China’s Ghost Cities

There are many signs that China’s economic growth could begin to slow. Inflation has increased over the past few months, export growth is slowing, unemployment remains high, and labor costs are rising. The central government is even tempering growth expectations among the Chinese population. In a speech in March, China’s premier Wen Jiabao (温家宝) set a growth target of only 7 percent over the course of the 12th Five-Year-Plan (2011-2015) in order to “ensure sustainable development.”

As reported in most major newspapers today, research conducted by China’s national audit office suggests high levels of local government debt throughout the country. This mounting local government debt will also threaten China’s economy.

According to David Barboza of the New York Times, local debt accumulation began when China implemented a $586 billion stimulus in 2008 and then provided massive amounts of state-backed lending in 2009 and 2010 to independent investment companies.

Problems really began when these bank loans were used for ambitious local-level real estate and infrastructure projects including luxury high rises, residential complexes, and even entire cities complete with hospitals, schools, museums, parks, and stadiums.

While basic infrastructure projects are welcome in many of China’s rural areas, this boom in construction created an excess of unaffordable housing and flashy infrastructure projects that don’t necessarily meet the needs of local populations. As Gillam Tulloch explained in a June 16th Business Insider article: “China consumes more steel, iron ore and cement per capita than any industrial nation in history. It’s all going to railways that will never make money, roads that no one drives on and cities that no one lives in.”

In rural Anhui province, for example, posters in the tiniest of villages indicate planned construction of luxury high rises with manicured landscaping, swimming pools, and well-dressed fully middle-class residents. A quick glance around development sites, however, suggests an entirely different reality. Residents live in poorly constructed cement buildings with only basic amenities; their ability to afford luxury housing is questionable at best.

As a result, newly-constructed skyscrapers and housing projects often remain vacant. There are even cases of “ghost cities” without a single resident. (See Business Insider slideshow for photos.)

Many argue that this phenomenon is evidence of a growing and dangerous real estate bubble in China. If this bubble were to burst, they say, the consequences will be felt globally. Others warn about the possibility of a related sharp rise in nonperforming loans. According to the NYT’s Barboza, Credit Suisse recently downgraded its profit forecasts for Chinese companies and state-owned banks, as it warned of slowing growth for the overall economy.

If China’s property bubble were to deflate, or if the economy were to slow for any number of reasons, we should expect a subsequent material slowdown in demand for commodities, and especially for construction-related commodities such as steel, iron ore, cement, and oil. According to Vikram Mansharmani, “approximately half of Chinese steel consumption is in construction…a slowdown in construction would reduce global demand for steel and also for iron ore.”

Considering that Brazil, Chile, Argentina, Peru, Venezuela and other Latin American countries have benefited tremendously from the export of commodities to China over the past few years, the consequences of slower growth in China could be felt throughout the region. According to an article published by the IMF’s Vivek Arora and Athanasios Vamvakidis in the December 2010 edition of Finance & Development, in the short and medium term, “a 1 percentage point shock to China’s GDP growth is followed by a cumulative response in other countries’ growth of 0.2 percentage points after three years and 0.4 percentage points after five years.” And, according to their research, the impact would be felt predominantly through trade channels. It is highly possible, of course, that countries reliant upon construction-related commodities exports to China will be hit much sooner and much harder.

The extent to which China’s “ghost city” phenomenon will impact Latin America depends upon China’s ability to foster economic growth while restricting bank lending and implementing measures to control inflation. While China’s massive store of foreign reserves could help to avoid a debt-related crisis scenario, lending restrictions and interest rate hikes could slow economic growth by making it harder for small and medium-sized businesses to access much needed capital.

The burden will also fall on Latin America. As Kevin Gallagher argues in his book The Dragon in the Room: China and the Future of Latin American Industrialization, although Latin American exports to China are relatively small as a percentage of total exports, Latin American nations must use revenue from high-priced, China-bound commodities in order to weather future economic crises, alleviate poverty, and diversify economically. A lack of forward-thinking in this regard could very easily impact future economic well-being.

China is forecasted to grow at respectable rates over the next decade (World Bank predicts 7% growth). A growing middle class and the urbanization of its sixty percent rural population practically guarantees continued development and a sustained thirst for commodities. However, as a result of the many economic challenges that the country is facing, and in light of evident banking sector vulnerabilities, a slowing of economic growth in China is very possible. And the impact of even a slight economic downturn will likely be felt globally. Latin American nations must continue to take precautions against China’s weakening economic growth.