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Land Reform and Local Government Finances

by | December 10th, 2012 | 02:30 pm
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Land reform is one of the most politically sensitive topics in China and it has direct implications for both the real estate market and local government finances.

In late November the Chinese State Council passed a draft amendment to the Land Administration Law (CN). The changes are aimed at boosting compensation for farmers whose land is acquired for new property development and protecting arable land.

The details of the changes are still under discussion, but some experts are predicting that the payment standards for dispossessed farmers to be increased to as much as ten times the current level of 100 renminbi per square meter.

If these changes go through, it would mark a welcome improvement in the lives of China’s farmers. For years farmers bordering urban areas have been displaced by legal and extra-legal land seizures. Urban residents are also often victims of land seizures when low-income areas are torn down within cities. The compensation these groups receive for their land amounts to only a small fraction of the value being captured by property developers.

Land seizures have grown steadily in conjunction with China’s rapid urbanization and property boom. An alignment of interest exists between property developers seeking new land for projects and local government officials try to boost revenues. There is also an illicit element to some land seizures. The Chinese press is full of stories of corrupt local officials receiving illegal kickbacks for helping projects go forward.

Revenues from land sales make up an important part of local government finances. The Ministry of Finance (MoF) published annual statistics on both land revenues and expenses related to land acquisition. Land revenues have increased rapidly, more than four times the level they were in 2006.

Land sales have associated costs as well. These costs include land development, infrastructure, and payments to those forced to relocate. These resettlement payments amounted to 1.5 trillion renminbi in 2011, around 45 percent of total land revenues. When total costs are included, net revenues for local governments from land reached 942 billion renminbi, 10 percent of their total budget (including central government transfers).

The new land reform proposal sets up a very interesting test case with respect to the relative influence between the central government, local governments, and property developers.

The central government is likely to set forth a new series of rules that require significantly higher compensation payments to those forced to relocate. These new expenses will come directly out of local governments land revenues, decreasing the overall profitability of land sales.

This comes at a time when local governments are already facing slower growth in revenues as a result of a moderating economy and new costs to meet the affordable housing mandates set by the central government.

Two interesting questions emerge. First, is the extent to which local governments are able to weasel around the new regulations and pay less than what is required.

There is a huge volume of research out there that examines this type of problem in China. The most well-known is probably the Lieberthal-Lampton work on Fragmented Authoritarianism.

The central government has set out a new policy that requires multiple subordinate levels of the bureaucracy (i.e., the local governments) to undertake actions directly against their economic interest. The extent to which local governments can avoid adhering to the new policy depends greatly upon the amount of attention the central government devotes to the policy’s implementation.  The level of compliance will also be determined by whether implementation and enforcement are clearly assigned or split between several bureaucracies.

Second, if this reform is implemented vigorously by the central government it will also reveal the relative power between developers and local governments. There will be a fight between the two groups over who is forced to bear the costs of higher compensation payouts. In the previous environment of rapid real estate growth developers might have been willing to eat the extra costs, but in a slower growing market they may resist more strongly.

This type of framework is useful to keep in mind when thinking about the future of economic reform in China. Vested interests, such as local governments and property developers, are powerful actors and have the ability to thwart new policy initiatives. Their influence, however, is limited when the top leadership assigns a high degree of importance to a new policy and establishes clear lines of authority in regards to policy implementation and accountability.