The illusion created by the initial success of central planning is that it can continue indefinitely, when the reality is it’s unavoidably self-liquidating as the distortions unravel the entire economy.
China offers a real-time case study of the upsides and downsides of central planning, broadly defined as the central state establishing the goals, financing, incentives and regulatory structure for various sectors of the nation’s economy.
In the U.S., examples include the transformation of the American economy to wartime production in World War II, and the razing of inner city neighborhoods to build freeways in the 1960s. A swath wasn’t just bulldozed in one or two cities; it happened everywhere because the federal government established the funding and incentives.
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Turning to China: those of us who were fortunate enough to visit China just before the “China miracle” took off recall the decrepit state of China’s housing stock, much of which was unchanged from the 19th century except for electrical wires strung haphazardly through dimly lit common areas.
Starting in the 1990s, China’s central government began selling land leases to households, retaining ownership but granting lessor ownership rights to those living in the homes, in effect transferring ownership from the state to households. The idea wasn’t to create an asset that households could sell, and so after-market sales were non-existent. The idea was to shift the cost of housing from the state to the private sector, freeing up state funding for industrialization and infrastructure.
As China’s economy shifted from rural agriculture to urban industrialization, the need for urban housing became a priority. As tens of millions of people left rural villages for factory jobs in cities, a new centrally planned model emerged that from the perspective of the central government was a win-win-win:
1. Local governments were given the right to sell land to housing developers, and the revenue from these sales eventually made up between a third and half of local governments’ budgets. In effect, a third or more of the costs of local government were shifted from Beijing to the private sector.
2. Construction of housing–much of it in high-rises–created millions of jobs, so roughly 10% of the workforce was employed in construction. This employment boosted the nation’s economy, a key goal of central planners in Beijing.
3. As China’s economy boomed, central planners prioritized bank lending for housing, enabling households to deploy their accumulated savings to buy a home (or later, an investment flat), a culturally favored “safe” asset to invest in.
Note that housing was funded by private capital in this model: developers pre-sold homes to households, who used their savings as the down payment and borrowed the rest from banks (often closely tied to the government). The buyers paid for the home in full, so developers had all the money upfront, and the temptation to use these funds to buy more land leases for future development and pre-sell more to-be-built-later homes was Irresistible.
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Since the sale of existing units would compete with new construction, there was no resale housing market as in the West. The value of existing units was set by new housing being sold/built in the area. So if a household bought a unit for $100,000, and the new development next door was selling for $150,000, then the existing homeowners reckoned their home was now worth $150,000 as well.
This artificial valuation generated a wealth effect–our homes are rising in value–that was entirely illusory, an illusion that has burst as the actual resale value of homes was never tested in an open, transparent marketplace.
As a result, this artificial wealth effect has flipped into a reverse wealth effect: households are awakening to the grim reality that their real estate-based wealth has evaporated, and given the extreme oversupply of housing and the declining population, it’s never coming back.
