Chapter 5

Land Market Competition Among Local

Governments: A Spatial Analysis
of Zhejiang Province

5.1 Land and Real Estate System Reform and Price

Restraint Policies

Since the 1990s, the Chinese economy has featured excess liquidity due to a continu-
ously low fixed exchange rate against the United States (US) dollar and has frequently
experienced sharp increases in asset prices commonly known as “bubbles.” While
some traders amassed great wealth through real estate transactions, skyrocketing
housing costs in major cities have been causing dissatisfaction among the masses.
There has been one protest after another over the government expropriation of land
in agricultural villages by farmers whose land has been taken by force with only
minimal compensation, and these practices have drawn wide-ranging concerns both
inside and outside of China.1
When this issue is covered by the media, the one-sided exploitation of residents and
farmers who are forced off their lands by regional governments alongside developers
is often portrayed as problematic.2 As frequently noted, the background to this issue
includes rent-seeking by regional governments via intervention in land markets, as
well as a tug of war over this issue between the central and regional governments.
There are two points that require attention here.
First, while reference is made to “government intervention in land markets” as a
single concept, the situation differs greatly depending on the region, the land use,

The empirical analysis in this chapter relies on Kajitani and Fujii (2016). I would like to thank
Daisuke Fujii for permission to reproduce our paper.
1 Huang (2006) analyzed systemic changes concerning such land issues. Li and Jia (2006) and Wang
(2006) examined the “landless farmers” problem and the living conditions of such farmers after
losing their land.
2 Ren (2009) investigated the behavior of real estate companies; Zhu (2007) analyzed the relation-

ship with public finances; and Zhang (2007) examined the environmental problems accompanying
agricultural land development.

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 67
K. Kajitani and T. Kamo, Political Economy of Reform in China,
Kobe University Social Science Research Series,
https://doi.org/10.1007/978-981-19-0202-4_5
68 5 Land Market Competition Among Local Governments: A Spatial …

and how the land was expropriated and turned over to the government. Second, such
rent-seeking by regional governments and the tug of war between regional and central
governments are not by any means new phenomena, but have rather been noted ever
since the earliest stages of China’s reform and opening up policy.
Consequently, when discussing the recent problems with regional government
intervention in land markets, it is necessary to examine the various facts regarding
such land markets and then clarify the points upon which they differ from the past
problems that have emerged between the central and regional governments as well
as their significance when considering China’s future economic development.
To understand these issues, this article focuses on the following three points:
(1) the relationship between land expropriation and the structural problems facing
regional government finances, (2) the real estate price increase mechanism and the
effectiveness of government policies to restrain prices, and (3) changes in the patterns
of economic development led by regional governments observed vis-à-vis this land
expropriation problem.
First, we review the establishment of the main laws concerning land and real
estate transactions during the reform and opening up period as well as the historical
changes in government policies to restrict real estate prices.3
It was not that long ago that China, which firmly maintained a public land owner-
ship system under its planned economy, began to trade land and developed related
laws. First, the Land Administration Law of the People’s Republic of China (here-
after, the “Land Administration Law”) was enacted in 1986 to arrange a legal system
for land management assuming a public ownership system.
In 1987, in Shenzhen City, the rights to use state land in the city were transferred
on a paid basis for the first time. The urban development method whereby the regional
government sold its land use rights to private developers and used the funds to invest
in the infrastructure and urban construction was initiated. It is said to be modeled after
the urban development method used in British Hong Kong during the colonial era.
Additionally, the legal grounds for such a system were provided by the Constitution
and the Land Administration Law, both of which were revised in 1998.4
Under these circumstances, the first real estate development boom (i.e., the new
land enclosure movement) was sparked by Deng Xiaoping’s 1992 South China Tour
Speech. The urban development method using paid transfers of land use rights spread
throughout the country, centered on cities in the coastal regions. The percentage of
real estate investment in national fixed capital investment suddenly rose from around
6.1% in 1991 to 9.3% in 1992 and to 15.6% in 1993. However, this real estate boom of
the early 1990s abated due to a series of “bubble smashing” and tightening monetary
policies enacted by Prime Minister Zhu Rongji and depressed investment resulting
from the 1997 Asian financial crisis.

3 Liu and Zhang (2006) and Huang (2006) were used as primary references in writing this section.
4 This is a system for the expropriation of land in cities. There are still strict restrictions in
place regarding the conversion of agricultural land that is collectively owned into non-agricultural
land. The current method in use is that agricultural land is first nationalized through government
expropriation and then transferred to developers.
5.1 Land and Real Estate System Reform and Price Restraint Policies 69

Yet, even during that period, systematic preparations for land and real estate trans-
actions steadily advanced. The most important advances included reforms for home
ownership and the commercialization of urban housing, which had previously been
allocated by units centered on state enterprises. First, the 1994 State Council “Deci-
sion on the Deepening of Urban Housing System Reform” and the 1998 “Notification
regarding the Further Deepening of Urban Housing System Reform and Acceleration
of Housing Construction” made clear the policy of advancing the commercialization
of urban housing, abolishing the system of directly providing housing, and promoting
the construction of new housing. A series of movements toward the commercializa-
tion of housing stimulated demand among urban residents and became a major cause
of the second real estate boom starting in 2003.
The preparation of systems for the government to expropriate agricultural land
and other collectively owned land for smooth development was advanced. First,
national land investment companies were established in Shenzhen and Shanghai in
1996, and a unified “land banking system” was established for expropriating land
for development and managing the preparation of plots and infrastructure under
consignment from regional governments via land banking centers, a system that
gradually spread nationwide.5
The new Land Administration Law revised in 1998 (enacted in 1999) strength-
ened the control over land development by higher government authorities (Gao and
Liu 2007). To develop collectively owned land in agricultural villages as plots for
construction, it first had to be expropriated by the state and “nationalized,” and the
rights to conduct examinations and give authorizations were limited to the State
Council and provincial governments. The terms for the rights to use state land were
set specifically according to the purpose of land use, with 70-year terms for residen-
tial uses, 50-year terms for industrial uses, 50-year terms for educational, science
and technology, culture, and hygiene uses, and 40-year terms for commercial and
entertainment uses. The standards for giving compensation to farmers when expro-
priating agricultural land were prescribed at payments of 6–10 times the value of the
average harvests over the 3 years prior to the expropriation (Article 47), establishing
systematic preparations for the paid transfer of land use rights.
The “Circular of the State Council on Strengthening the Asset Management of
State-Owned Lands,” which was issued in 2001, called for openness, fairness, and
justice in trading land use rights based on this land banking system. The consultation
method accounted for the overwhelming share of paid transfers of state land until
that time; the prices and process were criticized as lacking transparency. However,
the movement toward a bidding system and other market-based transfers of land use
rights advanced full scale thereafter.6

