Home > Uncategorized > Land, Rice fields, Golf Courses: Understanding China’s property bubble.

Land, Rice fields, Golf Courses: Understanding China’s property bubble.

Land, Rice fields, Golf Courses: Understanding China’s property bubble.

 

 

In Liny, a small town in Shandong Province, a blind lawyer by name Chen Guangcheng is being held under extra-judicial house arrest in a local village. The detention comes after serving a 51-month formal prison sentence for leading a class action suit against local party bosses [Commissars].  This is an example of the extraordinary powers that vest in party officials of the CCP that actually run China; away from the gaze of its spanking new metros and Beijing. Understanding how this power structure works is critical to an appreciation of what made Chinese reforms in the 70s work so efficiently.  Forty years later, it also the key to understanding why the Chinese economic miracle can grind to a halt without further course correction.

 

 

Consider an agrarian peasant village at the outskirts of Liny circa 1970s with its rice fields.  All land belonged to the State controlled by the local CCP bosses who decided what was grown, how it was grown, where and at what price it was sold, etc.  CCP bosses also decided your fair share of what the produce fetched and the kind of things you could spend your money on.  Any opportunity to break free of this monotonous drudgery, indeed semi-slavery, was manna from heaven.  That arrived in the 70s in the form of demand for cheap factory labor in sweatshops around the coastal province of Guangdong.  These factories were then churning out garments, shoes, toys and such like for the US markets. Their demand for cheap labor sparked off a virtuous cycle that pulled in Liny into the matrix of China’s economic development. Yet, many analysts overlook the role of the CCP bosses in Liny in sustaining this process, for without their iron grip over the peasants still in Liny, the virtuous cycle would long since have ground to a halt.

 

 

Consider the same village in Liny 40 years after the first band of peasants selected by the local party bosses left for the factory in Guangdong. Since labor was excess in relation to the available land, and still is, there was no fall in rice production even as Liny continued to export labor.  Instead monthly remittances from workers brought in extra income, which their families could keep to themselves rather than share with the commune.  The need to have families spend that extra income forced the bosses to relax dress codes, because they wouldn’t buy another pair of Mao pant & shirt. One or two were enough. Thus came consumer reforms.  Housing, always in short supply, was another thing to liberalize for which peasants were willing to pay with their life.  So CCP bosses stumbled onto housing as another area for reforms.  And it was basically in land, housing & related infrastructure development, that the CCP struck gold, spawning a model that was uniquely Chinese and not seen in South Korea or any of the other Asian Tigers.

 

 

All land virtually belongs to the CCP bosses. More importantly it is free, carrying zero cost.  And CCP can put the land to any use it deem fits, not per party directives from Beijing, but at the local managing committee level.  Furthermore, CCP is virtually the only capitalist in town because none other is permitted.  Talk of an entrepreneur’s dream with no competition, virgin markets, unique product and no price controls.  Any surprise then that the local CCP bosses took to capitalism like a duck takes to water?  It is this process by which local CCP bosses turned into entrepreneurs, with beneficial results for all, that to large measure explains the Chinese miracle and the little resistance to reforms.  Free ownership of land provided every CCP local committee with huge amount of equity capital that only had to be monetized by housing schemes to make money for everybody in the chain.  With such incentives, and a willingness on part of the party bosses to share “profits” among themselves, horizontally and vertically, success was assured.  We in India would have shouted corruption and brought the whole thing to a halt before the first house got built.

 

 

Liny’s Commissars did well.  From building houses with workers’ remittances, they have scaled up to building whole townships that will house workers as they retire from their factories in Guangdong and return to the villages.  In the 40 years since the first reforms, many such townships have been built, even occupied, but many many more are being built in many little Linys all over China.  The problem is that not many workers are returning to Liny anymore.  There are other alternatives available in bigger cities.  Migration controls are no longer that effective.  People can chose where to live. The Commissars no longer have captive customers. That has resulted in many Linys building ghost towns that are simply sitting vacant on what were once rice fields.  Some have added golf courses to attract the retiring workers to no avail. There are far too many of them to shrug off.  But that’s not the only problem.

