freeman report

Freeman Chair in China Studies

June/July 2010

freeman report more in this issue Publication “Asia’s Response to Climate Change and Natural Disasters: Implications for an Evolving Regional Architecture” by Charles W. Freeman III, Michael J. Green, Robert S. Wang, and Jeffrey Bean Conference July 13 Pingtan Island: From a Military Exercise Base to an Economic Zone Freeman Facts The Revival of the Silk Road: China’s Investment in Xinjiang (see p. 5) quote of the month “What will be the consequences if this issue is turned into an international or multilateral one? It will only make matters worse and the resolution more difficult. International practices show that the best way to resolve such disputes is for countries concerned to have direct bilateral negotiations.” ~ Chinese Foreign Minister Yang Jiechi responding to U.S. Secretary of State Clinton’s call for a multilateral approach to resolve territorial disputes in the South China Sea. Minister Yang emphasized that disputes are not a threat to regional security citing increasing maritime trade volumes between China and ASEAN countries and “open and smooth” communication channels. Source: Chinese Ministry of Foreign Affairs, July 26, 2010

The Freeman Report provides an open forum for individual opinions and commentaries on China. All opinions expressed in the feature essay of the report are those of the author.

Feature Article

COOLING CHINA’S OVERHEATED PROPERTY MARKET By Victor Shih

........................................................................ Amidst a roaring recovery of the housing market beginning in the fourth quarter of 2009, the State Council announced some tough-sounding policies to cool the market in April 2010. Although these policies have worked to slow transaction volume in China’s major cities, prices have barely fallen nearly four months after these policies. The main reason for their ineffectiveness is that these measures still left ample discretion at the local level, and local authorities all over China have strong incentive to protect the real estate industry. The April real estate policies made it more difficult and costly for speculators to borrow money from banks to speculate in real estate. First, for the purchase of second or more flat for the household, buyers must put up at least a 50% down payment. The State Council also urged local authorities in heated real estate markets to out-right ban mortgages for third or more flat for the household. Furthermore, the interest rate for mortgages for the second or beyond flat must be 1.1 times that of the PBOC base lending rate. In contrast, buyers of their first flats continue to enjoy a preferential 20% discount from the base PBOC lending rate. In subsequent decrees, the State Council also made it more difficult for developers to speculate on land. For example, Beijing decreed that 70% of new land must be used on low-rent and economy housing instead of luxury flats. This policy presumably would increase the supply of cheaper housing, thus decreasing demand for high price flats. Furthermore, the central government enacted a decree which raised the down payment by developers after they have successfully bid for a parcel of land. In combination with earlier decrees which allowed local government to forcibly take back undeveloped land held by developers, Beijing attempted to stop the practice by many developers to sit on an undeveloped parcel of land and wait for the land to appreciate in value. (continued on p. 2)

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2 | Freeman Report Although these are some of the toughest policies we have seen in the past year, all of them have been used before to slow the real estate bubble in 2007. Thus, developers knew exactly how to get around them. For example, the higher down payment for second or more flat can be circumvented by developers when they charge a higher price and refund part of the purchasing price to buyers for the down payment. Furthermore, higher interest rates may deter the smaller buyers but not large speculators, who often own businesses and can still get business loans at low rates. Cheap capital from business loans can still be plowed into real estate purchases. The bigger issue diminishing the effectiveness of these regulations is that local authorities are given enormous latitude to implement many of these measures. The ban on third mortgages, for example, was not a blanket ban all over China, but was a suggested ban for “overly heated markets.” Of course, few cities outside of Beijing thought themselves “overly heated” and continued to allow banks to provide mortgages for purchases of third flats or beyond. Despite a long-standing decree to take back undeveloped land after it sits idle for two years, few local governments have forcefully retaken land from land speculators. In terms of the construction of low-rent and economy housing, local authorities are extremely reluctant to provide valuable land for these projects. In some cases, local authorities have converted low-rent housing into luxury flats upon completion of the buildings to evade central scrutiny. Because of high local discretion and relatively weak monitoring by central agencies, the implementation of these policies has been highly uneven. To be sure, the higher down payment requirement and interest rates have dampened the housing market significantly. Transaction volume in most of China’s major cities has declined by over 20% from last year’s high. In some cities like Hangzhou, transaction volume for real estate fell by nearly 50% from last year by the middle of May, one month after the enactment of the State Council policies. However, because of uneven implementation of the policies and developers’ general anticipation for government tightening, most developers did not budge on prices even into mid July. In the mean time, local authorities are doing all they can to help larger and medium developers stay afloat and to avoid competitive lowering of real estate prices.

