The Impact of Economic Growth and Globalisation on the Chinese Property Market - Case Study Example

The impact of economic growth and globalisation on the Chinese property market: a comparative study on the demand & supply of residential and commercial property By Jun Fang WU 22-11-2007 Supervisor: Marie Byrom Executive Summary Globalization is purported to lead to economic growth and is one of the main arguments of those supporting it. China is one of the most often cited examples of how globalization benefits nations. Indeed, China's economy is now a far cry from the former Communist period. One of the industries that have boomed is the property/real estate market wherein the demand and supply of commercial and residential properties have soared. This research study was aimed at trying to establish the idea that the rise in the property market industry was due to the economic growth made possible by China globalizing itself. The method that was adapted in this study to accomplish the aim involved the discussion of the characteristics of globalization and how it leads to economic growth. A background on the property market and its dynamics is also provided. The period under study were divided into two: 1999-2000 and 2001 up to now. The topics were divided into the commercial and residential sector. This was done to provide for points of comparison. An extensive search of primary and secondary literature was conducted on all available resources such as peer-reviewed journals, magazines, newspaper, other scholarly articles and finally, the Internet. Business information providers from the public sector such as China's Statistics Center and private venture such as the GoldmanSachs provided many historical and statistical data and were subsequently used. Results of the study indicates that there were many factors that led to the boom in the property market industry which includes government reforms, flow of Foreign Direct Investment (FDI), worldwide events sponsored by China and other market reforms. With regards to the commercial sector, the supply was mainly fuelled by the demand generated by people belonging to multinational companies. In the residential sector, the supply was fuelled by people migrating from rural areas to work in the urban areas which was developed with the influx of investments of both Chinese and foreign businessmen. All of these developments were argued to be largely a result of China globalizing itself. In the end, it was concluded that globalization did indeed fuelled the rise in the property market sector. Chapter 1. Introduction China went under Communist control with the victory of Mao Zedong over the Nationalist Chiang Kai Shek. In spite of the spirit that animated the country, it was only due to the efforts of President Deng Xiaoping to reform and the open-up China that the country has undergone a profound transformation never seen in the country before. His efforts would prove to be a step toward China embracing the globalization concept. Chinese President Hu Jintao (2005) relates that China has benefited from globalization because in a short span of 26 years from 1978 to 2004, China's GDP increased from $147.3 billion to $1.6494 trillion registering an average annual growth rate of 9.4% while foreign trade rose from $20.6 billion to $1.1548 trillion with an average annual growth rate of over 16%. China's foreign exchange reserve increased from $167 million to $609.9 billion while the number of rural poor has decreased significantly from 250 million to 26 million. Jintao (2005) further notes that by the end of 2004, China had attracted a total of $562.1 billion in FDI, approved the establishment in China of more than 500,000 foreign-funded enterprises and created a huge import market of some $560 billion annually. At present, most countries and regions have had enterprises with investment in China, and over 400 firms out of the Fortune 500 have invested in China. The number of R&D centers set up by foreign investors in China has exceeded 700. The overall national strength of China has remarkably increased while the quality of life of its people is also seen to improve steadily. With its proud past, the 1.3 billion Chinese people are writing a new chapter in their history as they march towards building socialism with Chinese characteristics rather than hard core Communism. One of the most prominent and often discussed Chinese industries is its property market which is argued to be caused by the rapid globalization of China. Statistics from Ministry of Construction show that from 1980 to 2000, China's real estate industry had kept a rapid growth momentum with newly-built houses in rural and urban areas to have reached 20.3 billion square meters which presents an increase of two folds as compared with the past 30 years. Chinese government has taken real estates industry as a new drive for its economic growth and has taken various measures to support the industry. By 2001, the total investment in real estate hit 80 billion Yuan in China which accounted for 25 percent of the social fixed asset investment. Building and selling residential and commercial properties has become the most profitable business in the country after China started its reform on traditional housing welfare system in early 1990s. The real estate industry has grown so much that ninety-four of the 500 richest people in China are in the real estate business as reported by the Guangdong-based "New Fortune" magazine. Those real estate tycoons on the rich list possess wealth worth136.39 billion Yuan (about 16.4 billion US dollars) which accounts for 23 percent of the total wealth owned by all 500 richest. China's housing prices have also soared particularly in where the country's average housing price rose by 14.4 percent in 2004. In the first quarter of 2005, housing prices rose by 12.5 percent year on year. In east China's Shanghai municipality where one can find the most expensive housing markets in China, the average price of housing in urban and suburban regions has exceeded 10,000 Yuan (some 1,200 US dollars) per square meter. (Savills Research and Consultancy, 2008) Could this surge in the real estate industry be due to the economic growth brought about by the rapid