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The woes of Chinese property development firm, Evergrande, heavily indebted to both domestic and foreign lenders and on the verge of collapse, has engendered a Schadenfreude moment amongst China sceptics: but is it premature? After the crisis broke out, some proclaimed that the imminent failure of Evergrande might just be China’s “Lehman moment", referring to the 2008 bankruptcy of the New York investment bank, Lehman Brothers, which was the opening salvo in the global financial crisis. Yet, global financial markets settled after a day or two of turmoil, as investors bet that that the Chinese state, which still heavily regulates the economy, will restructure the debt-laden firm in a manner that forestalls any potential international contagion. The critics might just have to wait before popping the Schadenfreude champagne corks.
Yet, even absent contagion, the Evergrande saga is but the tip of the iceberg of an overheated and indebted property sector which potentially threatens the edifice of the larger Chinese economy and, therefore, indirectly the global economy too. In a fascinating long read, British-born historian Niall Ferguson makes just such a case (“Evergrande's Fall Shows How Xi Has Created a China Crisis", Bloomberg Opinion, 26 September bloom.bg/3A9KCWI).
As Ferguson observes, Evergrande is emblematic of a China that has developed in the past decade with an economic development paradigm premised on “urbanization on steroids". For all of the skyscrapers, both commercial and residential, that dot the landscape of Chinese cities, large and even small, many of them remain empty and their property developers unable to sell enough units to pay-off the debt incurred in putting up the buildings to begin with.
In other words, the property sector in China, larger even than in the US on the eve of the collapse of Lehman, is a ticking time bomb that could have significant macroeconomic consequences beyond the property and financial sectors through the impact on Chinese households, who are heavily invested in a property market that has been in bubble territory for some time. Citing research by Harvard economics professor Kenneth Rogoff and his co-author Yuanchen Yang of Beijing’s Tsinghua University, Ferguson notes that housing wealth accounts for a whopping 78% of total assets in China, much higher than the 35% share in the United States, for instance. The upshot is that consumer spending in China is, as per Rogoff-Yang, “significantly more sensitive to a decline in housing prices" than in the US. The impacts of a more generalized collapse in the property market in China could be large and consequential for the global economy.
For those with a long enough memory, none of these recent developments should come as a surprise. As long ago as 2004, economist James Dean and I argued, and as I summarized for Mint readers much later (“Will the elephant overshadow the dragon?", 5 March 2015 bit.ly/3ixSLyx), that the Chinese model is characterized by the glaring contradiction between ever-increasing economic freedoms and an authoritarian political dispensation. What is more, the economic development paradigm of the Chinese Communist authorities was focussed on an infrastructure-driven, “build and they will come" model, in sharp contrast to, say, the Indian model in which the supply of new infrastructure is driven by the demand for it, rather than the reverse.
The consequence, as Dean and I argued in 2004, was a Chinese development success story that was something of a house of cards, and built upon excessive investment, including in housing—what the Austrian school of economics would call “malinvestment". Chinese growth statistics would, therefore, in an important sense be inflated. After all, if the economy grows rapidly because of a stock of property and infrastructure that ultimately will never be put to use, and which leads to the accumulation of large debts, such rapid growth may be unsustainable and, in a certain sense, illusory.
Up until now, China sceptics, including your columnist, have been confounded by the reality that successive generations of the Chinese leadership have shown a remarkable ability to continue to refresh and reinvent their model—both economic and political—thus ensuring that growth rates remain high and that the spectre of social chaos and unrest remains at bay. Every Chinese leader since Deng Xiaoping and his pioneering reforms of the late 1970s have managed to maintain the unwritten but all-important bargain with the populace: “we will give you the opportunity to get rich, and the price is that you must stay out of politics". But perhaps, just perhaps, the chickens may finally have come home to roost on the watch of authoritarian strongman, Xi Jinping—what, writing in 2015, I had reckoned might be an “implosion" in the Chinese economy or a “belated and disorderly democratization" of the society.
What might make this time different is that in the past few years, Xi has begun to rewrite the unwritten social compact, and increase government and party control over the economy, and reign in what he clearly believes is an excessively free and insufficiently regulated market economy, undoing the premise of Deng’s reforms. He has also been, first quietly and now overtly, building a cult of personality to match that around Mao. If the economy and the public mood sour, Xi may end up ruing these choices.
Vivek Dehejia is associate professor of economics and philosophy at Carleton University, Canada.
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