Say’s Law in China

This video shows a brand new city in China with no residents, and has attracted a lot of attention.

In this video Gary Shilling takes a pessimistic view of China’s future.

In this video Mark Dow is much more optimistic.

Is China producing too much of everything?  Say’s Law says that’s impossible.  Then how about too much housing?  Perhaps, but here are some relevant estimates (or I should say guesstimates, as I had trouble finding data):

1.  When I visited in 2006 the Chinese media indicated that the average urban apartment had increased from about 85 sq feet in 1980 to somewhere around 250 sq feet.  By now I imagine it is well over 300 sq feet.

2.  Much of the urban housing is very substandard, and should be torn down at some point.

3.  In a modern economy housing units are up closer to 1000 square feet.

4.  Somewhere around 60% of Chinese residents (750 million people) live in rural areas.

5.  In the next few decades China will become overwhelmingly urban and middle class.

6.  China’s population will grow by at least another 100 million.

Now let’s put these numbers together.  No matter how I look as this picture, I can’t help thinking that China is going to build a mind-boggling amount of housing over the next few decades.  It is hard for me to imagine that China has too much housing.  Rather, the problems are quality and aesthetics.  Sometimes the housing is being built in the wrong places.  But the overwhelming majority of new housing units are built in existing cities.  Cities that are extremely overcrowded by western standards, and also that are attracting millions, tens of millions, and eventually many hundreds of millions of new residents.  I think the shock video on the Inner Mongolian city tends to obscure that reality.

Gary Shilling suggested they are building massive capacity in steel and cement facilities in order to supply their export industries.  My hunch is that most of this steel and cement will be used for housing, roads, subways, high-speed rail, sewage treatment plants, airports, power plants, office buildings etc.  Not exports.  I think Mark Dow has it exactly right; China probably isn’t the disaster in waiting that many expect.

China is the perfect illustration of the glass half full/half empty metaphor.  The system is still half communist.  Without property rights the environmental situation is deplorable (as it was in the Soviet bloc countries.)  There are all sorts of ways that the little guy gets abused by the system.  Much of the new housing is poorly insulated, which further worsens the environment.  Provincial governments have an incentive to build excess capacity in some industries.  And I could go on and on.

But don’t lose sight of Say’s Law.  Even with all the distortions in their economy, this rapid growth in investment will probably continue to drive fast GDP growth.  The distortions might mean that they need 12% measured GDP growth to get 9% growth in livings standards.  But whatever the numbers are, living standards are rising fast by almost any indicator.

Anyone who has an extremely optimistic or an extremely pessimistic view of China sees only a portion of what is happening there.  It is too complicated to be understood by simple statements like “they’re building too much capacity.”  China doesn’t really fit neatly into any models of communism or capitalism.  I have no idea what all these SOEs listed on the stock exchange are trying to maximize.  Every day they look less and less like the old Maoist-era SOEs, but they still don’t look anything like Western firms.  So what are they?  I doubt we have any good models.  Read people like Yasheng Huang and Michael Pettis, who know far more about the system than I do.

Even the Ordos video is more ambiguous than it might appear.   The video said most of the new Ordos apartments had been snapped up by speculators.  Who are they?  Why did they invest?  Is the price rising or falling?  These questions aren’t answered.

The most famous housing speculators in China are the people from Wenzhou, a capitalist enclave on the coast of Zhejiang province.  Even the sophisticated residents of Shanghai and Beijing are somewhat in awe of their business acumen. Now I have no idea how many Ordos apartments have been purchased by Wenzhou people, but I do know that it is almost impossible for you and I, sitting here in a Western country, knowing next to nothing about China, to try to decide whether these Ordos investments are wise.

Please don’t accuse me of blindly applying the EMH to Chinese housing.  There may well be bubbles in certain markets.  In fact I think it is quite likely.  All I am saying is that we don’t have any reason to second-guess the current market price of housing in an obscure provincial city in China, merely on the basis of a 4 minute video.

PS.  I will go to Houston in a few days, then to San Antonio.  Any suggestions?  I hope to see a few museums in Houston, and perhaps a Bucks game in San Antonio.



20 Responses to “Say’s Law in China”

  1. Gravatar of Thorfinn Thorfinn
    17. November 2009 at 15:11

    Hmmm, sounds a lot like the arguments being thrown around in Japan in the ’80s or here during the housing boom.

    Which isn’t to say that they won’t be someday needed. But if prices collapse, there are going to be lots of NPAs on bank books.

