Volume 45 Number 178,
July-September 2014
The Real-Estate Bubble in China
Mylène Gaulard*
Date received: June 14, 2013. Date accepted: January 30, 2014

Although some economists have rejected the hypothesis of a real-estate bubble in China, the rise in real-estate prices has gradually become detached from the increase in real salaries, principally in major Chinese cities. Specifically, the exponential growth in bank loans may stir up fears of problems related to over-indebtedness for a considerable number of real-estate developers in the near future. However, these difficulties are only the tip of the iceberg of deeper problems within the Chinese economy.

Keywords: China, real-estate sector, real-estate bubble, land speculation, cities, real-estate.

With a GDP growth rate of 7.8% in 2012 and 7.6% in 2013, China is starting to feel the effects of the recent global economic crisis and its commercial surplus has begun to fall (from 8.8% of GDP in 2007 to 2.7% in 2012), demonstrating that the country is less able to depend on exports for economic stimulation. However, although experts frequently look to external factors to explain the Chinese slowdown, we often forget that the nation has greater underlying economic difficulties, including consistent overproduction in the productive apparatus, which impacts profitability, the problems that local governments face in balancing their budgets and even the spike in real-state prices. Regarding the last item, although inflation remains low, and the consumer price index only rose 2.6% in 2012, real-estate prices have evolved much more sharply, increasing annually, on average, by 10% in the major coastal cities since the mid-2000s.

Following analysis of the literature on the Chinese real-estate market and data from international organizations, this article will focus, first, on demonstrating that there is a real-estate bubble that could burst at any time and throw Chinese economic growth into disarray. Next, it will focus on the reasons behind these price increases, especially the role of debt and land speculation as encouraged by local authorities. Finally, this article will discuss the difficulties the central government faces in controlling this bubble, partly because if it were to burst, it could reveal much more profound issues in the Chinese economy and its productive apparatus.

Arguments Against the Hypothesis of a Real-Estate Bubble in China
A Rapidly Growing Real-Estate Sector

In 2004 and 2011, real-estate prices doubled, on average, in the 35 largest cities in China, and a great deal of studies were published on this evolution in 2010 (Ahuja and Cheung, 2010; Lu Gao, 2010; Muto and Matsunaga, 2010). However, prices "only" increased by an average of 17% in 2010, as compared to 24% in 2009, and the price index even began to decline in 2011 (until mid-2012). This trend was studied by the National Development and Reform Commission (NDRC) based on a sample of 1,000 real-estate properties selected in 70 cities in the new and secondhand real-estate market, as well as by Tsinghua University (Deng, Gyourko and Wu, 2010). To sum up the NDRC work, the following figure shows that the majority of Chinese cities studied saw real-estate prices decline between October 2011 and May 2012, but they have since recovered.

Figure 1. Evolution of Housing Prices in the 70 Largest Cities in China, in Number of Cities that Recorded and Increase, Decrease or Stagnation in Prices per Square Meter

Source: National Bureau of Statistics, “Sale price indices of residential buildings in 70 large and medium-sized cities,” 2013.


The 2011-2012 slowdown came about when the Chinese government implemented measures to limit real-estate speculation, and the second section of this study will address these policies. However, it is undeniable that the Chinese real-estate sector has boomed since the mid-2000s, especially in the four coastal cities described below (see Figure 2). According to recent works by Yongheng Deng, Joseph Gyourko and Jing Wu (2012), the price increase may even be underestimated, given that research from official sources cannot always distinguish between the new and secondhand property markets, although the former has had the highest price increases and accounts for 60% of sales in the past three years.

Figure 2. Real-Estate Prices in Major Chinese Cities (in Yuan per Square Meter)

Source: National Bureau of Statistics, China Statistical Yearbook, 2011 and 2012.


In keeping with an increase in real-estate prices, investments in this sector have also gone up since 2004, representing a growing share of total domestic investment, growing from 23% in 2004 to 31% in 2011 (see Figure 3). Thanks to these significant investments in the real-estate sector, China now consumes around 60% of the cement produced around the world and 43% of construction equipment, such as bulldozers and other heavy machinery (Deng, Gyourko and Wu, 2012). The construction sector currently consumes 40% of the steel produced in the country, representing 12% of GDP, and employs 14% of the active population in China (BBVA, 2012).

Figure 3. Real-Estate Investment in China (in Millions of Yuan)

Source: National Bureau of Statistics, China Statistical Yearbook, 2011 and 2012.


