Say’s Law in China

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

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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.