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The Chinese housing market is clearly undergoing a correction that may eventually bring housing prices back to a more reasonable level. As the past several years have made all too apparent, housing downturns are economically painful and can lead to larger economic crises. The network of financial leverage that fueled the US housing bubble turned a modest correction in the housing market into a full blown financial crisis.
Homeowners in China, thankfully, are not as highly leveraged as their counterparts in the United States and other advanced economies were before the crisis. The risk therefore is not so much a financial crisis, but a more drawn out slowdown that affects the whole economy.
That a slowdown in real estate will have an impact on GDP growth rate is quite clear. Investment in residential real estate has emerged as the largest component of growth in recent years. Roubini Global Economics projects that the growth in residential real estate investment will slow to 10 to 15 percent in 2012, down from 34 percent in 2011. This could knock up to a point off GDP growth in 2012 and even more in 2013 if the correction persists.
What’s less clear is what the impact will be on Chinese consumers. There’s a wide literature on the relationship between housing prices and consumption in developed economies. The theory is that increases in home prices make homeowners feel wealthier and therefore consume more, i.e., the wealth effect. This trend was quite apparent in the United States where many homeowners took out home equity loans to finance higher consumption. The flipside, of course, is that for those trying to purchase or rent a home it will be more expensive, and they will therefore consume less.
In China the situation is less clear. The proportion of homeowners in urban China is extremely high, and therefore the negative drag of renters and would-be homeowners is less. But the data on new home prices are murky and the secondary market for homes is still quite undeveloped, making the magnitude of the wealth effect difficult to determine.
While the data is still unclear, there are two main reasons to believe that the housing wealth effect in China could be quite significant. The first, as mentioned before, is that home ownership in China is high, reaching 89 percent for urban households. This means a very large percentage of Chinese households have a direct stake in the housing market.
Secondly, the percentage of household wealth wrapped up in housing is quite large. We’ve put together an estimate of Chinese household wealth that draws upon and expands on the work done by UBS’ Wang Tao.
The share of wealth held in housing in China is almost 60 percent greater than that of American households and is equivalent to around 120 percent of GDP.
So not only are more Chinese households exposed to the housing market, but they also have a greater share of their wealth at stake. It follows that the drag in consumption in the United States resulting from declining home values may be replicated in China to an equal or greater extent. There are, however, several factors that may mitigate the effect in China, such as the lack of a liquid secondary housing market and the inability to take out home equity lines of credit.
The wealth effect from housing correction has broad implications for the economy. The housing market correction affects not only the usual suspect list of housing-related industries—cement, steel, etc.—but it may also dampen consumer-related consumption across the board. Upper-income families who made lots of money buying investment properties (at least on paper anyway) may find themselves much less inclined to consume if the value of their investments declines sharply over the next year.