I keep seeing people talking about how China is building way too many houses.  Maybe they are, but I’m having trouble following the logic.  Free Exchange links to a Barry Eichengreen column on the Chinese economic slowdown.  He supports the housing glut argument with a link to a Daily Mail column from 2011:

He added: ‘People there were joking that no one in Denaya could afford to live there. If these apartments sell at all, it is to speculators.’

Of the 35 major cities surveyed last year, property prices in eleven including Beijing and Shanghai were between 30 and 50 per cent above their market value, the China Daily said, citing the Chinese Academy of Social Sciences.

Prices in Fuzhou, capital of the southeastern province of Fujian, had the worst property bubble with average house prices more than 70 per cent higher than their market value, according to the survey conducted in September.

The average price in the 35 cities surveyed was nearly 30 per cent above the market value, the report said.

Or as Yogi Berra used to say; “no one goes there anymore, it’s too crowded.”

So let’s consider what China should be producing, if it is currently producing too many houses.  How about more exports?  I doubt the world would accept a tripling of Chinese exports, and I doubt they could find willing buyers.  How about infrastructure?  They are building roads, airports and railroads like crazy, and indeed Eichengreen suggests they are doing too much infrastructure as well.  That leaves domestic consumption, which almost 100% of economists point to as the area when China needs to increase production.

I think that’s probably true, but I am not convinced that housing construction is all that excessive.  First of all, 99% of my commenters insist I was wrong when I called the US housing bubble a surge in investment; they insist it was “consumption,” not investment.  They are wrong, but in that case why doesn’t almost everyone consider the Chinese housing boom to be a surge in consumption?  Which is it?  Or does it depend on the country?

And what sort of consumption does China need more of?  Obviously the urban middle class are doing OK.  The big problem in China is the vast rural population, as well as the 100s of millions of migrant workers in the cities. Their living standards are quite low (albeit rising fast.)  Most Chinese have enough to eat, and clothing is dirt cheap in China.  So what comes next?  If you are living in a ramshackle rural dwelling, then you dream of a sleek modern urban apartment.  Yes, you might also want lots of other things, such as home appliances.  And in the very long run you might want services like dog psychologists and spa treatments.  But most Chinese are far from that level of consumption.  So for now it’s a nice place to live and lots of stuff to put into your new house.

This is where George Carlin comes in.  He pointed out that the only real purpose of a house is to have a place to “put all your stuff.”  So if the Chinese need to consume far more goods (and they do) then they need a place to put all their stuff.  That means more houses, lots more.

Of course there is a grain of truth in the skeptics’ critique.  China has a state-dominated economy, and is building some houses in the wrong places. But that is certainly not the big story.  Most houses are going up in big urban areas, where the Chinese are moving by the 100s of millions. Another criticism is that the Chinese can’t afford to live in these places.  So print more money.  The response is that this would create inflation.  But weren’t you just telling me that Chinese housing prices were going to collapse?  Is it a supply-side problem or a demand-side problem?  Or a misallocation problem?  I’ve tried to show that with many hundreds of millions of poor Chinese people still in need of housing, it’s not a major misallocation issue, as the vast majority of housing is being built in the cities where people are flocking in huge numbers.

BTW, Chinese industries like home appliances and cars and cell phones are also booming at a phenomenal rate.

So here’s my question for all of you China skeptics that insist they are building way too much housing, infrastructure, heavy industry, etc.  What precisely do you want them to build more of?  And what are the 100s of millions of Chinese living in tiny ramshackle homes to do?  Sit tight for a few more decades while resources pour into nice urban services for the pampered elite?

PS.  Suppose you were a homeless person living under a bridge.  You had just enough money from selling aluminum cans to feed yourself adequately. Now you find a job making iPads, which pays a thousand dollars a month. Is your priority to spend most of that extra cash on even more food, or more clothing, or a place to live?

PPS.  Yesterday I got my hair cut in Beijing for $4.  It was much better than the $20 cuts (incl. tip) I get at Supercuts in America.  I went roughly 10 or 15 miles in a taxi for about 30 minutes–it cost $6.50.  In Boston it would be $40.  An ice cream cone at McDonalds is 50 cents.  The subway costs 32 cents, and is far better than the NYC subway.  The China Daily newspaper costs 24 cents.  If you priced Chinese consumption at America prices, then China might already have the largest consumption sector in the world.  And if they build lots of houses it will get even bigger–much bigger.

You see consumption everywhere, far more often than you see investment.  The TV channels are full of ads for shampoo and similar products.  Beijing is very much a consumer society, although that’s less true of the poorer parts of China.

