Your description of the fundamental different return characteristics of housing/infrastructure vs industry is valuable, showing in principle what have been and may well be the consequences of the 3RL and advanced manufacturing foci.
I do wonder if GDP is a red herring. For example, not only are nations' GDP wildly incomparable, but due to differing methodologies even deltas from year to year. To cap it all, I wonder if the Dungeon Master, whom evidence would suggest cares far more about substance than form, cares much about such numbers in reality:
1) I haven't looked if it is still the case, but according to https://www.globaltimes.cn/content/758065.shtml the "accounting" of relevant GDP and the resulting annual changes must be miles apart from the (sensible, I might add) "DCF" type proforma in your article:
"Chinese statistics have significantly underestimated housing consumption including rentals, utility and decoration expenditures. Rentals include actual rents paid by tenants and more importantly, imputed rents for owner-occupied homes. In practice, calculating imputed rent is not an easy task. China's statistics bureau uses construction costs multiplied by a fixed depreciation rate for a rough estimate. While this method is easy to employ, it greatly underestimates actual housing consumption. For starters, construction costs, which do not even include land costs, greatly underestimate the market value of housing, and the 2 percent depreciation rate applied for urban housing also underestimates the rental rate of return."
3) We don't really have the all important housing/infrasturcture and indeed industrial ROI figures, but directionally, isn't going after "new quality productive forces" a no-brainer? What other (sensible) direction exists in the value chain? More importantly, doesn't it look remarkably like checkmate?
Finally, why wouldn't China want to forever remain a "developing country"? ;-)
Yes, GDP isn't perfect but as some say, "it's all we've got" so we cannot ignore it either.
My approach is to recognize that there are imperfections, and understand what those imperfections and how they impact how are you are trying to use GDP:
-- Trend analysis within a country is generally okay and not impacted by accounting quirks (because it applies the accounting quirks on a consistent basis between periods - and if it doesn't, like when the NBS periodically upgrades its accounting methodology, it should disclose what those changes are and how they impact historical calculations retrospectively).
-- Comparative analysis between countries needs to take into account these accounting quirks (e.g. how imputed rent is calculated), which could be quite substantial. And it is not just accounting quirks but real differences in economic phase of development that can make it difficult to compare two nations. It is easier to compare two developing economies with each other than it is to compare a rich country with a developing country.
Indeed. Which you demonstrated by your Maslow's Hammer articles here, which I have just read. Love how you clinically dissected Michael Pettis' long held and widely repeated "consumption" fallacy, and putting Chinese figures in the context of the Asian Tigers'.
I like these kinds of contrarian contributions in general. and I think a bull case for China is underdiscussed. I agree with the various steps but I think we draw different conclusions. A few thoughts listed below. Much of it relates to property but there's a smattering of other topics listed as well.
As a starting point. On property, it's true that stimulus in 2009/10 played a big role in reviving demand and led to a reflationary outcome versus what had been the case, and that future stimulus subsequently was not well-spent. But constructing a bull case from that for me is more difficult.
1) There's lots of debt associated with those waves of stimulus that's on consumers, banks and local government balance sheets. That isn't going anywhere. For as long as it's hanging around it'll crimp the pace of the transition into these new light industries (which I agree have higher ROI than property). We see this in discussion from domestic banks and other credit providers who are simply extending and pretending, not having to mark it as an NPL. That may be better for short-term growth in that it puts off the evil day as it were but it means the financial system will be clogged with these low-ROI projects for some time. Hard to construct a bullish longer-term story from there without massive state direction that has a dubious track record of success.
2) The policy starting point of the property stimulus from the central government from 2012-2018 or so was 'we are underperforming our growth potential, we need to stimulate growth to raise it to target' and credit was made available to developers to boost growth. Implicit in the pivot away from the property sector is the acknowledgement that potential growth was lower than the central government supposed, so they no longer need to stimulate so much. I struggle thinking about that repositioning of policy in a bullish/reflationary way. You could say 'aha! now they have realised all those property investments were rubbish! So these new projects will be much better (trust them)!' but this is against a backdrop where growth targets in China have steadily fallen over time. Hard to square that circle.