  2. Gravatar of Jack Duvall Jack Duvall
    17. November 2009 at 15:13

    I watched a news item concerning this on television last week. Thanks for explaining it more thoroughly

  3. Gravatar of Scott Sumner Scott Sumner
    17. November 2009 at 15:42

    Thorfinn, You said,

    “Hmmm, sounds a lot like the arguments being thrown around in Japan in the ’80s or here during the housing boom.”

    That’s funny, I don’t recall any articles about Americans living in 250 sq foot apartments or 700 million farmers about to move to the city. BTW, American has 2 million farmers.

    Seriously, I see your point, and as I said there may be some local bubbles. But at least China doesn’t do the sub-prime mortgages. Buyers must put a lot of money down. Does anyone know the percentage required in China?

    As Mark Dow said, 10% RGDP growth covers up a lot of sins pretty quickly.

    Thanks Jack, although keep in mind that the bottom line is that none of us really have a complete understanding of China, so take what I write with a grain of salt.

  4. Gravatar of rob rob
    17. November 2009 at 17:05

    San Antonio: MR has the same bleg today.

    Houston: As a local it is hard for me to see the city through interested eyes, except for the run-down parts, but as far as art goes you want to see the Menil Collection. (If you were a drinker I could tell you where to drink.)

    Are you lecturing in Houston?

  5. Gravatar of randa randa
    17. November 2009 at 17:15

    China GDP is $4T with 300B direct exports to US markets, and another 150B indirect which accounts for a 10% share of GDP. China has 800B in US treasury debt. US dollar policy is diluting their holdings, erasing margins and leaving them few alternatives but to allow their own currency to float with the market, which they will have a very hard time doing. Yes there is a big asset bubble driven by falling US dollar which means they have few good options to deal with the dollar problem or the fact the US consumers are not buying. The funny if not ugly truth is that US skyrocketing govt debt is paid for by printing money which is backed by notes sold at auction where the China is the biggest purchaser, (that’s the ugly part and now here is the funny) essentially they are in effect making their own markets in US dollars so they have to buy to support their current positions or risk dilution in a market that quickly reinforce itself. In my view, China has made a big mistake and they can only follow the US, which raises the real question, whats the US going to do?

  6. Gravatar of q q
    17. November 2009 at 17:26

    the scare stories that i have read about china mention that the amount of internal credit has increased dramatically and that there is a danger therefore of a financial crisis due to non-performing loans. however, the loans are almost all internal to china, and all denominated in yuan.

    the upshot is that if there are insolvent banks at the end of this, the chinese government will bail them out.

    i wish that brad setser was still writing his blog.

  7. Gravatar of q q
    17. November 2009 at 17:27

    oh and in houston i would go to see the rothko chapel.

    (i don’t know houston well.)

  8. Gravatar of JimP JimP
    17. November 2009 at 18:06

    The bucks ?

    What sport is that ?

    The only proper sport is baseball.

    And the only decent baseball team is the Milwaukee Braves.

  9. Gravatar of rob rob
    17. November 2009 at 19:21

    If for some reason you want to have a drink in Houston, have it at Notsuoh 314 Main St.

    Rothko Chapel is a part of the Menil Collection. Do not waste time in the Cy Twombly building.

  10. Gravatar of rrm364 rrm364
    17. November 2009 at 21:19

    @thorfinn- most Chinese banks have a massive amount of non-performing loans, but since the loans are in yuan and internal and banks and expect a speedy bailout, this shouldn’t be a huge problem

  11. Gravatar of Ralph Musgrave Ralph Musgrave
    18. November 2009 at 00:07

    Why does Say’s law preclude over-production (at the macro or micro level)?

    First, there is a significant body of opinion that Say’s law is stymied in a money economy. Thus the point is irrelevant to China. But let’s assume money doesn’t mess up Say.

    If you assume – taking a very simple barter economy – that everything is produced for IMMEDIATE consumption or exchange, then overproduction would be impossible. However, I imagine that even in real world simple barter economies, some producers keep a stock of whatever they produce, so as to meet unexpected surge in demand. I would be quite possible in such an economy for everyone to get a bit over-optimistic (animal spirits….irrational exuberance) and do a bit of overproduction.

  12. Gravatar of woupiestek woupiestek
    18. November 2009 at 00:43

    I was thinking that level targeting might work for real estate prices, much like it might work for inflation. The difference would be that government would have to set a target, probably further into the future like five to ten years, and that fiscal policy and regulation would be the main instruments. This empty city makes me think that such a policy would suit China very well. What do you think?

