Razing urban villages will not expand domestic demand

This article in the New York Times is quite interesting for what it says and does not say. The piece includes a lot of very interesting and useful facts, but fails to some extent to ask bigger questions.

The biggest problem is that the government’s plan, as explained in the article, will not work. The piece says that the local Shenzhen government plans to raze and rebuild some older areas, ‘urban villages’, in an effort to “expand domestic demand”.

Now we should understand the appeal to ‘domestic demand’ is basically equal to a ‘consumer-led’ economy. The terms are different, but right now Chinese media is trying to work up an understanding of what the future of China’s economy could look like. Domestic demand specifically says nothing about who gains and who does not within the economy. A handout from the government to the wealthiest in society will still increase domestic demand, as they use that money to buy extra things.

A consumer-led economy is a very different thing. In a consumer-led economy people are able to earn, save and spend. They are allowed to develop their skills and career, and enjoy some of the finer things in life, from their perspective. People spend when they have some extra cash in their pocket, and are comfortable in their life.

When they are stressed about money, they will not spend as much. When they are comfortable and positive about the future, then they will spend more, or even take out a consumer loan to do something they want.

This freedom and comfort leads to economic growth. People develop things, they enhance things, they beautify things. They gain specialized knowledge that helps them advance themselves. If society is stable, then they will contribute to a growing economy, just through self-interest.

But this government plan doesn’t support domestic demand nor is it a plan that will help consumers.

Paying a construction company to redevelop this area will only expand domestic demand if the housing is low-income. And, we’ve seen in the past that such projects don’t really work well, because connected people jump to the front of the line in order to rent out the housing themselves, likely at market rates. But that is another issue entirely.

The reason that this plan will not expand domestic demand is because it will likely lead to higher rents in the area, taking money away from consumers’ pocketbooks. That is reduced, not expanded, domestic demand.

Those that have lived in China have seen these sort of projects many times. Older areas that were bustling centers of commerce are knocked down and replaced with expensive housing and limited retail spaces. They take an area where you can buy almost anything, and reduce it to a place where you can buy nearly nothing.

The logic of was simple enough: Businessmen would line up for the opportunity to buy in, and if the government is giving tax or other concessions, then there is very limited risk. Pay the owners, kick out the residents, and profit. Today, however, those businessmen might not line up as before. But that is also a secondary problem here.

The housing in these villages isn’t very comfortable, so the proposal seems positive. But those residents are living there precisely because of the low rent. Kicking them out will only lead them to move to another urban village, or leave entirely, perhaps back to their hometown, or somewhere else. They may have to leave their job, and they may have to take a lower-paying job. All of this means lower domestic demand. The informal businesses running in the urban villages will have to close or move. If they close, that’s lowered domestic demand.

Yes, the work of the construction company will bolster domestic demand, that’s true. If the goal is to stimulate business for construction companies, perhaps as a means of goosing employment, then this is a great plan. But the effect on domestic demand is likely negative.

What would expand domestic demand would be to subsidize the owners to renovate the places they have, with an agreement that rents will not increase. Clean up the places, make them a bit more comfortable.

Another interesting but unexplored aspect of this particular urban village is the fact that Evergrande owned it, and “handed” it to Shenzhen Metro, a state-owned property developer. So we see an example of Evergrande’s assets (or liabilities) being parceled out to the local governments, a move that was announced in 2022.

This just shows that the government has a few levers that it uses again and again, quite reflexively. The local governments have a lot of their plates, and now they are getting more obligations, possibly at the expense of Evergrande’s suppliers and bond holders.

It’s also quite unnerving that this would be the priority right now. China already has major misallocations of investment in housing and property development. Developing yet more land seems unwise at best.