Wednesday, January 2, 2019

China reading links - crony capitalism, real estate market, growth model etc

1. A fascinating account of corporate relationship building associated with political turnovers in China.
In this paper we empirically study how firms build their relationship with local government officials in China. We focus on two mechanisms: perk spending and personnel changes. We find that, following the turnover of the Party Secretary or mayor of a city in China, firms (especially private firms) headquartered in that city significantly increase their “perk spending” (e.g., travel expenses, business entertainment expenses, overseas training expenses, board meeting expenses, company car expenses, and meeting expenses)... we also find that the perk expenses increase more when the demand to build relation is stronger, e.g., when the incoming official is young, or is from a different city, and when the firm is less connected. This effect is weaker when officials are more reluctant to accept perks due to elevated risks of discipline, for example, after the 18th National Congress of the Chinese Communist Party, or after an arrest of local politicians for corruption cases. Our evidence also shows that firms with more perk expenses receive more future benefits such as government subsidy and access to financing, but do not have better future performance as measured by returns on assets or equity.

Interestingly, the second relation building mechanism, personnel change, is only effective among local SOEs. Local political turnover tends to be followed by changes of Chairmen or CEOs of state-owned enterprises located in that city, particularly for those controlled by the local government. In contrast, private firms and SOEs that are controlled by the central government do not seem to engage in personnel changes following the turnover in the local government leadership. We also find that those Chairmen or CEOs of local SOEs are the protégés of the local government officials: they are less likely to be replaced in the future as long as their “mentors” remain in offices. 
2. Wei Xiong develops the "mandarin model" of economic growth to explain China's mixed economy. 

Fundamentally, though regional (province, city, county, and township) government officials are appointed by the central government (the party) and not appointed by local electorate, the local governments have large fiscal independence - regional governments make up over 70% of the fiscal spending in China. The federal government put in place a tournament system to incentivise regional government officials - those achieving fast economic growth were promoted and those with poor performance penalised. Thus officials at different levels had both the incentive and fiscal resources to compete and promote local economic growth. 

He points to two features of the country's economy,
First, the government takes a central role in driving the economy through its active investment in infrastructure. Second, agency problems in the government system generate a rich set of phenomena in the Chinese economy, including not only rapid economic growth propelled by the tournament among local governors but also short-termist behaviors of local governors, which directly affect China's economic and financial stability... The latter channel helps to explain a series of challenges that confront the Chinese economy, such as overleverage through shadow banking and unreliable economic statistics.
The focus on economic growth on the one hand encouraged investments in infrastructure (since it contributed to aggregate economic growth), but on the other hand encouraged local officials to over-report growth and also leverage to expand their fiscal budget and over-invest. 

The agency problems triggered an unhealthy competition between provincial governors to over-report and leverage up. While the central government was aware of the over-reporting and leverage and tried to control it, their support for innovations also meant that the governors had enough flexibility to over-report and hide leverage in innovative financing approaches (eg different types of local government financing vehicles and shadow banks). Short-termist behaviours prevailed and motivated governor to indulge in them. 

3. In another paper, Wei Xiong and Chang Liu have an excellent account of the evolution of China's real estate market. This summary of the current challenge is apt,
First, housing holdings are the biggest component of Chinese households’ asset portfolios, partly due to a lack of other investment vehicles for both households and firms in China’s still underdeveloped financial markets. Second, China’s local governments heavily rely on land sale revenues and use future land sale revenues as collateral to raise debt financing through “Local Government Financing Platform” (LGFP). Third, firms also rely on real estate assets as collateral to borrow, and since 2007, firms, especially well-capitalized firms, have engaged heavily in acquiring land for investment purposes. Finally, banks are heavily exposed to real estate risks through loans made to households, real estate developers, local governments, and firms that are either explicitly or implicitly backed by real estate assets.
They explain the trajectory of policy led development of real estate market. In 1988, the government amended constitution to allow land transactions - it was however not ownership, but "land usage right" for a fixed period of time (upto 70 years for residential use). In 1994, the government allowed for the first time government employees to purchase full or partial property rights, at subsidised prices. 

In 1998, this welfare housing system with its discount was abolished and full-fledged private housing was allowed. This privatisation of housing released the pent-up demand for housing asset accumulation by households and catalysed the real estate market. It also alleviated credit constraints and stimulated entrepreneurship. Simultaneously, banks began to provide residential home mortgages at subsidised interest rates, and these rates were lowered five times between 1998-2002 to boost private house purchases. 

Further, in 1998, the de-jure ownership of land was transferred from the central government to the local governments. They were also authorised to sell usufruct/leasehold rights over their lands. To restrain corruption in sales, in 2002 it was mandated that all residential and commercial leasehold sales be through auctions. 

Then in the early 2000s, urbanisation became the growth strategy, though it was regulated with the hukou permit system (till its abolition in 2014, except in case of some very large cities). This led to the development of numerous greenfield townships which further boosted the real estate market. Doubtless it led to excesses and ghost towns, but over time, once built and infrastructure completed, these towns became fully occupied. All through this, the government fulfilled its responsibility in supporting growth by developing all the required infrastructure in quick time. 

Land was similarly central to industrial growth - while residential and commercial land prices boomed, industrial land prices remained stagnant since local governments offered it at heavily subsidised prices to attract industries. 
The housing boom also explains China's high savings rate and low consumption. The authors feels that the relatively high, 30%, minimum down payment condition for mortgage loans mitigates some of the risks that banks face from a property market collapse. 

This summary of what backstops the real estate market is important,
To the extent that local governments are local monopolies of land supply and heavily rely on land sale revenues for their own fiscal budgets, the markets for residential properties and commercial real estate are crucially tied to land sale policies and strategies of local governments. This is a special feature of China’s real estate market.
The under-developed and restrictive financial market too is perhaps a backstop for the real estate market. 

Two further reforms were important in steering local governments to focus more on real estate to realise resources. The Tax Sharing Reform Law 1994, apportioned a greater share of the tax revenues (all collected by local governments and shared with the centre) to the central government. The Budget Law 1995 prohibited local governments from running budgetary deficits or obtaining external financing. Both these forced local governments to expand their non-budgetary finances, especially from land sales. 
In 2008, in response to the global crisis, the central government eased the 1995 restrain on budget deficits and allowed local governments to float local government financing vehicles (LGFVs) and raise debt. This, as we know now, spawned its set of excesses. The LGFV is an entity to which some land reserves are transferred or which owns future land sale revenues. It then uses this collateral to raise money from banks and elsewhere. The LGFV can carry an implicit or explicit local government guarantee. 

According to Chinese National Audit Office, in 2013 total volume of outstanding local government debt was 19.2% of GDP, of which 37.23% used future land sale revenue as collateral. Further, governments have an explicit obligation in 61% of the debts. Since then, restrictions on bank lending to LGFVs has pushed the costlier and opaque shadow banking system to prominence as lenders to LGFVs. 

In recent years, the government has tried out some reforms to diversify away from land as a source of local government revenue. In 2011, property tax was trialled on second homes in Shanghai and Chongqing, but not expanded due to fears of public opposition and a real estate crash.

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