5 This “land banking system” has three different types: the Shanghai type, which emphasizes the
market mechanism, the Hangzhou type, which is conducted under government initiative, and the
Nantong type, in which the market mechanism is tied to land and resource management by the
government (Huang 2006, vol. 1: 23). At present, more than 1,000 cities have established land
banking centers (Jiang et al. 2007).
6 For example, the revenue from bidding-method land transfers nationwide grew by 40% per year

from 35 billion yuan in 2000 to 49.2 billion yuan in 2001. In addition, the percentage of the total
70 5 Land Market Competition Among Local Governments: A Spatial …

Strengthening the management of land development through the land banking

system was done fundamentally to prevent the unlawful diversion of the assets of state
enterprises that go bankrupt or are subject to restructuring and to address concerns
regarding the decrease in the amount of arable land through protection from rampant
development (“The Decipherment of Land,” Caijing Magazine, no. 153). Neverthe-
less, this unification of the land development authority through expropriation and
authorization by regional governments also precipitated the following results that
were not necessarily intended by the central government.
First, because the land sales market from the government to the private sector (the
primary land market) was unified through authorization by the central and provincial
governments, a supply shortage emerged from this monopolistic system, inviting land
price increases. Second, the land paid use system, which had previously been applied
primarily to state land in urban areas, began to be applied full scale to agricultural
and other collectively owned land.7 Third, while the percentage of land stockpiled
in regions that was transferred at market prices increased, because the compensation
paid when agricultural and other lands were expropriated was kept low, the income
of regional governments—the differential between the compensation paid and the
transfer price— increased greatly.
Under such conditions, the second real estate development boom advanced full
pace starting in 2002. Unlike the first boom, the method whereby regional govern-
ments expropriated collectively owned agricultural and other lands, nationalized
them, and then transferred them for profit had now become mainstream. For that
reason, the presence of “landless farmers”—those who had lost their land without
receiving sufficient compensation—began drawing attention as a social problem.
Amid such conditions, the Rural Land Contracting Law, which was implemented in
March 2003, stipulated that the land “contracting rights” of individual farmers repre-
sented a type of usufruct right over the land and opened a path to protecting farmers’
property rights. Specifically, it recognizes the inheritance, sale, and purchase of land
use rights based on the farmer’s volition and stipulates that the government or other
parties cannot recall the usage rights to agricultural land within the contracting period
(i.e., 30 years for arable land, 30–50 years for pasture, and 30–70 years for forests).
Then, in October 2007, the Property Law came into force, which was based on
socialist public ownership, and confirmed the principle of joint economic devel-
opment through diverse ownership systems and stipulated the equal protection of
ownership rights of not only the state but also of individuals. It is noteworthy that
this law confirmed that land use rights and other usufructs are secured through a
registration system, and it included provisions regarding what happens after contract
periods expire and set forth compensation guidelines for residents from whom the
government expropriates land.

land area transferred using the bidding and auction method increased from 15% in 2002 to 33% in
2003 (Huang 2006, vol. 1: 30).
7 For example, the land banking center established in one eastern county expropriated agricultural

land accounted for 14.4% of the total land stockpiled through 2001 but 88.3% in 2002 (“The
Decipherment of Land,” Caijing Magazine, no. 153).
5.1 Land and Real Estate System Reform and Price Restraint Policies 71

At the Third Plenary Session of the 17th Chinese Communist Party (CCP) Central
Committee held in November 2008, the CPC adopted the “Decision on Some Impor-
tant Questions in Promoting the Development of Rural Reform,” which recognized
the purchase and sale of agricultural land use rights under certain conditions including
free will and compensation, joint ownership of agricultural land, and no change in
the land use. In response to this decision, Rural Land Transfer Trading Centers were
established in Sichuan, Zhejiang, and other provinces as a systematic framework for
the market trading of agricultural land.
In addition to the development of industrial zones to attract foreign enterprises,
the demand for the development of commercial housing increased during the latter
1990s, so laws were implemented and active real estate financing was arranged to
support this. Due to this series of systematic preparations and the excess influx
of domestic and foreign capital against the background of insufficient projects for
domestic investment, the price of land and real estate consistently rose faster than
the price of goods, especially in major cities. In addition to this sharp increase in
real estate prices, a variety of social problems emerged such as forced evictions
associated with land development, pressure on the lifestyles of city residents from rent
increases, and dissatisfaction with real estate developers and regional government
officials making excessive profits.
The central government has responded by implementing laws and issuing indi-
vidual notifications to prevent regional governments and developers from expropri-
ating land illegally by violence and to ensure that sufficient compensation is provided
to farmers and other original land usufructuaries.
On the demand side, when the real estate market showed signs of heating up, the
central government adopted restrictive measures centered on the direct regulation of
real estate financing by financial organs.8 Harsh tightening measures were imple-
mented against realtors and markets including total volume limits on development
items that are not consistent with national industrial policy objectives, especially
during the heated real estate investment in and around Shanghai between 2003 and
2004 (see, e.g., “Missions Dilemmatic,” Caijing Magazine, no. 179). For example,
in June 2004, the government ordered the cancellation of a project in which the
land was obtained by illegal means for development by Jiangsu Tieben Iron and
Steel Company Ltd. in Changzhou City, Jiangsu Province, and those involved were
punished (Tanaka 2007). The October 2004 “State Council Decision on Deepening
Reform and Tightening Land Management” stipulated volume regulations on land for
construction, strict management of the conversion of agricultural land, and sufficient
compensation for living expenses to farmers on the occasion of land development.9

8 For example, the “Notification regarding Further Strengthening of the Management of Real Estate
Financing,” which was issued in July 2003, required project self-financing of at least 30% (35%
starting in 2006) when enterprises develop real estate with bank financing. However, the 30%
self-financing rule had various loopholes; for example, about 70% of “self-financing” was actually
covered by outside capital. See “Secrets of Housing Loan,” Caijing Magazine, no. 87, and other
materials.
9 Regarding the latest trends in the securitization of land in agricultural villages, see “The Restoration

of Land Ownership,” Caijing Magazine, no. 222.

