The financial mechanism that damages people’s mental health and their culture is being laid bare by the policies ordained by the Beijing Politburo. The communists are telescoping into a few formative years the policies that took centuries to evolve in Western Europe. It’s all to do with the way government funds the public’s services. Instead of developing a rational fiscal system, one that correctly links funding to services, China is using the hothouse financial techniques that impoverished generations of people in the West.
The Chinese model is a carbon copy of what was instituted in England 500 years ago. Back in the 16th century, English monarchs alienated the land that was held in common by peasants in their village communities. The land grabs were designed to fund the ego trips of kings and their aristocrats – in the main, military adventures and the construction of opulent palaces. The outcome is inscribed in the UK’s finances today. The state budget is bankrupt (the sovereign debt is ever-growing), and most people’s living standards are being reduced as private debts balloon beyond control.
Who wins? The people who pocket the nation’s rents. Between 1997 (when I issued a 10-year forecast that the world was heading for a global depression), and 2008, when the credit system seized up, house prices trebled. During that period, the construction of new dwellings was stagnant at record low levels of output. As John Plender noted in the Financial Times (September 25, 2013): “That reflects the historical experience whereby house-builders have made as much or more from inflation in the value of their land-banks as from putting up houses…Modest building activity puts a veneer of respectability over lucrative speculation”.
That is the model now being embedded in China.
The central government employs a funding arrangement that is a disaster in the making. The catastrophe is being played out in slow motion in towns and villages throughout this vast nation.
Legally, no-one can own freehold title to land. Urban land is owned by the state. Rural land is held by village communities. But Beijing recently changed the rules so that peasants can sell their “use rights” to developers. Now, peasants are cashing in, selling their holdings and in the process dismantling the ancient household economy. The self-serving attitude of rent-seeking is being incubated as traditional communities are broken up. Today, the goal is ownership of a property portfolio. The financial logic was recently documented by Bloomberg, the financial news agency, which dissected the property-buying spree of disillusioned investors.
People are comparing the benchmark Shanghai Composite Index (down 58% since the end of 2007), with the escalation in property prices in four major cities. Prices of new homes are skyrocketing: a 19% jump in Guangzhou over the last 12 months, according to the National Bureau of Statistics, and a 15% jump in Beijing and Shanghai. Little wonder that middle-class wage earners are building property portfolios! In this, they are aided and abetted by local government policies.
Paying the Pipers who call the Tune
The central government forces local governments to pay for public services by selling land to developers. Municipal residential land deals, measured by area, rose 26% in the first eight months of the year from the same period in 2012, according to China Investment Securities Co. The average price per sq meter jumped 43%, pushing proceeds up 80% to Y816.5 bn ($133 bn).
The implosion in government finances is accelerating as local officials are forced to repay debt out of further land deals – many of which are oiled by under-the-table bribes to civil servants. And this, in turn, is undermining Prime Minister Li Keqiang’s goal of securing social stability in the urban sector.
But while Li’s government cannot be held responsible for the earlier mistakes, he has announced the intention to drag 100m people from the countryside over the next 10 years. At least 80 new cities will be constructed in the biggest building boom in history. Result? House prices will peak in 2026 (+/- 6 months), followed by the deepest state-sponsored collapse of the economy in history. China’s economy is synchronised into the global business cycle, so every country on planet Earth is now heading for the next depression, which (if the history of the past 500 years repeats itself) is timed for 2028.
In the West, the property market is driven by private land-bankers. In China, it is being driven by the state. That is why (under current fiscal rules) nothing can stop the runaway train.
Asian commentators like Bei Fu, Standard & Poor’s Hong Kong-based property credit analyst, are unable to interpret the trends because they are locked into the conventional economic paradigm. “If the momentum in the land market can’t be cooled down rather quickly, it’s actually a fairly dangerous signal,” he told Bloomberg. “Should it keep heating up, we’re worried there might be further policy tightening, and there could be consequences for the entire market that are unpredictable at this point.”
The Beijing government has been trying to cool the housing market since April 2010. This followed the 14% jump in new home prices the previous year. The exercise proved to be futile. The most-recent curbs, introduced in March, included higher down-payment requirements and interest rates for second-home mortgages in cities with “excessively fast” price gains. It didn’t, couldn’t, and won’t, work.
Premier Li cannot slow down house price rises because that would constrain economic growth (down to under 8% for five consecutive quarters). Instead, he will fuel price rises as he pushes urbanisation as a “huge engine” of growth.
Already, builders have been buying more land to keep up with demand. China Vanke Co., the largest developer by sales, bought 3.4 million sq meters (37 million sq feet) of land in the first half of 2013. That is almost five times what it acquired a year earlier. The average cost of land for new projects jumped 23 percent.
Construction companies have paid record sums for land in Beijing and Shanghai. Their land banking fits with the indebtedness of local governments. Four provinces and 17 provincial capitals borrowed 774.7 billion yuan as of Dec. 31, pledging repayment with land-sale proceeds, up 18 percent from 2010, according to a National Audit Office report that was released June 10.
Average starting prices at auctions for residential land auctions, have jumped 16 percent from a year earlier to Y1,301 per sq meter in the first eight months of this year, according to SouFun Holdings Ltd., which monitors sales in 300 cities. A developer affiliated with the government of eastern Anhui province bought a nearby site in July for 12,600 yuan a square meter, more than double the 6,000 yuan starting price.
The land ministry in May 2011 required all counties and cities to report land sales where the selling price is more than 50 percent higher than the starting price. Regions reported 115 such “abnormal” transactions in the second quarter, 51 percent more than the previous three months, according to the land ministry. Those parcels were sold at an average 142 percent above the starting prices, it said.
Some cities, including Beijing and Hangzhou, have been capping prices at 50 percent above the starting price this year, though once the ceiling is reached, bidders can compete for the land by offering to build affordable housing or other projects for the government.
Beyond Property Taxation
Beijing is considering the implementation of property taxes to diversify sources of local revenues. A property tax has been imposed for the first time in Shanghai and Chongqing. None of the policies so far tried will have the desired effect. An example is limits on the number of dwellings that may be purchased. Restrictions have been applied in about 40 cities. To dodge that rule, some investors have bought properties in the names of their children.
The central government needs a financial formula for local governments that does not curb the productive energies of the people. The sale of leases to developers is a trap that leads to indebtedness. Land sales yielded Y2.67 trillion in 2012. That was equivalent to more than half of their total tax revenue, according to data from the Ministry of Finance. The shortfall had to be met with taxes that damage the economy, or credit from banks.
The sustainable fiscal mechanism is not a tax-based strategy.
China does not need a land “tax”, which would import all the economic and psychological baggage that is inherent in taxes on land values. Instead, leases should be written to provide secure private use of land, while guaranteeing the flow of rental income into the public purse in perpetuity. Rent revaluations should take place every two years to secure the rent gains from a growing economy.
Because Deng Xiaoping failed to adopt the post-capitalist financial model back in 1979, when he began to dismantle the command economy, the Beijing government’s reforms will now be confronted with resistance from land banking speculators and the emerging class of multi-home-owning citizens. We can hardly blame the land speculators for exploiting the flaws in public policy: after all, the Chinese communists are responsible for introducing the people to the economics of avarice.
This means that China cannot avoid a psycho-social showdown. The alternative is the economic catastrophe in the making, and a permanent loss of political power to the emerging class of rent-seekers.