Abstract: This article summarizes four challenges facing city cluster development in China and offers five suggestions on how finance can help address these problems. First, issue “special bonds for the citizenization of migrant workers.” Second, establish markets for nationwide exchange of land quotas and farmland compensation quotas. Third, promote market-based interest rates and decentralize local government bond issuance to the municipal level. Fourth, establish a fund for revenue and cost sharing within a city cluster. And fifth, encourage “l(fā)ocal solutions” for different local issues.
Effective urbanization and city cluster development could optimize the spatial allocation of economic factors, and, through coordination among clusters and cities, promote innovation, extend industrial chains, and unblock the circulation within the national economy. The financial industry has a big part to play in the development of city clusters under the new development paradigm. On the one hand, high-quality financial resources are needed to fund the development of infrastructure and green and smart cities, as well as the provision of public services for migrant workers (i.e., citizenization); on the other hand, with the concentration of debts of households, local governments, and local SOEs (such as city development and investment companies) in real estate and infrastructure construction, the high-quality development of metropolitan areas will also ensure financial security.
Therefore, providing funding for urban construction through proper financial instruments will boost the supply of high-quality RMB capital, stabilize the domestic financial market, and provide a solid foundation for the domestic and international circulation of RMB.
The development of city clusters should follow the trend of population agglomeration. It should allow the concentration of economic activities to improve productivity and transform employment and industrial structure. The cooperation and competition between big and small cities should be delicately handled. And the center and periphery of a metropolitan area should be better connected.
Oversight of objectivity could lead to spatial misallocation of resources. The growth of total factor productivity of China’s firms has been slowing since 2003. As a result of tightened land supply, eastern China has witnessed a dramatic spike in housing prices, which pushed up the wages in coastal areas and attracted more businesses to real estate purchases, crowding out investment in the real economy. In small- and medium-sized cities in central and western China reporting net population outflows, large-scale construction in outlying suburbs not only goes against economic rules, but has also put a heavy burden on local government budgets.
I. CHALLENGES TO THE DEVELOPMENT OF CITY CLUSTERS
1. Urban residency and public services for migrants. With an urbanization rate of 64%, China is still urbanizing and rural people are continuing to migrate to cities in large numbers. As the reform on factor markets deepens, freer flow of population, capital, and land (construction land quotas) will further drive population aggregations in the Beijing-Tianjin-Hebei area, Yangtze River Delta, Guangdong-Hong Kong-Macau area, and Chengdu-Chongqing area.
The seventh national population census shows that over 370 million people have not been able to register “hukou” in their city of residence, who are denied equal access to schooling, employment, healthcare, pension, subsidized apartment, and other public services. They tend not to stay for long-term work, which could destabilize labor supply for the development of city clusters and bring a series of economic challenges, including local debt issues and systematic financial risks.
2. Lack of construction land quotas in metropolitan areas. A common problem facing metropolitan areas and city clusters is the severe shortage of land available for development. Under the current quota allocation system, spatial misallocation of land resources has become a prominent issue: a disproportionate number of new quotas are allotted to areas recording net population outflows, whereas regions with large population inflows are not receiving the quotas they need to attract firms and provide sufficient housing for migrant workers. Furthermore, because excessive quotas cannot be exchanged across regions, population outflow regions tend to engage excessively in the construction of infrastructure and industrial parks, leading to inefficient fiscal spending and over borrowing among local governments.
3. High local government debts. From a spatial perspective, the structural problem of the macro leverage ratio in China is distinctively regional. Financial risks in more developed areas are relatively controllable, while bigger risks in less developed areas are likely to trigger comprehensive financial risks. Similar to the issue observed in the Eurozone, insufficient concentration of production factors caused by their lack of free flow (particularly the labor force) and a unified currency market together contributed to high government debt in underdeveloped areas in China. And just like how debt crisis spread from individual countries to the wider Eurozone, there is a distinct possibility that financial risks arising from local government debts in certain parts of China could eventually trigger a systemic financial crisis.
