The threat of declining real estate profits to China's economic growth.

China has transformed dramatically over the past 40 years and is now one of the two largest economies in the world. This spectacular success has lifted hundreds of millions of people out of poverty and into the global middle class, exceeding expectations and baffling those who predicted economic collapse.

The pace of growth is now slowing, however, for several reasons. Like many developed countries, China's population is aging - a demographic transition that was exacerbated by the country's one-child policy from 1980 to 2016. Globally, there has been a resurgence of economic nationalism since the COVID-19 pandemic. Trade growth, already suffering from market saturation, is slowing as manufacturers in Europe and theNorth America back home, diversify sources of supply, or impose trade barriers.

There is, however, another brake on China's growth. Its economy has depended for years on excessive domestic investment in real estate and infrastructure, and that investment is yielding diminishing returns. Local governments, dependent on land sales for revenue, must repay their debts, and revenues are falling as the real estate boom has faltered.

Will this lead to an economic collapse in China? Not necessarily, at least not in a financial crisis like the west has already experienced in 2007-2008. But the solutions to these problems will not be easy, the cures may be complicated, and the end result is likely to be a lot moreslower growth rate.

The impact of real estate on China's economy

In our joint study with International Monetary Fund economist Yuancheng Yang, we assessed how much China's economy depends on real estate and related infrastructure. In 2021, the direct and indirect impact of real estate on China's economy is 22% of GDP or 25% when imports are included. If you include infrastructure such as roads, mass transit and water pipelines serving residential and commercial real estate, the total is 31%.

In the years leading up to the COVID-19 pandemic, this figure was even higher.

The physical transformation of Chinese cities over the past three decades has been astounding. However, assessing the cumulative construction already undertaken, it is clear that growth in construction can no longer feed the economy Growth refers to all that will be built next, and returns to construction are diminishing. For example, China's housing stock per capita is now equal to or greater than France or the UK. While the U.S. housing stock remained stable at 65 square meters per capita from 2011 to 2021, China's housing stock has grown from 5 square meters per capitain 1992 to nearly 49 square meters per capita in 2021. Smaller and poorer cities contain 80% of this area, where agglomeration effects do not have as great an impact on richer and more prosperous cities.

Meanwhile, the shares of real estate under construction to completed commercial real estate continue to rise nationally, reflecting a market in which developers are failing to complete projects due to a lack of end buyers and financing. Infrastructure investments also face similar challenges. Project investment in high-speed trains far exceeds the growth in the number of people using them, and recent infrastructure investment has been concentrated in small and poor cities.

Challenges for.China

At the same time, local government debt is steadily rising from around 5% in 2006 to 30% in 2018 even by conservative estimates, and regional private banks will also be exposed. The central government can always decide to bail everyone out, but it may present a challenge to keep the necessary credit growth feeding the economy.

The Chinese population is largely concentrated in real estate. Even without a financial crisis, the central government will have to adapt and wean China's economy off its dependence on this sector.

Beijing can use its powers to restructure and redistribute economic activity, as it has done successfully in the past. There are also fiscalpolicies that would help address the problem, such as increasing remittances to support local governments or allowing local officials to impose property taxes, although the latter appears to be politically irrelevant.

Chinese authorities have dealt effectively with economic challenges during the past 40 years of growth, but solving this problem will not be easy even for them.

Kenneth Rogoff is Professor of Public Policy and Economics at Harvard University and is a member of the Policy Research Network of the Center for Economic Policy Research and International Lending.