in the news GENEVA --- Following the U.S.-China Strategic and Economic Dialogue (S&ED) in May, China announced on July 20 that its delegation in Geneva submitted a revised proposal for entry into the WTO Government Procurement Agreement (GPA). In conjunction, Chinese Minister of Science and Technology Wan Gang commenced talks on the same day with U.S. officials on China’s indigenous innovation policies in preparation for the U.S.-China Joint Commission on Commerce and Trade (JCCT) in November. This bid came after a period of vocal criticism that China’s indigenous innovation policies discriminate against foreign firms in government procurement. The reforms necessary for GPA entry would ideally open up procurement eliminating preferences for domestic bidders. While the proposal is an improvement, many barriers remain – high proposed contract value thresholds and exemptions for state-owned enterprises and provincial agencies despite the fact that they comprise a significant portion of government spending. SHANGHAI --- The IPO of the China Agricultural Bank raised US$19.2 billion in early July. As the last of China’s Big Four to be listed, it also marks a major milestone in the decade long process of financial sector reform, in which large Chinese financial institutions shed state control through debt write offs and internal reorganizational in preparation for public listing. The strategy of listing banks stems from the idea that being publicly traded would invite greater investor scrutiny, and further separate banks from bureaucratic control thus increasing efficiency. China AgBank’s dual listing in Hong Kong and Shanghai unfolds amidst fierce debate regarding the health of China’s banking system. Industry analysts say that Chinese banks will likely continue to fill their high needs for recapitalization with additional rounds of financing every few years for at least the next decade. Why are local authorities so protective of the real estate industry? According to my research, local governments all over China have borrowed over 11 trillion RMB mainly from the banks to finance local infrastructure since the early 2000s. For a sizable proportion of these loans, land was used as collateral. Furthermore, to generate cash flows for otherwise money losing infrastructure projects, local authorities have started hundreds of their own real estate developing companies. With the normal budget (continued on p. 3)

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Freeman Report | 3 barely sufficient for civil service salaries, the only discretionary cash flows at the local level comes from land and real estate sales or borrowing that is collateralized by land. If State Council policies are too effective and bring down real estate prices permanently, local authorities would suffer large losses and would be unable to finance new projects. It is thus not surprising that local leaders pleaded with the central government to leave considerable discretion at the local level. Local leaders want to work with developers to ride out this wave of tightening so that they can cash out in the next real estate boom in China. Victor Shih is Associate Professor of Political Science at Northwestern University. To send your comments on the feature essay, please email [email protected].

publications • “Asia’s Response to Climate Change and Natural Disasters: Implications for an Evolving Regional Architecture,” CSIS, July 16, 2010 Project Directors: Charles W. Freeman III, Chairholder, Freeman Chair in China Studies, CSIS, and Michael J. Green, Senior Advisor and Japan Chair, CSIS. Editors and Coordinators: Robert S. Wang, Visiting Fellow, Freeman Chair in China Studies, CSIS, and Jeffrey Bean, Research Assistant, Freeman Chair in China Studies, CSIS The report examines the politics of climate change in Asia, the region’s response to natural disasters, and the implications for the future geometry of Asian institutions and U.S. policies in the region. The authors believe that the United States will continue to play a critical role in supporting the region’s responses to many of the natural disasters it will face. The report suggests the United States seek to focus Asia’s attention on the long-term threat of climate change and other slow-onset disasters. It recommends the United States should continue its bilateral and multilateral programs to increase energy efficiency, and the use of alternative energy and clean-coal technology. The report also recommends the United States should begin to explore broad, secure, low-carbon pathways within the Asia-Pacific Partnership on Clean Development and Climate. • “U.S.-China Relations: Cooperation Faces Challenges,” Comparative Connections, Vol. 12, No.2, CSIS Pacific Forum, July 15, 2010 By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS Presidents Barack Obama and Hu Jintao met on the sidelines of the Nuclear Security Summit in Washington in April, and again on the margins of the G20 Summit in Toronto in June. Nevertheless, tensions lingered over U.S. arms sale to Taiwan and the military relationship remained tense with Chinese rejection of a request from Secretary of Defense Robert Gates to visit China. Despite long