Price Increases Explained by an Economic Boom

Despite the strong growth of the real-estate sector, some authors, like Ahuja and Cheung (2010), reject the hypothesis of a bubble, ascertaining that this growth is concentrated in a few coastal regions that also have the highest economic growth. Real-estate price increases are therefore a mere corollary of this growth, and unlike what would supposedly be behind the hypothesis of a bubble ready to burst, this development would be perfectly sustainable.

According to Kindleberger (1978) and Shiller (2003), a bubble is defined as an excessive increase in prices with respect to the fundamental value of goods exchanged and income, an increase that tends to be aggravated by the speculation it produces. Speculation here refers to purchases made with the single purpose of obtaining profit during resale. However, it could be said that the strong pressure on the real-estate market can be explained by the increase in urban income accompanied by extremely high GDP growth. While GDP growth has hovered around 10% over the past 30 years, real urban salaries have increased 15% on average every year (China Statistical Yearbook, 2012, Figure 4).

Figure 4. Annual Average of Real Urban Salaries in China (in Yuan as of December 2010)

Source: China Statistical Yearbook


It is notable that while only 17% of Chinese households owned their homes in 1990, this proportion grew to 86% by 2005 (Chamon and Prasad, 2005). In addition, the Chinese are increasingly saving more of their income in order to make future real-estate purchases (Wang and Wen, 2012; Bussière and Kalantzis, 2013). Although the majority of urban families are now homeowners, three-fourths still want to upgrade to a better home (Guo and Mongrué, 2009): the home savings rate reached 25% of gross income in 2012, versus 17% in 1995.

In this way, the real-estate market began to open up in the 1990s. Later, a series of measures were adopted to provide access to properties and urban homes, which were previously allocated to the public companies that used them (Barth, Lea and Li, 2012). Starting in the 2000s, the Chinese not only began to save, but also implemented a rather accommodating monetary policy (see Figure 5). The one-year loan rate was barely 6% in 2013, an extremely low percentage in a country where annual GDP growth has been around 10% for nearly three decades.

Figure 5. Interest Rates (One-Year Loans) (%)

Source: People’s Bank of China, China Monetary Policy Report, 2012.


Finally, another explanation that tends to come up to reject the Chinese real-estate bubble hypothesis is the speed of urbanization, which requires ever-greater investments in real-estate and causes a strong increase in real-estate prices. In 2012, the urbanization rate reached 52.57%, from lower than 20% in 1980. This urbanization goes hand in hand with better living conditions for Chinese families, especially in terms of housing. The average living space rose to 27 square meters per person in 2007 versus 6.7 in 1978 (Bingxi and Lijuan, 2007).

However, Price Increases are Unsustainable in the Long Term
A Growing Weight on Household Budgets
All of the above arguments cast doubt on the supposed real-estate bubble in China and excessive prices in comparison to the value of real-estate, and indicate no real reason why prices should go down in the future. Before a bubble bursts, it is difficult to detect, but some indicators would seem to objectively signal a disproportionate increase in real-estate prices, and this trajectory could lead to a sudden drop in prices when the bubble bursts. In fact, this situation is made evident by the fact that prices have spiked, but not in relation to income increases (Kindleberger, 1978). Chung and Kim (2004) analyzed the formation of a bubble in South Korea starting in 2000, by observing that the housing price index as compared to annual income (PIR: price-income ratio) was above 10, reaching 15 in some areas of Seoul, while "reasonable" levels are thought to be around 3 or 4 (Chung and Kim, 2004).

Besides this relationship, the weight of mortgage loans during the formation of a bubble is significant, a phenomenon studied by Koh and Mariano (2004) and Chung and Kim (2004). For example, on the eve of the Asian crisis in 1997 – and also in Japan at the end of the 1980s – the volume of bank loans surpassed 100% of GDP, and real-estate loans accounted for more than half. The banks are therefore victims of "disaster myopia" (Herring and Wachter, 2002), which means they underestimate supposed risks and keep handing out loans, not necessarily due to competition among them, but rather due to the increasing price of guarantees.

