China in Transition

Behind China's Housing Bubble

Chi Hung KWAN
Consulting Fellow, RIETI

Qingdao, a beautiful town nicknamed "the Switzerland of China," has been famed as a summer resort since its early days. On the heels of China's reform and open policy, there has been large influx of foreign direct investment, and Qingdao is also home to some of the leading Chinese firms, such as Haier and Tsingtao Beer. Thus, Qingdao has now become an attractive town both as a production base and as a vacation paradise.

Visitors to Qingdao would certainly be impressed by the thousands of three-storied townhouses along the coastline. With many of these houses still under construction, the ongoing boom has shown no signs of losing steam. On the face of it, the phenomena symbolize the prosperity of Qingdao, but stories I hear from people there suggest that a housing bubble is fast emerging in China.

These townhouses are being sold, not for residential purpose, but as vacation villas. When night falls, the neighborhood is thus plunged into darkness. Indeed, it would be no exaggeration to call it a ghost town. Initially, I thought many of them were left unsold with demand failing to catch up with supply. But I was told that most of them have actually been sold. Although they are vacation villas, most of their owners do not actually come and stay there and many are looking for tenants. Obviously, the prime purpose of purchasing these villas is to get capital gains from rising asset prices. Qingdao will be the venue for the sailing events of the 2008 Olympics, and a massive amount of capital has been flowing into Qingdao.

Being in a highly popular resort area, these villas are quite expensive. Some of them cost as much as 10,000 yuan per square meter. This translates into 2 million yuan ($250,000) per house on the assumption that they have an average floor space of 200 square meters. Among their owners are rich entrepreneurs, but many others are high-ranking officials of local governments and party committees in other regions, including those in the west. Considering that senior local government officials earn only a few thousand dollars a year, one might wonder how they can afford a house costing more than 100 times their annual income. Given the fact that they hold various authorization rights and authority over the privatization and disposition of state assets, however, the mystery disappears.

The striking contrast between the prosperity of Qingdao and the wretched state in the inland rural areas suggests that the polarization of wealth within China is fast taking place. Capital that should be spent on the development of the western region is further flowing out into the coastal areas. This provides a pessimistic picture for the softening of inter-regional disparities in China. The only consolation is that, while in most developing countries, a large amount of capital has been illegally channeled overseas, in China they have at least stayed within its borders.

Most people in Qingdao do not see the ongoing resort home boom as a bubble because real demand for those villas exists, and buyers do not even have to rely on bank loans so that it would not generate bad loan problems even if their prices fall. Nevertheless, this is no different from a bubble in that the rate of return on investment is extremely low and that valuable resources are not being used efficiently. As it is obvious from the experience of Japan in the late 1980s and of the United States in the late 1990s, the presence of bubbles can be recognized only after they burst. People learn lessons from their own experience but unfortunately it is difficult to learn from the experience of others. I hope that China will not fall into the same rut as Japan and the U.S.

October 4, 2002

October 4, 2002