And real estate is only the most visible aspect of the recent building boom, which has also included transportation systems (roads, trains and airports) as well as power generation and transmission. Some of these have provided much-needed improvements, while others turn into wasteful extravagances. Large scale airports have cropped up in even the smallest of towns, yet hopes for an influx of tourists in many interior cities never materialized.
Even the much celebrated and wildly expensive train network, in addition to its safety concerns, may never be economically viable. Most migrant workers making up a significant portion of train ridership can’t afford the tickets. Businesspeople traveling from Beijing to Shanghai may utilize that route, but easing travel and increasing economic activity in interior, less populated cities remains far less certain. The excesses of Japan’s high-speed rail network and its limited impact on rural communities serves as a potent reminder.
The questionable returns on this building frenzy are beginning to affect the financial system. China’s banks are exposed to a variety of questionable and interdependent real estate financing schemes including off-book lending to skirt Beijing's attempts to reign in the sector. Fitch estimates a rise in non-performing loans to 30 percent in the next 3 years. UBS and Credit Suisse are voicing increasing concerns as well. Without accurate assessments of total liabilities firmer figures are hard to come by, adding to the sector’s uncertainty.
Government officials have instructed state-owned banks to re-evaluate their property exposure, one in a string of new policies over the last year to tamp down speculation, control inflation, and rein in massive outlays for spending on development projects.
Developers will eventually feel the profit squeeze caught between high land prices and dwindling returns from commercial projects gone wrong. Many are already chasing foreign capital to remain afloat. Local governments, borrowing heavily against land slated for construction – their major revenue producer – will need increased central government funding (official debts have reached $1.6 trillion with defaults estimated at 20 percent to 30 percent.)
A policy shift towards building the middle class would bring a host of benefits: Freeing up financial resources to capital-starved small- and medium-sized enterprises to create durable job growth; reduced cement and steel production, two of China’s most energy intensive industries, to help lower inflationary pressures in commodities like coal, oil, and iron ore while also cutting emissions; and a boost in domestic consumption to relieve trade tensions as personal incomes rise along with imports.
This will require a degree of political will unseen to date. Economic modernization now risks stalling at best, and reversing at worst, with increased government control.
If even half the resources devoted to internal security (now larger than the national defence budget) were directed at fighting corruption, enforcing environmental regulations, protecting intellectual property, and hiring more judges, many of China’s social pressures would be alleviated.
Without a true middle class revolution, China’s economic foundations will increasingly rest on shifting sands. Ghost towns will remain empty, property investors will see diminishing returns, and banks will struggle with increasing defaults. China may be a victim of its own success, arriving at an economic fork in the road sooner than expected – one path leads to enriching the masses, the other back to business as usual.
Brian P. Klein is writer and international economist. A former U.S. diplomat with service in China and India he was a 2008-2009 Council on Foreign Relations International Affairs Fellow based in Tokyo. His articles and commentary have appeared in Foreign Affairs, The International Herald Tribune/New York Times (online), Japan Times, South China Morning Post and Far Eastern Economic Review, among others.
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smiley g
For all that is said, Brian Klein’s observation are still valid. Sometimes I wonder whether the Chinese government’s claim that i is a market economy is correct. As far as I can see, it is a mixed economy but lacking in knowledge in many areas since it is a developing country. Nevertheless, it will muddle through. The question is only – is the price worth it for the ordinary Chinese? You need an experienced “Lee Kuan Yew” and his team to steer China into development status with little heartache and growing pains. Pity there is none as such in China proper today.
Dominic Shum
This article has to be taken with a pinch of salt. In terms of building a robust middle class…May I ask which standard is your middle claass based on? Is there not a big army of Chinese shoppers buying everything in sight in Singapore, Paris, Hong Kong, Tokyo? Please take purchasing power into consideration when defining the middle class. In an economy that individuals can happily survive on US$3 a day..I think middle class China or for that matter India is quite big.
Kane Luo
the redistribution of wealth on this kind of grand scale which the author suggested would require a readjustment of not just the economic policies, but it require the restructure of the political system and a new kind of cultural revolution, which neither would happen instantly.
Milo Jones
Great piece. Beijing land prices have risen over 800% in the last seven years! that’s can’t be sustainable. For a similar line of thinking, see “China’s Present, the World’s Future, and the Pretense of Knowledge” at http://silberzahnjones.wordpress.com/2011/05/15/china%E2%80%99s-present-the-world%E2%80%99s-future-and-the-pretense-of-knowledge/
Jim Em
Every negative China economic prediction I have seen over the last ten years has turned out to be wrong. In many instances 180 degrees wrong.
There is no doubt that China has economic problems, yet they will manage, like they have always done and get through it. Like our economic collapse in 2008, they still managed 6% growth by turning to the one thing economists seem to ignore, their 1.3 billion people.
Peter
@Jim Em
Very good point!!!
However, keep in mind this is also an economic prediction:
“There is no doubt that China has economic problems, yet they will manage, like they have always done and get through it.”
No one has a clue what will happen in the long run – however, whether it takes 10 years or 100 a collapse is likely at some point.
Shannon
Klein writes: “The excesses of Japan’s high-speed rail network and its limited impact on rural communities serves as a potent reminder.”
Maybe this is true in Upside-Down world. In the real, actual Japan, one only has to look at the number of profitable private rail companies in business to know that Klein is simply making stuff up. Again.
Here’s a heads-up: before the disastrous rise of the supply-side zealots, governments everywhere understood that large public projects didn’t need to make an outright profit, but rather that (like the US Interstate system which has never made a dime) they “prime the pump” for hundreds of thousands of small businesses to be able to make money and return tax revenue.
Japan’s fast rail “unlocks” most of the country’s population to be able to work in the industrial zones, while still having a high standard of living (and high consumption) physically far from the actual work site. That is a *massive* success.
Darrin Wright
You’re missing the point. The rail infrastructure in rural areas was plotted to usher in population increases in said area. One need not study demographic data too long to determine that that just hasn’t happened. Matter of fact, it has actually made it far easier and more convenient for the youth to “flee” the farms for the cities.