David Schleicher’s Lessons for Modern China
Rick
Hills
In A Bad State is both
straight-up narrative history and politico-legal policy advice. That combination
invites the question of whether the lessons of the former are generalizable
enough to justify the latter. This is not to say that the narrative could not
stand alone without the advice. A giant
portion of United States’ history has been spent sorting out the bad debts of
profligate state and cities: No one before Schleicher has provided a comprehensive,
clear, and lively account of how the U.S. Supreme Court, Presidents, and
political parties have fretted about how to deal with these fiscal hangovers.
But do these stories have any lessons to
offer to anyone outside the peculiar and perhaps unique circumstances of the
United States? At the end of the book, Schleicher
offers sober, middle-aged, somewhat disillusioning advice that there are no
easy answers. An inevitable trilemma of moral hazard, macroeconomic stagnation,
or infrastructure disinvestment undermines confident prescriptions for hard
budget constraints or Keynesian revenue sharing. Balance, resilience, prudence — these maxims
sound like the sort of deflating kind of advice a marriage counselor gives to a
long-suffering and burnt-out couple who are better off together but just cannot
re-kindle the True Romance of Big Theory.
Does such advice apply to any other
society or just to our particular bickering, over-spending federal marriage? Perhaps because I have just returned from a
seven-year part-time job teaching in Shanghai, it seems worthwhile to ask
whether Xi Jinping should read Schleicher’s book for advice on how to fix
China’s municipal debt problem. In what
follows, I will argue that Schleicher’s book provides a surprisingly accurate
diagnosis and cure for what ails China today.
1.
The Chinese debt debacle
Since before covid, veteran China
watchers like
journalist Dinny McMahon have warned about Chinese subnational
governments’ drowning in debt? The expense of covid only exacerbated the
debt crisis by burdening local governments with massive
lockdown bills. It is not easy to figure out the exact extent of Chinese
cities’ indebtedness, because local officials conceal debt by attributing it to
non-governmental finance vehicles the bonds of which are secured by
governmental assets — primarily land. In
2023, however, Goldman
Sachs estimated that Chinese subnational debt amounted to $23 trillion.
That’s roughly the size of the entire United States’ GDP or 284%
of China’s entire GDP. By contrast, the combined federal, state, and local debt
of the United States amounts to roughly $28.8 trillion ($3.2 trillion of which
is state and local debt) or roughly 136% of GDP.
Despite this massive debt burden,
Chinese cities keep
piling debt on for dubious infrastructure projects — railroads to
nowhere, eco-parks and other tourist
attractions that no one wants to visit, and thousands of “ghost” apartment
buildings.
Why cannot Chinese local governments
pull out of their addiction to debt?
Schleicher’s trilemma suggests three reasons: (1) An out-of-balance
emphasis on avoiding macroeconomic stagnation above all else, (2) lack of close
monitoring of local investment decisions, and (3) the absence of resilient
precautions like promotion of citizen mobility to the most productive places.
Consider, first, the Chinese
government’s obsession with macroeconomic stability. As Schleicher notes,
subnational spending can be an important counter-cyclical strategy for avoiding
recession. The central government started
using this strategy back in 2008, instructing local officials, known as
“cadres” or “ganbu” ( 干部 ) in Communist
jargon to spend freely. Promoting cadres primarily on the basis of their
success in boosting local GDP, the central government gave mayors and party
secretaries plentiful incentives to juice wages and expenditures with debt-financed
construction projects.
Second, the Chinese government did not
install prudent monitoring mechanisms, as Schleicher recommended. State-owned
banks dumped
cash on unproductive firms, and local cadres dumped money on dubious
projects. Some of this investment took the form of off-the-books financing
through in-kind subsidies in land. Because urban land is owned by “the State,”
local governments in need of revenue “requisitioned” rural land, officially
controlled by villages, to urban use, dispossessing farmers and leasing the
land on 40-70 year terms to developers for lump-sum payments. Because any sort of construction generates
short-term spikes in GDP on the basis of which a cadre could earn promotion, local
cadres did not focus on the quality of the projects they were financing. China
sprouted vast crops of airports
where no one wanted to fly, theme
parks that few visited, and ghost
cities of empty apartment buildings in so-called “third-tier” cities where
no one wants to live.
Finally, China lacked the mechanisms for
resilience urged by Schleicher. In
particular, Schleicher notes that citizen mobility allows people to move from
unproductive to productive jurisdictions, a form of mitigation of bad
investments through migration to good ones. Citizen mobility is, in fact, high
in China: Hundreds of millions of rural residents left
their villages to work in cities between 1990 and 2020. But the central
government placed big obstacles in their way. The central government limits the
quantity of land that can be devoted to residential purposes in an effort to keep
a lid on the population of the fastest growing and most productive cities.
Local governments also lack sufficient mechanisms or incentives to recover
revenue from rural migrants: They have no authority to levy a property tax nor
are they promoted on the basis of rising land values, so neither their local
revenues nor their careers are advanced by attracting more migrants.
The result is that Chinese cadres keep
running the same playbook — promote local growth through investment in
infrastructure — but with less cash, as real estate prices start to collapse in
all but the most productive cities.
2.
