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The Role of Land Sales in Local Government Financing in China

by Major Tian

September 3, 2014

2013-China-Construction-Site

Land sales contribute significantly to local government financing in China as well as provincial GDP targets. But this is both unsustainable and problematic. A look at the situation and the kind of reform that needs to kick in.

Last month, China launched a national audit of the “land-transferring fees” collected by local governments in the past six years, which totaled RMB 15 trillion, or about $2.4 trillion. The fees—or in other words, the income from land sales—accounts for as much as 35% of local governments’ fiscal revenue in 2013, according to China Business News, a Chinese language finance newspaper in Shanghai.

But selling land is barely a sustainable source of income, as Beijing has set up a mandate to maintain at least 297 million acres of farmland to feed the world’s largest population; and with 334 million acres of farmland available today, there are limits to how much more can be sold.

In addition, local officials also rely on land sales and construction to achieve GDP growth goals, which could cause overcapacity and create so-called ghost towns (commercial or residential projects that have been built but no one is either leasing or buying). The residential housing market is already taking a hit now, and as Beijing reins in the shadow banking business, the financial condition of local governments’ is among the major risks of the Chinese economy, economists say. And that’s why the central government is leading the audit, which will serve as the foundation for rolling out further reforms on taxation and land management.

So to comprehend China’s effort to shift its land policies, one needs to understand how the current system works and what the challenges are. Ginger Zhe Jin, an economics professor at the University of Maryland, is conducting extensive research on the political economy of land sales in China. In this interview with CKGSB Knowledge, she walks us through the some of the issues within the current system and the pros and cons of potential solutions.

Q. When we talk about land sales here in China, the government doesn’t really sell the land, they lease it. Can you walk us through how this works in China? 

A. In theory, the land’s absolute ownership belongs to the government. Central and local governments are one government that owns the land. What they are selling is the right to use the land. For industrial use, it’s up to 50 years; for residential use, it’s up to 70 years; for commercial use, it’s up to 40 years. Sometimes farming land will be changed [to residential or commercial use for urbanization purposes]. The exact body that implements the land sales is typically the local government.

There is a centralized policy that guides every level of local governments to do this. However, the land value varies hugely across different areas. The local governments have some discretion in terms of how much they are going to compensate farmers or other people who originally live on that piece of land before they turn the land into other uses.

Q. So the government can sell land for residential, commercial or industrial use. Which is most lucrative?

A. It depends on how you define “lucrative”. There might be a tradeoff between one-time income revenue from land sales versus the future revenues or other benefits that the land could bring in. So for example, industrial land is still sold at much cheaper prices than commercial and residential land. However, industrial land, if used for manufacturing for example, typically will bring GDP growth and future tax revenue. If you count all those, I’m not sure whether industrial land would be less “lucrative” as compared to residential and commercial.

Q. Some of your research looked upon this in great detail. Have you found maybe certain provinces that are doing this more with an eye on long-term economic growth?

A. It’s possible that some provinces may have more incentives to do this. [But] there could be unique factors in those provinces. So in our study we actually have a “provincial fixed effect”, which means that we take out a common factor in one province and then we explore within the province across city variations. So within that province there might be some cities that have more incentives than other cities to sell more land for industrial use or sell at different prices. So that’s what we focus on.

For example, we think economic competition might be an important factor. If I am a city and I have other cities competing with me at a very close distance and I know that capital is very mobile between those cities—the firm could decide to be in my city or in a nearby city—then I face a lot of competition. Then in order to attract that kind of capital, maybe I have to give more favorable terms to the firm, which could mean that I will charge a lower price in lending the land for industrial use.

Q. We’ve been seeing stories about conflicts between local governments and farmers when arable land is turned into land for other uses. What’s at work here?

A. The compensation [local governments pay to the farmers for using their land] causes the most conflicts. The compensation standard has been changing over time, but in principle it’s calculated on the basis of the economic output of the land for agriculture use, which could be very low as compared to industrial or commercial use. So that’s probably why farmers are dissatisfied even if they got compensated according to that rule; they feel like they don’t have a fair share in the final overall benefit of the redevelopment of the land.


Ginger Zhe Jin on reforming the performance evaluation system
for Chinese local officials. (Video by Major Tian)

The compensation is such an issue that in 2006 the central government actually issued a guideline on the minimal compensation standard for industrial land. However in our data, industrial land prices we observe sometimes could be even lower than the minimal compensation standard, which means [the local governments] sacrificed [financially to sell the land].. I don’t know how they achieve that. Does it mean that… the county devotes more fiscal income to fill that hole? Or they didn’t compensate those people according to the standard? We don’t know exactly what happened.. Whether they really abide by the minimum standard is still a question. We don’t have data on exactly how much money they have paid for compensation, so we can’t say precisely on how the standard has been enforced.

Q. Land sales seem very crucial to local government financing. Are there reforms going on to change their reliance on land sales?

A. It definitely accounts for a large share of fiscal revenue. Over the whole country, according to the 2011 statistics, it accounted for about 25% of fiscal revenue across the board. So that’s a very big chunk of fiscal revenue. The central government is concerned about local governments’ reliance on this revenue. For example, if they charge too high a price for residential land, that may imply that apartment prices will be too high for local residents to pay. That may generate some social concerns and therefore, the central government actually has some policies saying that they want to devote some of the land for affordable housing. That’s going to reduce the fiscal revenue for land sales.

Q. What about property tax? Will collecting property tax help local governments balance their books?

A. The current policy is that there is no property tax charged on residential use. If there is property tax, that is going to bring not only one-time sales but also future streams of property tax revenue. However, another consequence is [the influence] on individuals’ incentives to buy or sell properties. After the real estate has been developed, if there is a property tax, maybe the cost of maintaining one unit of housing or more than one unit of housing will be more expensive. That’s going to redefine people’s incentives to buy, sell or rent. I think that is going to be a totally different equilibrium. But even before the implementation of a property tax, one obstacle is to have complete information on who owns what. I’m not sure if that information is clear or publicly available yet.

Q. Beijing has given its urbanization agenda another push forward recently. What does that mean for land supply and demand in China in the future?

A. The land supply is actually set by the central government. The central government would tell the local governments how much land you can sell this year. Then the local governments can decide exactly how to sell the land,, for what use, at what compensation prices. So the overall supply is actually controlled by the central government. To the extent that the central government wants to promote urbanization, that may affect their supply function.

Q. The central government is reportedly evaluating local politicians’ performance not only based on GDP growth, but also on other factors like environmental protection. Will that change how local governments go about selling land?

A. To the extent that the political structure is this top-down structure, every level is trying to look up for political promotion and that promotion is based on measurable performances such as GDP growth. It’s very important. If they define performances differently, that’s going to generate incentives for local politicians to rebalance their local policies. However it’s tricky to define “performance”.

For example, GDP might be easier to measure than environmental consequences because environmental consequences may not appear in the short run. The turnover cycle is about five years for each official at each position. Then how would you measure the environmental problems that appear [during] your term of office but [are] a consequence of your predecessors?

That’s one example, and the other example is maybe all officials, including the current official, contributed to this problem. How can you divide the responsibility for different officials? Even if the central government has a lot of data, some local data may still be at the discretion of local officials. It’s not as ideal as saying that as long as you redefine performance, then everything will be done. It’s quite complicated.

This interview is from the 2014 China-India Insights Conference which was co-sponsored by CKGSB’s Customer Information Management Center and the China India Insights Program (CIIP) of the Center for Customer Insights at the Yale School of Management.

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