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Will China’s property price drop hit its consumption growth?

by CKGSB Knowledge

July 1, 2011

Real estate has been a major contributing factor for China’s GDP within the past few years. However, it is believed that the government’s recent statement about continuing to “stabilize” property prices may drive some people away from consumption, which would be the opposite effect the government is hoping for. Given that China’s export-driven economy has essentially come to an end due to Europe’s debt crisis and the recession in the US, it would not be desirable for consumption to decrease as it is one of the three major driving forces of economic growth in China, the other two being investments and exports.

A low rate of consumption has always been a problem in China. Poor social healthcare and the expectation of more serious inflation will tend to result in Chinese people saving more rather than spending more.

The sudden decline in housing prices followed by a decrease in consumption was larger than expected in relation to the GDP, explains Professor Gan Jie of the Cheung Kong Graduate School of Business (CKGSB). Based on her monitoring of the real estate market in Hong Kong between 1992 and 2004, she concludes that the liquidity constraints and the precautionary saving motive have lead to people consuming less.

The liquidity constraint refers to the concept that increases in housing wealth relaxes borrowing constraints, resulting in a positive consumption response. The precautionary saving motive refers to higher housing values that reduces the need for precautionary saving and thus increases consumption. Gan describes the liquidity constraint effect as being limited to individuals who refinance their mortgages, whereas the precautionary saving effect can potentially affect all households.

Generally, property assets account for a big proportion of household wealth. The drop in property prices means homeowners’ wealth is significantly reduced, resulting in less marginal propensity consumption. In the case of a drop in property price, selling or refinancing a mortgage will mean a loss of wealth for the homeowner, with the natural result of less consumption. If the homeowner decides to keep the property, there could be an expectation of a continued loss of its value, which will also lead to a reduction in consumption.

From the buyer’s perspective, if purchasing property is considered an investment instead of a necessity and if the property value continues to increase, there will be no shortage of interested prospects; but when the property value starts decreasing, demand also decreases as potential buyers simply wait for better opportunities.  Therefore, any potential buyers will prefer to hold on to their money rather than engage in risky consumption.

The findings of Gan’s study fit into what is currently happening in China’s real estate market. Since April 2010, the Chinese government has adopted a series of sales and price limits on property leading to a price decrease in 40 percent of Chinese cities, according to the China Index Academy, a property research institute working with China’s biggest real estate agent Soufun. According to their latest data in November 2011, 30 cities studied had seen decreases in their property prices, among which Shanghai’s property prices dropped by 9.26 percent. This corresponds with the National Statistics Bureau’s monthly household consumption figures. Since this past September, when property prices began declining in some cities, the public consumption rate had declined from 1.34 percent to 1.30 percent during October, and further declined to 1.27 percent in November.

Marginal propensity consumption categories like jewelry have had the largest decrease in growth. According to the latest statistics from the Ministry of Commerce, in November, the sales of construction and decorative materials increased by 6.8 percent, a growth rate of 5.6 percent less, as compared to October. In addition, jewelry sales increased by 21.2 percent in November, a growth rate of 9.9 percent less, as compared to October, which is the lowest growth rate since 2010.

While working closely with Hong Kong banks, Gan was given access to mortgage and credit card data that proved invaluable information for her research. This data tracked the housing wealth and credit card spending of 12,793 individuals in Hong Kong. Encompassing nine Hong Kong districts, the dataset included 1.5 million housing transactions and 2.1 million mortgage loans originating between 1992 and 2004. Gan also tracked consumption growth through household credit card charges provided by five large credit card issuers in the autonomous region. In the absence of refinancing and relaxation of credit constraints, the research data shows housing wealth can have a substantial impact on consumption.

Gan Jie’s research is important because not only are the findings applicable to China, but to other countries as well, especially those facing tough economic times. According to the conclusion of her article, “The results in this paper illustrate a powerful channel through which housing price movements can be transmitted into the economy. In particular, they suggest that the current slowdown in the housing market in the U.S. may have an amplifying effect on economic growth due to reduced consumer spending.”

China’s Academy of Social Sciences predicted China’s GDP growth to be 8.9 percent in 2012, and the overall CPI to be 4 percent. The recent Central Economic Work Conference has decided China will maintain its prudent monetary policy and proactive fiscal policy next year. It pointed out that China would unswervingly maintain its current property regulation policies next year to ensure that housing prices return to a reasonable level. The question is: will reducing property prices lead to a sharp decline in consumption, thus creating uncertainty for the world’s second-largest economy? Whether or not this will occur remains to be seen.

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