Liaoning Sounds Warning on Chinese Economy

Although China's slowing real estate market draws the most attention, industrial sectors such as steel have been hit hard. Suffering from overcapacity and now a slowdown in demand, the sector led the slowdown in real estate. There is a feedback loop for some areas of the country, where the production of raw materials for real estate development fuel the local economy, which is also has its own real estate bubble. The result is rapidly slowing growth that could be a harbinger for the wider economy.

The data shows that real estate investment is plunging in the heart of China's industrial economy. The slowdown in real estate is happening nationally, with investment growth figures sliding in most provinces, but the three northeastern provinces are doing the heavy work of pulling down the national figure. One province among them is doing most of the work: Liaoning is the fourth largest province in terms of real estate investment, with 6.5% of the national total in September. The other two provinces, Heilongjiang and Jilin, are both over 1% of total investment. The other provinces in the top 5 of total investment are, in order, Jiangsu, Zhejiang, Guangdong and Shandong. Here's the real estate investment growth figure for each administrative region in China. This is the year-to-date cumulative growth figure (data from China's National Bureau of Statistics).

Real estate investment in the province of Liaoning hasn't slowed gradually, it has collapsed.

The yoy cumulative growth rate nationally was 12.5% as in the list above. The yoy national growth rate for the month of September alone was 8.6%. For Liaoning, it was negative 41%.

Investment numbers are volatile for many provinces, but the large provinces tend to see much more stable growth figures. Here's Liaoning along with the other 4 top provinces for real estate investment, again the cumulative growth rates. Looking at the trend in growth, Jiangsu hasn't slowed at all and Zhejiang (home to Wenzhou, Ningbo, Hangzhou and a few other bubble cities) is holding up amazingly well, only seeing a drop in growth earlier in the year when the national real estate slowdown started there. Guangdong has slowed a few percentage points, but not enough to take down the national growth rate.

What is going on in Liaoning? Here's a description of Liaoning's economy:
Leading industries include petrochemicals, metallurgy, electronics telecommunications, and machinery.[28] On a national level, Liaoning is a major producer of pig iron, steel and metal-cutting machine tools, all of whose production rank among the top three in the nation. Liaoning is one of the most important raw materials production bases in China. Industries such as mining, quarrying, smelting and pressing of ferrous metals, petroleum and natural gas extraction, are all of great significance.

Iron ore prices have been falling all year due to the slowdown in Chinese demand and steel producers are dumping their product on the world market.

As of September, Liaoning's capital, Shenyang, has seen prices fall 3.8% from last year, which makes it one of the largest yoy price drops in the country. Inventory figures fluctuate based on monthly sales, but earlier this year, inventory was estimated at over 30 months in Shenyang. This story posted earlier this year (with many photos) is also very relevant: In Yingkou, Liaoning Unfinished Buildings Stretch For 50 Square Kilometers; Real Estate Graveyard.

Liaoning is not alone in seeing real estate investment growth collapse. The real estate slowdown is happening nationally except for a few outliers, and several cities have seen similar drops in their growth rates. Comparing the September 2014 real estate investment growth rate to September 2013, Liaoning leads with a drop of 34.3 percentage points (see chart below), but 15 provinces have seen declines of more than 10 percentage points and very few have seen increases.

Liaoning relies heavily on the real estate industry too, in part because the rest of its economy grew slower than the real estate sector. 中国大陆哪些省份最依赖地产投资? (Which Chinese Provinces Rely Most on Real Estate Investment?)

Good News or Bad?

If you're an optimist, the slowdown in raw materials is a regional economic factor that is weighing on the northeastern economies. Liaoning has the worst of both worlds: the real estate sector is slowing along with the rest of the economy and this directly impacts the basic industries that proliferate in Liaoning's economy.

If you're a pessimist, the commodities sector is a higher stage of production, more sensitive to changes in the economy and a leading signal for future growth, in which case Liaoning is sending a big warning signal. Industrial production fell below 10% in 2012, but it slowed gradually the the ensuing years, down to 8.2% in July. It also had been keeping pace with the national growth rate. In the past two months, growth collapsed and Liaoning's industrial production contracted by 1.6% in September.

The national growth rate is red in this chart, Liaoning blue.

Investment and Production Drive the Economy

Here's the he Hayekian Triangle.

The triangle gives a good depiction of how the seemingly smaller sectors of the economy that take place at the earlier stages of production can have a big effect on the economy. Imagine the far left of the triangle growing taller and then expanding outwards as the goods move through the economy. GDP mostly measures the last (rightmost) parts of the triangle because that's where the final sales occur. (One big reason to favor gross output over gross domestic product is because it measures these intermediate stage transactions.)

Liaoning is not China's largest provincial economy, though it isn't small either. Liaoning was 4.76% of national GDP last year, 7th largest. The argument here isn't that Liaoning will affect China's national economy by sheer size, rather that it is the canary in the coal mine. Liaoning has more industries in the left side China's triangle. As these sectors stagnate or contract, this contraction propagates through the economy over time. Real estate investment by itself also takes place at an earlier stage in the economy.

The Economy's Tripwire

Liaoning is more exposed to the higher stages of production and therefore is one of the provinces most likely to experience a slowdown first assuming a normal contraction phase of a business cycle. We know steel and other industrial sectors have overcapacity. Problems in steel surfaced in late 2011, but wider economic growth was not impacted until very recently, following a steady deterioration in the market for more than 2 years and then a slowdown in real estate as well.

Liaoning's slowdown could be a false signal, but it could also be the beginning of a much sharper slowdown in China's economy. Industrial production in Shanxi province, which leans more on the coal industry, also slumped in recent months. Real estate was the replacement growth source for economies experiencing recessions in their main industries; now that real estate is slowing, the remaining economy is revealed.

Liaoning has sounded a warning bell on China's economy. The real estate slowdown and economic slowdown that had been broad and general, is now turning acute. This process is slow at first and it might take until the middle of 2015 for a national trend to emerge. There's no reason to panic yet, but Liaoning is warning that this slowdown may not be a gradual one.

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