Economic analysis of the Chinese housing market

 For macro purposes you could skim most and read the last paragraph; to get a good idea of how to analyse something and provide evidence for the statement in the last paragraph take a deeper look at some of the charts and consider what they reveal:

The Case of Evergrande: Is There a Housing Bubble in China?

Daniel Fernández 

– November 16, 2021Reading Time: 5 minutes

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China has made the world’s capital markets nervous. Evergrande, the largest real estate developer in China and one of the largest in the world, is on the ropes. It is very likely to go bankrupt (it has already defaulted on some interest payments on its bonds). Some people are debating whether this is the “Chinese Lehman Brothers.” Are we on the verge of a new global financial collapse?

Let’s begin by analyzing the health of the sector in which Evergrande finds itself. What is the state of the housing sector in China? Are there signs of a housing bubble?

The Chinese Housing Bubble and Empty Cities

The Chinese housing bubble has been reported for over a decade. The primary evidence is the existence of ghost cities, cities that are practically empty. For over ten years, ghost cities have not appeared to be causing a systemic problem, although they undoubtedly pose a local problem. However, the vacancy rate has continued to grow in China’s secondary cities. Even in Beijing, the vacancy rate has reached 20 percent.

China’s housing vacancy rate is relatively high when compared with other countries, although in 2017 it was lower than that of Spain and Italy.

The data on the vacancy rate are not alarming, but when this indicator (and the existence of ghost cities) is combined with other indicators, the Chinese housing sector’s situation does indeed look alarming.

Housing-Price/Rental-Price Ratio

Housing is a durable capital good, and as such must be valued. How is the price of a capital good determined? The most common way is to base it on the income the good is capable of generating. In the case of housing, the income it generates is the rent (either through the market or through the rental payments the owner avoids). Accordingly, it is crucial that the value of the house be a reasonable multiple of the rental value.

The housing-price/rental-price ratio gives a sense of how inflated a housing market is. When the indicator is very high, purchasing a house cannot be justified by the income it will generate. The only reason someone will buy a house in this case is if they hope to sell it for a higher price (and if everyone operates on the same expectation, we are facing a bubble by definition).

The housing-price/rental-price ratio in the Chinese real estate market is incredibly high. It is exceeded only by the real estate market in Turkey and Taiwan. Purchasing a home in China and renting it out is a very poor business plan, as it takes a whopping forty-eight years to recoup the investment.

The Profitability of Purchasing a House

The profitability of investing in housing can be analyzed in a similar manner. The income of a house is divided by the house’s sales price. The result (once costs are deducted) is the profitability of investing in the housing sector. An analysis reveals that investment in real estate in Chinese cities is less profitable than in cities almost anywhere else.

Further, the returns from investing in China’s housing market are much lower than the country’s prevailing mortgage interest rate. So purchasing a house in China does not make economic sense. This is a clear sign of a housing bubble.

Homes’ Purchase Price versus Citizens’ Median Income

Another way of analyzing whether the housing market is in a bubble is to determine whether the average citizen can buy a home. The main purpose of a house is to be lived in (final demand). If the price of housing grows well above the purchasing power of the average citizen, the demand for housing (which drives the price growth) may well turn out to be purely speculative and collapse in the future when it becomes clear that the final demand does not exist.

China’s ratio of housing price to per capita income is the second highest in the world (behind only India’s). It would take the average Chinese citizen 146 years to pay for a home if they were to devote all of their income to housing.

The previous indicator could be problematic as a means of comparing countries since it relates national per capita income to the price of urban housing (despite this, it is worth discussing it because of the huge contrast between China and other countries). If we disaggregate the indicator by city, we reach the same conclusion: the price of housing is too high relative to the income of Chinese inhabitants.

The Housing Sector’s Contribution to GDP

Another way to assess whether the Chinese housing market is in a bubble is to look at the housing sector’s contribution to GDP. A high contribution indicates too many resources are allocated to housing. This indicator is the logical corollary of those discussed above: if house prices are high, producers react by increasing supply, in the process drawing resources from other parts of the economy.

The contribution of China’s housing sector to its GDP is greater than the corresponding contribution seen in the huge Irish and Spanish housing bubbles of the 2000s. Nearly a third of China’s economic activity is linked to bricks.

The Disproportionate Concentration of Wealth in Housing

Another sign of a bubble is the concentration of wealth and investment in a single sector. Real estate is a favorite investment among Chinese citizens. The recent increase in the income and quality of life of Chinese citizens have exponentially increased their ability to save and invest. The asset in which they invest has almost exclusively been real estate. In 2018, 76 percent of Chinese household wealth was invested in housing (in Japan this figure is 41 percent, and in the United States it is 27.7 percent).

