Noble Prize winner economist Joseph Stiglitz commented once that urbanization in China and development of high-tech industries in US were the two great events that would shape human development in the 21st century.

By the end of 2013 China’s urbanization reached to a level of 53.7%. Having climbed to 730 million the urban population in China is almost equivalent to the entire population in Europe.

China’s urban population is spread into 658 municipals and 20000 towns. There are 6 municipals of population over 10 million, 15 are in between 4 to 10 million and 140 are over one million.

China’s urbanization is estimated to grow by 1% per annum which means 16-20 million people would relocate to cities. Chi Fulin, a well-known economist in China, assumed that this could double China’s consumption, currently at 25 trillion yuan, and stimulate fixed investment up to 50 trillion yuan by 2020. The total domestic demand would hit 100 trillion yuan then.

However being a flawed process, China’s urbanization is not on a solid path that its future is surely predictable. Fundamental adjustment is needed before it could become a major engine to China’s future growth.

  1. Unsustainable approach

Entrust local governments of great economic autonomy through economic decentralization while keep their political function intact is one of the pillars underpinning China’s reform that aims at integrating the power of one-party state with market efficiency.

In such an approach Chinese local governments are encouraged to invest heavily in setting up low-cost production base for the attraction of foreign investment.

Chongqing, China’s leading city in fixed investment in 2013 spent 1.1 trillion yuan to secure its position as an economic hub in southwest China and new frontier in the attraction of foreign investment.

In a similar pattern all major Chinese cities had their fixed investment over 100 billion yuan in 2013, including Tianjin (1.01 trillion), Beijing (703.2 billon), Wuhan (600.1 billon), Shanghai (564.8 billion). The investment-to-GDP ratio of Chongqing was 88.5%, Tianjin 70%, Xian 105% and Guyiang 145%.

The local government initiated and coordinated investment has a nature of promoting local export. Massive buildup of infrastructures and manufacturing capabilities and rapid expansion of export have been the most important engines driving China’s economic expansion and urbanization as close to 200 million migrant workers taking jobs in cities from rural areas.

Such development can only continue if the authority can effectively sterilize its two consequences: oversupply of money and rise of local government debt.

With rapid growth of export and continued trade surplus, the Chinese central bank has to issue large amount of money to redeem foreign currency from Chinese exporters in order to keep the exchange rate of yuan at a targeted range. This in combination with expansionary policies has resulted in supply of money continuously outstripping growth of the economy. In recent years the money supply has been at a rate almost doubling the growth of the Chinese GDP.

The Chinese government has to build a “dam” within the economy to withhold excessive money from circulation in order to control inflation.

In addition, given conventional means are impossible to satisfy the financial needs of Chinese local governments in supporting their heavy investment, extra resources must be made available for local governments to raise fund and secure bank loans.

It is in such a context, the housing sector in China has become the “dam” on one hand holding excessive money within the economy and on the other financing government investment by turning land into capital.

It works in such a way: Given extreme violation of the Chinese stock market, real estate has been the primary choice for investment since the late 1990s when housing reform was initiated. Influx of capital from both domestic and overseas has pushed land and houses prices consistently up which increased by 84% in the past 9 years and even higher in major cities. The housing sector received 70% of the social finance which was the sum of domestic credit expansion by banking and non banking sector in 2013.

The Chinese government is the most outstanding beneficiary of this property boom. Soaring of the price on properties and land has increased the financial capability of local governments by both selling land and borrowing from banks on mortgage of the land in their control. Further local governments have enjoyed consistent increase of tax revenue related to sale of properties.

It is reported that the ratio of land sale to government revenue was one third to the central government and over 50% in average to local governments in 2013. In some extreme cases it reached to 156% for Hangzhou, capital city of Zhejiang province; 110% for Nanjing, capital city of Jiangsu province; and 105% for Changsha, capital city of Hunan province.

Without the housing boom it would impossible for China to push ahead the investment-export driven economy and urbanisation while keep inflation at an acceptable level. However this important sector has shown signs of cracking due to its abnormalities.

The house prices to average annual income currently in China is about 10 times with major cities even higher. It is 19 times in Beijing and 16 times in Shanghai and Shenzhen. Such price level makes property far beyond affordability to most Chinese citizens but favorite tool for investment to the rich.

However the demand for investment in property is declining due to factors ranging from high level of oversupply, tightening of the money supply, crackdown on corruption and to returning of hot money to the US as a result of withdraw of the US QE policy.

In a report published by China Southwestern University the unoccupied dwelling in China was estimated to be 22% by 2013. Housing price is dropping in some second and third tier cities and wobbling in major cities including Beijing and Shanghai. Some commentators believe the Chinese housing market is heading to a collapse.

If this would happen it could significantly reduce the capacity of Chinese local governments in serving their debt. Given total debt of Chinese local governments and business combined is estimated 220% of China’s GDP by Standard Chartered, the abrupt contraction of government spending could trigger bankruptcy of large number of businesses and financial institutions.

Though there are objections to the judgment that the Chinese housing sector would trigger a 2008 style financial meltdown, it is widely accepted that the time has gone of making the housing sector the foundation to China’s economic expansion and urbanization.

Apart form the downturn of the house market; China’s urbanization also faces other challenges.

