Chinese government land sales

If This is Chinese Corruption, Give Me More!

All governments favor local businesses. Some do it better than others. China is among the best. The system of government support in China is more extensive, more fair and less prone to corruption than elsewhere. Surprised? Many will be, since they operate on the false, though comforting,  assumption that everything Chinese officials do is the result of bribe-taking.

The thing about corruption is, most of it, everywhere, is hidden from view. There is no real empirical basis to assess which countries have the highest corruption. Instead, everyone tends to fall back on the “Corruption Perceptions Index”  reports generated by a group called Transparency International. It does what it can to measure the unmeasursable. Its results get skewed by relying rather heavily on Western businessmen’s own perceptions about where bribery is most rampant. For many of these people, China fits the Western stereotype of a country whose officialdom seems rotten from top to bottom.

The reality is rather different. Look, I’m not saying China doesn’t have a corruption problem. It manifestly does. The country’s own leadership is frequently heard denouncing the problem of corrupt officialdom. Indeed, China’s outgoing Communist Party boss, Hu Jintao, warned this week that if not tackled, official corruption would  “cause the collapse of the party and the fall of the state.”

My point here is to discuss the productive, above-board and even-handed ways government in China, at every level, provides useful and valuable support to companies. Here, the comparison with the US is very stark indeed. Government favors in the US are mainly, and explicitly, sold to the highest bidder. It’s what drives much of the billions of dollars “invested” every year by companies, unions, lobbyists and individuals in political campaigns. You help a politician win, and he helps you then get a tax-break, a loophole, a sweetheart government contract, a loan guarantee, a no-bid contract, a regulatory exemption, an R&D grant, a zoning change.

In the US, the system of favors-for-money is so widespread, so deeply woven in the grain of the political system, that Americans don’t even bother to talk about it much. It’s as American as apple pie.

Let’s look at China. Buying off politicians is less visible, and outcomes are different, than in the US. China’s tax code is not the unwieldy monster it is in the US. It isn’t the product, as America’s is, of an anybody-want-to-buy-a-taxbreak system. In the US, General Electric can get away with paying no income tax despite billions in profits because it’s very good at working the system and buying the favors required to create tailor-made tax loopholes. In China, I know of no instance where a big and profitable company, including some very powerful SOEs,  pays no tax.

Big companies, especially SOEs, do get many special favors. One example:  the government tends to be very relaxed in its role as controlling shareholder. It seldom demands an SOE turn over a large percentage of its after-profits in the form of dividends. The Chinese system generally dings companies once, through profit tax, rather than twice.

Where China’s system of political favors works better than elsewhere is in spreading the perks far more widely and equitably. So, both state-owned giants and small entrepreneurial companies can both partake.  In the US, Europe or Japan, the system of political favors is “pay to play”. In China, it’s more a matter of maintaining a modest level of employment (probably above about 50 workers) and paying at least some of the taxes you nominally owe. Do that and the government will make available a wide assortment of grants and benefits, from land at low concessionary prices,  to investment credits and tax holidays to free infrastructure upgrades.

Again, what is most notable, and commendable, about the system of political favors in China is how much more inclusive it is. You don’t need to pay off a local official, or put his kid through college in the US. That sort of stuff may happen, and may for all I know bring even larger benefits. But, a payoff is not a prerequisite for a government favor or handout. In fact, the most valuable forms of government support I’ve heard of go to companies that successfully IPO. Nothing else. They don’t need to take government contracts or employ the mayor’s nephew. Companies are rewarded by the government for going public — which, by the way, given high IPO multiples in China,  is enough of a reward in itself. One reason companies get rewarded for going public is because it also is a big boost to local officials’ careers. In today’s China, a key metric used to evaluate local government officials’ job performance is how many local companies have IPO’d.

These newly-public companies are often, if not always, sold a piece of land to build a new headquarters on. The price of that land will almost certainly be sold to the newly cash-rich IPO company for a fraction of its market value.  I’ve also seen cases where a local government gives a plot of land, at a very low price, to a local company that successfully raises PE.

A case of rich getting richer? Perhaps. But, note, this valuable land is not sold to the guy offering the valise filled with untraceable $100 bills. It is a reward for achievement, not a backhander. I prefer this kind of businessman-to-politician transaction to what routinely goes in the US, or UK, where political parties, in return for donations,  sold knighthoods and other titles.

But, the land-for-IPO deals are a very small part of a very large whole, making up the totality of government favors and support available to businesses in China. The government in China has far more power and far more wealth at its disposal than anywhere else I’ve lived. In other words, it has complete discretion, as well as more prizes to dole out. The remarkable thing is how evenly they do try to spread their help around.

In the US, a small businessman is told by the newly-reelected President he is a “millionaire and billionaire”, and should cough up half his income in taxes, with little special in return. The same scale businessman in China pays less punitive rates and is rewarded by government with favors that help his business grow, and his profit margins increase. If this is corruption, give me more!



What is the Major Source of China’s Economic Competitiveness? Surprise, it’s Not Labor Prices


True of false? The basis of China’s global economic competitiveness is cheap labor? False. It’s cheap factory land.

