, particularly the hundreds of millions of migrant workers living in its big cities who cannot enjoy the social benefits urban residents do. The only long-term solution for this resident-migrant divide is to help migrant workers relocate to cities with their dependents, so they and their children will no longer be considered migrants.
So, China’s problem is not that it’s real-estate sector is too big. On the contrary, China still needs a large and vibrant property sector that can build enough housing in its large cities to meet the demands of urbanisation.
That said, there are housing gluts in certain regions, especially in lower-tier cities, but prices there are only a fraction of those in large cities. Overall, China has a geographical mismatch of housing demand and supply; too much housing in less-developed areas, but also an acute shortage in large cities where people want to work and raise families.
So, the best policy is to rapidly increase housing supply in high-priced areas. In the past, officials in charge of land supply did not follow price signals, and housing supply in large cities did not increase nearly as fast as in less-developed areas. This supply-demand mismatch has exacerbated the shortages in large cities, causing prices to rise quickly.
Thus, the correct policy prescription for the Chinese government is to increase housing supply in these large cities. It certainly has the ability to do so, since it owns the land and can build very efficiently.
There are still arcane zoning laws in some major cities; in Shanghai, for example, a third of the land is reserved for farming.
Recently, the Hong Kong government announced a massive housing development project in an area with a lot of farmland. Other major Chinese cities can certainly learn from that. If Beijing can successfully facilitate massive investment in urbanisation, a large and healthy real-estate sector will be an opportunity rather than a risk.
Krugman also said China has an unsustainably high level of investment. I would argue that this is a blessing rather than a curse for the Chinese economy, which has certainly benefited from its very high levels of investment in technology and infrastructure.
Besides urban housing and infrastructure, there are many productive investment opportunities in China, such as clean energy. To achieve carbon neutrality by 2060, many countries including China need to make massive investments to upgrade their energy infrastructure.
Global investment in clean energy needs to increase by an estimated US$131 trillion by 2050 to avert catastrophic climate damage; every country would need to spend 5-10 per cent of its GDP on average to meet this. One can argue that China, with its high savings rate, is in a much better position to afford this massive investment than countries with low savings rates.
Of course, there are still problems for the Chinese economy. One of the biggest is China’s ultra-low fertility rate, which will hurt economic growth and competitiveness in the long run. Last year, China had only 12 million births, just half of the average in the 1990s.
At an average of 1.3 children per woman, China’s fertility rate is even lower than that of Japan, which already suffers from an ageing workforce. In just one generation from now, China’s pool of young workers could be reduced by half. Unless the Chinese government can quickly implement an effective pro-fertility policy, in 20 years, the workforce will be ageing and shrinking rapidly.
But that is 20 years from now. Until then, China still needs large real-estate investment in big cities. High rates of savings and investment, particularly in real estate, are not weaknesses but instead serve as potential, and are an opportunity for fast growth – but only if the government can clear the land supply bottlenecks in large cities.
While China’s property sector is already on a downward trend, plans to expand the property tax will probably only add to the housing market’s woes. The market is wondering why Beijing is sticking to its property tightening amid intensifying economic headwinds and, more importantly, whether further deterioration in the property market will endanger financial stability.
There have been rumours about a new round of property tax pilot programmes for some time now. President Xi Jinping’s essay in Qiushi, a journal controlled by the Communist Party, appears to have given this policy a final push.
In the essay, Xi said: “We should actively and steadily promote the legislation and reform of real estate tax and do a good job in the pilot work.”
The government’s tax reform will be set against the backdrop of Chinese authorities prioritising “common prosperity” in their political agenda.
The first trial run for the property tax took place in Shanghai and Chongqing in 2011 and only affected a small group of people. The tax was primarily focused on those with second homes or who live in luxury properties.
While there is little data available, it appears property tax receipts contribute little to government revenue. In Shanghai, for example, property tax revenue in 2020 was about 20 billion yuan (US$3.1 billion), only accounting for about 1.2 per cent of total tax revenue. Property tax revenue in Shanghai also includes tax paid by businesses, so payments from households were even smaller.
Even with the government’s support for the policy, there is still strong resistance among homeowners. Given that the final form of the scheme will most likely tax households with more than one property and could include a progressive tax regime, it makes sense that wealthy families would be displeased with the plan.
This should be one of the most important factors driving the new pilot tax schemes. As Beijing pushes forward with its pursuit of “common prosperity”, it must narrow the income and wealth gaps. From this perspective, the property tax is a feasible option for rebalancing wealth distribution.
In the meantime, a strange phenomenon has emerged in China’s property market in the past few years. While growth in mortgage lending has slowed, housing sales and property prices – particularly in big cities – have still risen.
This seems to suggest that many people are using other instruments to finance their property purchases. There have been reports of people taking out business loans and using the money to buy property. A wealthy family could buy a flat with cash and later collateralise the property and take out loans from commercial banks, claiming the reason for borrowing was to run a business.
This family would need to own a company to qualify for business loans, of course. But the Shenfangli case earlier this year in Shenzhen showed how shell companies could be registered to get bank financing that is used in the housing market.
This suggests that the actual financing exposure to the property market could be much higher than official figures suggest. It also shows how the dynamics of the property market matter in maintaining financial stability.
The obvious question is whether a property market collapse would threaten China’s financial stability. The answer is “yes”, but Beijing’s bottom line of preventing systematic risks in the financial system remains intact.
Several recent cases involving property developers going into default might shed some light on the issue. Financial regulators have kept up their tough tone on the property market. However, they have also urged developers to complete their unfinished projects, restructure debts and prepare to make upcoming bond coupon repayments.
Past cases of debt restructuring already point to a calibrated policy approach, which suggests that the entire debt restructuring process will be a prolonged one.
I believe Beijing will use the same tactics and take a step-by-step approach in its implementation of the property tax. While the countrywide scheme is likely to be approved shortly, its execution will still be cautious and calibrated.
This could also mean the regulatory controls on property prices will remain in place for a while yet. During that time, the market will gradually adjust its expectations. As long as “common prosperity” remains at the heart of the government’s strategy, though, property prices are likely to stagnate or even fall in the coming years.
Given the importance of the housing sector in China’s overall economy, a property slowdown suggests the country’s economic growth will be less impressive going forward.
It seems Beijing has accepted the prospect of slower growth, though. It sees that some fundamental changes are more critical for the country’s future and will better position it against the changing demographic and geopolitical landscape.
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