Keynes and Hayek in China’s Property Markets

HONG KONG – Real-estate prices in China’s top cities are spiking, generating contradictory predictions of either bursting bubbles or a coming economic turn-around. What’s really going on in China’s hot property markets?

China’s National Bureau of Statistics (NBS) revealed last week that ten of the 70 large and medium-size Chinese cities surveyed had recorded annual price increases of more than 20% for newly built commercial housing. In the first-tier cities of Shanghai and Shenzhen, those gains were even higher: above 37%. In the second-tier cities of Xiamen and Hefei, the increases exceeded 40%.

Chris Watling of Longview Economics compares China’s property market today to the Dutch tulip mania that peaked in 1637. He points out that property prices in Shenzhen, in particular, jumped 76% since the start of 2015, bringing a typical home to $800,000, just below the average home price in Silicon Valley. This, he suggests, may be the last hurrah before a market meltdown.

Liu Shijin, former Vice Minister of the Development Reform Center of China’s State Council, disagrees. Instead, he posits that after six years of reduced investment in infrastructure and construction, growth in the Chinese property market may be bottoming out, and liquidity and consumer confidence may be shifting back to housing.

To determine who is right, it is important, first, to recognize that not all Chinese cities’ property markets are surging. In 42 of the cities surveyed by the NBS – those with industrial overcapacity and excessive property inventories – price increases amounted to less than 5%, with eight cities recording falling or stagnant property prices. This pattern of divergence creates a dilemma for Chinese policymakers and investors, who now must weigh carefully the insights of two economic giants: John Maynard Keynes and Friedrich Hayek.

At a time of slowing economic growth, some are advocating more Keynesian macro-stabilization measures, much like those China used to sustain growth after the global economic crisis of 2008. But in many areas, particularly in the northeast, central, and western parts of the country, the slowdown cannot be resolved through more stimulus.

In fact, stimulus in those regions would largely flow out, along with the labor and capital that is already being propelled toward coastal areas, which boast more advanced technology, higher rates of innovation, superior infrastructure, and a more market-friendly business environment. What slower-growth regions need, therefore, is time to carry out supply-side structural reforms, including cutting inventories, reducing overcapacity, and writing off the bad debts of local governments and state-owned enterprises.

The regions with surging property prices, meanwhile, tend to be the ones that are drawing labor and capital with high growth and superior job opportunities. A study by China Securities International showed that, in 2000-2010, cities in eastern China received 82.4% of total migrant inflows. By 2010, the migrant population in Beijing, Shanghai, and Tianjin had more than doubled, to 34.5%, 37.9%, and 21%, respectively.

In an attempt to manage the growth of these cities, which faced a huge shortage of land, housing inventories, and urban public infrastructure, China’s government imposed restrictions on both demand for and supply of housing. But, as the spike in housing prices in these cities shows, their efforts didn’t work.

Chinese policymakers had forgotten about Hayek. Otherwise, they would have expected that labor and capital markets would continue to drift toward growth and innovation in urban centers. They would also have recognized that market prices naturally transmit complex, specific, and changing local knowledge, which is distributed among individuals and corporations, not controlled by central planners. And they would have appreciated that if supply is to be matched with demand over time, real-estate and infrastructure investments must reflect that knowledge.

Instead, China’s policymakers inadvertently created bottlenecks in local land supply. Residential land transactions in first- and second-tier Chinese cities remain thin and heavily influenced by urban planning policies, despite the depth and sophistication of residential property markets.
Fortunately, there is scope for China’s urban planners to relax restrictions on the supply of land and on the floor area ratio (the ratio of gross floor area to the size of the lot on which the building stands). According to a study by China International Capital Corp, the urban built-up area in Shanghai is only 16%, compared to 44% in Tokyo and 60% in New York City. Within that area, only 36% is used for residential functions in Shanghai, compared to 60% in Tokyo and 44% in New York City.

In other words, the available residential land for sale in Shanghai is considerably smaller than that available in New York City or even Tokyo, which is a major reason for surging property prices in these cities. And, in fact, if the supply of land and usable floor area is not increased, more spending on local public infrastructure will cause prices of existing space to rise even higher.

Liu’s observation that households are becoming increasingly confident in the housing market also seems to be correct. The recent increase in demand for housing may reflect households’ desire to hedge their high savings against inflation or, more fundamentally, the sense that they must secure housing urgently, given limited supply. Either way, they now seem convinced that investment in housing is a relatively safe bet.

If that is the case, the risk of a property bubble in China is probably being overstated. But that does not mean that all is well in China’s property sector. If the government ignores market price signals, mismatches between supply and demand could build up, undermining growth in dynamic regions, while leaving low-growth regions weighed down by excess capacity and bad assets.
The good news is that there is still considerable room for policy maneuver. The question now is whether the Chinese authorities will manage actually to recognize and respond effectively to market signals.

Andrew Sheng, Distinguished Fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance, is a former chairman of the Hong Kong Securities and Futures Commission, and is currently an adjunct professor at Tsinghua University in Beijing. His latest book is From Asian to Global Financial Crisis.
Xiao Geng, Director of the IFF Institute, is a professor at the University of Hong Kong and a fellow at its Asia Global Institute.

By Andrew Sheng&Xiao Geng

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