3) The urbanisation theme in China's long-term growth to me is overplayed. They're starting from a lower base, sure, but their population is also older than Japan/Korea/Taiwan at similar stages in their development miracles. There's probably some headroom for more Chinese growth to come from urbanisation, but we need to compare apples to apples, and older people are typically less mobile (this can be seen in the US aging context). We can also say that aging and the number of people probably will have some impact on long-term infrastructure returns in some way (bad for whoever holds them).
4) Isn't there a scenario where the property sector negativity has further to run? You cite completions, and it's true authorities have been pretty good at getting developers to complete outstanding projects. But this has been as sales and starts have been falling dramatically and developer sources of funding have dried up. How long can the property sector completion track record be sustained? Without some way to pay workers to finish these properties, the completion track record will go too won't it? I don't expect a massive crisis or anything but the state has to make a decision to either give money to developers (draining on available cash for the high-tech transition) or to let them fold (cataclysm). The better side of that choice is just a continuation of the kind of slow-death we have seen for months.
5) I tend to think the high-tech boom/overcapacity narrative is overplayed. There are specific eye-catching sectors where growth is strong like autos or solar panels but this is actually very small. China's balance in cars is like $122bn in 2023, that's a step up from $0bn in 2020, but quite small compared to electronics ($350bn) or the grand total ($890bn). The larger story for me is the internalising of these intermediate processes within China in a way that wasn't happening pre-2020. China's import volumes have been falling sharply, both owing to domestic weakness and a re-shoring of Chinese production. As much as this might be helpful for Chinese growth it can only happen once. I go back and forth on if this learning can be sustained from (say) 2022 onwards in the same way China was doing from 2001, with the geopolitical situation the way it is, but I struggle to definitively state "yes! China's growth miracle has only just begun!".
All the same, an interesting piece! And it's good to get a new perspective.
(1-4) Grouping together the real estate / urbanization comments. I view it in terms of stocks (assets/debt) and flows (ongoing construction + rising consumption component based on rising HH incomes). There is overbuilding in large swathes of the country (especially lower tier cities) that needs to be absorbed. Some need more time to absorb. Others will never be able to absorb it. We don't yet know what those proportions are but I think we will get clues drip-feed out re: LGFV restructuring. And remaining urbanization is relevant here because that will dictate the pace at which non-/under-utilized assets are absorbed and all the stuck capital being put to some form of productive economic use.
IMO the flow component has largely been addressed and it has been relatively smooth with the flexible migrant construction labor force shifting from residential construction sites to clean energy construction sites or building new EV and battery factories. Some even argue that the run rate of new floorspace capacity is below just natural depreciation.
In the meantime, the other flow component continues to rise. HH incomes drive an increase in (mainly) imputed rent on housing stock . As excess housing stock is absorbed by continued rural-to-urban migration, this also boosts this metric. This is a more conceptual GDP (vs. real flows represented by construction labor) but does ultimately impact the calculated GDP figure.
One notable difference between the debt problem today and the last big credit issues in the 90s is the nature of the underlying assets. In the 90s, the issue with "extend-and-pretend" was continued operating losses at inefficient SOEs, capitalized as debt. In this round, the bulk of the expenditures take place in upfront construction; an unoccupied asset does not incur new expenditures (and debt). As such I do not think asset impairments are in the same ballpark as in the 90s, although nobody really knows yet the exact magnitude. The key is that with "extend and pretend" you aren't really creating as much incremental new bad debt. It's more the opportunity cost of all the capital you have stuck in under-utilized or empty assets. This goes back to the original point about how long it will take to absorb them and how much really just needs to be truly written off (by being demolished and rehabilitated and land available to be developed for other, more productive uses - including farming!).
(5) In the same vein, we also need to look at the real flow shift in labor and capital from the property sector to advanced manufacturing and "new" mostly clean energy oriented infrastructure in terms of stocks and flows. Mirroring the comments above, there have been major and noticeable shifts on the flow side. But the stock of assets necessarily takes longer to shift. I am actually trying to model this out right now (making assumptions on RoI) to see how this shows up in the GDP numbers with stocks gradually shifting from lower RoI housing and old infrastructure to higher RoI advanced manufacturing (but still quite-low RoI clean energy infrastructure).
