Econ Dean at Renmin University: Old ways of stabilizing growth may not work
Liu Shouying: If the confidence of market entities is not restored, there will be no engine to restart the entire national economy.
On December 18, 2022, the National School of Development (NSD) at Peking University held the 7th National Development Forum, co-organized by the Economics and Technology Research Institute of the China National Petroleum Corporation(CNPC), the petro giant’s in-house think tank.
This newsletter is a translation of the speech published in the NSD’s WeChat blog at the forum by Professor 刘守英 Liu Shouying, Dean and Secretary of the Party Committee at the School of Economics of the Renmin University of China.
Liu Shouying: Old ways of stabilizing growth may not work
Our life has to move on after the pandemic. Therefore, our research needs to develop a correct perception of the current economic problems rather than simply attributing them to the pandemic. Otherwise, we will repeat the same mistakes. I think China's current problems are due to a combination of economic transition and the pandemic.
The Covid-19 pandemic is not the root cause of the current economic problems.
Since 2008, the development model of China's economy has been to mortgage land via local government financing vehicles to generate capital, leverage financing, [engage in infrastructure building] and then recoup the investment from real estate, ultimately achieving urbanization.
This development model led to two consequences. On the one hand, it brought debt and financial risk to local governments. The leverage ratio of local governments has climbed, and housing prices have risen too fast, leading to higher leverage in the residential sector and increasing financial burden for residents in terms of housing. On the other hand, the efficiency of relying on real estate and infrastructure to drive growth has gradually diminished since 2008. In other words, the contribution of real estate and infrastructure investment to economic growth has declined.
Against this background, since 2014, China's economy has begun to change, as evidenced by a continued decrease in growth. Beijing judged this as the new economic normal, which requires changing the engine for development and conducting supply-side structural reform.
Based on this judgment, China began to carry out the transition of its economic development model, which directly responded to several major problems of its post-2008 economic development model：
1. Local government debt. Nowadays, it has been stipulated that local governments are allowed to issue bonds, and the responsibility of local governments has thus increased, which is the so-called "opening wider the front door" [for local government financing.]
2. "Blocking the back door." The most important thing was regulating state-owned urban land reserves and preventing local governments from mortgaging land. This means that financing based on mortgaging land, the most important growth tool in the post-2008 economic development model, has been called off.
[Pekingnology: In 2016 and 2017, out of concerns for runaway local government debt, central government departments ordered, via 《关于规范土地储备和资金管理等相关问题的通知》and《关于进一步规范地方政府举债融资行为的通知》, required that local governments must no longer inject state-owned urban land into local government financing vehicles where the land would be used as collateral to secure loans from banks.]
3. For real estate, the most important pillar of the post-2008 economic development model, the central government established the principle of "houses are for living in, not for speculation" in the bid to form a new housing model by stabilizing housing prices, land prices, and expectations. However, implementing these policies has tightened the restrictions on bank loans for real estate and other ways of financing.
4. In line with the principle of "houses are for living in, and not for speculation," the Chinese government imposed more interventions in the supply of land, implementing what is known as the 双集中 “two centralized” land sales policy in an attempt to stabilize land prices, real estate prices, and expectations.
[Based on China’s current constitution, all urban land belongs to the state. So the government has a monopoly on supplying urban land. Taking advantage of the state monopoly, the central government rolled out the so-called concentrated land supply policy in 2021, requiring local governments to limit the frequency of land sales to force a cool-down of land acquisitions. All in all, the policy has been walked back because developers, which also faced difficulties in sales and financing, couldn’t afford to participate in the less frequent but more difficult land biddings.]
Overall, the above policies directly address the key issues, such as increasing local government debt upon mortgaging state-owned urban land, the function of real estate, and land supply in the post-2008 development model. These policies were adopted not in coordination but by different central government departments. They were implemented respectively and were of a “shock therapy” nature. They have produced the following consequences.
1. China’s local government always has the ability to raise funds through borrowing, and the policy above opened another channel of borrowing without bringing down the total local government debt. That adds to debt risks with frequent credit risk events happening.
2. The halt of local governments’ mortgaging of land makes it appear that China's development model has returned to the pre-2008 model, namely the 土地财政 “land finance” model.
On the one hand, the halt of mortgaging land prevented local governments from investing in infrastructure through local government financing vehicles, resulting in a significant decline in land for infrastructure and its share of all urban land use. On the other hand, local governments designate most of their state-owned urban land for industrial use and try to attract investment with the industrial land, just like they did before 2008.
Besides, due to the loss of funding from the halting of land mortgages, local governments had to sell more land to residential and commercial developers to generate revenue. As a result, it can be seen that during this period, local governments' revenue from land sales has been rising. Still, the cost of land development and acquisition has also been rising significantly in parallel.
[Pekingnology: Local governments must spend money on moving people out to acquire what is known in China as “clean land” before selling it to residential and commercial developers or industries.]
