How tech unicorns are just like China’s “ghost cities”

Since the Great Recession, there has been an explosion of interest and activity in the tech startup arena. Tens of thousands of tech startups have been founded in recent years and there are now over three hundred new “unicorn” startups that have valuations of $1 billion or more. The startup gold rush began as countless entrepreneurs attempted to follow in the footsteps of Facebook founder Mark Zuckerberg and the “Google Guys,” Larry Page and Sergey Brin. Unfortunately, the majority of today startups – including today’s hottest unicorns – are burning copious amounts of cash. In this piece, I will make the case that today’s startup phenomenon is very similar to China’s construction of countless empty “ghost cities” for the purpose of creating jobs and economic growth.

(Article by Jesse Colombo republished from RealInvestmentAdvice.com)

Though the U.S. was the epicenter of the Global Financial Crisis of 2008 and 2009, China’s economy was still strongly affected as well. After all, China’s largest export market – the U.S. – had just succumbed to a powerful recession. In an attempt to cushion the economy and create growth again, China’s government announced a RMB¥ 4 trillion (US$586 billion) stimulus package and helped to encourage an aggressive debt binge. A good portion of this stimulus package and debt binge was used to build massive infrastructure projects, extravagant government buildings, and entire cities throughout the country.

A very high proportion of China’s construction projects over the past decade were basically make-work projects that were undertaken for the purpose of creating jobs and GDP growth, despite the fact that they are typically wasteful and inefficient. Make-work projects are very common in centrally-planned economies like China. The economist John Maynard Keynes was a strong proponent of make-work projects and is even known for saying, “the government should pay people to dig holes in the ground and then fill them up.”

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As an adherent of the pro-free market Austrian School of economics, however, I vehemently disagree with make-work projects and Keynesian-style stimulus programs because they create tremendous waste and misallocation of resources, which ultimately leaves society poorer in the long-run. China’s numerous empty “ghost cities” are an eerie reminder of the gross misallocation of resources that has occurred in the past decade. China’s government and real estate developers were hoping that “if you build it, they will come,” but that hasn’t proven true for many of the country’s brand new cities and malls that are almost completely devoid of people. There are an incredible 65 million empty apartments in China currently, which amounts to approximately a fifth of the country’s housing stock.

The pictures below show some examples of these empty cities:

Meixi Lake development near the city of Changsha. Source: Kai Caemmerer

Zhengdong in Zhengzhou in Henan Province. Source: Wade Shepard

Evergrande Splendor Kunming. Source: J Capital Research

Now, it’s time to discuss why the startup mania of the past decade is very similar to China’s construction of grandiose infrastructure projects and ghost cities. In addition to the housing and stock market plunge, the U.S. lost 8.7 million jobs during the Great Recession, so the Federal Reserve was desperate – just like China was in 2009 – to engineer another economic boom to create jobs and GDP growth again. China relied more heavily on fiscal stimulus, while the U.S. relied more heavily on monetary stimulus. The Fed cut and held interest rates at ultra-low levels for much of the past decade and pumped trillions of dollars worth of liquidity into the U.S. financial system via its quantitative easing programs. Unfortunately, dangerous economic bubbles and other distortions form when central banks and governments aggressively interfere with financial markets, especially interest rates. The chart of the Fed Funds rate below shows how bubbles form when interest rates are at low levels:

The Fed pumped trillions of dollars worth of liquidity into the U.S. financial system via its quantitative easing programs, which can be seen in the chart of the Fed’s balance sheet since QE started in 2008:

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