Housing Prices in Urban China as Determined by Demand and Supply

• Author: Gregory C. Chow,Linlin Niu
• DOI: http://doi.org/10.1111/1468-0106.12080
• Published date: 01 February 2015
• Date: 01 February 2015

HOUSING PRICES IN URBAN CHINA AS DETERMINED

BY DEMAND AND SUPPLY

GREGORY C. CHOW*Princeton University

LINLIN NIU Xiamen University

Abstract. This paper studies the demand for and supply of residential housing in urban China since

the late 1980s when the urban housing market became commercialized. Using aggregated annual

data from 1987 to 2012 in a simultaneous equations framework we show that the rapid increase in

the urban residential housing price can be well explained by the forces of demand and supply, with

income determining demand and cost of construction affecting supply. We find the income elasticity

of demand for urban housing to be approximately 1, the price elasticity of demand to be approxi-

mately −1.1 and the price elasticity of supply of the total housing stock to be approximately 0.5. The

resulting long-run effect of income on urban housing prices in elasticity terms is approximately 0.7,

because the increase in income has shifted the demand curve outward more rapidly than the supply

curve.

1. INTRODUCTION

China’s urban housing market has experienced rapid development since the

gradual privatization and housing market reform began in the late 1980s. From

1987 to 2012, the residential floor space per capita increased by 159%, from 12.7

to 32.9 m2. Meanwhile, the relative housing price has increased by 230%.

Over the past decade, the rapidly rising housing prices have become ever more

disruptive economically and politically and have caused heated tension in

Chinese society and in the government policy arena. Continuing rising housing

prices are pushing the dream of owning a home further away for low income

urban households. The Chinese Government has intervened to curb the rising

prices and to provide affordable housing. Around 2005–2006, the government

began to take various measures to control the increase in prices, for example,

through stringent taxation and land planning, and increasing mortgage rates

and down payments. However, the effect of such measures has been rather

limited. The housing bubble in the United States (Case and Shiller, 2003, Shiller

2006) has become an important and interesting subject because it contributed to

the Great Recession in the United States in 2008 (Mian and Sufi, 2009).

Although urban housing prices in China were depressed in 2008 mainly due to

the global recession originating from the United States, a strong price reversal

since 2009 has led to fear of a possible housing bubble in China. A contributing

factor is land prices, an important cost factor in housing prices. As shown by

*Address for Correspondence: Fisher Hall Princeton University, Princeton, NJ 08544, USA. E-mail:

gchow@princeton.edu. We would like to express our thanks to two anonymous referees for their

helpful comments and to Wei Yang and Yide Chen for data collection. The first author would like

to acknowledge research support from the Gregory C Chow Econometric Research Program of

Princeton University. Linlin Niu acknowledges the support of the Natural Science Foundation of

China (Grant no. 70903053 and Grant no. 71273007).

bs_bs_banner

Pacific Economic Review, 20: 1 (2015) pp. 1–16

doi: 10.1111/1468-0106.12080

© 2015 Wiley Publishing Asia Pty Ltd

Deng et al. (2011, 2012), China’s heavy-handed macroeconomic stimuli in

response to the financial crisis worked through housing markets to push up real

land auction prices in eight major cities by 100% in 2009 via the channel of

state-owned enterprises, which obtained the lion’s share of loans for investment

from state-owned banks, as ordered by the government. The fear of a housing

bubble has re-emerged.

The main purpose of this paper is to explain the rapid increase in the relative

price of housing in urban China using the framework of demand and supply and

estimating a set of demand and supply equations. In our analysis the quantity

and price of urban housing are aggregated from data on all urban areas. Since

residential housing in urban China became commercialized in the late 1980s, the

price of residential real estate has increased rapidly, from 408.18 yuan/m2in 1987

to 5429.93 yuan/m2in 2012, or at an annual rate of 11.3% (see data in Table 1 of

this paper). Our study shows that this rapid price increase is mainly due to the

upward shift in demand resulting from the rapid increase in disposable income,

with the supply of the total stock of urban housing unable to catch up.

Shing-Yi Wang (2011) discusses the micro aspects of the commercialization of

China’s housing market in terms of correcting state misallocation, and deter-

mines that the net effect on the equilibrium price is an increase of approximately

7.5%. Using panel data across regions with variations in the sex ratio, Wei et al.

(2012) estimate that due to ownership of real estate being associated with good

status, a rise in the number of males in comparison to females in China

accounted for 30–48% of the rise in real urban housing prices in China during

2003–2009. A large part of the persistent upward trend in housing price over

more than two decades remains to be explained by other factors.

Concerning the existence of housing bubbles there are two questions raised in

the literature. First, were there housing bubbles in China in the period 1987–

2012? Second, if not, what are the factors driving up urban housing prices? The

first question has been addressed in the existing literature, for example by Ren

et al. (2012), who run a test of rational expectation bubbles (Blanchard and

Watson, 1983) using the annual housing investment returns of 35 Chinese cities

between 1999 and 2009 and reject the bubble hypothesis. In searching for

explanatory factors, one strand of the literature considers the determination of

nominal housing prices. Zhang et al. (2012), for example, find that monetary

factors are at work, such as on the monthly series of national house price index

from January 1999 to June 2010; Zhang (2013) does the same using a sample of

quarterly data between 1998:Q1 and 2010:Q3. Using annual data from 1997 to

2009, Shen (2012) defines a new measure of housing affordability in terms of

permanent income and finds that housing prices are, in fact, reasonable and

affordability in China is high in light of the high rate of growth and low interest

rates. However, there has not yet been a thorough examination of the more than

doubling of the relative housing price during 1987–2012. Our study attempts to

explain the rapidly and persistently rising relative price of housing during 1987–

2012 without resorting to using a theory of housing bubbles.

In an effort to provide a simple model to explain the aggregate behaviour

of the most important variables in the housing market, several simplifying

G. C. CHOW AND L. NIU

2

© 2015 Wiley Publishing Asia Pty Ltd