In my view, the bigger real impact from both advanced manufacturing and clean energy doesn't happen within the sectors, but in the productivity gains it unleashes in other sectors. Electric vehicles are creating many first-time car owning households and that will unleash new economic activity and associated GDP growth. Declining energy costs will translate into real improvements in economic production and unleash new creative ways to use this lower-cost energy. I talk about these themes in this thread here about EVs and why the economic gains will be greater outside the auto sector than within: https://twitter.com/GlennLuk/status/1769933722713788737
I like the idea that real estate is fundamentally consumption-driven and it's important to remeber that property is not 'just investment'. My concerns:
(1) Does it ring trickle-down economics? Household only benefits from the growth indirectly (by declining prices, externality of infrastrature, etc.).
Just look at the urban income/property-price ratio, especially in magecities like beijing & shanghai (where trickle-down is most prevelant for profitable for developers). Median young people cannot really afford a decent home.
And, (2) it is one thing to say property has a very long useful life, but quite another for developer's balance sheet, and for consumers' preferences. Developers do not have decades to wait. People want new houses.
1) Households benefit from the houses themselves (upgraded housing, amenities, more space, etc.). Households also benefit from the gainful employment and wages - the vast majority of the gross capital formation is actually simply labor. Especially blue-collar migrant laborers that made up the bulk of construction personnel and their families (often back in the village, or in the nearest town or city).
Tier I cities had high price/income issues and one irony is that they were also under-supplied with housing. The local governments did not suffer from lack of demand, but their challenge was the responsibility of having to provide local city services. Beijing also favored spreading our urban development across the country instead of concentrating in three or four megacity regions.
In lower tier cities, many faced the opposite issue: over-estimating demand and building too much supply of housing. Price/income ratios are much lower - that is not the issue. The issue is more demand-driven. The Tier I megacities have a "gravitational effect" on demand, which pulls demand away from the lower-tier cities. Again as mentioned above, as a matter of national policy Beijing is fighting against this natural economic gravity by putting policies in place to try to get more households to stay closer to home.
2) Developers matter because they represent housebuilding capacity and matching supply with demand (driven by consumer preferences on location, amenities, etc.). But if they go bankrupt (as many have, and more will), some of that construction capacity can shift to other sectors of the economy with better prospects (like clean energy) or they will be consolidated into more efficiently and better managed developer operations.
I always look forward to your Twitter threads, and your Substack articles are great too. However, I find substack articles a bit less coherent, mainly because of the narrative flow and grammar, compared to your twitter threads.
Here's a suggestion: run your articles through Claude 3 or GPT-4 and ask for minimal edits, focusing on logical coherence and grammar. The changes are often subtle, like an extra or removed comma, but they can also be significant, such as clarifying the object being referred to, which is the main reason I sometimes have to do a double-take:
<Prompt>
You are copyeditor. Your focus is on making written pieces more logically coherent and grammatically correct.
Please edit the below:
</Prompt>
<Before>
China’s Q1 GDP figures were released yesterday by the National Bureau of Statistics (NBS), featuring headline year-over-year growth of 5.3% which came in ahead of “consensus” figures from outside analysts and observers.
In this essay, I will tackle #1: the ongoing transition of China’s economy from property to advanced manufacturing. My views are different from the consensus — in short, that the Chinese economy is transitioning to a new era in which GDP growth gets a healthy boost from the structural shift into advanced manufacturing that more than offsets demographic decline in its working-age population. This goes back to the age-old question of “Will China become old before it becomes rich?”.
<After>
China's Q1 GDP figures were released yesterday by the National Bureau of Statistics (NBS), featuring headline year-over-year growth of 5.3%, which came in ahead of "consensus" figures from outside analysts and observers.
In this essay, I will tackle #1: the ongoing transition of China's economy from property to advanced manufacturing. My views are different from the consensus — in short, I believe that the Chinese economy is transitioning to a new era in which GDP growth gets a healthy boost from the structural shift into advanced manufacturing that more than offsets the demographic decline in its working-age population. This goes back to the age-old question of "Will China become old before it becomes rich?"
</After>
For instance, it was unclear (to me) whether you were describing the general consensus or your own view, as the explanation came after the noun "consensus". It wasn't until the end of the paragraph that the tone implied it was yours.
Your description of the fundamental different return characteristics of housing/infrastructure vs industry is valuable, showing in principle what have been and may well be the consequences of the 3RL and advanced manufacturing foci.
