Forty years of continuous growth have made China one of the world's two largest economies.
This is a remarkable achievement that has lifted hundreds of millions of people out of poverty into the global middle class, consistently exceeding expectations and confounding those who predicted economic collapse.
This pace of growth is now slowing for several reasons. Like many advanced economies, China's population is aging – a demographic shift that was exacerbated by China's one-child policy between 1980 and 2016.
There is a resurgence of economic nationalism worldwide in the wake of Covid-19. Trade growth, already suffering from market saturation, is slowing as manufacturers in Europe and North America relocate their supply sources, diversify their sources or their governments erect trade barriers.
But there is another brake on China's growth. The country's economy has relied on outsized domestic investment in real estate and infrastructure for many years, and these investments have shown sharply declining returns.
Local governments that rely on land sales for revenue are having to service their debts, and revenues are collapsing as the real estate boom stalls.
Will China's economy collapse as a result? Not necessarily – at least not in a financial crisis like the one the West experienced in 2007-2008. But getting to grips with these issues won't be easy, the solution may be difficult, and the end result is likely to be much slower trend growth.
In joint research with economist Yuanchen Yang from the International Monetary Fund, we estimated how dependent the Chinese economy is on real estate and related infrastructure.
China has not intervened in the real estate market as aggressively as many expected. Image: Twitter
In 2021, the direct and indirect impact of real estate on the Chinese economy was 22% of GDP and 25%, respectively, when imported content is taken into account. When infrastructure such as roads, public transport and water pipes that serve residential and commercial properties are taken into account, the total share rises to 31%.
In the years immediately before the Covid-19 pandemic, the sum was even higher. The only advanced economy in recent history with a similar share of real estate and infrastructure investment in GDP was Spain in the run-up to the global financial crisis, although that peak was below the 30 percent level that China has maintained for a decade now.
The physical transformation of Chinese cities over the past three decades has been remarkable. However, looking at the overall buildup that has already taken place, it is clear that the growth engine in construction can no longer drive China's economy as it did in the past.
Real estate is long-lasting. As the inventory increases, the economic income from the construction industry decreases. For example, the living space per capita in China is now equal to or greater than that in France or the United Kingdom.
While housing stock in the United States remained stable at 65 square meters per capita from 2011 to 2021, housing stock in China increased from 5 square meters per capita in 1992 to nearly 49 square meters per capita in 2021.
80% of this usable space is in smaller, poorer Tier 3 cities, which have not benefited from agglomeration effects nearly as much as the richer, wealthier Tier 1 cities such as Shenzhen, Beijing, Guangzhou and Shanghai, as well as mid-tier Tier 2 cities . The population of Tier 3 cities is already declining, prices are falling and vacancies are high in many regions.
Nationwide, the ratio of properties under construction to completed commercial properties has been steadily increasing, indicating a market where developers are unable to complete their projects due to a lack of end buyers and financing.
Infrastructure investments face similar challenges. Projected investment in high-speed rail far exceeds the growth in the number of people using it, and recent infrastructure investment has been focused on Tier 3 cities.
At the same time, even according to conservative estimates, local government debt has risen inexorably from around 5% in 2006 to 30% in 2018, and regional private banks are also at risk. The central government can decide to bail out everyone at any time, but maintaining the credit growth needed to stimulate the economy is a challenge.
China's local governments are suffering from mountains of debt. Image: Twitter screengrab
The wealth of Chinese households is predominantly concentrated in real estate. Even without a financial crisis, the central government will be forced to make adjustments to free China's economy from dependence on this sector.
Beijing could use its broad powers to restructure and redistribute economic activity, as it has successfully done in the past. There are also fiscal policy measures that would address this problem, such as: B. higher transfers to bail out local governments or allowing local officials to raise property taxes – although the latter appears to be off the political table for the foreseeable future.
The government can also look to redirect infrastructure investment to areas where tier 3 cities are still under-invested, including schools and hospitals. The Chinese authorities have successfully navigated economic challenges during their four decades of growth, but overcoming these problems will be challenging even for them.
Kenneth Rogoff is the Thomas D. Cabot Professor of Public Policy and Economics at Harvard University and a member of the CEPR Research Policy Network on International Lending and Sovereign Debt.
This article was originally published by East Asia Forum and is republished under a Creative Commons license.
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