China Translated

Inflation has eased down the list of people’s concerns recently as the CPI has come in below expectations over the last few months. Monetarists who feared last year’s explosive credit growth would fuel inflation in 2010 have waited in vain for a price spike. However, as the blue ear crisis of 2007 highlighted so clearly, inflation in China is more often than not a food-driven phenomenon, and on that front there is room to start getting nervous.

First we have the international picture. Wheat prices have soared thanks to weather conditions that have devastated harvests in Russia and the Ukraine. Although the market may be hyperventilating on this issue, and prices could well drop back as people realise that most key wheat markets have good stocks to draw down, wheat prices are certainly likely to stay elevated relative to last year. While grain prices in China do not always follow those on the world market, the latter are certainly likely to exert some influence (if only because smuggling starts to rise if the difference grows too large). This goes all the more for soya beans, which China is a big importer of, and where poor prospects for the US harvest are pushing up prices.

Meanwhile, at home China is suffering from an unusually extensive flooding season that has hit much of the Yangtze delta, and more recently north-eastern Jilin province. The latter is particularly worrying. Jilin is one of China’s bread baskets, accounting for roughly 13% of China’s maize crop in 2008. As one of the officials combating flooding efforts along what is known as the 2nd Songhua River (a stretch of the massive Songhua River) recently put it: ”This [region] is Jilin’s hinterland. The 2ndSonghua River affects around 73% of Jilin’s land area, and this is the province’s key region for foodgrain production. It’s very important”.

Details of how much floods have affected harvests are difficult to come by. The government has been sounding reassuring notes, but then it does that whatever the actual situation on the ground. In any case, such positive notes sound a bit tinny against a recent move to curb the regular auctions of maize from the state reserves. Bizarrrely prices actually fell after this move, possibly because officials exerted influence over bids so as to reassure the market. However, the restrictions on supply will clearly push up prices on the secondary market, and given how much the authorities tend to dislike rapid grain price rises this suggests that stockpiles may be running worryingly low.

With corn, soya beans and wheat all experiencing upward price trends, it is surely only a matter of time before this begins to feed through into wider food inflation. We are still unlikely to see a repeat of the frothy food prices witnessed in 2007-08, but it looks like inflation will soon be back at the top of people’s concerns.

Duncan Innes-Ker is a senior economist with the Economist Intelligence Unit

Agriculture, Guest contributor, inflation

In my last post on pig production and inflation I argued that though pork prices do have a big effect on China’s consumer price index, the underlying cause of inflation is not too few pigs but rather too much money.  But that does not mean that food prices are not important.

I think this extract from a story called ‘Pounds, Ounces, Meat’ by Zhu Wen, is an interesting illustration of the importance of food prices in Chinese life.  I read the story in translation and I believe the original was written in the mid 1990s, but having visited a few Chinese vegetable markets, I can attest that Zhu’s account still rings true today.

The story takes place in a vegetable market.  An old lady whose newly purchased tomato has just been crushed by another shopper is demanding compensation:

‘The old lady said she had bought 6 tomatoes, costing 2.5 yuan altogether, making each tomato 0.41666 yuan on average.  Rounding it up, he owed her 0.42 yuan.  After a brief stunned pause, the man demanded to see the other 5.  The old lady brought over the basket from the ground and, one by one, rummaged out the tomatoes from in amongst the potatoes, cauliflower, asparagus, lettuce, ginger, onions, long chillies, and pickled garlic.  I disagree, the man pronounced after thorough investigation, these 5 are all quite big, but the one I squashed was obviously much smaller.

The old lady glared upon her adversary, suddenly realizing he was not yet a spent force.  Well, what do you say?  The man pulled out from his bicycle trailer a carrot and laid it in front of the old lady: Look, I bought 4 carrots, 625 grams altogether.  At 2.4 yuan a kilo, they cost me 1.5 yuan which makes each carrot 0.375 yuan on average, but because this one is the thickest and the longest, it’s bound to be worth more than 0.42 yuan.  Take this and we are even.