In China, the first difficulty that came along with price increases was that it forced Chinese families to save even more (Chamon and Prasad, 2008), while internal demand has stayed low. Although the Chinese household savings rate is no higher than in Taiwan or Singapore, where it reaches 30% of available income, the share of consumption in GDP is much lower in China, below 40% (as compared to 60% in Singapore and Taiwan) (China Statistical Yearbook, 2012). Given these massive savings, there is a growing disconnect between the strong increase in investment and internal demand, in an environment in which the gross formation of fixed capital hit a world record: 48% of GDP in 2012. However, the Chinese are using a growing proportion of their income to purchase housing, which affects consumption and reinforces the overproduction that is further detrimental to already decreasing productivity (Gaulard, 2009; Lee, Syed and Liu, 2012), an issue that will be addressed in greater detail in the second half of this article.

The housing price index to annual income ratio reached an average of 8.5 in Chinese cities, and exceeds 14 in coastal cities. Compare these figures to Spain or the United States, where it peaked at 8 at the highest point of their respective real-estate bubbles (Deng, Gyourko and Wu, 2010; Ding, 2012).

For this reason, young urban couples are now more frequently obliged to use up their parents’ savings to become homeowners, a process that is evidently made easier by the one child policy. Although low interest rates encourage urban households to take on debt, we must not forget that 30% of real-estate purchases are made without bank loans (Guo and Mongrué, 2009), which is telling of the pressure price increases exert on family budgets.

An Important Increase in Bank Credit

Real-estate purchases, however, have been stimulated even more by the fact that over the past ten years, it has become easier for Chinese households to obtain bank loans. Since 1998, the government has encouraged the development of real-estate loans to face the Asian crisis and stimulate internal demand as Chinese real-estate was privatized. Since then, loans can represent up to 80% of the purchase value of real-estate, at least for the first property purchased, and the maximum authorized term is 30 years (Bingxi and Lijuan, 2007). Chinese monetary policy has also expanded, in spite of the minimal increase in interest rates and mandatory reserve requirements, between 2010 and 2012, aiming to combat overheating. As a result, between 2004 and 2012, bank loans rose by 208% (see Figures 6 and 7).

Mortgage loans, which account for 80% of household loans (Bingxi and Lijuan, 2007) constitute only a small portion of the banking sector’s total loans, but this number is increasing (from 4.6 to 19.4% between 1999 and 2012) (see Figure 7). Likewise, the value of mortgage loans was multiplied by 27 between 1999 and 2012, and while these loans represented 5% of the GDP in 1999, their share grew to 24% in 2012 (BBVA Research, 2012). However, bank credit for the private sector reached 135% of GDP in 2012 (against 88% in 1995), a rate similar to recently industrialized Asian countries before the 1997 crisis and Japan at the end of the 1980s (Chen and Zhang, 2013), and much higher than the rest of so-called emerging countries with which China is generally compared (see Figure 6).

Figure 6. Bank Loans Granted to the Private Sector (in % of GDP)

Source: People’s Bank of China

Figure 7. Bank Loans in China, in Millions of Yuan

Source: People’s Bank of China


Although household mortgages constitute two-thirds of mortgage loans (the rest are given to developers (BBVA, 2012)), they only account for 13% of all bank loans, far below the percentage in other OECD countries, which range from 35 to 50% (BBVA, 2012). However, in recent years, China has been marked by the accelerated development of its informal banking sector, the famous shadow banking system, which makes it difficult to know for certain how much debt families, companies and the local governments have. Between 2010 and 2012, as monetary policy was made more stringent, banks transferred some debt, especially to memorandum accounts, where they created alternative financial products (Faure and Peltier, 2013). Informal financing describes inter-company loans, some formal banking sector activities with memorandum accounts, micro-financing activities and loans granted by informal and clandestine credit enterprises that have sprung up in recent years (Faure and Peltier, 2013).

Just by adding off-balance sheet financing from the banking sector to official bank credit, the private sector financing rate goes up to 170% (Faure and Peltier, 2013). According to other estimates (Chen and Zhang, 2013), this rate could even be higher than 200%, by adding in all informal sector loans. Officially, non-recoverable loans only account for 1% of credit, but the Fitch ratings agency estimates this figure rather on the order of 5 to 6% (Faure and Peltier, 2013), and, according to Violaine Cousin (2011), it could even be as high as 10% of GDP.

However, debt contracted by developers officially represents 71% of their assets (Chen and Zhang, 2013), as compared to 40% in 2009, indicating that developers are very dependent on bank loans, and they would be in an extremely precarious position should real-estate prices drop (Chen and Zhang, 2013).

