Evergrade and China’s dependency on building stuff.

Since the economic reforms initiated by Deng Xiaoping over 30 years ago the Chinese economy has relied on investment growth to drive its economy. The World Bank has estimated that China’s annual growth rate over the last ten years has averaged approximately 9.8% of which expenditure on investment accounts for 6-8%. For future growth China cannot be dependent on this model of investment growth as, not only is it unsustainable, but the carbon footprint will become increasingly intolerable.

Between 1995 and 2010 China’s average growth rate was 9.9% but total investment in infrastructure and real-estate projects rose on average by 20% each year accounting for approximately 42% of GDP. In 2018 as a % GDP (5.57%), China’s average infrastructure spending in 2018 was 10 times higher than that of the United States and significantly higher than anywhere else in the world. What also has been increasing China’s investment rate is the declining efficiency of investment capital which is reflected in its high incremental capita-output ratio – annual investment divided by annual output growth.

Too much supply
With the increased investment by companies too, there is an issue with overproduction in which producers tend to look to international markets as domestic demand has been exhausted. This assumes that the international market for goods and services is buoyant, but the impact of global financial crisis in 2008 resulted in surplus products, lower prices and falling profits. As with many developed countries, China has expanded credit in order to maintain demand, but this can lead to a repeat of what caused the crisis originally.

Evergrande
Corporate sector debt in 2011 was 108% of GDP but this increased to over 160% in 2020. Most of the debt been brought about by new development including housing. This sounded alarm bells as the return on this investment will take a lot longer than planned when you consider that the occupancy rate of apartments is approximately 25%.

But an even more important reason behind the continued insistence on superblock planning is the reliance of Chinese city governments on land lease revenue. Sincethe tax-sharing reform of 1994, cities have been obliged to fork over an enormous percentage of their tax revenue to the central government. In order to generate enough revenue to cover social services and other costs, cities have come to rely heavily on China’s land-lease mechanism that allows the city to rent parcels of land to private developers for a period of 70 years. Thoughts from the Frontline

Evergrande and similar building developments have maintained social order and geared the revenue that officials have wanted. Capitalism with Chinese characteristics?

Unfortunately this building boom has led to many Ghost Cities in China where apartments lay empty and have done so for many years. Below you can see what one developer did when he ran out of money in 2013 – the empty towers were imploded in Kunming this year.

Final thought

In a response to changes in both domestic and international economic developments, China will need to create a new growth model and ensure that development is based on improved quality and performance. An integral part of this development is to support and guide the private sector and ensure that it can enjoy an equal chance of success in competing against government-run organisations. By enlarging domestic demand and science and technological innovation there is more likelihood of acquiring a sustainable economic model that is not dependent on infrastructure development, housing and export markets.

Source: Thoughts from the Frontline – Xi’s Changing Plan. John Mauldin – 2-10-21

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