The old lady closed her eyes a while, out of habit, then grabbed the hostage carrot and tucked it into her own basket.  But take it from me, she added as an afterword, though the current official price for carrots is 2.4 yuan, you can sometimes get them down to 2.3.  As I’m running late and I’ve got to get home to cook for my children, I’ll leave it here for today.’

Zhu’s underlying point is that reform era China is obsessed with money and material things.  In one of his other short stories, entitled ‘I love dollars’, a young man bargains his father out of a good time by refusing to pay the going rate for a prostitute.  But even though Zhu is using the old woman’s haggling to illustrate a wider point, a visit to any food market in Beijing would be enough to indicate that his fictional account is not too far from reality.

Food makes up around a third of the average Chinese person’s consumption basket, and with incomes low, even small changes in food prices can mean the difference between keeping your head above water, or going under.

Agriculture, Culture, Monetary Policy, Retail

How much for a pork chop?  In China, that’s an important question.  With the money supply exploding last year, and growth accelerating this, all eyes are on consumer prices, to see if the unwanted side effect of last year’s stimulus is a nasty bout of inflation.

About a third of the consumer price basket is food, about a third of the food basket is meat, and pork is the most popular meat.  Add all that up and it turns out that the price of pork accounts for a fair few percent of the CPI basket.  And with the price of that pork chop pretty volatile, it is often the price of pork that is the determining factor in movements in the CPI.

That means that the Chinese inflation numbers are vulnerable to shocks in the pig supply chain.  Back in 2008, a disease in the pig population pushed pork prices sky high and the CPI touched 8%. 

High pig prices, and some hefty government subsidies, encouraged farmers to start piping Marvin Gaye tunes into the sty, nature took its course and a few months later a glut of piglets hit the market and prices started to fall. 

But maybe they fell too far.  At least, that is the view of Xu Qiyuan of the Chinese Academy of Social Sciences.  Xu is evidently a man who has spent some time on the farm, and in a recent paper he gives us chapter and verse on the pig production cycle and the potential impact on the CPI in the year ahead.

This is my translation of the main points from his paper:

‘The pig sector is dominated by small producers.  According to Ministry of Agriculture figures, less than 1% of China’s pigs are produced by farms with more than 5,000 hogs.  Small producers are more vulnerable to changes in the market, and ramp up or down production in response to small changes in prices.

China’s pork reserves are just 300,000 tons, compared to annual consumption of 50m tons.  So the pork reserves do not provide a real cushion against sudden changes in production.

China accounts for 50% of global pig production, and so if domestic demand outstrips supply there is little possibility of raising imports to fill the gap.

It takes 8 months to get a pig to market - four months of gestation and four months of fattening.

Pork prices hit a low in the first quarter of this year.  The response from pig producers will naturally be to slow production. 

The result will be a dearth of pigs from around August onward.  With less pigs available, the price of pork will rise, and this will also push up the cost of other meat products. 

The combined effect could add 1-1.5% to the CPI from August on, and take the total past 4%.’

The counter argument is that it is too much money, not too few pigs, that is the cause of inflation. 

The vagaries of supply and demand in particular markets might mean that inflation is seen first in higher pork prices, rather than higher costs for electrical goods, train tickets, or some other good. 

But if the government was able to rationalise the pig production chain to prevent fluctuations in supply, the result would not be no inflation anywhere, it would be inflation in the prices of some other product.  Better animal husbandry will not solve China’s monetary policy problem.

Agriculture, Monetary Policy

I am reading Yasheng Huang’s ‘Capitalism with Chinese Characteristics’.  His main thesis is that the widespread perception that China’s reform and development has been a continuous process stretching from the late 1970s to today is wrong.

In fact, he argues, there are 4 distinct periods in China’s reform process.  The first period, led by reformers like Zhao Ziyang, was entrepreneurial, private sector lead, and pro poor, characterised by a million flowers blooming in the Chinese countryside as peasants left their farms to start small businesses and improve their quality of life.