I do wonder if GDP is a red herring. For example, not only are nations' GDP wildly incomparable, but due to differing methodologies even deltas from year to year. To cap it all, I wonder if the Dungeon Master, whom evidence would suggest cares far more about substance than form, cares much about such numbers in reality:
1) I haven't looked if it is still the case, but according to https://www.globaltimes.cn/content/758065.shtml the "accounting" of relevant GDP and the resulting annual changes must be miles apart from the (sensible, I might add) "DCF" type proforma in your article:
"Chinese statistics have significantly underestimated housing consumption including rentals, utility and decoration expenditures. Rentals include actual rents paid by tenants and more importantly, imputed rents for owner-occupied homes. In practice, calculating imputed rent is not an easy task. China's statistics bureau uses construction costs multiplied by a fixed depreciation rate for a rough estimate. While this method is easy to employ, it greatly underestimates actual housing consumption. For starters, construction costs, which do not even include land costs, greatly underestimate the market value of housing, and the 2 percent depreciation rate applied for urban housing also underestimates the rental rate of return."
2) Again I am unsure if it is still the case, but https://web.archive.org/web/20200321163609/http://jedsnet.com/journals/jeds/Vol_3_No_3_September_2015/6.pdf suggests Japan's imputed rent, important given high home ownership in both countries, was circa 20x China's on a per square meter basis.
3) We don't really have the all important housing/infrasturcture and indeed industrial ROI figures, but directionally, isn't going after "new quality productive forces" a no-brainer? What other (sensible) direction exists in the value chain? More importantly, doesn't it look remarkably like checkmate?
Finally, why wouldn't China want to forever remain a "developing country"? ;-)
Yes, GDP isn't perfect but as some say, "it's all we've got" so we cannot ignore it either.
My approach is to recognize that there are imperfections, and understand what those imperfections and how they impact how are you are trying to use GDP:
-- Trend analysis within a country is generally okay and not impacted by accounting quirks (because it applies the accounting quirks on a consistent basis between periods - and if it doesn't, like when the NBS periodically upgrades its accounting methodology, it should disclose what those changes are and how they impact historical calculations retrospectively).
-- Comparative analysis between countries needs to take into account these accounting quirks (e.g. how imputed rent is calculated), which could be quite substantial. And it is not just accounting quirks but real differences in economic phase of development that can make it difficult to compare two nations. It is easier to compare two developing economies with each other than it is to compare a rich country with a developing country.
Indeed. Which you demonstrated by your Maslow's Hammer articles here, which I have just read. Love how you clinically dissected Michael Pettis' long held and widely repeated "consumption" fallacy, and putting Chinese figures in the context of the Asian Tigers'.
Very impressive!
The clarity in your article is first-grade
I like these kinds of contrarian contributions in general. and I think a bull case for China is underdiscussed. I agree with the various steps but I think we draw different conclusions. A few thoughts listed below. Much of it relates to property but there's a smattering of other topics listed as well.
As a starting point. On property, it's true that stimulus in 2009/10 played a big role in reviving demand and led to a reflationary outcome versus what had been the case, and that future stimulus subsequently was not well-spent. But constructing a bull case from that for me is more difficult.
1) There's lots of debt associated with those waves of stimulus that's on consumers, banks and local government balance sheets. That isn't going anywhere. For as long as it's hanging around it'll crimp the pace of the transition into these new light industries (which I agree have higher ROI than property). We see this in discussion from domestic banks and other credit providers who are simply extending and pretending, not having to mark it as an NPL. That may be better for short-term growth in that it puts off the evil day as it were but it means the financial system will be clogged with these low-ROI projects for some time. Hard to construct a bullish longer-term story from there without massive state direction that has a dubious track record of success.
2) The policy starting point of the property stimulus from the central government from 2012-2018 or so was 'we are underperforming our growth potential, we need to stimulate growth to raise it to target' and credit was made available to developers to boost growth. Implicit in the pivot away from the property sector is the acknowledgement that potential growth was lower than the central government supposed, so they no longer need to stimulate so much. I struggle thinking about that repositioning of policy in a bullish/reflationary way. You could say 'aha! now they have realised all those property investments were rubbish! So these new projects will be much better (trust them)!' but this is against a backdrop where growth targets in China have steadily fallen over time. Hard to square that circle.