But the main issue related to the growth of bank credit regards local government debt and the role of local government in the formation of a real-estate bubble. Currently, local governments and the public enterprises linked to them represent three-quarters of loans granted by the formal banking sector in China (Cousin, 2011), and their role in real-estate price increases indicates that there are deeper problems in the Chinese productive system.

Financial Difficulties and Local Authorities
Local Governments Engage in Land and Real-Estate Speculation

Local governments (provinces, administrative regions and districts) manage to elude the prohibitions on banks granting them loans by creating ad hoc companies, known as local government financing vehicles (LGFV). Through these financing bodies, local governments have absorbed nearly 50% of bank loans granted over the past ten years (Artus, 2011), and currently, local authorities are linked to about ten LGFVs, as compared to only two in 2008. According to an audit by the National Auditing Office (NAO) in 18 provinces, 16 cities and 36 administrative regions (Artus, 2011: 285), the territories studied were in debt at a rate of over 400% of their income.

This growing indebtedness means that local authorities have played an important role in the formation of the real-estate bubble in China. To capitalize their financing bodies, local governments transfer land or property to the banks as collateral. In this context, the special status of land property is essential to understanding how the real-estate sector has developed since the 2000s. Legally, land still belongs to the State in urban zones and to local governments, essentially municipal committees, in rural zones. However, since 1998, the Chinese Constitution has stated that local governments are authorized to sell their land rights, which explains how millions of farmers have appropriated land en masse (Rozelle and Swinnen, 2006: 221). In the early days, the majority of these rights were acquired at very low prices by public companies or entities closely related to local authorities that sought to take advantage of low-cost land (Aglietta and Bai, 2012: 357) to rapidly generate revenue through real-estate investments.

In 2010, an estimated 71% of land-use rights in Beijing had been bought by public enterprises, as compared to merely 37% in 2003 (Deng, Gyourko and Wu, 2010). Of the 129 state enterprises controlled by the central government and supervised by the State-Owned Assets Supervision and Administration Board (SASAC), 70% had made investments in real-estate (Hu, 2011: 34). The proportion is assumed to be even higher among public enterprises that depend on local government. For this reason, one-third of the 2008 stimulus plan was targeted at the real-estate sector.

This system not only allows local governments and the public enterprises linked to them to invest in the real-estate sector through bank loans, but it also means that some of them take advantage of the opportunity by reselling the land-use rights at higher prices (Liu, 2008). Aiming to limit corruption, since 2004, the law has required land-use transfer transactions to take place in the market, and not through direct negotiations with local governments. Although hard to enforce, this rule explains that since the mid-2000s, the share of land in real-estate value has only gone up (Liu, 2008: 35), accounting for over 23% of housing prices (Liu, 2008: 79) and up to 60% in Beijing, where successive speculation on land-use rights considerably increases prices. Over ten years, the average price of land has gone up an estimated 192% as compared to growth of 250% in real-estate (Chen and Zhang, 2013).

With little reason to attract low-income residents, local governments therefore favor investments in the luxury residential sector to attract high-income families and also generate significant tax revenue (Liu, 2008: 254). This behavior only strengthens the relationship between housing prices and the incomes of the poorest households. According to Gao Lu (2010: 16), this ratio reached 20, on average, in the ten largest cities in China, but was a mere 2.45 for the wealthiest 20%, as compared to 22.69 for the poorest 20% (with an average of 5.6 and 9.7, respectively, in the rest of the world).

However, in 1998, a law was passed to define the concept of “budget housing” (jingji shiyong fang) with subsidized sales, in addition to “low-cost housing” (lianzu fang) with rental subsidies. This new policy aimed to provide housing to low and medium-income families for a price only 3.5% higher than the cost of construction. However, currently, only 3% of housing being built is budget-cost, as compared to a peak of 25% at the end of the 1990s (Barth, Lea and Li, 2012: 4).

As evidence of widespread speculation, rather than a real-estate sector that responds to the housing demand as needed, there is overinvestment in construction and the luxury residential housing sector. In essence, ghost cities are rising up, including Ordos1 in Inner Mongolia, which is fairly characteristic of the phenomenon, with under-used highways and airports. Empty housing is multiplying with current estimates at 70 million empty residences (Barth, Lea and Li, 2012: 14).

However, the way in which local governments have behaved has sparked real-estate price increases. They attract wealthier families to their regions by promoting luxury residential real-estate, which can largely be explained by looking to the financial difficulties facing local governments.

