A tale of two countries

China’s real estate sector—entering its sixth year of adjustment—“appears to be in the middle stages of a multi-year correction,” according to a paper to be discussed at the Brookings Papers on Economic Activity (BPEA) conference on March 27.

The authors, Kenneth Rogoff of Harvard University and Yuanchen Yang of the International Monetary Fund, explore why China’s real estate sector “has exerted such substantial contractionary effects” on its broader economy—the world’s second largest, after the United States’.

And they compare China’s experience so far to the so-called “Lost Decade” of economic stagnation that followed Japan’s real estate collapse in the late 1980s, “uncovering striking parallels …. despite profound institutional differences.” The parallels include demographics (China’s population is aging even faster than Japan’s) and over-development.

“If China’s adjustment unfolds in a similar way as Japan’s, it would mean China has not gone halfway through the transition,” the authors write.

Real estate has long been a cornerstone of China’s economic development and has become even more critical in the context of escalating global tension over China’s voluminous exports, the authors note.

China is the world’s largest trading nation, by volume. However, the authors note that real estate (along with its direct and indirect inputs such as building materials, furniture, utilities) and infrastructure (roads, bridges, water supply and power grids) accounts for nearly one-third of economic demand in China. Plus, Chinese households allocate far more of their wealth to housing (nearly 70%) than households in other countries.

Financial factors such as bank failures and credit crunches are often seen as driving real estate collapses. Indeed, many attribute China’s real estate slowdown to the introduction in August 2020 of China’s ‘three red lines” policy imposing borrowing limits on property developers and the subsequent collapse, in 2021, of China Evergrande Group, once the world’s most valuable real estate companies. However, the authors note, the real estate sector’s contribution to Chinese growth was already declining by 2018.

“Three red lines was a trigger but the real estate slump was going to happen anyway because of the fundamentals—demographics and oversupply,” Rogoff said in an interview with the Brookings Institution.

In explaining the persistence of the downturn, the authors focus on broader real-economy channels related to investment, consumption, and sentiment. Chinese cities where housing was most over-built are experiencing an investment overhang that will suppress new construction for a substantial time, the authors note. Additionally, sharp declines in housing prices have depressed consumption spending and undermined household and firm confidence.

 “In the absence of comprehensive social safety nets [in China], housing wealth is a form of…