72 5 Land Market Competition Among Local Governments: A Spatial …

During the real estate price jumps that occurred in 2007 and 2009, the government
repeatedly intervened directly in the real estate market by increasing down payments
for condominiums purchases and regulating real estate loans.
However, while this series of policies did have some temporary restrictive influ-
ence, it was not sufficiently effective in preventing sharp price increases in the real
estate market. The special relationship between China’s land market and its regional
governments may explain why these policies were ineffective, as seen in the following
sections.

5.2 Land and Real Estate Markets and Regional

Governments’ Fiscal Revenue

During the reform and opening up period, regional governments that suffered a
chronic shortage of sources for fiscal revenue repeatedly intervened in factor markets
and used the resulting “rent” as a non-regular fiscal source. We now discuss in detail
how regional governments secured fiscal sources by intervening in the land market
specifically.
First, regarding the tax revenues related to land in regional government budgets,
we will review the items that are subject to taxation, the basis for their inclusion, tax
rates, and the percentages retained by regional governments.
As shown in Table 5.1, the first distinctive characteristic of the real estate taxation
system in China is the existence of different systems for taxing land and buildings. For
example, the provincial real estate tax and the city real estate tax on foreign-affiliated
enterprises are charged only on buildings and not on land. In contrast, the city land
use tax is systematized as a use expense paid to the government by enterprises that are
not publicly owned, so this is significant for adjusting differential rents in accordance
with the land’s profitability.10
Another institutional characteristic that should be noted is that while the state
holds the ownership rights over land in urban areas, the land in agricultural villages
is fundamentally collectively owned. To reflect this fact, the tax structure adopts
different systems for agricultural villages and cities in taxing both land and real
estate, and there are charges, such as the city maintenance construction tax, that are
additional taxes charged on the amount of taxes paid, making the system extremely
complex. The following problems have been noted with the current land taxation
system (Qin and Li 2007).
• The tax base is too small, and the properties subject to taxation are not clear.
There are many provisions for tax exemption; for example, real estate taxes are

10 Land use expenses were introduced for the government to collect land rents from state enterprises
that had been using state land free of charge up until that time. The collection amounts were initially
set at symbolic levels sufficient to demonstrate that the land ownership rights belonged to the state
(Onodera 1997). The tax rate of the city land use tax was also initially set at a minimal level but
was increased to three times its prior level in 2007.
5.2 Land and Real Estate Markets and Regional Governments’ … 73

Table 5.1 Real estate-related tax revenue

Type of tax Tax basis Tax rate
Taxes on real estate Real estate tax Real estate cost 1.20%
occupiers City real estate tax Real estate cost 1.20%
Arable land Arable land area 5–50 yuan/m2
occupancy tax
City land use tax Land area 0.6–30 yuan/m2
Tax on real estate sales and Contract tax Contract amount 3–5%
purchase and transfer Stamp tax Contract amount 0.03–0.1%
profits
City maintenance Amount of taxes paid 1–7%
construction tax
Enterprise income Enterprise income 3–30%
tax
Individual income Personal income 3–45%
tax
Land value-added Value-added 30–60%
tax
Real estate tax Rental income 12%
Tax on real estate rental City real estate tax Rental income 18%
income Enterprise income Enterprise income 3–30%
tax
Individual income Personal income 3–45%
tax
Source Prepared by the author from “The Start of Property Tax,” Caijing Magazine, no. 99; Liu
(2020); and other materials

not charged if the property is not used for business purposes, and public enterprises
are not charged land use taxes.
• The rates of land value-added taxes and certain other taxes are too high, providing
a strong incentive for false reporting and tax evasion.
• There are large distortions in the tax rates; for example, the tax burden on land
transactions is heavy while the tax burden on land holdings is light. For that reason,
there is a lot of land being held for speculative purposes and not being used.
• Rents, taxes, and expense burdens are commingled and inconsistent.11
The scale of tax revenues from these land transactions and land holdings,
excluding those that contain revenues from other industries such as business and
income taxes, has certainly been expanding in recent years, but the ratio of these tax
revenues in total regional government fiscal revenues has not significantly changed.

11 To resolve such problems with tax revenues from land transactions and land holdings, the intro-
duction of a more comprehensive real estate tax (property tax) has been examined (“The Start of
Property Tax,” Caijing Magazine, no. 99; “Truth of Property Tax,” Caijing Magazine, no. 179). In
January 2011, the cities of Shanghai and Chongqing both announced the introduction of a trial real
estate tax on housing holdings.
74 5 Land Market Competition Among Local Governments: A Spatial …

Nevertheless, regional governments collect the following various expenses from

developers and other parties in addition to the aforementioned tax revenues related
to land transactions and holdings (“The Decipherment of Land,” Caijing Magazine,
no. 153).
1. Arable land reclamation expenses, land use rights transfer fees, land use fees for
new construction and additions, management expenses, registration expenses,
eviction expenses, and other revenues managed by the land department.
2. Land use expenses, land rental expenses, and other revenues managed by the
fiscal department of the regional government.
3. Revenues from diverse expenses paid to the agriculture, real estate, water use,
transportation, post and telecommunications, culture, air defense, forestry, and
other departments.
It is worth noting that the scale of land use rights transfer fees and other expense
revenues managed by the Department of Land and Resources and other departments
(hereafter, “land use rights transfer revenues”) has been growing year by year, and
that these revenues are also gained by regional governments that sell their own use
rights on the market using their de facto ownership rights over agricultural land and
can be interpreted as a type of rent gained by government intervention in the real
estate market.12
This paid land use system was introduced in Shenzhen City at the end of the 1980s.
At the national level, its implementation was stipulated by a series of legal prepa-
rations including the July 1988 State Council “Notification regarding the Authority
to Ratify the Transfer of State Land Use Rights,” the revision of the Constitution
that year that recognized the transfer and lease of land use rights, and revisions
to the Land Administration Law. This system was advanced full scale centered on
cities in the coastal regions with the active solicitation of foreign capital following
Deng Xiaoping’s 1992 South China Tour Speech with the purpose of promoting the
development and management of land using foreign capital.13 In addition, the “Noti-
fication on Some Issues regarding the Development of the Real Estate Industry”
stipulated that collectively owned land in agricultural villages and elsewhere could
be expropriated by the state, converted to state land, and then transferred (Onodera
1997, p. 31). Such paid transfers of collectively owned land advanced full scale in
the latter half of the 1990s under the land banking system previously described.
Initially, land use rights transfer revenues were split by the central and regional
governments with a 4:6 division. Thereafter, the amount paid to the central govern-
ment was reduced to 32%, and with the 1992 “Provisional Regulation regarding the