Lessons
for China from the United States’ Gilded Age?
In A Bad State, in short,
seems to diagnose China’s debt woes pretty well for a book that does not
venture outside of United States history. The accuracy of diagnosis might be
the result of the resemblance between China’s current state of affairs and the
debt crises of Gilded Age America described that Schleicher describes so
well. As Yuen Yuen Ang notes in China’s
Gilded Age, China’s boom-and-bust
economy today looks a lot like postbellum America before the Depression of 1893,
when “American state governments were fiscally independent and eager to promote
development, both to win elections and to get rich.”
In A Bad State provides one
more parallel: Both Gilded Age America and contemporary China suffered from a
massive municipal debt crisis. A huge portion of the U.S. Supreme Court’s
docket was taken up by states’ and municipalities’ trying to evade repayment of
their bondholders. Those creditors lent money to starry-eyed boosters who
wanted to transform their hamlet into the next Chicago with a railroad spur. Like
Chinese cadres, the local politicians who promoted this boosterism were
sometimes corrupted by investment promoters, sometimes simply suckers, and
sometimes merely politicians with a short time horizon. The result was a mad
scramble for investment followed by defaults as the United States was glutted
by rail lines and hit by depressions and panics, including a mammoth depression
in 1893.
The United States climbed out of the
1893 Depression despite the trilemma described by In A Bad State. Will China do the same? Predictions about China are always hazardous.
There are reasons, however, for cautious pessimism: Parallels between the
United States and China may diverge, because institutions promoting balance,
resilience, and prudence in Nineteenth Century United States are missing in the
People’s Republic of China.
Consider, first, how two independent
tiers of federal and state courts simultaneously promoted infrastructure
investment and monitoring of local officials. Federal courts took on the role
of forcing local governments to re-pay bondholders for debts already incurred,
thereby saving the market for municipal bonds necessary for financing useful
infrastructure. This role not only required federal courts to crack down on
municipal officials’ creative ways of evading repayment but also to overrule
state courts that regularly protested against the federal judiciary’s usurping
the state judges’ job of construing state laws and municipal powers. But state courts played an important role as
well, in narrowly construing local governments’ power to insure indebtedness in
the first place with doctrines like Dillon’s Rule. Such state doctrines
required extremely specific statutory authorization for local investments,
thereby enlisting the state legislatures and state courts in monitoring local
officials’ investments.
Both the federal and state doctrines
were judicial inventions with little justification in previous doctrine or
specific statutory language. The justification for these innovations was not
law but policy: Failure to pay bondholders would dry up investment in
infrastructure, while failure to restrict local investments would invite civic
boosters to plunge into future doomed ventures. The willingness of each
judicial system to impose these limits, however, depended on their independence
from each other. State judges, often elected by angers taxpayers, tended to
resist repayment of bondholders, while federal judges, detached from the
nitty-gritty of state politics, played little role in restraining future bond
issues.
China lacks such independent checking
institutions. The Communist Party’s central leadership —increasingly, Xi
Jinping — calls the shots, and local
cadres scramble to outdo each other in demonstrating their commitment to
whatever the central government announces. Right now, the Party’s leaders want
to bolster falling real estate prices, so local officials have little incentive
to limit their indebtedness. As a result, there is little independent
monitoring of local investment decisions.
Consider, next, how Chinese Communist
Party’s ideological commitment to centralization prevents accurate monitoring
of local cadres. Shitong Qiao and I have
suggested that freeing up land markets and promoting citizen mobility would
enable the central leadership to use land values as a proxy for local cadres’
performance. If Chinese homebuyers were freer to choose among competing
jurisdictions when buying real estate, then the central government could use
those choices as a basis for assessing which local governments were doing the
best job in attracting homebuyers. Local governments that invested in useless
white elephants would lose buyers; local governments that gave homebuyers what
they wanted would gain buyers. The resulting slumps and rises in local land
values could be a signal for central officials of comparative performance of
competing cadres. In effect, Chinese homebuyers would vote with their feet for
or against local officials without threatening the central leadership with
protests or ballots.
In practice, however, the Chinese
Communist Party’s Leninist ideology discourages such delegation of
decision-making power to private decision-makers. Xi Jinping remains determined
to pick winners among Chinese cities, capping growth in China’s most productive
areas and thereby forcing the population into less productive cities. In
particular, the Communist Party has steadfastly refused to give rural
households a right to alienate their farming rights, preferring that local
governments expropriate and use the gains from converting rural to urban land. This is in stark contrast with nineteenth
century United States, where farmers retained the gains in real estate values
from expanding cities while the central government had little power to control
rural migration into the cities with the best wages. Those farmers became active monitors of
their local officials’ investment decisions, because the value of their land
was at risk.
In short, an ideology that celebrates
central control stymies accurate monitoring of local cadres’ performance in
today’s China. The result is an imbalanced trilemma, where macroeconomic
stimulus always trumps monitoring local cadres. Schleicher could have warned Xi
Jinping that such an imbalanced model of local debt is a recipe for moral
hazard.
Rick
Hills is the William T. Comfort III Professor of Law at NYU Law School. You can
reach him by e-mail at roderick.hills@nyu.edu.