Evergrande, a Chinese real estate company founded in 1996, rolled closer toward formal default in October 2021 after failing to meet further payments toward its $300 billion debt. Evergrande isn’t alone – real estate developers in China carry an estimated $5 trillion in debt, and other Chinese property firms this week reportedly defaulted or struggled with repayments.
So what does the Evergrande crisis reveal about the challenges and distortions within China’s “state capitalism” model? Under this top-driven economic system, the Chinese government and Communist Party intervene throughout the economy, creating conditions for real estate developers to rise high and fall hard.
Real estate construction, property management services and related industries account for a quarter of China’s economy. These four factors help explain how this crisis evolved.
Government policies have distorted the land market
Local government intervention shapes the supply and price of land in China. City and county governments exercise a near-monopoly over the supply of land for the primary urban land market. By law, only the government can convert rural areas into urban land that can be used for residential and commercial real estate or industrial parks. As cities expand, real estate developers generally pay high prices for the rights to use the surrounding land, generating large windfalls for local governments.
Policy changes proposed in 2013 would have eliminated this government monopoly. In theory, farm households could sell the rights to use their land directly to real estate developers. However, these proposed changes – which were unpopular with local governments – have made almost no headway.
China’s fiscal policies leave local governments with few options
Local governments don’t want to give up their power to take rural land and sell it to developers, because they rely heavily on windfalls from the sale of land to fund government projects and services – and because they exercise a lot of discretion over these funds. Last year, local government receipts from land sales topped $1.3 trillion, equivalent to 46 percent of total government fiscal revenue, up from 30% in 2017.
China’s unitary fiscal system centralizes control over revenue in Beijing but places most expenditure responsibilities on local governments, leaving a large fiscal gap. Local governments fill this gap not only with revenue from land sales but also by borrowing via “local government financing vehicles,” using land as collateral.
New policies proposed over the last decade would have put in place a new property tax to provide a more solid fiscal foundation for local governments. A functioning property tax system would likely reduce local government windfalls from land sales, and would likely dampen real estate speculation. But no new property tax measures appear on China’s 2021 legislative agenda.
Urban development doesn’t reflect actual demand
Local governments also face top-down political pressure to meet economic growth targets. As real estate development and construction projects are important drivers of growth, local governments have a strong incentive to encourage housing developments, particularly in smaller, “lower-tier” cities beyond the largest 35 metropolises.
Local governments use their political power to artificially boost demand for housing developments and construction, driving urbanization by mobilizing rural households to give up their homesteads and move into new high-rise apartment complexes. In the process of relocation, millions of rural households pay money over and above the compensation they receive for their old houses in order to resettle. Government intervention determines the timing, scale, pace and location of resettlement.
This “rural revitalization” is an official policy promoted by the central government – and by President Xi Jinping. Past statements from China’s State Council emphasized that participation was voluntary. But numerous reports suggest that local governments persist in forced demolition and relocation.
Financial repression fuels real estate speculation
A government strategy to keep wealth in China also helps drive real estate speculation. Individual investors face tight capital controls that restrict opportunities to invest abroad, but banks offer low interest rates on household deposits.
For many Chinese, real estate has become a favored investment. Most urban households own their homes – and many families invest in second and third apartments, counting on higher returns than they can get in savings accounts. Moreover, until late 2020, China’s state-owned commercial banks directed lending to real estate firms and related sectors.
China’s state capitalism is in crisis
China’s government-directed economic growth model has left property firms, local governments and urban households deep in debt. The system has also resulted in oversupply of housing, reflected in vacancy rates around 20 percent in lower-tier cities and many empty high-rise developments evocatively referred to as “ghost cities.”
The Chinese government response, beginning in late 2020, was to ease the real estate bubble by targeting developers with restrictions on borrowing, captured in the slogan “three red lines.” The “red lines” set limits on firms’ liability-to-asset ratio, net-debt-to-equity ratio and cash-to-short-term borrowing ratio. Companies such as Evergrande that fail on all three of these measures have been barred from receiving additional bank loans. For Evergrande, this policy intervention triggered the current liquidity crisis and potential default.
My research on China’s political economy shows that China’s interrelated land, fiscal, financial and political systems constitute the backdrop for Evergrande’s rise. But these government-directed systems are also a reason the Chinese government isn’t likely to let Evergrande collapse completely. Failure in this sector of the economy would hurt urban homeowners and local governments as much as private developers.
The lack of progress on policy changes to the existing land market, fiscal and financial systems that have been under discussion throughout Xi’s first two terms in power suggest that his administration is hesitant to alienate two key constituencies: local governments and the urban middle class. A decline in the real estate sector would reduce local government revenue from land sales. And a major correction in housing prices would undermine the wealth of China’s urban middle class.
Instead, the government has tried to rein in large private developers, precipitating the current crisis. But the deep systemic flaws in China’s government-directed growth model remain unaddressed.
Susan H. Whiting is professor of political science at the University of Washington in Seattle, where she also holds adjunct appointments in the Jackson School of International Studies and the School of Law. Her current book project with Cambridge University Press is entitled “Illiberal Law and Development: Property Rights and Conflict over Land in China.”
Note: Updated Sept. 11, 2023.