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5/27/2018

Tianjin's binhai zone: Real estate as a GDP driver

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The importance of real estate development to local government income can hardly be overstated. Much has been made of the dependence of local governments on land sales to support themselves. The poorer and more remote a city, the higher this degree of dependence. Nationwide, the proportion of land sales in local revenue is about 25%. The most real estate-dependent cities tend to be very high on the scale of land dependency. For example, Ordos County in Inner Mongolia in 2011, when it experienced a real estate bust, saw 69% of local revenue from land sales, according to an Oxford University report. Here is the correlation between government revenue and commercial real estate for Tianjin. (NBS data)
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Land sales, though, are only a portion of local government benefit from real estate. Tax revenues from real estate developers, construction companies, and manufacturers of materials for the construction of commercial property have been the highest proportion of taxes for a decade now. In Tianjin, for example, a massive region and massive economy, real estate taxes represented 26% of local tax revenue in 2016, the last year of the statistic. Construction activities generated 12% of local revenue in 2016, down from the peak. This disparity is much more acute in the "new zones" that cities develop in their remote suburbs, where land is (originally) cheap. The Binhai zone of Tianjin, for example, which hosts the mini-city that Binhai officials used to call "Little Manhattan" (until they caught on that international visitors were having a laugh), is almost entirely dependent on construction activities and land sales for its local revenue.
As they run out of land for new development, desperate for GDP growth, some cities have dynamited existing buildings and counted the demolition toward GDP.
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Controlled demolition in Zhengzhou, Henan Province August 2017. Photo by China Radio International: chinaplus.cri.cn
It has often been noted that China's current ills tie directly back to the 1994 tax reform, in which the central government started collecting all taxes and reverting a portion back to local governments. This was part of the overall centralization of government authority under Zhu Rongji that responded to fears of a Soviet-style smash-up post-1989.
An April 2016 paper by the Asian Development Bank shows a direct connection between the central government's fiscal transfers back to local governments following the 1994 deal.

Earmarked transfers account for around 40% of the total. The paper shows that earmarked transfers have the effect of forcing sharp increases in local government spending on infrastructure. Abstract:

Results showed every 1% increase in earmarked transfers to be associated with a 5% increase in local spending on infrastructure. These fiscal transfers also increased the size of local government spending such that a 1% increase of fiscal transfer would increase the ratio of local fiscal spending to gross domestic
product by 1%.

One of the prevalent ideas about China is that debt woes are due to sneaky local governments that steal money from the people. If only the emperor knew! Actually, it's more the opposite. The increasing power of the central government has squeezed local governments into a fiscal straitjacket. Not only must local governments fulfill the GDP growth targets set by the center, on which they are increasingly dependent, but they are responsible for providing basically all services--schools, medical services, pension, roads, water, electricity--and they have no ability to levy their own taxes and make their own budgets. Selling land and borrowing for centrally approved infrastructure projects are the only strategies that provide local governments with resources to meet the needs of their people.

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    ​Construction and Real Estate Development as a % of GDP (real)

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    Property Construction and Sales Growth YTD YoY (by area)

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    FAI YTD YoY

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    the importance of construction

    Since China’s panicked infrastructure build-out begin in the winter of 2008, construction activity and real estate development together have become the largest components of GDP, 14% in 2017, up from a combined 4% in 2008. Finance, the next biggest portion, has also grown, from 2% of the economy in 2008 to 7% last year, and the driver for that is real estate. Furthermore, the construction and real estate count omits key portions of the property phenom—the “value added” from land sales, leasing income, sales of construction machinery and the steel, coal, aluminum, and other materials used to create housing and infrastructure. If the portion of manufacturing and other activities relevant to real estate were added, the portion of GDP driven by property would be at least 25%. (Source of chart data on left: NBS)
    For about six years now—since China used stimulus in 2012 to counter the sharp slowdown in property and construction of 2011—China’s economic policy has been captive to fear of low growth and of financial crisis. Growth has become wholly dependent on credit of a very high intensity, and yet to credit-to-GDP percentage—well over 300% now makes policymakers fear that too much more credit will precipitate a crisis. So they rocket back and forth between pouring cash into the economy when growth falters and pulling it back when there are visible defaults.
    2018, with Xi and his Politburo firmly in place, was to be the year when they pulled back. But Q1 turned out instead to continue stimulus, with all the money going to local governments to fund their infrastructure projects. Builders were unenthusiastic about housing, so large social housing projects were funded and built by fiat. Still, in property construction, virtually all China’s numbers trended down in the four months through April. The National Bureau of Statistics measures new sales by amount of floor space at 1% year to date through April. The NBS presents sales data only on a year-to-date basis, and the first quarter showed 4% growth, so April must have declined sharply.
    Fixed asset investment growth came in at 7% year to date April, the lowest growth since December 1999. Added FAI in April amount to about ¥544 bln, compared with a March increment of ¥5.6 trn. FAI in property was not reported in April but has similarly been decelerating rapidly.
    This pulling back, however slight, will have a powerful impact on growth in May and June. Then we will see whether the Chinese government has the resolve to continue with slightly tighter liquidity. We guess not.



    creative destruction

    Some cities resort to demolishing empty towers and building new as their GDP starts to flag, and the demolition can be a major contributor to GDP. Below are pictures of a demolition in Shanghai. Toward the back of the lot are piles of bicycles collected from streets cluttered with spares from the many bike-sharing companies that are competing to make their bikes cheaper and more available than the next company's.
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