12 The following land use rights transfer revenues can be broken down into three components: land
acquisition expenses (including living expense compensation to farmers), land and infrastructure
preparation expenses, and sales and purchase revenues (transfer revenues).
13 In fact, the transfer of these “revenues from expenses” can be summarized as follows. First, the

government completes the relocation of, and compensation for, the enterprises and residents that
have been using the land, prepares the land, and develops the basic infrastructure (i.e., roads, water
supply, sewage, telecommunications, gas, heating steam, and grading), and then transfers the land
to real estate developers. See Onodera (1997).
5.2 Land and Real Estate Markets and Regional Governments’ … 75

Collection and Management of Revenues from the Paid Transfer of State Land Use
Rights,” it became sufficient for the regional government to allocate only 5% of the
transfer revenues to the central government. Since the tax sharing system was imple-
mented in 1994, all of the revenues have remained with the regions and have become
an important source of funding for regional governments.
During the real estate boom that started in 2003, it was not unusual for the transfer
revenues received by regional governments in coastal provinces to reach billions
of yuan, and much of it was spent on disorderly urban construction. Under such
conditions, in 2004, the State Council demanded that 15% of regional government
transfer revenues be allocated to agricultural development (“The Redistribution of
‘Land Leasing Fees,’” Caijing Magazine, no. 155). In addition, the “Notification
regarding the Standardization of the Management of Revenues and Expenses from
the Transfer of State Land Use Rights,” which was promulgated by the Office of
the State Council in December 2006, stipulated the range of land use rights transfer
revenues and demanded stronger management of collections.
Some of these transfer revenues are posted as “fund revenues” in regional budgets
and are ratified by the central government.14 The scale of such revenues was 203.751
billion yuan in 2006, accounting for less than one-third of total revenues (807.764
billion yuan), and it varied by region. The remainder is believed to be retained by
regional governments as “funds outside of the system” that are not shown in statistics
or as “a second budget” or “hidden reserves.15 ” There are also said to be many cases in
which regional governments expropriate land illegally during this process, including
cases in which regulatory compensation is not paid to residents or residents are
evicted by violent means.
Figure 5.1 shows that the revenue from the sale of land usage rights dramatically
increased starting in 2003, that is, from the time when the second land development
boom began to heat up.16 There is a large difference in growth between the eastern
and central and western areas, showing that these revenues reflect regional deviations
in land development.
In general, such land use rights transfer revenues are allocated about 40% to
governments above the township and village level and 40% to village committees,

14 “Fund revenues” are a temporary category born amid the tax reforms that occurred since the
1990s in which funds outside of the budget were incorporated into the budget. These are managed
by each department including the industry, transportation, commerce, education, culture, and agri-
culture departments, but their expenditures must be ratified by the central government. Their partial
incorporation into general budget revenues is also being considered. See Ma et al. (2003).
15 The decision was made to make all revenues and expenditures from paid land transfers subject

to regional fund budget management in January 2007. At the same time, clear stipulations were
made limiting the range of use for land revenues to land expropriation, eviction compensation,
land development, farmer assistance, and city construction expenses (“Real Property Tax,” Caijing
Magazine, no. 179).
16 For example, in 2007, the total amount of transfer revenues reached about 52% of total regional

public finance revenues (estimated by the author from China Land and Resources Statistical Year-
book, China Statistical Yearbook, and other materials). The ratio was believed to be even higher
when examining only cities in the coastal regions.
76 5 Land Market Competition Among Local Governments: A Spatial …

Fig. 5.1 Total revenue for sale of land use rights in China. Source Almanac of Chinese Land
Resource, 2000–2018. Note Amounts show the totals of land use rights transfer fees, land
development expenses, land preparation expenses, and other costs paid by land users to the state

with just 20% or less being given to the farmers themselves.17 The changes in transfer
income are shown in Fig. 5.1.

5.3 Land Market Structure and Rent-Seeking

In economics, when considering real estate and land prices, the land rent is usually
first determined by the rental market and, with that rent as a given, the land price is
then determined through arbitration with other investment assets on the asset market.
However, as shown in the following example, the conditions surrounding China’s
real estate market greatly differ from those assumed by standard economic theory.
The most distinctive characteristic of China’s real estate market is that land is
publicly owned and only land use rights can be traded, while the ownership of
housing and other real estate constructed on land by individuals and corporations
is permitted. Because of this, China’s real estate market has a complex, multi-level
structure with various characteristics.
First, there is a market on which regional governments expropriate agricultural
land or old city land and transfer the use rights on a paid basis to developers and
other businesses. This is the primary real estate market. Next, there is a secondary
market on which developers and other parties develop the land that they acquire
from regional governments, construct condominiums and other real estate, and sell

