Impact of Chinese Government’s Regulation on Urban Residential Quality
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Abstract. This paper describes the connotations and features of residential quality; according to the clues to the life cycle of real estate projects, based on the Static Bayesian theory in economic game theory, Backward Induction Method and Principal- Agent Theory, it analyzes three existing government regulation consisted of land transfer system, advance sale of commodity housing system and construction management system, and points out that the production problems of residential quality rooted in three irrational, imperfect government regulation. Then, it puts forward feasible proposals for the existing problems and provides innovative ideas and scientific methods for the modification and improvement of the regulation.
Key words: residential quality, government regulation, advance sale of commodity housing system, economic game theory
1. Introduction
Urban residential quality not only relate to living quality of millions of households, but have connection with effective allocation of social resources, in this sense, it’s both a social and economic issue. However, the residential quality of this sort has shown market failure in recent years. The government's regulation aims to correct the micro-market failure, promote fair market and competition and increase market efficiency; the government must assume the responsibility to protect the interests of the public and take universal selected management action to put main activities under regulated from the micro perspective [1]. Market failure is caused by a variety of reasons, among which the unreasonable government regulation is the basic cause. Only a scientific and reasonable government regulation can intervene with the housing market effectively and eliminate the potential factors from the origin.
2. CONNOTATIONS OF RESIDENTIAL QUALITY
The standard for residential quality is the degree how to meet customers’ demand. Residential quality carries with the characteristic of the project, that is, the residential quality control throughout the entire life cycle of the project. The life cycle of residential project includes the official acquisition of lands, promotion, plan at the beginning of the project, and design, construction, marketing in project construction process as well as the delivery of the accomplished[2]. Residential quality has the attributes of economic, time-efficient, systematic and general.
3. ANALYSIS OF RELATED GOVERNMENT'S REGULATIONS
3.1 The Land Transfer System
land prices affect the residential quality in two aspects: first, land prices push up housing prices, and comparing the high housing prices, the actual residential value are actually lower, then the residential quality are affected; Second, the land cost takes a larger proportion in the development cost, that means the developers must cut other costs to keep pace with the rising land prices at the expense of quality lower.
In the year 2000-2011, the housing price of 35 main cities in China has risen accumulatively to 76.8%, and during the same period , the price of residential land has risen accumulatively to 163.5%. Land prices rose faster than housing prices, and land cost took larger and larger proportion in housing prices. The main drive that pushes up housing prices is land price, the cause of which is the transformation of Land Transfer System. chinese Land Transfer System has three main features: first, the government is the monopoly land supplier; second, auction by competitive bidding is the only transfer mode; third, land pricing is payment for 70 years in one time. According to the Static Bayesian in economic game theory, where is more bidders, there is higher price. When the bidders tend to achieve infinity, the sellers can earn almost the whole thing [3].
3.2 The Advance Sale of Commodity Housing System
The Measures for the Management of Advance Sale of Urban Commercial Houses (China) regulates that the real estate development enterprises can sell the houses under construction to purchasers and the purchasers should pay the earnest money or the prices of houses. Throughout the whole pre-sale process, the participants include the development enterprises, contractors, consumers, and government supervisors and so on. Among them, the development enterprises take the jobs as acquisition of land, construction, financing, marketing, planning, etc, and it actually lead and control the entire pre-sale process. What the buyers can do is just paying the money and receiving the housing, they can’t participate in other process. The only process that the buyers can have inspection effect on residential quality is receiving the housing, but at this time, the development enterprise has got all the pre-sale money, and it couldn’t refund and compensate on quality problems even if quality problems have been found without the main structure problem. According to backward induction method[4,5], as the result of the absence of hash punishment mechanism, the seller’s commitment to quality is incredible. Therefore, to the buyer, the advance sale system is far from fair. From the capital leverage and finance perspective, the pre-sale housing system does have a positive meaning, and promotes the development of real estate industry, especially the real estate is just emerging and it’s shortage of capital at the start. After 20 years’ development, the real estate development market has become mature, and the developer enterprise has accumulated strength. Nevertheless, to some extent, the advance sale of commodity housing system has been a motivation for development companies to reduce the quality standards and harm the interests of buyers.
