This is fascinating. Land sales as a way of aligning everyone's growth incentives! Amazing that a Communist state achieved such a beautifully capitalist way to make local governments care about economic growth.
This puts a whole new light on America's homestead acts and railroad land grants in the 1800s. It seems like nearly the same thing, dressed up in an older fashion of financial instruments.
I learned from Yuen Yuen Ang's _How China Escaped the Poverty Trap_ how much local Chinese governments profited from local growth, but this post makes me realize what made the incentives so mechanical and reliable.
When your entire government budget depends on land sales, and land sales depend on growth prospects, of course the local government will move mountains to create prospects for growth. It's got no choice!
But how ironic that this incentive system has now become the toxic bubble threatening China's future growth. Was there any way they could have saved themselves from this?
Michael Pettis writes how stagnant decades are almost inevitable after miracle generations. Maybe no growth miracle goes unpunished.
That ratio of housing to stock and bond investments is horrifying.
In addition to your many points, much of China's development is car-dependent, due to single-use zoning and a lack of alternative ways to get around (because of all the large arterials and freeways to manage the massive traffic.) Auto-oriented development is expensive and wasteful; even in the US it's a strain, and it's going to be a massive burden going forward for a much less wealthy (per capita) China.
It seems as though moving to real estate taxation as a source of revenue will be difficult and perhaps result in a cycle of devaluation. Increased property taxes will result in decreased values of properties. The government will then have to increase tax rates to maintain revenue, which will cause further pricing pressure (who wants to hold an investment asset that has an unknown/increasing future cost?). How will they find an equilibrium until real estate is valued for its utility rather than as an (speculative) investment?
A lot of Americans who bought real estate before the crash already lived through this type of reckoning. We bought our first house in 2005, lived in it for 12 years, and sold it in 2017 for a 36% loss. This was the result of speculative buying in our area in 2005, and of course those famous loans with weird terms where you didn't have to repay all the interest for a while.
In the CCP period, Chinese people have favored hard assets over intangible ones. They had little access to foreign markets and domestic markets were (and are) poorly regulated by international standards.
Property, precious metals and highly valuable assets such as jewelry and art were seen as more stable, more liquid and less likely to garner government attention. Where possible, many have sought to acquire property overseas or at least in Hong Kong, which is why HK has had the most expensive real estate in the world for much of the past 25 years.
As this post well explains, today’s credit fueled construction of new housing in China is not justified by housing needs while the viability of housing as an investment is greatly weakened. As was noted, the central government has some resources to moderate these impacts but application of these resources in specific situations may not be sufficient to avoid social disruption. It is not for nothing that the CCP is now increasing its surveillance and social control mechanisms.
This is occurring at the same time that China’s population is starting to decline and it’s advantage in labor costs is fastly eroding in favor of Southeast Asian and South Asian economies, among others. The central government may be able to catch this falling knife but it may be a bloody mess before the Chinese economy adapts to the ongoing squeeze.
Isn't it time for China to abolish the hukou system, at least for all cities except the big four?
Restricting rural-to-urban migration never made a lot of sense but with a massive oversupply of urban housing and a declining national population, it makes even less sense now.
“Regular households for whom property represents their retirement account will be pretty angry if they’re suddenly left unable to sell or forced to take a big loss.”
Real estate with 20% of GDP tanking, and 20% of youth (18-29) unemployed. Not good. China, like Iran, has a high percentage of youth living with Mom & Dad, which is not a good formula for new household formation and having children. What a drag on long-term demographics. And when the young unemployed graduates (10 million annually) can’t afford to pay rent, they will be forced to move back home to live with Mom & Dad, who likely invested a lot in their children’s education. Xi’s response: “Eat bitterness and move into rural areas.” I’m guessing this does not go down well with the educated unemployed and their parents. You can push people only so far before they push back. I don’t think building sandboxes in the South China Sea and “Jousting with Tom & Charlie” (ala Tom Wolfe) in the skies above are more important than domestic tranquility.
One thing that you didn't touch on; how has the real estate crash affected the financial sector in China? Because to me that's still the ultimate shoe to drop. In 2008, the real estate crash is what created the recession, but it was rotten structure of the financial system (shoddy underwriting practices, Credit default swaps given out like candy by AIG; the rea secret fulcrum around which the entire real estate economy apparently depended upon), that made the recession into the "Great" recession.
I know this answer is complicated because very often in China the lender is the government or that the lender is beholden to the government. But that only makes me believe that the underwriting practices that undergirded this explosive property growth must have made 2007 underwriting practices in the U.S. look like paragons of good risk management. So far it's only been Evergrande, but there has to be a number of other financial firms in China that are on the brink right now. And given the terrible incentive structure that was created via the lack of property taxes (having your local revenues entirely dependent on land sales just seems an absolute recipe for useless property construction), I have to believe we are likely going to see a pretty bad financial crisis coming soon.
This is fascinating. Land sales as a way of aligning everyone's growth incentives! Amazing that a Communist state achieved such a beautifully capitalist way to make local governments care about economic growth.
This puts a whole new light on America's homestead acts and railroad land grants in the 1800s. It seems like nearly the same thing, dressed up in an older fashion of financial instruments.
I learned from Yuen Yuen Ang's _How China Escaped the Poverty Trap_ how much local Chinese governments profited from local growth, but this post makes me realize what made the incentives so mechanical and reliable.
When your entire government budget depends on land sales, and land sales depend on growth prospects, of course the local government will move mountains to create prospects for growth. It's got no choice!