3) The urbanisation theme in China's long-term growth to me is overplayed. They're starting from a lower base, sure, but their population is also older than Japan/Korea/Taiwan at similar stages in their development miracles. There's probably some headroom for more Chinese growth to come from urbanisation, but we need to compare apples to apples, and older people are typically less mobile (this can be seen in the US aging context). We can also say that aging and the number of people probably will have some impact on long-term infrastructure returns in some way (bad for whoever holds them).
4) Isn't there a scenario where the property sector negativity has further to run? You cite completions, and it's true authorities have been pretty good at getting developers to complete outstanding projects. But this has been as sales and starts have been falling dramatically and developer sources of funding have dried up. How long can the property sector completion track record be sustained? Without some way to pay workers to finish these properties, the completion track record will go too won't it? I don't expect a massive crisis or anything but the state has to make a decision to either give money to developers (draining on available cash for the high-tech transition) or to let them fold (cataclysm). The better side of that choice is just a continuation of the kind of slow-death we have seen for months.
5) I tend to think the high-tech boom/overcapacity narrative is overplayed. There are specific eye-catching sectors where growth is strong like autos or solar panels but this is actually very small. China's balance in cars is like $122bn in 2023, that's a step up from $0bn in 2020, but quite small compared to electronics ($350bn) or the grand total ($890bn). The larger story for me is the internalising of these intermediate processes within China in a way that wasn't happening pre-2020. China's import volumes have been falling sharply, both owing to domestic weakness and a re-shoring of Chinese production. As much as this might be helpful for Chinese growth it can only happen once. I go back and forth on if this learning can be sustained from (say) 2022 onwards in the same way China was doing from 2001, with the geopolitical situation the way it is, but I struggle to definitively state "yes! China's growth miracle has only just begun!".
All the same, an interesting piece! And it's good to get a new perspective.
Thanks for your long comment and feedback.
(1-4) Grouping together the real estate / urbanization comments. I view it in terms of stocks (assets/debt) and flows (ongoing construction + rising consumption component based on rising HH incomes). There is overbuilding in large swathes of the country (especially lower tier cities) that needs to be absorbed. Some need more time to absorb. Others will never be able to absorb it. We don't yet know what those proportions are but I think we will get clues drip-feed out re: LGFV restructuring. And remaining urbanization is relevant here because that will dictate the pace at which non-/under-utilized assets are absorbed and all the stuck capital being put to some form of productive economic use.
IMO the flow component has largely been addressed and it has been relatively smooth with the flexible migrant construction labor force shifting from residential construction sites to clean energy construction sites or building new EV and battery factories. Some even argue that the run rate of new floorspace capacity is below just natural depreciation.
In the meantime, the other flow component continues to rise. HH incomes drive an increase in (mainly) imputed rent on housing stock . As excess housing stock is absorbed by continued rural-to-urban migration, this also boosts this metric. This is a more conceptual GDP (vs. real flows represented by construction labor) but does ultimately impact the calculated GDP figure.
One notable difference between the debt problem today and the last big credit issues in the 90s is the nature of the underlying assets. In the 90s, the issue with "extend-and-pretend" was continued operating losses at inefficient SOEs, capitalized as debt. In this round, the bulk of the expenditures take place in upfront construction; an unoccupied asset does not incur new expenditures (and debt). As such I do not think asset impairments are in the same ballpark as in the 90s, although nobody really knows yet the exact magnitude. The key is that with "extend and pretend" you aren't really creating as much incremental new bad debt. It's more the opportunity cost of all the capital you have stuck in under-utilized or empty assets. This goes back to the original point about how long it will take to absorb them and how much really just needs to be truly written off (by being demolished and rehabilitated and land available to be developed for other, more productive uses - including farming!).
(5) In the same vein, we also need to look at the real flow shift in labor and capital from the property sector to advanced manufacturing and "new" mostly clean energy oriented infrastructure in terms of stocks and flows. Mirroring the comments above, there have been major and noticeable shifts on the flow side. But the stock of assets necessarily takes longer to shift. I am actually trying to model this out right now (making assumptions on RoI) to see how this shows up in the GDP numbers with stocks gradually shifting from lower RoI housing and old infrastructure to higher RoI advanced manufacturing (but still quite-low RoI clean energy infrastructure).
