RBA stays bullish on Chinese construction

While the rest of world is paring back its assumptions of the potential for further Chinese urbanisation, the RBA is having none of it. In a paper published yesterday (h/t 3d1k) , the RBA made some guesstimates for the path of ongoing construction and there’s no over-capacity in sight as far out as 2040:

This paper assesses the medium-term prospects for the Chinese urban residential construction boom, using projections of urbanisation rates, building size and construction quality. Chinese urban residential construction is expected to remain at elevated levels for the next couple of decades, but growth will undoubtedly slow.

As the urbanisation process winds down and as improvements in building quality become more incremental, construction is expected to peak in 2017 and fall back below current levels some time around 2030.

This projection is dependent upon a number of assumptions, and we consider the sensitivity of our projections to these assumptions. If urbanisation advances at a slower pace than envisaged, then the peak of residential construction could be close to hand. However, there are upside risks as well. The evolution of floor space per capita is quite uncertain; should this advance at a faster pace than the
relatively conservative view in the baseline scenario, the high-growth phase of Chinese residential construction could continue for several more years.

Fundamentally, the construction boom is the result of extraordinary economic growth and urbanisation, which are intertwined in complex ways (Spence, Annez and Buckley 2008). Other countries, for example Korea, have experienced similar, or even more rapid, increases in the proportion of residents living in urban areas.

Yet no country can compare to China in terms of the sheer scale of its urbanisation. China’s urbanisation process has other distinct features. The hukou system, which determines individuals’ residency status and welfare entitlements, limits labour mobility to a degree that could be responsible for a large gap in wages between urban and rural areas (Henderson 2009). There is also evidence suggesting that Chinese cities are undersized compared to some optimal level, suggesting scope for further expansion in city sizes (Fujita et al 2004; Au and Henderson 2006). This paper does not take account of these features explicitly in the analysis, but they are likely to have only minor implications relative to the influence of China’s overall growth.

Construction requires steel, which in turn requires iron ore, of which Australia is a significant producer. We estimate that residential construction uses about 14 per cent of China’s crude steel output. More intense use of steel, due to taller buildings and other amenities such as underground car parks, means that steel use by residential construction will grow at a faster rate than the volume of floor space built. Indeed, we project that steel used in residential construction will peak around 2024, at a level that is 30 per cent higher than in 2011.

This paper also touches on the structure of the Chinese economy and its evolution. As is well known, Chinese nominal investment as a share of GDP is high. We estimate that the residential construction share of GDP has risen from 5½ per cent in 2004 to 9 per cent in 2011. The extent of this increase is somewhat higher than suggested by the volume of floor space constructed. Quality improvements and higher materials prices could account for this.

I will leave you to read the wonkish meat of the article but there is one point I’ll make. The analysis is based upon other Asia nation urbanisation paths:

But really, is it a good idea to compare a giant, immensely poor, continental economy with small, coastal, mercantile states? Just askin’.

The assumptions of the paper are also revealing:

Given uncertainty about China’s trend rate of growth, we consider two possibilities: a high-growth and a low-growth alternative.

• First we assume that the Chinese GDP per capita grows at 8 per cent per annum for the next 20 years, rather than around 6 per cent in the baseline. Lin (2011) suggests that China has the potential to do so considering China’s stage of development relative to that of the United States, and the growth performance of Japan, Taiwan and Korea when they were at a similar stage of development.

In this case we project that China’s growth rate will follow the same deceleration after 2032 as the growth rate from World Bank and Development Research Center (World Bank and Development Research Center of the State Council, the People’s Republic of China) (2012). Accordingly, China’s PPP-adjusted GDP per capita reaches almost US$80 000 by 2040 (at 2005 prices), compared to around US$40 000 in the baseline projection.

• In the low-growth alternative we assume that GDP per capita growth is 2.7 percentage points lower than the baseline growth rate. This difference is equivalent to one standard deviation of the distribution of growth rates experienced in China between 2000 and 2009.

In this case, China’s PPPadjusted GDP per capita reaches US$20 000 by 2040 (at 2005 prices). Under the high-growth assumption, floor space construction peaks in 2023, 25 per cent above recent levels, and remains above current levels for all but the last couple of years of the projection period (Figure 15). Under the low growth assumption, construction is effectively at its peak now and will be almost 40 per cent below the baseline by the end of the projection period.

So, at least we got a proviso. 8% GDP for the next 20 years? Maybe. I’m happier with 5.3% though even that sounds pretty aggressive. There is also the assertion that only 14% of steel goes into real estate. ANZ estimates 39%. That’s an almighty discrepancy which I can’t explain.

Full report below.

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