Case study in Boom/Bust economics–China’s empty cities

The Austrian theory of the business cycle is often misunderstood as an overinvestment theory–where too much investment causes a boom, which must be corrected by a bust.  Prominent economists such as Paul Krugman characterize it this way,

Call it the overinvestment theory of recessions, or “liquidationism,” or just call it the “hangover theory.” It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.

Of course, this is NOT the Austrian theory; rather the Austrian theory is one of malinvestment–the wrong kind of investment, not overinvestment, or too much investment.  The is classically underway yet again by foolish stimulative policies in China, which has created perhaps the world’s greatest real estate bubble.  This piece from 60 minutes will tell you more about the Austrian business cycle theory than any economist ever could.  As you watch (about 12 minutes), notice the displaced people who are having their homes torn down to build housing that is unaffordable–its not that housing isn’t needed, but the government policies are enabling the wrong kind of housing.  This is the essence of malinvestment.  Capital is misallocated away from true consumer preferences toward something either favored by the government directly or indirectly enabled by manipulation of the interest rate.

China Bubble

13 thoughts on “Case study in Boom/Bust economics–China’s empty cities”

  1. Wow I had no idea that that was going on in China! You so often hear of China’s immense population, but I would have never thought you would find “ghost cities” there. Scary to think about what might happen if the housing bubble does burst in that country and how devastating it would be to the people there.

  2. Yes, that is true. However, what constitutes overinvestment will vary. For example, China invested heavily in crops in the United States. One of the strongest relationships it has on a state-Chinese relationships is with one of the states that is known for crops, Iowa I believe it is. This is more public investment than private. For example many companies invest in China. This however does not constitute overinvestment. Investment in one of those things which does not exactly follow the law of marginal utility. The more investment you have, it still has less value per unit. However, I believe that it does not have much less of a deflation of value than standard marginal utility according to the microeconomics principle/Law of marginal Utility. What I think is the most important quality that really we need to be on the look out is private vs. public investment in a country and how concentrated the investenment. Overinvestment though is one of many factors and should not be confused with other concepts including manipulation of a currency.

  3. I can’t help but wonder what will happen to all those misplaced people who were forced to move to make room for houses they cannot afford. Where will they go?

  4. Rachel, that is a real problem–one that we often do in the name of urban renewal here in the U.S. This is often another example of what Dr. Wheeler is addressing in another post, Crony Capitalism. In the name of helping the community (and the poor), favored parties get access to land via government exercise of eminent domain.

  5. I wonder if there would be a good parallel here to the green energy and ethanol industries of the United States. While few people actually care about whether there gas is part ethanol or not, the government subsidizes ethanol enough to make it a good business option, at the expense of consumers who pay more for less. Similarly with the green energy industry, I can imagine that bubble bursting as soon as state support is no longer viable. In China, viability ends when the displaced population is too large to ignore, whereas in the United States viability ends when a different political party pulls out the rug, or when voters grow too tired of paying for escapades like Solyndra.

  6. I find it disconcerting that the nation that claims the greatest amount of US bonds is heading down a similar path to what caused the 2008 downturn in the first place.

  7. I never really knew much about the housing situation in China. I knew it was bad but I feel sorry for those who are going to have to find new housing because they cannot afford the new homes that are being built.

  8. I think there’s no doubt the bubble will burst. It’s unfortunate, but the government shouldn’t limit individuals on where they want to invest. If the bubble does burst there may be a revolt. If my mom and dad decide to invest in something and it fails it’s their fault of the decision they made. And the same is true if they succeed in investment. The Chinese aren’t the only ones though that displace the poor for a more affluent population. My mom and dad said before I was born they went to Hilton Head. My dad commented to a worker at a store it must be great to work here and live here. They said, they used to live there but now they can’t afford the property taxes. So they work their and then travel quite a distance to live in a more affordable part of the state. Many of the workers were also college students from other states on their summer break. So local people were not only moved involuntarily due to high property taxes they were outsourced for work. Back to China when I see that developer say that there is a bubble it scares me. It will have an affect on the world eventually. Investing in China is investing in the world.

  9. I had heard about these ghost cities, but thought the stories were exaggerated. This problem is enormous. It’s really hard to believe that they didn’t learn from our example. Big change in China is just around the corner. To re-stimulate their economy, China just may have to adopt a purer form of free markets. With that will inevitably will come a more democratic system. It’s just a matter of time.

  10. I have to admit I was unaware of the extent of the housing situation in China. With China’s involvement in the U.S. economy, I am surprised investors are still purchasing properties after the initial warning signs. I think Ben had an interesting question. Since the housing market was the only attractive investment available in China, what is the likelihood that the government will open up foreign investment to its citizens in order to avoid situations like this housing bubble in the future?

  11. This is an excellent example of unintented consequences in economic policies. I looked on a few additional news sites for more information on this, and another site repeated the point that Chinese citizens with money had no real good investment options other than property. The Chinese government unintentionally created (or enhanced) this bubble by unintentionally channelling too much of its citizenry’s investment into one place. Aside from just trying to devalue property, the wisest decision would be to unrestrict investment options and relieve this situation of its growing financial pressure.

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