The heavy investment on infrastructures and skyrocketing of property prices has inevitably transferred into rise of business cost in terms of increase of rent, road tolls, government fees, and wages. This hits small do medium sized businesses in the private sector particularly hard as they are also troubled with access to loans from state owned banks.

Therefore China’s urbanization faces pressure of delivering sufficient jobs for migrant workers in long term. In accordance to international benchmark service industries that could accommodate migrant workers in large amount should take off when urbanization reaches 50%. However the share of Chinese service industries to GDP only accounts for 44% which is in the lower-middle range internationally.

In addition, China’s urbanization so far has avoided tackling the household registration system. Because of historical factors, only citizens with urban household registration are provided with various social security benefits. It is estimated that it would cost up to 100 thousands yuan per head in offering migrant workers and their family members with the social welfares equivalent to their urban counterparts. At the aggregate level this would cost up to 42 trillion yuan. It will be a huge burden for local governments to fulfill such commitment.

So far it has been very difficult for migrant workers to settle down in cities as neither they are afford to buy apartments nor access to the benefits in healthcare, education and employment. Despite of reaching 53.7%, the real level of urbanization in China is much lower as only 35% of the people living in cities have urban household registration and enjoy social security benefits.

There are comments that the urbanization at the current terms has been one of the most effective factors causing social disparity and tension. While rich people dramatically increase their wealth through investment in property, poor people suffer from devaluation of their saving. When spending money overseas becomes a fashion for the rich, poor people are struggling with their income to meet the needs in healthcare, education and mortgage. Obviously urbanization in such terms has very limited effect on lifting up domestic consumption.

Furthermore, the concentration of resource and labour intensive industries around major cities has made pollution, water shortage and traffic congestion major bottlenecks to future development.

 

china building

2.Reconfiguration

The change of economic conditions indicates that China is unable to grow its economy in the existing pattern any longer. It is urgent for China to restructure its industries and increase domestic consumption.

It is in such context, urbanization which can be considered as a by-product of the economic expansion led by investment and export in the past has been highlighted as one of the most important initiatives for future growth because of its potential in stimulating domestic consumption.

Currently major Chinese cities in coastal regions like Beijing and Shanghai are facing constrains ranging from rise of production cost, pollution, water and land shortage and overpopulation. In the contrast, cities in inland provinces are relatively having comparative advantage in labour cost and availability of land and raw material.

It is logical that the restructure of the Chinese economy should be focused on facilitating development of high-tech, high value added manufacturing and service industries in advanced cities while shift labour and resources intensive industries to inland provinces.

The highlighted plans of the current government in this regard are to build Yangtze River economic corridor and new Silk Roads by land and sea. Specifically based on existing major economic centers along with Yangtze River from its upstream in the west to downstream in the coast, several city clusters will be set up covering thousands of kilometers in distance and 600 million in population. The Yangtze River economic corridor is further extended to major cities in China’s northwest and southwest connecting international trade routes to Europe via Central Asia; Africa and Middle East via India Ocean and Southeast Asia.

The investment on infrastructures like high-speed rail, waterway, highway, airport, and power-energy supply networks linking these cities will be the key stimulus securing China’s growth around 7-7.5% throughout the transition period.

The development of advanced manufacturing and service industries in China’s major cities should take a lead in the upgrade of the Chinese economy. The relocation of matured manufacturing industries to inland provinces in combination with new trade routes should maintain China’s advantage in export of manufactured products. The rise of inland provinces in economic activities will be the most important catalyst to the urbanization as it should absorb most of the migrant workers.

The past experience indicates that it is likely that China could succeed in creating hardware for expansion of urbanization by shifting laobur and resources intensive industries to inland provinces and building up infrastructures. However this will not be a decisive win. The real challenges for China in advancing its urbanization lie at two aspects:

First, if China could build up an innovative economy. There are complicated factors so far have prevented China from producing high-end products in large commercial scale with indigenous technology and components.

Without breakthrough in this aspect, the mega cities in China’s coastal regions will decline gradually. The problems such as overcapacity and pollution will be extended to inland provinces along with relocation of labour and resource intensive industries to these regions. Obviously China’s urbanization can not sustain in such a situation.

Second, if the authority could rebalance the interests among different social ranks in relation to advancement of urbanization.

To advance urbanization in China at this stage requires coordination and support from other fronts. Reforms to the household registration and social welfare distribution have to be carried out so as to help migrant workers and their families to settle down in cities. The system for the acquirement of land has to be reformed so that rural residents could benefit from appreciation of land and such value should be converted into the financial resources supporting relocation of rural residents into cities.

These reforms will significantly increase government spending on one hand and reduce government revenue on the other. Consequently it becomes inevitable for the introduction of property tax, streamlining government, reduction of government spending on reception, car and overseas trips and increase of profit submission to state by major state corporations.

The above government responses are actually shifting economic welfare from the privileged to disadvantaged social ranks which will be subjected to resistance from the interest groups whose interests are to be negatively affected.

Urbanization in China in the next stage will be a very difficult process as it directly or indirectly related to some most crucial aspects to the restructure of the Chinese economy and society. The determination and capacity of the Chinese leadership in removing the resistance and pushing ahead key reforms is the most important factor determining if China could successfully advance its urbanization.