Erasmus University Rotterdam: The potential collapse of the Evergrande construction company

In a program from BNR Nieuwsradio’s panel of economists, professor of public economics at Erasmus School of Economics Bas Jacobs discuss issues regarding Chinese real estate company Evergrande.

300 billion dollars indebted: Chinese real estate company Evergrande is in big trouble. This became known because the Chinese government forced real estate companies to publish their debt in order to limit the price of real estate projects. For a long time, the strategy of Evergrande has been to borrow huge sums of money from state banks to finance its operations. At this point, the company seems unable to repay its debt. Some people called Evergrande “The Chinese Lehman brothers”.

A real dilemma

However, Jacobs points out the differences between these two situations. The analogy seems wrong, as the interdependence between business and government is much higher in China in comparison with United States. Right now, the Chinese government is considering how the problem can be solved without the middle class feeling the pain of absorbing the shock. This is extremely important for the administration, as it anticipates an emerging middle class that needs to be on top of economic progress. The government faces a dilemma: How do you get there without signaling to businesses and banks that even the acquisition of huge amounts of debt doesn’t cross a line? One thing seems certain: the government will intervene to limit the damage caused to the economy and to the confidence of its people.

The risk of a domino effect

According to Jacobs, Evergrande is not in itself important enough to cause big problems for the Chinese economy. However, the situation is different when it turns out that there are other real estate companies that have toxic loans outstanding. This complicates the situation, because it is not excluded that the system has financed dangerous projects. In addition, forecasting is all the more difficult as the information from China is often unclear. It seems there is a deeper matter; the government maintains the target of achieving a GDP increase of 6 percent per year. Jacobs points out that this just won’t be possible in the long run. ‘After convergence, if China approach to the developed world, developmental growth will come to an end. This means that economic growth cannot go faster than technological advances which lead to increased productivity ”.