globalization The aim of this research is to analyse the impact of globalisation on the Chinese property market. Specifically, it seeks to analyse the growth trend of the demand & supply for residential and commercial facilities in this market. To be able to achieve this aim, it would provide answers to the following question: "Has globalisation and economic expansion had an impact on the Chinese property market If no, then the research enquiry ends here. If yes, then the research inquiry gets headway. The significant point to answer this question is the fundamental premise that globalisation and economic growth in a country has a positive correlation with the demand for property. This research would now investigate which of the property market has witnessed growth in demand/supply than the other. The conclusion from the findings could then be a good decision point for economic operators to invest in the appropriate property market. Chapter 2. Review of Related Literature 2.1 Defining Globalization According to Steger (2003), the effects of internationalization now known as globalization are everywhere apparent. It is an opportune time to take note of this process because of the major role it is playing in sustaining the economic expansion of the global economy in the second half of the 20thcentury. Globalization is seemingly shrinking the planet as barriers to trade such as taxes and tariffs are dismantled, transport and communications costs fall and global production systems are established and managed by giant multinational corporations. There are many definitions of globalization but I am going to adapt that of Stiglitz (2002). Stiglitz defines the term 'economic globalization' as words referring to the flow of goods, capital, information/technology and people across national borders and the effects of such flows on the economies of the nations involved. It refers to the growing interdependence of countries resulting from the increasing integration of trade, finance, people, and ideas in one global marketplace. There are several dimensions to this dynamic process, including the increased internationalization of economic markets as reflected, for example, in trade and financial capital flows. It also involved institutional and social changes that are taking place within the geographic borders of nation states. These institutional changes include modifications in policy, in industrial organization and in the administration of laws and regulations governing the behavior of economic agents. Globalization started after World War II but has accelerated considerably since the mid-1980s, driven by two main factors. One involves technological advances that have lowered the costs of transportation, communication and production to the extent that it is often economically feasible for a firm to locate different phases of production in different countries. The other factor is the increasing liberalization of trade and capital markets which basically means that more and more governments are refusing to protect their economies from foreign competition or influence through import tariffs and nontariff barriers such as import quotas, export restraints, and legal prohibitions. International institutions promoting free trade in place of protectionism have been established - including the World Bank, International Monetary Fund (IMF), and General Agreement on Tariffs and Trade (GATT) which was replaced in 1995 by the World Trade Organization (WTO). Parallel to the rising trend of trade in goods and services, private financial capital inflows to developing countries known more commonly as Foreign Direct Investments (FDIs) have increased rapidly in the past two decades. In the years immediately following the Second World War, most of the foreign direct investment (FDI) was made by US firms investing in Europe. Later, FDI among industrial and developing countries began to grow rapidly. At its peak, before the Asian financial crisis of 1997/98, about 40 percent of FDI went to developing countries particularly the People's Republic of China (PRC), Indonesia, and Malaysia. According to Wolf (2004), empirical evidence suggests that globalization has significantly boosted economic growth in East Asian economies such as Hong Kong (China), Singapore and the Republic of Korea. But not all developing countries benefit from it such as Latin American nations The balance of globalization's costs and benefits for different groups of countries and the world economy is one of the hottest topics in development debates. 2.2 Costs and Benefits of Globalization The increased flows of goods, services, and investment funds across national boundaries appear to be associated with rising world economic growth. As argued by the Sen (1999), economic development theory suggests that openness enables economies to make optimum use of its resources through greater specialization in production of the goods and services that it produces relatively cheaply which it can trade for goods and services produced more efficiently abroad. A more open trade regime also encourages competition between local and foreign firms, thereby raising the level of efficiency of domestic firms. There is adequate empirical evidence to support this view of the positive impact of globalization on national economic growth and per capita income-see, for example, Murray (2006). Moreover, as more countries have been drawn into the global economy, world economic growth has accelerated. Global trade enables developing countries to import capital and other inputs that are critical to long-run growth. These critical inputs include new technologies that "spill over" to it from its trading partners such as knowledge embedded in imported production equipment. These technological spill over are particularly important for developing countries because it gives them a chance to catch up more quickly with the developed countries in terms of productivity. Former centrally planned economies such as that of China today aspire to tap into these benefits by reintegrating with the global trading system. However, active participation in international trade also entails risks particularly those associated with the strong competition in international markets. For