Distilling China’s Development

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The economic rise of China has created two growth industries pulling in opposite directions. There’s either the school of blind praise of ‘The China Miracle’ or its opposite, apocalyptic predictions about the country’s impending implosion.

On the surface, it appears as if the fundamentals of China’s modernization are similar to what the Western nations went through in the past, that is, a mass migration of farmers from the countryside to the urban centers to work in factories and construction sites. Taking into account the enormous scale at which this migration is happening, the country seems to be moving toward what some observers are dubbing the ‘Chinese Century’.

Similarities aside, however, China’s development is uniquely Chinese. Whereas the U.S. was built upon the backs of immigrants from outside of its borders, China’s development owes its current success to its own huge population. China will never become a nation of external immigrants and will remain a homogenous behemoth long into the future.

China’s current condition and its immediate future remain shrouded in a state of unsettling mystery. Having lived and worked as an architectural designer in China for nearly a year now, my own fervent curiosity has hardly been assuaged. There are a few things I’ve learned though that should be clarified regarding China’s development. Following, I will attempt to belie some common misconceptions.

Misconception: As China continues develop, it will become more open to outside influence and the government system will reform itself to become more democratic and free.

To the naive Western observer, China’s continued economic evolution means that the country must allow more democratic freedoms in order to remain competitive in the future. This assumption is extraordinarily dubious. China’s model is top-down, centralized planning and it has proven to be successful. To argue that it will not continue to work for China is a biased Western-projected fantasy.

A pre-existing culture of collectivism constitutes one reason why state-driven development continues to blaze forward totally unhinged. When it comes to sensitive issues like media censorship or human rights, most Chinese citizens passively shrug their shoulders knowing full well that protesting will ultimately prove futile and self-defeating. Furthermore, most citizens are too busy hustling to make money and pull themselves up the socioeconomic ladder to be concerned with such matters.

Perhaps the past two centuries of Chinese history will offer some clues into why the status-quo is so apathetically accepted. China’s experience of 19th and 20th Centuries consisted largely of a series of hardships: the Opium Wars to the fall of the Qing Dynasty, the subsequent Japanese Invasions and Chinese Civil War, and concluding with Mao’s Cultural Revolution. It is obvious that China is much better off now than it has been for the past 200 years.

This might explain why China’s populace is now seizing the unique opportunity of “reform and opening” to make the best out of the current situation. It might also explain why people are reluctant to disrupt the established order. Thought about in this way, China’s current system of rule is not so much a 'big-brother’ entity as it is an unspoken collective social contract to keep peace.

Misconception: China’s rise to global prominence is over estimated. The looming real estate bubble in China means that economic collapse is imminent.

Doomsday predictions about China’s collapse have become something of a growth industry. Commentators like Gordon Chang and hedge fund manager James Chanos are placing their bets on China’s demise. Many of these criticisms stem from what is speculated to be a coming crash in the real estate market.

To the central government, constructing new buildings is much more than just providing new and modern accommodations for the populace; it stands for social stability. It doesn’t take an economist to acknowledge that city-building is an important part of economic growth. But what is often overlooked is how city-building is a key part of the modernization process, employing rural migrants and giving them opportunity to earn substantially more than they could as farmers.

In China, real estate development is only one part of economic growth equation. Chinese leaders are well aware that the mad pace of constructing new buildings cannot last forever and already there seems to be an overabundance of supply in the residential and commercial sectors in first-tier cities like Shanghai and Beijing. Yet China is not anywhere near finished with its construction boom as 2nd, 3rd and 4th tier cities race ahead to catch up with their 1st tier counterparts.

Looking into the future, China’s leaders are preparing to shift the economic growth to more information-based sectors. The city I live in, Chengdu, the capital of Sichuan province, has already recruited American heavy-hitters such as Cisco and Intel. Chengdu has been successful in doing this by investing in new infrastructure and developing a series of high-tech industrial zones that give foreign companies the option of lower operational costs than found in the increasingly pricey coastal cities.

Misconception: Revaluing China’s currency will help bring manufacturing jobs back to the U.S.

