According to an August 1 report from The Price Monitoring Centre of the National Development and Reform Commission (NDRC) of China, housing prices continued to rise in the first half of this year. Since March, prices in 36 medium-to-large cities have risen by more than 1.5% year-on-year for four consecutive months. In addition, prices in Beijing have been rising for the past 23 months. And finally, data released by E-House Estate Research Institute, a Shanghai based non-profit research agency, indicate that units sold in square meter terms exceeded new supply every month this year. After two rounds of macroeconomic control policies meant to curtail runaway prices, the average price per square meter in Shanghai still exceeds RMB10,000 — a key threshold.

Real estate is a key part of China’s modernization and urbanization . Governments, banks, developers, investors, consumers and many other industries are all stakeholders. Is the industry entering a new round of fast growth and price increases? What is causing these price increases? Are they supported by real demand? What has been the impact of the government’s macro-economic policies? What lies ahead for the housing market? China Knowledge at Wharton interviewed professor Zhang Yongyue, president of Shanghai E-House Estate Research Institute and dean of the Orient Real Estate College, East China Normal University, about these issues.

China Knowledge at Wharton: Professor Zhang, can you give us an overview of today’s real estate industry?

Zhang: The real estate industry affects the wellbeing of the country and its people. After two years of macroeconomic control policies, the industry is reacting and adjusting. We have new challenges today to address, including: How do you maintain the real estate industry’s important role in driving economic development while providing housing for ordinary people and contributing to a harmonious society?

It is fair to say that the real estate industry has been driving economic growth over the past decade and has improved the living standards of ordinary people. But there are other important issues as well, such as how to benefit wider groups of people, achieve sustained development and avoid risks, and keep prices at reasonable levels. These issues need to be explored and resolved.

China Knowledge at Wharton: Housing prices have been rising rapidly in the first half of this year. What are the drivers?

Zhang: I see two reasons. First, more people are buying. Second, expectations are changing — in other words, people believe future prices will be even higher. This has been a direct driver behind this round of price rises.

China Knowledge at Wharton: What has led to this change in expectations?

Zhang: There are several underlying factors. First, excessive liquidity. China’s MM1 supply have been huge over the past 30 years. We have ever-increasing foreign reserves, which [lead to] more RMB in circulation. According to traditional theory, this would have caused inflation, as happened in late 80s and early 90s. But today, there is [an overabundance of most products — like clothes, watches and electronics –- [which means that] prices haven’t risen.

Resource-intensive products are quite different, such as housing: Supply is limited by land. With excessive liquidity, prices of resource-intensive and capital-intensive products rise. This is seen all over the world and has been reflected in China in recent years. Housing [includes] consumption goods as well as capital goods. When people buy [housing] for investment, demand increases further. Another important factor is urbanization.

Young people today care very much about housing prices; they definitely want to see prices drop, but they are the ones pushing prices up at the same time, because demand comes from them. How many people living in Shanghai today are from outside the town? Why don’t prices rise in some county towns? Outsiders don’t buy there. Shanghai is different. It is an open market; demand comes from local people, immigrants, etc. It is huge.

There are other issues as well. A young couple in Shanghai, for example, makes about RMB10,000 a month. By international standards, they can spend one third of the household income, namely, RMB2,000-3,000, on housing. If they rent a 2,000 square foot apartment in Shanghai, it can be quite nice. But their parents back home might be shocked. They would say, ‘Our total monthly pension is less than RMB2,000.’ But if the couple buys an apartment, the parents might be willing to contribute RMB100,000, perhaps their lifetime savings, for the down payment. They can boast to relatives and friends that their kids have an apartment in Shanghai. Immigrants don’t feel secure without buying an apartment. The urbanization process also pushes up housing prices.

[Looking at it from] another angle, supply is limited.

China Knowledge at Wharton: Could you explain what caused the insufficient supply?

Zhang: Three things. First, land is scare. Second, demand for housing swells rapidly within a certain period of time, mainly due to demographics, urbanization, migration and marriage peaks. Supply of, and demand for, housing has not come to an ideal equilibrium for one reason or another. Third, what is launched on the market might not be what most people really want. Supply doesn’t catch up with demand, leading to price increases.

China Knowledge at Wharton: Many people say high land prices are the real culprits. Should the government change land policies to reduce prices?

Zhang: These days, land is open for bidding and prices go up all the time. But demand is increasing and developers are still confident about sales prospects.