example, a country runs the risk that some of its business sectors that are less competitive and adaptable will be forced out of business due to international competition. Meanwhile, reliance on foreign suppliers may be considered unacceptable when it comes to industries with a significant role in national security. For example, many governments are determined to ensure their country's food security in case food imports are cut off during a war. Governments of developing countries and even developed countries argue that there are certain industries require ng temporary protection until they become more competitive and less vulnerable to foreign competition. Such protectionist policies can be economically dangerous because they allow domestic producers to continue producing less efficiently and eventually lead to economic stagnation. The costs and benefits of international trade also depend on factors such as the size of a country's domestic market, its natural resources and location. For instance, countries with large domestic markets generally trade less while ountries that are well endowed with a few natural resources, such as oil, tend to trade more. 2.3 Globalization and China China practiced globalization in the Han dynasty (206 BC-AD 220) when trade took place between the Han Chinese and neighbouring people in the northwest through the Silk Route. During the Tang dynasty (AD 618-901) trade flourished and the Silk Route expanded. However, in the Qing Dynasty and in the period of the People's Republic of China up to Deng Xiaoping's open-door policy China tried to close its doors and resisted globalization. Before reform, China was the world's most important opponent of globalization. It had an centrally planned economy striving for equality among its constituents. It opposed the global economic order, political order and major global institutions such as the IMF and the World Bank. Since 1978 with the efforts of Deng Xiaoping, China has encouraged free trade and abolished trade restrictions step by step. The government has changed its policy from the administration of foreign trade by the central government to giving much greater autonomy in foreign trade to provincial governments and allowing private enterprises to directly engage in foreign trade. With this reforms, the total volume of foreign trade increased from 20.64 billion US dollars in 1978 to 1.155 trillion in 2004 when it grew at the rate of 36%. Because of the reforms, China became the third largest trading country in the world next to the United States and Germany. China's reformed policy concerning foreign investment has made a 180 turn, from treating it as a form of exploitation by foreigners to welcoming it for China's economic development. In the years 2002-04, the amounts of direct foreign capital that poured into China were respectively $US55 billion, $US56.1 billion and $US64.1 billion. Foreign investment has provided physical and financial capital, technology and management skills to China. There are three fundamental factors that are driving economic growth in China and they are the following: (i) abundance of high-quality human capital that includes skilful and hardworking labourers and very resourceful entrepreneurs; (ii) sufficiently functioning market institutions; and (iii) a latecomer position that can adopt modern technology from more developed countries. These three fundamental factors have enabled China to attract foreign capital. China is now exporting capital as well not only to developing countries but also to the USA. Chinese investment has helped the economic development of some Asian and African countries. I In retrospect, the open-door policy first advanced by Deng Xioping when China had a very different ideology has been essential in the modernization of China. The open-door policy has allowed globalization and economic development to take place. The flow of goods, capital, technology/information and people to and from China has been essentially beneficial to both China and its partners in the globalization process although there are short-run harmful effects to some. 2.4 Characteristics of Property Markets Property markets have become synonymous with the term Real Estate market. According to the Oxford Law Dictionary (2006), the word is defined as a legal term that encompasses land along with anything permanently affixed to the land, such as buildings, specifically property that is fixed in location. Realestatemaybeacquired, owned, and conveyed (or transferred) by individuals, business corporations, charitable, religious, educational, fraternal, and various other non-profit corporations, fiduciaries such as trustees and executors and partnerships. The main participants in real estate markets are (BIS, 2003): Owner/User - These people are both owners and tenants. They purchase houses or commercial property as an investment or utilize as a business. Owner - These people are investors. They do not use for themselves the real estate that they purchase but rent out or lease the property to someone else. Renter - These people are pure consumers. Developers - These people prepare raw land for buildings and other development which results in new product for the market. Renovators - These people supply refurbished buildings to the market. Facilitators - This includes banks, lawyers, real estate brokers and others that facilitate the purchase and sale of real estate. The owner/user, owner, and renter belong to the demand side of the market, while the developers and renovators comprise the supply side. In order to apply simple supply and demand analysis to real estate markets, a number of modifications must be made to standard microeconomic assumptions and procedures. In particular, the unique characteristics of the real estate market must be noted. These characteristics include: Durability - Real estate is durable. A building can last for decades or even centuries, and the land underneath it is practically indestructible if properly constructed. Because of this, real estate markets are modeled as a stock/flow market where 98% of supply consists of the stock of existing houses with the remaining 2% consisting of the flow of new development. The stock of real estate supply in any period