You can’t simply fake demand
Guest post by Sandy Ikeda
Sometimes, prosperity is an illusion. The massive building boom in the People’s Republic of China is creating outer signs of affluence, but there isn’t enough demand to put residents in the new homes.
As in many similar urban projects across the country, the Chinese government has been pouring billions of dollars into Gansu Province to build a new city called Lanzhou New Area. The Washington Post reports,
This city is supposed to be the “diamond” on China’s Silk Road Economic Belt — a new metropolis carved out of the mountains in the country’s arid northwest.
But it is shaping up to be fool’s gold, a ghost city in the making.
Lanzhou New Area, in Gansu province, embodies China’s twin dreams of catapulting its poorer western regions into the economic mainstream through an orgy of infrastructure spending and cementing its place at the heart of Asia through a revival of the ancient Silk Road. Hundreds of hills on the dry, sandy Loess Plateau were flattened by bulldozers to create the 315-square-mile city. But today, cranes stand idle in planned industrial parks while newly built residential blocks loom empty. Streets are mostly deserted. Life-size replicas of the Parthenon and the Sphinx sit surrounded by wasteland, monuments to profligacy.
China’s central planners haven’t even begun to appreciate, let alone practice, the lessons of the great urbanist Jane Jacobs, who viewed cities and the socioeconomic processes that go on in them as largely the result of spontaneous, unplanned entrepreneurial development. As an economist quoted in the Washington Post article points out,
Urbanization and modernization are processes that naturally take place.… You can’t force it to happen or have 1,000 places copy the same model.
Construction of these so-called ghost cities is likely financed by artificial credit expansion. In other words, people aren’t necessarily saving to buy a home in the future; the government is simply printing money. As a result, when the houses are finished, people haven’t saved enough to buy them all. This kind of construction doesn’t contribute to prosperity; it is the illusion of prosperity.
If you build it, they may not come.
When production is involved — say, a builder constructs a new house — whether that house adds to prosperity depends on whether there is someone who values the house for consumption and is willing to offer the builder more than the minimum she is willing to accept (that is, enough to cover her opportunity cost). If so, then in the eyes of the ultimate consumer, the house’s value is greater than its price, giving him a net gain, and to the builder, the value of that payment is greater than the cost of construction, giving her a net gain as well.
Only when both parties to a transaction gain in this way does the transaction add to overall prosperity.
What Is Wealth?
Planners in the People’s Republic of China have fallen for the illusion of prosperity — the belief that wealth consists of things, in the outer signs of affluence. To say that economic value is subjective may sound abstract, but the idea that well-being is purely objective can lead to economic disaster.
Economics teaches us that success is ultimately determined by the person who subjectively experiences it, not by an outsider or a third party. What an outsider thinks she sees may be quite different from the way a person actually perceives his well-being. And it doesn’t really influence the way that person feels if the outsider says that he ought to feel differently.
Prosperity, then, is the cumulative result of myriad additions to net value, as experienced by those who ultimately use the things that are produced — the final consumers. This is, in fact, how Adam Smith conceived of wealth in The Wealth of Nations:
Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.
Production Is Not the End Game
Like those Smith criticized, too many people still believe that production is an end in itself.
The millions of people employed in China’s construction boom are being paid with money that the government has created out of thin air. Yes, they will spend their new incomes and add to current aggregate demand. But if the construction has not been financed through real saving, then down the road, the cost of those resources will inevitably overwhelm people’s willingness to pay for them. If you build it, they may not come. So unless China can somehow find hundreds of millions of willing and able buyers, we may see an economic collapse beside which the Great Recession would pale in comparison.
This is but one example, a big one for sure, of the sort of pseudoprosperity that politicians and economic charlatans routinely offer their constituents and supporters. When bust follows boom, they try to pin the blame on what they call the “free market” and “neoliberalism.”
The free market isn’t crony-capitalist building boondoggles.
In a true free market, the road to prosperity lies not through forcibly taking what others have created but through producing and trading peacefully with others without engaging in fraud and organized theft. And in a free market, people are free to experiment and make mistakes, as long as they pay for them, and to reap the rewards when they are successful.
The free market isn’t crony-capitalist building boondoggles. The free market isn’t artificial credit expansion. The free market isn’t government planning of (illusory) economic development. The free market isn’t building cities, or anything else, for their own sake. And while there are plenty of jobs in a free market, jobs aren’t its ultimate object, either. Jobs alone aren’t prosperity. Even the houses those jobs help to build don’t constitute prosperity, unless consumers are able and willing to buy them and developers can profit from selling them.
For Adam Smith, economic understanding begins when we recognize that consumption, not production, is “the ultimate end and object of all industry and commerce.” That’s also the starting point of real, not illusory, prosperity.
Sandy Ikeda is a professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism. He is a member of the FEE Faculty Network.
This post first appeared at FEE