Urbanisation has helped millions escape rural poverty in China and transformed its economic prospects, not to mention those of its many trading partners, but is it sustainable?
The construction boom is built – literally – on reforms to a communist-era land title system, creating so-called Land Use Rights (LURs). These allow for private development and property transactions on land that remains nominally state-owned.
Research from the Lee Kuan Yew School of Public Policy provides new insight into how these LURs are granted, contributing to our understanding of China’s urbanisation and where it might be head.
In the paper Market-led transactions and illegal land use: Evidence from China, Assistant Professor Li Hui, examines LURs in the context of further, market-led reforms introduced in the early 2000s.
The results provide a fascinating case study of how such market mechanisms can be used as a policy tool — to curb illegal land use and promote orderly urban planning aligned with broader social and economic goals.
Keeping up with demand
Since the 1990s, some 260 million people have migrated from China’s rural communities to its cities according to the World Bank, fuelling its continued and rapid transition from developing to developed nation.
Unprecedented construction across dozens of large cities has also stimulated demand for an array of once exotic imports, from the raw materials needed to making building products, to the luxury goods and services consumed by an increasingly prosperous urban middle class.
This huge demand has influenced global markets for three decades. But in China itself, the forces generating it are often on a local level.
As in many other parts of the world, responsibility for managing construction approvals rests with the municipal authority, not the national one.
It is local governments which award and renew LURs and local governments, crucially, which reap the financial benefits.
In many cases, however, the sheer scale of activity has proved beyond their capacity to provide sound oversight.
Vast sums of money, along with inevitable pressure to support development and growth, have created incentives to subvert due process, not to mention opportunities for rent-seeking and corruption.
Building a bubble
As the paper points out, income from land transactions is the single greatest source of off-budget revenue for local governments in China, comprising more than 70% of the total in some cases.
“However, most urban LUR decisions in the 1990s were made via arbitrary administrative allocation (xingzheng huabo) or negotiation (xieyi), and these non-transparent and non-competitive LUR transactions with weak oversight from the central government have opened the door to prevalent illegal land use,” according to the paper.
Survey evidence from 15 cities suggests that, as a result, more than half of all development projects in the early 2000s were technically illegal.
Aside from its criminal aspect, this rampant violation of planning regulations eventually began to acquire wider implications for financial stability and national economic policy.
The property bubble in cities like Shenzhen — where house prices rose by 62% in a single year — is just one example of the negative effects market distortions can have, and China’s central government became increasingly concerned.
Heightened risk of over-investment and land speculation helped prompt its decision to begin encouraging a new model of land allocation, so called market-led transactions or MLTs.
MLTs require local officials to adopt tender, auction or quotation in place of arbitrary administrative allocation or negotiation. “Theoretically, the market-led transaction approach is expected to enhance competition and transparency in land use rights decisions,” says Professor Li.
Unlike the old approach where LURs could be granted subject to negotiation with individuals or simple bureaucratic fiat, MLTs provide a more transparent process where bidding from multiple parties gives a truer reflection of market value.
According to Professor Li, the market-led approach also cuts down on intermediaries, reducing the possibility of reselling land at a profit and of the formation of land market bubbles. This in turn prevents corruption and stimulates healthy development of the real estate market.
Market forces
The fact that MLTs are not mandatory allows a comparison with areas where they have not yet been adopted.
Using a multi-level analysis model that controls for a number of variables, the paper sets out to exploit this opportunity, examining how effective MLTs have been in achieving their intended outcome.
The results are striking.
They show that a 1% increase in MLT adoption results in a 0.765% reduction in illegal land use cases and a 1.45% reduction in the total area of land affected.
“Although the overall level of illegal land use in China is still serious, the adoption of MLTs has been effective in reducing both the number of illegal land use cases and the areas affected,” says Professor Li.
“The adoption of MLTs in the 2000s can be seen, at least, to have prevented an increase in illegal land use during this period of very rapid economic and urban development.”
But the story of MLTs has a twist. Their use by local governments grew strongly until the global financial crisis in 2008. Changing priorities and economic stimulus seem to have encouraged a return to less market-oriented principles that are seen as fostering industrial expansion.
The result is a “u-shaped” trend in MLT adoption which the authors associate with the regulatory problems that are persisting in China’s urban development process to this day.
The study suggests that “the Chinese government should continue to utilise market mechanisms as a policy instrument to curb illegal land use and also try to close institutional loopholes to improve implementation.”