China's Empty Cities and the Law of Supply and Demand

China's Empty Cities and the Law of Supply and Demand

Why Beijing needs to keep on building, snarky bloggers be damned.

    BY Daniel Altman

    MARCH 21, 2014 / http://www.foreignpolicy.com/articles/2014/03/21/china_s_empty_cities_and_the_law_of_supply_and_demand

An old friend of my mother had a saying about cooking for guests: "If there isn't too much food, then there isn't enough." Most mathematically inclined people would agree that the chance of guessing exactly the right amount of food to leave everyone at a dinner party full and happy -- that is, on a continuous spectrum ranging from no food to infinite food -- is virtually zero. But the analysis of economic growth, and China's urban planning in particular, has not always heeded this simple insight.

On March 16, the Chinese government released a seven-year plan for the continuing urbanization of its population. So far, the process has been an important engine of China's growth, making workers more productive by giving them better access to capital, services, and economies of scale. There have been plenty of bumps in the road, though, with huge urban districts built under government orders still waiting for their first inhabitants.

This is where the adage about cooking comes in. How likely was Beijing to guess exactly the right size and number of cities to house its enormous population? Just like having food left over at the end of a meal, the risk-averse strategy was to build a little extra, in case the technocrats didn't guess correctly the first time.

This situation repeats itself millions of times every day around the world, and it's not unique to planned economies. Almost any industry, let alone the economy of an entire country, involves myriad decisions about how much to invest, produce, sell, pay, or save. It's inevitable that some of those decisions are wrong, and a few are inevitably wrong in a big way.

As the Great Recession took hold in the United States, thousands of new homes were left vacant or abandoned -- notably in Florida, but in many other states as well. Spain today also has hundreds of thousands of empty properties, as jobs are much scarcer than newly built apartments. And booming Australia may have as many as 125,000 unneeded houses.

Whatever the economic system, whatever the point in the economic cycle, the market for newly constructed buildings does not always clear. Developers make bets based on expectations that turn out to be incorrect. Sometimes, they might not even expect the market to clear right away; they might want to build property while construction is cheap, even if the right time to sell might be a few years away. But other developers may simply overestimate demand. Indeed, it would be astonishing if all of their forecasts for demand were correct, all the time.

And yet that's what pundits seem to expect. The results of overbuilding are easily visible, and just as easy to poke fun at. But if China's overbuilding is the worst planning mistake in its past quarter-century of economic development, I call that not too bad at all. Moreover, it's not as though those empty buildings will have zero value for eternity. Just consider what happened with fiber optic cable.

During the previous recession in the United States, after the bursting of the dotcom bubble in 2000, the fiber optic cable industry suffered almost as much ridicule as China's ghost towns. Firms like Global Crossing built enormous fiber networks on the "if you build it, they will come" theory, but not enough people came. That has started to change. Last June, fiber accounted for almost 8 percent of broadband connections in the United States, after growing 12 percent in the previous 12 months, far outpacing the overall increase in broadband penetration of less than 4 percent. Today, major cities are posing like contestants in a beauty contest in hopes that Google will choose them to launch its ultra-high-speed fiber hook-up.

By the same token, Chinese people may yet move into some of those empty districts, especially if the relaxing of the one-child policy and increased immigration lead to higher population growth. Changes to China's strict internal migration rules, which are likely to occur as part of the agenda released this week, will help as well. In the grand sweep of China's post-reform growth, any waste associated with overbuilding will probably end up as a footnote -- just like those vacant condos in South Florida and the Great Recession.

Of course, being out of phase with demand is not the only reason why an industry might suffer a gap between investment and revenue. Sometimes the pace of innovation is out of step with consumers' preferences, necessary infrastructure, or the economy's absorptive capacity. In recent times, these factors combined to create decades-long delays between the invention and mainstream adoption of personal computers, mobile phones, and electric cars, to name a few.

But innovation can also lag behind the economy's wants and needs. We don't have good synthetic substitutes for copper and rare earth metals, so their availability can be a constraint on the size of electric grids and the production of electronics. Supply can fall short of demand in traditional markets, too, where innovation is hardly an issue. For instance, as incomes rose in the last global boom, people wanted to buy more food. Harvests couldn't just expand instantaneously, though, and the slow response of supply to higher demand led to higher commodity prices and shortages.

These are normal growing pains in a world economy that is complex and full of frictions. In the short term, they can result in odd mismatches of supply and demand. In the long term, however, they tend to smooth themselves out. The critical question is whether it's worse to have too much of something or too little.

In the case of Chinese housing, the answer is clearly too little. Empty cities might spawn a thousand jokey articles in the Western media, but they don't spawn many riots or rebellions at home. Millions of homeless Chinese, who can find jobs but not a place to sleep, might be another story. So get back into that kitchen -- the guests will be here ... eventually.

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