China’s Real Estate Bubble: To Pop or Not to Pop?

by Lorna Wilson

(Watch to 0:50)

In the imminent future, the government of China will be able to effectively control the rapidly growing real estate bubble that is threatening the entire nation.

The Chinese peoples’ eagerness to industrialize and urbanize led to a largely increased demand for metropolitan real estate, which preceded the bubble. Like many others, “The China Bubble […] start[ed] out as a boom based on successful economic reforms and modernization that helped to lift hundreds of millions out of poverty” (“The China Bubble”). The real estate growth began as a great achievement that helped boost the country’s GDP and rescue peasants from the paucity of the countryside. All ranges of people, from migrant workers to wealthy company owners, embraced the advancement. However, success quickly gave way to potentially dangerous circumstances as it “eventually devolve[ed] into an orgy of wild real estate speculation” and the “reckless construction of empty cities […] create[d] economic growth and materialism mania” (“The China Bubble”). The overzealous reaction of avaricious proprietors of the construction companies left the newfound economy vulnerable to a major crash.

The government itself also contributed to the creation of the property bubble through the banking system. For example, “bank deposits guarantee interest of only 2.25%, lower than inflation, which for months has been at more than 3%” (Asia News). The government enforced low interest rates to discourage saving and increased loaning in order to encourage spending, both originally designed to grow the economy. However, this effort spurred an unprecedented massive increase in real estate investment. In fact, “[s]ince the late 1990s, investment in China's real estate sector has been outpacing the country's impressive GDP growth, rising from around 4% of GDP in 1998 to around 14% of GDP by 2012” (Hirst). Consequently, China is left with a large overinvestment in property, and their financial system has become accustomed to relying on their realty.

Since China’s economy became so dependent upon its real estate sector, if the real estate bubble were to pop, the financial standpoint of the entire nation would be put at stake. In the Communist Party’s paper People’s Daily, economist Yi Xianrong warned, “many investors rely on a constant increase in prices in the housing market, but the market is overheated. This is a serious threat to the Chinese economy” (Asia News). The threat grows with more new construction, which still occurs due to benefits for the giant companies, barring the workers. To make matters worse, “More than 60 million empty apartments await buyers, and the residential housing market is essentially comatose” (“China's Slowing Economy: The Worst Has Yet To Come”). Clearly, the amount of available realty has far exceeded the demand. However, the real estate sector still “accounts for between 25% and 30% of China’s GDP (if upstream and downstream industries such as steel, cement, glass, furniture, and appliances are included), so it is impossible for the Chinese economy to regain momentum without reviving this vital industry” (“China's Slowing Economy: The Worst Has Yet To Come”). The whole economy can be significantly impacted by merely the property sector; therefore, the imminent threat of recession has become an overbearing need to solve the problem before the bubble bursts.

The real estate boom benefitted groups in all ranges of social classes, but as the boom turned into a bubble, those groups were affected quite differently. In the beginning, the middle class families settling into city life benefitted greatly from the increase of urbanization. But as realty took on a more capitalist influence and elite members of construction and manufacturing companies began reaping the rewards, the focus of the market shifted, allowing the bubble to grow as long as it benefitted those in charge. Growth continued because a “weakening property market could drag down China's growth and pose significant risk to local government balance sheets in the country, which rel[ied] heavily on land sales to developers for revenues” (Hirst). Local government pressure placed upon these companies prompted a corrupt system focused solely on growth, both privately as well as nationally. According to Chuang, an avid researcher of Chinese migrant workers, “The Chinese state has ‘always turned a blind eye’ to the vulnerability of migrant workers,” because “this is how you fuel industrialization for so cheap and at such a fast pace” (“The Second-Class Workers behind China's Urban Construction Boom”). Thus, millions of migrant workers from rural villages are left working in exceedingly poor conditions for low wages and under none of the protection provided by Chinese labor laws. These significant changes to Chinese life come simply as a consequence of the real estate surge.

Despite the strong desire for growth, the Communist Party of China recognizes that it cannot afford the extensive negative effects an unalloyed real estate crash would cause; therefore, the government will prevent such a crash from occurring at all costs. They recognize that the current measures encouraging growth “will likely cause an outright recession. For a leadership team that is up for reappointment in 2017, China’s government will do just about anything to avoid this” (“China's Slowing Economy: The Worst Has Yet To Come”). Logically, political leaders stand a better chance at reappointment if they avoid a drastic crash in the coming couple of years, so each of them possess personal incentive to avoid the crash. In fact, the government has already begun installing reforms in effort to prevent this collapse, signifying their dedication to preventing this crisis. In January 2014, China “made several moves […] to do just this, including reimposing a sales tax on homes sold within five years of their purchase from this year and increasing the down payment requirement for property purchases to at least 50 percent of the total price” (“China's Real Estate Bubble”). With the proper motivation and the first steps already taken, the Chinese government is poised to regain control of the real estate sector of its economy in the oncoming years.

Although avoiding a long-term real estate crisis may hurt the short-term economy, the government will do their best to avoid it due to the importance of the middle class. Government reforms designed to slow the growth of the bubble have already resulted in financial deficit; for example, in June of 2014, “a sample of 70 major cities across China reported that housing prices dropped in 55 of them […] Annual growth in property investment grew 16.8 percent in the first three months of 2014, down from 19.3 percent in the first two months” (“Why China's Economy Can't Pop Its Real Estate Bubble”). The slow deflation of the real estate bubble, while not ideal for anyone, is essential to avoid a full-blown crash, which would significantly impact the middle class in particular. This social class, having risen incredibly quickly since the 1990s, controls an increasingly large portion of the nation’s purchasing power. Many understand that “[c]ompanies that can effectively understand the composition and needs of this diverse group will be positioned to reap massive rewards” (“Understanding China’s Middle Class”). If the middle class’ investments—which are mostly in property—were to disappear, their purchasing power and the Chinese economy would go alongside it. Therefore, the government is able to sacrifice in the short-term in order to ensure that the middle class can retain the value of their property investments.

On the contrary, some experts believe that China’s bubble will follow the pattern set by Japan’s realty crash and their subsequent economic deficiency, as history often repeats itself. For instance, “the present slowdown has been led by a sharp reversal in housing construction, one that UBS economist Wang believes ‘will bring dis-inflationary or deflationary pressures through various demand channels.’ That, again, is uncomfortably evocative of the Japan syndrome” (“Is this the end of China’s Economic Miracle?”). Because of the striking similarities between China and Japan’s economies, the fear of following in Japan’s footsteps is prevalent for Chinese politicians and economists. However, the Communist Party clearly is already addressing the emerging issue, which the Japanese government did not do before their crash. One expert admits, “One part of the comparison may be overwrought. In China, the residential real estate market is nowhere near as leveraged as Japan’s was (or the U.S.’s after that). The damage from a significant correction, which is undeniably under way, is less likely to threaten the entire system” (“Is this the end of China’s Economic Miracle?”). Thus, the Chinese economy will be far more under governmental control, making the two situations less similar and giving China a brighter look upon the future.

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