China’s economy would not be the success it is today without the foreign investment that flooded through the gates since they first opened in 1978. The number of foreign enterprises directly benefitting from the low cost of labor in China has expanded greatly since that time. China’s maintaining a low valuation of its currency, the Renminbi (RMB), has been a key factor in attracting and keeping investment from overseas businesses.

Yet the talking heads in Washington have taken to pressuring China to revalue the RMB in order to help ‘rebalance the global economy’. Just ahead of the G20 last month, Treasury Secretary Timothy Geithner told Congress that China’s RMB peg to the U.S. dollar is an ‘impediment to sustainable global growth.’ Responding to the pressure, China announced that it would in fact let the RMB appreciate against the dollar.

Following China’s announcement, the RMB rose a whopping .4% in value leading to what Economist Paul Krugman called the ‘Renminbi Runaround’. Krugman is correct to call out China on its currency manipulation- but it should be no surprise that what China is doing is simply looking out for its own national interests. A rapid rise in RMB value would cause some serious damage to the Chinese economy.

American politicians know this but will continue to pressure China to raise the RMB value to score brownie points with their constituents. The reality is that both China’s economy and foreign companies using Chinese labor benefit from the low value of the RMB. For instance, companies such as Apple would not be able to sell their much coveted iPads at reasonable prices if it were not for cheap Chinese labor.

Pressuring China too much could result in a trade war which would in fact not only hurt Chinese exporters but the American consumer as well. Politicians are also deluded into thinking that manufacturing jobs will come back to the U.S. if China’s RMB goes up. On the contrary, companies will move manufacturing operations to some other place where regulations and labor costs remain substantially lower.

Conclusion: China’s accomplishments over the past two decades are unprecedented and fascinating. The scale at which change is happening means that complexity and uncertainty are unavoidable facts of life. Many challenges lie ahead, both for China’s domestic issues and its relationship with the rest of the world. As far as China has come, there still is a long way to go as millions still aspire to a better life.

Adam Nathaniel Mayer is a native of California. Raised in Silicon Valley, he developed a keen interest in the importance of place within the framework of a highly globalized economy. Adam attended the University of Southern California in Los Angeles where he earned a Bachelor of Architecture degree. He currently lives in China where he works in the architecture profession. His blog can be read at http://adamnathanielmayer.blogspot.com/

Photo by DavidM06



















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The Chinese housing bubble

Adam and Damian too - thank you both for your follow up perspectives. Its good to have the perspectives of both architects and mine as a developer. Lets just say we developers can be acutely sensitive to development and financial imbalances - to put it all rather delicately!

Lets see how things play out in coming months.

Hugh Pavletich
Performance Urban Planning
www.PerformanceUrbanPlanning.org
Christchurch
New Zealand

Understanding needed

Adam, I think the post is great article and an interesting piece that should be read by those involved in any way with property in China. I agree with your assumptions and comments in the post about the Chinese property market and central planning.

I think it is too hard for people who haven't lived and worked in China to understand the central system of urban planning along with the number of factors that central government has control over including the financial system. Also the culture is the most important factor in understanding China and its growing economy.

Is there a high housing prices in China? - simply put - yes in but for most part as Adam said in Tier 1 cities - will they burst? no. they will fluctuate but not burst as over the last few months the government has put in place financial mechanisms that have curtailed the sales of existing and new property in Shanghai and this is flowed on to reducing property sales and the number of real estate agents closing up.

Many people don't understand the history and the speed at which property prices have change in China. In my 5 years in China, I have seen some areas in Shenzhen rise in price by 40-60% and fall by 50-70% and rise again by 30% all in the space of four years.

I think the issue with amount of media claiming a bubble (mind you many have been claiming this for a year+) is there too many people from outside China that think that the market is exactly the same as the rest of the world or more importantly the USA but the two are at totally different positions of development. And this is also exacerbated by the fact that many are just now focusing on China and its economy but fail to realise that property in Tier 1 has been rising and falling for years.

