Declining property investment the key to China's slowdown

The worry of the week this week is the mainland's export performance. After the country recorded year-on-year export growth of just 2.7 per cent last month a bevy of analysts have warned that continued weakness will weigh further on already slumping economic growth.

Slower shipments are certainly a concern for exporters, and troubling news for policymakers worried about the millions of manufacturing jobs at risk if export growth falls any more.

But weaker exports are not the principal cause of the slowdown in the overall growth rate that we've seen over recent quarters.

According to official figures, net exports have not contributed positively to the economy's quarterly growth rates since the end of 2010.

So if we want to find the cause of the recent slowdown, we'll have to search elsewhere. One obvious thing to look at is residential property investment.

Back in early 2010 Beijing introduced a suite of restrictions aimed at reining in China's runaway property market. To cool down price rises running at annual rates of 30 to 40 per cent in some cities, the authorities raised minimum deposits, slapped restrictions on mortgage lending, and in some cases banned the purchase of multiple apartments.

It took a while for these measures to take effect. But by the beginning of this year prices were falling in most cities. With the government insisting it would not ease its restrictions, the pace of property investment naturally slowed in response to the decline in prices.

By July, the year-on-year growth rate of investment in residential property had fallen to just 5 per cent, down from 38 per cent a year earlier.

The decline mattered. Independent research house Capital Economics calculates that urban residential real estate investment made up 8.5 per cent of the mainland's gross domestic product last year (see the first chart). Other estimates put the figure at 10 per cent.

Either way, investment in housing makes up a sizeable chunk of the economy, and in recent years has contributed significantly to GDP growth.

So the recent slowdown in investment has dragged heavily on overall growth. Capital Economics estimates that the decline in investment knocked 2.2 percentage points off China's second quarter growth rate.

That means if there had been no slowdown in housing investment, the economy would have grown at a blistering 9.8 per cent pace in the April-June quarter, rather than at the 7.6 per cent rate actually recorded.

Or to put it another way, the fall in China's economic growth rate over the last year and a half has little or nothing to do with the weakening external environment, but can be blamed entirely on a decline in real estate investment in response to Beijing's efforts to cool the property market.

To some observers that will be welcome news. What Beijing takes away, it can give back again. Indeed, following renewed official encouragement investment did pick up in August, with the number of new construction projects increasing for the first time in over a year.

But the revival in housing investment isn't all good news. Although in the long term the mainland will require tens of millions of new homes to accommodate its growing urban population, there is no doubt that in recent years investment has run ahead of its current needs.

The result is millions of unaffordable luxury flats, and some believe tens of millions of flats in total, sitting empty.

To cut out overbuilding and bring property investment down to a sustainable 5 per cent of GDP, Capital Economics argues that the growth of urban real estate investment needs to fall to half the level of the last five years.

So while a rebound in investment now may support growth, it risks exacerbating the economic excesses and imbalances that China's policymakers should be working to eliminate.

tom.holland@scmp.com