China has made enormous economic progress in the years following the death of Mao Zedong. The liberalization of the economy has lifted hundreds of millions of people out of conditions of abject misery, in which most earned little more than the equivalent of a cup of rice per day. It also brought less expensive goods and services and a productive workforce to perhaps billions of people all over the world. However, this spectacular market success has overshadowed the vast inefficiency and repression caused by China’s government as it indulges in wasteful central planning and seeks to maintain tight political control.
In 2008, fearing that the global economic crisis might lead to a severe downturn in economic growth and fuel popular discontent, Chinese leaders embarked on a range of measures to stimulate the economy — especially an unprecedented construction boom. Three years later, the Economist Intelligence Unit issued a report expressing caution at the scale of the boom. It calculated that only 44.9 percent of China’s population lived in urban areas by the end of 2010, but it had already created per-capita residential space that approached that of the United Kingdom, which had 90 percent urbanization and an average disposable income level many times higher than in China.
The boom has continued during the four years since that report, with supply far outstripping demand. Securities group CLSA reported in 2014 that China had a 15 percent vacancy rate for homes built in the previous five years — a figure expected to climb to 20 percent in the next two years. Some areas, such as Ordos City, have a vacancy rate so high that they are effectively ghost towns.
The construction boom has been driven in part by the central bank’s monetary expansion. In a 2014 study, economist Rongrong Sun detailed a dramatic loosening of China’s monetary policy stance in early 2008 that continued until early 2009, followed by another round in 2011. The Telegraph also reported in 2009 that the “big four” Chinese state-run banks were ordered to lend the equivalent of £700 billion in just the first six months of that year. Most of the loans probably went to state-owned enterprises (SOEs) — and, tellingly, one of the most important SOEs is China State Construction & Engineering Corporation, one of the biggest construction companies in the world and the largest in China in terms of revenue.
The Chinese construction boom implies an astronomic misallocation of resources, and steel production serves an illustrative case in point. According to the data from World Steel Association and OECD, China produced more than half of the world’s steel 2014 — almost as much as the entire world produced in 2001. We can reasonably hypothesize that a tremendous portion of this steel was wasted in stimulus construction of buildings that aren’t being used by the Chinese people, the resources and labor used to create that surplus of steel has been similarly misallocated, and a staggering array of other resources, goods, and services have been similarly diverted from other potential productive uses.
This effective subsidy of large-scale construction projects is a classic example of an inter-temporal misallocation of resources. Monetary expansion, low interest rates, and direct government expenditures can all lead to projects that would not have been undertaken if decisions were made based on undistorted prices and profit motive. Regardless of which underlying form of government-induced distortion proves to be predominant, however, the results are largely the same.
It is not possible to wave a magic wand and turn an enormous stock of unoccupied urban residential space, along with its supporting physical infrastructure, into a source of economic value. People are attracted to population centers by more than just residential space, they also need long-term productive enterprises that will employ them and support a thriving local service economy. Malinvestment not only fails to foster this kind of enterprise, but actively hampers it. Entrepreneurs are deprived of the capital and resources that are diverted to construction of unused buildings.
Labor can be just as easily misallocated, and new buildings that have managed to attract inhabitants may well represent relocation at the wrong time or to the wrong city for truly productive economic growth. This would mean that a projected 20 percent vacancy rate significantly underestimates the scale of over-construction.
The key resources used in large-scale construction have many uses in multiple industries. Steel, copper, glass, paint, coating materials, and their precursors, as well as the energy sources for powering construction and transportation machinery can all be used profitably elsewhere in the economy. They are also traded globally, which means that massive misallocation in China has diverted resources from producers throughout the world. In cases where those resources would have otherwise been produced in lower amounts, such as steel and cement, other resources that were necessary to supply the former would not have been wasted.
This economic disaster has implications far beyond immediate economic considerations. By misallocating resources and impeding real growth, China’s construction boom has made millions of people around the world poorer. By bidding up the worldwide price of key resources, the boom may have frustrated economic calculations behind long-term investments and hampered recovery after the 2008 crisis in many regional economies. And, by riding an unsustainable bubble, the boom has positioned the Chinese economy for a rough landing.
The opinions expressed in this commentary are solely those of the author.