The second period, which ran from 1989-92, was characterised by a very repressive atmosphere in which the Party clamped down on anything which looked like a threat to its power - including enterpreneurs and the institutions that supported them.

The third period, which I guess you could say was the Jiang Zemin era, ran from 1992-2002, and was the opposite of the first.  Growth was focused on urban areas and led by state owned enterprises.  The countryside and its entrepreneurs were starved of the resources they needed to start or grow a business.  Growth was anti-poor as the benefits of China’s growth flowed to the cities and, within the cities, mainly to the rich.

The fourth period is the Hu Jintao era and is ongoing.  Huang argues that the early signs from the Hu era are positive, with a renewed emphasis on enabling private sector and pro-poor development.  I’m not sure that thesis would hold up so well given the events of the last year, where the government has pumped massive amounts of resources into the state sector and policies that would support rural entrepreneurs (notably land reform) have been placed on the back burner.

Huang certainly provides a compelling and carefully researched counter-narrative to the standard understanding of China’s upward march.  One significant event he doesn’t seem to find room for in his version of events is China’s entry into the World Trade Organisation, which occured at the end of the Jiang era, and runs contrary to his theory that Jiang was exclusively pro-industrial interests (many industrial interests lost out from, and lobbied hard against, China’s entry into WTO).

One interesting side point from Huang’s analysis is his view on the privatisation of China’s State Owned Enterprises.  China followed a policy of ‘grasping the big and letting go the small’ which basically meant selling small and unprofitable enterprises and keeping hold of big, profitable enterprises, especially if they are in strategic sectors.

Huang argues that from the point of view of maximizing economic efficiency and social welfare they should have done exactly the reverse.  Profitable enterprises are best run by the market, so they should have been privatized.  Non-profitable enterprises, if they have a social welfare function, should be run by the government.  If not, they should be closed down. 

By privatizing big profitable enterprises first, the government would have been able to use the proceeds from the sale to cushion the blow of unemployment from the closure of these moribund smaller state owned enterprises.  Instead of ‘grasping the large and letting go the small’ the government should have ‘grasped the small and let go the large.’

Agriculture, History, Industry, Social Policy

Back at the beginning of the year, many commentators expected the global economic slowdown to have a wrenching impact on China’s social stability.  China’s export industry is a major employer, the argument ran, with exports slowing down then will be mass unemployment and, therefore, social unrest.

That social unrest has, so far, failed to materialise.  A new study by Stanford University and the Chinese Academy of Sciences (CAS) helps explain why. 

The study shows that the initial impact of the collapse in the global economy on China’s off-farm rural workers was severe - with 45m of an estimated 265m losing their job.  But the study also shows that by accepting, in many cases, a lower wage, or moving to a new area of the country, the vast majority of them were able to find a new job within a few months.  Re-employment, not revolution, was the first reaction of those who lost their job to the wave of factory closures.

Prof Scott Rozelle (one of the authors of the Stanford CAS study) and I, have an article in the latest issue of the Far Eastern Economic Review (FEER) setting out the results of the study.  FEER subscribers can see the whole article here.

This is a short section of the article which contains the most interesting new information from the study:

‘The survey data show that the initial impact of the crisis was much worse than was previously imagined. Of the 265 million rural-dwellers with off-farm employment, 45 million, or 17%, either lost their jobs or delayed their move out of agriculture between September 2008 and April 2009. The impact was felt more deeply in southern provinces than northern, which was to be expected given the concentration of exporters in the south. Younger workers were hit harder than older workers, perhaps because the experience of older workers made them more valuable and factory owners were more reluctant to let them go. Less educated workers were more likely to lose their jobs than more educated; those educated to primary school or lower were most likely to face unemployment. The impact of the crisis was neutral between men and women, which suggested that the trend toward a higher share of female workers in the off-farm labor force will not be interrupted.

