by SHENG Hong, Director of Unirule Institute of Economics
Translated by MA Junjie, Project Researcher, Unirule Institute of Economics
As we usually see, when government departments issue certain policies, they justify the necessity of these policies. A recent example is the price regulation upon the housing market issued by the government in several big cities. Shanghai stipulates that the premium ratio for second houses is raised to 70%, and more limits are set upon non-local buyers. Langfang, a city bordering Beijing, sets up regulations on buying houses in the counties under its administration. It also grant buyers only one apartment with a premium payment ratio of over 30%. Limits on buying houses are not lifted at all in Beijing, whereas situation is not much different in Shenzhen. Is there something wrong? Data shows that housing price in Shanghai increased by 25% in March compared to the same time period last year. Comparatively, housing price in Beijing grew by 16%, and what’s worse, 61% in Shenzhen. Housing price in all these cities has increased over February.
Source: National Bureau of Statistics,
So why did the housing price sharply go up? As we know, China’s economy had taken a downturn that bothered the central government so much it began promoting “supply side structural reform”. This has something to do with institutional reforms, but more importantly, the reform aims at solving urgent problems. Such problems include “cutting over-capacity, and cutting excessive stock”. And there is excessive stock in the real estate industry. Therefore, specific measures are called for, such as lowering the premium payment ratio, cutting taxes and fees, which may lead to decrease of the loan interest rate. A majority of Chinese cities have cancelled purchasing limitations. Some cities are even considering encouraging migrant workers who are normally enable to buy departments in cities to buy houses on loans. Such measures worked: from January to March 2016, the sale area of housing has increased by 33% compared to last year.
People have to doubt whether the stock of houses for sale is really a burden in the macro sense as housing prices go up? According to the National Bureau of Statistics, by the end of December 2015, the nationwide sale areas of housing amounted to 720 million m2, approximately the same with the sale area of July, which was not much. However, according to some observers, the sale area of housing accounted for 8.08 billion m2 if adding the areas under construction. To consume this stock required 6.3 years. This raised an issue. However, if all real estate developers are enterprises in the market economy sense, they should decide their operations according to the cost and benefit. Apparently, it’s not worth investing if the cost fails to bring about benefit.
Then why does the central government emphasizes cutting excessive stock in the real estate industry? As a matter of fact, what the decision makers are concerned with is the slowdown of China’s economic growth. China’s nominal GDP grew by 6.9% in 2015, and the real GDP growth rate was much lower. And the housing market weighs significantly in the economy with a RMB 870 million sales revenue in 2015, 12.8% of the GDP. Even minor changes in the housing market have macroeconomic implications. In addition, the real estate market also involves a series of other industries, such as steel and construction in the upstream, and services and interior decorations in the downstream. The growth rate of sale area of housing has decreased significantly since 2010, and it hit -7% in 2014. Based on the sales revenue of the year before, it affected 1% of the GDP growth. The growth in 2015 was much slower than that in 2013. [Page]
Source: National Bureau of Statistics
What, then, caused the slowdown in growth rate of the sale areas of housing? In perspective, it all started in 2010. A “10 New State Regulation” by the central government was issued to restrict the purchasing of housing that stipulated “strictly restrict unreasonable housing demands,” and “every household is only allowed to purchase one set of house”. The document also raised the down payment ratio of the second house to over 50%, and halted the grant for loans for a third house. All big cities in China followed the document and set up restriction measures whose main content was to restrict the number of houses purchased by consumers, especially non-local residents. In the meanwhile, many cities adopted direct price regulations.
Looking back, why should there be restrictions? The main concern was the rapid growth of housing price since 2007. Taking Beijing for an instance, from 2001 to 2013, the housing price increased by 20.4% yearly; from 2007 to 2010, the housing price increased by 142%, a 34.3% increase on a yearly basis; the housing price increased by 63% in 2009 over the previous year. Therefore, the government issued this document in the light that “housing prices grow too rapidly and at big scales, which made it harder for residents to solve their demand for housing via the market, and it increases the financial risks, which is not good for the coordinated development of the economy and the society.”