  13. Gravatar of StatsGuy StatsGuy
    18. November 2009 at 07:44

    Many (most?) of the non-performing loans on the books of Chinese banks are to state-owned industries. In that sense, a bailout isn’t exactly like the bailouts in the US (which were transfers to private actors). It’s really just (formal recognition of) public spending – but public spending implemented through banks rather than directly by the government. I’m not saying this much public spending is good in China. The allocation of investment capital – that is, building lots of steel mills, etc. – is highly questionable. (Then again, we’ve proven just how well we can misallocate capital too!) But unlike in an advanced economy, where it’s quite hard for the government to isolate areas of future demand without market assistance, in China it’s probably a lot easier. Simply look at historical development trends, and consider – as ssumner notes – that there is a massive housing/transportation/infrastructure gap. Even if 30% of the public spending is inefficient, that may not prove crippling (as long as they can continue to generate foreign exchange earnings to cover their raw materials inputs).

    The harder part will be figuring out how to transition the economy toward one that is not dependent on catch-up (and that’s where the growing private sector comes in).

  14. Gravatar of Scott Sumner Scott Sumner
    18. November 2009 at 17:27

    rob, Yeah, I’m going to see the Menil collection. No speeches, it is just a vacation.

    randa, I’m not sure I follow your analysis. The more T-bonds they buy, the less they invest in their own country. So what’s the link between their T-bond holdings and Ordos?

    q, I agree. I have been reading scare stories about China for 30 years, and the only thing that happens is occasional bank bailouts. Those are bad things, but life goes on.

    Thank for the Rothko tip, I had forgotten that was in Houston.

    JimP, I am old enough to barely remember the Milwaukee Braves. I know most sports fans don’t like the NBA, but then most sports fans have never seen Brandon Jennings.

    rob, Thanks for the tip,

    rrm364, I agree.

    Ralph, Those are good questions, which I address in my next post. I agree that Say’s Law allows for overproduction, but only if unemployment is too low. And that’s not a problem in China.

    woupiestek, If you target real estate prices through non-monetary means, then you have price controls, which are very bad. But they do need better regulation of the banking system, from what I have read. However, it’s not so much that banks are lending too much, but rather too much to SOEs and not enough to private businesses.

    Statsguy, I agree with the general thrust of your comments. As I said in other replies, I view the bias toward the SOEs as the biggest distortion. Some of the projects look like they are well done (to an untrained eye like me.) On the other hand Yasheng Huang argues that some of the infrastucture that I find impressive, is actually too sophisticated and fancy for a country at China’s stage of development. And I’ve seen examples of that, like maglev trains built in Germany, that even the German’s don’t have. It’s hard for me to judge; some of the infrastructure (like subways and airports) lasts a long time, and China will soon be a much richer country than it is today.

  15. Gravatar of V V
    24. November 2009 at 05:11

    Make a four minute video in Houston and we’ll see what can be read into it.

  16. Gravatar of rob rob
    24. November 2009 at 09:37

    I can make a 4 minute video of Houston: The Empty City, if I shoot it downtown on a weekend.

  17. Gravatar of Andy Andy
    29. November 2009 at 21:37

    Eat a lot in Houston. It has the best cheap food of any U.S. city that I’ve been in. Chinese, Vietnamese, and of course Tex-Mex (although I have surprisingly had less luck with actual Mexican food). I have heard that good Mexican food in San Antonio is also surprisingly hard to find.

  18. Gravatar of Scott Sumner Scott Sumner
    1. December 2009 at 08:52

    Andy, I had some good Tex Mex food, and also steak. Steaks on Boston are overcooked, so I rarely order them here.

  19. Gravatar of srp srp
    1. December 2009 at 16:46

    StatsGuy has the key point for optimists–at this stage of development it’s pretty easy to guess on an investment pattern that matches development needs, at least in crude terms. You know people are going to want cars, houses, air conditioners, roads, etc. in certain proportions and you can emulate more-developed places’ material conditions. Lots of room for inefficiencies and bubbles along the way, though, especially with all the SOEs and political stuff that goes on. In the US, we had massive capital losses on canals and railroads during out boom periods, some of which contributed to serious panics and temporary downturns.

    What worries me is that if China hits an airpocket and growth stops for a couple of years that government legitimacy will come into question, and then they’ll try to get it back–possibly by scapegoating foreigners or attacking Taiwan. Rising expectations, nationalism, and a sudden deceleration of growth is a dangerous mixture.

  20. Gravatar of ssumner ssumner
    4. December 2009 at 07:35

    srp, yes, that is the risk, but I doubt it will happen. Their governmnet is fairly pragmatic.

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