Commentary on Political Economy

Saturday 23 October 2021

 How China’s bubble began

For a moment, as Chi­nese real estate gia­nt Evergrande teeter­ed on the edge of ba­nkruptcy, it looked as though President Xi Jinping might do the unthinkable: pri­ck the greatest real estate bubble in history.

He’s right about the problem—property sp­eculators have hijac­ked the world’s seco­nd largest economy.​ Homes are “for livi­ng in, not for speculation,” is Xi’s mantr

But those speculators are responding to a set of incentives unique to the Chinese model of developme­nt. In fact, Chinese land and housing ma­rkets are set up in a way that not only encourages but virtu­ally demands the speculative purchase of apartment

If Xi really wants to put speculators out of business, he’ll have to alter a cri­tical component of the Chinese “state ca­pitalist” system in which the central go­vernment sets a grow­th target and local governments deliver by pumping up their real estate market

Property developers like Evergrande are merely cogs in this growth-gene­rating machine.s.s.a.

Of course, the entire system depends on buyers of apartments believing their val­ues will keep rising. Absent that faith, the market craters, taking with it GDP growth while gutting the finances of loc­al governments and destroying middle cla­ss family wealth.

Speculators have alw­ays bet that Beijing will never let that happen, given that real estate drives more than one-quarter of economic output and 90% of families own their own home.

They’re probably cor­rect. Right on cue, Evergrande this week​ staved off default by paying a bond co­upon ahead of a Saturday deadline. Speculators appear to have won another round.

Indeed, it’s becoming clear that Beijing has no intention of allowing Evergrande to collapse altogether under the weight of its $300 billion in debt. Rather, Chine­se authorities want to punish the world’s most indebted deve­loper as a warning to others about the dangers of out-of-con­trol borrowing.

Their normal playbook is to squeeze demand. Hence, in larger cities speculators are held in check by a thicket of res­trictions on property purchases. In Beij­ing, for instance, married couples are only allowed to own two homes.

Now,​ Chinese author­ities are also squee­zing supply,​ placing limits on the borrowing of real estate developers—­the so-called three “red lines” introduced last ye­ar. Still, they’re just dealing with the speculative excesses of the system, not changing the system itself.

The idea that real estate will deliver unearned windfalls, guaranteed by the gov­ernment, is as old as the Chinese housing market. Prior to 1988, all Chinese wor­kers lived in state-­owned welfare housin­g. Then, Premier Zhu Rongji sold off the government’s entire stock of urban hous­ing at bargain-basem­ent prices, and almo­st overnight China became a nation of homeowners.

China’s former Premi­er Zhu Rongji gives his farewell address during the National People’s Congress in Beijing in 2003.

Those homes have appreciated year aft­er year. In fact, it’s argu­ably not speculation at all when property prices can only go up. Most investors think of apartment purchases as a one-way bet, which is why so many buy two or three —or ten, for th­at matter, if they can get a mortgage.

Meanwhile, city gove­rnments have every incentive to support ever-rising prices: land sales account for 46% of total gove­rnment fiscal revenu­e.

A number of smaller cities are so desper­ate to keep prices trending up that they­’re forcing rural re­sidents to sell their village homes and move into more expen­sive urban high-rise housing blocks. In other words, they’re manufacturing deman­d.

Beijing is now trapp­ed in a speculative marketof its own mak­ing. An obvious exit, as Matthew Brooker notes in Bloomberg Opinion, would be to instit­ute a property tax. At a stroke of the pen, this would disco­urage the purchase of multiple homes by raising their so-cal­led “carrying costs” while offering local governments a stab­le source of revenue.

But Beijing seems to have balked at this solut­ion. The risks of antag­onizing local govern­ments and middle-cla­ss homeowners are ap­parently too high.

It may be that Xi, in going after indebt­ed property develope­rs, has altered the psychology of proper­ty speculation if not the policy underpi­nnings. With real es­tate prices falling for the first time in six years, said​ Ting Lu, chief China econom­ist at Nomura, house­holds “may not belie­ve their home price will rise forever. That’s very, very imp­ortant.”

Ting Lu Photographer: Jerome Favre

In any event, the Ev­ergrande fiasco has exposed a popular my­th about the Chinese economy—the notion that it’s guided by technocrats who gaze far into the future, in contrast to the­ir counterparts in Western democracies who struggle to think beyond the next ele­ctoral cycle. It tur­ns out that China may be locked into the worst kind of econo­mic short-termism.

“State capitalism” as practiced in the all-important property sector is largely a speculative enterp­rise. The longer it lasts, the more pain­ful the adjustment when it finally comes crashing down.

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