Indebted Dragon

The Risky Strategy Behind China's Construction Economy

For four decades, the Chinese economy has grown by between seven and ten percent each year. It is the envy of the world, despite its relatively sluggish recent performance. Visitors to Beijing, Shanghai, and other major Chinese cities are quickly awed by impressive skyscrapers, glittering shopping malls, new highways, and high-speed rail lines, all of which leave the impression that China is a developed economy -- or at least well on its way to becoming one. Even in some smaller cities in inland provinces, government buildings make those in Washington and Brussels appear meager. In an area of Anhui Province that is officially designated an "impoverished county," the government office block looks exactly like the White House, only newer and whiter.

Underwriting the impressive facade, however, is an incredibly risky strategy. Governments borrow money using land as collateral and repay the interest on their loans using funds they earn from selling or leasing the same land. All this means that the Chinese economy depends on a buoyant real estate market to keep grinding. If housing and land prices fall dramatically, a fiscal or banking crisis would likely soon follow. Meanwhile, local officials' hunger for land has displaced millions of farmers, leading to 120,000 land-related protests each year.

RISKY BUSINESS

The recklessness can be traced to two things: First, local Chinese officials are evaluated for promotions and other rewards based on how well the economy they manage performs. Construction and real estate activities are among the most straightforward ways to stimulate growth. White-elephant construction projects thus offer eager officials a perfect opportunity to impress their political superiors, even if massive developments do not necessarily make any economic sense. Take, for example, the city of Ordos in Inner Mongolia: Its elaborate urban infrastructure and its sea of new flats and office blocks are nearly all unoccupied, making it China's largest ghost city.

Another factor was China's fiscal recentralization reform of 1994, in which the central government raised its own revenue by taking back power from local governments to levy some major taxes. The move lowered local governments' revenues but left their financial responsibilities -- providing education, health care, subsistence allowances, and pensions -- unchanged. So local officials had to find other ways to generate money.

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