China’s land market: The key to continued economic growth?

In China, residential land is sold for about ten times more than industrial land. 

There is a question why municipalities don’t sell more residential land and less industrial land until the marginal prices of the two equalize. 

Using the 2007-2019 comprehensive sales data, the authors claim that the decision is determined by the different time profiles of industrial and residential sales revenues, the financial limitations of municipalities and the sharing of tax revenues by municipalities with others. administrative levels. 

China’s domestic market has been the main driver of the country’s extraordinary economic growth over the last 40 years. Several recent studies have analyzed the housing boom in China (Zhou et al. 2015) and whether China’s housing stock is overbuilt (Rogoff 2022). 

A unique feature of China’s land market is that, unlike land markets in most developed economies, it does not generate revenue for local governments through property taxes. Instead, local governments act as monopoly sellers, controlling the supply of land and relying heavily on land sales for their tax revenue. About a third of the municipalities’ income in 2010-2012 came from land sales. 

Considering the importance of land sales revenue to local governments, it is a surprising fact in China’s land market that residential land zones sell about ten times more than land for industrial use. We call this price difference the “industrial nation discount”. This raises the question of why municipalities do not sell more residential land and less industrial land until the marginal prices in the two countries equalize. 


china land market

A popular explanation for the industrial land discount is the non-monetary benefits (eg economic growth and employment) of providing industrial land (Liu and Xiong 2020). In our new work (He et al. 2022), we propose an alternative explanation for the industrial land discount, focusing on local public finances. 

We suggest that the choice of municipalities between selling industrial and residential land should reflect a trade-off between revenues. The sale of residential houses increases the prepayment income of municipalities. However, there are no long-term future revenue streams in the residential district, other than one-time taxes from single-family homes sold in the residential district. 

On the other hand, the sale of industrial land gives a significantly lower upfront income. However, industrial companies pay annual VAT and income tax in subsequent years, so the sale of industrial land will generate income in the future. 

Tax revenues and Overall cost

Are the separate tax revenues between the sale of residential and industrial land large enough to offset the difference in pre-sale revenue? To answer this question, we draw an analogy between the land sale decisions of local governments and classical corporate finance theory. The government’s decision to sell a piece of land zoned for industrial housing can be considered an investment project. 

The initial cost of the investment is the industrial discount and the future cash flows of the investment are the future differences in taxable income from the sale of industrial land compared to the sale of residential land. 

Based on estimates of the industrial discount and additional tax revenue, we can define the government’s internal rate of return (IRR) on the sale of industrial land as the rate at which the government should discount the cash flows to obtain a present value. cash flow taxes exactly equal to the initial cost. 

We then quantify these local government IRRs using extensive data on land sales in China from 2007 to 2019. We estimate industrial discounts by comparing the prices of residential lots with industrial lots of similar characteristics and vice versa. We estimate the additional tax revenue from land sales using a difference-in-difference approach by comparing firms that purchased land to control firms that did not. 

To identify the potential choice of land acquisition firms, we use control firms from the same industry and province and perform propensity score matching based on past sales growth and profit margin. 

To estimate the one-time taxes paid by housing developers for each residential land transaction, we estimate the marginal increase in taxes for one RMB increase in housing sales, using data from public developers, multiplied by one for each city’s floor ratio and housing prices. a year after the sale of the residential land. 

We find that from 2007 to 2010, the average industrial land discount is 1000.6 RMB per square meter. Meanwhile, the sale of industrial land earns about 113.6 RMB per square meter in the first two years after the sale, and about 21.2 RMB per square meter in the following years, while the sale of residential land earns 1,215.5 RMB per square meter. in the following year. This translates to an IRR of approximately 8.1percent on the sale of industrial land. That number compares to most city capital cost estimates, which range from 3.5 percent to 7.5 percent. Our results therefore suggest that before 2010 the large decline in industrial land relative to residential land can only be explained by income. After 2010, the IRR decreased significantly from 6.8% in 2010 to 3.79% in 2019. Thus, it seems that the sale of industrial land gradually became a less profitable investment from a purely financial perspective from the government’s perspective. These models raise a number of following questions: 

Do governments take these tax differences into account when making land allocation decisions? Also, what other factors influence these decisions? 

China’s land allocation is the result of a joint decision-making process between the state and local governments, including quotas set by the Ministry of Housing and the Ministry of Urban and Rural Development; we discuss how this process occurs both top-down and bottom-up between different levels of government. To understand the forces influencing land allocation decisions, we construct a simple model of the optimization problem faced by a profit-maximizing local government between the sale of industrial and residential land. We combine two realistic strengths for the Chinese land market. First, municipalities can have market power in the land market, thus their marginal revenue

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