SPEAKER 1: The following this part of Cornell Contemporary China Initiative Lecture Series under the Cornell East Asia Program. The arguments and viewpoints of this talk belong solely to the speaker. We hope you enjoy.
SPEAKER 2: So today, we are welcoming Dr. Zhi Liu. Dr. Liu comes to us from Beijing by way of Ecuador. So I'll explain that story to you as best as I can. Let me go back about nine years. There is an Institute in America called the Lincoln Institute of Land Policy, which, about nine years ago, decided to institutionalize its growing connections to researchers and policymakers in China.
And to do this, they went to Beijing University and opened-- I'm sorry, I have to read this. Because I'll get it wrong-- the Lincoln Institute Center for Urban Development and Land Policy in Beijing at Beijing University. At that time, Dr. Liu, who earned his PhD in Urban Planning from Harvard, in '93, 1993, at that time, he was working for the World Bank, where he was at for several years and traveled all over the world in that capacity.
ZHI LIU: Part of it.
SPEAKER 2: But he has recently, about three years ago, became the director of this Land Institute, housed in Beijing University. And so he has some unique perspectives, I think, on some of the big changes going on in China and some of the financial and financing issues behind some of those [? land ?] changes. He was very recently, just a few days ago, in Ecuador for the third UN Habitat meeting. Am I saying that right?
ZHI LIU: Yeah.
SPEAKER 2: There's only one every 20 years. So you'll have to wait 19.5 more years for the next chance. But this recently held in Ecuador. And you and 40-some thousand other people--
ZHI LIU: 45,000.
SPEAKER 2: 45,000 other people were there, wow. But we took advantage of him being, more or less, in our time zone and brought him here to Cornell, with the help of our co-sponsors City and Regional Planning. So thanks to them and thanks to Dr. Liu. Let's welcome him.
ZHI LIU: Well, first of all, I am very happy to have the opportunity to Cornell and to discuss with you about the subject of municipal financing in China. And before I came here, I actually thought about what's the best way to introduce the sectors to you, knowing very little about your academic background and your academic interest. And then I think I assumed the group would come from perhaps the different departments-- economics, and planning, and government, or history or so.
So I think that the best thing for me to do is to give a historical perspective of the evolution of the municipal financing in China in the context of a very rapid and massive urbanization. And then I will tell you what's going on now, today, in the Chinese cities. The cities are facing continuing urbanization, but also somehow getting into some major financing issues, which was very much the legacy of the evolution.
And then I will also also talk a bit about the current challenges we have facing the municipal financing reform. And I believe some of you may read the New York Times, Wall Street Journal, or the Financial Times from time to time. And in these newspapers, there are coverages about municipal financing in China. Yesterday, when I was in the airplane, I read the Wall Street Journal.
There is an article about shrinking cities in China. And it started with the story of the city in Massachusetts, Lowell. Because Lowell used to be the textile center of the US. And then they [? drew ?] up and left the place and migrated to the South. And the city struggled. And today in China, the study was about Dongguan. And Dongguan, at the peak, is more than 10 million population.
And so there is a several million population. So a shrinking city also faces a special type of municipal financing. And so I mean anyway, what I want to say is that there are a lot of international coverages about simple financing in China now. So I think, for me to be here is perhaps effective to talk about the history of municipal financing and the current challenges we face.
OK, and I need to make a first statement that my talk here is not an academic research. Instead, it's just an overview of the challenges. And so it's a bit like a journalist coverage of the topic. And I tend to have five sections. And first, I would talk about the history of the land-based financing, which is the key part of the municipal financing in China. And that drives the urbanization, over the last 20 years or so.
And in the second section, I will talked about the unintended consequences of the land-based financing. And then I will move on to talk about the current reform and the kind of difficulties we face in the reform. And finally, I will discuss with you about the way forward. I mean, today, we are not in a very ideal situation. Moving ahead is a difficult. And what should we do? And this is the kind of discussion that I want to have. And then perhaps after my presentation, I will have this question and answer section.
OK first, I'll just show you a few very familiar pictures. Shanghai-- the top picture is Pudong. That's the other side from the river. And that's a very underdeveloped area in the 1990s and today. And of course, this is a landmark of urban development all around the world. And today, Pudong has brand new city districts. Similarly, Shenzhen, in 1980s-- Shenzhen is basically a [INAUDIBLE]
I first visited Shenzhen in 1982. And at that time, Shenzhen was designated to be the special economic zone. And it was up to the Guangdong Provincial City and Regional Planning Research Institute to plan the city for Shenzhen. And so at the time when I went there, Shenzhen got the population of 50,000 people. It's like a small border village. And the planners discussed what would be the population in 20 years. So that would be the year 2000.
And at that time, the debate was around the number of 500,000 people. Because many planners think that Shenzhen would not exceed 500,000 people by the year 2000. And some people think it should be much higher than that. But how much higher? No one got the idea. But anyway, people talk very much. They [? zoom ?] in on this number. And by the year 2000, Shenzhen is already a 10 million population metropolitan area. So that's the kind of development we have, OK?
