Deflate the housing bubble

While it is impossible to predict future changes in housing prices, there is an increasing consensus that land-driven growth in China is unsustainable - it is leading to a dangerous housing bubble.

The tone of the Third Plenary Session of 18th Communist Party of China Central Committee is to speed up reform, so although drastic measures are unlikely to be adopted to puncture the housing bubble, some changes are in three interrelated policy areas: fiscal, land and housing.

Photo taken on July 19, 2013 shows buildings in downtown Shanghai, east China. According to the National Bureau of Statistics, of 70 major Chinese cities, 62 saw month-on-month new home price rises in July. Meanwhile, 57 cities reported month-on-month price gains in existing and second-hand homes. [Photo / Xinhua]

The driver for the frenetic real estate growth comes from the dependence of local governments for revenues from land sales and land related incomes. Since the adoption of the 1994 tax-sharing system, local governments have incurred a de facto fiscal deficit - while their expenditure responsibilities have remained unchanged, they have had to rely more on extra-budgetary land income to make up the gap between their spending and revenue. This has greatly incentivized the local governments and enabled them to capture the land value spilled-over from infrastructure development. The city governments thus have become entrepreneurial like an enterprise that is engaged in property development.

The land-driven fiscal system has made local governments more speculative in land development, using their muscle, through their monopoly power, to acquire agricultural land and sell it at a higher price in the land market. The governments are keen to use their "visible" hands to urbanize the land not people, which deviates from the course of market-oriented reform.

The adjustment of the fiscal relation between the central and local governments may not mean further fiscal decentralization to give the local government a higher budgetary return. But rather, for the central government to take on some responsibilities that constitute national "citizenship" such as social security, education and pensions. With a more balanced local fiscal structure, there will be no excuse for them abducting the economy with speculative land development.