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China’s Rental Market Flooded with Listings as Rents Continue to Slide - Caixin Global
(www.caixinglobal.com)
It's a little funny that Chinese media even does the "But at what cost" thing.
Here’s the problem: in China, local governments are the landlords!
With nearly 30% of the local government budget revenues relying on land premium (and in some cities like Guangzhou, a key manufacturing hub that is now experiencing slowed export from Trump’s tariffs, this proportion is 40+%), the plunging property prices are significantly curbing a key income source of the local governments. Somebody has got to keep the subways, rails, infrastructure, public utilities running, you know.
To understand how we got to this debacle, we need to understand a little bit about China’s economic history since the reform and opening up era.
A major feature since the reform era is the highly decentralized economy of China, as many reformers believed that the central planning bureaucracy under Mao was too inefficient and led to devastating output like during the Great Leap Forward.
The central government grants a very large autonomy to the local governments to drive local development, and in turn, it controls the behavior of the local governments and sets national priorities through promotion of local officials. The main KPI for promotions is GDP numbers. It is no coincidence that Chinese officials are obsessed with raising the GDP numbers by any means necessary.
Initially, local governments only had to pay a fixed amount of fiscal tax to the central government. This wasn’t so much a problem when most of the provinces were still poor at the start of the reform era.
However, soon, by the 1980s, the coastal Southeastern cities like Shenzhen and Guangzhou were able to take advantage of their export capacities to grow very lucrative light industries and allowed them to grow a disproportionate of wealth compared to the rest of the country. Because they only had to pay a fixed amount of fiscal tax, the local governments of these coastal cities were left with a large amount of profit and soon, these cities had grown so rich that they even exempted corporate income taxes altogether. Businesses flocked to the Southeastern provinces to take advantage of the business-friendly environment and relaxed taxation.
By 1993, the central government received only 20% of the national tax revenues, but was still responsible for financing large scale investments and operating the state-owned enterprises (SOEs) across the country. Meanwhile, local governments were able to pocket the rest of the wealth, but mostly concentrated in the wealthy coastal regions.
The attempt to wrestle back financial control came during the 1994 Tax Sharing Reform, with two significant changes to the taxation rules:
- A much higher proportion of value-added tax (the most important form of tax revenues in China) would be levied by the central government, and is then redistributed back down to the local/municipal levels. (Nearly 75% goes to the central government, while only 25% are retained by the local governments)
- More importantly, the local governments are now responsible for financing the investments as well as operational budgets of the SOEs under their jurisdiction.
Such a radical change would have far-reaching consequences. The first provinces to panick were the Three Northeastern Provinces (Heilongjing, Jilin and Liaoning), where China’s heavy industry SOEs were concentrated. Because of the huge amount of investment and budget required to run heavy industries, the local governments now suddenly tasked with financing their own budget turned to an even more radical act: privatization. As private capital took over China’s state-owned heavy industries, the “reform” resulted in mass layoffs and the ensuing economic crisis in 1994-1996, the first large scale unemployment never seen under Mao.
It is estimated that between 1996-2002, more than 60 million workers in China were laid off during the privatization wave, a trend that would not be reversed until China joined the WTO in 2001 and turned itself into the famous “world factory”.
But perhaps more consequential is the fact that the 1994 Tax Sharing Reform forced the local governments to look for non-tax revenues to obtain a stream of income to keep the municipalities running. And where could a local government obtain lucrative non-tax income? That’s right - by selling and leasing land. And how do you raise the land price? By driving heavy investment in property market.
When Zhu Rongji officially ended the welfare housing (distributed based on seniority, rank and job responsibilities) in 1998, the age of private property market has finally taken off in China.
In 2007, the subprime mortgage loan crisis hit Wall Street and kickstarted a global financial crisis with tens of millions of unemployment worldwide. The sudden slump from the American consumer market caused severe drop in tax revenues for both the central and local governments (remember, the value-added tax is the most important form of tax revenue in China). Many local governments took the signal from the central government to turn towards infrastructure investment (the infamous “4 trillion yuan stimulus”) to go all in on property market to use the land revenue to make up for the loss of income.
Initially, local governments were not allowed to issue municipal bonds directly, so they turned to establishing shadow banks (LGFVs) to borrow massively from financial institutions and various unofficial sources to finance the property market development (these are known as “hidden debt” since they are off the book). Tons and tons of new housing projects were built and high speed rails connecting cities across the country.
The resulting hidden debt grew so massively that by 2015, even the central government had panicked and issued a stern warning to the local governments, the famous “you’re now responsible for fetching your own kids” (i.e. the central government is tired of cleaning up your mess from reckless borrowing). Hoping that the local governments would turn more fiscally responsible, they are now given the authority to issue their own municipal bonds instead of borrowing through the shadow banks in the form of “hidden debt”. Surprisingly, or perhaps not so surprisingly, the local governments became even more reckless in their borrowing and it became a competition to drive up GDP by issuing more and more debt to invest in more and more infrastructure. Many local officials made the career promotion of their lifetime during this period, as their GDP numbers shot through the roof through reckless expansion.
The property market peaked in 2021, and with the implosion of Evergrande in 2021-2023, many local governments are now running into budgetary issues since they have been relying so much on land premium to keep their provinces and cities running.
It is no coincidence that the Chinese government is throwing a lot of money into slowing the free fall of the property prices (an inevitability at this point, just how much you can cushion the fall). This is because mass mortgage defaults can risk triggering a crisis in the financial sector and the local governments that rely on the land prices to stay up, and in turn, the manufacturing and tech industries that rely on the local governments subsidies to survive!
This is how wealth is repeatedly being funneled to the top to prevent a larger economic crisis from happening. A scale of the 2007 subprime mortgage crisis in the US is unlikely to happen in China, because the costs are being socialized through the vast amount of the national wealth. As such, despite the amazing economic development in China over the past two decades, this has not been translated into wage growth and increase in purchasing power for your average Chinese worker. Hence, deflation sets in as their home prices fall, and people become even more cautious with spending.