The concentration of assets in the housing market makes Chinese households vulnerable to shocks in that market. The valuation of the Chinese housing market today is double the valuation of the US housing market, even though China’s GDP is 25 percent lower than the United States.’ In the Japanese housing bubble that burst in the 1990s, the market valuation at the peak was also double that of the US housing market.

The huge demand for housing is generating a housing supply far greater than the housing needs of Chinese citizens (a typical bubble trait). In 2008, only 30 percent of new housing was bought by people who already possessed at least one home; in 2018, this figure was 88 percent.

Chinese Authorities Want to Burst the Bubble

The problems discussed here are so evident that the Communist Party leadership has taken action. They have implemented relatively restrictive financial measures such as debt ratios and capital requirements for housing developers. These measures have meant that the most financially irresponsible developers are prohibited from increasing their debt by even a single yuan. The Chinese housing bubble is enormous; various economic indicators leave no room for doubt. Evergrande’s problem is not an isolated issue but a systemic problem with the Chinese economy.

Job creation by government... what Economics teaches us

 Get your head round this and it will give you solid evaluation:

Green Jobs Are a Cost, not a Benefit

James E. Hanley 

– November 1, 2021Reading Time: 4 minutes

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The International Energy Agency recently reported that shifting to clean energy will create between 13 and 26 million jobs by 2030. They present this as a benefit, but that’s misleading; jobs are not a benefit but a cost.

That might sound counterintuitive, but it’s easy to understand. Say you need to do repairs on your home, and you can’t or don’t want to do them yourself. That means you have to pay for both materials and labor. But imagine that the materials would magically assemble themselves into the needed repair work all on their own. Then you would only have to pay for materials, and you would save the cost of hiring someone.

This is true for any business as well. Suppose the elements of their business could magically assemble themselves into the finished product or service. The business owner could then avoid spending on employees and pass some of that savings on to customers. That’s why automation has replaced so many laborious tasks over time, from agriculture to washing clothes to taking orders at fast-food restaurants.

Can you save the cost of labor by doing your own repair work on your home? No, because your time has value. The time and energy spent doing the home repair can’t be spent on something else, whether that something else is a money-making activity or just leisure. That’s the opportunity cost of your labor, the lost opportunity to do the next most valuable thing with your time, whether for you that’s doing something that makes money or just enjoying some leisure time. Even if you find working on your home pleasurable, there’s still an opportunity cost. If that cost is high, then it’s worth hiring someone else. If it’s low, it may make sense to do the work yourself. But either way, there’s a cost.

But aren’t jobs a benefit to the person who has the job? No. They are no more a benefit than your labor on your own home is a benefit. The income is the benefit, and the job is the cost you pay to get the income. That’s easy to see if you imagine getting the same income without having to work for it. Consider why nobody talks about what job they’ll have in heaven. Our standard picture of heaven is that we have all our needs taken care of without doing any work. All our time is leisure time. That vision implicitly recognizes that having a job is a cost. It may be a necessary cost here on earth, but it is nonetheless a cost.

Which brings us back to green jobs. The International Energy Agency suggests that creating millions of jobs in clean energy is a benefit, but now you should see that these jobs are really a cost. You can see this more clearly by thinking about who pays that cost. After all, someone has to pay for all that labor. And that someone is the public. Imagine how much cheaper the transition to clean energy would be if it required fewer jobs, so the public didn’t have to pay for as much labor. Then the clean energy policies would have even more net value. 

And if such a loss of jobs in the energy sector were to occur, it would not mean a net loss of jobs. Instead, those workers would become available for employers in other sectors of the economy to hire. Then for the same amount of labor, we would get both green power and whatever other goods and services those workers would end up providing for us. So if government wanted to craft a truly economically beneficial clean energy policy, it would devise one that requires fewer workers in the energy industry.

Government is not needed to create jobs. The private sector does that on its own and does it best when government stays out of the way. Consider that the U.S. population has tripled in the past century while at the same time automation has eliminated countless jobs. Yet, in the years just before the Covid-19 pandemic, the unemployment rate was historically low. Or consider automated checkout in grocery stores that has reduced the number of cashiers. Naively one would expect a reduction in grocery store employment. Instead, those workers have shifted to tasks like shopping for customers who then come to the store just long enough to pick up their order. Freeing up labor from one job makes them available for new tasks that nobody could do for us in the past.

