Deflate the housing bubble
While it is impossible to predict future changes in housing prices, there is an increasing consensus that land-driven growth in China is unsustainable — it is leading to a dangerous housing bubble. The tone of the Third Plenary Session of 18th Communist Party of China Central Committee is to speed up reform, so although drastic measures are unlikely to be adopted to puncture the housing bubble, some changes are in three interrelated policy areas: fiscal, land and housing.
The driver for the frenetic real estate growth comes from the dependence of local governments for revenues from land sales and land related incomes. Since the adoption of the 1994 taxsharing system, local governments have incurred a de facto fiscal deficit — while their expenditure responsibilities have remained unchanged, they have had to rely more on extra-budgetary land income to make up the gap between their spending and revenue. This has greatly incentivized the local governments and enabled them to capture the land value spilled-over from infrastructure development. The city governments thus have become entrepreneurial － like an enterprise that is engaged in property development.
The land-driven fiscal system has made local governments more speculative in land development, using their muscle, through their monopoly power, to acquire agricultural land and sell it at a higher price in the land market. The governments are keen to use their “visible” hands to urbanize the land not people, which deviates from the course of market-oriented reform.
The adjustment of the fiscal relation between the central and local governments may not mean further fiscal decentralization to give the local government a higher budgetary return. But rather, for the central government to take on some responsibilities that constitute national “citizenship” such as social security, education and pensions. With a more balanced local fiscal structure, there will be no excuse for them abducting the economy with speculative land development.
To cool house price inflation, the past housing policy required local governments to develop large-scale formal public housing, while restricting house sales. This policy treated the symptom rather than curing the underlying cause. It is increasingly evident that after 10 years of implementation, this policy has failed to achieve its stated aims. The problem is again the reliance on the visible hand of the government. Local governments seized on this policy to promote real estate expansion.
Affordable housing is often developed in inconvenient and cheaper locations, which fails to meet the genuine housing demand. The housing demand originating from fast urbanization is not being met by the formal housing provision. Rural migrants in urban China largely live in informal rental accommodation in urban villages, generating a handsome income for local owners. However, the newcomers cannot settle down in the cities. A shift in the housing policy is also needed for their social integration.
Related to the housing policy changes is the controversial informal land market, the xiao chanquan fang, or “partial-property-rights” housing. On the one hand, some argue that the role of the informal rental market should be allowed to suit the different housing needs of diverse social groups and the informal housing market is of practical help to people. They suggest there might be a policy experiment to allow the sitting rural migrant tenants or new immigrants from other cities who are not property owners to buy informal housing at a market price in the large cities where such demand is high, which they claim would help stabilize rents. However, demolitions initiated by the local governments and forced housing upgrading cause rents to rise.
However, recognition of “partial-property-right” housing will be extremely difficult. The linked fiscal-land-housing adjustments are likely to be prudent. The rural collective land will not be easily allowed to enter the formal land market. Such a move may destroy the foundation of urban infrastructure investment, leading to the hard landing of the economy.
But for the first-tier and large cities that have already experienced de facto land conversion, the agricultural land that has been converted into urban uses become indistinguishable from the leased land, except in ownership. People may gain the deeds after paying a betterment fee. This is actually being experimented in Guangdong with so-called three olds redevelopment, san jiu gaizao, (the redevelopment of old factories, old neighborhoods, and old villages).
The property tax has been controversial. In a market with buoyant demand, the burden is likely to be born by consumers, with little effect on house prices. To implement the tax, accurate property registration information is required, but this is likely to meet resistance, and it is unlikely that the property tax will be implemented nationwide immediately after the plenum. The idea of levying property tax to increase the cost of speculation can be replaced by stabilizing house prices, because housing speculation requires value appreciation.
But some excessive housing developments, often in the form of large commodity housing estates or new towns, in the lower ranked cities may inevitably become redundant. There is no evidence to suggest that there would be major labor force relocation. In the third-tier cities, housing development has outpaced wealth creation. Under the new growth approach, some local government may experience fiscal difficulty. But the measure adopted now would hopefully prevent the problem spreading in the future.
In short, the Plenum may hopefully fine-tune the “growth machine” and thus deflate the housing bubble. In the 1990s, Shanghai saw a high property vacancy rate in its new Pudong district. The bubble has been deflated by a decade of sustained economic growth and rising demand for highquality office space after accession to the World Trade Organization and accelerated globalization. The change in the local government behavior from an entrepreneurial developer to a market regulator and service provider would reduce the impetus for land development, and the establishment of more universal housing rights and recognition of the role of the market would prompt diverse housing development.