Deng Xiaoping, the architect of China’s reform always believed that the single party political system was of great advantage to China in its purist of modernisation. Deng was confident that by integrating the government power and market efficiency China could create conditions linking its abundant labour supply and market potential with foreign capital and technology and leading to repetition of so called East Asia Economic Miracle in China.

The ultra challenge for China to seek development in this approach is to find a way making its political system and state owned economic sector compatible with the market.

Making local governments capable of taking part in market operation through economic decentralization and maintaining their political and social function intact is the core of the Chinese solution to the task.

Under such a guideline, Chinese local governments of different levels (province, municipality, and county) have been granted with high level of autonomy in economic management ranging from sharing tax revenue with the central government, selling land in large scale, privatising state owned enterprises in various forms and to approval of major foreign investment.

In such a way Chinese local governments have been effectively turned into “economic entities” while they are still vital parts of the existing political and administrative systems designated to carry out tasks of social management.

This has created conditions to the break-up of the comprehensive state control of economic resources, development of a private sector and establishment of a mixed structure in economic management between government planning and deployment of market mechanisms. Based on this system China has embarked on an unprecedented economic expansion led by heavy fixed investment and strong export.

Land finance 

It has always been a puzzle to outsiders that how China can keep its fixed investment at an extreme level persistently and control its inflation when its money supply has been expanding at an extraordinary rate.

“Land finance” has been China’s secret to the challenge. The state monopolistic control of land in combination with a strong demand for properties has provided the government with great leverage in turning land into capital: By taking advantage of their power, Chinese governments of different levels can massively acquire land from rural and urban residents with limited compensation and sell such land to developers at significantly increased prices. Wu Jinglian, an influential Chinese economist, estimated that such price difference had created a huge profit of 30 trillion yuan in the past decades in a speech in 2013.

This huge profit, being stipulated as local level revenue, mostly went to local governments. This explains why Chinese local development normally starts with massive acquirement of land because revenue from land sale is often sufficient to initiate local projects ranging from infrastructure to manufacturing. In numerous cases the revenue from land sale has also been the key factor supporting the setup of social security networks and payment to redundant workers of failed state owned enterprises.

Apart from generating huge capital from land sale, expansion of the housing market has also created a reservoir for the deposit of huge amount of money being circulated within the economy, thanks to persistent trade surplus and expansionary government policies.

China’s money supply was 47.5 trillion yuan in the end of 2008; it increased to 124.27 trillion by January of 2015.

The massive circulation of liquidity within the economy is eager to find their destinations. When China’s export and manufacturing face downturn due to decline of foreign demand and rise of production cost it is the housing market that has become the safe heaven for capital.

The housing sector received one fourth of the total Chinese fixed investment or 70% of the social finance which was the sum of domestic credit expansion by banking and non banking sector in 2013. Without the house sector, China’s inflation will be much higher than the target set by the government.

Turning land into capital and development of the housing market has prepared China financially for its integration with the world: The capital derived from land sale enables the government to set up infrastructures and improve conditions for the attraction of foreign investment; the huge money in circulation as a result of persist trade surplus and government stimulus has found way in the housing sector.

“Land finance” perfectly illustrates the nature of China’s economic expansion which is to input resources into the economy at artificially low prices by taking advantage of government power. Inevitably this way of expansion has its downsides.

Unsustainable industrial structure 

Turning land into capital significantly increases the capability of Chinese local governments in offering low-cost environment to businesses through tax exemptions, cheap loans, offering industrial land for free or at very low price.

Such government assistance significantly reduces the entry barrier to a wide range of industries that require heavy initial investment and large operational scale and lead to establishment of such manufacturing industries all over the country, even in places where conditions are considered unfavorable.

Such local orientated projects are normally small in size but combined they can easily push the aggregate supply far beyond the domestic demand. Overcapacity becomes a huge and stubborn problem to the national economy and export a lifeline to a wide range of Chinese industries.

Chinese manufacturers, being excessively engaged in low value added assembling and processing, have had limited profit as their technology and international distribution are normally controlled by foreign companies. The benefit brought to the country by Chinese manufacturing industries sometimes hardly justifies the damages they imposed upon China’s environment.

