We have received an e-mail from a friend, which was the latest example of countless similar ones we have seen during the past few years. The attached graph argues that China’s property prices had “The Mother of All Bubbles”. Now, that’s a title that sells…
Since we have only seen the graph, but not the original report itself, we don’t know what the “best case” and the “worst case” meant. Anyways, this is not our concern right now. We want to object this “mother of bubbles” argument from two different points of view, about which we will write in the future: (1) It is very misleading to reach on a conclusion about China (in fact, about many countries), based on only one insulated data and (2) China should be treated as a special case, where the trends and data can easily dwarf other country examples.
Before moving on, we want to strongly emphasize that we don’t argue China’s real estate sector has no risk or speculative price movements. There are some risks stemming from over-investment (in some areas) and rapid price increases (in some others like Shanghai). However, this is a long subject to be written in another post.
First of all, we object the argument that China had a property bubble, by only looking at the prices in Shanghai alone. Most comments about a bubble in China’s real estate sector uses megacities, like Beijing, Shanghai, Shenzen and Guangzhou, to support their argument. However, when we look at smaller cities, we can easily see that the prices did not go up that dramatically.
We have a confession here. We have chosen the Tier 2 and Tier 3(*) cities on purpose, among the ones with the lowest increases in property prices. This serves us well, in supporting our argument that “one or few observations does not explain all of China”. Anyways, does anyone reach a conclusion about the housing prices in the U.S., by only looking at New York?
Our second objection is built around our view that concluding to an asset bubble only based on the price is wrong. When we look at the graph, the sevenfold increase in Shanghai property prices in the past 15 years is indeed noteworthy. However, before reaching a conclusion about a bubble in a certain asset, a sensible economist should first look at the supply/demand conditions and whether these conditions justify the price movements. Let’s see, if we can assess the supply/demand conditions in Shanghai housing market. Our data misses few years of the price graph above from both ends, however, that would not affect our argument much.
First, the demand. The population of Shanghai had increased by 7 million (**) people between years 2003-14 and a 2015 study shows that average housing space per capita is around 24 squared-meters (m2). Thus we can easily calculate that only the population increase means 168 million m2 of new housing demand. Adding up other factors, like existing home owners’ demand for newer property, married couples leaving their parents’ homes to have their own, increased demand for larger houses as Shanghai citizens’ income grow(***) etc., besides speculative moves, the total space sold, during the same period, sums up to 275 million m2. Looking at the other side of supply/demand balance we calculate that in the same period, the total supply of new housing property was 242 million m2. That means, demand is more than supply, i.e. prices are naturally expected to increase.
The demand for housing in the biggest four cities is also mentioned by others. For example, this working paper by the IMF (2015), which conludes that housing stock has been decreasing particularly in the “Big Four”, supports our argument about Shanghai, at least. We strongly recommend this paper, due to its’ emphasize on the difficulties of understanding China’s property market, as well as on price developments should not be considered individually.
As a result, we repeat that one should refrain from reaching conclusions about China by only picking certain individual examples. Furthermore, if we want to understand China, we should be prepared to come across some incredibly big numbers, which could look irrational at first sight.
(*): In China, the biggest cities are divided into three (sometimes four) “Tiers”, according to their size. However, even official documents do not clearly state which cities fall into which Tiers, nor how many cities in total are classified. Nevertheless, it is generally accepted that Beijing, Shanghai, Shenzen and Guangzhou are the “Big Four” cities that make up the 1st Tier.
(**) This is the official number, so it supposedly doesn’t count the immigrant workers, who are outside the “hukou” system.
(***): Real per capita GDP of Shanghai has inceased by 2,5 times (3,7 times, nominally) between years 2010-2014.