Too Large To Grow So Fast

Anyone forecasting a hard landing for China's boom is typically met with the same skepticism that doomed the boy who cried wolf. But the lesson of the fable is that the wolf did come, the third time. Now, after two false alarms in 2004 and 2006, the slowdown is at the door. China has simply grown too big to keep expanding at the 10 percent rate it has sustained for 30 years, and is likely to slow to 8 percent at best next year and for the foreseeable future. The decisive end of the era of double-digit growth is here, with major implications for the nation and the world.

Until now, China had defied the traditional theories of how fast developing nations could grow, and for how long. Its economic growth has compounded at an annual average rate of 10 percent over the past 30 years, a record that has surpassed the other miracle economies, such as Japan and South Korea. Japan's growth rate downshifted significantly after 1973, when it reached a per capita income of $3,000—a level China hit earlier this year. Now the law of large numbers is catching up to China: in 1998, to grow its $1 trillion economy by 10 percent, it had to expand its economic activities by $100 billion and consume only 10 percent of the world's industrial commodities. Currently, to grow its $3.5 trillion economy that fast, it needs to expand by $350 billion a year and suck in nearly 30 percent of global commodity production. Even more important, there are clear signs in China's response to the slowdown that the leadership understands that this moment was inevitable—that it is abandoning its old growth-at-any-cost mentality, and will not try to artificially revive double-digit growth.

Until very recently, of course, the China headlines had remained entirely bullish. The red-hot expansion had shown only marginal signs of moderation through the first half this year, and most economists blamed weak growth in Western countries, which are China's best export customers. They had also assumed that sluggish exports could be offset by stronger domestic demand, powered by Beijing's big spending on infrastructure projects and the rising purchasing power of the Chinese consumer. However, the latest signs are that the Chinese domestic economy is not immune to slowdown: it is starting to falter, too, and the property sector is the heart of its troubles, as in many countries.

For the first time since the Chinese housing market was fully privatized in the late 1990s, a coordinated real-estate downturn has set in across all major provinces. The feeding frenzy of rising prices and increasing demand has given way to a vicious cycle of falling prices and slowing demand. Housing is increasingly unaffordable, as property prices doubled between 2000 and 2007, and authorities began raising interest rates last year in an attempt to prevent overheating. Still, for much of this year, developers have continued building with abandon, counting on demand to revive and refusing to lower prices, even as sales began to collapse and inventories mounted. Property sales started to drop in October 2007, turning negative in the second quarter of 2008.

Now there is widespread anecdotal evidence that a price war is breaking out from Beijing to Shenzhen. Discounts of 10 to 20 percent are increasingly common on existing residential projects. New construction activity is grinding to a halt. Auctions of apartments in new buildings are failing to attract bidders even in formerly hot coastal cities like Shanghai.

A bear market for real estate will have widely unforeseen ripple effects across the economy: while the consensus forecast is for still-robust growth of 9 to 10 percent in 2008 and 2009, down from 11.9 percent in 2007, those predictions factor in only falling export growth, which is expected to slip from the 20 percent pace of recent years to single digits next year, stalling a sector that accounts for a third of investment spending in China. Businesses in some of the most energetic export hubs, such as the Pearl River Delta and Yangtze River Delta regions, have been reporting a softening in demand for months now. But real-estate construction accounts for another third of total investment spending, and its collapse should lop off at least an additional percentage point from economic growth.

The downside risks don't end there.