Suppose the captain set the steering wheel at a position that would be expected to lead us to New York.  At least as long as there was no wind. But it was windy, and we ended up in Boston.  Would you:

1.  Blame the wind.

2.  Blame the captain for not adjusting the steering to compensate for the wind.

Some commenters ask why I have such a strange definition of monetary policy, attributing any change in NGDP to monetary policy.  Heh, I’m just using Captain Ben Bernanke’s definition.

PS.  Some people argue that the Fed’s made a big effort, it just hasn’t been enough.  Actually the Fed’s made a negative effort.  Printing money is profitable, and hence the Fed ‘s profits have more than doubled form the level of 2007.  They are now earning the largest profits earned by any bank in human history.  Since when does printing money require a lot of effort?

PPS.  In any case, the recent recession was not caused by Fed errors of omission.  The dramatically slowed the rate of growth in the base during late 2007 and early 2008, from about 5% per year to zero percent.  That error of commission triggered the recession in December 2007.  Then in late 2008 they dramatically raised real interest rates, making the recession far worse.  Neither of those are good indicators of monetary policy, but no matter what indicator you use, the Fed is at fault.

PS.  Not much time today, but a few responses to comments.  After all the quotes I provided there are still some commenters who seem to think I was unfair to DeLong in simply pointing out that he had claimed that because the Fed was out of ammo we needed to use fiscal stimulus.  All I can say is “this is your brain on politics.”  The pushback on my defense of Mankiw et al was more reasoned, but I’m still not convinced.  The issue seems to be that they reported findings from others that supported their hypothesis, but overlooked findings from the same paper that contradicted it.  I claim that’s fair.  I do that.  I’ve seen Krugman do that.  As far as a know it’s OK to say “So and so claims X” and then later to say “and we believe Y” as long as So and so does claim X, even if elsewhere he argues “not Y.” 

On the other hand I won’t defend their entire paper, there are some rosy scenarios on taxes and growth.  I support supply-side reforms, but don’t expect a big boost to GDP.

Where did I get the crazy idea that back in 2009 DeLong believed we needed to use fiscal policy because monetary policy was out of ammo?

Taken from my own comment section (where I never delete comments, except for language or libel of others):

I tried to post these to Brad’s site yesterday but he deleted my comment…

January 19, 2009:
“The fact that monetary policy has shot its bolt and has no more room for action is what has driven a lot of people like me who think that monetary policy is a much better stabilization policy tool to endorse the Obama fiscal boost plan.
The fact that Gary Becker does not know that monetary policy has shot its bolt makes me think that the state of economics at the University of Chicago is worse than I expected-but I already knew that, or rather I had thought I already knew that.”
http://delong.typepad.com/sdj/2009/01/will-gary-becker-please-return-from-the-gamma-quadrant.html

January 27, 2009:
“I think we have done [monetary stimulus–the central bank buys short-term safe government bonds for cash] and can’t do any more of it and expect it to have any effect.”
http://delong.typepad.com/sdj/2009/01/delong-smackdown-watch-slope-of-the-lm-curve-edition.html

February 09, 2009:
“Why We Need a Big Fiscal Boost Program:
Because monetary policy is already tapped out-Treasury interest rates are at zero”
http://delong.typepad.com/sdj/2009/02/why-we-need-a-big-fiscal-boost-program.html

And someone emailed me the following:

The answer to the question “why not do monetary policy?” is “we are.” We are doing expansionary monetary policy–but that we have done all the expansionary monetary policy that we can, and we do not think that it is enough to keep us out of a depression.

Link:  http://delong.typepad.com/sdj/2009/03/notes-for-uc-davis-debate-on-the-stimulus-package.html

In early 2009 both Paul Krugman and Brad DeLong frequently argued that we needed to use fiscal stimulus because the Fed was out of ammunition.  These posts and articles contributed to an appalling lack of understanding of the role of monetary stimulus, especially on the left.  Even Matt Yglesias has conceded that this is a weak spot for progressives.  Of course that’s not to say that these two figures never said unconventional monetary stimulus was worth a shot.  But the vast majority or readers assumed that they were saying the Fed was out of ammunition, as that’s the message they highlighted.  Obviously things changed later on, and now both are demanding monetary stimulus from the Fed.

I see that Brad DeLong is now trying to rewrite history, and deny he made these claims.  This surprises me, as he wrote an article for The Economists Voice (published in February 2009) that was almost entirely devoted to the proposition that monetary stimulus (and several other options) were not feasible, and hence Obama’s fiscal stimulus plan was the only solution to the recession.   Just a month later I published a rebuttal in the same journal.  Indeed I got into blogging primarily because I was appalled by what I was reading in the other blogs during late 2008 and early 2009.  Almost no one was talking about how tight money was driving NGDP sharply lower, and dramatically worsening the recession.

