Debt socialism in US vs. China
Expropriation of land and wealth was vital for growth
By Leslie Young
If you ask the US how it got rich, it might cite capitalism, democracy and the rule of law ― but not the low-price real estate that it got from the American Indians (Manhattan for some beads, the Southeastern US for blankets from a smallpox hospital). If you ask China how it got rich, it might cite its social market economy with Chinese characteristics ― but not the low-price real estate that the PLA “liberated” in 1949. Each nation became a world power via institutions that generated infrastructure and industry from its low-cost real estate. Their contrasting institutions have now led to contrasting crises in real estate, debt and deficits.
Growth requires investment in infrastructure and industry ― before incomes have risen high enough for high savings, and before financial markets have developed to channel savings into investment. In the US and the People’s Republic of China, the state initially owned all the land; export-led growth raised the value of land, which was sold to fund infrastructure and industry, which promoted more exports, which raised the value of more land…
In the US, the collateralization of private land funded many private business startups (see Hernan de Soto, The Mystery of Capital). In China, local governments used low rents to attract foreign investment and sold state land to fund infrastructure and industry. Now they are collateralizing more state land for the same purpose.
Socialism With American Characteristics
As the US ran out of land to sell, it instead funded infrastructure and investment by savings, channeled by a financial system of growing sophistication. The US ideology of individual freedom and its institutions of private property ensured that the capital thus created remained privately owned – and inherited. This bequeathed privilege to those whose forebears had accumulated wealth early. This inequity became invidious at retirement.
In principle, financial capitalism funds retirement neatly. Citizens work to build real assets that enhance future consumption. They accumulate financial claims on the assets via pension funds. They fund retirement by selling those claims to the next generation, as it starts to work and save. But the concentration of asset ownership in the few who inherit large blocks prevents the many from accumulating enough for a decent retirement; their votes, channeled by democratic institutions, ensure the socialization of retirement: tax-funded Social Security and Medicare.
Voter-wary federal legislators never levied taxes high enough for the Social Security or Medicare systems to accumulate assets that matched their liabilities. Likewise, voter-wary state legislators lavished pensions on state employees in lieu of wage increases and shareholder-wary corporate executives lavished pensions on employees in lieu of wage increases, but these pension liabilities were never fully funded. However, citizens’ confidence in their legal claim to the pensions reduced their savings. Thus, the interaction of the core US institutions of democracy, law and capitalism brought backdoor socialism: trillion-dollar deficits.
Socialism kept coming through the back door via policies to democratize asset accumulation via real estate: tax deductions on mortgage interest, Fannie Mae, Freddie Mac, FHA… But the benefits of each policy were impounded in real estate prices, and accrued to current homeowners. Those benefits were passed down to their heirs, but bypassed those not yet able to purchase a home, such as recent immigrants and future generations. Thus, each housing policy redressed intra-generational inequity only by exacerbating inter-generational inequity. This created political pressure for more backdoor socialism: mortgage securitization, asset-backed securities, alt-A loans, sub-prime loans and the result was more trillion-dollar deficits ― the ultimate in inter-generational inequity.
The 2008 financial crisis blew in a veritable gale of socialism through the back door: the Treasury lavished $8,000 of tax credits on each new home purchase; the Fed printed $1.2 trillion to buy mortgage-backed securities; via Fannie Mae and Freddie Mac, the US government today guarantees 92% of all US mortgages. For, real estate is the one industry that employs many modestly-skilled people, yet is safe from Chinese competition: it must be upheld to sustain US employment. But real estate cannot be exported, so its continual absorption of resources is crippling the US balance of payments. Sooner or later, US credit ― and US imports ― will collapse.
Capitalism With Chinese Characteristics
How can China deal with that collapse? Exports have driven land appreciation, which has funded infrastructure and industry. If exports falter, can China grow endogenously via investment in infrastructure and industry? This question is salient for the investment that local governments launched in response to the financial crisis, which was often funded by bank loans collateralized by land: can the land appreciate fast enough to cover the loans if the infrastructure and industry yield insufficient cash flows?
Yes, because of the macroeconomic implications of a cash shortfall for residential real estate. As in previous bank crises, the central government would ultimately cover a cash shortfall by some mixture of: printing money, widening the spread between deposit and lending rates at state banks, and siphoning profits from statelinked corporations. As in previous bank crises, these measures would drive down the real returns to private savings, and drive up investment in private real estate ― and the price of land. The mechanism is as follows.
Low returns on savings pose a severe dilemma for Chinese citizens. They will retire for about 15 years, after 45 years of work, a 1:3 ratio. If they save and spend in that 1:3 ratio while working, then their savings could fund retirement at the lifestyle that they expect to enjoy in their last year of work – provided that the real return on their savings equals the real rate of growth of their incomes. Suppose that current investments in infrastructure and industry enhance the growth rate of personal incomes, but the state needs to cover cash shortfalls in these investments by skimming off the real returns on personal savings. Then citizens must not only raise their saving: spending ratio well above 1:3, they must also seek much higher returns on their savings.
Investment in inner-city apartments is one of their few options. The urban population of China is rising fast and must be housed. The urban poor live on city outskirts; the rich, closer to the city center. Investing in inner-city apartments enables today’s prospering citizens to intercept the income gains of those who will arrive in cities later and prosper later.
The Communist Manifesto: Expropriate the Expropriators!
Could the very policies needed to cover cash shortfalls drive up land prices by enough to cover the bank loans to local governments? Two problems jeopardize this neat resolution: inter-generational inequity and corruption.
Those who arrive in cities later and prosper later will never catch up with those who arrived earlier, for they must spend more on housing. Like the US, China can redress this inequity via state support for housing, pensions and health. Unlike the US, China has the resources to do so without jeopardizing the solvency of the banking system and the state. It can dedicate more state land to house lower-income citizens; it can use the capital held in statelinked corporations to fund state pensions and health. China has made a start in both; whether it will finish is a matter of political will.
Corrupt local officials are siphoning off the revenue from the sales of appreciated land. Such corruption is China’s counterpart to the corruption of Wall Street, where bankers privatized the upside of risky bets via stock options, while socializing the downside via taxpayer bailouts of their banks. In return for the bailouts, the US government took preference shares. Taking ordinary shares instead would have secured it more of the upside from its bailouts, not to mention the right to veto high bonuses and corporate lobbying against financial legislation. Ideological/ institutional hostility to “communism” prevented this. But no such constraints prevent China from bailing out its banks by injecting assets expropriated from officials who cannot account for them. Sure, this is communism ― but why should that be a problem for the Communist Party?
Having launched growth by expropriating landlords and capitalists, China can perpetuate it by expropriating corrupt Communists. Too bad US ideology and institutions prevent it from perpetuating growth by expropriating Goldman Sachs the same way it expropriated the American Indians, i.e., by purchase of their Manhattan apartments with some beads and smallpox-ridden blankets.
Leslie Young is Professor of Finance at The Chinese University of Hong Kong