In my view, the bigger real impact from both advanced manufacturing and clean energy doesn't happen within the sectors, but in the productivity gains it unleashes in other sectors. Electric vehicles are creating many first-time car owning households and that will unleash new economic activity and associated GDP growth. Declining energy costs will translate into real improvements in economic production and unleash new creative ways to use this lower-cost energy. I talk about these themes in this thread here about EVs and why the economic gains will be greater outside the auto sector than within: https://twitter.com/GlennLuk/status/1769933722713788737
I like the idea that real estate is fundamentally consumption-driven and it's important to remeber that property is not 'just investment'. My concerns:
(1) Does it ring trickle-down economics? Household only benefits from the growth indirectly (by declining prices, externality of infrastrature, etc.).
Just look at the urban income/property-price ratio, especially in magecities like beijing & shanghai (where trickle-down is most prevelant for profitable for developers). Median young people cannot really afford a decent home.
And, (2) it is one thing to say property has a very long useful life, but quite another for developer's balance sheet, and for consumers' preferences. Developers do not have decades to wait. People want new houses.
1) Households benefit from the houses themselves (upgraded housing, amenities, more space, etc.). Households also benefit from the gainful employment and wages - the vast majority of the gross capital formation is actually simply labor. Especially blue-collar migrant laborers that made up the bulk of construction personnel and their families (often back in the village, or in the nearest town or city).
Tier I cities had high price/income issues and one irony is that they were also under-supplied with housing. The local governments did not suffer from lack of demand, but their challenge was the responsibility of having to provide local city services. Beijing also favored spreading our urban development across the country instead of concentrating in three or four megacity regions.
In lower tier cities, many faced the opposite issue: over-estimating demand and building too much supply of housing. Price/income ratios are much lower - that is not the issue. The issue is more demand-driven. The Tier I megacities have a "gravitational effect" on demand, which pulls demand away from the lower-tier cities. Again as mentioned above, as a matter of national policy Beijing is fighting against this natural economic gravity by putting policies in place to try to get more households to stay closer to home.
2) Developers matter because they represent housebuilding capacity and matching supply with demand (driven by consumer preferences on location, amenities, etc.). But if they go bankrupt (as many have, and more will), some of that construction capacity can shift to other sectors of the economy with better prospects (like clean energy) or they will be consolidated into more efficiently and better managed developer operations.
I always look forward to your Twitter threads, and your Substack articles are great too. However, I find substack articles a bit less coherent, mainly because of the narrative flow and grammar, compared to your twitter threads.
Here's a suggestion: run your articles through Claude 3 or GPT-4 and ask for minimal edits, focusing on logical coherence and grammar. The changes are often subtle, like an extra or removed comma, but they can also be significant, such as clarifying the object being referred to, which is the main reason I sometimes have to do a double-take:
<Prompt>
You are copyeditor. Your focus is on making written pieces more logically coherent and grammatically correct.
Please edit the below:
</Prompt>
<Before>
China’s Q1 GDP figures were released yesterday by the National Bureau of Statistics (NBS), featuring headline year-over-year growth of 5.3% which came in ahead of “consensus” figures from outside analysts and observers.
In this essay, I will tackle #1: the ongoing transition of China’s economy from property to advanced manufacturing. My views are different from the consensus — in short, that the Chinese economy is transitioning to a new era in which GDP growth gets a healthy boost from the structural shift into advanced manufacturing that more than offsets demographic decline in its working-age population. This goes back to the age-old question of “Will China become old before it becomes rich?”.
<After>
China's Q1 GDP figures were released yesterday by the National Bureau of Statistics (NBS), featuring headline year-over-year growth of 5.3%, which came in ahead of "consensus" figures from outside analysts and observers.
In this essay, I will tackle #1: the ongoing transition of China's economy from property to advanced manufacturing. My views are different from the consensus — in short, I believe that the Chinese economy is transitioning to a new era in which GDP growth gets a healthy boost from the structural shift into advanced manufacturing that more than offsets the demographic decline in its working-age population. This goes back to the age-old question of "Will China become old before it becomes rich?"
</After>
For instance, it was unclear (to me) whether you were describing the general consensus or your own view, as the explanation came after the noun "consensus". It wasn't until the end of the paragraph that the tone implied it was yours.
Thanks I appreciate the comment and suggested approaches!