17See Guo (2005). According to this paper, the average compensation received by farmers was
equivalent to approximately 3–5 years of their average annual income.
5.3 Land Market Structure and Rent-Seeking 77

land use rights and real estate ownership rights together as a package to individuals
and companies. Finally, the market and rental contracts for such real estate bought
and sold on the secondary market can be understood as being traded on a tertiary
market.18
The arbitration with other assets assumed by standard economic theory is believed
to function on the secondary and tertiary markets. However, the total amount of stock
of land on the secondary market and its expected returns are believed to be greatly
influenced by the supply of land on the primary market. Accordingly, let us now
carefully examine the conditions regarding land sales on the primary market.
The primary land market is none other than the market on which the government
sells the rights to use land owned by the state in cities and agricultural villages to
the private sector. These sales of land use rights can be broadly divided into three
methods—gratis transfers, consultations, and bidding or auctions. Until 2000, gratis
transfers accounted for the sale of more land area than paid transfers; however,
since 2001, the latter has greatly exceeded the former. State land transferred gratis
is believed to mostly be in demand by the state itself for the provision of public
goods such as roads, parks, green belts, and cultural and educational facilities.19 The
following considerations focus exclusively on paid transfers.
Among paid transfers, the consultation method is the sale of land to certain devel-
opers and enterprises at a low price for the construction of factories and public
facilities. Because attracting factories to a locality increases the prospects for long-
term tax revenues, regional governments compete in establishing economic develop-
ment zones and lowering sales prices to enterprises, which are reportedly sometimes
almost lowered to the level of the land acquisition costs. However, the percentage of
consultation transfers in total paid transfers is on a declining trend due to government
policies to promote competitive bidding. The bidding system has suddenly increased
as the development of agricultural land advanced full scale from the late 1990s
through the aforementioned land banking system, and this format now accounts for
most commercial and residential land transfers.20
The consultation method accounted for 60%–70% of the total land area transferred
through 2006, but only for about one-half of that percentage on a monetary basis.
This also demonstrates the fact that land transferred under the consultation method
is sold for prices far lower than land sold under the auction and bidding method.
As previously explained, that is the result of regional governments competing for
lower supply prices on the primary market to attract enterprises, and considering
only this point, one might think that the land market is in a desirable condition

18 This refers to Gao (2007) and other materials.

19 Problems have been noted including regional governments using such land that should properly
be used for public uses entirely for the construction of luxury office buildings and other structures.
(Jiang et al. 2007).
20 However, it is important to note that among competitive sales methods, in recent years the method

called Guapai, which has a stronger collusive nature compared with pure competitive bidding, has
become the mainstream (accounting for more than 70% of both area and amount in 2008). See Cai
et al. (2009) regarding the problems with how sales under the Guapai method easily give rise to
collusion between government officials and developers.
78 5 Land Market Competition Among Local Governments: A Spatial …

with market competition working. On the other hand, however, this suggests that the
market is under monopoly conditions for land acquisition by the government and that
sufficient compensation is not being paid to farmers and others as land sales prices
are artificially depressed.
This phenomenon whereby clearly different transfer formats with large price
differentials are used depending on the purpose of land use is an indication of regional
governments’ monopoly over the primary market’s land supply. This phenomenon
can be understood as a typical price differentiation strategy by a monopoly enterprise.
A price differentiation strategy arises when a monopoly enterprise with price-
setting power on the market faces two types of buyers with greatly different price elas-
ticities of demand and sets lower product prices for those buyers with a higher price
elasticity. Well-known examples of typical price differentiation strategies include
student discounts and charging higher taxi fares late at night.
How does this apply to China’s primary land market? For example, when a manu-
facturing company is seeking land to construct a factory, except for cases in which
a special industrial agglomeration is being formed, the company has no need to
insist on any specific location and is strongly attracted to locations with the lowest
land prices, personnel expenses, and other costs. As illustrated by the succession of
manufacturing company production bases that are relocating from industrialized to
developing countries, the production locations of manufacturing firms are not neces-
sarily restricted by the geographic locations in which their products are in demand.
Therefore, the demand for land to construct factories is believed to have a very high
elasticity to land prices.
In contrast, because housing and commercial facilities are originally constructed
anticipating the demand of local residents (their location is highly restricted by
demand), their substitutability with other locations is considered low. For that reason,
if a given area has a large population and a certain level of profitability prospects,
there is an incentive to obtain land in that area, even if the costs are somewhat high.
In other words, compared to land for the construction of factories, the price elasticity
of the demand for residential and other land is rather low.
So, if the regional government supplies land on a monopoly basis, it can adopt a
price differentiation strategy for the demand for the two types of land. That is, the
regional government can supply land for the construction of factories at an excep-
tionally low price (P2) to attract as many factories as possible and secure future tax
revenues (the case depicted on the right-hand side of Fig. 5.2), while enjoying a high
price (P1) and high monopoly rents for residential land that has a low price elasticity
(the case depicted on the left-hand side of Fig. 5.3).
While there may be some difference in the extent to which this phenomenon is
caused by price elasticity, in both cases, the supply volume is less than that under
full competition because it is set at the intersection of the marginal revenue (MR)
and marginal cost (MC) curves, so land rents and prices rise. After deducting the
compensation paid to residents and other land acquisition costs from the land transfer
5.3 Land Market Structure and Rent-Seeking 79

The market for the Commercial or

Residenal use of lands
The market for the industrial use of lands

Fig. 5.2 Price differentiation in the land market. Source The author

Fig. 5.3 Trends in the price of land use rights. Data: CEIC Data (http://www.ceicdata.com). Note
Each line stands for the average value of land use rights in national major 105 cities
80 5 Land Market Competition Among Local Governments: A Spatial …

revenues (the shaded area of the figure), the regional government’s revenue is equal
to a monopoly rent on the land market.21
The fact that this type of price differentiation is being implemented can be
confirmed by comparing the difference in the price elasticity of demand for land
uses. Figure 5.3 shows the trend of the average unit price of land use rights in 105
major Chinese cities. This shows that for all cities listed, the unit price of residen-
tial and commercial land is much higher than that of industrial land. This wide gap
between the price of commercial and residential land and industrial land might be
caused by a kind of price discrimination by local governments that calculate the
difference in demand elasticity for different land uses.

5.4 Empirical Studies on the Fiscal Competition

by the Local Governments

In following section, we mainly focused on the competition between local govern-

ments in China to attract industrial companies.22 The earliest theoretical studies such
as Oates (1972), or Zodrow and Mieszkowski (1986) and Wilson (1986), analyzed
fiscal competition by the local governments, and focused on interaction due to tax-
base mobility, which is known as “tax competition” or “yardstick competition.”23
They pointed out that each region finance provision of a public good with a tax on
the locally employed capital.24 When capital can moves among regions in response
to tax rate differentials, the tax rate for capital in each region tends to be lower than
the optimal level.
Inspired by pioneering studies, various types of fiscal competition have been
analyzed. Hoyt (1993) examined tax rate competition in case of mobile residents

21 As stated above, it has been noted that land sales prices for enterprises advancing into economic
development zones and other lands for factory construction have been decreased nearly to the level
of the land acquisition costs. Under such conditions, it might be thought that there is no leeway
for acquisition of monopoly rents by regional governments which are land suppliers. However,
as noted in the previous section, when enterprises locate factories they pay various expenses to
different government departments aside from the land sales price, and the total amount of these
expenses is of a scale that cannot be overlooked. These various expenses are not systematized like
taxes, and so they are considered to be a type of rent generated because the regional government is
the monopoly land supplier.
22 See Kajitani and Fujii (2016) for more information on the theoretical model upon which the

empirical analysis in this section is based.