But how ironic that this incentive system has now become the toxic bubble threatening China's future growth. Was there any way they could have saved themselves from this?
Michael Pettis writes how stagnant decades are almost inevitable after miracle generations. Maybe no growth miracle goes unpunished.
That ratio of housing to stock and bond investments is horrifying.
In addition to your many points, much of China's development is car-dependent, due to single-use zoning and a lack of alternative ways to get around (because of all the large arterials and freeways to manage the massive traffic.) Auto-oriented development is expensive and wasteful; even in the US it's a strain, and it's going to be a massive burden going forward for a much less wealthy (per capita) China.
It seems as though moving to real estate taxation as a source of revenue will be difficult and perhaps result in a cycle of devaluation. Increased property taxes will result in decreased values of properties. The government will then have to increase tax rates to maintain revenue, which will cause further pricing pressure (who wants to hold an investment asset that has an unknown/increasing future cost?). How will they find an equilibrium until real estate is valued for its utility rather than as an (speculative) investment?
A lot of Americans who bought real estate before the crash already lived through this type of reckoning. We bought our first house in 2005, lived in it for 12 years, and sold it in 2017 for a 36% loss. This was the result of speculative buying in our area in 2005, and of course those famous loans with weird terms where you didn't have to repay all the interest for a while.
In the CCP period, Chinese people have favored hard assets over intangible ones. They had little access to foreign markets and domestic markets were (and are) poorly regulated by international standards.
Property, precious metals and highly valuable assets such as jewelry and art were seen as more stable, more liquid and less likely to garner government attention. Where possible, many have sought to acquire property overseas or at least in Hong Kong, which is why HK has had the most expensive real estate in the world for much of the past 25 years.
As this post well explains, today’s credit fueled construction of new housing in China is not justified by housing needs while the viability of housing as an investment is greatly weakened. As was noted, the central government has some resources to moderate these impacts but application of these resources in specific situations may not be sufficient to avoid social disruption. It is not for nothing that the CCP is now increasing its surveillance and social control mechanisms.
This is occurring at the same time that China’s population is starting to decline and it’s advantage in labor costs is fastly eroding in favor of Southeast Asian and South Asian economies, among others. The central government may be able to catch this falling knife but it may be a bloody mess before the Chinese economy adapts to the ongoing squeeze.
Isn't it time for China to abolish the hukou system, at least for all cities except the big four?
Restricting rural-to-urban migration never made a lot of sense but with a massive oversupply of urban housing and a declining national population, it makes even less sense now.
Very interesting article, I'm sure you've read this news report that came out this morning?
https://www.msn.com/en-us/money/realestate/china-plans-new-property-market-support-package-to-boost-economy-bloomberg-news/ar-AA1c1Zan
A very well-written piece that is intelligent and accessible. Thank you!
“Regular households for whom property represents their retirement account will be pretty angry if they’re suddenly left unable to sell or forced to take a big loss.”
Real estate with 20% of GDP tanking, and 20% of youth (18-29) unemployed. Not good. China, like Iran, has a high percentage of youth living with Mom & Dad, which is not a good formula for new household formation and having children. What a drag on long-term demographics. And when the young unemployed graduates (10 million annually) can’t afford to pay rent, they will be forced to move back home to live with Mom & Dad, who likely invested a lot in their children’s education. Xi’s response: “Eat bitterness and move into rural areas.” I’m guessing this does not go down well with the educated unemployed and their parents. You can push people only so far before they push back. I don’t think building sandboxes in the South China Sea and “Jousting with Tom & Charlie” (ala Tom Wolfe) in the skies above are more important than domestic tranquility.
“Export industries generally have to be pretty competitive.” I’d agree if market forces were the only or most important factor of export success. But for China that’s not the case. The more they subsidize their exporters, the less productive they need to be to grab international market share: https://www.bloomberg.com/news/articles/2023-05-29/china-considers-tax-breaks-for-manufacturers-as-economy-cools
One thing that you didn't touch on; how has the real estate crash affected the financial sector in China? Because to me that's still the ultimate shoe to drop. In 2008, the real estate crash is what created the recession, but it was rotten structure of the financial system (shoddy underwriting practices, Credit default swaps given out like candy by AIG; the rea secret fulcrum around which the entire real estate economy apparently depended upon), that made the recession into the "Great" recession.
I know this answer is complicated because very often in China the lender is the government or that the lender is beholden to the government. But that only makes me believe that the underwriting practices that undergirded this explosive property growth must have made 2007 underwriting practices in the U.S. look like paragons of good risk management. So far it's only been Evergrande, but there has to be a number of other financial firms in China that are on the brink right now. And given the terrible incentive structure that was created via the lack of property taxes (having your local revenues entirely dependent on land sales just seems an absolute recipe for useless property construction), I have to believe we are likely going to see a pretty bad financial crisis coming soon.
Wrote about this way back in September 2021
https://open.substack.com/pub/contrarianpod/p/evergrande-and-the-trouble-brewing?utm_source=direct&r=ag2nj&utm_campaign=post&utm_medium=web
Always enjoy Noah's writing
Do the classic ghost cities play any part?
There was a good interview with Yasheng Huang in re Development of the Chinese State on March 8 on the podcast “Conversations with Tyler”
https://podcasts.apple.com/us/podcast/conversations-with-tyler/id983795625?i=1000603291955
Noah is spot on: “The fact is, China just doesn’t need that many more places to live.” So why does China keep building so much of it? My take: Chinese salaries and consumption are just too low. More here: https://open.substack.com/pub/debunkingthedebunkers/p/chinas-surging-auto-export-is-not