Now, a lot of infrastructure-- and today, if you go around the developing countries and compare the infrastructure development in China and many other developing countries, I mean, these are my personal experiences. Because I worked for the World Bank for many years. And I traveled to many developing countries. And I compared these countries with my own country. And what I can say is that the infrastructure development in China is perhaps the fastest. And also the quality improvement is also the most significant across the developing countries.
Now, if you look at the infrastructure development from the municipal financing perspective, the map there shows the metro system, the subway system, or the rail system in Beijing. Today, the total length is like 600 kilometers. And the unit cost to build the subway system is $100 million US per 1 kilometer, $100 million US 1 kilometer. And Beijing costs $600 kilometers more.
And not only Beijing, Shanghai, Guangzhou-- and in fact, there are about 20 cities in China that have the metro network built in the metro line, or are planning the metro line. We have like 30 cities which want to go ahead to build the metro line. And so this size of investment is a huge challenge of our ending municipal development.
OK, you may also hear a lot about the ghost towns. In Chinese cities, they build a lot of the houses. But many houses remain empty. And it became international headline news about the so-called ghost towns. And so I mean, the question is that we don't see a lot of the ghost towns in economies like in the US. We don't see those towns in European countries.
And so China's ghost towns are quite unique. But recently, I learned from my Indian colleagues that in the suburban area of Delhi there are also ghost towns. So it looks like the phenomenon is not very unique in China. And the amazing thing is why this also happened in some other developing countries. But anyway, I don't have an answer. Today, I only focus on the story of China.
Now, the question is-- I mean, given all these pictures together, you may think, why did all this happen? I mean, in such a short period of time. And how did this happen? So my presentation will really try to find the answer to it. And to really answer the question, I want to revisit several aspects of the Chinese political economy, and the governance structure of the country, and the tax sharing system, and land policy, and also the constraints and response at the municipal level. I think we need to look into these dimensions in order to get a better understanding of the urbanization process and the municipal financing in China.
Now first of all, let's look at the urbanization trend in China. And you all know China has an institutional system that's called hukou. Basically, people can be identified by your residency. And it's registered, the residency. So if you are an urban resident, you are entitled to the urban services. Because this hukou system is tied to the welfare provided by the government.
But if you are the rural residents, I mean, in the government registration system, you are classified as the rural resident. And your social welfare is provided by the rural sector. Of course, the rural package is different from the urban package. The challenge for China is that, over so many years, we have a few 100,000-- almost 300 million rural people migrate to the urban sector. And they are the migrant workers with the rural residential status working in the city, but not in entitled to the full urban services. And so that's the distinction we have.
So when we look at the urbanization rate, I mean, the figure actually shows that, in the year 2012, we can see the people who hold the urban residential status at the urbanization rate is at 35%. But then all the people who live and work in the city, and the urbanization rate is 52.6%. So there is a gap of 17% there. And these are the people who actually live and work in the city, but do not have the full urban services. And so that's the kind of issue we face.
Now last year, according to the National Statistical Bureau, we have 771 million people, or 56% of the total population living in the city, OK? And I'll give you a bit of the historical overview. And so I just picked a few milestones that are relevant to municipal finance in China. As many of you know, China's economic reform, initiated by Deng Xiaoping, started in the year 1978. So that's the milestone for the transition from the planned economy to the market.
And then in 1994, two things happened. One is that China adopted this so-called tax sharing system, which is basically a framework to sort out the central, and local, physical relationship. In the same year, the Chinese government designated the automobile industry as one of the pillars of the national economy. So the Chinese city planning and urban lifestyle, starting from that point, got a bit more and more similar to the US's urbanization process. And we got the [INAUDIBLE] in the place in 1994.
Then in 1998, it was the housing reform. And that moved the housing provision to the market. And the housing reform lagged behind the economic reform mainly because the housing was originally provided by the government, or by the employer as a part of the compensation to the employee. And to link the housing as a component of the compensation takes a much longer time. But in any case, when you get to 1998, the urban housing is mainly provided by the market.
And then year 2004, the government designated the real estate sector as one of the pillars of the national economy. So we have the car, we have houses, and the city expands, and a lot of real estate development going on all around the country. And in the year 2008, there's an international financial crisis. And that also affected China. And out of the concern about the loss of jobs and loss of demand for exports, the Chinese government decided to inject funds to the economy. And that's the stimulus package of 4 trillion Chinese Yuan into the economy. And as I will tell you later, much of this money actually went to the real estate sector.
OK, and then to the year 2013, basically a lot of problems show up, I mean, resulting from this urban development model. And then the central government announced a new round of economic reform. So today, it's already two years since the initialization of the new round of economic reform. I will tell you later the kind of difficulties we run into. So that's the kind of historical milestones that I want to highlight
OK, and first, let's get to the governance structure in China. And I would say China has a very unique governance structure. And all the Chinese governments, in different levels, are all-purpose governments. In the US, you may find that school district is called a kind of a government. And this is the government that provides a specific service to the community. But in China, we don't have such things. So we have different levels of government. But each level of government is an all-purpose government. Basically, within that territory, the government takes care of everything, right?
