Further Thoughts on Real Estate’s Impact on GDP
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.