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Beijing Running Out of Options with its Real Estate Bubble

David Godow
April 18, 2011, 10:30am

Can the Chinese government stop the runaway (bullet) train of housing and infrastructure overinvestment before it's too late? That's the question NYU Stern's Nouriel Roubini asks in his latest column at Project Syndicate. In the 2010-2011 fiscal year, fixed investment as a share of China's GDP reached 50 percent -- half of the entire country's wealth goes towards new buildings, trains, "highways to nowhere" and industrial machinery. As Roubini notes:

... no country can be productive enough to reinvest 50 percent of GDP in new capital stock without eventually facing immense overcapacity and a staggering nonperforming loan problem.

Reason Foundation's Shikha Dalmia and Anthony Randazzo tackled this issue as it was heating up last summer, pointing to the massive bubble gripping the Chinese real estate market.

One shining example: Ordos City in the Autonomous Region of Inner Mongolia. Called the "Dubai of northern China", Ordos is a gleaming metropolis featuring state-of-the-art architecture and amenities, built to house 1 million people. The only problem? Independent estimates put the full-time population at a few thousand. People simply do not want to move there.

Of course, the fact that no one want to live in Ordos hasn't cooled the real estate market. Most of the empty housing has been snapped up by individual investors confident they'll see a return on their money. The fact that the city has been empty for five years doesn't seem to have dissuaded anyone.

This hysterical demand has pushed housing prices across China to over 8 times the average household income -- in Shanghai, the average price hit reached 37 times income last year. In the U.S., the figure is closer to 3-4 times income.

Beijing, though its own state-owned banks have fueled the bubble, hasn't been blind to the insanity that has gripped the real estate market. In an effort to calm investors and its own middle class, who are increasingly boxed out of the market by skyrocketing prices, the government announced it would build 36 million new units of affordable housing over the next five years. It's also taken steps to cool demand by increasing down payment requirements and mortgage rates.

The problem of the bubble is now being exacerbated surging inflation, exactly the outcome Beijing was trying to avoid last year when it began to take efforts to cool the Chinese economy. The government is now increasing restrictions on bank lending, hiking rates, and instituting price controls on some consumer goods.

Inflation is forcing the central government to crack down even harder on runaway capital investment -- unfortunately, it may be difficult to stop the train. It's long been known that China's local governments have a huge stake in the property bubble; real estate sales make up to 50 percent of municipal revenues in some cities. A sudden fall in prices could also devastate state-owned banks, which have been forced to finance increasingly outrageous developments across the country.

Analysts both within and without the Chinese government have long known that the Chinese economic model will need to change soon. According to Credit Suisse economist Dong Tan, inflation, which averaged 1.8 percent over the last decade, might sit closer to 5 percent in the next.

That China is no longer able to relentlessly build, build, build without affecting price levels is a sign that Nouriel Rubini is right: the country just doesn't need that much more fixed investment. These economic pressures will make gently winding down the real estate and infrastructure bubbles without a catastrophic collapse that much more difficult.


David Godow is Research Assistant


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