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Further Thoughts on Real Estate’s Impact on GDP

January 20, 2012

In my previous post, I offered a rough-and-ready estimate of the impact that a real estate slowdown could potentially have on China’s impressive rate of GDP growth.  Based on some of the official figures for 2011, released earlier this week, I concluded that a mere leveling off (zero percent growth) in property investment — much less an actual contraction — could easily push China into “hard landing” territory.

Wei Yao of SocGen, some of whose figures I cited, apparently reads this blog and posted a comment that offered some helpful insight into some of the numbers we’re working with.  He notes that while GDP figures reflect cumulative value-add, “investment in fixed assets” and “investment in real estate” are all-in sums that include not only construction value-add, but also material inputs as well as existing assets such as land.

Based on this observation, I think it would be fairer to say that the calculation I ran does include the impact on the output of upstream industries (such as steel and cement), whose value-add is included in the investment sum, but does not include the impact on continuing high rates of investment in capacity expansion by those industries, predicated on ever-rising demand.  The estimated fall-off in GDP I arrived at, therefore, reflects part, but not all, of the slowing impact on those industries’ GDP contribution.

I would argue that land sales should be included as a contribution to GDP, for two reasons.  I realize this is a somewhat unconventional claim, so let me explain.  First, part of what developers in China pay for when they acquire a piece of land is what is called “primary development” — removal of previous residents, demolitions, clearing and leveling, and basic infrastructure installation — which takes place before the plot is auctioned by the local government.  In Beijing and Shanghai, this process is fairly transparent and is limited by law to a modest portion of the overall land price.  In other cities, however, the process can be quite opaque and account for large mark-up in price, much of which makes its way into the pockets of local officials and their friends.  Whatever one thinks of this practice, the “value” added constitutes a form of (albeit dubious) economic activity, not a pre-existing asset.  The underlying value of the land itself constitutes a much smaller portion of the total investment amount than one might conclude by looking at auction prices.

Second, land revenues themselves may not reflect any upstream GDP contribution, but they do fund a great deal of downstream activity in the form of local government spending (the “G” component of in the C+I+G+X=GDP equation).  Land sale revenues account for roughly 40% of local government budgets across China.  We’re not even talking about local government-sponsored investment projects here, where are mainly funded by LGFV borrowing; nor are we talking about the ability to repay such loans — I’ll discuss both these issues in Part 2B.  We’re talking about day-to-day operating expenses:  police, hospitals, schools, and other social services.  Without revenue from land sales, that spending (which contributes to GDP) cannot take place — which is exactly what Caixin magazine reports is starting to happen already in cities throughout China.

So even though the real estate investment figures and the GDP figures are not an exact match, in terms of what they are measuring, I believe comparing them still give us a reasonable window into the direct impact of a real estate slowdown on GDP.

That said, I want to emphasize that the calculations I’ve played with here are not meant as a precise prediction of what actually will happen in 2012, but as a thought exercise that highlights just how dependent China’s rate of GDP growth has become on not just high, but ever-rising, levels of real estate investment.  The main take-away being, you don’t need a collapse, you just need the runaway rate of growth to slow, in order to drain the pool.

If investment actually declines — which is hardly unthinkable based on other property booms and busts — the picture is even worse.  For instance, if property investment falls 10% (in real terms) in 2012, GDP growth drops to 5.3%.  Even if investment grows at 10% (half last year’s growth rate, in real terms), GDP still drops to 7.9% — below the magic 8%.  You can plug in any numbers you like, and see what you get.  The point is, real estate has been a huge driver of growth, and even a modest real estate slowdown matters — it can’t just be brushed aside as though it were of minimal consequence for the broader Chinese economy.

I also want to emphasize — before we get totally preoccupied with the fate of the property bubble — that the property story is really just one aspect of a much broader investment boom that has been driving the economy.  If real estate accounts for 10-13% of GDP, investment in fixed assets accounts for roughly half.  The health of the property sector is particularly important in China because of the pervasive role that land values play in underwriting lending, but the risks to China’s economy extend far beyond the market for homes and offices.  For China, real estate is just the tip of a much larger iceberg, one that I’ll explore in my next “China data” installment.

16 Comments leave one →
  1. Pu Neng permalink
    January 20, 2012 10:07 pm

    Given that there is only a compilation of other’s work here (like nearly every other post on this blog), it is certainly “rough and ready”.

    This is not research. It’s pulling together other people’s research.

    • andao permalink
      January 21, 2012 5:41 pm

      What type of research does not rely on existing research?

      I guess if you disagree with his conclusions you could say so, but it just sounds like you’re trolling.

  2. Robert Paulsen permalink
    January 20, 2012 11:59 pm

    Your point is? If aggregating a composite view based on research sources (which is reasearch btw) is correct then you can still draw important conclusions about the scenarios that could lead to a slowing of Chinese GDP. You don’t say whether you agree with the conclusions – do you?