But the results also show that the ability of China’s migrant workers to adapt to the crisis was much better than was previously imagined. By April 2009, the results suggested, 25 million of those rural workers who lost their off-farm jobs had found new employment. By August, that number had increased to 32 million, leaving just 13 million unemployed, or 4.9% of the total off-farm rural labor force.

The results also indicated that the reason for the success of migrant workers in finding new employment was a willingness to accept lower wages. In response to the massive increase in surplus labor, off-farm wages adjusted downwards by about 10%. For China as a whole, that meant a fall from about 850 yuan ($125) per month average off-farm wages in 2008 to about 765 yuan per month in 2009, with a steeper fall from a lower base in the south than in the north. It was not clear whether falling wages resulted from falling hours, falling hourly rates or some combination of the two. But what is clear is that the market for China’s off-farm rural labor is flexible, and wages have adjusted to accommodate the shock from the sharp decline in demand.’

Agriculture, Financial Crisis, Labour markets, Social Policy

One year ago, in a speech in Anhui province, President Hu Jintao seemed to make a committment to solve one of China’s most complicated and pressing social problems - land reform.  Giving China’s 700m peasant farmers legal title to the land they farm would do more than perhaps any other policy to make a reality of the current leadership’s committment to build a harmonious society. 

But no sooner had President Hu spoken, the financial crisis erupted and land reform was off the government’s agenda.  In an article in today’s WSJ China, Prof Scott Rozelle and I argue that the time to return to China’s stalled land reform has arrived.  You can see the article in Chinese here.

Agriculture, Financial Crisis, Labour markets, Social Policy

Last week was an important one for economic data releases.  Data on trade, investment, consumption, and industrial output in August were all released.  For many China watchers, the focus was on the disappointing export figures and the encouraging rebound in real estate investment.

But for at least one Beijing newspaper, the headline grabbing statistic was a 0.5% year-on-year increase in food prices.  The fact that the New Beijing Times (新京报 － Xin Jing Bao) chose the tiny increase in food prices as their front page story says a lot about economic priorities within the nation’s capital.

The paper notes that this is the first time food prices have increased in the last 6-months.  They add that in his speech at the World Economic Forum in Dalian last week, Wen Jiabao departed from the familiar script on the economic recovery to mention the risk of inflation.  And that the Ministry of Commerce’s index of agricultural prices has shown increases in each of the last 9 weeks.

A spokesman for the National Bureau of Statistics said ‘the increase in food prices reflects strengthening domestic demand, but we are completely confident that food prices will remain stable going forward.’  A spokesman for the Ministry of Agriculture said: ‘though some areas of the country have been affected by drought, barring any unforeseen disasters, we are expecting a good harvest.’

Why did the New Beijing Times lead with the food price story when trade or investment figures speak more loudly to the current state of the economy?  I think there are two reasons.

First, food prices are a big deal in China.  Last year’s food price inflation had President Hu Jintao out in the food markets conversing with peasant vendors and local shoppers, inquiring about price changes and their impact.  Food makes up a substantial part of China’s household spending, and the poorer you are the higher the percentage of your income you spend on food.  So changes in food prices can quickly translate into popular discontent, and it is only a short path from popular discontent to social instability.

Second, the massive monetary stimulus in the first half of the year has created the right conditions for inflation to take off.  So far, most of the new money that has been created has flowed into capital markets (equities and property) and that is where we are seeing the price rises.  If it starts to flow in goods markets then we could see inflation accelerating pretty quickly - and that is something the government will be paying close attention to going forward.

Here’s the original article.

Agriculture, Monetary Policy

One of the big unknowns about how China is dealing with the economic crisis is the situation of migrant workers.  At the beginning of the year, reports of 20m unemployed migrant workers conjured dark visions of social unrest.  Fast forward several months, and the National Bureau of Statistics has published a note suggesting that the vast majority of migrant workers have in fact found work, and the ones that have not have industriously started their own micro-enterprises.  An unemployed horde laying waste the social order or happy workers returning from the fields to the factories?  The truth lies somewhere in between.