And then the second point is that we have five levels of government, OK? So the central government is the top level. And when you read any literature about central/local relationships in China, local in China means the provincial level and anything under. So the amazing thing is that, under the province, we have four levels of government. I mean, the local government includes four levels.
Now in the US, you have federal government, you have the state government, you have county government. And then you have the special district governments, like the [INAUDIBLE] point and planning organization, or the [INAUDIBLE] point and service district, and school district. So these are the single-purpose governments. But in China, our structure is like that. We have five levels and all purpose governments.
And then we have this political structure. And the political appointment is highly centralized. So the top leadership in the central government appoint the party secretary for each province. And then party secretary, I mean, the leadership in the province will appoint the top leaders for the prefecture. So this is the political system we have.
But in terms of tax power, the central government has all the tax power. And the local government in China do not have any power to create and assay the category or change the tax rate. And that's a key thing that we need to remember. Because today, a lot of literature talks about decentralization in China. I mean, if you look at the expenditure side in China, it's a highly decentralized country. But then if you understand that the tax power is rested all with the central government, I think that decentralization in China is already half done. And that creates a very strong incentive for municipal financing performance.
And then the GDP-- for many years, the Chinese government used the GDP as the target for economic growth. Now of course, I mean, the country is very big. And the central government itself does not produce anything. So to achieve the GDP, it has to be done by the local level. And we can see the phenomena in China that the local government looks at the central government's target and tries to achieve the target, or over-achieve the target.
And that's kind of incentive for the local government to work harder on economic performance. And the incentive is really in the GDP growth rate. And if you are a local leader, if your GDP growth rate is higher than, let's say, the other leaders at the same level, you may get a better chance to be promoted. Of course, this issue is still up for debate in China. Some people think that the GDP competition may not be such a strong incentive.
But in general-- I work in China for the World Bank Project. I think I met almost 30 municipal leaders from 30 cities. Every time when I went and talked to them about their incentive for GDP growth, they all mentioned that this is the way that their superior in the provincial level expects them to achieve. And so for them, I mean, as a civil servant, you want to be promoted.
And so you have to work hard. And so even though there are debates about the empricial evidence. This is a really good incentive for municipal competition or not. But I think, in reality, basically every mayor in their mind tries to do their best job and tries to meet the mandate from the higher level government. And that would also give them a better chance to be promoted.
So that's our governance structure works, very briefly. And there must be a lot of other stories. But here, I think these are the key highlights we have. OK, so the system can be illustrated by this figure. First of all, the central government, for many years, liked to set the GDP growth target. And even over the last few years, there were a lot of discussions about whether it makes sense for the central government to set GDP growth rates. Because it could be a benchmark. And it could be a disincentive as well. But in any case, the latest five year plan-- that's the 13th five year plan-- included the GDP target. And so I believe, for the next few years, all local government will still use the GDP target as a major objective for their work.
So looking at that, when the central government set the GDP target, the achievement will be made at the local government level. And so the mayors will be sitting there thinking what he or she is going to do. But I mentioned to you that local government is an all-purpose the government. So the mayor will take care of employment and also take care of the following direct investment and other investment.
Because it is their job to attract the outside investment to the city for employment, right? And then they will also have to provide the public infrastructure services. And they also take care of the real estate development, and, of course, local tax revenue. There are many other things. In the past, even family planning is the job of the municipal government. There are many other things that the local government have to take.
But then they face a major constraint. And the constraint actually comes from the tax sharing system. So here, I will give you some explanation what the tax sharing system we have. Now in China, the physical system is designed in the way that the central government determines what to tax. So we have a few major categories of taxes, OK?
Basically, we have three-- the taxes can be classified as a turnover tax, income tax, and resource, and specific purpose taxes. But who gets what? I mean, it's specified by the rule. It's the rule of the game. So there are some taxes that belong to the central government completely. There are also taxes that belong to the local government 100%. But then we also have some categories of taxes that are shared between the central government and the local government.
So in this slide, I used the different colors. I also have generated a matrix. But the different colors show the taxes that go to different governments. And the red one is to the central government. And the green one is the shared tax. And blue one is the local tax. And so we have this kind of system. And basically, the central government collects 45% of the total tax each year. And local government gets 55%.
But in terms of expenditure, the central government spends about 15% of the national tax revenue. And local governments spend 85%. What's in the gap? that's the intergovernmental transfer, OK? And intergovernmental transfer is the money that the central government collected from the local authority and then gave back, perhaps, to the same local authority, or to the different local authority.
All countries have intergovernmental transfer. But in China, intergovernmental transfer can be divided into two types. One is the general purpose intergovernmental transfer basically, the central government gives back the money to the locality without attaching any specific purpose. But the other type of intergovernmental transfer is earmarked. For example, intergovernmental transfer is earmarked for education. And local government cannot use that part of the money for public health. So they're earmarked to one.