is determined by the existing stock in the previous period, the rate of renovation of the existing stock, the rate of deterioration of the existing stock, and the flow of new development in the current period. Heterogeneous - Every piece of real estate is unique because of the differences of its location, building, and financing. This makes pricing difficult, increases search costs, and creates information asymmetry. Economists Muth (1960) define supply in terms of service units or any physical unit can be deconstructed into the services that it provides. The real estate market is typically divided into commercial, residential and industrial segments. It can also be further divided into subcategories like income generating, historical/protected, etc. High Transaction costs - Buying and/or moving into a home usually costs more than any other type of transactions. These costs include search costs, real estate fees, legal fees, moving costs, land transfer taxes and deed registration fees. Long time delays - The market adjustment process is subject to time delays due to the length of time it takes to finance, design, and construct new supply and to the relatively slow rate of change of demand. Both an investment good and a consumption good - Real estate can be purchased with the expectation of attaining a return or with the intention of using it or both. These functions can be separated with market participants concentrating on one or the other function or can be combined in the case of the person that lives in a house that they own. Immobility - Real estate is locationally immobile except for for mobile homes but the land underneath them is still immobile. Consumers come to the good rather than the good going to the consumer. Because of this, there can be no physical market-place. This spatial fixity means that market adjustments should occur by people moving to dwelling units rather than the movement of the goods. Spatial fixity combined with the close proximity of housing units in urban areas suggests potentials for externalities inherent in a given location. 2.5 Dynamics of Real Estate Supply and Demand According to Zhu (2003), the determinants of property prices are in many ways similar to those of other assets namely the expected service stream (consumption service) or expected future cash flow (rents) and the required rate of return (the long-term interest rate plus the risk premium) as a discount factor. In the long run, property prices depend on demand factors such as average discount rates and national income and on supply factors such as land availability, cost of construction and the quality of the existing stock. Nevertheless, property markets also have a number of distinctive features compared with other types of asset. The supply of property is intensively local. The delivery of the new stock can take quite a long time due to the length of the planning and construction phases. Rents can be very sticky because of the use of long-term rental contracts. Market prices usually lack transparency and most transactions occur through bilateral negotiations. The liquidity of the market is constrained because of high transaction costs while borrowers rely heavily on external finance. Real estate is widely used as collateral and short sales are usually not possible. These features cause property prices to behave differently. Fluctuations in property prices can arise not only owing to cyclical movements in economic fundamentals, risk premium, interest rates but also as a result of the intrinsic characteristics of the property market itself. The business cycle causes property price fluctuations for obvious reasons. Improvements in overall economic conditions are known to increase the average income of households and boost the demand for new homes which puts upward pressure on house prices. Similarly, businesses see profitable opportunities and seek to expand the scale of their investments. Such an expansion results to a higher demand for office space and storage which drives up commercial property prices. In addition, the market perception of risk also changes with the phases of the cycle. During a booming phase, the risk involved in a given project is considered to be lower compared to a downward phase. The changing risk premiums combined with time-varying interest rates determines the discount rates and has a sizeable impact on real estate prices. Property price oscillations are also driven by endogenous factors such as supply lags and the historical dependence of investment decisions. On the one hand, the supply response in the property market is much slower compared with that of other goods as a result of limited land supply and length of the approval and construction process. On the other hand, the flow of information in the property market is usually inefficient. Because the turnover rate of properties is usually very low, the price information is limited and is often inaccurate. In particular, much of the information that is important to understand the dynamics of property prices is related to knowledge of local markets accessible only at a substantial cost. Therefore, it is usually very difficult, if not impossible, for market participants to forecast accurately the future movements of property prices. In practice, market forecasts rely heavily on current property prices or are computed by extrapolating past trends. This so-called "myopic" or "rule of thumb" expectation forwarded by Hendershott (1994) and Herring and Wachter (1999) can contribute to endogenous oscillation of property prices or deviations from long-run equilibrium values. Beyond these common characteristics, the dynamics of property prices can vary significantly across sectors (residential vs commercial, office vs retail, etc).and across countries as a result of differences in a number of specific demand and supply factors. While housing prices on average have posted robust growth since the mid-1990s, experience has differed considerably across countries. House price growth is strong in Australia, Ireland, the Netherlands, Spain and the United Kingdom, followed by the United States and some of the Nordic countries. At the other end of the spectrum are Germany, Japan and Switzerland, where prices have declined over the past decade. A second example is the divergence between housing markets and commercial property markets. In the most recent economic downturn, the residential sector was very strong which reflected the substantial role of low interest rates. Conversely, the commercial property sector seemed to be more constrained by the sluggish macroeconomic environment and posted capital losses in most industrial countries. Such national and sectoral differences can be attributed to asynchronous business cycles and the distinctive local factors (elasticity of supply, funding methods, subsidy/tax polices, legal framework, etc). 