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Wednesday, August 15, 2012

Tushnet Reviews Modern Chinese Real Estate Law

Rebecca Tushnet (Georgetown) has kindly agreed to let us post her review of Gregory Stein's Recent Book, Modern Chinese Real Estate Law: Property Development in an Evolving Legal System.  Here's Rebecca: 

Gregory M. Stein, Modern Chinese Real Estate Law: Property Development in an Evolving Legal System: Ask your law librarian for a copy!  This is a significant look at an important subject: what is the relationship between property, the rule of law, and economic growth?  China has a powerful government but a weak rule of law; its explosive growth challenges some truisms of law and development.  Stein did interviews to figure out what’s actually going on.  This has obvious limitations in a repressive country suspicious of foreigners, and Stein only occasionally mentions that much of the new construction is empty.  He does devote greater attention to the fact that many new developments require displacing existing residents, often with extremely below-market compensation, with resulting political unrest.  Stein also gets some explanations of how projects are actually approved and financed, which is an important addition to the literature.  Separate chapters cover financing of residential construction, commercial property, and infrastructure.
 
Among other things that stood out to me: Shanghai has been trying to improve the formality and predictability of its procedures, limiting reliance on guanxi (connections), but this may have the effect of locking in the advantages of those who relied on guanxi at the beginning of the boom, became successful and experienced, and now have a head start.  Since all the land is owned by the state (only use rights can be leased, and that at most for several decades; no one knows what happens when that time is up—whether there will be additional fees to stay in place, renewal as of right, or something else), and since there isn’t much in the way of conventional property tax, the lease of land rights is a major way for governments to get funding.  There are Ponzi scheme elements to this: without property taxes, leasing new land is the only way to get more money.  This contributes to the building boom, as does the fact that individual Chinese are also desperate to own property.  Interest rates are heavily controlled and very low, while the stock market is small and rickety, so property is the most attractive form of investment.  (Many Chinese expect to have to self-fund their retirement and perhaps take care of parents; agricultural workers aren’t entitled to the same kinds of state support as urban dwellers, and even those don’t expect much in retirement.  This makes valuable investments vital.)  Stein reports that, by 2007, 15% of urban households owned more than one home—though such homes are often held only for investment, and won’t even have plumbing put in; they’re not even generating rental income but rather expected to appreciate in value.
 
How is all this financed?  Banks focus on proposals’ compliance with legal requirements—the key four documents indicating that the developer has the land lease and other required government approvals—rather than on economic feasibility, as Western lenders would.  This appears to be in part lack of experience and in part politically determined.  The banks don’t generally lend based on ability to repay; they lend because they have lending targets. While some informants suggested that many if not most banks are insolvent due to high percentages of nonperforming loans, residential loans are likely to be performing because of the massive real estate bubble of the last decade or so.  Presales mean that would-be individual owners finance large parts of the project early on, despite serious legal uncertainties about what it is that they would actually own if the overall project were to fail.  Subcontractors are also important sources of sub rosa financing because developers routinely delay paying them; Stein suggests that they are likely to pass these delays along to individual works, often internal migrants with limited employment opportunities.


One point I particularly noticed because of the way that correspondences in practice still reflect fundamental underlying differences: banks charge higher interest rates on loans to buy additional residences, not because (as in the US) they’re deemed riskier but as a matter of social policy trying to put some limits on this investment strategy.  Anyway, the banks are doing what the state wants, including financing state-owned ventures that are themselves probably insolvent but provide jobs and benefits for many people.  “Chinese citizens thus may be supporting China’s banks indirectly, by paying taxes to a government that dispenses some of those revenues to banks for risky loans to government entities and real estate developers, and directly, by placing significant private savings in those same banks.”  Everyone recognizes that a significant slowdown in the economy would risk disruption of every part of this system.  “One real estate developer’s answer to my question of whether China’s banks are stable—‘They must be!’—succinctly captures the combination of hope and faith that so many Chinese appear to feel.”
 
But does it work?  Stein quotes a description of a mall with a hundred restaurants, 20,000 employees, an ice rink and a climbing wall, where no one buys anything—some visitors even bring their own snacks.  “It is difficult to apply law and development theory to a nation in which non-economic government incentives such as these lead to the construction of projects that do not appear to be meeting any market demand.”  In that sense, Stein suggests, as with the French Revolution, it may simply be too early to tell whether the system is working, though he points out that Western financial follies such as securitization aren’t looking too good right now either.
 
The bigger question is whether the liberal dogma that development requires robust and clear legal systems and strong protection for property rights is challenged, disproved, or altered by China’s experience.  Stein offers various possible takes on this—China is unique; China actually provides more security than the formal law would seem due to relatively predictable informal practices; China proves that people will optimistically take risks even with low protections for investment if the return is high enough; and so on.  His modest conclusion is that China’s development shows that the standard model is only a model: local constraints and human behavior are key variables even if the rule of law is also important for long-term success.  What is really up in the air is how Chinese law—and government—will respond to an extended slowdown, which none of his informants had ever experienced in the relatively short period that China has had a land development/construction sector.
 
You can read the introduction on SSRN.  But I would urge anyone interested in property law to read the whole 204 pages.

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