Incentive structure and market performance : institutional analysis of governments' roles affecting land and housing prices in China

Abstract

This thesis explores governments' incentive structures affecting land and housing prices in China. There are three reasons for such institutional analysis: There has been a profound transformation from a welfare housing system to a commodity housing system, which affects the central government's incentive structure. Land reform and fiscal reform have significantly influenced local governments' incentive structure. Changes and conflicts of central and local governments' incentive structures result in governments' interference with the urban land market and the commodity housing market, which affects land and housing prices. Although China's economic reforms and the subsequent changes of its housing system has been the subject of numerous studies, this thesis takes another perspective that could broaden the discussion. While land and housing markets are expected to respond to institutional changes and conflicts of central and local governments' incentive structures, there has been little theoretical explanation and empirical evidence in China's context. This thesis establishes a conceptual framework to discuss the impacts of such changes and conflicts, with the case of China. Research process of this thesis is as follows: First, it provides an extensive literature review on the changes and conflicts of governments' incentive structures pertaining to financial system, fiscal distribution, and land use rights. These changes and conflicts have reshaped China's land and housing markets in a way that differs from what is explained by classical economic theories originating from western economies. Second, a conceptual framework is established to integrate the impacts of institutional changes and conflicts on land and housing price movements, proposing the research hypothesis and testable propositions. Third, econometric models are applied to the derived propositions to study the impacts of governments' incentive structure changes and conflicts on the land and housing prices. Econometric techniques applied in this thesis include panel data model, cointegration test, and Granger causality test. The research hypothesis of this thesis is: Local governments' incentives include political promotion incentive, fiscal revenue incentive and economic growth incentive, whereas the central government's incentives include social stability incentive, fiscal revenue incentive and economic growth incentive. Changes and conflicts of central and local governments' incentive structures have significantly affected land and housing prices in China over the past two decades. Empirical results show that China's land and housing markets have experienced a prolonged boom with occasional adjustments. The property boom was mainly promoted by local governments. Specifically, local officials are motivated to increase GDP growth, which enhances their political promotion probability. To achieve this goal, a higher proportion of land for residential and commercial usage is sold by public auction, which has a positive impact on GDP growth. Public auction results in higher land price, which gives rise to real estate developers' land hoarding strategy. Land hoarding, together with increased public expenditure, contributes to housing price escalation. On the contrary, the central government cautions inflationary pressure and social welfare. Affordable housing project, among other regulative policies, has been introduced to mediate land and housing market booms. In conclusion, it is found that there are diverse goals between central and local governments that have significantly affected land and housing prices in China. When the central government takes control, the market turns to adjustment; when local governments gain advantage, the market experiences a period of boom. As commodity market being established, the central government's influence on market adjustment is gradually lessened; while local governments' impact on market boom is increasingly intensified. The nature of this incentive-performance nexus is that natural experiments such as financial, land, and fiscal reforms balancing central and local governments' interests have affected China's land and housing markets over the past two decades.