discussions, the two countries were unable to agree on an appropriate coordinated response to the sinking of the South Korea warship. Progress was made during the second round of the U.S.-China Strategic and Economic Dialogue held in Beijing in late May, yielding agreements on energy, trade environment, and healthcare. In June, China finally announced the long-awaited decision to allow its currency to be more flexible. • “Rising Wages in China: A New Shift Begins at the World’s Low-Cost Factory,” China Knowledge@Wharton, June 23, 2010 By Wen Jin Yuan, Research Intern, Freeman Chair in China Studies, CSIS, and Autumn Zhu, Managing Editor, China Knowledge@Wharton The recent protests by Chinese workers on a wage raise, combined with the government’s initiative to reduce China’s reliance on exports, are drawing attention on whether China’s role as the world’s low-cost factory will be threatened. The article concludes that the sizable margin between the productivity gain and the wage increase allows China to increase wages in its export sector without crushing its competitiveness. However, the reduction of labor supply will probably drive up wages along with China’s domestic consumption and inflation, which will require the government to carry out policies that maintain economic stability and develop a stronger culture of innovation. • “China’s Burgeoning Foreign Reserves: Too Much of a Good Thing,” China Knowledge@Wharton, June 23, 2010 By Wen Jin Yuan, Research Intern, Freeman Chair in China Studies, CSIS China’s foreign reserves reached US$2.5 trillion in March, and around 70% is said to be in U.S. dollars. The Chinese government is worried that the United States’ burgeoning budget deficit and the Obama administration’s loose monetary policy could both weaken the dollar and devalue China’s reserves. The article points out that the steps China can take are limited, and the most effective way for China to safeguard the value of its reserves is to preserve a good political relationship with the United States. • “China’s Cheonan Problem,” PacNet #31, CSIS, June 18, 2010 By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS, and Brad Glosserman, Executive Director, Pacific Forum, CSIS The sinking of the South Korean vessel Cheonan and the lack of an appropriate Chinese response may well be a turning point in China’s relations with Asia. It has remained silent regarding the findings of the international investigation and has refused to exert any form of pressure on North Korea to curb its destabilizing actions. The indifferent Chinese response reveals a blatant willingness to pursue self interests at the expense of wider regional concerns, which is at odds with China’s espoused foreign policy principles.

center for strategic and international studies | freeman chair in china studies

4 | Freeman Report

Publications from the Freeman Chair 2010*

.................................................................................................. *Please visit our Web site to access archived publications dating back to 2002. 2010 July • “Asia’s Response to Climate Change and Natural Disasters: Implications for an Evolving Regional Architecture,” CSIS, July 16, 2010 Project Directors: Charles W. Freeman III, Chairholder, Freeman Chair in China Studies, CSIS, and Michael J. Green, Senior Advisor and Japan Chair, CSIS. Editors and Coordinators: Robert S. Wang, Visiting Fellow, Freeman Chair in China Studies, CSIS, and Jeffrey Bean, Research Assistant, Freeman Chair in China Studies, CSIS • “U.S.-China Relations: Cooperation Faces Challenges,” Comparative Connections, Vol. 12, No.2, CSIS Pacific Forum, July 15, 2010 By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS June • “Rising Wages in China: A New Shift Begins at the World’s Low-Cost Factory,” China Knowledge@Wharton, June 23, 2010 By Wen Jin Yuan, Research Intern, Freeman Chair in China Studies, CSIS, and Autumn Zhu, Managing Editor, China Knowledge@Wharton • “China’s Burgeoning Foreign Reserves: Too Much of a Good Thing,” China Knowledge@Wharton, June 23, 2010 By Wen Jin Yuan, Research Intern, Freeman Chair in China Studies, CSIS • “China’s Cheonan Problem,” PacNet #31, CSIS, June 18, 2010 By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS, and Brad Glosserman, Executive Director , Pacific Forum, CSIS May • “Preparation Needed for North Korean Collapse,” PacNet #27, CSIS, May 20, 2010. By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS, and Scott Snyder, Director, Center for U.S.Korea Policy, The Asia Foundation • “Responding to Change on the Korean Peninsula: Impediments to U.S.-South Korea-China Coordination,” CSIS, May 6, 2010. By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS, Scott Snyder, Director, Center for U.S.-Korea Policy, The Asia Foundation, See-Won Byun, Research Associate, Center for U.S.-Korea Policy, The Asia Foundation, and David Szerlip, George Washington University •“China’s Cheonan Problem,” PacNet #31, CSIS, June 18, 2010 By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS, and Brad Glosserman, Executive Director , Pacific Forum, CSIS April • “U.S.-China Relations: The Honeymoon Ends,” Comparative Connections, Vol. 12, No.1, CSIS Pacific Forum, April 14, 2010. By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS, and David Szerlip, George Washington University February • “President Obama to Meet the Dalai Lama,” Critical Questions, CSIS, February 17, 2010. By Charles W. Freeman III, Chairholder, Freeman Chair in China Studies, CSIS • “Debunking Myths about U.S. Arms Sales to Taiwan,” PacNet #6, CSIS, February 17, 2010. By Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies and Senior Associate, Pacific Forum, CSIS