3.3 The Construction Management System
According to the principal- agency in information economics, the buyers, the development enterprises and construction companies formed a multi-principal-agent relationship in housing construction process. To begin with, the buyers have to entrust their rights to government function departments because buyers can’t control the behavior of enterprises. Although there is no obvious entrusted relationship between them, the interest of one party has relations with the behavior of the other party. One party has difficulty in controlling and supervising the other party behavior, so they form the first layer of principal-agent relationship by affecting the activities of the other party through indirect means. Then, the functional departments of the government are the principal and the development enterprises act as the agent, which constitutes a second layer of principal-agent relationship. In addition, the development enterprise and construction enterprises make the third layer of principle-agent relationship. In the first layer of principal-agent relationship, there is the moral hazard of the functional departments of government; when in the second one, so does the development enterprises; In the last circle, it is the moral hazard of building construction enterprises.
4. PROPOSALS FOR IMPROVING THE RELEVANT GOVERNMENT regulation
4.1 Proposals for Reform of the Land Transfer System
Compared to the previous negotiable land system, the trading patterns of the present land Transfer system are a little more advanced as it’s more equitable and open. Also, the highly land price greatly improved the financial income of the government and enable it to set a great amount of capital free and invest in other areas. From healthy and sustainable development of the housing industry aspect, the existing land transfer system is the behavior of “living beyond the overdraft”. The land transfer system can reform in several aspects. First, as the increase of urban population and the decrease of rural population yearly, it’s necessary to balance the relationship between supply and demand of urban and rural residential land and transform rural residential land to the urban residential land gradually to increase the supply of urban land. Second, eliminate the “land finance” totally through fiscal reform. Third, comprehensive evaluation criteria of the housing replace the original land price evaluation criteria. In addition, change the land Transfer system-payment for 70 years in one time into annual rent system, and thus thoroughly change the mode of auction by competitive bidding method.
4.2 Proposals for Advance Sale of Commodity Housing System
The improvement of the commercial real estate pre-sale mainly focuses on the implementation on process and links, which can refer to the recall system in automotive industry, and establish the recall system of commercial real estate[7]. Although “Management and Operation for the Urban Real Estate Development” regulates that after the delivery of commercial housing, if the buyers consider the main structure of the housing in substandard condition, they can apply for re-verification to the engineering quality supervision institutions. If it does exist, the buyer can refund the housing and the real estate development enterprise shall compensate the loss of the purchaser. However, to the development enterprises, this provision is just “incredible threat” in practice because the reasons of substandard quality have been defined as failure of the main structure. Under “incredible threat” situation, only if the development enterprises have received all amount of pre-sale housing payment and ensured that the main structure of was qualified, as a rational broker, they will pursue their maximum interests. Therefore, the development enterprises don’t care about whether they can achieve the quality they promised in the pre-sale process, if not, there will not be harsh severe punishment, particularly in booming market, the buyers will not refund their housing because of the quality issue. Housing projects are with integrity, especially some of the public, hidden engineering problems, or the common problem of the building, and individual buyers cannot repair and maintenance thoroughly. The establishment of recall system for commercial real estate can force the development enterprises pay the high cost of the words they promised, and when the violate cost is high enough, the development of enterprises will construct qualified products after pre- sale of commercial housing.
4.3 Establishment of the Quality Credit Rating System of development enterprise
In the real estate finance, the credit rating has become an important benchmark for banks to choose the loan object. Enterprises with good credit tend to be the priority target of bank loans, and banks are always reluctant to loan for poor credit business to avoid bad loan. Due to the high dependence on the bank’s funds, the real estate companies are very concerned about their credit rating. Once in a while, they are wary of their dishonest acts will make their credit rating downgrade, they will spare no effort to remedy the situation by various means. In the principal-agent relationship between the government departments and real estate development enterprises, we may learn from the real estate finance industry to establish the quality credit rating system of the development enterprise. The evaluators of the quality rating should be compose of government departments, relevant assessment and monitoring institutions , of course, the most important member should come from the owners’ committee or the owners’ temporary committee. Thus, the users feedback will be the basis of the enterprise survival, if serious quality problems happened, the quality credit rating of the enterprise will be lowered to a certain level, or even worse, their development qualification can be canceled meanwhile they should also compensate for the loss of consumers. The development enterprises will be always concerned about the quality of their products to avoid being severely punished. In fact, the set of this system is essentially enhancing the supervision of the principal, reducing the possibility of agents' moral hazard.
4.4 Establishment of Temporary Owners' Committee System
The whole process of the residential development is leaded and controlled by the development enterprises, and process design is task-oriented, rather than focus on the results. In the present sale process of commercial housing, the buyers can’t participate in the execution of any process except paying the money. It is very difficult for the owners to protect their own interests, the condition to establish the Owners' Committee is that the residential occupancy rate reaches to 50%, usually 2 years after the district delivered. Owners almost know nothing but accept everything passively. Such process design has contributed to the behaviors of bad faith, lower quality, and cannot control developers diverted for other purposes, and thus the interests of buyers can't be guaranteed. In order to prevent the development companies make adverse action on the quality of the pre-sale housing, buyers should make full use of their dynamic monitoring capabilities.