23 Tax competition between local governments consists of tax rate reductions implemented to attract

a tax base, such as companies and laborers, into a region. In contrast, yardstick competition occurs
primarily due to the propagation of information between regions. It is typical that the residents of
each region affect their residential tax rate by voting in regional local elections, by comparing the
tax rate of their area to that of other areas.
24 Zodrow and Mieszkowski (1986) shows that capital tax rate competition to attract firms among

homogenous local governments causes an undersupply of public goods as a result of a Nash

equilibrium.
5.4 Empirical Studies on the Fiscal Competition … 81

and showed that competition results in higher levels of government service when
the demand for housing is elastic and lower levels when the demand is inelastic.
Wildasin (1988) compared tax rate competition and public expenditure competition
as a policy variable and demonstrated that the supply of public goods at equilibrium
in both cases was at an inefficiently low level. Furthermore, it also showed that the
equilibrium in tax competition is greater than in public expenditure competition.
On the other hand, Noiset (1995) and Matsumoto (1998) pointed out the possibility
of the overprovision of public goods, because although a higher tax rate drives out
capital, the tax base may ultimately expand if the increased revenue leads to an
increase in public inputs that attract capital by increasing productivity. Therefore,
if we consider leased land as a public good that improves the utility of residents, it
may be underprovided, while if we consider land as a public input that improves the
productivity of firms, it may be overprovided.
Brueckner (2003) overviewed previous studies on such competition between local
governments. According to him, the theoretical model for such studies can be clas-
sified into two types of basic models, the “spillover model” and the “resource flow
model.” In the spillover model, local governments are assumed to directly affect the
behavior of residents in other regions. Yardstick competition is a kind of spillover
model, because the spillover of information relating to policy decisions in one region
directly impacts the voting behavior of residents of other regions. On the other hand,
in the resource flow model, policy decisions by local governments are assumed to
indirectly affect residents in other regions through the interregional movement of
policy elements (i.e., capital or labor). Tax competition in which the tax base moves
toward the area with the lower tax rate can be considered an example of the resource
flow model.25
From an empirical viewpoint, many existing studies have adapted a spatial lag
framework in spatial econometrics to consider the strength of interaction based on
distance or contiguity between governments. One of the earliest studies using this
method is Case et al. (1993), which estimated the interaction function of public
expenditure at the state level in the US. Inspired by their study, many empirical
studies have examined expenditure interactions among local governments (Revelli
2003; Solé-Ollé 2006).
While Case et al. (1993) examined expenditure competition, studies focusing on
tax competition to attract firms can be found. For example, Brueckner and Saavedra
(2001) estimated the response function of property tax rates among local governments
in the Boston metropolitan area, and its results indicate the presence of strategic
interaction. Buetter (2001) also analyzed tax rate competition using data on the local

25 Such recent studies on competition between local governments have also incorporated the results
of spatial economics. Ottavianoa and Yperseleb (2005) theoretically investigated tax competition
using the concept of the so-called “integration rent,” which is based on spatial economics. According
to them, when there is tax competition to attract companies, the externality of integration provides
an integration rent to companies located in regions in which enterprise integration already exists.
Therefore, the regions with integration have the ability to attract companies, compared to areas in
which integration does not exist. This means that the former region might impose a higher asset tax
rate than the latter.
82 5 Land Market Competition Among Local Governments: A Spatial …

business tax rate in Germany, and concluded that governments are indeed in tax rate
competition. Chen and Hong (2009) also employed the spatial econometric approach
to estimate tax competition among regions in Taiwan.
With respect to fiscal competition in China, existing empirical studies have mainly
focused on expenditure competition. This is because, although Chinese local govern-
ments have not been able to independently choose tax rates in the Tax Sharing
System (Fenshuizhi) since 1994, they have greater authority in public expenditures.
For example, Guo and Jia (2009) examined the strategic interaction of public expen-
ditures at the provincial level during the 1986–2006 period and demonstrated the
existence of expenditure competition. Zhang and Chen (2007) also examined expen-
diture competition among provinces and came to the same conclusion. On the other
hand, studies that have examined tax rate or revenue competition are rare. As far
as we know, Yao and Zhang (2008) is the only example of a statistical analysis
of revenue competition by local governments. Their study took a spatial statistics
approach and calculated Anselin’s local spatial autocorrelation index, the so-called
LISA (Anselin, 1995). Fujii (2016), with the reference to Case et al. (1993), pointed
out that there is an expansion of government spending competition between local
governments. Fujii also noted that there is a mechanism for evaluating local bureau-
cracy in the background of such competition. In short, to evaluate and promote the
Chinese bureaucracy system, the regional growth rate is a very important criterion.
However, these studies did not focus on tax competition among local governments
in China because in China, the property tax system is under construction and local
governments cannot set taxes independently. This does not mean, however, that such
competition between governments to attract companies does not exist in China. We
could not find any studies that have empirically analyzed land lease competition by
local governments, to the best of our knowledge. In the following section of this paper,
we will therefore consider the possibility of competition among local governments
to attract companies through subsidies for investment and land purchases.