And today, there are also many studies that are trying to analyze the negative consequence of earmarked intergovernmental transfers. Because sometimes, in the center, you transfer a certain amount of funds into local government without knowing exactly what's the need. And you cause inefficiencies in the expenditure. So we have to, in many cases where, as I said, the local government has already invested a lot in schools or so, but they continue to receive the money from the central government earmarked for schools. And if you don't spend on school, then you lose the money. So they continue to spend the money for the schools. And of course, the capacity for school may be in surplus. And so it's always a better idea to have more intergovernmental transfers with a general purpose instead of a specific purpose.
But in recent years, we also see that the share of central tax revenue has been declining, but is declining quite slowly. Given this governance and the tax sharing we have, we can imagine how the city government would function, OK? Here, I'm focused on the city government. Because city government is one level of the local government. I mean, above the city, you always have a provincial government.
Now, the city government has a fiscal constraint. Number one is that the city government has no tax power. So basically, if you need to meet the demand for service for your constituents and you don't have money, but you cannot create a tax through a democratic process. So you cannot adjust the tax rate of the current tax you have in order to raise more funds. So that's a kind of constraint in the city.
But then the Chinese city governments are always very creative. And they find their way to raise funds, and not only raise a little bit of funds. They raise a lot of funds. There are several ways. And the first is to raise the funds from the land concession. Land concession in China, I mean, by broad definition is to be considered as a type of a tax, OK? But in China, the administrative for the land-- I mean, revenue from land concession is not considered to be a tax. That's a little bit of freedom given to the municipal government. And the municipal government maximizes this opportunity to raise funds, all right?
Now, with land concessions, the municipal government also finds other ways to leverage for commercial borrowing. So the Chinese budget law does not allow the municipal government to borrow. The Chinese budget does not allow provincial government to borrow. I mean, until very recently, the budget all changed. But for many years, that law did not allow local government to borrow.
Then, commercial banks exists, domestic capital market exists. And the municipal government finds a way to borrow. And they create what we call the Urban Development Investment Corp. It's basically the local government financing platform, or SPV, special purposes vehicle. And this is a commercial entity that would be subject not to the law, but to the commercial law. So they are able to borrow from the capital market.
And so through the UDIC, then local government can raise funds from commercial borrowing. And then the other thing is that local government loves real estate. Because all the taxes imposed on the real estate sector are local taxes. So if we stay in a particular city grows rapidly, the local government stands there to collect a lot of the tax revenue.
Now, the situation for China. Because for the cities, because urbanization was quite rapid in China. So for a certain period of time, real estate development was very hot. And local government also collected a lot of the tax revenue from the sectors. And of course, there are also some ways to impose charges and surcharges. So some of these are not quite legal. It's in the gray area. But local governments sometimes do it. And I can tell you some specific stories, if you are interested. How local government get this done?
OK, the next thing I want to explain is the land policy in China, which is also very unique. By the law, all the urban land is owned by the state, which is represented by the municipal government, by the local government. And all the lands in rural areas are owned by the village collective. So we call it a collective ownership. Basically, if you go to the rural area, you can identify a particular piece of land to be owned by a particular village. But you cannot identify who in the village owns the land. Because I mean, in the village, all the villagers are not supposed to own anything. And ownership is through the village level, which is represented by the village committee.
OK, and very important is that the Chinese Land Administration Law gave the power to the state to control and regulate land use. So if you are a villager sitting on a piece of land, you don't have the right to convert that piece of land into urban use. It applies to the village as well. I mean, the village committee has no legal right to convert the land into the urban use, even though you see that the land is just right in front of you. So only the state is given the power to convert the rural land into urban land. So this is defined by the Chinese law.
Now, we have another policy. So the farmland preservation policy is known to be a strictest protection policy in the world. And basically, the Chinese government put it as one of the top national policies. That 1.8 billion mu of farmland must be maintained. And one mu is a measure unit of a piece of farmland. And one mu is equal to 666 square meters. It's a Chinese measure. So basically, the government knows that we have a high rate of farmland. That's what we call the basic farmland. And for the purpose of farmland preservation-- I mean, how does China feed 1.3 billion people? So the food security is a key concern. The government is determined to impose this limit.
So what does it mean to cities? When cities expand, cities cannot take that basic farmland. If you take one mu of basic farmland, elsewhere you'll create another mu of equivalent quality of farmland. So that's why it's so strict. Now, if you really need it, you have to go to the state council to get approval. Now, the [INAUDIBLE] is so high. So basically, there is no way for the municipal government to take farmland in substantial quantity.
Of course, beyond the farmland, you have other agriculture land, which is not in the high grade category. And you can use that. But the farmland preservation policies still require that, for each unit of farmland you take for urban development you also find another unit of land within the same province. And so that's the farmland preservation policy, which we will need to consider when we look at the Chinese urbanization, OK?
