Constructing Corruption: Institutional Failure in China’s Urbanization Strategy

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CELINE WANG scrutinizes corruption in the Chinese real estate industry.

Starting in 2017, a new school district housing (xuequfang) frenzy began to sweep China’s developed cities. School-district housing is 2017’s buzzword among the urbanized middle-class families with school-aged children. The phenomenon is responsible for pushing up real estate prices in Beijing, Shanghai, Guangzhou, and other first-tier mainland cities. The school district system, instituted by the Ministry of Education, stipulates that all students in nineteen major Chinese cities should be enrolled in schools near their homes. For parents stuck in an institutional system where outcomes are often predetermined, the motto ‘let not your children fall behind at the starting line’ is motivation to do whatever possible to secure housing in elite school districts, no matter the cost. The craze has led to housing investment bubbles in Beijing, in neighborhoods such as Dongcheng, Xicheng, and Haidian, areas with the best school catchments. This has exacerbated an already existing housing bubble in a middle-income country where middle-class housing costs are more than in Paris or New York. According to Caixin, in mid-March 2017, the school district housing price of Desheng in Xicheng District, Beijing spiked to RMB165,000 (USD23,946) to RMB200,000 (USD29,025) per square meter.

The skyrocketing prices of coveted school-district homes are just the tip of the iceberg, as housing prices continue to soar across China. According to the China Real Estate Association, in March 2017, Beijing’s housing prices had risen by 15.6 percent in the previous 17 months, from RMB52,500 (USD7,619) to RMB60,700 (USD8,809) per square meter. And China’s housing bubbles are not limited to Beijing. Cities experiencing exorbitant housing prices are not only first-tier cities such as Beijing, Shanghai, Guangzhou, and Shenzhen, but also second-tier cities including Hefei, Suzhou, Wuhan, Tianjin, Fuzhou, Jinan, and spreading even lower to many of third and fourth-tier cities such as Langfang to Baoding in Hebei’s Jingjinji fringe. [As far as I know, the xuequfang problem does not extend to all of these lower-tier cities, however.]

However China’s rapid industrial development over the past three decades has been predicated on urbanization and correspondingly high growth in materials industries like steel, cement, and glass.  The real estate industry has played a significant role in helping lift millions out of poverty and into urbanized environments. However, along with the economic boom, the inevitable increase in housing prices has become one of the ‘new three mountains’ (xinsanzuodashan) faced by the  contemporary Chinese middle class along with securing medical insurance and education. Though the real estate industry has served as an  economic powerhouse in modernizing the country, it is also one of the most corrupt economic sectors in China.  Collusion and corruption between local governments and property developers leaves citizens living in China’s newly urbanized society with little legal recourse for the social ills created by corruption.

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From the late 1970s, the State Council began to reform the socialist housing system and privatize urban public housing. China’s real estate market only emerged at the end of 1980s in the wake of relaxed rules for foreign direct investment from overseas Chinese . However housing bubbles  did not come into being until the late 1990s, after a 1994 State Council directive commercialized and privatized the work unit-based housing system and 1995 banking reforms introduced new financing channels for property investors. By 1998, the state’s mainstream housing policy had begun to encourage private homeownership, and as a result fueled explosive growth in housing markets across the country.

However the nascent Chinese private real estate market has yet to improve market organization and institute institutional safeguards. The rapid expansion of both the real estate industry and real estate market over the past decade has highlighted deficiencies in the immature market and called into question the government’s ability to administer the market itself and to control rampant corruption within the industry.

Although real estate corruption is not a phenomenon unique to China, real estate industry corruption in China has unique features due to the political and economic system under which it operates. The coexistence of centralized and decentralized corruption in the real estate industry has emerged in a variety of entities, and power-for-money deals between real estate developers and government officials run through the whole process of real estate development, from land acquisition and transfer, approval and permission, project bidding, planning and construction, property registration, and sales. According to an article by China Daily, from start to finish, a real estate project on average needs approvals from 166 government departments, involving about 180 officials. Such complicated administrative procedures naturally invite corruption.

Characterized by high investments and risks and extremely fierce market competition, the Chinese real estate industry makes it very difficult for small and medium-sized development companies to survive and grow without the aid of government. As a result, the interlocking interests of developers and governments lead to clientelistic collusion—client developers have to pay their tribute to patron officials at every stage of the government approval process. Chinese economist Cheng Siwei has asserted that most of the approximate 30 percent profit margin taken by developers goes to the grey costs of bribery.