  3. Charles permalink
    January 21, 2012 11:08 am

    Pat, I am a student and your ability to make these complex issues relatively simple is much appreciated. Clarity on China is hard to come by.
    Class of 2008

  4. January 25, 2012 1:29 am

    There will always be truths and untruths, even in collective summary of accumulated data. Is the growth or failure there-of, important in these Countries or for these Countries? There has never been a Country before this time, who could assemble such an aggressive bind in its historical search for unity and conformity. They are creating a fear in the West, because, for now, they are a terrific example of a Communist system actively producing a paradisaical utopia. They are not only a Nation being liberated, they have been so far retarded in the dark ages, that their enlightenment will serve terms of time, which will drive the West crazy. Be assured of one thing, what is happening in that block now, cannot terminate soon. This utopia will endear for ten to twenty years before the tail gets hooked on some unpleasant realization that this is a normal World with normal failures and penalties. If you have Forex available, invest, you wont be sorry. From a Western Guy.

  5. Pu Neng permalink
    January 25, 2012 9:54 am

    Yes, Mr. Chovanec does a very good job making complex issues simplistic. I agree.

    These are summaries of work elsewhere, disguised as “calculations”.

    Very much like Mr. Chovanec’s article in Foreign Policy magazine, which did not bother to cite the sources of the numbers he presented. The numbers were drawn from the work of other people, not his calculations.

    Research is original. Or it’s not research.

    • prchovanec permalink*
      January 25, 2012 11:26 am

      First of all, I think you mean my article in Foreign Affairs. Anyone who goes and reads that article will see that I either cited or linked to all of the sources I used, to the best of my knowledge. If you can cite a specific example of where I did not properly attribute a source, I would be grateful and would immediately contact the editors at FA to correct this.

      I find the notion, however, that I should be out collecting own-source property pricing and transaction data, when established indices already exist, to be a bit preposterous. The purpose of my blog posts is to interpret and make sense of data. If the meaning of all the data out there were obvious, discussions of China’s economy would be dull indeed.

      I’m being very tolerant with this comment thread in order to make clear that I welcome critical comments on this blog. However, it must be meaningful criticism. As I’ve said before, I will not tolerate personal nastiness, outright untruths, or unfounded slander.

  6. james mcevoy permalink
    January 26, 2012 12:58 pm

    [comment deleted] James, you make some very valid points. It’s too bad you couldn’t make them without being personally insulting. Remember that we are all human beings here, and try to be a little less vicious in your tone.

    To clarify: I did NOT state that FAI contributes 64% of GDP. You are correct — they are different metrics (the former is a gross all-in figure, the second is a net value-add figure – you can’t compare gross to net). That is why I clearly stated that value-add investment comprises roughly half of GDP. The reason I mentioned that “total FAI adds up to a sum equivalent to 64% of GDP” was merely to give some sense of scale relative to both GDP and net value-add investment. If this was misleading — and I didn’t think it would be, given the previous discussion — I apologize. I have removed the reference to avoid any future misunderstanding by readers.

    Remember that the whole purpose of this exercise was to get a rough handle — rough because the statistics themselves are imperfect — of what portion of China’s GDP growth is due to rapid growth in investment, and real estate investment in particular. The reason why I refer to FAI figures at all isn’t because I’m an idiot (as James suggests) but because we don’t HAVE figures for real estate’s value-add contribution to GDP, so we have to devise some kind of an estimate. The issue then becomes identifying the potential pitfalls of this imperfect methodology, and developing a nuanced understanding of what we are and are not reflecting with our estimate. As the preceding discussion indicates, there are SOME ways in which gross FAI figures actually may more inclusively capture real estate’s total impact on the economy, including upstream industries and local government revenues.

    – Patrick

  7. January 28, 2012 7:48 pm


    Just saw this in Businessweek today and thought it was very interesting. Apparently Chinese lawmakers believe they can lower housing costs by 30% without causing the economy to collapse. I would be interested to see how they plan on backstopping real estate if it falls beyond 30% of previous prices.

    Anyway, do you think they can really control this drop?


  1. Further Thoughts on Real Estate’s Impact on GDP | Five Pillars of Wealth
  2. Columbus Investment Properties » Blog Archive » Further Thoughts on Real Estate’s Impact on GDP
  3. No Growth? Not Us! | Capital Market Alerts
  4. China Economic Watch | Chinese Housing Market Correction Update
  5. Weekly Round Up February 1st – 2012 | Connect the Dots
  6. China Real Estate Unravels « Patrick Chovanec
  7. Real Estate Crash in China Underway: Foreign Funding Down 80%, Land Sales Down 57%, Starts Down 27%; Expect Chinese GDP to Plunge | FavStocks

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