4. Administrative jurisdictions limit policy coordination and the integration of market within a city cluster. It is costly for different local governments in a city cluster to coordinate their policies due to implementational hurdles and jurisdictional divisions. Moreover, because local authorities are only concerned about the provision of infrastructure and public services within their own jurisdiction as that is where their fiscal revenue comes from, inter-city coordination tends to be overlooked. Ultimately, it comes down to the sharing of costs and benefits among local governments within the cluster. In absence of a sophisticated mechanism, it is difficult to form a truly integrated market. In this sense, how to coordinate the division of labors between and within clusters will be the crux of city cluster development.
II. POLICY SUGGESTIONS ON FINANCING THE DEVELOPMENT OF CITY CLUSTERS
The above challenges could be addressed through market-based coordination, where finance can play a key role.
1. Issue “special bonds for the citizenization of migrant workers.” To promote the citizenization of the migrant population in city clusters, RMB-denominated bonds could be issued in domestic and overseas financial markets, not necessarily in the name of the local government, but in that of the central government, as the credit endorsement from the latter would reduce the cost of financing. Such bonds could be called "special bonds for the citizenization of migrant workers". It is also recommended to issue simultaneously at home and abroad but focus on the offshore financial market because the cost there is much lower. The move could expand the offshore financial market, increase the liquidity of the offshore RMB bond market, and promote the internationalization of RMB.
2. Establish markets for nationwide exchange of land quotas and farmland compensation quotas. To improve the efficiency of land resource allocation through financial means, we could build a trading market to enable market-based pricing for the quotas of urban construction land. First, the government could function as a market for new construction land quotas. The new quotas allocated by the central government to the provincial-level governments should be linked to the increase in population and the number of newly citizenized permanent residents. Second, reallocate the unused quotas in population outflow areas to other regions. Third, allow the cross-regional exchange of idle construction land, quotas generated from the reclamation of rural idle collective operational construction land, and quotas generated under the arable land balance policy. Fourth, promote the recultivation of idle rural homesteads. Reclaimed homesteads could be converted into commensurable construction land quotas and traded in the market at a price that is nationally unified, adding to farmers’ property income. Fifth, allow the exchange markets for land quotas and farmland compensation quotas certain investment and financing functions.
3. Relax limitations on the scale of the local government bond financing, promote interest rate marketization and let financial markets price the risks of local government bonds. Resolve local government debts, especially implicit debts by relaxing restrictions on the scale of local government bond financing, decentralizing bond issuance to the municipal level, and deepening market-oriented reform of interest rates and debt risk pricing. To this end, it is necessary to gradually break the rigid payment of local government debt so that interest rates can reflect the risk of debt default. Meanwhile, a lifelong accountability system should be set up to hold government officials responsible for debt default to prevent short-term behavior and moral hazards.
4. Establish a fund for the revenue and cost sharing within a city cluster. The aim is to promote the free flow of production factors, coordinate policies, and address common concerns such as environmental protection. Such an integration fund also enables a revenue and cost sharing mechanism among local governments. Regarding the capital composition, cities could make their initial capital contribution to the fund and receive the equity shares in proportion to their GDP. Subsequent capital investment can be supplemented by way of tax revenue distribution by the State Administration.
5. Other problems in the city clusters require “l(fā)ocal solutions.” Challenges vary among cities with population outflows and inflows, and different response methods should be adopted. For the bad debt risks faced by small and medium-sized banks in cities with population outflows, there are two solutions for local government to consider: issue special bonds to supplement the capital, or set up cooperation between local government and local asset management companies for market-based disposal of the non-performing assets. For the insufficient supply of supporting infrastructure in cities with population inflows, real estate investment trusts (REITs) could be established to raise funds for infrastructure construction.
This report is abridged from the fourth sub-report in the 2021 Jingshan Report, the outcome of a research project headed by Lu Ming. Other members on the team include Zhong Huiyong, Li Jiewei, and Zheng Yilin. The views expressed herein are the author’s own and do not represent those of CF40 or other organizations. It is translated by CF40 and has not been reviewed by the author.