Essential Income for Local Governments

The role of local governments in real-estate price increases has allowed them to extract considerable income from this sector. In 2009, out of total income of 3.258 billion yuan among all local governments, an estimated 481 billion (15%) was derived from the real-estate sector (Muto and Matsunaga, 2010: 6). However, there is other significant revenue not included in this figure, such as income earned through the sale of land-use rights thanks to land expropriated from farmers and sold at ridiculously low prices. For example, in Beijing and the province of Zhejiang, the sale of land-use rights only accounted for 30% of local government income (Ahuja and Cheung, 2010: 4). On the national level, if we add land transfers to the income from real-estate investments, all real-estate related income would sum up to 1.366 billion yuan, or nearly 50% of total local government income in 2009 (Muto and Matsunaga, 2010).

This income is essential to local governments, given the profound difficulties they face in obtaining financing (Chen and Zhang, 2013). Following recentralization policies in 1994, the central government captured between 50 and 55% of annual fiscal income, as compared to only 33% the decade prior, although since the end of the 1990s, local governments have been responsible for 80% of public spending (Wong, 2000). Local governments are financially liable for public services and implementing social welfare policies. This means that currently, over 90% of spending on education, health and environmental protection is paid by local authorities. The way in which the proportions of public spending and income have evolved is by growing local government deficits, which went from 3% of GDP in 1994 to 8.5% in 2011 (see Figure 8). And while central government debt only reached 20% of GDP, local government debt had reached 27% officially by the end of 2012 as compared to 18% in 2008.

Figure 8. Budget Balance of the Central and Local Governments (% of GDP)

Source: China Statistical Yearbook


Local authorities therefore depend, in large measure, on increasing real-estate sector and land prices to ensure sufficient income. As such, the efficacy of measures adopted by the central government to limit speculation remains low. To help finance local government spending and avoid a lack of transparency in financing vehicles, which have been used to obtain bank loans up until now, in October 2011, the central government began a pilot program to issue municipal bonds in cities such as Shanghai and Shenzhen, as well as the provinces of Guangdong and Shejiang. In particular, Shanghai and Chonqing received authorization to collect a property tax (Peltier, 2013), which will not only buffer income for these communities, but also combat real-estate speculation (Barth, Lea and Li, 2012).

In addition, aiming to fight against speculation, vacant lots are no longer allowed, and local governments have the power to recover land-use rights if two years go by and construction work has not yet begun (Liu, 2008). However, merely digging a hole in the ground counts as the legal start of construction, which is a serious loophole in controlling speculation. Finally, the central government encourages building social housing at low prices; at least 36 million subsidized houses should be built by 2015. However, local governments do not necessarily see this project as being in their best interest, even though construction of these units largely depends on them.

Conflicts of interest between local governments and the central administration have led the latter to combat the real-estate bubble by adopting measures related to the rest of the economic agents in the market. Speaking of monetary policy, and aiming to limit over-indebtedness of banks, the one-year loan interest rate rose constantly between 2009 and the end of 2011 – from 5.31 to 6.56% – and, above all, the required reserve ratio grew from 14% in 2009 to 21.5% in 2011. Between 2010 and 2011, this ratio grew 12 times, while the interest rate tripled. Moreover, in 2010, new laws were approved to better target the real-estate sector and, the next year, “eight new articles” (Seki, 2012) were enacted specifically to limit bank loans for mortgages. Since 2010, for example, loans have been suspended beyond the third property purchased. The minimum down payment to purchase a house rose from 20 to 30% and, since 2011, starting with the second home purchase, the personal down payment had to be equivalent to 60% of the sale price.

Although it is likely that these measures would have slightly lowered prices between 2011 and 2012 (see Figure 1), they have been counteracted by local governments, especially because it is useful to the State to limit the scope of their deficits. Specifically, we will see that it is not so much the high profitability of real-estate investments that drives economic agents to invest in this sector, but rather the increasingly high profitability of the productive apparatus. Consequently, if the real-estate bubble bursts, it could be extremely detrimental to the Chinese economy, because it would reveal underlying issues with over-indebtedness among local governments and have significant and risky implications for public and private, national and foreign enterprises in the real-estate sector. This situation is why the required reserve ratio was reduced on December 5, 2011, the first time the Chinese governments had allowed banks to make a reduction in three years, and the reference interest rate was reduced starting in June 2012 (see Figure 5). Starting in March 2012, preferential interest rates were granted to first-time buyers (BBVA, 2012).