No doubt,  until a few years ago, China’s low labor costs were a vital part of its economic growth story. That is no longer the case. Labor costs have risen sharply in the last five years. There are now many countries with a decided labor cost advantage over China. And yet China remains the “factory of the world”. For one thing, its workers have higher productivity than those earning lower wages in countries like Vietnam, India or Indonesia.

But, there is a more fundamental, and most often overlooked, reason for China’s global economic competitiveness. Factories, and other productive assets like mines or logistics centers, are built on land that is either free of close to it. The result is that in China land costs usually represent an inconsequential component of overall manufacturing and operating costs. This, in turn, gives China an inbuilt edge and, when added to the productivity of its workers, an insurmountable cost advantage over the rest of the world.

There is no good international data on the percentage of a company’s fixed costs that come from purchase or rental of land. But, it is certainly the case that in China, this percentage will be far lower than in any developed – and many developing – countries. This isn’t because land is cheap in China. It isn’t. The market price, in most areas, is often on par with land costs in the US. But, good businesses in China don’t pay market price. Often they pay nothing at all.

This has two useful aspects for the favored Chinese business. First, it means the cost of expanding operations is limited primarily to the cost of new capital equipment and factory construction. Second, the business given a plot of land is thus endowed with a valuable asset it can use as collateral to secure more funding from banks. Even better, if the business runs into trouble or later goes bust, the owner will be able to sell the land at market price and pocket a huge personal gain.

It can’t be overstated just how important this is to a business owner’s calculation of risk, and so the success of Chinese entrepreneurial companies. Owners know that if all goes bad, they still hold land acquired for little or nothing for that is worth millions of dollars.

All land in China belongs to the Chinese government. Every year, a fraction of it is released on a long-term lease (usually forty years or longer) for development into commercial or residential land. While there is no official central policy to make land available at low prices to successful businesses, in practice, this is the way the system works. Land is sold at deeply-discounted prices, or given outright, to businesses that are seeking to expand, often by building a new factory or office building.

Land in China, it goes without saying, is in very high demand. It’s a crowded country, and only 15% of the land is flat or fertile enough to be suitable for cultivation. This “good land” is also where most new factories get built.

There isn’t enough new land released every year to meet the enormous demand. This is true both for residential land, a key reason why housing prices are so high, and commercial land. For most businessmen, it’s impossible to get new land, at any price. A privileged group, however, not only gets land to expand, but gets it at artificially low prices. In China, land prices are elastic. Different levels of government have ways to transfer land to companies at prices equal to 5%-15% of its current market value.

Officially, the land allocation system in China is meant to work in a more market-oriented way, with new land for development being auctioned publicly, and selling prices controlled and verified by higher levels of government. In other words, the system is meant to discourage, if not prohibit, land being given to insiders at low prices. In practice, these rules are often more observed in the breach. Local governments have ways to control the outcome of land auctions and so guarantee that favored businesses get the land they want at attractive prices.

These below-market sales deprive the local government of revenue it might otherwise earn from a land deal done at closer to market prices. But, there is some economic logic at work. The sweetest of sweetheart land deals are generally offered to successful companies whose growth is being stifled by insufficient factory space. The new land, and the new factories that will be built there, will increase local employment and, down the road, tax revenues.

Note, the deeply-discounted land prices are available mainly to companies that are already successful, and straining at the leash to maintain growth and profits. Both private and state-owned companies are eligible. It’s a rare example of even-handed treatment by officials of state-owned and private companies.

Is corruption also a factor? Are cheap land deals really not all that cheap when various under-the-table payments are factored in? My personal experience, though limited, suggests such payoffs, if they happen,  are not compulsory.

I’ve played a walk-on part in several below-market land deals. My role is to meet with local officials, usually the mayor or party secretary,  to urge them to provide my client with the land needed for expansion. All local government officials in China are also motivated by, and rewarded for, having local companies go public. I stick to that point in my discussions with the local officials – my client needs land to grow and so reach the scale where the business can IPO.

In each case, the deal has gone forward, and clients have gotten the land they were seeking, at a price 5-15% of its then-market value. My client wins the trifecta: the business grows larger, unit costs remain low because of scale economies and the cheap land, and the balance sheet is strengthened by a valuable asset purchased on the cheap.

In all respects, this system of commercial land acquisition is unique to China. It is also a key component in the country’s economic policy, though it never has been proclaimed as such. The government at all levels is keen to keep GDP growing smartly. This process of rewarding good companies with cheap land for growth plays a key part in this, everywhere across China. China’s government (at national, provincial and local levels) is not hurting for cash, unlike for example America’s. Tax revenues are growing by upwards of 30% a year. So, maximizing the value of land released for development is not a fiscal priority.

Who loses? There are likely incidences where peasants are thrown off land with little or no compensation to make way for new commercial district. But, that way of doing things is becoming less common in China.

Mainly, of course, the losers are the international competitors of Chinese companies getting cheap land to expand. It’s hard enough to stay in business these days when facing competition from China. It verges on hopeless when the Chinese companies can build output and lower unit prices because of land they get for free or close to it.