The Great Housing Boom of China

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China’s housing market has seen spectacular growth over the past several years, with house prices growing at an annual rate of 17 percent. But some of the country’s fundamentals would suggest that such a boom should not be continuing. A 2014 working paper (which was revised in September) attempted to uncover how such a boom has been possible.

In their working paper “The Great Housing Boom of China,” Yi Wen, an economist with the Federal Reserve Bank of St. Louis, and Kaiji Chen, an assistant professor at Emory University, examined the circumstances surrounding the rise in house prices. The characteristics of this boom seem to suggest a paradox:

• According to data based on 35 major Chinese cities, average real house prices grew at an annual rate of around 17 percent for the past decade, while average income growth was 11 percent. GDP averaged 10 percent growth over the same period.
• In 2013, the national urban housing vacancy rate was 22.4 percent. For comparison, the U.S. homeowner vacancy rate during the peak of the housing bubble in 2006 was about 3 percent.
• Between 1998 and 2012, China’s real rate of return to capital was around or above 20 percent.

As Wen and Chen noted, “The combination of these features … is puzzling.” They also noted that traditional models would not explain all these characteristics being present at the same time.

In this paper, Wen and Chen proposed a theory to explain the great housing boom. The authors explained that a key element of their theory is that flourishing firms may seek housing as an alternative store of value for their rapidly growing wealth if they expect the high capital returns they’ve enjoyed to eventually subside. As the authors wrote, “[S]uch speculative investment behavior can create a self-fulfilling housing bubble that grows much faster than the national income during an economic transition, thus explaining China’s massive ‘ghost apartment’ phenomenon and decade-long faster-than-income growth in housing prices despite high capital returns.”

They concluded, “Our theory suggests that China’s unprecedented income growth is not the full story behind the great housing boom. The decade-long housing boom contains a rational bubble arising naturally from China’s economic transition, which is featured by labor reallocation from the traditional low-productivity sector to the newly emerging high-productivity sector. … The model’s predictions are thus consistent (quantitatively and qualitatively) not only with China’s broad pattern of economic growth, but also with the three paradoxical features of the great housing boom.”

Additional Resources

• Working Paper: The Great Housing Boom of China
• Economic Synopses: The Great Chinese Housing Boom
• On the Economy: Why India's Structural Transformation Is Unusual