Infrastructure: Invest In Affordable Housing, Transport & Urbanisation
Last week CNBC invited me to debate former Morgan Stanley star economist Andy Xie for about 20 minutes in a China "Bull vs. Bear" showdown. You can see the three segments here, here and here.
Xie has been one of the most vocal bears on China's economy for years. He even wrote a few weeks ago that some real estate markets there were going to drop 90% and that overall real estate was priced at twice its actual worth.
Add to that a pinch of rising personal, local and central government debt, and Xie, like short-seller Jim Chanos, believes we have the makings of a bubble that could take down the world's second- largest economy.
Scary stuff. But how credible are Xie's arguments?
Xie overestimates the dangers of high prices and empty apartments, because he wrongly dismisses the role leverage plays in causing bubbles. Leverage, not high prices, causes systemic risks. China has policies that force residential buyers to have enough cash in hand (30% for your first home and 50% for your second) to minimize leverage and risk. Xie also underestimates how incomes are rising in China. If you don't trust me about that, ask Apple, Starbucks and Nike why they have aggressive growth plans for China and already make huge profits there.
However, although I disagree with the bears' fear of imminent collapse, all is not rosy in China's real estate sector. There are some very real concerns that the government needs to address.
First, there simply is not enough low- and middle-income housing, because developers build luxury apartments where the fattest margins are. The government recognizes this problem and has slowed the construction of heavy-land-use standalone villas (most homes in China are in skyscrapers). It also has limited the number of large apartments in these complexes.
However, wealthy individuals simply buy multiple units and knock down walls in between. Limiting luxury production goes against market demands and is not effective.
What the government should be doing is forcing developers who build luxury apartments to also build cheaper units farther away from downtown. These should include a large number of rental units at below market rates that are available for people not originally from the locality. But they should have owners, too, to keep them from being stigmatized the way housing projects are in America's inner cities. This will help solve the problem of, for instance, where in Shanghai non-Shanghai natives can live.
During the great privatization of homes, state-owned enterprises sold housing units to their employees at below market rates. The result is that if you are from Shanghai or another urban area, you probably have decent housing now. However, people who move to Shanghai from other cities can't find adequate housing. Graduates from top universities working at white collar jobs often live five or six to an apartment, in bunk beds.
Second, building quality homes in the middle of nowhere does no good without cheap and convenient transportation, so China actually needs to invest more, not less, as many argue, in infrastructure.
Many bears like Prof. Michael Pettis of Peking University fret that China is relying too heavily on infrastructure investment for its growth gains and is becoming like Japan in the 1990s.
Such analysis surprisingly fails to take into account the differences between China's and Japan's spending and the fact that many Chinese are still heartbreakingly poor while Japan's quality of life is arguable higher than America's.
Japan's infrastructure investment is incredibly wasteful. Roads and projects prop up tiny hamlets that are unsustainable without subsidies. China, on the other hand, is investing in projects like subway systems in its major cities like Chengdu and in railroads that increase productivity, much as Japan did in the 1960s, which helped it become an economic might in the 1970s and 1980s.
There is still more room for growth, however. China has more than 100 cities with a million or more people, and most of those cities still don't have subways. Traffic snarls are horrible. And faster railroads are needed to connect those cities. Last year it took 12 hours by rail to travel between Shanghai and Wuhan, where over 30 million people live. This year new rail links cut the travel time to five hours. China's infrastructure investment increases productivity, while Japan's saps it.
Finally, though there's no real estate bubble right now, China is absolutely not immune to bubbles and economic cycles. At some point, the country's growth will slow, perhaps a lot, and there certainly will be recessions. But that time is not now. China's economy is still starting from a low point, and its market remains inefficient overall.
More than 400 million people are shifting from agricultural lives to urban ones, and they will need more homes and a change in economic structuring. Companies are investing in all that.
My firm, the China Market Research Group, interviewed executives from several hundred big multinationals over the past quarter, and 80% of them said they planned to substantially increase domestic investment over the next three years. Most expect increased profits this year.
