Lessons from China’s home sale crash

The comment is an excellent example of what happens when building and selling new homes becomes a perpetual growth strategy, and then goes wrong beyond a point. In a working paper titled Peak China Housing, Kenneth S. Rogoff and Yuanchen Yang estimate that in 2016, the size of all direct and indirect inputs to the real estate sector amounted to 29% of China’s gross domestic product (GDP).

This essentially implies that any slowdown in the sector is likely to have a huge impact on overall economic activity in the country. In July, sales of the 100 top builders in China fell by close to 40% from July 2021. An estimate made by S&P Global Ratings suggests that Chinese home sales in 2022 are likely to fall by 30% in comparison to 2021. This is worse than the 20% drop in 2008, the year the global financial crisis began.

This data explains what was behind the comment made by the CPC official. The real estate sector has become way too important for Chinese growth.

In fact, a 2016 estimate made by consultant KPMG in an Indian context suggested that real estate has “significant backward and forward linkages with more than 250 ancillary industries". The same linkages are true for China as well, or any other country. As far as forward linkages go, building more homes creates demand for steel, sand, cement, bricks, pipes, ceramics, paints, wood, plaster, etc. As far as backward linkages go, demand is generated for bank home loans, transportation, furniture, furnishings and so on.

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Let’s take the case of cement. As Vaclav Smil writes in How the World Really Works: “In just two years—2018 and 2019—China produced nearly as much cement (about 4.4 billion tons) as did the United States during the entire 20th century (4.56 billion tons)." Of course, not all of this production went into building homes, but some of it did. This was one impact of China relying on building homes as a growth strategy. It created demand in many other sectors which drove economic growth.

At a macro level, building homes also helps developing countries move people away from agriculture. Farms tend to have huge disguised unemployment in developing countries. This means that there are way too many people trying to make a living out of farming. On the face of it, they seem employed. Nevertheless, their employment is not wholly productive, given that agricultural production would not suffer even if some of these employed people stopped working. Building new homes creates jobs for low-skilled and semi-skilled individuals and helps them move away from agricultural employment.

For all these advantages to be sustainable over a long period of time, it is important that new homes are bought by individuals looking to live in them. The trouble is that this is not how the world operates. The price of real estate operates in two dimensions. One is rooted in the real world and the other in financial speculation.

As Edward Chancellor writes in The Price of Time: “The ostensible rationale for China’s incredible building spree was urban migration. Yet while hordes of migrants worked on construction sites, they couldn’t afford to acquire the properties they built. Instead, much of the demand for new homes came from investors."

Over the years, this has led to the building of ghost cities where no one stays. It has also led to finances of those wanting a home to live in getting extremely stretched, and finally, it has led to heavily-indebted real estate builders. These factors have led to China’s recent crash in home sales. And given how huge the sector has become there, this slowdown must be impacting overall economic activity.

China’s is not the only example of a government trying to create economic growth by pushing the building of new homes. Before it, much of the rich Western world, including the US, pursued this strategy through the 1990s and the 2000s.

As Raghuram Rajan wrote in Fault Lines: How Hidden Fractures Still Threaten the World Economy: “Politicians love to have banks expand housing credit… It pushes up house prices, making households feel wealthier, and allows them to finance more consumption. It creates more profits and jobs in the financial sector as well as in real estate brokerage and housing construction. And everything is safe—as safe as houses—at least for a while."

The trouble is that flipping houses to the next person who doesn’t need to live in it and wants to flip it further cannot go on endlessly. At some point, it comes to an end, as it did in the US between 2006 and 2008, and in China now.

To conclude, as Chancellor writes: “In December 2016, [China’s President] Xi Jinping proclaimed that ‘houses are for living in, not for speculation.’ Yet at the time nearly a third of Chinese families owned one or more vacant properties." Clearly, this wasn’t the last time a politician didn’t mean what he said.

Vivek Kaul is the author of ‘Bad Money’.

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