Local governments' revenue from land sales increased, but the net income (revenue minus cost) decreased significantly, adding to the financial risk.
3. The Chinese government policy under the principle of "houses are for living in, not for speculation" has led to a clear trend of destocking in real estate/reducing unsold apartments, but the supply, sales, and other links are shrinking along with the whole real estate market. The construction, completion, and sales have all declined. At this point, the real estate industry was already in bad shape, but the policy further tightened the restrictions on real estate
Later, the "Three Red Lines" policy led to a sharp decline in the profitability of the real estate industry. The developers’ acquisition of land from local governments took a nosedive.
4. Residential land should have been used to stabilize land prices and thus stabilize housing prices. However, after the “two centralized” land sales policy, the land market shrank instead of stabilizing, defying policymakers.
[Pekingnology: some details of the policy are hereby omitted because they are too technical.]
What is the result of this series of policies? Today's local governments can no longer raise funding through mortgaging land (via local government financing vehicles). Because of the real estate market setback, after returning to the land finance model, local governments are facing greater financial difficulties, and the downward pressure on their land concessions is increasing.
The dilemma we are now facing is about the transition of economic development, not just Covid-19 prevention and control.
The original development model for China's economy was the "financing via urban land" development model supported by the four policies [listed above]. To put an end to this model, China decided to change tracks. That process and the coronavirus resulted in contraction - the biggest problem facing China’s economy.
Many economists are now discussing stabilizing growth, which will likely not be achieved if China only uses the old policies. The biggest problem of China's economy is the paradigm shift superimposed on the negative impact of the epidemic, which leads to the contraction of the economy. The contraction is reflected in two aspects: one is the contraction of economic growth, showing negative growth; the other is the contraction of consumption on the demand side.
How to restart the economy after Covid-19?
I believe that in 2022 and 2023, in the first place, China should continue to repair the economy from three aspects.
The first one is real estate. Starting in 2022, the relevant policies have already evolved from strict regulation to loosening and then bailout.
The second one is the relaxation of debt issuance by the local government. The relevant policies have been launched, and the government hopes this will play a role in stabilizing growth and investment. In addition, the government has expanded the scope of investment supported by China‘s special-purpose bonds, and the government has taken a variety of measures to resolve the risk of local government debt.
The third one is the relaxation of the “two centralized” land sales policy, by which government hopes to revive market confidence.
At present, the above policies seem to have a very limited effect, mainly for three reasons.
First, local government debt continues to grow, and the pressure continues to increase. Second, the real estate market has not responded to the policy easing as expected, and housing sale is stabilizing but still declining. The year-on-year growth rate of mortgage loans keeps declining, and the month-on-month decline in real estate investment has worsened. The fall in new housing construction has slowed down, but the funds in place for real estate companies remained low, and the financing structure for real estate enterprises is changing.
There is a bigger problem: the interest in land for real estate construction is continuing to decline, and developers’ capacity for acquisition and construction is weakening. The land market downturn continues, and the volume of unsold apartments is increasing. Housing prices continue to fall. Real estate companies are not enthusiastic about acquiring land, leaving only state-owned enterprises and industry leaders doing that. The policy of concentrated land supply is still being eased, but that can only work so far.
Against the above background, I believe some fixes are far from enough for a post-Covid economic revival. Another four things need to be done:
1. Unclog the circulation of the national economy. The circulation of the national economy is related to Covid-19 and a series of domestic policies. I believe that to smooth the economic circulation, China must start from all parts of the circulation, including production, consumption, and income. There is also a need to smooth the governance. Over the years, there have been a lot of state interventions in the economy to achieve Covid-19 control, and these interventions have, to some extent, disrupted the circulation of the entire national economy.
2. Restore market vitality. Whatever measures to rescue the market may not work if the market vitality is not restored. If the confidence of market entities is not restored, there will be no engine to restart the entire national economy. At the same time, we must consider the national order and security issues caused by the pandemic, including unemployment, non-resident workers’ mobility in urban areas, and migrant workers. The just-concluded Central Economic Work Conference also placed special emphasis on high-quality development. We need to learn from the lessons of the pandemic, make it an important part of high-quality development to transit from the "development based on urban land" model, carefully summarize the lessons, and return to the path of transition.
This includes transforming the roles of urban land in the economy, resolving local government debt problems, and preventing serial financial risks.
3. The existing land mortgage system should not be simply ended. Financing based on land plays an important role in urbanization, and this is a feature of China's development. I believe land-based financing needs to be institutionalized rather than finished abruptly.
4. Conduct market-oriented reform in terms of land to support China's urbanization and promote urban development and urban-rural integration. These are the key measures for us to construct a new development model, implement high-quality development, build a new development paradigm, make China a manufacturing power, and march on the Chinese path to modernization.
We need to promote institutional opening further, develop a high-standard market economy, and enhance institutional opening. (Enditem)
Check out a detailed account of China’s Land Finance exclusive to Pekingnology
Great read. Thank you