The temporary owners' committee can be established when the pre-sale rate reaches a certain level, such as about 20% ,and the members of the committee can base on the sales progress to implement the round of the election system, and the Committee supervise the fund flows of the developers, the construction process, the specific technical requirements, material selections and engineering quality , and joint the government departments involved in the project Participate in the completion and acceptance, then the development enterprises under the supervision of the temporary owners' committee have to strictly control the quality.
4.5 Formulation of Reasonable Salary and Motivation System for the Government Functional Departments
There are multiple principal and agent relationships in residential construction, and the relationship between the buyers and government functional departments is an implied contractual relationship due to they differ in some aspects, such as information asymmetry, monitoring costs, opportunistic behavior and the function of objective earning, there are moral hazards for the government functional department who acted as an agent. Due to the nature of principal-agent relationship is full of uncertainty and difficult features of supervision, the principal cannot pay the agent through the agent’s actual working condition, and can only pay according the working achievement or phase achievement, the salary paid by the Principal must not less than the agent whose effort produced negative utility. First of all, the principal pays the salary must be closely linked with the agent's effort, the salary of the government departments should be linked with the degree of fulfillment of its responsibilities on the whole process of supervision over the residential quality. Secondly, the agent’s effort produced negative utility should be given some compensation, that is for an agent who fulfill the Government's strict supervision and management responsibilities should be commended. On the contrary, the passive and negative departments should be severely punished, and resolutely crackdown the corrupt behavior. Thirdly, actively promote the system of making information known to the public, and increase the principal’s supervision efforts, do our best to mold the positive, healthy honest and clean government culture. The harsh law can just punish and corruption the agent from negative aspects to have a deterrent effect, only the honest and clean government culture can flexible agent behavior from the positive direction, making them reluctant to corruption.
4.6 Reform on the Constant Tax System of the Construction Enterprises
In the principal and the agent relationship between the development enterprises and construction enterprises, it seems that the reformation on the constant tax system of construction enterprises has nothing to do with the relationship between the principal and the agent; however, it has been proved that the constant tax system is precisely the source of quality problem. In general, China's construction enterprises take a fixed rate of 3% -5% business taxes and additions, and this rate are relative lower than many other industries, and much lower than the real estate development enterprises. There are many problems existing in constant tax system of the construction enterprises; first, it directly results in the loss of government tax revenue; Secondly, it's not easy to check the profit of the construction enterprises, and also, it is difficult to investigate and deal with their dishonest behavior, which has been the potential factor that could trigger the moral hazard of the construction enterprises. In addition, it's easy for the construction enterprises collude with the development enterprise since the construction enterprises rely on the development enterprises in business, and they often work together to forge economic business and false increase construction costs for tax evasion, so the tax system of the Construction enterprises must be reformed. To reform the fixed rate of construction industry as a "consumption-type” (Value-added tax), it can directly promote the development of the building materials industry on supply-chain, rather than artificially cut off the chain of the Value-added tax. It is beneficial to the tax collection authorities perform on the tax inspection. The reform of the tax system will also enable the construction enterprises to strengthen their internal quality control cost, improve management level, and put an end to the moral hazard between the estate development companies and construction companies.
5. CONCLUSION
As the Residential projects have complicated and systemic features, the control over residential quality can’t be confined to a certain aspect. It's not just a stakeholder’s problem, so it should take the whole life cycle of the real estate projects as a clue, and dredge the institutional origin from the industry regulation perspective to eliminate the market and government failure, then, the fairness and efficiency of resource allocation can be improved.
References
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[3] Zhang Weiying(2004), “static game with incomplete information and Bayesian Nash equilibrium” in Game Theory and Information Economic,ch.3 pp.152-154.
[4] Xie Shiyu(2002), “Complete and perfect information dynamic game” in Economic Game Theory, ch.3, pp.155-156.
[5] Chen Lingyun(2012), “ Quality control under China's Advance Sale of Commodity housing System” in Scientific Management Research, vol.30, pp.213-215.
[6] Zhang Weiying(2004), “Principal-Agent theory” in Game Theory and Information Economics, ch.5, pp.248-256.
[7] Xu Shiying(2008). “Basic theory of Product Recall System” in Product Recall System：The gospel of Chinese Consumers, pp.1-2.