This land is my land

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land, a valuable asset class, is governed by a unique system in China. Chinese land is completely publicly owned: Urban land belongs to the state, as stipulated by China’s constitution, while rural land (except state-run farmland) is collectively owned by China’s rural residents. Many aspects of the Chinese economy now run by the rules of a market economy, but land is not one of them. The government still maintains an absolute monopoly over its allocation.

Because rural land is collectively owned, Chinese peasants are entitled both to usage rights for residential land and contractual land-use rights for farming. However, their contractual rights can be insecure, with rural government officials often reallocating contracts where they see potential profit.

And while Chinese peasants have the right to use collectively owned rural land, they have no right to sell or develop it. When rural residents do sign contracts to transfer land usage rights to other parties, they are often ruled invalid or non-binding. And when farming land does get repurposed for non-farming activities, rural residents often have little to no bargaining power in determining the sale price and receiving compensation.

Only the government can take over collectively owned rural land from rural residents in order to develop it. This fact is key to understanding China’s land system.

In addition to monopolizing land transfers, the central government also requires different levels of local governments to ensure an adequate amount of land is devoted to grain production. Land use guidelines stipulate that China maintains roughly 1.2 million square kilometers of arable land. In accordance with this “red line,” the central government fixes annual and longer-term quotas for the amount of farming land that can be developed in different regions. Local governments without quotas are banned from building on farmland.

Local governments with quotas have two methods for reallocating land for construction. They can allocate (zhengyong, in Chinese) existing urban land or requisitioned rural land for construction of government projects by government organizations, in which case they are required to compensate the previous owners. They can also rezone barren mountains, deserts and tidal flats for the same purpose.

The government can also transfer (churang) state-owned land’s usage rights for a fixed number of years at auction or through a mutual agreement with a third party, in exchange for some share of revenues – what is typically described as a local government “land sale.” The terms of use are capped at 70 years for residential land, 50 years for industrial, educational, scientific and cultural land, and 40 years for commercial use.

This excessively strict land system has created a bottleneck that restricts China’s economic development and results in a variety of unintended, adverse consequences, including infringing on farmer’s rights and damaging the environment.

Feeling the pinch

Since farmers are prohibited from developing or selling their land for development, they are deprived of the opportunity to maximize the value of their most basic asset. If they hand over land to the government for development, their compensation – which is fixed at several times the value of the land, as determined by the government – neither reflects the land’s real agricultural value nor the increase in value due to the imminent sale.

While China’s land system was established with the goal of protecting and maintaining a certain amount of farmland, it can often hurt agriculture. To ensure an adequate supply of farmland, Chinese authorities insist on a use-resupply policy: For any farmland repurposed for construction, an equal amount and quality of farmland must be created. This practice inevitably leads to the clearing and destruction of mountains and forests that damages the environment.

Rural residents are also more inclined to use the land to live on rather than to farm, since the leasing rights for farmland are so insecure. These weak contractual rights mean farmers are often unwilling to invest in improving or maintaining farmland, reducing agricultural yields and lowering the price of rural land.

The current land allocation system also suffers from structural problems that reduce economic efficiency. First, the centralized control of quotas for construction land makes it difficult for the government to distribute resources in a way that meets the divergent and ever-changing demands of different regions.

In addition, local governments seeking to enhance their track records are prone to allocate land to universities, highways, public squares, factories, industrial parks and other projects by partyor government-affiliated organizations at little to no cost, resulting in excessive supply and wasteful use of land. Yet for residential and commercial land, local governments intentionally inflate land prices to seek high transfer fees, driving up land prices and eventually house prices and rents. These higher costs force Chinese to consume less, lowering the growth potential of the economy.

The current system also restricts the process of urbanization and industrialization, resulting in inefficiencies and further widening the income gap between urban and rural residents. Migrants moving from the countryside to Chinese cities often leave large tracts of land idle, and they cannot liquidate these holdings to finance their lives in the city. It is also impossible for urban residents to obtain usage rights for residential land in the countryside. This is not only a significant waste of resources, it also drives up urban land and housing prices.

Finally, government officials have the sole authority to determine whether to grant land, how much land should be distributed and for what price. Weak governance means corruption and rent-seeking are rampant, leading to a huge loss of profits from state-owned land.

Keys to the city

China’s land system needs to evolve in two fundamental directions. First, it should be reformed to strengthen rural residents’ property rights. Farmers should have permanent contractual rights to their land that allow them to use, transfer and inherit land, as well as use it as collateral.

Secondly, the government monopoly over land allocation should be eliminated, allowing the market to play a more pivotal role. That includes amending the constitution so that urban land can also be owned by the collective.

Of course, these reforms will undoubtedly reduce local government revenue from land transfers, a major source of their financing. Therefore, the tax system must first be reformed to ensure that local governments still have access to a stable source of revenue.

A regulated land planning system should replace the current system of land construction quotas. Governments should reduce the frequency with which they requisition land, only doing so when it benefits public interest and ensuring that those who lose their land are compensated in line with market prices.

The local government practice of allocating land for public projects should also be restricted. If land is designated for public infrastructure construction, its users must pay a fair market price. If the government decides to continue allocating land at below market cost, that power should be restricted to the People’s Congress and its Standing Committee. Local governments’ transfer of land usage rights should also be limited to certain types of state-owned land.

Push comes to shove

While abuses of China’s current land system have attracted popular attention, there are still many challenges and obstacles to reform. These include the widespread conviction that land should be publicly owned; the government’s concerns that opening up the land market may affect food security and social stability as the number of rural residents without land increases; and local officials’ strong motivation to control land in order to continue to fill their pockets and fund large construction projects.

But as it becomes increasingly obvious that the land system is harming Chinese society and the economy, leaders may be forced to implement reforms. As for almost all systematic reforms in China, these measures are likely to be incremental and be carried out on a limited scale.

Land reform is clearly on the minds of China’s top officials. In a report unveiled during the National Party Congress on November 8, the Communist Party pledged to reform the land requisition system and protect rural residents’rights to farm and residential land, as well as their “right to share in the earnings of collectively owned land,” in accordance with the law. In late November, the State Council passed a revision to the land law that could pave the way for improving compensation for rural land requisition. And in the mid-December Central Economic Work Conference, top leaders identified passing reforms to allow migrant workers to urbanize as a key task for 2013. While these statements send moderately positive signals, it remains to be seen how reforms will materialize.