5.5 Data and Empirical Method

5.5.1 Data

In this section, we postulate the hypothesis that local governments compete with
each other to attract firms by dumping land use rights for industrial purposes. This
dumping by local governments can be considered as a subsidy for firms. To verify
this hypothesis, we use county-level socioeconomic data from Zhejiang Province,
including land auction prices for industrial purposes in 2010.
We choose Zhejiang Province as the sample for this research for the following
three reasons. First, Zhejiang Province is a highly developed region and its scale
of public finance is quite large. Therefore, local governments can afford to join
intergovernmental fiscal competition. Second, trading land use rights has been done
5.5 Data and Empirical Method 83

since the early stages of the opening up process, and most farmland has already been
liquidated. Third, there are many distinctive industrial agglomerations, especially in
the coastal area in the province.
Our dataset consists of the average land use price for an industrial purpose, popu-
lation, population density, gross regional product (GRP), public revenue, labor popu-
lation ratio, and the existence of national industrial parks in 89 counties in Zhejiang
Province. In this dataset, the average land use price for an industrial purpose is calcu-
lated from the publication of land use rights auctions by the Zhejiang provincial
department of land resources, and the average price of each auction in a county for
2010. The GRP and public revenue are per capita data. The labor population ratio is
the share of the population aged between 15 and 59. The existence of national indus-
trial parks is treated as a dummy variable. These data are obtained from Zhejiang
Statistical Yearbook, Zhejiang Yearbook, China 2010 County Population Census
Data with GIS Maps, and the website by the Zhejiang Provincial Department of
Land Resources (http://www.zjdlr.gov.cn). The descriptive statistics of our dataset
are shown in Table 5.2.
In addition to socioeconomic data, we use spatial information to consider the
geographical relationships of county-level governments. This spatial information is
quoted from “China Geo Explorer,” which is provided by the China Data Center,
University of Michigan (http://chinageoexplorer.org/cge/). We combine this spatial
information of population census data and socioeconomic data in 2010 and compose a
so-called GIS dataset. Using our GIS dataset, we draw a map of the spatial distribution
of the average price of land used for industrial purposes in Fig. 5.4. This map shows
that the land use price is quite higher in coastal areas including the central business
districts (CDBs) of big cities such as Wenzhou, Hangzhou, Ninbo, and Xiaoxin. On
the other hand, the price is lower in inland areas such as Lishui and Quzhou.

Table 5.2 Descriptive statistics of valuables used for empirical analysis

Variable (unit, year) Obs Mean Stand. dev Min Max
The average price for the industrial 89 353.0 207.5 1239.2 102.1
purpose (Yuan/km2 , 2010)
GRP per capita 89 45,883.9 22,857.4 16,655.7 152,968.4
(Yuan, 2010)
Public revenue per capita 89 219,979.3 209,412.0 0.0 981,659.0
(10,000 Yuan, 2010)
Labor population ratio 89 71.4 5.1 60.0 84.4
(%, 2010)
Population 89 516,074.7 285,392.0 88,362.0 1,233,348.0
(persons, 2010)
Density of population 89 1271.4 2754.5 78.5 18,308.7
(persons/km2 , 2010)
National Industrial Park 89 0.157 0.364 0.0 1
(unit, 2010)
84 5 Land Market Competition Among Local Governments: A Spatial …

Fig. 5.4 Spatial distribution of the average price of the land use rights for industrial purposes, by
county. Source The author

It seems that spatial autocorrelation of the price of land use rights exists between
counties. To examine spatial autocorrelation, we calculate the Moran’s I index. If this
index has a positive value, the spatial distribution has a positive spatial correlation
(Moran 1948). The Moran’s I index score of the price is 0.608 and is significant
at the 1% level. Therefore, the price can be considered to have a positive spatial
autocorrelation.

5.5.2 Empirical Method

To examine the dumping interaction by local governments in our hypothesis, we

follow the models of Case et al. (1993) and Brueckner (2003) and adopt the spatial
econometrics method. They applied the spatial lag model (SAR) with a spatially
lagged dependent variable on the right-hand side of the estimation equation to
examine the interaction by governments. In other words, the model supposes that
the price is influenced simultaneously by both the regional characteristics and the
prices in surrounding regions. Whereas Case et al. used taxation and Brueckner used
public expenditures as their dependent variables, we use the price of land use rights
as the dependent variable to examine our hypothesis. Furthermore, we also consider
the possibility of interaction effects among the error terms. The model that considers
5.5 Data and Empirical Method 85

the interaction error terms is called the spatial error model (SEM). To consider both
endogenous interaction effects and interaction among the error terms, we combine
the SAR and SEM models. This combined model is called the SAC model (Elhorst
2014).
Thus, our estimation model in matrix notation is expressed in Eqs. (1a) and (1b)
as follows:

Y = α I + δW Y + Xβ + u (1a)

u = λW u + ε (1b)

In this model, α, β, δ, and λ are unknown parameters to estimate. If δ = 0 in

Eq. (1a), this SAC model is equivalent to the SEM model, and if λ = 0 in Eq. (1b),
this model is equivalent to the SAR model. In addition, if both δ = 0 and λ = 0, then
this model is equivalent to the ordinary least squares (OLS) model. For a robustness
check, we also estimated the SAR, SEM, and OLS models.
Y denotes the average price of land use rights in each county in Zhejiang Province.
X denotes the matrix of explanatory variables, and we use population, popula-
tion density, GRP, public revenue, labor population ratio, and a dummy variable
for national industrial parks. The dependent and explanatory variables (except for
the national park dummy and the labor population ratio) are in logarithmic form.
W denotes a weight matrix that considers the geographical location of county-level
governments. We apply two types of weight matrices here. One is the k-nearest
method in which the element of matrix wi j is a binary value. If j county is one of
the k-nearest counties to i county, wi j takes the value of one and zero otherwise. We
set the value of k to 4. Another is the inverse distance method in which the distance
between i county and j county is di j , and the element of the matrix becomes 1/di j .
These spatial weight matrices are normalized in each row.
In this estimation, the result in which we are most interested is the sign of parameter
δ and its significance. If δ has a significantly positive value, this means that the price
of land use rights in influenced by the price in nearby countries, and it implies that
bargaining competition exists among the local governments. If δ is significantly
negative, this means that if a government lowers the land price, then the surrounding
governments raise their price. If the value δ is not significant, it means that there is
no interaction between the counties. In the next section, we show the results of the
estimation.

