Xu Chenggang on the Government’s Role in Real Estate and How to Roll Out Economic Reforms in China

This interview consists of two parts. The first part focuses on stimulating domestic demand, reducing government debt, currency exchange reforms. In the second part, Xu talks about the connection between rising housing prices and the government’s fiscal revenue, the major challenges of pushing reforms in China and how state-owned enterprises and local governments should roll out these reforms.

Building Long-term Mechanisms for Real Estate Regulation

Q. The property industry has contributed to the economy but also ‘hijacked’ the economic growth model. How can we reflect on that and establish a system to adjust and regulate the industry?

A. This question touches on another fundamental problem in China: land ownership. As a socialist country our land is owned by the government, so land prices are closely tied to government income. Local governments should diversify their income and get less involved in land renting and sales. Issuing local bonds on the market would be a good way to diversify income. Short-term solutions for local government debt could involve selling bonds, and in the long term, the government should reduce its role in the market economy through institutional reform, cutting redundancies and making government smaller. Currently, the size of the government means it also has high expenses. The government’s income largely relies on selling land and the broader property industry, and that’s why the land and real estate industry is tied to the fiscal and taxation systems.

Why are housing prices in China’s first- and second-tier cities still increasing, while in third-tier cities the price gaps between different regions are huge? The situation is even worse in fourth-tier cities. This is because the tiers are divided in accordance with administrative levels and provincial capitals. Usually first- and second-tier cities get more resources, so rich people like to be close to those resources. In addition, people would want save investment, and Beijing’s housing prices are still increasing, so it’s a safe investment for them. Even if the whole country’s economy had problems, Beijing’s housing prices wouldn’t drop much.

Q. Investors consider buying a house in Beijing to be the safest choice for investment?

A. Indeed, it’s very safe. Many people buy houses in Beijing houses for investment purposes, and this resulted in skyrocketing house prices. People who return from overseas are always shocked by Beijing house prices and think it’s increasing irrationally compared to other capital cities. That’s not a good comparison, because Chinese people think Beijing is the best city to invest in property, and if this is the case, of course the price will keep going up. If one day the housing price slumps, it means a financial crisis has already happened. For example if the stock market crash hadn’t occurred last year [and stock price kept going up] and the crash instead erupted today, then there would be a severe financial crisis that affected all industries, and the Beijing housing price would crash too.

Reform and Execution

Q. Starting from the 1980s, every 10 years China has undergone significant reform, such as propelling rural economic reform, setting up special economic zones or joining the WTO. These breakthroughs improved productivity and boosted the economy. But in the past 10 years, there’s been less ‘reform’, and the government put patches on problems as a form of macro control. What’s your view of China’s economic trajectory?

A. The early reforms successfully encouraged private enterprises to develop. China joined the WTO, and private enterprises grew under that broad environment. In the following years China’s economy went through a period known as ‘State-owned companies advancing and private companies deteriorating’, which hindered the development of private companies. This has become the focus of the current economic reform. In the 1990s, China’s economy showed a signs of a process dubbed ‘invigorating large enterprises while relaxing control over small ones’. This, on the one hand, freed private enterprises for growth as some small- and medium- sized SOEs went private, but ‘invigorating large enterprises’ had a big impact which is affecting and obstructing development now.

‘Invigorating large enterprises’ means all the crucial industries have to operate under the government’s control. So when the crucial industries become monopolized, and using their advantages to squeeze other businesses, which are mostly private owned and represent 80% of employment in China, it leaves less and less profit for them, so people’s income are generally low. And with less profit, private companies are having difficulty expanding, so their revenue shrinks and eventually they barely break even. This problem has lasted for quite a long time.

Q. Supply side reform has been promoted for one year and has had some achievements in terms of resource allocation, but the arguments regarding system mechanism reform are still unsettled. Currently these two kinds of reforms are a bit mixed up, what’s your view on this?

A. My thought is when making a reform plan, we can’t ignore problems with the system itself. Otherwise taking different measures is just beating around the bush, it doesn’t solve the fundamental problem. Reform is like an inquiry, first step is to find out where the problem is. If there’s a tumor, then cut it out. If the diagnosis and treatment never touch the fundamental problem, then the disease remains.

Q. Other experts have said similar things. It is believed that economic stagnation is a result of our old market system, not because of overcapacity or a lack of supply side resource, so reform of mechanism and supervision systems is the pressing matter of the moment.

A. The market indicates whether there’s overcapacity. When there’s overcapacity, too many goods on the market remain unsold, so the companies that produced those goods don’t get money to pay their debts, and eventually go bankrupt. But when those companies are state-owned companies, they won’t go bankrupt. The problem lies in the ‘state-owned’ aspect. Changing this to more diverse forms of ownership will solve the problem.

Q. After the 3^rd Plenary Session of the 18^th CPC Central Committee, people’s expectations of reform have been high, but currently it seems the execution of reforms has been weak.

A. Since the 1980s, China has encouraged subnational governments to set their respective reform plans, and because China’s promotion mechanism comes in the form of top-down appointments, government heads are doing their best to boost GDP growth and move up the ladder. About 10 years ago the central government figured out that this measurement was too unilateral, so the criteria changed: besides GDP growth, environmental protection became another criterion. In addition, wealth disparities and social stability are ways to measure ‘good government officers’ too. Essentially, GDP growth doesn’t necessarily result in them getting promotions, but the new rating system for government officer has not yet been set. So the time has come to replace top-town appointments with an advanced system, and stop measuring government officer’s work with GDP growth.

Q. Currently China is going through a transition period and managing the country has become more challenging than ever. How can government build a harmonious society and healthy economy?

A. Our political structure is the fundamental problem. When I say our government should run the country according to the principle of ‘rule of law’, some people think I’m challenging the government, but I am not, I’m saying people should follow the rules and do things accordingly, just like the way a company will set rules and managers that come to run the company should follow those rules. China runs via a regionally decentralized authoritarian system. The central government has control over personnel, whereas subnational governments run the bulk of the economy.

Subnational government may initiate, negotiate, implement, divert, and resist reforms, policies, rules, and laws. A policy from top levels of government may be twisted and not implemented well at the regional level. How can we solve this problem? By changing China’s hierarchical electoral system. Let people at the county and town levels vote for their own mayor and village head. This is not new, back in 1988 when Deng Xiaoping pushed for political structural reform, this method was used to solve the problem at village, town and city levels.

There are also people who object this electoral system, saying that at the village level the election results are not ideal. Why? Because our elections are affected by power and ‘guanxi’ and candidates might conduct illegal behavior to win the elections like bribing or threatening the voters, and often candidates might get away with it, because the government, which is where the candidate works, can intervene in the judiciary. If the judiciary is independent and the elections are run strictly according to the law, it won’t be as messy. And another reason is that the local party branch secretary is appointed by the town head or mayor, in this way it completely lost the essence of elections—democracy. If the local party branch secretary is elected by all local party members, it would solve the problem.

Prof Xu Chenggang was talking to Caijing’s Wang Yanchun on the sidelines of CKGSB’s 3rd China Economic Symposium.