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China’s Market Reforms: Land and Debt

 
 

Trans-Pacific View author Mercy Kuo regularly engages subject-matter experts, policy practitioners, and strategic thinkers across the globe for their diverse insights into U.S. Asia policy. This conversation with Dr. Spencer Cohen – Senior Economist at Community Attributes, a Seattle-based research consultancy, and former senior policy adviser for the Washington Economic Development Commission – is the 102nd in “The Trans-Pacific View Insight Series.” 

In which areas has China’s market reforms shown productive results?

China’s President Xi Jinping and Premier Li Keqiang have made continued economic reform a priority. Statements out of the latest Central Leading Group on Finance and Economic Affairs emphasized the need to continue to encourage an open economy, along with lifting of restrictions on foreign ownership in non-sensitive sectors of the economy. Greater transparency and openness are welcomed and necessary, but it remains unclear if China ultimately moves toward a market economy or a hybrid model.

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In many areas, China’s market reforms have remained partial and incomplete in substance. This applies to labor markets, where the household registration continues to persist as an obstacle to permanent urban residence for many rural migrants; capital markets, where, despite numerous IPOs the banks often still serve as policy instruments; and housing markets and land leaseholds. It’ll be interesting to see what reforms come after the 19th National Party Congress later this year.

Assess reforms in China’s land leasehold markets and its impact on the domestic economy.

Land leasehold markets are often inseparable from local government finance. Earlier in the reform era, land commodification was a direct source of revenue for many local governments, realized through the expropriation of collective land, conversion to urban use (and thus state land), and the selling of leasehold rights to developers, with the local government earning the difference.

More recently, land has become an important source of collateral, such as for local government investment platforms that can borrow against the value of their land holdings to invest in local infrastructure investments. Land holdings have also been used as part of the formula for restructuring of insolvent local state enterprises, such as the prominent role Yufu Capital Management Corporation has played, as a state enterprise owned by the Chongqing Municipal government, in facilitating the relocation of older state enterprises from areas of high real estate demand to urban outskirts. All of this illustrates the unremitting importance of land in the domestic economy, but its transfer and allocation is seldom a function of purely market forces. Much of this is precariously predicated on the continued rise in real estate prices.

Explain reforms of local government finance and regulatory policy implications.

Local government debt has been become major concern, due to both the scale of local debt (equal to 40 percent of GDP) and unregulated nature of much of this borrowing. The latest announcement out of the Central Leading Group on Finance and Economic Affairs that local officials will be held accountable even beyond their tenures for bad debt illustrates the government’s real concerns about this issue.

Many local governments, prohibited under most conditions from running debts, have adopted the investment platform model pioneered in the 1990s in Shanghai’s Pudong District and Tianjin and expanded significantly by the China Development Bank as a means circumventing these rules. These entities are state enterprises under the local, prefectural-level State-owned Assets Supervision and Administration Commission, or SASAC, with land leasehold rights transferred to these entities to serve as collateral for subsequent borrowing. This was a common practice during the 2009 stimulus, and much of this debt has not been resolved in the economy.

What is the global impact of China’s local reforms?

There are very real concerns over a possible new wave of non-performing loans among local state enterprises. More lending to local government-owned enterprises means less capital available for higher productivity private sector businesses that in turn need to resort to shadow banking and higher interest loans. This is a misallocation of capital, which could undermine future growth and demand for foreign imports.

That said, the dynamics of China’s borrowing are different from more recent systemic financial crises. For example, unlike the Asian Financial Crisis in the late 1990s, the vast majority of Chinese debt is domestically owned, so there is less risk of significant capital flight by foreign investors like we saw in Southeast Asia. The rate of return on investment in China has been declining in recent years. This is often what we’d expect from a developing economy that is growing at the rate that China has, but the economy has remained stubbornly driven by gross capital formation and historically low shares of household consumption.

What is your outlook for China’s market reforms and potential risks that U.S. policy and business communities should watch.

The Communist Party will continue to make decisions with respect to the economy to accommodate growth goals, irrespective of whether these policies are market-oriented. What this all means for U.S. companies and policy makers is two-fold. First, Chinese regulators have considerable more leverage over domestic firms, especially in areas such as information and internet businesses. Tencent’s compliance with regulators to limit access based on age to its most popular game through WeChat directly resulted in a market cap loss of $15 billion. China is already the largest online market in the world, with nearly 400 million internet users and growing. U.S. tech firms will need to have a China strategy, regardless of whether they want to enter the China market.

Second, for those that do want access to the Chinese market, they’ll need to comply with Chinese regulators, which in some cases can conflict with company values. For others, Chinese firms, with the support and protection of the Chinese government domestically, are beginning to make significant inroads into the U.S. markets and elsewhere. And this applies across many other sectors, not just tech, such as aerospace and medical devices.

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