And then with this kind of mechanism in place, you know urbanization is growing rapidly. And demand for land is there, for industry, for residents, and for public infrastructure. So the government is really given the legal power to play the key role. What the government can do is to acquire the rural land and convert the rural land into urban use. So it's basically just like rezoning in the US, right?
So once you've determined this piece of land is converted from rural to urban, the local government will try to finance the infrastructure, to service the land. And once the land is serviced, the government will use this land concession process to get the real estate developer to bid for that land. In high demand, all real estate developers bid a very high price for the land. And the land concession fees go to the local government. So that's the kind of money the Chinese municipal government raises for urban development, for capital investment of infrastructure.
And then because land becomes so variable, local government can also give for some converted land you think UDIC. So with the land asset, the UDIC can go to the commercial bank to borrow. So the land is used as a collateral for the UDIC to borrow. So two things-- one is the land concession revenue. Another is land as a collateral for commercial borrowing, what we call the land-based financing in China.
But then we also need to keep in mind the land price is distorted. And we have a very low cost of rural land-taking. We also have a very low cost of industry and supply. And that's what I'm going to explain. OK, this is a slide that basically gives you a sense of the mechanism, how this land-based financing works. So lets start from the city government here. The city government created the UDIC. The UDIC can function like a government department to be responsible for the land acquisition, resettlement, and infrastructure investment. Because UDIC is like a company.
I think in the US, I mean in the city of New York, historically you would also have something like UDIC. Robert Moss is the head of the Urban Development Corporation in New York. More or less, I mean, that kind of entity also is a similar thing like the UDIC we have in China, OK? The UDIC can also borrow. But then when we move to the next stage, I mean, we see the land conversion from rural to urban land under the strict constraint of the farmland preservation. But then when we get the land, the local comment is an all-purpose government. And you have to care about industry development. You have to provide the land for commercial and residential development.
But for industry, local governments compete to get business into the city. And the industry land is often given to the businesses at a very low cost. In fact, in China, we have cases where the industry land is given at zero cost. And also, we industry land that is given at a negative cost. So basically, the government not only gave up the piece of land, but also gave some other preferential treatment to the business to the following [INAUDIBLE] investment to come to the city.
Because the mayors of a city, they are seeing other things. With the industry land in place to attract the business, you get the FDI investment, you get the employment, you get people to the city, and then you have the demand for real estate, OK? So on the other hand, the municipal government supplies land fr commercial and residential development and builds the houses. With more people, more business comes to the city. You have more real estate. And you've got a tax from the real estate sector. And
Commercial and residential land supply is a mechanism to cross-subsidize industry and industry land. For many years over and over nine years it was going on rapidly with a very strong demand for urban services with rapid growth of population. And this, again, is growing really well. That's why we see there's a huge urban development in China. So my next slide will show you the size of the land-based financing in China.
The blue bars are the size of local tax revenue, local tax revenue. And the red bar is the land concession revenue. This diagram does not show the borrowing here yet, OK? So look in the high years, that land concession revenue can be as high as 60% of the local tax revenue. This is the situation we have. And the Chinese local government mobilizes financial resources from land concession, and to build the cities that will provide that infrastructures rapidly. So that's why you see Shanghai, and Shenzhen, and the big change in just two decades or three decades.
Now, we are going to see the price distortion, OK? And the red dots underneath are the industry land unit prices for the other cities. Here, I have like 70 cities. Each red dot corresponds to a green dot. Because the horizontal axis is the per capita income of the city. For the top green dot-- I mean, the top four, Beijing, Shanghai, Shenzhen, and Guangzhou.
Here, it shows the residential land price compared to the industry land price. And the industry land prices are all kept at something like 723 Yuan per square meter. Even today, many cities still use this very low price for industry land. But then residential price is determined by the market, real estate market. Now, we can see the big difference, OK?
So here, its story is a monopoly story. If the government wants to attract business, and you distort the price, and you use very low prices for industry land to attract business. But on the other hand, you supply the residential land, perhaps with a a limited quantity smaller than the demand. So you can expect a monopoly 30 price for that. And I suspect this is what happened in China.
Now, that said, residential land price and the real estate and the housing price-- the residential land is supplied for housing development. So this is the data I got from 70 cities in the year 2013. And I just plotted the dots, and the residential land price, and the housing price. And you can see they are hardy correlated. And today, if you buy a house in the high income cities, you will expect that maybe 50% of the housing price comes from the land. That's the relationship, OK?
Now, of course, the price is so high the question is, who can buy for it? And the local government, of course, is happy to see a very strong real estate market. So the real estate developer will come to bid for the residential land at a high price. So local government collects the money for infrastructure development for other things, for their are political performance. And the housing market will absorb this price. The real estate developer bids a very high residential land price. And they push up the housing price. And the housing buyers basically absorb the increase of the land price.
So let's put the story together. There are many factors actually there to affect urban land supply. And we have the farmland preservation policy. And that's a key to remember. And then we have the industrial land supply, and the supply for infrastructure, affordable housing, administrative purposes. I mean, the land supply for these purposes are also at a low price. So the only land that can make a profit is the land for commercial and residential development.