Source: Jieanxin, Housing Price in Beijing, 2014
The issue here is why was there such a rapid growth of housing price? Where did it come from? There are three reasons. The first reason is the speeding-up of the urbanisation process. In the planned economy, the urbanisation rate of China was generally low. By 1978, the urbanisation rate was slightly under 18%, lower than that of 1960. By the late 1990s, China’s economic miracle has brought industrial development and growth of wealth, which brought about rapid urbanisation. The average annual urbanisation rate was 1.2%. In this process, the previous housing supply pattern failed to adjust to the new demands of the people, so there came the reform of housing market. This reform has much positive significance. The reform relied on the market to allocate the housing resources, which also reflects the scarcity of land by prices. In this sense, the rapid growth of housing price after 2000 reflected the speeding urbanisation process.
Secondly, the central government decided to crack down “Houses with limited property rights”(小产权房). Ever since the amendment of the Land Management Law in 1998, the central government has been suppressing the development of houses with limited property rights in order to monopolise the land supply. From 2006 to 2008, the central government and other departments issued 7 policy documents to constrain the construction of houses with limited property rights. According to a survey by the Ministry of Land and Resources in 2007, the total area of houses with limited property rights in that year amounted to about 6.6 billion m[Page]2. At least 220 million people could be housed at the rate of 30 m2 per capita. Putting this area in comparison with the 770 million m2 commercial houses in the market, apparently the houses with limited property rights would contain the rapid growth of housing price. However, suppression of houses with limited property rights affected the supply of housing, which led to the rapid growth of housing price.
And a third reason was the rampant construction of economy houses. Why economy houses? The facade was to deal with the rapid growth of housing price and provide housing for the low-income residents, and what lies beneath was more than meets the eye. In the second year after China’s reform in the commercial housing, a document entitled “General Office of the State Council of the People's Republic of China’s Notice to Ministry of Construction ‘On deepening housing institutional reforms and implement measures for Beijing-based state departments’” (《在京中央国家机关进一步深化住房制度改革实施方案》的通知”（厅字10号）) stipulated that, “In a certain period of time, Government Offices Administration of the State Council and National Government Offices Administration are allowed to organise the construction of economy houses and sell these houses to staff of the Beijing-based departments and government offices.” This document initiated the construction of economy housing by civil servants, and governments of all levels followed suit.
This article does not speculate the incentive of such policy. Whatsoever, the rapid growth of housing price after 2000 coincided with the construction of economy houses in 1999; and the high housing price after 2007 coincided with the economy houses’ occupation of commercial housing lands from 2006 to 2008. Economy housing is necessary because of the high housing price, while housing price goes up thanks to the economy houses. According to Mr. REN Zhiqiang, a real estate tycoon, from 2005 to 2009, the land supply for economy housing accounted 66% of the total land supply in Beijing (2012). As the land for commercial housing was used otherwise in economy housing, the decreased supply of land caused high prices. Therefore, in Beijing’s case, the 66% decrease of land supply led to a 60% increase of housing prices in commercial housing.
Based on the discussion above, what the incumbent administration needs to address right now is the issues caused by the previous administration, and the policy consequences of the last policy was designated to solve the problems brought by the previous policy. The bottom line is, the original policy was a mix of a lack of neutral attitude towards the market responses, and the administration’s concern for its own interest. One thing led to another, a malicious circle emerged. Because of the government intervention, more intervention is called for to address the negative implications of the last intervention. The short-memory of the common citizens, however, lead them to ignore the true cause of all the conundrums at hand, and believe the government should interfere even more. [Page]
We’ll talk about the neutrality of the government in dealing with the market first and then it’s incentives to interfere. The neutrality of the government forbids the government to direct the market with policy, regulation, or direct market operations. The intention of the government usually results in huge market fluctuations; even when the government tries to reverse the market development, it normally ends up with excessive government intervention. In fact, the economic problems that are faced with today are not a problem of fast or slow economic growth, but excessive fluctuation of the economy. And this is due to government intervention. Some may ask whether the market itself fluctuates to extremes. Is it that there is market fluctuation in the first place, and then the government intervenes? To answer this question, we need to distinguish government from market.
