China’s construction boom is wasteful but has deep socio-economic roots

The Chinese government has recently reported energy intensity data for the first six months of 2007. How they manage to have reliable statistics within thirty days of the end of the period is a matter for speculation. But if we accept the data at face value then there has been a significant improvement in the energy intensity of certain industrial sectors, including steel, cement and glass – key inputs to the country’s booming construction industry. But making these specific energy-intensive industries more efficient, though laudable, addresses only part of the problem.

In a wide ranging and enlightening analysis,  Daniel H. Rosen and Trevor Houser and of the Petersen Institute for International Economics in Washington DC in their article “China Energy: A Guide for the Perplexed” pinpoint a number of other key factors which underpin the construction boom, including the cost of land and the price of coal. However, the attitude to construction and to property ownership in China reflects a wide range of economic and social factors, as it does in other countries. In Britain, for example, the population seems to have an obsession with owning their own homes, preferably in the form of a house; whereas many in continental Europe seem to be content to rent or buy an apartment.

Two questions in China today which are very relevant to the energy intensive industries are: how much construction is “unnecessary” or “wasteful”, and what factors in the market are stimulating this wasteful investment? Of course, one has to be very careful in how one defines the terms “unnecessary” and “wasteful”, but for the purposes of this column I will take a relaxed approach to terminology.

First, what is the evidence of “waste”? In the absence of national statistics on wasteful investment in construction, I will rely on my own casual observations. I start in Beijing itself. Next to the Lido Hotel, on the airport road, stands an office building of about fifteen stories. Construction started just before I arrived to live in Beijing for four years, in April 1990. This building, though standing in a prime location, remains unoccupied.

Every summer I spend a week relaxing in a county town in the outer part of Beijing municipality. Here I am surrounded by “waste”. Within one kilometre of where I stay are four hotels built in the early 1990s which are now completely unused, and have been for several years. In the meantime other newer hotels have been built, and they appear to be greatly underused.

Right next to where I stay is a compound with about twelve large, two-story villas, each with between ten and fifteen rooms. They have all stood empty since they were completed in 1998. A succession of developers took on the challenge of completing and selling them. The current developer clearly thinks he has the answer, and is adding another one or two stories to each villa.

As I walk along the road out of town, I pass through an area of grand new buildings. Some belong to bureaus of the county government, others to local branches of state companies. Given that the population of the county is about half a million, the size of these offices is astonishing. They would be appropriate for a major municipality like Beijing, but their size is quite excessive for a modest county. The grandest building of all that I see on my walk is the courthouse – if they have that many criminals, then the county has a serious problem.

At the end of my walk I find a compound of ‘holiday homes’ completed two years ago.  These town houses range from 200 to 300 square meters and sell at a price of 6,500 RMB per square meter, without fittings and decoration. A fully fitted and decorated large house would cost about three million RMB. They are nearly all sold, and yet almost nobody lives there. They are too far from Beijing for a convenient commute to work, and are indeed kept as ‘holiday homes’; again these homes have ten to twelve rooms, excluding numerous bathrooms.

So, what is causing all this apparently excessive construction? Let us pull together some ideas, some of which are well-founded, others of which are more speculative.

Urbanisation and economic growth continue to be the goals of local governments in China. So they are happy to grant local enterprises access to land for construction at relatively cheap rates. The enterprises themselves, or rather those that are state-owned, pay no dividends and thus have plenty of excess cash. Likewise they have no demanding private shareholders and may have a local monopoly position. Thus they can spend their excess cash on grand office buildings rather than on enhanced productivity.

These enterprises can also afford to speculate in building hotels and other property which may remain empty for years, in the confidence that neither banks nor shareholders will ask awkward questions.

The local governments themselves, like local governments everywhere in the world, like to spend the money collected through local taxation on grand buildings. In the absence of direct accountability to the local population and in the absence of tight control from higher levels of government, they are indeed able to indulge themselves in self-aggrandising construction.

And what about the individuals buying the extravagant “holiday homes”? Here there seems to be a reversal of the European concept of a ‘holiday home’. In Europe the holiday home of an affluent middle class family is likely to be much simpler than the main residence: possibly just a three or four room house, which may not have all the modern conveniences, but which sits in an idyllic village, or by the sea, or in the countryside. Why spend a very large amount of money on a home where you only spend a few weeks each year?

In China, the attitude appears to be different. Why is this? I speculate that this arises from the convergence of a range of factors related to the housing market itself, investment opportunities for individuals, the banking system, the tax system and social aspirations.

I shall focus on what I shall call the ‘newly affluent middle class’, and I do not consider the very rich. They have income from well-paying jobs or profits from successful businesses. A family may also already have one or more apartments in Beijing that have been bought at low cost by family members from their work units.  A high proportion of their earnings accumulate as savings. But where to invest this growing pot of money? Bank interest rates are absurdly low. The domestic stockmarkets are highly volatile – worth a bet with a chunk of savings, but not a place to risk the entire family future, especially since the new systems for social service provision are still in their infancy. Property prices have more than doubled in the last ten years, even in the county town where I stay. So, property provides an apparently safe and profitable investment. Few can afford to buy a townhouse in downtown Beijing, and most live in apartments. So the chance to buy a large, townhouse out of the city, to luxuriate in and show off to friends is very attractive, affordable and a relatively sound investment.

Even if the family lacks all the capital to buy the house of their choice, mortgages are now widely available, and the banks seem to be fairly relaxed in their attitude to risk in the property market. Further, the government has only recently introduced a tax on the profits realised from the sale of second homes. But, at 20%, the rate is low.

Though the story I have just woven may have its faults, the issue of constraining wasteful construction is important because the construction of real estate accounts for almost one-quarter of fixed investment in China, and the causes of this waste are multiple.

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