I want my household surplus back!

A client did not show up to a lunch meeting, so instead I had a [likely] more interesting chat with my colleague, our banking sector analyst. It was a wide-ranging discussion of China, its economy and geopolitics.

He started by noting that Mexico had a nominal GDP per capita of over US$10,000 and asked "Why is Mexico so rich?" (China's per capita GDP is roughly $6000 in PPP terms and between $2500 and $3000 in nominal terms, though this blog post at Marginal Revolution notes the complexity of arriving at this number)

I have been to Mexico enough to think the $10,000 number is fair. Mexico is not a poor country at all, but one beset by a horrendous wealth gap and a society that does not create enough opportunities for its people. So I turned around the far more interesting question of "Why is China so poor?"

Long story short, he thought a key factor was land policy. Land is still strictly controlled by the monopoly of the state and many local governments get a significant portion of their operating budget from land sales (or rather 'use transfer right' as all land technically belongs to the government). As with any monopoly, profit maximization steals household surplus. Housing in urban China is ridiculously expensive compared to the average disposable income. In the US, the affordability ratio of median housing price to median income has historically hovered around 2.7-3. In Europe, I think the ratio might be roughly twice that. In China, reliable nationwide data is hard to come by (I will ask our property analyst when he returns), but a rough guess might be 10-12 currently. Housing bubble cities like Shenzhen saw it go up to as high as 20. Of course, I should add the caveats that 1) housing has to be examined locally 2) Chinese income statistics are unreliable 3) subsidized public housing is a larger mix than in the US 4) some public sector employees have often had their housing subsidized or outright paid for (although this practice is being phased out).

Compared to Americans, Chinese prefer physical assets and are far more likely to want to own rather than rent. Anecdotally, I know that many well to do Taiwanese or Chinese families in the US own multiple properties. Also, the number of investment options are limited in China. Real estate is one. Another is an underdeveloped and retail-heavy equities market that, even today, seems more like a casino designed by the government to channel money from household savings into mostly state-owned companies. These factors are among those that have kept housing prices high. And Chinese banks typically take 30% or more as downpayment. The result is that many Chinese save excessively, including when they are young, mainly to buy homes. Later on, they save excessively for their children and their retirements.

If land was liberalized, according to my bank analyst colleague, housing prices might fall by as high as 50%. The result would be a massive transfer of surplus to Chinese households and a spur in both general economic activity and, importantly, consumption.

This is interesting. The Communist government, I opined, has lauded itself for maintaining 10% growth for a number of years. But why should it? China started at such a low base due to past mismanagement, had access to capital and technology from around the world and could rely on exports as one engine of its growth. But could China have grown even faster and better with the right policies? Clearly, it is not that [neo-liberally] simple, but it deserves some thought.



Another factor he pointed out was the underdeveloped financial system, but I will reserve that thought for another day...