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TRENDS in the real estate mar- kets in cities across China have defied new control measures. Transaction volumes have spiked， and prices are heading up rather than stabilizing as intended. The domestic media has given wide coverage to home buyers queuing literally for at local authorities offices to get official stamps on their documents and pay relevant taxes before the newest measures take effect at the end of March.
All of this begs the question， are these kinds of “control” policies working？ Furthermore， are they targeting the right phenomenon？
The State Council has been passing incremental measures to control urban real estate prices for almost a decade. Most recently the government called for stricter application of a 20 percent capital gains tax， as well as further strengthening down payment requirements and restrictions on purchases of second homes. In the weeks that have followed the domestic media has been full of reports of a mad rush by both buyers and sellers to make deals ahead of this latest set of controls targeted at urban property prices.
To find answers to these questions， many have turned to commentary from the people they most expect to have good explanations for what seems to many outside observers as irrational behavior –economists. I regret to inform you， however， that conventional economics has little to contribute to a real understanding of what is happening in major urban property markets in China. Housing prices are just too high relative to incomes.
More informative is a systems perspective that better accounts for the relationships between major social and economic factors and how they are driving prices than simple notions of supply and demand. With this in mind this article will look at the interaction of three such factors： cultural values， power and wealth.
One critical aspect of China’s real estate boom is the role of culture. In general， we can say that culture is to a social system what DNA is to a biological one. When it comes to real estate， the security of home ownership is part of an image or blueprint of the present and future that has resulted in strong demand for urban housing in the face of high prices and successive rounds of policy control measures. Additionally， a preference for saving over consumption is deeply ingrained.
Some researchers have gone so far as to propose that a major driver of housing demand results from what they call the“mother-in-law phenomenon”： pressure from future in-laws and cultural norms that has made owning urban real estate almost a prerequisite for discussions about marriage. Be this as it may， the cultural importance of urban home ownership in a country still transitioning from the countryside into the city has proven nearly impossible to contain. For many households worldwide， real estate serves as an important store of wealth. It is a classic hedge against inflation and has provided better long-term returns than other forms of investment in many developed economies. It is thus no surprise that many historic sites across the country tell a story of successful families investing their growing wealth by building extensions to their courtyards or undertaking renovations to existing ones. Related potential tourist destinations are numerous along the great trading routes of the past， including those along the Silk Road and major inland waterways. Enduring wealth is a function of real assets.
Another important part of the real estate story in China， also one where economics has little to contribute， is about power. This topic is often related to control over the supply of land in China， and the reliance of local governments on property-related taxes to close fiscal funding gaps. These phenomena are important parts of the story， but perhaps more important is what central authorities are or are not doing in other areas， the results of which serve to divert demand to property investment.
Households in China save a large proportion of their incomes， creating a very large pool of investable assets， most of which are parked in bank deposits with an interest rate not much higher – and sometimes even lower – than the rate of inflation. Real estate has consistently provided a good alternative， not for rental income， but as a means of preserving the purchasing power of their funds against inflation.
By moving too slowly on capital market reforms and the implementation of laws to protect the interests of household investors， central authorities may have diverted an unnecessarily large proportion of household savings into real estate.
In recent years trust companies and commercial banks have attracted a lot of retail investor interest with so-called“wealth management products，” many of which are ultimately linked to loans to real estate developers in exchange for a relatively high return. Recent events have shown， however， that the risks associated with these securities can be quite high， especially when the legal mechanisms for resolving defaults and disputes are underdeveloped.
All in all， these trends have shown that regulatory and administrative power in the financial sector can be better used to help improve faith in more conventional stock and bond investments， and in doing so reduce the fanatical demand for urban property that has been observed in recent months. With all of this in mind and in the broader macroeconomic context we find today， one has to ask， is the current fixation on real estate in urban China rational？ In many ways it would seem that the answer to this question is “yes”： it is rational for many to expect that strong cultural and investment demand for real estate will overwhelm administrative control measures. Furthermore， the impact of these factors is amplified by a lack of adequate investment alternatives for households who save a large proportion of their incomes. An additional reality not described above is local governments’dependence on land and property sales to make up for annual revenue shortfalls. Adding to this combination of factors is the fact that households in China have comparatively low levels of mortgage and other forms of consumer debt， and it looks like the probability that prices will fall significantly any time soon appears relatively low.
The momentum behind urban property prices in China is， however， becoming harder to sustain. Current trends require constant additional inputs of energy in the form of credit to property developers， and information to drive household investment behavior. The former is a positive force where it comes to investment in property development， which drives increases in the supply of new real estate. The information （in the form of actions， coming from central regulators） indicates to households that real estate investment is probably their best choice， with few alternatives. Together these forces are part of what is driving a feedback loop that continues to send first-tier property prices ever higher.
Returning to ideas from systems theory， when the state of a system depends on a set of variables， a significant change to one factor beyond a certain point can cause what is called a “phase shift，” when a new set of relationships between the individual factors comes in to govern the system. As indicated above this is about managing opposing forces to maintain a certain equilibrium. In this case， a necessary step to preserve systemic stability is the rapid development of capital markets and reliable new investment opportunities for households. This would help deflate the demand bubble that currently exists.
A second necessary step is to better manage the supply of new credit to property development， improving transparency and formalizing informal channels for raising capital. This would help to deflate the supply bubble， a phenomenon that increasingly holds the financial system and much of the rest of the real economy hostage to the property sector as it gets larger.
Looking ahead， the successful management of the economy will depend more on the government’s ability to balance opposing forces rather than strict adherence to ideological economic policy agendas. The property sector is perhaps the biggest and best case in point. With this in mind and when it comes to divining future price trends in the property sector， it will be important to think through how policy reforms elsewhere will feed back into and balance with the systemic characteristics of the property sector in China. So will these most recent measures targeting high home prices have their desired effect？ Probably not. Prices are a product of systemic relationships， not an autonomous phenomenon.