The market is a place where many individuals undertake transactions in a decentralised manner. Due to the comparison and influence of the transaction information, the decentralised transaction information converges to an equilibrium price. The effectiveness of the market depends on this feature of the market. As individuals exchange according to their own goals and judgments, normally, they don’t buy or sell in the same direction at the same time. Their dispersed decisions off-set each other, and therefore, prevent the market from excessive fluctuation. Of course, in the natural state of decentralised market transactions, voluntary buying does not necessarily off-set voluntary selling. Sometimes, voluntary buyings prevail and the prices go up which pushes up the market prices, and sometimes, the opposite market development takes place. These form the normal fluctuation of the market. Thanks to the negative feedback mechanism of the market in a certain range, supply increases when prices go up, therefore, demand decreases, and the supply and demand relation changes to constrain the prices develop in the same direction any longer.
And in specific times and very rare occasions, the decentralised decisions of individuals accidentally form voluntary transactions in the same direction, such as massive selling which results in huge market fluctuations. However, these are very rare instances that require the government to handle. Direct intervention by the government was only seen during the Great Recession in 1929, or the Black Monday in 1987. As Greenspan recalled, the Federal Reserve injected credit to commercial banks in 1987, and money was basically piled up in the doorsteps of those commercial banks. These policy interventions are designed to be contingencies in desperate circumstances as the real economy can be affected by the sudden break of liabilities and decrease of credit and money supply. However, what’s worth noting is that such instances in history were not caused by the market. As we now come to recognise, the sub-prime debt crisis was a result of long-term stimulus policy by the American government to stimulate consumption on expanding credit. The direct cause was [Page]Fannie Mae and Freddie Mac which misled consumers.
Let us now appreciate the nature of government intervention. The government is a super player in the market place. Thanks to the massive scale and compulsiveness of its measures, the government’s policy, regulation and direct market operations are able to throw the market in a certain direction and there is no power that can offset the trend. In fact, China’s went through decades of planned economy, and a market economy in the last three and a half decades, historic statistics shed light upon the reality and remind us of the times when there were huge economic fluctuations. The following graph shows the growth rate of China’s economy from the 1950s to 2014. Quite directly, we come to the conclusion that the more the government intervenes in resource allocation, the more severe the economy fluctuates, and the slower the economy grows. Government intervention coincided with massive economic fluctuations. The economy fluctuated at the largest scale from 1958 to 1971; and followed by big fluctuations in the early years after the reform and opening up as there was a lack of complete market institution. And after 1990s, the economy developed steadily.
Source: National Bureau of Statistics
Taking the global economic crisis in 2008 for an example, an “investment multiplier” effect was witnessed where the Chinese government pushed forward a RMB 4 trillion stimulus package in 2009, which directly invested over RMB 1 trillion. The other concrete measure taken by the government was to encourage local governments to invest, to speed up approval process for local construction projects, and to push state-owned banks to lend quickly and recklessly to local governments and state-owned enterprises. In fact, the high current item surplus in 2009 has led to sufficient supply of money in commercial banks. The loans of that year accounted for nearly RMB 9 trillion, an approximate 20% increase compared with the year before.
The measures taken by the Chinese government prevented China from taking the hit like the US or other western countries. However, immediate inflation was a result. In 2010, the commodity price index increased over months and reached 5.1% in November, 6.5% the following July, and the factor price index hit 7.5%. On the other hand, investment by the local governments and state-owned enterprises based on administrative orders lowered the efficiency of the investment significantly. Many projects were bound to fail when they were invested. And the consequence of such government-led investment was deflation. And what the central government promoted was immediately countered by opposite demand for action.
The government intervention in recent years not only comes in the form of inductive policy measures, such as interest rate and tax rate, but more and more often in forms of direct restriction of purchase or regulated prices that result in more serious consequences, more abrupt changes and bigger fluctuations. This is why the real estate industry, and the macroeconomic shifts and turns with abrupt price regulations, come into being. Is the government intervention good for the economy? Not at all. On the contrary, government interventions have negative effect on the economy. [Page]
In general economic terms, a normal market can’t possibly avoid any fluctuation. Sometimes, fluctuation is good for economic structuring. Of course, big fluctuations are not good. Peter Lindert and Charls Kindelberg discussed how stable prices will bring welfare to the world in their International Economics. On the other hand, large economic fluctuations will bring about harm. A simple example is the fluctuation in agriculture. If the agricultural yield fluctuates at a level of 15% between a good year and a bad year, then people expect to economise a little in the bad year in order to survive. But if the fluctuation exceeds 50%, there may be famines and death. China has a long trail of such events in its history.
