America’s Silicon Valley and China’s Silicon Delta share a serious problem: housing affordability. For San Francisco, the astronomical price of housing may increasingly deter the very human capital on which the tech hub so desperately relies.
Halfway around the world, Shenzhen too has transformed from a sleepy swamp that was once populated byfarmersintoa gleaming but exorbitantlyexpensivetech hub.Between2014to 2020,Shenzhenproperty priceshavemore than doubled, far exceedingthe~60% increase in San Francisco during the same period. In fact,Shenzhen’s average apartment price has risen so much that some are finding it cheaperto live inHong Kong, one of the most expensive property markets in the world.
But the similarities between the two cities end there. San Francisco’s housing problemseems mainlyattributable to regulatory restrictions on building more housing supply. The issue for Shenzhen is more fundamental: the city government limits the allocation of residential land because it owns allof it.
Herein lies the rub:at the heart ofChina’shousing booms and busts is adistorted landallocationsystemthat underpins theentire propertymarket. Shenzhen, then,reflectsa microcosm ofasystem thatoften drives housing prices into the stratosphere, beyond the reach of affordability.
Abundance of Commercial Land
Demand factors such as population inflowscertainly contributed to Shenzhen’s housing shortage. But an important factor is the local government’s land supply policy that tends to favor commercial development over households. Between 2008-2018,despiteseeing more thanfivemillionpeoplemove intothe city,the Shenzhen government supplied almost three times more land for commercial use than for residentialuse.
Shenzhen’s pro-business bias in land allocation can be illustrated by the case of Huawei, the Chinese tech giant that has garnered quite a global reputation. Headquartered in Shenzhen, Huawei in 2012 decided tobuildan Apple Park-stylenew campus inDongguan, a manufacturing hub one-hour away from Shenzhen. Huawei’s reason for relocating? High land prices.
This is tantamount to Amazon leaving Seattle because it couldn’t afford to stay in the city. And as expected, the Huawei announcement shocked Shenzhen officials and spurredtheminto action. The Shenzhen governmenteventuallyreached a deal with Huawei to provide “support and services” to the company’s satisfaction for it to keepitsheadquartersin the city.
That scarring experience may have ledShenzhen officialstooverlearn the importance ofhaving affordable commerciallandtoattract businesses.By2017,the city’scommercial land supply was more than 40 timestheresidential land supply (see Figure 1).
Figure 1.Shenzhen’sCommercial Land Supply Far Outstrips Residential Land
Source: Wind andMacroPolo.
This strongly biased land policy has had negative effects on Shenzhen’s income distribution and overall growth. Since 2014, the year Shenzhen sharply adjusted its policy to favor commercial land, the cityhasseen below average GDP growth. Meanwhile, the city’sfiscal revenue and corporate profit growth both exceeded the national average by a large margin.
But that has come at the expense of household income growth, which has been below the national average (see Figure 2). This also doesn’t help China’s low consumption problem, since consumers have less disposable income. And to the extent they have money to spend, it is probably concentrated on saving for one major purchase: a home.
Figure 2. Shenzhen Government and Businesses Grow at the Expense of Household Income
Note:Positive value indicates Shenzhen growing faster than national average.Corporate profit is proxied by corporate incometax.Shenzhen’s corporate profitsdippedin 2018 due tothe US-Chinatrade war.
Source: Wind andMacroPolo.
Scarcity ofResidentialLand
Shenzhen’s problem isnot unique and is symptomatic of thenational property market. China’s urban housing boom is well known. Since 2015, residential property prices have appreciated by more than 50% in China’s largest cities.Over the past decade, average residentiallandsupply per new residentin the top 10 citiesis only 230 square feet—little more than the size of a typical hotel room—or less than 60% of the average per capita residential space in China.
Thecommercial propertymarket, on the other hand, is just the opposite. Thatmarket seems to be in a state of perpetual oversupply, with average office vacancy rates hovering around 20% over the last decade.