Now, if I'm the mayor, I want to make a decision to maximize the land concession revenues. So what are you going to do? My suspicion is that the local government will limit the supply of the commercial and residential land. It's easy to do. Because the farmland preservation policy is there. And so anyway, there is a constraint.
But on the other hand, I think that today more and more empirical evidence can model that residential land supply falls behind the big demand for housing. So that basically pushed up the housing prices, as I showed. I mean, first, it pushed up the prices for land, and then for the housing. But then for the local government, it's not a big deal. Because they just stand there to collect the revenue, OK?
Now, we have some suspicion about the shortage in residential land supply. And we look at the land supply plan from Beijing for the three years-- 2011, 2012, and 2013. You can see the land supply for residential purpose accounts for only like 30% in year 2013, while the industry land supply is 16%. Beijing's economy today is more or less similar to the economy in London, and New York, or so.
Because the manufacturing has moved up. And the industry sector in Beijing has really moved up the value chain. And so the question is, why do you still need so much land for industry and for other things? And the residential land certainly is a major limitation in this development. And so we think one of the major constraints for residential land is a key factor to push up the land price.
OK, let's look at the housing price. Remember, we have this kind of land-based financing for the last 15 years or so. And this figure shows the housing price. And we call the hedonic housing price for eight cities in China. And this index is a bit similar to the Case-Shiller Index in the US. And then you can monitor the housing price trends in the United States. And basically, we adopted this approach to create the index for China. And this is the work by the Peking University Lincoln Center and Tsinghua University under the guidance of the professor, Chip Case, who is the partner for the Case-Shiller index in the US.
Now, we can see that this is the price for the same quality and quantity of a house. And it's increasing rapidly for the eight cities where we have the data. But for the whole country, the last 12 or 15 years are the golden years for real estate development in China. So the question is there. I mean, when the price increases rapidly, why does the demand remain so strong in China? The demand for housing, even though the price increases so rapidly.
And we can look a bit more. Actually, we can see a lot of distortion in our economy, where people tend to think that real estate investment is the best investment for the saving they have. Now, we can see the Chinese household has a very high saving rate. Perhaps, the Chinese household has the highest saving rate in the world. And you have so much saving. What are you going to do? You can go to the store market. You can invest for your kid to study in other countries. And you can also buy a house. And you can put your savings in the commercial bank in a savings account.
But in China, we have major distortions, OK? First of all, inflation has been high over the last few years. And there's a lot of money in the hand of the households and the firms. And so the liquidity is very high. And then the interest rate for savings accounts has been very, very low. So basically, if you put the money in the savings account with the commercial bank, you are losing value of the money, because of the inflation.
And the Chinese stock market is very poorly regulated. And most people who went to the stock market just lose everything. And so not many people want to put their money in the stock market. And we don't have a very well developed capital market for people to put their money. So many households consider that housing is the only viable investment.
So that's why, even when the price grows rapidly, and households continue to buy. Because they buy the house for investment. And they like to see the prices increased instead of decreased. Of course, these are for the people who are able to buy. We have other social economic factors, too. I mean, there's a study made by Shang-Jin Wei and his colleague, Zhang Xiaobo, in year 2012. And they also found out that many parents of a young boy portray the house to enhance the boy's competition to find a bride. And that actually is a kick for the housing market.
So that's the kind of complexity you can see in the Chinese housing market. Now, this kind of land-based financing, on one hand, helps Chinese local government to develop cities rapidly. I mean, that's why today, you go to China, you see the brand new infrastructure. You see a lot of housing. And that's amazing, I mean, comparing to many developing countries.
But on the other hand, this land-based financing practice also causes a lot of negative consequences. Housing price is the key problem. It's now going up so high. And we say the price income ratio in China is reaching a very dangerous point. In Beijing, it's over 30, which means that, if you work for 30 years, you don't spend a penny of your salary, you save it for 30 years, and then you are able to buy a reasonable sized housing for yourself.
And that's what the price income ratio will tell you in China and some cities, like Beijing. I mean, the price income ratio, reached 30. In the US, I think it's under 10. For many years, the price income ratio is like 4 or 5 or so. But for the last 10 years, this changed quite a bit all around the world. But today, even in many European cities, this ratio is just about five or so, which means, if you work for five years and you don't spend anything from your salary, you can buy a house. Of course, with the mortgage, you can buy it easily. But today in China, housing is very, very affordable now.
On the other hand, we also have a lot of housing weakness. Why? Because the people who are able to buy, who come up with a lot of saving buy many houses, more than one. So they just keep the house there. And the houses are empty. They have no way to [? pack ?] the money. And so the housing vacancy is another issue. And now we worry about the real estate bubble. And the vacancies are one major concern.