2.5.1 Residential property prices A house is a long-lived asset that delivers consumption services over many periods. It is more like a durable good than an investment asset. Given that residential property can provide accommodation to its owner, it has an intrinsic reservation value determined by the discounted value of the expected service stream. Due to this, nominal housing prices are usually less likely to fall as sharply as equity prices and commercial real estate prices. In many situations, the downward pressure on the housing market is reflected usually in shrinking transaction volumes rather than in the collapse in nominal prices as owners refrain from selling at a loss. As noted, housing price fluctuations can also be driven by macro factors and intrinsic characteristics of the housing market itself. Empirical evidence suggests that the market has its own distinct dynamics. Almost three fifths of the overall variation in housing prices is explained by innovations in the housing market itself. The combined effect of other explanatory factors, such as interest rates, GDP, bank credit and equity prices accounts for the rest. The demand for houses is determined by demographic dynamics. The supply of new homes can be constrained by land availability and the local land planning system and the financing cost of home purchases depends on the housing financing system. The liquidity of the housing market may be constrained further by the existence of transaction costs such as VAT, stamp duties and registration fees, as well as real estate taxes. 2.5.2 Commercial property prices Commercial property markets have some unique characteristics, such as longer construction lags, long-term leases and volatile income streams which cause the difference in ommercial and residential property cycles. Commercial property cycles may be asynchronous across regions and sectors. Depending on the elasticity of supply, development lags, durability of assets and funding methods, different types of commercial property may themselves have varying dynamics. Unlike residential real estate, commercial property is more of a pure investment asset and its value is determined by the discounted value of future rents. When there is a weakening of macroeconomic conditions, shrinking business activity cuts down the demand for commercial property and results in higher vacancy rates. Rising vacancy rates and lower rental rates lead to a deterioration of real estate market fundamentals and will cause prices to fall. Compared with a residential property, the reservation value for a commercial property is lower because the consumption value is low while its maintenance cost is very high. As a result, commercial property prices tend to be more responsive to macroeconomic conditions. More commonly, one can observe a sharp decline in nominal commercial property prices during an economic downturn. This research aims to identify whether there is a relationship between the boom in the commercial and residential property sector with the globalization of China with consideration of the concepts discussed in this literature review. Chapter 3. Methodology 3.1 Outline of the theoretical study The background to the theoretical study would examine the broad characteristics of globalisation and economic growth. Then particular emphasis would be paid to the characteristics that relate to population growth and an increase in business investment needs. The points to be substantiated here would be theories that link population growth and the demand for residential property, as well as theories that link business investment growth needs and the demand for commercial property. The second theoretical base would examine traditional factors that influenced the demand for and the supply of both residential and commercial property in China. Then related literature would be viewed on the modern day factors fuelling the growth demand for and the supply for property. 3.2 Methods to be used The research would undergo the following process: 1. Examination of theory/ies on commercial and residential property, as well as the factors influencing their demand and supply. This process would entail a review and discussion of the characteristics of the commercial and residential property market. The main topics to be discussed involve the illustration of property market dynamics particularly those factors which govern demand and supply. 2. Primary and secondary data collection relating to information on globalisation and economic growth Information on the nature of globalization and how it contributes to economic growth will be collected from available literature. The sources will include peer-reviewed journals, magazines, other scholarly materials and information from web sources. 3. Primary and secondary data related to the demand for and supply of property. This would involve reading publications by state agencies and private property dealers, as well as interviews. On the whole, two periods would be taken into consideration for comparative studies. This would cover the period from 1990 to the year 2000, and from the year 2000 to the present day of China's glaring economic boom. Upon conducting the research, it was found that much statistical information can be derived directly from web sources from companies specializing in providing data for businessmen who are thinking of investing in China. There were efforts to diversify but other sources prove to be too limited or inaccessible. Nonetheless, the statistical and theoretical information provide much data for the accomplishment of the paper. Read More