When the economy is influenced by the government policy, regulation and direct intervention, the excessive fluctuation is a false market signal, as it does not reflect the real supply and demand relation. The investment encouraged and promoted by the government is not met by efficient demand, and the regulated price does not reflect the real demand. The frequent shifts in the short-term due to the changeable policies mislead investors. Investors become coy to invest as the policy shift may turn the expected gain into loss. With distorted market signals, it is impossible for the resource allocation to be efficient. The government regulation itself is harmful. If the regulated price is a deviation from the market price, then no matter whether the price is high or low, the supply cannot meet the demand, and social welfare loss is resulted.
It may seem that price regulation benefits the low-income people, but the truth is, it does not. As pointed by Professor Steven N. S. Cheung, if the “rent” (the difference between the regulated low price and the market price) is not designated to a certain people, then people will compete (such as queuing) to get this rent, and the water resources in the competition equals the rent. That is to say, the rent is dissipated. In addition, as Chinese administrative officials are acting with the biggest discretion, the rent from government regulations is more likely to be owned by some government officials who hold public powers. And the result is more likely to be anything but benefiting the low-income groups.
As we see in the frequent policy shifts and adjustments, the social welfare is not increased. On the contrary, harm and efficiency loss are made. Then, why are there policy shifts and adjustments? How to establish a government of positive value? This is an issue concerning the positioning of the government functions and its code of conduct. We believe that the central government has a duty to the macroeconomy, but only in a very narrow area, that is when the economy is likely to collapse without proper intervention. In most cases, the macroeconomy concerns only the market and enterprises. Such a positioning of the government reflects a principle that is the government should maintain neutral toward the market. [Page]
To maintain neutrality means to withhold stance and contain the impulse to intervene when market fluctuations occur. Even when the government has to interfere, direct and compulsive measures should be avoided, such as price regulations, quantity regulations, or entry barriers; directive measures should be favourable, such as influencing the behaviours of the market players by influencing the market parameters. Besides, caution needs to be taken when adjusting policy parameters, too. This requires deep understanding of the market mechanism, and trust in the effectiveness of the market, which is hard. Chinese government officials are heavily affected by the planned economy mentality, and they tend to treat the market as irrational result of individual decisions, and policies as the rational result of careful consideration.
Such a phenomenon is criticised by Hayek as rationalism. As Hayek pointed out that “the most important trait of the price system is that it economise the knowledge it requires to run. That is to say, individuals in this system need but very little information to take the right action.”(1989, p82) And the spontaneous order that contains rich information and neat mechanism cannot be fully understood by human rationality. Once human beings think they have understood the market and design an institution to replace the market, which institution always falls short of the market, and is likely to bring disasters. This has been proven by history.
Secondly, the government should trust the market. It should not only trust that the market is better at allocating resources, but it also is better to self-adjust in terms of economic fluctuation. As argued before, there is a negative feedback mechanism in the market that is to reversely adjust itself against the market trend when there is a fluctuation. In terms of long term and significant market trend, caution is needed to assess whether it’s good or bad. For example, the rapid economic growth after the reform and opening up, or the rapid urbanisation process since the 1990s are either attributed to the released efficiency due to institutional reforms, or the concentration of population due to economic development and industrial growth. When there is short-term odd fluctuation, we need to consider if it is due to non-market factors, such as government policies. As Confucius said, “The Heaven never speaks, and the seasons run naturally…” (天何言哉？四时行焉) It means even though the Heaven never speaks, we all believe winter is followed by spring. So should we believe that the negative mechanism of the market is effective.
Thirdly, the government should be self-conscious. We need to recognise that government officials are human beings who have limits. This requires us to fully acknowledge the lessons from the planned economy, and to be conscious whether the current government policy will bring abrupt shifts and turns in the marketplace. We can always look into the long term and evaluate whether the consequences of some macroeconomic policies are satisfactory, or whether the policies are made just for the sake of intervention instead of handling a tough situation. As Lao Tzu said, “the policies seem plausible, but the citizens are suffering.” ([Page]其政察察，其民缺缺) Some seemingly rational policies may lead citizens to blind belief of the government and speculation.
