By Yukon Huang
China angst is not unique to Washington. India, Brazil, and other major emerging market economies dream of catching up with China, but their ambitions have been thwarted by overwhelmed urban services, antiquated transport systems, and inadequate power grids. For them, too, competing with China may mean investing in new infrastructure.
But Washington has another thing in common with these countries: the dilemma of how to pay for such investments. There is already much skepticism about the financial feasibility of Biden’s proposal, which he says may be paid for through higher capital gains tax rates, a new inheritance tax, and improvements in tax collection—all of which face either staunch opposition or hard limits of feasibility.
Meanwhile, China’s economic structure and financing mechanisms are fundamentally different from the United States’ and, consequently, its experience investing in infrastructure only highlights how difficult it will be for the United States to actually compete in these terms.
China’s per capita income is nearly one seventh that of the United States, and its fiscal and financial systems are far less sophisticated. Yet, it has still been able to find the resources to transform its economic landscape. Modern metropolises are now home to more than half the country’s population, high-speed rail and highway networks blanket the nation, and world-leading firms go toe-to-toe with international competitors. China was able to accomplish all this because it was able to secure the finances needed to sustain high levels of investment. Indeed, those outlays have averaged around 40 percent of GDP over the last three decades. By contrast, the United States’ share has been around 20 percent. Even the middle-income countries that are in a catch-up process made it to just 25 to 30 percent.
All of this has fostered a debate about the relevance of China’s infrastructure investment to Biden’s proposals. But it also raises an obvious question: How was China able to raise all that money when governments around the world have been unable to generate the resources for even modest programs through either higher tax revenues or tapping capital markets?
China’s solution lies in a poorly understood phenomenon: the government’s success in tapping the hidden value of land that became available for development as China transitioned from a socialist- to a market-driven economy. In the pre-reform socialist era, land in China had limited commercial value since both ownership and usage rights belonged to the state. A robust market for residential and commercial property only began to emerge in the late 1990s when the government privatized housing and launched auctions of land parcels for commercial use.
This led to a surge in the price of land-based assets as markets sought to establish their real commercial value. Those who nominally owned plots—households, firms, and local governments—suddenly found themselves blessed with assets that were appreciating rapidly. The Chinese Residential Land Price Indexes suggests the average value of land increased eightfold between 2004 and the end of 2017. (The Russian property market saw a similar dynamic in the years following Soviet collapse and privatization of its housing stock. Between 1990 and 1996, property prices in Moscow soared twelvefold.
Increasing land prices also gave regional and municipal governments the opportunity to establish so-called local government financing vehicles (LGFVs) to raise funds and invest in infrastructure. Formally state-owned enterprises, LGFVs could use the land assets that had initially been granted by their parent governments as collateral to take out loans or issue new bonds. That got them the cash to build everything from power grids to subway systems.
As long as land appreciated faster than interest rates charged by banks or the corporate bond market, borrowers could keep taking on debt to pay off older loans. But this trick doesn’t work forever. Land appreciation may continue, but it is unlikely to outpace interest rates forever as land prices approach their equilibrium levels. As younger generations have more consumer choice, they are choosing to save less than their parents did. That will drive interest rates upward. Moreover, returns on investments are falling for many government infrastructure projects, which are increasingly directed toward inland provinces for equity and strategic reasons, making the margin for solvency even smaller. Thus, borrowing by LGFVs has moderated given Beijing’s concerns about rising debt levels. The pace of infrastructure investment will likely diminish in the coming years.
Elsewhere in the world, robust property markets have typically already existed for decades if not centuries. That means most governments cannot count on the type of windfall that fell into the laps of China’s leadership’s current generation with market reforms.
For Biden, that means if he cannot raise taxes, he will have to pay for much of the new spending with debt. In that case, Biden would be borrowing not against tangible assets but against the creditworthiness of the U.S. Treasury Department. That might mean U.S. local jurisdictions get their chance to build and repair infrastructure, perhaps closing the perceived gap to China as it begins to face the same financial constraints as Western nations.
Aside from potentially destabilizing inflationary pressures, relying on the almost-bulletproof reliability of U.S. Treasury bills might be as good a trick as China’s land-financing one was. But unless the U.S. dollar remains the de facto global reserve currency, it too has an expiration date.
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