Difficulties Facing the Productive Apparatus
The Problems of the Productive Sector

Besides the fact that the real-estate sector is becoming even more lucrative for investors and helps local governments facing economic difficulties increase their revenue, this article really aims to uncover another structural weakness, directly related to the productive apparatus, which will explain how the bubble formed.

The disconnect between investment, which reached 48% of GDP in 2012, and demand close to 35% of GDP, has long generated a rather leisurely style of production in China. In 1980, only 66% of the production capacity of the productive apparatus was being used (Boutillier and Uzinidis, 1989: 19). At the end of the 1990s, in the Guangdong region in the midst of a full industrial boom, 52% of the 320 enterprises studied recorded use rates of productive assets below 40% (Minqi Li, 2004). These problems were aggravated in the 2000s, as exports became less able to absorb production surpluses.

Nowadays, the rise of investment is still responsible for overproduction and competition in many sectors requires companies to lower prices, and sometimes even recur to mafia-style gangs to rid themselves of the most dangerous competitors (He, 1999). In 2006, according to the Chinese National Development Minister, Ma Kai, the production capacity of the steel sector surpassed demand by 120 million tons, and the coal industry also had surplus production of 100 million tons.

Since the end of 2009, officials have acknowledged that there is surplus capacity, and have therefore banned bank loans and financing through the issuance of bonds and shares in six sectors of the Chinese economy (steel, cement, wind energy, coal chemistry and glass) (Delozier and Rebillard, 2010). The problem of excess investment also explains why, starting in 2013, the central government decided to implement a plan to merge companies in 19 sectors.2 At this point, overproduction is no longer on the rise, even as Chinese provinces have sought to stimulate local companies through a series of tariff protections (Poncet, 2004; Batisse, 2005).

Local officials and public enterprises have also played an important role in this evolution. Some rather unproductive state enterprises have been maintained with the goal of reducing the social risks of economic liberalization to a minimum. That is also why public investment still accounts for 40% of total investment in China, where 17% of companies in China are state enterprises. The low profitability reported by the latter group is sometimes attributed to their social function (Yueh, 2010: 140), and the fact that they are set up in regions where prices are low to facilitate national accumulation (Oi, 2010). Instead of merely focusing on economic profitability, they assume a social and economic function that is key to national accumulation.

China is now facing a problem of overinvestment, manifest in the fact that a strong increase in labor productivity, which has been present in the country since 1991, has been accompanied by reduced capital productivity (Barnett and Brooks, 2006, Cieniewski, 2006; Qin and Song, 2009; Lee Syed and Liu, 2012) and decreasing total factor productivity (Delozier and Rebillard, 2010). We can also look at this decrease in capital productivity as the consequence of any accumulation process, in keeping with many economic studies, whether we are talking about Karl Marx in the nineteenth century with his theory on the downward trends of profit rates, or the Solow model, and, more recently, the middle-income trap theory (Eichengreen, Park and Shin, 2013). The latter principally explains losses in productivity brought on by salary increases and rising unit salary costs (Cai, 2012; Artus, 2013). However, the purpose of this article is not to return to these theories, which could be the subject of another study, nor to explain the cause behind falling productivity that impacts capital profitability. Rather, this study seeks to establish a link between this phenomenon and the enormous investments in the real-estate sector that have contributed to the formation of a bubble.

A Marxist Analysis of the Real-Estate Bubble

In 1929, the Polish Marxist economist Henryk Grossman was already trying to explain the extremely strong boom of the financial sector and real-estate investment market in the United States. Back then, he saw it as the consequence of a reduced profit rate afflicting the productive apparatus (Grossman, 1992: 116). These sectors were effectively new investment opportunities to capture capital surplus. A slowdown in the accumulation process in the productive realm, facilitated by booming speculative sectors, would also put the brakes on falling capital productivity brought on by overinvestment.

It has been recognized that the Chinese productive apparatus is also facing serious difficulties, and it is time to slow down the rhythm of productive investment, rather than further stimulating it. According to Yu Yongding (2009), the fact that local officials have slowly distanced themselves from building new factories and begun to orient towards real-estate investments can be explained by the recurring overproduction seen in the productive apparatus and the profitability issues that plague it, as Grossman’s thesis says. Given all of the difficulties affecting the productive apparatus, it could also be understood that bank credit is going less and less towards stimulating productive investment, and more towards a fully booming real-estate sector.