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Freeman Report | 5

conferences and events • July 16 Asia’s Response to Climate Change and Natural Disasters: Implications for an Evolving Regional Architecture The event features the rollout of a CSIS report, “Asia’s Response to Climate Change and Natural Disasters: Implications for an Evolving Architecture.” Charles W. Freeman III, Chairholder, CSIS Freeman Chair in China Studies, Victor Cha, Senior Adviser and Korea Chair, CSIS, Stacey White, Fellow, CSIS Post-Conflict Reconstruction Project, and David Pumphrey, Deputy Director and Senior Fellow, CSIS Energy and National Security Program discussed their findings on the politics of climate change in Asia, the region’s response to natural disasters, and implications for the future geometry of Asia’s institutions and U.S. policy in the region. Kurt Tong, of the U.S. Department of State, and other panelists provided commentary. • July 13 Pingtan Island: From a Military Exercise Base to an Economic Zone Pingtan Island, the fifth largest island in China, is becoming a special economic zone, co-managed by mainland China and Taiwan. Dr. Shao Yuqun, Deputy Director of the Department of South Asia Studies at the Shanghai Institutes for International Studies, discussed the current plan of Pintan Island and its implications for cross-Strait relations. Bonnie S. Glaser, Senior Fellow, Freeman Chair in China Studies, moderated the session. • June 22 CSIS Press Briefing: The President’s Trip to the G8 and G20 Summits CSIS hosted a press briefing on President Obama’s trip to the G8 and G20 Summits. Heather Conley, Director, CSIS Europe Program, Charles W. Freeman III, Chairholder of CSIS Freeman Chair in China Studies, Fariborz Ghadar, CSIS Senior Adviser and founding director of the Center for Global Business Studies at Penn State University, and Lisa Carty, Deputy Director, CSIS Global Health Policy Center shared their perspectives at the event. • June 18 Taiwan’s Experience of National Health Insurance System in Supporting Public Health Emergency Response Taiwan Minister of Health Dr. Chih-Liang Yaung delivered a speech on Taiwan’s experience of national health insurance system in supporting public health emergency response at CSIS. Dr. J. Stephen Morrison, Senior Vice President and Director of the Global Health Policy Center, CSIS, moderated the discussion. • June 16 Congressional Briefing: China’s Trade and Industrial Policies Charles W. Freeman III, Chairholder, CSIS Freeman Chair in China Studies, testified before the House Ways and Means Committee on China’s trade and industrial policies. Click here to read his full testimony.

Freeman FACTS The Revival of the Silk Road: China’s Investment in Xinjiang 1. The Civil Aviation Administration of China stated that by 2015 Xinjiang would have 6 new airports, bringing the total number of airports to 22. 2. By 2020, the Ministry of Railways will invest US$45.6 billion to increase the length of railways in Xinjiang from 3,599 km to 12,000 km, covering 90% of county-level cities. 3. In the next five years, around US$19.1 billion will be allocated to fund new road construction and old road maintenance in Xinjiang, among which 7,155 km will be highway. 4. The Chinese Ministry of Culture managed a US$2.1 billion cultural investment in Xinjiang aiming to establish the public culture service system, to enhance its cultural heritage protection, and to build county-level digital libraries. 5. Until July 2010, 17 Chinese provinces have initiated 96 development programs in Xinjiang, totaling US$420 million. Sources: People’s Daily, Tianshannet, Xinhua

The Freeman Report is an electronic newsletter produced monthly by the Freeman Chair in China Studies at the Center for Strategic and International Studies (CSIS), a private, tax exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions; accordingly, all views, positions, and conclusions expressed in this publication should be understood to be those of the author(s). © 2010, Center for Strategic and International Studies. All rights reserved. Freeman chair in china studies Charles W. Freeman III, Freeman Chair in China Studies Bonnie Glaser, Senior Fellow Robert S. Wang, Visiting Fellow Melissa Murphy, Fellow Savina Rupani, Program Coordinator and Special Assistant to the Freeman Chair Xiaoqing Lu Boynton, Research Associate Lee Ridley, Project Coordinator/Research Assistant Jeffrey Bean, Research Assistant Robert Lyons,Wen Yuan, Diana Zhang and Luxi Zhou, Research Interns

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