Skyscraper Effect in China?

Chinese Skyscrapers Mania

Skyscrapers are some of the most long-term building projects on the planet, and China seems to build a new one every day. Shanghai currently has three of the 16 tallest buildings in the world: the Jin Mao Tower (1999), the Shanghai World Financial Center (2008) and the Shanghai Tower (2014). And China is planning to finish the tallest skyscraper in the world with a project in Changsha, the capital city of central China’s Hunan province.

 

 Do Skyscrapers Cause Economic Depression?

The economist Andrew Lawrence created the “skyscraper index” in 1999 to point out the correlation between the building of the latest “world’s tallest skyscraper” with impending global financial disaster. Lawrence called his index an “unhealthy 100 years of correlation.” Bottom line: if you hear that some builder is constructing the “tallest skyscraper in the world,” watch out! It is not that the building of the skyscraper causes the economic depression, but is rather a prominent symptom of powerful economic forces. Specifically, these skyscrapers tend to get built when there is the largest disconnect between the actual interest rate and the natural interest rate. That is, when government intervention forces the actual interest rate lower than the natural rate of interest for a long period of time and to a great extent.

Boom-Bust Business Cycle

The builders announce and begin constructing the world’s tallest skyscraper in the late phase of the boom in the Austrian business cycle, while unemployment is still low. Next is a sharp economic downturn and increase in unemployment. The skyscraper is finally completed during the early phase of the inevitable economic correction. Had the builders known the future, they would not have continued their incredible building project in these cases, but, the relevant price information typically comes too late for them to make an informed decision on construction.

Capital-Intensive Boom

The most famous economic disaster in U.S. history, the Great Depression, took place at a time of what Austrian economist Mark Thornton called a “capital-intensive boom in the construction of ever-taller buildings.” What was he talking about? Everybody has heard about the massive gains and bubble in the stock market at the end of the 1920s, but fewer are aware of the massive construction bubble that occurred at the same time. At the time of the great stock market crash, U.S. builders were in the midst of constructing not just one of the “world’s tallest skyscrapers,” but three: 40 Wall Street (71 stories in 1929), the Chrysler Building (77 stories in 1930), and, of course, the Empire State building (102 stories in 1931).

What is the Austrian Explanation of the Skyscraper Effect?

skyscraper

Planned “world’s tallest skyscraper” in Changsha, China.

The skyscraper has become the symbol of the capitalist system in the modern era, much like railroads and factories were its symbols in earlier eras. Skyscrapers are very long-term investment projects – just the kind of projects that artificial booms encourage. Remember, during the Great Depression, the famous “cluster of errors” occurred first in capital-goods industries rather than consumer-goods industries.

Mark Thornton explained, “In the Austrian view, changes in the interest rate change the relative price between longer-term capital projects and shorter-term capital projects. A lowering of the interest rate raises the prices of longer-term capital goods relative to shorter-term capital goods.” The market responds to this change in relative prices by diverting resources to long-term capital goods, such as skyscrapers. There are only so many resources in the economy at any given time, and they do not always get diverted to the best long-term projects for the actual market. “These resources become formulated in a highly specific capital good that may not be well suited to the alternative production processes of the postadjustment economy,” said Thornton.

And then there is the earthy question of what happens when land prices go up and construction prices go down? Skyscrapers go up.

Thornton explained what happened in four major financial crises throughout the 20th century:

“First, a period of “easy money” leads to a rapid expansion of the economy and a boom in the stock market. In particular, the relatively easy availability of credit fuels a substantial increase in capital expenditures. Capital expenditures flow in the direction of new technologies that in turn creates new industries and transforms some existing industries in terms of their structure and technology. This is when the world’s tallest buildings are begun. At some point thereafter, negative information ignites panicky behavior in financial markets and there is a decline in the relative price of fixed capital goods. Finally, unemployment increases, particularly in capital- and technology-intensive industries. While this analysis concentrates on the US economy, the impact of these crises was often felt outside the domestic economy.”

Perhaps the Chinese government knows about the skyscraper effect and that is why last summer they called it off “until the project passes relevant safety examinations and gains building permits.”

 

Read Mark Thornton’s Skyscrapers and Business Cycles

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