Unfair distribution of national income

China’s economic reform is actually a process of reshuffling the control over the assets once state owned. The excessive dependence upon government in this process provides a favourable environment to the formation of interest groups between privileged (people have or close to power) and social elites who are running businesses and academic institutions. Without effective counterbalance such interest groups inevitably gain unfair advantage in the distribution of national income.

The rate of privileged in accumulation of their wealth is astonishing. Wang Xiaolu, an influential Chinese economist estimated in a report published in 2011 that the grey income which was about 3-6% of China’s GDP was mainly to be shared by 20% of Chinese families of privileged background through illegal, immoral and improper ways. The difference in average income in China between the top 10% families and the lowest 10% families was 26 times. It climbed to 65 times when the rural residents are included.

Rapid economic growth has not transferred into reinforcement to the regime. Seeing massive corruption and multiplication of assets by the rich, poor people who feel being left behind and betrayed are increasingly critical to the government. The social unrests have been around 100 thousands per annum in recent years as China has become one of the most unequal major economies in the world.

Escalation of crisis

For a prolonged period, in expectation that rapid growth would ease social tension, to pursue economic expansion at what ever cost has become a norm among Chinese local governments. Such an attitude pushes the dependence of Chinese local governments on “land finance” to a new high.

Currently land sale contributes to one third of the total revenue to Chinese local governments in general. 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 in 2013. Furthermore through their investment vehicles local governments borrow money heavily from shadow banking institutions to fund their ambitious projects by mortgaging their land.

The local governments backed projects are ether concentrated in infrastructures or related to the housing sector. Logically the industries to be stimulated by the investment are those construction related that are already troubled with overcapacity such as steel, cement, glass and aluminum.

For a prolonged period in the past, strong economic activities provided opportunities to the digestion of the overcapacity. However table has been tuned due to increase of production cost, decline of export and the environmental crisis.

China’s labour supply declined at a rate of 3-4 million per year since 2012. Consequently the average monthly wage for a migrant worker increased from 1340 yuan in 2008 to 2609 yuan in 2013. Furthermore, rise of price for land, high mortgage rate, inflation and social tension are inevitably transferring into increase of business cost.

China’s environment can not handle the growth in the current pattern any longer. The pollution of water, air and soil to China’s industrial regions including Beijing and Shanghai is often far worse than the normal standard suitable for human inhabitation. The water supply in north China where Beijing and Tianjin are located is so tight that a dam-cannel-pumping system of hundreds of kilometers has to be built to divert water from Yangtze River to Beijing. Despite that the water shortage in Beijing region will continue.

The tense situation has been compounded by wobbling of the housing market. Even a mild downturn of the Chinese property market will create a huge shortfall to heavily indebted Chinese local governments that are intensively dependent on revenue from land sale and property related tax. The danger that those heavily indebted local governments could not pay back their debt could trigger domino effects on those shadow banking institutions that are heavily engaged in making loans to local governments.

China on the surface is still fast moving, but deep down its problems are increasingly acute. The government is under great pressure to maintain a decent growth and ease social tension. However the corruption within the government makes people wondering if the government is able to take necessary steps to avoid the collapse of the economy and social management.

 

 

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Xi Jinping, General Secretary of Chinese Communist Party and President of China

 

Way out

China again faces a critical moment. This promotes all political powers within China to voice their vision for the future. While the rightwing claims the only solution is the combination of policies ranging from total privatization of state owned economic sector, freedom of media and to multiparty political system, the leftwing advocates returning to Mao era.

To the Chinese leadership both the way is unacceptable: while the one from the right will destroy the power base of the communist party; the one from Mao’s left will terminate China’s market orientated reforms.

Since taking office in later 2012, President Xi Jinping repeatedly affirms that solutions should be sought under the guidance of Deng Xiaoping’s theory which is to seek fusion between the signal party political system and the market.

To the Chinese leadership as long as it controls power, it will have sufficient ground for the test of different solutions. On the contrary should the authority be indecisive in upholding the single party political system it would open floodgate of criticism and lead to formation of organized oppositions capable of challenging its authority.

Recently Xi Jinping’s slogan of “four comprehensives” which are comprehensively build a moderately prosperous society; comprehensively deepen reforms; comprehensively govern the country in accordance with law; and comprehensively strict the party discipline has been highlighted as the vision of the authority to advance China’s economic and social development.

The primary interpretation is that the authority will continue to uphold the one party political system and push ahead market orientated reforms with particular focus of handing back excessive government power to the market.