You may have seen a dramatic video filmed in the southern Chinese city of Kunming, which reveals the sheer size of China’s property bubble. Inhabitants of the city can be heard screaming as fifteen high-rise apartment blocks are razed to the ground in less than a minute. You can have a quick look, here.
It is a visual representation of China’s real estate sector crisis, as Evergrande, the largest property company in the world, is in very real danger of defaulting on the unfathomable debt it has accumulated in its attempt to “build, build, build”. Two years ago, the company was ranked as the world’s most valuable property stock, now investors won’t go near it with a bargepole. Its rapid decline has shocked even the most Sino sceptic economists out there and has exposed the deep flaws in China’s property-driven growth model. Effectively, their real estate sector is WAY too big.
A recent report has suggested the sector makes up 29% of the Chinese economy. That is unheard of. Historically unprecedented. The Chinese government has attempted to reduce its size, introducing the “three red lines” to reduce debt levels. But Evergrande could be its first victim – the bigger they are, the harder they fall.
For this reason, some are referring to this episode as a potential “Lehman moment”, comparing its decline to the Lehman Brothers collapse preceding the 2008 financial crisis. This is inflammatory, for most can only see the CCP’s severe mismanagement causing a default. But what is true, is that any attempt to rescue Evergrande by Chinese policymakers is in conflict with their attempts to force property companies to borrow less and reduce in size.
Yet the regulatory changes and Xi Jinping’s rhetoric reveals how GDP growth is not necessarily a failure for the Chinese Communist Party, a metric Western centric economists find hard to accommodate. Indeed, Xi’s new catchphrase of “common prosperity” suggests there’s been a shift in the CCP’s growth model. With enough empty properties to accommodate 90 million people, when hundreds of millions live in subpar housing conditions because the inflated property industry maintains unaffordable prices, the current misallocation of resources is a stain on China’s nominally Communist record. Xi’s intervention is another step in his ideological diversion from the trend towards liberalisation evident in the 90s and 00s.
But is it too late? After years of being taught in geography GCSE, and elsewhere, of the incredible GDP growth of China and its catching up with the USA, opinions are beginning to change. A well-regarded economist has suggested that the transition to a different growth model, one based more on higher grade manufacturing exports rather than “build, build build”, could depress GDP growth down to as little as 1 or 2 percent a decade from now. This is because it is incredibly difficult to fill the gap in economic output which even a small contraction in the property sector would leave. In another recent report, it has been estimated that a “20 per cent fall in the housing sector and related activities (if one did occur), could lead to a roughly 5-10 per cent decline in the level of output”. The Chinese growth phenomenon is seemingly in peril.
To make matters worse, the real estate boom following the global financial crisis, which increased real estate’s share of GDP by 10% within 5 years, is beginning to be seen as “fake growth” with the hindsight the Evergrande situation has provided us. Given real estate’s share of GDP hasn’t increased since 2013, it means that real estate contributed half of China’s GDP growth in the years. Now, with images of “ghost cities” and houses for millions either unfinished or empty, to what extent has such impressive GDP growth improved Chinese society? China’s lifting of millions out of poverty remains a success story, but its success has created obstacles it is already tripping over.
So what’s next? It’s not all doom and gloom for the CCP and the Chinese economy. It’s true, their authoritarian nature has moved heads throughout the pandemic, with their relatively successful bounce back compared to other major economies. Moreover, with still over 500 million people living in urban areas, China could yet have much to offer.
But as China has gained economic maturity, its leaders have searched for ways to “rebalance” their economy. But towards what? And at what cost? The recent failings of Evergrande reflect how reining in the economic giants of their economy will come at huge expense to the state or customers. Unless Xi is willing to radically overturn China’s social and economic hierarchies, then a growth in consumption to accelerate demand won’t be close to providing an answer. So perhaps investment is still the CCP’s best option, but if so, it must promote quality rather than quantity of investment. There’s still a lot to come for China, but the cracks are certainly beginning to show.