After the stock market crashes of August 2015 and January 2016, foreign and domestic investors in China have been putting their money into real estate. Yet while housing prices in Beijing, Shanghai, Shenzhen and Guangzhou skyrocket, other cities are experiencing an overabundance of modern residential development. These cities are not major centers of trade or manufacturing, yet for the past decade construction has rapidly turned rustic suburbs into futuristic metropolises.
Many of these brand new urban areas are largely unused. Walking through them is reminiscent of apocalyptic Hollywood films, as perfectly laid out buildings and gardens tower above streets that are dead silent. These developed but vacant urban centers have been nicknamed ghost cities, and are rumored to cover much of inland China.
The ghost city phenomenon is closely tied to China’s state of limbo between free and planned markets. Much of the motivation for construction comes from the Chinese political system, but the long-term effect on China’s economy will be determined by market forces.
Land Leases and Urban Versus Rural
Strictly speaking, there is no private land ownership in China. However, land not allocated for public welfare is leased for private use in China’s thriving property rights market. Private individuals or entities can purchase government leases to use land for a set period of time, either directly from the government or from private leaseholders. Local governments can also purchase land from neighboring local governments, which then can be leased to third parties.
Legally, land lease prices are based not on the land’s potential, but on its current production value.  This means development after purchase can dramatically increase land value, giving a short-term boost to local GDP. Many urban governments take advantage of land valuation laws to purchase land from neighboring rural governments, paying based on the production value of the land as it is at that time being used, and then build infrastructure, apartment complexes, and shopping areas.
Wanting to quickly and dramatically increase the price at which land rights are sold, urban governments have been rapidly increasing the number of new city districts. In the short term, this development produces a predictably high return on investment, even when creating highly inefficient urban design. Once the new infrastructure is in place, local governments can sell property rights at a high profit. While this happens mainly on the outskirts of cities, town and village collective governments also have an incentive to develop other non-farming land in order to similarly raise land value for low initial investment and increase local tax rates.
Political Incentives For Rapid Non-Market Driven Urbanization
The land pricing system has obvious incentives for local governments to purchase inexpensive undeveloped rural land and turn it into high-tax residential or business centers. However, there are even stronger incentives at play that are hidden in China’s government revenue policy.
Profits earned by local governments from selling property rights are not subject to the same inter-government fiscal sharing rules as regular income. Normally, revenue collected by local governments fall under the prerogative of the provincial government, which may choose to allocate the money to other localities within the province. The central government has similar jurisdiction over provincial governments, making them also indirectly able to control local government revenue. However, there is an irregular revenue category, “extra-budgetary revenue” (EBR), which higher-level governments cannot force local governments to share. Both profits from rural collective governments selling land rights, and urban governments selling property rights fall under EBR, meaning that both parties can quickly earn secure money for infrastructure expansion or other projects through rural-urban land transfers.
Officials also have a strong personal incentive to develop land in order to promote their own careers. Rob Schmitz, China correspondent for NPR’s Marketplace, states: “Local officials are promoted due to how much GDP growth they create locally, and taking land, converting it, using it as collateral for loans, has been a popular way to create that growth.” A study by Hongbin Li and Li-An Zhou showed that there is a significant positive relationship between cadre promotion and GDP growth rate. This tendency is amplified by the fact that Chinese government officials have very limited opportunities for career changes. Additionally, China’s nationwide policy of transferring leadership to other localities after three to four years means that officials have no incentive to consider the long term effects of construction projects.
Between the recent slowdown in economic growth and changes to the government official promotion system under Xi Jinping, China’s breakneck urban development is expected to slow down. However, this still leaves the question of what effect these already completed new urban areas will have on China as a whole.
Newly Urbanized “Ghost Cities” and their Macroeconomic Effects
Anecdotal evidence suggests that since urban development has been driven by incentives other than market demand, many of these newly urbanized areas remain empty long after construction is completed. These so called “ghost cities” are scattered around middle to low-income cities, where there is little need for increased housing.
There is strong concern for the effect ghost cities will have on China’s economy. J Capital Research Director Anne Stevenson-Yang says that these unused housing projects are going to push growth down in the long term. “During the [economy’s] rise, all of these things were accelerating GDP and now they’re sitting around as costs.” Along with rampant wasteful investment, urbanization appears to be suffering diminishing returns with respect to local GDP. With the average returns on construction and investment falling in recent years, the amount of investment required to increase GDP output has doubled.
However, there is some debate as to how widespread a problem ghost cities are. With government subsidies and lower rent for housing, some people and business are moving into ghost cities. After moving, new residents are now creating a market that appears at least somewhat self-sustaining. A report from Standard Chartered suggests several infamous ghost cities in Changzhou, Dantu and Zhengdong saw 20-100% increases in residents between 2012 and 2014. With no systematic records, it is difficult to definitively say what proportion of newly urbanized land remain vacant or are flourishing.
While it is likely housing prices in Beijing, Shanghai and other rich cities will remain strong, middle to low-income city real-estate prices likely will drop in response to government efforts to fill ghost cities. Since ghost cities are mainly situated in areas with low housing demand, the overall property market likely will remain largely unchanged in the short term.
In the medium term, as China’s labor market shifts to be more service based and the internet and telecommuting make worker location less important, savvy consumers and business owners may come to see low-priced housing as an opportunity. Many young workers may also choose to remain closer to their aging parents as more non-manufacturing jobs become available. If ghost cities gain residents, the costs to China as predicted by Stevenson-Yang may be minimal.
On the other hand, even if the best-case scenario occurs and ghost cities have no direct negative effect on China’s growth, over-saturation of urban areas limits policy options for government leadership facing low or negative growth. In cases of crisis or slowdown, economies can receive a push from government funded infrastructure projects, as happened in the United States under FDR. Having already built extensive infrastructure, Keynesian economics would become less effective for Chinese policymakers in mitigating economic failures.
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