It is very difficult to do the three things mentioned above. Everyone is but common man. And common man is characterised to be “self-loving.” Adam Smith said, self-loving leads to “overestimating one’s capability” and “misjudging one’s luck.” This shortcoming of man also brings overestimation of two statuses, “ambition makes men overestimate the difference between a private position and a public one; vanity makes men overestimate the difference between anonymity and reputation.” (Coase, 2010, p132) For common people conceitedness and over optimism lead to immediate punishment; for government officials, if they are always claiming to offer the remedy to market fluctuations and blame it on the irrational action of the market players, then they are likely to be punished. And what’s also likely to happen is they tend to bring the people and the market into harm’s way while maintaining and expanding their shortcoming of self-loving. And that’s what ambition and vanity entail.
In addition, human beings are economic men, government officials are economic men as well. It has been proven by the example of economy housing. Self-loving and self-interest is the original sin of human beings that can’t be corrected by persuasion or self-constraint. Therefore, an impersonal institution is required to supervise the government and to hold it accountable. For instance, hearings should be held when there are conflicting policies, and critiques on macroeconomic policy and housing policy should be tolerated. What’s more, government’s intervention of the market and enterprises should be restrained.
All in all, the best way to prevent the government from excessive intervention is to uphold the market as an infrangible constitutional principle. In China, the Constitution stipulates that China is a socialist market economy. However, the Constitution is not observed in reality. Whereas in most countries, there is little dispute over the boundary of the market. This shows that in most cases, this constitutional principle is strictly observed. Or to put it in another way, culture has a role to play. On the Black Monday of 1987, Ms. Thatcher said, “You don’t need to worry, the market is sound.” (Steven K. Beckner, 1999, p69) and after the stock market value decreased by 25%, President Reagan was the “least nervous man”. He said, “The market has hit the bottom, and it will rebound.” (Steven K. Beckner, 1999, p70) It was because of his neutral stance that Greenspan issued the proper measures to save the market.
Of course, there are different scenarios. For example, the recent case between Apple and the United States Department of Justice concerns the foundation of market, which are property rights. No matter how this case plays out, it will be a constitutional event that demonstrates how the boundary of market is drawn. However, in China, we were informed of the sharp decrease of housing price in Shenzhen and Shanghai due to forceful government intervention and strict restriction of purchasing. And yet we still remember vividly how important “cutting the excessive stock in real estate market” was at the Central Economic Work Conference at the end of last December. What can we say? Coase said, “The continuous expansion of the government will inevitably led us to such a state: most government activities are harmful instead of beneficial. And I guess we are in such a state.” (2010, p75) Apparently he was referring to the US. And I think we have not left that state in China yet. However, I am positive that we will step out of that state. I believe so not only because rule of the Constitution has wide social consensus, but also because there’s such as saying that weathered two thousand years and is still relevant. It goes, “the Way usually does nothing, and does everything. If the prince can constrain himself, then everything in the world will run according to the natural order. ”[Page]
Steven K. Beckner, Back from the Brink: The Greenspan Years, Jiangsu People’s Press, 1999.
DENG Haiqing, CHEN Xi, “Is the Stock of Housing Market Really High?—The Return of Cycle and the Soft Landing of Investment”. hexun.com, 2016-04-14, http://house.hexun.com/2016-04-14/183314946.html
Friedrich Hayek, Individualism and Economic Order, Beijing Institute of Economics Press, 1989.
Jieanxin, Housing Price in Beijing, 2014. http://wenku.baidu.com/link?url=qEl0lYvjOwGFQiRF3WPyJdUnBehJxvTfHPRzifoJtwuIz_2ar7INwuOqQMQLZiRV8SYQvdyjjUxgxa6CX76IOT_GC7EEVvH6FgrlzxTxtyq
Ronald Coase, Essays on Economics and Economists, Truth & Wisdom Press, 2010.
REN Zhiqiang, “Economy Housing Leads to Institutional Power Corruption”, 2012-05-01, http://www.360doc.com/content/12/0501/02/699582_207810027.shtml