NEW EVIDENCE OF A CHINESE HOUSING BUBBLE

by Cullen Roche

When people discuss the surge in Chinese real estate you’ll often hear that the issue is not broad and is instead contained to a few of the larger cities (sounds familiar – hello Miami, Los Angeles, NYC and Boston!), but new research from Professor Christian Dreger and economist Yanqun Zhang say the problem is more wide ranging and consistent with a bubble that threatens the Chinese economy:

“In recent research (Dreger and Zhang 2010), we use a dataset for 35 major cities to estimate the size of the bubble relative to the equilibrium level implied by the panel cointegrating relationship. We suggest that positive deviations from the long run might indicate the presence of speculative bubbles. However, many analysts have argued that a bubble has emerged only in recent years, probably spurred by the recent fiscal stimulus package (Wu et al. 2010). Hence, the evidence can be misleading if the cointegration relationship is considered over the entire period. In a first step, we estimate the long-run relationship only up to some point in time. The fundamentals include real per-capita income, real interest rates, real land prices and population. Cointegration between these variables and the real house price can be established. City fixed effects are embedded to control for unobserved heterogeneity.

In the second step, the house price evolution is predicted over the rest of the sample, i.e. the last two years, where perfect foresight is assumed with respect to the fundamentals. This gives an estimate of the fundamental development of house prices, and the size of the bubble can be addressed. As an exception, land prices are held constant throughout the forecasting horizon to reduce endogeneity problems.

Our results indicate the presence of a house-price bubble. In Figure 1it can be seen that increasing imbalances have emerged over the past two years. For example, real house prices in Shanghai have been 28% above the long run equilibrium in 2008, and 35% in 2009. While the evidence is similar for Beijing, the increase is more spectacular in Shenzhen. Compared to the cointegrating relation, real house prices are overvalued by 66% in 2009, after 23% in 2008. In general, the bubble is more pronounced in the special economic zones and the south-eastern coastal regions. Overall, the size of the bubble is 20% in 2008 and 25% in 2009, regardless of whether GDP or population weights are applied.”

Figure 1. House price bubble in major Chinese cities

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