 

Commissars in Liny not only controlled all land, but just about everything in Liny including the local banks, steel shops, the odd oil refinery and much of the older smoke stack industry that exists. The local banks in particular are still the preserve of the Commissars.  On the way up, when the first houses were being built, this common ownership of all assets, and mutual profit sharing among the Commissars, ensured everybody was on the same page and totally committed to the local enterprise.  No housing scheme lacked for capital, labor or captive customers. Commissar control over peasants was total & tailor made for housing led development. Since no peasant owned houses, selling a house was a matter of allotment out of a queue, profits assured.

 

 

But the same nexus turned vicious over time as liberalization led to loss of control over customers who sought better things than the commissars had to offer.  Unsold housing, even with land free, had to be financed by banks, and held on to.  Gradually the stock of unsold houses accumulated while frenetic development unchecked by market forces continued unabated.  The Government in Beijing was most supportive.  They had this wonderful device to mark all land and property valued to indices they fully controlled.  The Commissars in Beijing ensured the land & housing there on went up in value in all districts year after year by 5 to 10%, sometimes more.  Liny’s commissars were therefore able to mark to market, their stock of unsold houses that yielded decent profits on books, even as unpaid bank loans and interest thereon piled up.  Since the same commissars controlled the banks & the housing development companies, nobody complained.  Profits to Commissars still came in though the cash was harder to scrounge.

 

 

These ponzi like schemes work when the general economic tide is rising lifting all boats but up to a point as long as incremental cash to pay running expenses is available.  It collapses when the local banks can no longer fund the unsold houses without help from banks in Beijing.  For many that point has now been reached.  If there has been no collapse so far it is because the Beijing commissars now realize they cannot unwind the housing ponzi schemes in Liny without sacking the commissars who elect them to their positions in Beijing. Indeed the problem is so deeply intertwined with they way CCP has evolved over the last 40 years that to reform would invite a revolution of sorts.  The virtuous cycle that powered China’s development has come full circle and turned vicious with a malevolence that is hard to exaggerate.  The CCP will try anything and everything before it gives up its hold on and support for Liny’s commissars. Chen Guangcheng’s fate is but a small though vivid example of what happens to whistleblowers that threaten to expose the Commissars, near and far.  Dissent and tightening cash could blow the lid off this can of worms any time.

 

China’s GDP numbers are much admired and there is little doubt that on the whole they are very impressive.  How much of that GDP growth is “real” and comparable in value creation to say that in the US?

 

Consider land held at zero cost in Liny.  When you build houses on the land, the entire monetary value of the land gets “monetized” and added to the Chinese GDP as soon as the houses are declared ready.  Liny’s commissars don’t wait for houses to be sold to book profits.  The old commie system of accounting for “production” and marking to market persists.  But the land was always there and had value even before houses were built on it.  In other words, just because the commissars usurped land from peasants in the past, and carried it a no cost, doesn’t mean all of the value of a house was incremental GDP.  Land accounts for 15 to 30% of the value of a typical housing project or townships that are being built in the countryside.  Housing by itself is close on 20 to 30% of China’s incremental GDP.  So about 1 to 2 percentage points of the 8-10% GDP growth are merely due to monetization of land!  This fact is usually overlooked or glossed over in the China story.

 

 

The fact is the property bubble in China is intrinsically intertwined with CCP’s control of political and economic structures in the provincial towns of China.  The bubble is huge as is evident from the reports of ghost towns but it is hard to put a number on it.  China cannot deal with the problem through normal market mechanisms, as that would endanger the CCP’s hold on power.  Chinese authorities are trying to contain & compartmentalize the problem by curbing local bank lending to property, shoring up bank capital, and improving supervisory mechanisms.  There is much talk of banning shadow banking which is nothing but a variation of Liny’s ponzi whereby several banks get together to form a informal syndicate to lend to township development.  The bubble in Chinese property will unwind, as al bubbles must.  The question really is if it can be done without deep reforms in the way CCP is currently managed.  Meanwhile China trudges on its managed book profits in Liny, approaching a 50 year cycle that marks deep cyclical turns in economic and social systems.  The unwound property bubble combined with an ageing population ensures the next Kondratieff cycle in China dues end of this decade will be momentous.

 

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Categories: Uncategorized
  1. Vinod
    November 2, 2011 at 3:40 am

    Interesting read. Do you have any references for further reading?

  2. November 5, 2011 at 9:30 pm

    Just one question, ever visited Chinese countryside?

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