Government policies that “create” jobs – green or any other color – are not adding to the total number of jobs. They are only shifting them away from other economic sectors. And they can only do so by offering higher wages, which are paid for by us members of the public. So once again, those jobs are a cost of the policy, not a benefit.

This isn’t an argument against clean energy. This is an argument that jobs are not a reason to favor clean energy. If we have decided to transition to clean energy for environmental reasons, then we should hope for clean energy that requires fewer jobs. That would be a real benefit.

Two sides to the minimum wage story

This encapsulates the “on the one hand... but on the other...” approach you need to develop for a high grade.

The credibility revolution

CARD, ANGRIST AND IMBENS: THEIR LEGACY IS EVIDENT ALL AROUND US

marginalrevolution.com

The Nobel prize for economics went this year to David Card, Joshua Angrist and Guido Imbens, says Alex Tabarrok. “If you seek their monuments, look around you.” They developed methods to analyse “natural experiments” – that is, observing the results when circumstances change in one part of the world but not another. Much empirical work in economics follows their lead.

JUST OPEN YOUR EYES

Take the long-running row about minimum wages. The obvious way to estimate the effect of a minimum wage is to look at the difference in employment before and after the law goes into effect. But other things are changing over time, making it hard to know whether the observed changes were really due to the wage floor or not. When New Jersey passed a minimum-wage law in 1992 but neighbouring state Pennsylvania didn’t, a natural experiment was set up, and its results studied by Card and fellow economist Alan Krueger in 1994. Given that it is reasonable to assume that factors affecting employment in both states would be roughly similar apart from the changed law, the effect of the law on employment levels could be seen. Their surprising finding was that minimum wages in fast-food restaurants did not reduce employment and may even have boosted it. Their approach seems obvious today, but it was a brilliant innovation in 1992, at least in economics.

Angrist and Krueger dealt similarly with another classic problem in economics – how to estimate the effect of schooling on earnings. People with more schooling earn more, but is this because of the schooling or because people who get more schooling have more ability? To find out, the economists exploited a quirk of US education, meaning that children born in the fourth quarter of the year are more likely to have had a little more education than those born in the first quarter. The effect is as if someone had randomly assigned some children to get more education than others – ie, another natural experiment. Analysis of the data showed that those getting less education did indeed earn less – the implication of the numbers is that an extra year of education raises earnings by 10%. (Imbens, the last of the Nobel-winning trio, was more involved in the development of the theoretical framework underlying work such as this.) 

The real lesson from this “worthy trio” is not so much in their results as the method: “Open your eyes, be creative, uncover the natural experiments that abound –  this was the lesson of the credibility revolution”.

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What the Nobel winners get wrong

mises.org

The work of the Nobel-prize winners (see above) purports to have solved the problem of how to distinguish cause and effect from mere correlation in data, says Frank Shostak. This is nonsense. Even in the natural sciences, all that can be done is to isolate various facts and hypothesise about the true law that governs their behaviour. If the theory and the facts agree, the theory is tentatively accepted. But economics, as Ludwig von Mises explained, is nothing like this. In economics, we do not need to hypothesise, for we can “ascertain the essence and the meaning of people’s conduct”. We know from introspection that human action is purposeful and that the meaning of our actions can be determined. This knowledge is “certain and not tentative”. 

So, to take the example of minimum wages, we know that fast-food workers take the job in order to earn money to achieve their goals. The business owner is set on making profits, and will not employ workers if he is forced to pay more for the work than it is worth. It stands to reason, then, that wage floors will undermine the labour market to the detriment of both workers and businesses. No amount of data gathered from complex phenomena and then examined will tell us anything to challenge these insights.

Important analysis of current monetary policy stance

Bank of England steps closer to a rate hike

Next month’s vote pits the Bank’s doves against its hawks, whose calls for higher rates to tackle inflation are gaining ground 

While Covid cases remain stubbornly high, the Bank of England's emergency stimulus – brought in to counter the effects of the pandemic – could start to be reversed in as little as three weeks.

Officials at Threadneedle Street are looking at raising interest rates. Financial markets think there is a 50-50 chance this will happen on November 4.

Sterling leapt to €1.185 on Friday, its highest level against the euro since Covid first erupted on the global stage, as the prospect of higher rates attracts international financiers.

Pound vs dollar

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This would represent something of a handbrake turn for an institution which had taken a leading role setting out steady policy and reassuring markets, businesses and households.