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According to Professor Zhu Jiangnan, an expert on corruption in China, most corruption in the real estate industry occurs during the process of transferring land-user rights, mainly concentrated in interaction with the local government and local land management department. According to Article 2 of the Land Administration Law, ownership of all land ultimately belongs to the state. At the center, the State Council exercises the right of ownership on state-owned land and makes the major decisions, policies, and regulations related to land, including setting the price of land. According to a 2012 order by the State Council to encourage more market forces in the urban land market, land-user rights, particularly of commercialized housing, are tradable and transferable on the open market through open tender, auction, and listing.

Nonetheless, under the current land system, the land administration bureaus of local governments are the de facto owners of most forms of land and hold the power to allocate land resources. Most local governments implement the central government policy only reluctantly. To be granted land for construction, real estate developers communicate with local government authorities and establish close ties with them through ‘public relations activities’ (gongguanhuodong). Given the lack of a monitoring mechanism and loopholes in the legal, regulatory, and administrative systems that oversee land transfers, land has become the primary source of performance ratings improvement for local officials and of fiscal revenue for most local governments. This developer-government collusion has become so entrenched that local governments have been characterized as addicted to land finance. Some scholar have speculated that without the revenues from auctioning off collectively-owned land for rezoning as urban land in return for kickbacks from the developers, many local governments in China would simply collapse. This means that local governments are not simply passively soaking up easy institutional rents, they are often aggressive seeking land transactions, with an emphasis on extending the campaign of land enclosure in order to fulfil their budget requirements, as well as to line their own pockets.

However, though their primary motivation is to fund government activities, through the land expropriation process, authorities engage in numerous illegal practices.. These practices include forced land acquisition, forced demolitions, grossly reduced compensation for property and relocation, and embezzlement and seizures, local authorities severely damage the interests of both urban and rural residents. In recent years this has led to intensifying disputes and popular protests or ‘mass incidents’ (quntishijian). Land disputes are a primary cause of social unrest, and account for 65 percent of mass incidents in China, according to Lynette Ong and Christian Gobel. This subjugation of land-occupiers to land development and land regulators has raised more concerns about social stability, according to Feng Yujun, a law professor of Renmin University.

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In addition to land, construction, installation, tax, and other business operations, the cost of corruption occupies a large proportion of the real cost of housing. The inflated prices on the one hand have increased payment pressure on buyers, and on the other hand caused a huge amount of wealth flow to the hands of corrupt local politicians. As private consumption remains sluggish and new developments remain empty,the price of housing around attractive school districts continues to deprive citizens of core government services such as education, healthcare, and housing itself.

China’s real estate market needs to develop countermeasures in accordance with the current market situation as well as the current state of relevant laws and regulations in the Chinese market. Such measures will make it possible to combat corruption in the Chinese real estate sector.

It is also imperative to change the government’s power management by separating land market management from land transfer operations and the related proceeds. As both land owner and land market manager, the government’s double role has blurred the boundaries between administrative and operating powers, resulting in the abuse of administrative power, rent-seeking, and power-for-money deals.

In addition to strengthening real estate regulations and closing institutional loopholes, the central government also needs to improve supervisory mechanisms, both within the government and outside of it , to prevent the abuse of powers. Internal supervision includes administrative supervision among the government agencies on the same level or between higher and lower levels, judicial supervision by prosecutors and courts, and supervision by discipline inspection and supervision departments, such as the Central Commission for Discipline Inspection. External supervision should come from genuine third-party public service agencies.

For all the economic benefits that urbanization has brought coastal China, the still immature real estate market coupled with an institutionalized failure of local government means that the central Chinese government must improve the legal and regulatory environment around land-rights and transfers in order to maintain stable macroeconomic control. In a system rampant with corruption and rent-seeking, local government officials and land developers are locked in a binary institutional arrangement of mutual corruption. The Chinese government should not only continue the anti-corruption campaign, but reform local government budget mechanisms, introduce stronger citizen protections for land-user rights, and move towards fee simple ownership. Without these systemic changes, the children going to school in Beijing’s beacon high schools will only grow up to enter a system which requires institutional corruption to be able to educate the next generation.

Celine Wang is Research Intern at the Public Policy Research Centre in Almaty, Kazakhstan. She is a 2016 25 Under 25 honoree of China Hands Magazine. Contact her at celine.wang@yale.edu.

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