I’ll say this in defense of Brad DeLong; he didn’t go off the deep end like Krugman did in response to the Romney economic paper.  I read all the criticism, but when I looked at the paper I couldn’t find a single place where they had misquoted anyone.  The fact that the people they relied on don’t entirely agree with their conclusions is not surprising.  All papers in support of campaign promises are going to rely on rosy scenarios.  But why the big fuss?  It seems to me that Taylor, Hubbard, Mankiw and Hassett quoted each paper accurately.  I’ve seen Krugman quote papers and then leave out the part that conflicted with his views. And yet he throws around terms like “fraud.”

Update:  I see that commenters Patrick Sullivan and Steve are finding other examples.  Thanks google.  I wish I had time to dig through his old blog posts–I could find dozens of examples.

Update:  Mark Sadowski commented as follows:

Scott,
You should provide a link to your Economist’s Voice article so people don’t have to search for your rebuttal:

http://www.degruyter.com/view/j/ev.2009.6.4/ev.2009.6.4.1543/ev.2009.6.4.1543.xml?format=INT

David Henderson quotes from a email by Jeff Hummel:

Most explanations for the current persistence of high unemployment fall into one of three broad categories:

1. Insufficient aggregate demand. This is the position of the Sumnerites who advocate more monetary stimulus and the Keynesians who advocate more fiscal stimulus. While I agree with Scott Sumner that Bernanke’s monetary policy was too tight when the crisis hit during 2007-2009, I think that is irrelevant now. Why hasn’t there been sufficient time for inflexible wages or prices to adjust?

A few points in response:

1.  Most other explanations (such as policy uncertainty) also require sticky wages to explain high unemployment.

2.  The 2008-09 slump was different from all other deep recessions in one key respect.  After the severe 1907, 1921, 1929-33, 1937-38, 1957-58, 1974-73, and 1981-82 slumps, NGDP recovered rapidly.  This time the recovery was very slow.  Hummel seems to accept my view that the big crash in NGDP (due to bad monetary policy) pushed unemployment from 4.5% in 2007 to 10% in late 2009.   Can that explanation explain why unemployment has only fallen to 8.3%?

From a common sense perspective the answer is no.   Common sense would suggest that wages and prices should have adjusted by now to the negative nominal shock.  But there’s another way of thinking about the problem that makes my argument much more plausible.  Let’s start with the fact that we really don’t understand wage stickiness very well.  Most people visualize long term contracts that get renegotiated, but it’s also about things like minimum wages (which were raised sharply), government unions, money illusion at the zero rate increase point, protected sectors like education and health care, etc.  It’s a very complex labor market.  So let’s consider sticky wages a sort of black box that we don’t fully understand.

Now let’s consider the stylized facts:

1.  Nominal shocks have real effects, just as the sticky wage theory would predict.

2.  Big nominal shocks have big real effects, just as the sticky wage theory would predict.

3.  Fast NGDP growth during recoveries is associated with fast recoveries in employment, just as the sticky wage theory would predict.

4.  The extremely slow recovery in NGDP after 2009 was associated with an unusually slow recovery in employment, just as the sticky wage theory would predict.

5.  Wage growth slowed sharply after 2008, just as the sticky wage theory would predict.

6.  Aggregate wage growth never fell below zero, which is hard to explain from long term contracts alone, but can perhaps be explained by combining all the factors discussed above, especially money illusion.

7.  Given the combination of very slow recovery in NGDP, and wage growth only slowing from about 4% to 2%, you’d expect a very slow recovery.  And that’s what we got.

8.  But we did get some recovery, despite the fact that NGDP has been growing at below trend during the recovery.  So there has been some wage adjustment.

Given that other theories like “policy uncertainty” also require wage stickiness, I’m not really sure what’s gained from moving away from demand-side models.  Bernanke experimented with a historically slow recovery in AD (i.e. NGDP), and he got a historically slow recovery. What else would you expect?

In comment sections of recent posts people pushed back against my claim that the collapse in housing didn’t cause the recession, but most didn’t seem to understand the issues at stake.  Lots of people talked about how it wasn’t the fall in home-building alone, but that there were also bubbles in areas like commercial real estate.  No, commercial RE did fine until the second half of 2008 when NGDP collapsed.  Or they said it was the hit to consumers from mortgage defaults, or the hit to banking.  But those are channels that would reduce aggregate demand. And if it’s an AD problem, then ipso facto it’s a tight money problem. It’s the Fed’s job to stabilize AD.  If you are going to argue against monetary explanations of the crash, you need a non-AD mechanism, such as misallocation of labor into housing construction.  One commenter even mentioned the strong dollar in late 2008.  That was supposed to be a counterargument to the Fed causing the crash, as if a strong dollar has nothing to do with tight money!