All of this begs the question， are these kinds of “control” policies working？ Furthermore， are they targeting the right phenomenon？
The State Council has been passing incremental measures to control urban real estate prices for almost a decade. Most recently the government called for stricter application of a 20 percent capital gains tax， as well as further strengthening down payment requirements and restrictions on purchases of second homes. In the weeks that have followed the domestic media has been full of reports of a mad rush by both buyers and sellers to make deals ahead of this latest set of controls targeted at urban property prices.
To find answers to these questions， many have turned to commentary from the people they most expect to have good explanations for what seems to many outside observers as irrational behavior –economists. I regret to inform you， however， that conventional economics has little to contribute to a real understanding of what is happening in major urban property markets in China. Housing prices are just too high relative to incomes.
More informative is a systems perspective that better accounts for the relationships between major social and economic factors and how they are driving prices than simple notions of supply and demand. With this in mind this article will look at the interaction of three such factors： cultural values， power and wealth.
One critical aspect of China’s real estate boom is the role of culture. In general， we can say that culture is to a social system what DNA is to a biological one. When it comes to real estate， the security of home ownership is part of an image or blueprint of the present and future that has resulted in strong demand for urban housing in the face of high prices and successive rounds of policy control measures. Additionally， a preference for saving over consumption is deeply ingrained.
Some researchers have gone so far as to propose that a major driver of housing demand results from what they call the“mother-in-law phenomenon”： pressure from future in-laws and cultural norms that has made owning urban real estate almost a prerequisite for discussions about marriage. Be this as it may， the cultural importance of urban home ownership in a country still transitioning from the countryside into the city has proven nearly impossible to contain. For many households worldwide， real estate serves as an important store of wealth. It is a classic hedge against inflation and has provided better long-term returns than other forms of investment in many developed economies. It is thus no surprise that many historic sites across the country tell a story of successful families investing their growing wealth by building extensions to their courtyards or undertaking renovations to existing ones. Related potential tourist destinations are numerous along the great trading routes of the past， including those along the Silk Road and major inland waterways. Enduring wealth is a function of real assets.
Another important part of the real estate story in China， also one where economics has little to contribute， is about power. This topic is often related to control over the supply of land in China， and the reliance of local governments on property-related taxes to close fiscal funding gaps. These phenomena are important parts of the story， but perhaps more important is what central authorities are or are not doing in other areas， the results of which serve to divert demand to property investment.
Households in China save a large proportion of their incomes， creating a very large pool of investable assets， most of which are parked in bank deposits with an interest rate not much higher – and sometimes even lower – than the rate of inflation. Real estate has consistently provided a good alternative， not for rental income， but as a means of preserving the purchasing power of their funds against inflation.
By moving too slowly on capital market reforms and the implementation of laws to protect the interests of household investors， central authorities may have diverted an unnecessarily large proportion of household savings into real estate.
In recent years trust companies and commercial banks have attracted a lot of retail investor interest with so-called“wealth management products，” many of which are ultimately linked to loans to real estate developers in exchange for a relatively high return. Recent events have shown， however， that the risks associated with these securities can be quite high， especially when the legal mechanisms for resolving defaults and disputes are underdeveloped.
All in all， these trends have shown that regulatory and administrative power in the financial sector can be better used to help improve faith in more conventional stock and bond investments， and in doing so reduce the fanatical demand for urban property that has been observed in recent months. With all of this in mind and in the broader macroeconomic context we find today， one has to ask， is the current fixation on real estate in urban China rational？ In many ways it would seem that the answer to this question is “yes”： it is rational for many to expect that strong cultural and investment demand for real estate will overwhelm administrative control measures. Furthermore， the impact of these factors is amplified by a lack of adequate investment alternatives for households who save a large proportion of their incomes. An additional reality not described above is local governments’dependence on land and property sales to make up for annual revenue shortfalls. Adding to this combination of factors is the fact that households in China have comparatively low levels of mortgage and other forms of consumer debt， and it looks like the probability that prices will fall significantly any time soon appears relatively low.
The momentum behind urban property prices in China is， however， becoming harder to sustain. Current trends require constant additional inputs of energy in the form of credit to property developers， and information to drive household investment behavior. The former is a positive force where it comes to investment in property development， which drives increases in the supply of new real estate. The information （in the form of actions， coming from central regulators） indicates to households that real estate investment is probably their best choice， with few alternatives. Together these forces are part of what is driving a feedback loop that continues to send first-tier property prices ever higher.
Returning to ideas from systems theory， when the state of a system depends on a set of variables， a significant change to one factor beyond a certain point can cause what is called a “phase shift，” when a new set of relationships between the individual factors comes in to govern the system. As indicated above this is about managing opposing forces to maintain a certain equilibrium. In this case， a necessary step to preserve systemic stability is the rapid development of capital markets and reliable new investment opportunities for households. This would help deflate the demand bubble that currently exists.
A second necessary step is to better manage the supply of new credit to property development， improving transparency and formalizing informal channels for raising capital. This would help to deflate the supply bubble， a phenomenon that increasingly holds the financial system and much of the rest of the real economy hostage to the property sector as it gets larger.
Looking ahead， the successful management of the economy will depend more on the government’s ability to balance opposing forces rather than strict adherence to ideological economic policy agendas. The property sector is perhaps the biggest and best case in point. With this in mind and when it comes to divining future price trends in the property sector， it will be important to think through how policy reforms elsewhere will feed back into and balance with the systemic characteristics of the property sector in China. So will these most recent measures targeting high home prices have their desired effect？ Probably not. Prices are a product of systemic relationships， not an autonomous phenomenon.