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Land use reform is most crucial

By Tao Ran (China Daily)
Updated: 2009-09-17 08:04

Local governments around China have been busy setting up large-scale development zones, in which land use rights are transferred to users at very low price to attract investment since the 1990s. If taking infrastructure and land expropriation expenditure into cost, most land transferred for industrial use was making losses while the authorities can only make money from land for commercial and residential projects. Therefore, it is inappropriate to arbitrarily accuse local governments of mobilizing "land revenue" when they expropriate land at low prices, and then transfer them at a higher price, for making high profit.

The different features of the manufacturing industry and service industry should be blamed for the price gap between land for industrial use and those for commercial and residential projects. Manufacturers always give priority to seeking best locations for factories on cheap but easily-accessible land, with low environmental and labor protection standards so that their products can be easily distributed through modern logistics. The service industry and real estate sector, however, are usually confined to certain areas as they mainly provide services to local residents.

As a result, all the local authorities are trying on the one hand to lower their industrial-use land price as a preferential measure to attract more outside investment. On the other hand, they snatch extortionate profit through limiting land supply for commercial and residential buildings, as the governments at different levels enjoy monopoly in local land transactions.

The prerequisite for the construction boom of industrial development zones from coastal developed areas to inland provinces, in disregard of the macro-control efforts of the central government, is that the local governments can expropriate land from local farmers at relatively low prices.

The low investment cost of manufacturing industry in competing development zones, coming at the expense of environmental protection, reasonable compensation of land expropriation and labor security, had brought excessive investment which led to surplus production capacity. Most products are highly dependent on overseas markets. With a favorable trade balance, the steady Renminbi appreciation would stimulate more hot money into the commercial property market, resulting in soaring housing prices.

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There are two important changes taken place in the late 1990s, which contributed to the aforesaid phenomenon. First, during the process of corporation reform, many State-owned and township enterprises were transformed into private firms or joint ventures. Unlike their previous role as enterprise owners, the local governments became tax collectors of enterprises. Without any power to fix tax rates, the local governments tried every method to attract investment in order to increase local fiscal revenue, which in turn lead to cutthroat competition between different development zones.

The second change happened during the evolution of the relationship between the central and local authorities. After the tax-sharing reform of 1994, central finance takes 75 percent of the value-added tax of the manufacturing industry and leaves the other 25 percent to local governments. In the light of the new taxation system, the local governments are under pressure to establish more development zones in a bid to boost economic development and expand tax sources.

Without a flourishing manufacturing sector, there will be no room for the healthy development of service, business and property industries. Therefore, introducing more manufacturing industry can not only bring value-added tax and boost local service industry, but also bring sales tax and more revenue on commercial and residential land leasing.

To sum up, this unsustainable development pattern could increase the government revenue swiftly in the short term, but it will cause economic imbalance in the long run and do harm to the whole economy when overseas demand fluctuates. Various measures at multiple levels should be adopted to change the development model, of which the most crucial step is to reform the land expropriation system.

A mechanism of direct negotiation between land users and farmers should be employed in the land expropriation system reform to give farmers more voice in disposing their arable land. A rising land-use cost for manufacturing sector can constrain excessive investment as well as blind expansion of development zones. The local government can impose land value-added tax to make up their losses in land-use right leasing fees.

The reform is an essential step, which not only involves how to protect farmers' property rights but also concerns the issue of re-adjusting the national economic growth pattern. Generally speaking, the current financial system and the relation evolution of local governments and enterprises should be blamed for the current development pattern. It would be better for further reforms if local governments can be given more fiscal stimulus, including land value-added tax and property tax.

The author is an associate research fellow of the Center for Chinese Agricultural Policy, Chinese Academy of Sciences.