Huong Trieu is a PhD student at the University of Michigan, focusing on access to public services for migrants in China.  She has spent the last 6 months conducting field research amongst migrant communities in Beijing, and will spend another year performing research in Shanghai, Zhejiang and Guangdong.  She was kind enough to answer Chinatranslated’s questions on the migrant worker situation.

Chinatranslated: We hear a lot about how migrant workers are being affected by the economic crisis, you have spent a lot of time interviewing migrant workers over the last few months, what’s your assessment of the impact of the crisis on their lives?

Huong Trieu: This really depends on which city these migrant workers are located in. Since Beijing is not a large exporting city, its economy is less affected by the economic crisis. So migrant workers in Beijing are less affected. Unlike coastal cities where migrant workers are concentrated in factories, migrant workers in Beijing mainly work in service industries. When you walk around Beijing, you’ll notice job postings on restaurants, hotels, salon and so on, which suggest that there is actually a labor shortage.

The situation in Guangzhou is quite different.  Migrant workers in Guangzhou are affected by the crisis because most of them work in factories and some of those factories have less work or have closed down. One surprising discovery  from my conversations with scholars and social security bureaucrats in Guangzhou, is that many medium and large firms are not laying off workers. While these firms have cutback hours for many workers, they do not want to lay off workers because they are waiting for orders to rebound. They want to keep these workers on the payroll because it is difficult to hire and train new workers.

For migrants who have returned to the countryside due to economic crisis, many are not too worried. As migrant workers, they lead a very transient life style. It is not the first time that they have lost a job and returned to the countryside. They are optimistic that jobs will rebound, especially given the current government stimulus package. They still have land in the countryside, plus their expenses are very low. Housing and food are not a concern because their houses are paid up front, and they usually have enough food to subsist for at least 1.5 years. However, if they cannot return to the city within that time, social instability is definitely a concern.  Migrants are exposed to new ideas and living conditions in cities, so a prolonged stay in the countryside where they are excess labor with little upward mobility could potentially lead to unrest.

Chinatranslated: The migrant experience is different in different parts of the country.  You have been conducting research in Beijing, Guangzhou, and Shanghai, what are some of the similarities and differences between life for migrant workers in these three important centers?

Huong Trieu: There are important similarities in the migrant experience across the country. Migrants are relegated to the poorest living conditions because their wages are often a fraction of the local population. They are often doing work deemed undesirable by locals or the so called “3-D” (dangerous, dirty and difficult). Plus they are treated as outsiders in their host cities, ‘waidiren’, in terms of social policies.

Despite these general similarities, major differences do exist between cities. In Guangzhou, Dongguan, Shenzhen, migrants mostly work in factories. While conditions may be abysmal in these factories, most workers do have labor contracts which stipulate minimum wage, overtime pay, labor safety and social insurances. With the passing of the 2007 Labor Contract Law, workers are more aware of their rights. Even though workers are still at a disadvantage because enforcement of the labor contract law is a problem, the fact that these workers are employed in the formal sector means that there is an opportunity for them to use legal action to address their grievances.

In contrast, in Beijing and Shanghai many migrant workers work in the informal sector. They do not have labor contracts because they are usually working in small enterprises such as restaurants, hotels and so on. They may also be entrepreneurs themselves, selling knickknacks, operating 3 wheel carts, or performing household repairs. As a result, they do not have social insurances and are at the whim of city developers who can designate their home or workplace for demolition within a 1-2 month period.

As a result, migrant workers in Shanghai and Beijing are at a major disadvantage when it comes to disputing about their rights. Another point to keep in mind is that when you have a large number of workers in a single factory, it is much easier for workers to organize. So you see more worker protests and strikes in Guangdong. In contrast, you rarely see large protests in Beijing and Shanghai among migrant workers because they are working in a large number of small, disaggregated enterprises.

Chinatranslated: Your research is focused on access to public services for migrant workers, could you briefly outline the access migrant workers and their dependents have to education and healthcare, and how the costs and the benefits of the services they receive differs from the native population?