Next month’s vote between the nine members of the Monetary Policy Committee (MPC) is finely balanced as hawks come out of hiding to make the case for higher rates to control inflation, while doves – in the ascendency until the past few weeks – defend ultra-low rates as a key prop to the economy.

A move in the coming weeks would mark an end to the emergency policy introduced in March 2020, taking the base rate from its current level of 0.1pc, a record low, back to 0.25pc.

More hikes could follow.

City traders are fully pricing in this first hike for December, with repeated tightening over the next year taking rates as high as 1pc by the end of 2022, a level not seen since 2009.

Bank officials have already indicated that once the base rate rises to 0.5pc, the door could be open to consider running down the stock of bonds bought under quantitative easing (QE), at first by simply not replacing those bonds which mature over time.

Robert Wood, economist at Bank of America, anticipates “quick fire” hikes, raising rates to 0.25pc in December then 0.5pc in February, and beginning to let the total stock of QE bonds shrink from March.

Until this week, he had forecast one hike in February then a second a year later, so his new predictions underline the extent of the U-turn.

This represents a remarkably rapid change of tack for a central bank which had appeared to be on a steady trajectory: end QE on schedule in December at a total of £895bn, very gradually raise rates in 2021 or later, eventually stop maintaining the stock of bonds to reverse the emergency policy.

Until recent weeks, hawks were in such short supply on the MPC that they risked going extinct as a species.

In May and June, only Andy Haldane, the chief economist, voted to curtail QE early, and he has since left the Bank.

His mantle was taken up by Michael Saunders, an external member of the committee, and Sir Dave Ramsden, a deputy Governor.

Even then, their two votes to stop QE were a small minority against the other seven members.

It looked as if any plan to tighten policy was dead.

Then came the supply crises, the petrol panic and inflation surging above 3pc – firmly beyond the Bank’s 2pc target. Price rises are set to rise above 4pc and stay there for some time.

In September’s MPC meeting, policymakers included a highly unusual statement which initially was so confusing to markets and analysts that it received little attention.

It indicated that the seven policymakers who voted to hold policy “agreed that any future initial tightening of monetary policy should be implemented by an increase in Bank Rate, even if that tightening became appropriate before the end of the existing UK government bond asset purchase programme.”

This raised the prospect of the unconventional combination of interest rates going up even as the Bank continues quantitative easing – tightening policy at the same time as the loosening voted for last year is still being implemented.

George Buckley, economist at Nomura, says this points to a chance of a hike very soon: “With the [QE] programme due to end close to the time of the December meeting, we think the MPC’s comments could only be referring to a possible November move.”

Financial markets have taken this possibility to heart, but economists are concerned it could show petrol-panicking drivers are not the only ones overreacting to events.

Kallum Pickering, economist at Berenberg Bank, says the economy has recovered strongly with many current supply problems a function of booming demand, meaning it is right for the Bank of England to look at “normalising” policy.

But he advises against any moves which are too sudden.

“A November or December rate hike would look a bit panicked,” he says, adding that Bank communications have appeared “muddled”.

“November will be an opportunity for the Bank to clarify its guidance and signify whether a rate hike is due in December or February, so that the market will not be surprised.”

Who has said what?

In the hawks’ corner are Saunders, Ramsden and the new chief economist Huw Pill.

“I think it is appropriate that the markets have moved to pricing a significantly earlier path of tightening than they did previously,” Saunders told the Telegraph. He was speaking when markets expected a February rate rise, and had half priced in a December tightening, but investors reacted by anticipating an even quicker hike.

Meanwhile Ramsden last month said he was particularly focused on the risk of higher inflation. Pill last week said “the current strength of inflation looks set to prove more long lasting than originally anticipated” – comments which indicate they are both leaning towards tighter policy.

Most prominent among the doves are Silvana Tenreyro, Jonathan Haskel and newcomer Catherine Mann, all external members of the committee.

Tenreyro expects inflation to be short-lived, suggesting there is little need for a rate rise and warning that acting now risks being “self-defeating”.

Mann said that market expectations have already had the effect of tightening financial conditions, removing the need for the Bank to act.

Up for grabs are the votes of Ben Broadbent and Sir Jon Cunliffe – both Deputy Governors – and Andrew Bailey, the Governor himself.

The first two have remained quiet on the topic.

But Bailey has given succour to those anticipating higher borrowing costs by warning that rising inflation could become embedded, rather than fading as policymakers had previously anticipated.

 “We have got to, in a sense, prevent the thing becoming permanently embedded because that would obviously be very damaging,” he said in an interview with the Yorkshire Post last weekend.