And then local government also piles up debts. Already in year 2010, the central government realizes that local debt is going to be a problem. Today, the local debt is about 30% of the GDP, not very dangerous yet. But the concern is that it could grow very rapidly. So for the last few years, the central government has been making greater effort to establish a local debt management system in China. Today, I think we've more or less got the local debt under control.
Sometimes I mean, some cities under some political mandates and local debt still continue to grow. In any case, this is a big concern of the central government. Then we also have the social tension. Local government uses land as a way to mobilize financial resources. And so the land-based financing deviated from the real demand. I mean, in many cases, particularly in the smaller cities, in the cities in the western part of China, the local government basically copied the practice of the cities from the east.
But they don't have that kind of urban growth demand. But they continue to convert the rural land into urban land expecting that, with more land supply, the business, and the firms, and the employment will come to their city. But by doing so, they offend the farmers a lot. Because the farmers lose their land, lose their livelihood. The compensation is not enough. So that's a social tension that China faces almost everywhere.
And then we have a very inefficient and wasteful land use. And this happens not so much in the eastern part of China. In the coastal area is where the engine for the economy, and jobs, and economic growth, and everything seems to work quite well. But in the western part of China, many local governments still think that, if they copy the land supply strategy from the eastern cities, they may be able to attract a lot of investment to the city.
But then if they do it too excessively, a lot of lands are not utilized. I have visited one city in the western part of China where the current town is 20 square kilometers. And the new city development is another 20 square kilometers. You see the people who are cleaning the street more than anyone who is walking around the area, completely wasteful.
So these are all the problems that you eventuality discover after almost 20 years of the land-based financing practice. And then the central government tried to fix the problem. So in November 2013, the central government announced a new round of economic reform. There are like 14 major categories of reform actions. But several are related to the municipal financing and urban development.
And the first one is the hukou. Hukou is seen as a very discriminative approach. So the government wants to phase out the hukou system. But it causes new concern for local government. Because in the past, you need the employees from the rural sector. But you don't have enough money to provide social services to them. And then today, land-based financing is not going as strong as before. But then the government wanted to phase out the hukou system. That means a lot of people will receive for social services from the municipal government. So it is a headache for municipal government. Because revenue is dropping, but then the expenditure may be higher, if they want to meet the demand of the migrant workers.
On the land, there is also reform. And the reform is to basically break the monopoly role of the local government for land supply. And the key is to allow the villages to supply the construction land to the urban sector. So that's the reform direction. And then for tax, for municipal finance, the government tried to improve the local tax base. And here, the key is a property tax. And so today, the Chinese government is still in the process of drafting national property tax law.
But then I mean, the reform directions all look good. Be in implementation, we find a lot of challenges. So today, we know that the economy is not going as strong as before. Our growth rate this year is like 6.7%, comparing to 9.9% for 10 years, between the year 2004 to the year 2014. The economy cooled down quite a bit. So when the economy cools down, the demand for industry and demand for residential land may be shrinking. So for many cities in China today, the land-based revenue dropped. I think that in the peak years, land concession revenue could go as high as-- I think that it's-- three trillion Chinese Yuan in the high year. And this year is under one trillion. It dropped a lot.
But on the other hand, the local government asked to accommodate the migrant workers. So affordable housing, urban social services will be provided to the migrant workers. That means expenditure to the local government. So the question is, where is land revenue from? And where is the money coming from? And the Chinese government likes to emphasize this, to develop toolkits.
And so in the toolkit, you have several tools. And you decide which tool to use when the opportunity comes. Today, let's look at what we have in the toolkit. Property taxation is a work in progress. The government is drafting a national property tax law. Many cities are trying to establish the property assessment and the administration system. So one day, when the government allows to roll out the property tax, the cities can just go ahead to do it. So we are in the preparation phase. But we still don't know. I mean, politically, the law has to be passed by the National Congress. And this is an uncertainty. And also, when the government wants to make the law effective after the approval is another uncertainty.
Now, we have PPP, Public Private Partnership in infrastructure. And that's a big deal for the Minister of Finance. Because they know local government today have a very limited revenue to finance capital investment for infrastructure. So China finally wants to go very big in PPP. But I have worked on many PPP issues in developing countries. And I know how difficult it is. I mean, PPP cannot be applied to everything. I mean, in some sectors, the energy sector, [? expressway, ?] PPP is wonderful. But for some other sectors and other urban industries, it may not be that easy. It really depends on their revenue flow.
And land readjustment-- in China, some cities are using land readjustment for urban development, particularly for the urban village redevelopment. And then we have some land value capture instruments learned from Japan and Hong Kong, like the [? transoriental ?] development of land value. Basically, the way to do it is through the co-development of real estate and urban rail projects.
And finally, it's the local government borrowing. Now, our budget law has been amended. And that allows local government to borrow by the law. But it also sets a very high stressor. And for any local government to borrow-- I mean, here, when the budget law basically says the local government, they mean the provincial government. So today, if you are the mayor, you cannot go to the domestic or capital market to borrow. You have to go through the provincial government and ask the provincial government to borrow on your behalf.