5.6 Results of the Empirical Analysis

Table 5.3a shows the estimation results of the SAC, SAR, SEM, and OLS models in
the upper part and the spatial dependence tests in the lower part using a four-nearest
86 5 Land Market Competition Among Local Governments: A Spatial …

Table 5.3 Estimation result

(a) K = 4
OLS SAR SEM SAC
Constant −0.047 (0.975) −0.258 (0.846) 0.753 (0.639) −0.205 (0.816)
GRP per capita −0.185 (0.193) −0.207 (0.085) −0.052 (0.699) −0.246 (0.004)
Public revenue 0.524 (0.063) 0.452 (0.104) 0.647 (0.023) 0.306 (0.093)
per capita
Labor 0.054 (0.000) 0.031 (0.002) 0.027 (0.001) 0.025 (0.014)
population
ratio
Population 0.238 (0.014) 0.177 (0.003) 0.214 (0.001) 0.121 (0.007)
Density of 0.106 (0.016) 0.067 (0.141) 0.086 (0.069) 0.032 (0.253)
population
National −0.244 (0.024) −0.160 (0.110) −0.054 (0.607) −0.146 (0.060)
industrial park
W*land price 0.539 (0.000) 0.842 (0.000)
W*u 0.610 (0.000) −0.816 (0.000)
Obs 89 89 89 89
R2 0.528 0.551 0.5271 0.6060
Degrees of 82 81 82 81
freedom
AIC 86.384 64.111 64.223
Test for spatial DF Value
dependence
LM (lag) 1 34.451 (0.000)
Robust LM 1 15.750 (0.000)
(lag)
LM (error) 1 18.978 (0.000)
Robust LM 1 0.277 (0.599)
(error)
LM (lag and 2 34.728 (0.000)
error)
(b) Inverse distance
OLS SAR SEM SAC
Constant −0.047 (0.975) 0.046 (0.973) 0.965 (0.553) 0.021 (0.981)
GRP per capita −0.185 (0.193) −0.165 (0.184) −0.036 (0.791) −0.192 (0.019)
Public revenue 0.524 (0.063) 0.433 (0.130) 0.599 (0.040) 0.323 (0.062)
per capita
Labor 0.054 (0.000) 0.033 (0.001) 0.030 (0.007) 0.030 (0.001)
population
ratio
(continued)
5.6 Results of the Empirical Analysis 87

Table 5.3 (continued)

(b) Inverse distance
OLS SAR SEM SAC
Population 0.238 (0.014) 0.137 (0.030) 0.168 (0.015) 0.091 (0.086)
Density. of 0.106 (0.016) 0.072 (0.129) 0.105 (0.033) 0.040 (0.169)
population
National −0.244 (0.024) −0.164 (0.114) −0.081 (0.441) −0.150 (0.052)
industrial park
W*land price 0.476 (0.000) 0.711 (0.000)
W*u 0.562 (0.000) −0.636 (0.000)
Obs. 89 89 89 89
R2 0.528 0.6060 0.527 0.626
Degree of 82 81 82 81
freedom
AIC 86.384 83.971 81.393
Test for spatial DF Value
dependence
LM (lag) 1 27.753 (0.000)
Robust LM 1 13.509 (0.000)
(lag)
LM (error) 1 15.216 (0.000)
Robust LM 1 0.972 (0.324)
(error)
LM (lag and 2 28.726 (0.000)
error)
Note Probability values are given into parentheses

spatial weight matrix. Table 5.3b shows the estimation results and spatial dependence
tests using an inverse distance spatial weight matrix.
Anselin and Rey (2014) demonstrated the procedure of model choice using a
Lagrange multiplier and robust Lagrange multiplier tests. Following their procedure,
the results indicate that the SAC models are appropriate in both matrices. Even so,
the estimation results are also stable in the other models, and the coefficients of
determination in all of the models are at a sufficient level.
Recall that δ is the parameter in which we are most interested. The estimation
results of δ are all positive in the SAC models and significant at the 1% level, and
in the SAR models as well. The results in the SAC models indicate that a local
government lowers (or raises) the price of land use price rights by 0.841 or 0.711
yuan, if nearby governments reduce (or raise) their price by 1 yuan. This response
of the local government is consistent with our hypothesis.
The estimation results of parameter β are as follows. In the model using the four-
nearest spatial weight matrix, the GRP per capita is significantly negative at the 1%
level, population is significantly positive at the 1% level, and the labor population
88 5 Land Market Competition Among Local Governments: A Spatial …

ratio is significantly positive at the 5% level in the SAC model. The results in the other
models are similar. In the model using the inverse distance spatial weight matrix,
the GRP per capita is significantly negative at the 5% level and the labor population
ratio is significantly positive at the 1% level in SAC model. Based on the results of
the SAC and other models, the land price for an industrial purpose is higher in the
areas with a high labor population ratio and that are highly populated. This result is
quite reasonable. On the other hand, the results in some models show that the land
price becomes cheaper in areas with a high per capita GRP.

5.7 Conclusion

The results of our empirical analysis show that the prices of land for industrial use
are strongly influenced by the land prices in neighboring regions, in addition to
the attribute values that determine the land prices in the region. These findings are
consistent with the hypothesis that there is competition between local governments
to attract companies by auctioning land use rights. This suggests that, in China,
where the property tax system is still underdeveloped, discounting land use prices
is a powerful tool for local governments to attract industrial companies. However,
competition by dumping land use rights prices might disturb the price mechanisms
of the real estate market and induce a shortage in land use rights for residential and
commercial uses due to steep increases in those prices. It is therefore necessary that
the central government begin reforming land market institutions and breaking down
the land supply monopoly system controlled by local governments.
Our analysis features many inadequacies that should be confronted in future
research.
First, in this analysis, we do not directly investigate the correlation of subsidy rate
t i because it is difficult to obtain data for t i . But, we can actually estimate the value of
t i , by taking the following steps. First, we can estimate the land price fundamentals
in each region land using a hedonic function. Next, we can obtain the value of the
subsidy from the difference between the fundamental and real land price. We would
like to directly investigate the correlation of subsidy rate t i, which is estimated as
previously described, in our next study.
Second, in the area in which land auction data cannot be obtained, we performed
data compensation by making a fairly unreasonable assumption. Therefore, we
should revise our data mining methods.
Third, it was necessary for the analysis to incorporate geographical factors such as
highways, rail, and port access, which would influence the formation of land prices.
Fourth, the analysis should be extended to a broader region, for example, the
Yangtze River Delta area including Shanghai and Jiangsu Province.
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