Why do I have to live far away from my parents? Why is housing so expensive? Why don't I feel like I belong? All these questions commonly faced by youth are related to how local governments push forward economic development.

• As mentioned before, China's unique land rights system gives local governments monopoly over this valuable resource and allows them to cash in on large amounts of capital that can be used for urbanization. Local revenues are locked into land prices which are locked into property prices.
• In 1980, only 20% of Chinese citizens lived in cities, by 2019 it was over 60%, meaning a net influx of 500mm people. But if we go by hukou (residency permits) alone, then that number is just 44%, meaning over 200mm are living in cities but don't have the hukou there, and cannot enjoy the local education system, etc. because all those public services are provided based on hukou.

1. Property Prices and Resident Debt

• As we know from Chapter 2, 1994 tax reform was the first step of urbanization. And then in 1998 property reform allowed folks to buy homes.

  • From 1998 to 2018, property prices went up 4.2x, but very unevenly. In 3rd/4th tier cities prices went up as much as incomes did, but in first tier cities, it was much faster, from 2005-2015 it was a CAGR of 13%.
  • This is mostly a problem of demand far exceeding supply. From 2006-2014, about 40% of China lived in large cities (5mm+ population) but only had 20% of the increase in residential property area. For small cities, especially away from the coast, it was the opposite.
  • In order to develop the West, even more land was allowed to develop, allowing for even more skewed results. By 2014, Western / central cities accounted 60% of the new land supply authorized by the central govenment.
  • A large part of this is because there is no national level land exchange market, and so each province gets a separate allotment from central on how much land can be developed and cannot trade it, resulting in distortions. In 2020, the central government put forth proposed reforms on making this cross-regional.

• Residential debt primarily comes from real estate. Lessons from the West:

  • From 1950 to 2010, UK real estate share of citizen wealth grew from 36% to 57%, France 28% to 61%, Germany 28% to 57% and America 38% to 42%. The higher the household debt from real estate, the more consumption will go down in an economic crisis.

• From 2008-2018, Chinese residents' debt increased 3x+, but at 54% it is still lower than the 76% in US, but is already close to Germany and Japan. PBOC data says that 53% of household debt is property, 24% is other consumer debt such as cars, but it's probably lower.

  Personal debts of US (dash), Japan (gray line), Germany (dotted), and China (dark gray line). Source: IMF, includes bank loans and bonds.

  

  • To calculate debt service, we cannot use an abstract concept like GDP but must use income. At end of 2019, survey of 30K urban residents by PBOC showed 1.6x debt to income ratio, close to America's (which was 1.5x in 2000, 2.1x in 2008, falling to 1.7x afterwards). Of the debt, 76% was for property. In China, 60% of peoples' wealth comes from real estate, whereas it is just 28% in the US (72% from financial assets). This, by the way, also explains why the two governments focus on property market and stock market respectively.
  • Real estate also accounts for most of the inequality in China. Beijing residents have average gross assets of 8.93mm RMB, 8.07mm in Shanghai, which are 6-7x greater than Xinjiang (1.28mm) and Jilin (1.42mm).
    • By this measure, the 10% richest folks in China have 49% of the wealth and poorest 40% only 8% of the wealth.
  • This has also led to trickle-down consumption where the poorest in China have no savings. 2015 onwards the various internet lending businesses such as Ant grew tremendously, until banks realized this was risky.
    • While urban residents had 1.6x debt-to-income ratio, for those households with annual incomes less than 10K USD, it is closer to 3x, and the 20% lowest assets will even get loans from other people, which is even riskier.
    • During Great Financial Crisis, the poorest 20% of Americans got their bank accounts wiped out ($30K to 0) whereas the richest 20% only saw their net assets decrease by <10% from 3.2mm to 2.9mm, and only briefly. They actually gained those assets right back in 2016, whereas the bottom 50% returned to the poverty of 1971. 40 years of wealth accumulation vanished overnight.

• Does China have the same property risk as US (during the GFC)?

  • Unlikely to be sudden crisis because down payments are up to 30%. So property prices have to drop a lot for citizens to want to foreclose. (In 2018, that number is just 0.3%.)
  • Residential real estate debt have not been made into derivatives, the RMBS market is just 3% vs 63% in the US.
  • Due to capital controls, very little foreign capital is in the Chinese residential real estate market.
  • But the solution to resolving the property debt risk is to not just make sure prices don't go up anymore; incomes must be improved, especially in the lower and middle portions, and to have development be more even across the country.

1. Imbalances and Factor Market Reform

• By 2017, the CCP had pointed out that the main contradiction in China is between the citizens' wish for a beautiful life and the country's uneven development.
  • This is the first change in "main conflict" since 1981 when back then the contradiction between the growing material and cultural needs of the people and the backward social production. This means the main aim of economic policy has changed.
• China's income disparity comes from 2 places:
  • Urban-rural: in 2018, urban disposable income is 2.7x that of rural
  • Regional: Beijing & Shanghai disposable income is 3.5x that of Guizhou, Gansu, Tibet
  • Both of these are related to restrictions in movement of the population
• US has great disparities in GDP from state to state, but most of it can be explained by population. Bar is 2019 % of national GDP, line is % of population, and you can see that they line up mostly.

It's much more uneven in China:

• In China right now, rural areas have 40% of the population but agriculture is just 10% of GDP, so of course their incomes are lower.
• While the logic of letting more people flow into cities, especially large cities, is very sensible, but it is controversial in reality. Most people are afraid of the strain on public services such as housing, education, healthcare and public safety. It is also necessary. For Shanghai where 35% of registered residents are at least 60 years old, they really need new labor to come in and take care of everything.
• There should also be land reforms. Recall there are two types of land, national and agricultural (collective). Beijing has 50% agricultural land within city limits but the density is far lower than nationalized land. Shanghai has 30%. If this land can be utilized properly, there should be enough room to build the hospitals and schools needed.
  • A series of reforms and pilot programs have taken place, including in 2019 when 13 cities (including Beijing, Shanghai, etc.) made it possible for (~50% of) collectively owned land to directly participate in the market (vs. having to be turned into national land first), breaking the local government's monopoly on land.
• Residency reforms have also accelerated. In 2019, cities with between 1-3mm population were told to eliminate residency requirements, and larger 3-5mm cities will broaden them. Top tier cities still have restrictions, but some are removing them as well.
  • Residency requirements, remnants of state capitalism, will have severe economic costs if not removed.