Page 2 - Overbuilt Assessing the Diminishing Returns to Building in China

The accumulation of unfinished projects in tier 3 cities has also gained pace. The ratio of housing under
construction to annual housing completed has climbed from six times in 2011 to 10.6 times in 2020, suggesting
more developers are unable to complete projects for lack of final buyers and funding. In China’s current property
downturn, real estate prices have flattened in tier 1 cities, but continue to fall in tier 3 cities. A similar trend is
apparent in commercial real estate.

The authors also analyze several forms of infrastructure investment. High-speed rail expansion continues,
significantly outpacing passenger growth, despite the 6 trillion yuan in liabilities and continuous financial losses
at the China State Railway Group. This growth, along with other infrastructure investments like sewage pipes and
roads, remains heavily tilted toward tier 3 cities.

The returns to new real estate investment are falling. The authors show that real estate investment has a positive
effect on city-level GDP growth — but the gains diminish as the stock of housing, or the total occupied and vacant
living space in a city, grows. The analysis found cities with higher housing stock grew more slowly, confirming that
overbuilding reduces future returns. On average, a city where the housing stock is one standard deviation above
the mean in 2020 would grow 1.1 percentage points more slowly than a city with an average housing stock in the
same year. Alternatively, a city with an average housing stock in 2020 would grow 2.2 percentage points more
slowly than a city with an average housing stock in 2010, since average housing stock increased by more than four
times in that decade.

Local government debt, dependence on land sales for revenue have surged alongside construction. Real estate
investment has been heavily funded by debt — often through Local Government Financing Vehicles (state-owned
entities that borrow on behalf of local governments). The study finds that cities with higher real estate investment
have significantly higher debt-to-GDP and bond-to-GDP ratios. Additionally, tier 3 cities rely on land sales for up
to 43% of their revenue. The ratio is even higher in tier 2 cities, at 46%. Land sales are still important in tier 1 cities,
albeit accounting for only 30%. This debt dependence makes localities highly exposed to a real estate downturn,
while complicating efforts to shift toward more sustainable sources of growth.
Can China pivot away from construction? China’s real estate boom
has powered one of the greatest economic transformations in
history, but the data suggest a new growth strategy is overdue.
With mounting local debt and diminishing growth returns from real
estate, a transition away from construction-led growth will likely be
difficult but necessary. Recognizing China’s track record in tackling
complex challenges, the authors propose reforms such as fiscal
transfers, property taxes, and structural changes to reduce reliance
on land-based finance. However, they caution that these measures
will be difficult to implement within China’s hybrid public-private
economic system, leaving significant risks of prolonged stagnation
or recession.