It is puzzling thatlocal governmentstend toflood the market with commercial landwhen there is clearly a premium for selling residential land (see Figure 3).While it is tempting to attribute the proximate cause to the Chinese state’s monopoly over land ownership,it actuallyhas more to do with local governments’ incentives for allocating land.
Figure 3.Stronger Demand for Residential Land
Source: Wind.
That’s because themainprerogative for local governmentsis to accrue benefits, usually in the form of fiscal revenue, tothemselves.Therefore, if they can attract more businesses into their jurisdictions, and if those businesses become profitable, then thelocalgovernment will collect more corporate taxes.
With ever increasing competition between cities, local governmentsface intensifying pressure to vie for businesses. So they haveresortedto one of the largest assets attheirdisposal, commercial land, as a major incentive.The people and the job opportunities, it is assumed, will follow.
At the same time, residential land supply is deliberately kept scarce so the government can actually make money on residential land sales. In effect, residential land sales serve as a cross-subsidy on local governments’pro-business land policy that sells commercial land cheaply. Ultimately, local governmentsget revenue from selling residential land at apremiumprice and getrevenue from businesses that locate there—a twofer that primarily serves the local governments’ interests, not households.
Property Tax to the Rescue?
Beijing has taken notice. The central government has called on major cities to increaseresidential land.Since 2019, Shenzhenhas suppliedmore residential land than in the previous decade combined.
Yet it is too early to declare victory.The central government can mandate local governments to increase residential land supply, but a long-term solution requires more fundamental changes to land ownership. That isn’t likely anytime soon because land is a financial asset for local governments, which means it directly affects local financial stability. If land is privatized, or its allocation and conversion become more market-based, that amounts to local governments losing their largest source of revenue.
Given that local governmentscurrently have$10 trillion in debt, and land sales beingthe most crucial and reliable source of income for debt repayment, any drastic changes to land ownership will seriously raise the risk oflocal governmentdefaults.Thatcaution isreflected inthe absence of notable changesin the 2019 land law revisions.
Meanwhile, Beijingispushing hardforimplementing the long-delayedproperty tax, whichin theoryis meant to reshapethe land market.Property taxcouldprovide an alternative source of revenue for municipal governments,whichshould reduce their reliance on land sales.By changing that incentive, local governments may be more inclined to naturallysupply more residential land.
So goes the thinking anyway.Butthe property taxin realitymayhave the opposite effect than intended. That is,aprogressive property taxwould make it moreexpensive for wealthy individuals to own multiple unitsand thereforereduce demand without affecting much change on the supply side.
That’s because the property tax is unlikely to come anywhere close to offsetting the revenue loss that would result from selling less land.With a 45% marginal tax rate for the topincomebracket, personal income taxrevenue isequal to around 1% ofChina’sGDP. Given that Beijing has openly stated that average households will be exempt fromtheproperty tax, it seems unlikelyto generate more revenuethantheincome tax.
In contrast, annual land salesarecurrently on theorderof more than 7% of GDP. Even after deducting for cost, it is safe to say that land salesgeneraterevenue equal to at least3% ofChina’sGDP.In fact,experiences inShanghai and Chongqing—where each city has imposed aproperty tax for a decade—are illustrative.Revenue from property taxisonly around 10% of land salesin Shanghaiand less than 5% for Chongqing.Unlesstheproperty tax canfill that gaping holefor local governments, there islittlehope thata propertytax will significantly alter China’s landallocations.
It isno surprise, then,why local governmentshave beenlukewarm ontheproperty tax.This lackluster interest will make it much more challenging for the central government to nationalize the tax. Eventhough the central government canmandate thetax,it is ultimately up tolocal governmentsto tailor andimplementthetaxbased on local conditions.In the near-term,notmuch uptakeshould be expectedon the tax.
Fundamentally,China’s landsupplydistortionsarerooted in local politics.It’s asystemthat has servedlocal governments wellat the expense of households, which means it has strong status quo inertia andisresistant toreform.
Sothe hope of sweeping changes on land policy should be tempered. And that means expensive urban housing in Chinais here to stay, at leastfor the foreseeable future.
