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Chinese Cities’ $1 Trillion-a-Year Piggy Bank

What drives the Chinese economy? One piston of growth, perhaps surprisingly, is land. In China, all land technically belongs to the government. Local authorities sell rights to use it, effectively leasing parcels to different parties to generate income. More than a quarter of local government revenue comes from land sales, totaling ¥7.3 trillion (US$1 trillion) in 2019, and local government spending accounts for a quarter of GDP in the world’s second-largest economy. Understanding how the land market works is key to understanding the explosive growth of China’s economy over the past 40 years.

One striking feature is the price discrepancy between land rights sold for industrial use and residential use. Land-use rights for building factories or mines sell for about one-tenth as much as those for residential development. Students of the Chinese economy long thought this reflected a mechanism to subsidize business activity and spur growth. The actual dynamics are more complex, according to research by Chicago Booth’s Zhiguo He, Scott Nelson, Yang Su (a Booth PhD student), and Anthony Zhang and Tsinghua University’s Fudong Zhang.

The “industrial land use discount,” as it’s known, in fact translates into a revenue stream that over time is greater than what local authorities get from residential land-rights sales, the researchers find. When municipal authorities sell a parcel of land to housing developers, they get a one-time cash infusion with no promise of future revenue, as there’s no property tax. When a city authority sells to an industrial developer, there may be less cash up front, but the factories and other commercial facilities the buyer builds produce goods and services that generate future tax revenue.

The researchers suggest that local governments in China employ a kind of three-legged stool for balancing their budgets: borrowing through bond sales, selling property for apartment blocks when they need a cash infusion, and auctioning off land to industrial developers to create a longer-term stream of revenue.

This year, China’s local governments face a massive revenue crunch as land-rights sales dry up. Amid government efforts to curb risks associated with excessive borrowing, China’s real-estate giants can’t borrow more to roll over their debt or finish existing projects, so residential sales have stalled. Meanwhile, a cooling economy is slowing demand from industrial buyers, leaving local governments running to debt markets to fund their budgets.

The researchers analyzed publicly available data on land-rights sales between 2007 and 2019, recording how many parcels were sold and to whom. Focusing on sales to industrial developers for manufacturing, mining, or utilities installations, they tracked the performance and cash flow of the businesses before and in the years following each land purchase. Then they estimated the extent to which buying land rights for new factories boosted companies’ sales, as well as the resulting increase in tax revenue from those businesses.

Two very different real-estate markets 

Chinese authorities have sold industrial land at a substantial discount compared with residential land—and research suggests that has to do with future tax revenue.

The analysis demonstrates that enterprises did indeed record more sales when they built new facilities on recently purchased land. The rise in value-added tax that they paid to governments was significant. The researchers estimate that tax revenue jumped by ¥114 per square meter of land in the first two years, eventually rising to ¥214 per square meter. They find that over time, industrial land sales generated annual rates of return of almost 8 percent.

The findings challenge the narrative that selling land rights for industrial use is unprofitable or just a bad deal for local governments, Booth’s Zhang says. When authorities need to raise funds, the study demonstrates, they can borrow by selling bonds or they can essentially sell land. Residential land will deliver a fast payoff, and industrial land will generate longer, slower-burn revenue.

The findings also shed new light on how any government can use resources as an instrument for liquidity when they need to raise cash. A lot of it depends on timing, says Zhang—and how impatient governments are for revenue.

“We measure patience by looking at local government bond yields over time in China to pinpoint moments of financial pressure or constraint,” he says. “And we see that when governments are impatient or squeezed for income, they do indeed resort to selling more residential land over industrial land—even when the market demand for housing is low. As our study shows, this has nothing to do with the intrinsic profitability of one transaction over another. It’s about how urgently they need the cash.”

In China, one measure of just how urgently local authorities need to raise funds could very well be the number of apartment blocks rather than factories that are being built.

“If you happen to see a new condo building going up in Shanghai or Beijing, the reality is that it might have nothing at all to do with demand or a spike in the local population,” Zhang says. “It could just be because the city needs to get its hands on cash fast.”

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