This is why more investment is pouring into real-estate, which accounts for one-third of national investment (as compared to less than 20% in the 2000s, see Figure 3), and national and foreign businessmen and women are gradually distancing themselves from the productive apparatus. Now, more than one-fourth of foreign direct investment (FDI) entering China ends up in the real-estate sector (see Figure 9). Of the 105.7 billion in FDI that flowed into China in 2010, 20.1 billion was destined for the real-estate market, which is equivalent to 20%, as compared to only 10% in 2001, and currently, FDI officially accounts for about 15% of the Chinese real-estate sector. In light of this, various authors have studied the growing effect of this mass inflow of foreign capital on the rising prices of Chinese properties (Chu and Singh, 2004; Zhang and Fung, 2006; Guo and Huang, 2010; Muto and Matsunaga, 2010).

Given the weight of informal financing in this country, and therefore, the absence of data on the true destination of loans granted, it is hard to find precise figures on the share of debt from real-estate investment, especially in the private sector and in small and medium-sized enterprises, which most often rely on the shadow banking system.

Figure 9. Foreign Direct Investment in China, in Billions of Dollars

Source: China’s State Administration of Foreign Exchange, Ministry of Commerce of the People’s Republic of China.


However, we know that public enterprises are investing more in this sector, even though their main activities are not directly related (Liu, 2008; Deng, Gyourko and Wu, 2010; Hu, 2011). In particular, if we look at the strong growth of financing granted to the private sector in recent years, we see that this trend is incongruent with an investment rate in the productive apparatus that continues to be undoubtedly high, but has not grown proportionally.

The example of the city of Wenzhou (Liu and Zou, 2012) could suggest the hypothesis that, in the entire country, many enterprises, both private and public, have chosen to abandon the productive apparatus and redirect their efforts towards the real-estate sector, which is riskier, but perhaps more profitable in the short term. Although this coastal city has been looked to as a model for growth since the 1980s, because it has many SMEs related to the export sector, its sudden drop in real-estate prices – which fell by 50% between 2011 and 2012 – revealed profound underlying weaknesses in the model. Many companies took on debt within the informal system to invest in the real-estate sector. However, when the bubble burst, significant problems related to over-indebtedness emerged, which have led to a collapse of the clandestine financial system and caused over half of the SMEs in the city to go bankrupt.

Many investors in China now seem to prefer the real-estate sector. Although strong surpluses generated by this sector are one of the main reasons behind this phenomenon, the fact that the productive apparatus is in the midst of difficulties could also be a determining factor. Although the official Chinese banking system is under greater State control than the United States system was after the First World War, both in terms of directing most of its loans to the public sector and the strict rules that govern private sector loans, we must not forget that local officials and public enterprises have also played an extremely important role in the current land and real-estate bubble, and that the informal banking sector is not subject to government oversight. This analysis concurs with Grossman’s (1992) thesis. Similar to how Europe and the United States had to find new sectors in the 1920s to valuate capital, China must now put a stop to surplus accumulation in its industry sector. In the absence of a sufficiently developed financial sector, capital will continue to flow more and more towards real-estate.


China is currently facing a developing real-estate bubble, aggravated by the considerable indebtedness of the private sector and local officials and, specifically, local governments' efforts to increase their revenue in an environment in which their budgets are increasingly imbalanced. However, this is not the only analysis of the situation. For Henryk Grossman, the Marxist economist, speculative activities of the 1920s in developed countries were the result of a lower profit rate in the productive apparatus. China now faces a series of challenges to its industry, which means that investors, whether they are public enterprises in the hands of local government or private investors, Chinese or even foreign, are turning towards other activities, especially the real-estate sector.

China’s economic growth is still very fragile. The policies that could be adopted to combat these difficulties, such as the over-indebtedness of local government and the development of a real-estate bubble, would not only fail to resolve underlying economic weaknesses, that is, the profitability issues afflicting the productive apparatus, but if the bubble formed over the past years bursts, it would also pull the curtain back on these issues, casting doubt on Chinese economic growth.

Far from wishing for and promoting speculation in China, which is an essentially unstable process that only increases income inequality, this article aims to spark a serious debate on China’s structural economic fragilities, which is a crucial topic to better understand one of the greatest challenges facing the current global economy.


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1 Five years after construction, this city, built to house more than a million people, is currently home to only a few thousand, because the proposed prices were inaccessible to the local population.

2 Wei Tian, “Ministry proposes more mergers in key industries,” China Daily, January 23, 2013.

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