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Today we are going to talk about a huge change in the fiscal model of local governments. In the first section of this course, I emphasized the analytical method of looking at the government with corporate logic, and behind this is the importance of fiscal logic. Finance is the money bag and the foundation of the place, so the change in the fiscal model affects almost everyone, and it affects your house purchase, residence, education, medical care, business and other aspects.
And this new change is that local governments are transforming from “land finance” to “equity finance”.
Maybe some students hear the words “finance”, “land” and “equity” and their heads are big. What do they mean? Next, I will analyze it with you in two parts: Let’s first talk about what land finance is? How does the dilemma it brings profoundly affect economic development and your life? Then let’s talk about why equity finance is the future trend? And how will it affect your city choice and personal planning?
The dilemma of land finance
Let’s start with a recent trivial matter, that is, Hefei Feixi Industrial Investment has obtained a 3A credit rating in the rating market.
What is the origin of this Feixi Industrial Investment? It is actually the investment and financing platform of the local government of Feixi County, Hefei City. Its predecessor was the Urban Investment Group responsible for infrastructure and public services. After 2021, it will be officially transformed from an urban investment to an industrial investment. Here is an explanation: Urban investment is to obtain income by investing in various urban infrastructure, while industrial investment is to obtain income by investing in the equity of various enterprises. In short, the money-making model is different.
After the successful transformation, Feixi Industrial Investment currently has a fund group of more than 70 billion yuan, and has achieved the investment promotion and landing of 28 external projects through equity investment funds. Moreover, it is the first industrial investment in the country to obtain a 3A rating. Being able to obtain 3A means that it has been recognized by the market.
This signal is very important. It means that even for a small county, the urban investment platform that was previously considered to be difficult can be transformed into an industrial investment platform. This fully shows that the transformation of the “land finance” that the local government cannot get rid of to “equity finance” is feasible and is a sustainable new fiscal method.
Let us further explain the transformation process of local governments from “land finance” to “equity finance”.
The finance of our local government in the past few years is called “land finance”. Simply put, it is to obtain fiscal revenue by selling land and building houses.
This should be talked about from the national tax-sharing reform in 1994. After the tax-sharing reform, local governments “handed over financial power to the upper level and transferred power to the lower level”, facing the dilemma of less money and more things. In order to raise funds for local development, after the housing system reform in 1998, local governments embarked on the road of “selling land”, capitalizing and financializing land, overdrawing the future value of land in advance to meet current funding needs, and local governments obtained a steady stream of fiscal revenue by selling land. This is “land finance”.
Data shows that in 1999, the proportion of land transfer income in local public budget revenue was only 9%. By 2003, in just 4 years, this proportion had risen to 55%, and land transfer income became the main source of local fiscal revenue. The peak was in 2010, when this proportion rose to 68%. Later, with the proposal of “housing for living, not for speculation”, the proportion began to decline, and in recent years it has remained between 30% and 40%.
The obvious side effect of land capitalization and land financialization is to push up the housing price bubble, or in other words, land finance is dependent on high housing prices. When housing prices peaked in 2021, the collapse of “land finance” by local governments followed. According to statistics, in less than three years, the national land fiscal revenue has been halved from the peak of 8.7 trillion in 2021 to less than 4 trillion in 2024.
Moreover, the degree of dependence on land finance varies from place to place, with the lowest being only 10% and the highest being more than 70%. Therefore, the decline in land finance often has a smaller impact on the economically developed eastern regions, while the “pain” in the underdeveloped central, western and northeastern regions is very strong. Because in these regions, land finance is the main source of income, and once the land cannot be sold, they can only eat dirt.
The decline in “land finance” has also brought about a series of chain reactions: some local governments have no money, and civil servants’ salaries cannot be paid. The money for enterprises working for the government has been delayed again and again, and various subsidies cannot be paid. The cold is a process of transmission. Everyone has no money, and then they don’t spend money, which makes the local consumption and development chain formed around government finances and civil servants stagnate.
Some local governments have no money because of poor land finance, so grassroots services have become the norm, and a series of expenditures involving grassroots people’s livelihood, such as education, medical care, social security, and housing security, have been affected.
A few local governments have taken a different approach, trying to find ways to conduct more tax inspections, impose more fines, and set up more names, and even adopt “distant-sea fishing” methods, that is, cross-regional, go to developed areas to find companies to make money to increase revenue, which seriously interferes with the normal operation of local people’s livelihood and enterprises.
You should understand here that if local governments continue to have no money, then our food, clothing, housing, transportation and other things will have problems.
The future trend of equity finance
Therefore, at this point in time, local governments must gradually get rid of their dependence on “land finance” and move towards a more stable and sustainable fiscal path. This method must be able to make up for the huge fiscal funding gap after the abdication of “land finance”. And the first choice is “equity finance”.
To put it bluntly, if the land cannot be sold, don’t sell it. Just invest the money in the industry that represents the future and make money in the future. Simply put, it is to establish an equity platform through the government, invest in enterprises, cultivate corresponding advantageous industries based on their regional resource advantages, form agglomeration effects, and thus expand enterprises and industries on a large scale.
In this way, on the one hand, the government obtains cash dividends and equity income from the development and growth of enterprises, and on the other hand, more enterprises invested by them come to pay taxes locally, and the government can obtain more tax revenue. Kill two birds with one stone.
From “land finance” to “equity finance”, in essence, the government still uses its own status and resource advantages to “sit on the market”, but it has changed from the simple and crude sitting on the market in the past, engaging in land development and selling land resources, to a higher level of sitting on the market, engaging in industrial development, and letting capital make money for itself.
Now many places are taking action, such as Shanghai, Hefei, Shenzhen, and Suzhou, they have all begun to set up their own industrial investment platforms to replace the previous urban investment platform and land finance model.
The core advantage of this transformation is that it is more sustainable. The previous land finance relied on high housing prices, but we know that housing prices cannot rise forever. Equity finance, on the other hand, relies on the development of the industry itself, which obviously requires more sustainable and healthy development.
Of course, we cannot ignore that the current size of “equity finance” is far smaller than that of “land finance”.
On the one hand, the main source of the current “equity finance” is the tax revenue brought by state-owned capital income and government industry cultivation, and the size gap is relatively large compared with “land finance”. On the other hand, “equity finance” is more suitable for the economically developed eastern regions with stronger financial strength, and it is difficult to do it in many underdeveloped central and western regions. Therefore, in the eastern region, it is a general trend for equity finance to replace land finance, while other regions need a more difficult transformation.
Further, this also means that the smoother the transformation of the developed eastern regions in the future, the greater the advantages, while many underdeveloped regions will have less and less space. Finance itself determines the business environment and development potential of a place. The richer the local finance, the less it will rely on more fines to generate income, and the business environment will naturally be better; the richer the local finance, the higher the local consumption capacity, the more support for enterprises, the more virtuous cycle of business, and the greater the development potential.
So many times, trends and the fate of the city, personal choices, etc. behind them are formed in this way.