If you control land prices and offer land on the cheap, will you also control housing prices? We do have this category of housing, when both prices of land and units sold are under control. In Beijing and a few other cities, we see this category. But if the whole market operates this way, the industry will only have social functions. This way, the state will have less income, and a slice of GDP will also be taken away. Land policy cannot be designed in isolation; it has to be considered in a comprehensive framework. You can make a perfect hypothesis, but that would be only a best-case assumption. This is an issue about the design of the whole economic system. Shall we regulate the entire real estate market, or part of it; if so, which part and how? We shouldn’t overlook the rules of the market.

China Knowledge at Wharton: Some people say that if the society is fair, housing prices shouldn’t be so high. If people all use their income to buy houses, prices will naturally fall since the average income of Chinese people is low. But in reality, many people have illegitimate or grey income. If this is a large group, prices will be driven up. To what extent do you think housing prices are distorted because of unfairness?

Zhang: This is entirely another matter — the fairness of income distribution. On the surface, we see the issue of housing prices. Behind it, it is actually about distribution of benefits and fairness. It takes some time to resolve the issue.

I once commented that housing price increases will magnify unfairness. For example, if you bought a RMB1 million apartment a few years ago, it would have appreciated over the years. But if you couldn’t afford an apartment a few years ago, you will have to pay even more to buy a place now. One cannot say that there are no connections between unfairness and price rises, but it is too simple to attribute price increase entirely to inequality.

China Knowledge at Wharton: At the BoAo Real Estate Forum last week in Hainan province, Larry Lang — a highly controversial economist — claimed there was no excessive liquidity. He coined a phrase — “virtual currency”. He also said that prices of meat rose because pig-raisers had been speculating on housing and neglected raising pigs.

Zhang: Intuitive judgment cannot replace factual analysis. There might be virtual prices with shares. But virtual economy and real economy can be mutually converted. When someone buys 100,000 shares worth RMB10 each, and sells all at RMB20 a share, he will have realized a RMB1 million gain and GDP will rise by RMB1 million. He has RMB2 million in real money at hand. This is conductivity in economics.

China Knowledge at Wharton: Some people say that macro economic control policies of the government are contradictory, and that the more controling policies [there are], the higher the prices. What do you think?

Zhang: Policies need to be further fine-tuned…. Under the market economy, the market will find its own way to react to policies. It is like air-conditioning, which is meant to lower the temperature. But what degree you get to has a lot to do with the original temperature of the room. The market continues to evolve according to its own rules. When supply doesn’t meet demand, some policies don’t get the intended conductivity effect. For example, the government taxes retail sales, hoping to deter demand. But when demand exceeds supply, the tax burden is passed on to eager buyers, and prices increase as a result. I believe control policies will be improved and will gradually take effect.

China Knowledge at Wharton: What should the government do regarding the housing industry?

Zhang: The government should facilitate healthy and stable development of the industry, try to maintain stability and help control prices to some extent and satisfy the needs of ordinary people. I think macro economic control policies have exactly this purpose. The key is to make efforts to establish a public housing system for low-income people – i.e., the government would sponsor or subsidize houses for people who are priced out of the commercial housing market.

China Knowledge at Wharton: What is your view of the direction the real estate market is taking?

Zhang: First of all, there is still a lot of room for the real estate industry to develop in China, an opportunity brought by urbanization and economic development. Second, government policies will need to focus on fairness and resources utilization, benefiting more people. The government must also care more about stability. Third, China should establish a housing system for low-income people. Prices on the market will stay at certain levels, but hopefully the trend will be more stable thanks to controlling policies.

Why is Hong Kong okay with high housing prices? The public housing system is great and we need to learn from it. In addition, we need to increase land supply. Some developers grab land, and this needs to be pushed to the market. Certainly, industry efficiency is also important; we need to make the best use of energies and land.

China Knowledge at Wharton: Young professionals all over the world are mainstream home buyers. In the U.S. and U.K., for example, these people can well afford a decent house. But in Shanghai, many young professionals are housing slaves. Does it mean prices are problematic? Will it negatively impact the whole society?

Zhang: Young professionals are a sensitive group. In a mature market, income is stable, housing prices are stable and expectations are stable too. In China, expectation is not stable — a key characteristic of a developing country. That’s the cruelty of the market economy. But there are always buyers; that’s the key.

You might think young people and young professionals are losers. This is right and wrong at the same time. It is true that they can live a great life if they don’t have to buy an apartment. Boys are under even more pressure. Salaries don’t rise as much as house prices.

But if you look at China today, workers and peasants are the basis and mainstream of the whole society, and they don’t even have a voice. Construction workers build all the houses but they cannot afford them. People on the margin are the most volatile groups.

People on the margin are not only white collar people. Our young professors tell me they should be able to travel and pay for studies with their income, but now they have to spend it all on housing. Meanwhile, in the past, government officials were given a