Is Chinese real estate a real bubble? The question, because of its global implications, has been floating around for many months. Pessimists believe it is - and that it is something that could trigger a larger crisis possibly like the one engulfing the United States, which started in 2008 with the bursting of the country's real estate market.

Yet, Jin Pei, head of the influential department of industrial economics at the Chinese Academy of Social Sciences, has weighed in recently with a look at the Chinese real estate problem from a totally different perspective.

He argues that when China started its development offerings in the global market, everything was at very low prices - not only labor costs but also the cost of the land and of its resources. [1] Land for industries and coal for energy was given free or very cheaply to factories. China could do this because everything belonged to the state, and the state could offer anything as it wished.

This massive injection of low-capital investment kept prices down and conquered a place for China in the world market. In other words, it was not only the Chinese workers who sacrificed their income to get competitive products. China also sacrificed overall by charging no or little money for things such as energy (produced by state-monopolized coal, sold at a discounted price) or land - that could have been a source of revenue for the country and elsewhere could be quite expensive.

Then China exchanged actual revenues in all its forms in return for the transfer of technology and know-how that entailed new market share.

All of this is now coming to a close as China wants - and it is pushed - to expand internal consumption. To consume its own products, export less, and import more, China needs money - real cash. One way is to increase workers' salaries, but a broader policy needs to turn into real value what was previously given for free - mainly land. Land could become collateral for banks, which in turn could lend money and create a cash flow.

Not all land is the same in China. Commercial land is sold for high prices, industrial land is still given out at a discount, and land for state or military buildings is granted for free.

If the real estate problem has to be addressed, it must start here: land must have a price and thus cannot be used liberally (and greedily) by entities that own them for non-commercial reasons but can in the future turn them to commercial use. Jin Pei argues that there should be restrictions on the size of government buildings or on the use of military barracks.

Arguably, although the state may decide to let them out for free, these plots of land should be accounted for and have a price tag next to them on the official books.

Only if all this land is brought onto the books can we have a real picture of the market. This could certainly cause a drop in prices, but here Jin takes a different turn.

He explains that in the last 10 to 15 years of reforms, China has created immense wealth for its urban middle class. A very conservative estimate reckons that some 500 million Chinese collectively sit on at least 100 trillion yuan (US$15 trillion) of capital. (About 80%, or 500 million, of the roughly 600 million urban Chinese own their homes, constituting some 200 million family homes each worth at the very least 500,000 yuan.)

These people are the foundation rock of social stability, the ones who have gained from the reforms, and now they have concrete capital to defend. The interests of those people must be defended and taken care of. A drop in the value of those assets benefits only a small minority of people who are looking for a flat to buy in the cities, but hurts the majority of the urban population concerned about their key financial asset and safety net.

The rest of the population is also not completely deprived. Many are given lots of land in the countryside, where they have a house. The vast majority of the population thus has a stake in the overall stability of the country. Therefore, the goal of the state should be to protect those assets, which can also be monetized and given as collateral to banks or sold for other developments.

Then forget a huge drop in real estate prices. They are more than assets to be traded in an inconstant market - they are guarantees of social stability.

Beyond commercial and agricultural land are the land lots given for industrial development and official purposes. State-owned enterprises (SOEs), local governments, and central ministries sit on huge potential and actual property treasure booties inherited from when the communists took power in China and all private property was nationalized and split among potentates. This land - under-paid for and under-utilized - is a potential threat to the value of homeowners' assets.

This land can reach the commercial market any time and in any given quantity. Industries previously located in the central urban district have been expelled, leaving areas for development. Or a local administration can take over land previously "left behind" by former agricultural communes or factories. This land is a potential huge distortion in the market, and it is also a huge waste of resources for the already inefficient SOEs.

Sheng Hong, a professor at Shandong University, has been detailing for years the inefficiencies of the SOEs. But last month the semiofficial Global Times (Chinese edition) carried a strong article by Sheng arguing that private companies produce 96% more industrial value added than SOEs and 39% more profits.

Still many very inefficient SOEs survive thanks to their monopolistic position and their better connections with the credit system. Another way for SOEs to grease their profits is to sell their land assets to developers or turn themselves directly into real estate developers.

This creates a further distortion of the market, and it creates unfair competition against private companies that have to purchase their land directly in the market.

Moreover, the appreciation of land prices, resources, and labor makes it more difficult to get the transfer of technology and know-how that powered Chinese growth in the past 20 years. Foreign companies are no longer enticed by the cheap land, labor, and resources, so they skip China and move elsewhere.

In theory, China now has money earned from exports surplus and it can monetize its land and buy foreign necessary technology and know-how. Yet there are many visible and invisible barriers to Chinese acquisition of foreign companies, as there are many similar restrictions for foreigners buying controlling stakes in "strategic" Chinese industries like automotive or telecom.

It is impossible to think of a wholesale liberalization of the investment market for foreigners, just as it is impossible to think of a total deregulation of the land market. Things could easily get out of hand. But it is possible to think that if China were to grant more latitude to foreigners investing in China then it should be rewarded in kind.

Possibly the realigning of all these distortions, land evaluation and SOEs' privileges, could send a stronger message to the world about China's long-term intentions and future. It certainly would address deep-rooted problems caused by the conflict of modern economy (private companies, land for commercial use) with legacies of the past (SOEs and land granted to industries and government offices) that could drag its future development and endanger the engine of its past growth - non-state companies and private home owners.

Note
1. Zhongguo jingyingbao, September 6, 2010. (2010-10-07 Asia Times)