But the provincial government takes care of not only urban areas, but also rural areas. So it's still in the very early states of local government borrowing. And it will be up to the state council's approval. So it's not really based on the credit rating of the local government. But anyway, the budget law basically closed all the back doors for UDIC borrowing, but opened up the front door for local government borrowing. But we still have a long way to go to move to create a base for the local borrowing here.
Now, let's see the impediments we have for the reform today. And the land reform remains highly controversial, with a lot of details to work out. There's a lot of discussion in China. And basically, how much will you pay the farmers? That's one question, OK? And when the villagers want to supply land to the city, this is allowed by the policy. But the government still constrains the rural sector to supply land for real estate development.
They allow the rural sector to supply construction land for industry, but not for residential. Mainly because today the real estate prices are very high. And they worry that land supply for residential sector, if it increases a lot, the housing price will drop. And then the real estate sector will have problems to repay the bank loan. And the loan was based on the expectation that the price is that high. So today, the land reform has gone very slowly. And it has a lot to do with the concern about the real estate bubble.
Now, hukou reform is actually difficult. China is a very big country. When you move to the fourth tier cities-- the lowest level cities-- hukou doesn't mean anything. Because they don't have much urban services anyway. So the farmers do not care about the hukou status. They just go to buy the house and live in the city if they have ability to buy.
But then in Beijing, we have estimated that, if you have the hukou in the district where Peking University is located, your hukou can be as variable as three million Chinese Yuan. Because if you have that hukou, you can send your kid to the best school, your housing unit there is at a very high price. So that's why, I mean, the hukou reform for the biggest cities remains extremely difficult. But in any case, I think we will need to take many years to phase out the the hukou system.
Now, residential property tax-- we don't have property taxes on the ownership of residential property on an annual basis. So China wants to introduce it into the system. But it's a bit too late. We missed the opportunity back 10 years ago, when the housing markets started to jump. If at that time we had a real estate property tax, people took it as a reality that [INAUDIBLE] anyway.
But I just mentioned to you, in the year 2004, the central government designated real estate sector as the pillar of the national economy. So at that point, even though the Lincoln Institute suggested to the Chinese government to impose a property tax-- it's the right time to do so-- the Chinese government decided not to do it. Because they think that the property tax is going to be a kind of a constraint for the real estate sector. The national objective is to use the real estate sector as the driver for the economy.
But today in hindsight, I mean, it makes property taxation more and more difficult. Today, in the cities, 90% of the urban households own houses, own one or more houses. And you ask them to pay property tax, when they invested to buy the house? In their mind, they didn't have any property tax concept. Today, you ask them to pay. It's very difficult.
So even today, we introduced the property tax into the Chinese urban sector. For example, assume, what will happen? I think perhaps that the way to go is to define the broad base, but then use a very low tax rate, so that people don't feel a lot of pain. You get it in place. And then after years, you can gradually raise the tax rate to the point that you can find the rate is in the equilibrium to provide the urban services. I think that that's the kind of political approach that we would recommend to the central government.
But what this means to us is that, even today we introduce a property tax for Chinese cities, you don't expect property tax to be a major source of revenue for the next 10 years. In fact, I mean in OECD country property tax revenue is about 4% to 6% of the national GDP. For most developing countries, it's under 1%. Latin American countries, Mexico, it's under 0.3% of the national GDP. So the international experience also tells us that property tax can be a good, sustainable source of revenue for cities. But then you may not raise a lot of money. But for China, I think the Chinese government is determining to go ahead with it.
Now, PPP is good, I mean, for some sectors, but not for others. And of course, the Chinese government still has a lot to do to basically reform the legal and regulatory environment, in order to make it work. And land value capture also has a lot of constraints. And then the capital market-- finally, we get to the capital market. It's very promising. Because the Chinese institutional investors are collecting a lot of money than [INAUDIBLE]. So the market potential is there. But we need to really get the local government and financial management in place, and local management system in place, before we can do it.
So this is what I call the whole new agenda for the municipal physical health for China. And then of course, when we move to the next step, we have several major questions to ask. One is decentralization, whether we should give local government authority to ration revenue to meet local demand. Own source revenue is another question.
And the sustainability of the land-based financing-- currently, land concession fee is a one-time payment. It does not have a substantive [INAUDIBLE] consideration there. I mean, if I'm mayor, today I want to raise a lot of money. I don't care about the next mayor, who may not have any plan to get the revenue, right? And then also municipal borrowing-- we have big potential. But we still have a lot of fundamental work on the institutional side to make it work.
So I think I've run out of time. But I end my presentation here and look forward to the question answers. Thank you.
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Zhi Liu, Director of the China Program at the Lincoln Institute of Land Policy and the Peking University – Lincoln Institute Center for Urban Development and Land Policy, outlines the many facets of municipal financing in China and its consequences for urban land development. Co-sponsored by the Department of City & Regional Planning. Recorded October 24, 2016 as part of East Asia Program’s Cornell Contemporary China Initiative.