Huong Trieu: On education, migrant children are supposed to receive free, compulsory education in public school in cities, but all schools have quotas for migrants due to limited resources. Migrant children need to take qualifying exams to attend public schools. Good public schools are very hard to get into because the space is very limited. Even local residents have a hard time securing spots for their children in good schools because they need to have enough resources to buy an apartment in that particular community.

What is more, under the current education system, all migrant children need to return to their hukou place (home town) to take the college entrance exam. This is a not a national, standardized exam. Each locality has its own curriculum and therefore a different exam. So many of these migrant children are sent home to their grandparents when they reach middle school age because attending schools in their host cities would be useless if they want to pursue a college education. If these children plan to go attend vocational schools, they do not need to return to their hukou place.

On healthcare, there are three types of public insurance available in China: urban employee basic medical insurance, urban resident basic medical insurance, and rural new cooperative medical system. In the new healthcare reform released in April 2009, migrants can choose between urban employee basic medical insurance and rural new cooperative medical system (RNCMS). A 2006 State Council report showed that only 10% of migrant workers have any type of health insurance. I believe this number is much higher today because the 2007 Labor Contract Law has pushed many enterprises to provide social insurance for their workers. Plus the rapid roll out of RNCMS has also captured some of this migrant population.

In my interviews, many migrant workers have signed up for RNCMS at their hometown. While many of them do not have any experience using this new system, they are relieved to have some health insurance coverage. For many migrants, unless it’s an emergency, they would wait and return to their native place to seek medical treatment, partly because overall medical costs are lower and partly because they can get reimbursement from their health insurance in the countryside.

In China, all medical costs need to be paid in full and then reimbursed. To get a medical procedure done, you need to put down a deposit to secure an appointment. Depending on the procedure, it can be a couple of thousand to tens of thousands yuan. In many respects, migrants cannot afford to get sick. In host cities, local residents can apply for social assistance, but migrants cannot because local social assistance bureaus are not responsible for them. They would need to return to their hukou place to apply for social assistance.

Chinatranslated: Migrant workers have been a feature of Chinese society since the beginning of the reform period.  How are the latest generation of migrants different in their attitude and expectations from previous generations?

Huong Trieu: The biggest difference between older and younger generations of migrants is that the younger generation is less tied to their native places. While many migrants still come to cities through social networks, they may not always stay within this social network. They may choose to socialize and live with friends made outside their native place network.

In Beijing, there used to Zhejiangcun, Anhuicun, Henancun where migrants from a single province would live in the same settlement, but these no longer exist, partly because the city government have demolished them and partly because people have chosen to live with people from other provinces.  Migrant villages still exist in Beijing, mostly outside the 5th ring road, but not by native place anymore. These villages have become a melting pot of people from all over China coming to Beijing looking for better opportunities.

This younger generation of migrants does not see Beijing or Shanghai as their last destination. They are young, and they want to see the country. They are willing to move wherever their next job takes them. They do whimsically think about going back home eventually when they strike rich.  But if they do get rich then they can buy an apartment in Beijing or Shanghai as well, they need not return to their native place. This is very different from the older generation who sees their last destination to be their native place (laojia). They have built 2-3 stories homes in their villages with earnings from earlier sojourns in the city. Even though they are still working in the city to support their children through higher education, they plan to retire to their village with future financial support from their children.

Agriculture, Financial Crisis, Labour markets, Law, Regional, Social Policy

One of the standard narratives about problems with the Chinese (and world) economy goes something like this:

Chinese industry is hugely profitable but responds only clumsily to market signals. The result has been massive overinvestment and a build out of production capacity in excess of the needs of the domestic market. That excess capacity is then exported to the US and EU in the form of cheap consumer goods. The profits are used to build yet more production capacity, exacarbating the trade imbalance which is at the heart of the current crisis.

Exporting overcapacity, the story goes, has saved China from the consequences of its poor investment decisions. But with overseas demand drying up, there is no foreign market for the goods China produces and they are being dumped on the domestic market, causing a fall in prices and a slump in profitability for producers.