There are many factors in the property market in China and many sectors that remain to be developed. Something you often can only understand from living in China even then as an outsider you can't fully understand. (Adam writing that last statement made me cringe as it something you have heard from locals many times but there is some truth to it)

Damian Holmes
Director SUSTAIN DS - Landscape Architecture & Urban Design Studio - Shanghai

Hugh, Thanks for your

Hugh,

Thanks for your comment. There is no question that there is currently a problem with the price of residential real estate compared to household income in China- especially in the first tier cities like Beijing, Shanghai and Shenzhen. No one is more acutely aware of this predicament than Chinese government leaders who are doing everything they can to reign in the out of control speculation. Even Premier Wen Jiabao has been very vocal about his concerns with the real estate market.

Yet there are some very fundamental differences between the way real estate works in China versus its Western counterparts, especially with the people purchasing individual living units. In China, buyers are required to put at least 30% down for a first home and, in order to discourage 'flipping', government regulations require 2nd home buyers to put at least 50% down. Not only that, many buyers are reluctant to take out loans from the bank and will instead borrow money from parents or other family members to make their debt situation less daunting.

Compare this with the U.S. before the recession where individuals and families were buying multiple homes on credit, with no money down, high interest loans and using home-equity lines of credit to fuel consumption. This is simply not happening in China. As such, if there were to be a market correction in the price of real estate, the blow to individual homeowners would be much less. Yes, the value of their home may go down but they will probably not be underwater with mortgage debt.

What about all those empty residential units on the periphery of Beijing? Those were probably built by developers (many of them state-owned) who took out construction loans from large banks (state-owned) and encouraged by the government (the state) to develop that land. You see, when the municipal and provincial governments auction (or give) land to developers, they mandate what must be built there (this is China's version of 'zoning'). They also give time limits on when something needs to be built by so if the developer does not get their act together, they will lose the land and the local government will take it back. Thus, they are encouraged to act quickly.

What happens when a residential development is built and remains empty? Well, nothing, except the building sits empty. Because many of these are developed by state-owned enterprises who got loans from state-owned banks, the state will be the one who either takes the property from the developer who cannot pay back the construction loan or will just let it sit. As a matter of fact, it doesn't even matter because the government still owns the land anyway! I understand this line of thinking is extremely foreign to anyone accustomed to the development business in the West but the reality is fundamentally different.

If and when the value of residential real estate begins to stagnate or go down, this will be good news for buyers currently priced out of the market. It also means that those empty units will be absorbed by these new buyers. China's rural population still sits at around 900 million people- that is an incomprehensible number! The urbanization of China's cities is still in its very infant stage.

Don't expect a real estate correction to bring down the Chinese economy. The economy is diverse and robust enough to deal with such issues. Like I mentioned in the article, the central government is doing everything it can to diversify investment in economic sectors other than real estate.

In conclusion, I would just like to say- don't underestimate the power of the Chinese government to regulate itself out of a crisis!

Adam Mayer

China's housing bubble

Adam - i hope your benign view is correct, but regrettably I have serious doubts.

There is an excellent article on Mish's (Mike Shedlocks) website today thats well worth reading.

My view is that China has a massive bubble with major malinvestment problems.

Of particular concern are the grossly elevated residential unit prices in relation to household income - a hugely important measure indeed. You will note within Mish's article that Beijing now appears to be a whopping 22 times income. I suggest you read the recent excellent article on New Geography comparing Texas and California by my co author of the Annual Demographia International Housing Affordability Surveys, Wendell Cox. Note his superb graph showing how California hit near 9 times incomes, before the bubble burst, triggering the Global Financial Crisis. Beijing appears in excess of double that.

It has also been reported out of China in a recent Zerohedge article, that there are around a whopping 65 million new vacant residential units in Chinas major cities. At a guess of an average bubble value of $US150,000 - that could represent $US10 trillion - without even considering the bubble values of the existing residential stock. I covered this in a recent brief article Scoop " China: The Mother of All Housing Bubbles".

Thank you for your most informative perspective.

Hugh Pavletich
Performance Urban Planning
www.PerformanceUrbanPlanning.org
Christchurch
New Zealand