All of this means that China should respond to the crisis by boosting domestic consumption - so that Chinese consumers can take up some of the slack left by newly-frugal consumers in the US and EU. The best way to achieve this would be to use stimulus funding to subsidise households - for example through personal income tax cuts, or higher levels of education and health spending. Unfortunately, the government has chosen support for the corporate sector as the main vehicle for stimulus spending. This will mean the building of more production capacity, at a time when external demand looks set to enter a period of prolonged weakness.

That’s the story, and I for one think it makes a lot of sense. But I was speaking to a professor at one of the universities in Hong Kong, an expert in the Chinese economy, and he was very relaxed about the overcapacity problem, at least from a medium term perspective. The point he made is that with growth of 8% a year, the economy doubles in size every 9 years, and so even 100% overcapacity would be gone in a decade, and the much lower levels of overcapacity would be dealt with in a much shorter period of time. That might not be of much comfort in the immediate future, but at least it suggests that a still rapidly growing Chinese economy will be able to accelerate through any poor investment decisions made in response to the crisis.

We also spoke briefly about barriers to trade within China - provinces favouring local producers and barring market access to producers from other provinces. This has been a hot issue in the current crisis, with some provincial governments following a ‘buy local’ policy with their procurement (a more extreme version of ‘buy China’). One province reportedly required all government employees to smoke a certain number of locally produced cigarettes a day.

The professor I spoke with had a story about crossing the line between two counties in Sichuan a few years ago, and being searched for edible mushrooms. Apparently one county had a tax on mushroom producers and the other did not so mushroom smuggling was rife. Notwithstanding this example, the professor thought that provincial protectionism was not in fact a serious problem. The removal of all barriers might boost inter-provincial trade by 10%, but it was difficult to see the political will to make that happen.

Agriculture, Competition, Financial Crisis, Industry, Investment, Regional, Trade

Reliance by local government on sales of land to finance their spending comes at a cost in terms of social and economic stability. A research institute under the Ministry of Finance has recently published a review of some of the key issues. The main findings from their report, as translated by me, are:

As land is a scarce resource, reliance on land sales as the basis for local government finances is inherently unstable. What will local government’s rely on for finance when they have sold all the land?

A second reason for instability is that there is a strong link between demand for land and the situation in the property markets. A downturn in the property markets will mean less demand for land and a shortfall in local government’s finances (which is exactly what is happening now).

The scope for massive profits from land sales encourages local governments to break laws and regulations to sell land. This has negative consequences for social stability (peasant farmers whose land has been requisitioned are not normally happy people) and for food security (less agricultural land means less food supply).

Revenue sharing arrangements for different types of tax (for example corporate tax), whereby local government only gets to keep a fraction of the revenue they collect (the rest being transmitted up the the next level of government), encourage local government to focus on land sales as a revenue source. The same system also encourages local government to keep revenue from land sales off-budget - and so out of the hands of higher-level local and national governments.

These factors have contributed to a surge in revenue from land sales by local government, both as an absolute number and as a percentage of total revenue. In 1987, revenue from land sales by local government was Rmb230m, less than 0.1% of total local government revenue. In 2006, land sale revenue was Rmb860bn, 35% of total revenue.

Furthermore, the reliance on land sales as one the mainstays of local government finance contributes to pressure on the price of land - as local governments try and secure the best price. The knock on effect is higher house prices, which changes Chinese people’s saving and consumption behaviour. As Chinese people have to save more and consume less if they are to have any hope of affording to buy a house, this contributes to the imbalance in the overall economy.

The authors note that the slowdown in the property market as a result of last year’s macro-economic tightening and this year’s economic slowdown have brought these problems to a head. But they also believe that they cannot be addressed in isolation from thinking about the entire system of local and central government finance, and the relations between the different layers of government.

You can see the report in Chinese here: http://www.crifs.org.cn/0416show.asp?art_id=3105

Agriculture, Fiscal Policy, Property, Regional, Social Policy