To Build Outward or Upward? The Spatial Pattern of Urban Land Development in China

Transcription

1 To Build Outward or Upward? The Spatial Pattern of Urban Land Development in China Zhi Wang, Qinghua Zhang, Li-An Zhou February, 2017 Abstract This paper studies the determinants of the spatial pattern of urban land development. Our study is motivated by an interesting fact observed in the past decade, the fact that the fastest-growing Chinese cities have undergone outward expansion of urban land development with relatively low use intensity. We link this pattern with the career concerns of local leaders who act as city developers. We first develop a theoretical model to demonstrate how a city leader whose career advancement depends on city economic growth chooses the spatial pattern of urban land development. Two major testable predications are derived. First, city leaders with high career incentives are more likely to expand the city outward in order to boost land sale revenues for financing public infrastructure and enhancing economic growth. Second, the average use intensity of newly developed land is lower for city leaders with stronger career incentives due to the trade-off between a city s upward and outward expansion. We test the theory using a large dataset of residential land transactions matched with city leaders from 2000 to We find robust evidence consistent with the predictions of our model. JEL Classification: R1; R52; H7 Keywords: Urban land development; Spatial patterns; Land use regulations; City developer; Political economy We would like to thank Vernon Henderson for substantive comments and suggestions on this research project. We thank all seminar participants at the 2016 Meetings of the Urban Economics Association, the China Meeting of Econometric Society 2016, Singapore National University, Jinan University, Xiamen University and Fudan University for helpful comments and suggestions. Zhang gratefully acknowledges support from the Chinese National Science Foundation (Grant# ). Zhang gratefully acknowledges the support of a Global Research Program on Spatial Development of Cities, funded by the Multi Donor Trust Fund on Sustainable Urbanization of the World Bank and supported by the UK Department for International Development. Any remaining errors are our own. School of Economics, Fudan University, No. 600 Guoquan Road, Shanghai, , China. address: wangzhi@fudan.edu.cn, Phone: Guanghua School of Management, Peking University, Beijing, China, , address: Zhangq@gsm.pku.edu.cn, Phone: Guanghua School of Management and IEPR, Peking University, Beijing, China, address: zhoula@gsm.pku.edu.cn. 1

2 1. Introduction China has experienced a massive process of urbanization in the past two decades on an unprecedented scale in human history. According to the National Bureau of Statistics of China, the nation s urbanization rate increased from 26% to 49.9% from 1990 through In this process 372 million people, the vast majority of whom were originally from rural villages, moved into the urban population. Built-up urban land area also expanded substantially, increasing at an annual rate of 5.73%, or 134,550 hectares per year from 1990 through This astonishing scale of urbanization has been accompanied by tremendous growth of real GDP in cities. In these two decades of urbanization, China has undergone a very interesting landdevelopment pattern. Figure 1 depicts the correlation between outward expansion of land development and population growth for China s top 50 cities from It is clear that faster population growth is associated with increased outward expansion of land use. For the same set of cities, Figure 2 shows that the cities with higher population growth have lower floor-to-area ratios (FARs) imposed on newly developed residential land. Contrary to the common impression that heavily populated cities in developed regions such as New York, London, Singapore, Tokyo, and Hong Kong tend to build more intensively, China s intensely populated cities, such as Beijing, Shanghai, and Guangzhou, have much lower FARs than some second-tier or even third-tier cities like Xi an and Guiyang (provincial capitals of Shaanxi and Guizhou, respectively, in the western region of China). This paper attempts to explain this puzzling pattern by investigating the decisionmaking of urban land development policies. Chinese city leaders play a central role in urban land development. They act as city developers and set the key parameters shaping decisions about how much new land is to be developed and where, and the regulation of the intensity of land use such as the building density (i.e., FAR) for each land parcel (Lichtenberg and Ding, 2008, 2009; Cai, Wang and Zhang, 2016; Brueckner, Fu, Gu and Zhang, 2016). This is in stark contrast to many developed countries where homeowners have considerable influence on local land development. In the meantime, Chinese city leaders, who hold critical control over local economic activities, are placed in promotion tournaments for economic growth (Chen, Li, Zhou, 2005; Li and Zhou, 2005; Xu, 2011; Wu, Deng, Huang, Morck, Yeung, 2013; Yao and Zhang, 2015; Gong, Knight, Xiao, Zhang, 2016) in which their promotions are closely linked with regional economic outcomes (such as growth of GDP and fiscal revenues). 2

3 In this paper, we link the peculiar pattern of urban land development we discussed earlier with the career concerns of city leaders. There are very few studies in the literature that examine the determinants of land development patterns in developing countries (Gyourko and Molloy, 2015). Most of the relevant studies are set in the context of the developed world (e.g., Burchfield, Overman, Puga, Turner, 2006). Our paper fills this gap. More importantly, the current literature emphasizes the idea that incumbent home-owners have incentive to influence the local planners to restrict land development in their neighborhoods in order to keep their property values from falling (Fischel, 2001; Glaeser, Gyourko and Saks, 2005; Hilber and Robert-Nicoud, 2013; Ortalo-Magne and Prat, 2015). The influence of developers neither shows up in their framework nor constitutes the focus of analysis in this line of literature, although land developers may have also played a salient role in determining land development (e.g., Molotch, 1976; Logan and Molotch, 1987; Sole-Olle and Viladecans-Marsal, 2012). 1 We first develop a theoretical model to demonstrate how a city leader whose career advancement depends on city economic growth chooses the spatial pattern of urban land development. Specifically, she faces a choice regarding urban boundary (i.e., how far the outward expansion of urban land development goes) and land use intensity within the city reflected by a certain regulatory FAR schedule. Her payoffs depend on the likelihood of her promotion, which hinges on both the ex ante career-concern intensity determined by her initial age and political hierarchy level when she first took office, and the ex post economic performance during her term. If she has a higher ex ante career-concern intensity, she will have a stronger incentive to promote the city s economic performance since doing so can more effectively enhance the likelihood of her promotion and her expected payoffs. We assume that the city government collects revenues from the sales of the longterm leaseholds of land use rights to private developers, which is consistent with China s current land property institutions. The land sale revenues are supposed to finance public infrastructure provision, as is commonly done in China, and in turn are 1 There are some studies that argue for the importance of local governments and business developers in urban development. Molotch (1976) proposes the idea of a "growth engine" and highlights how the close connections between local government officials and local business leaders help to create land policies that are in favor of local economic growth. Logan and Molotch (1987) argue that urban growth machines, which combine real estate, banking, and commercial interests to support the expansion of cities, are a typical feature of many U.S. cities. However, these arguments do not provide a formal theory or empirical analysis of the role of developers in the formation of land development policies. Sole-Olle and Viladecans-Marsal (2012) find some indirect empirical evidence pointing to the influence of developers on local land development regulations in Spain. 3

4 expected to boost local economic growth. Developing more land at the city edge (i.e., outwardly expanding the city) can create more land sale revenues for the city treasury because the development costs near the city edge are much lower than those near the city center. However, land expansion is subject to the quota restrictions imposed by the upper-level government. As a result, the city leader has to exert greater effort to bargain with the upper-level government in order to obtain more quotas for rural-to-urban land conversion if she wants to outwardly expand the city (Xie, 2015). Such efforts may be rather costly to the city leader. Only those city leaders with high career-concern intensity are willing to exert more effort to seek more quotas from the upper-level government in exchange for the benefits of increasing land sale revenues and boosting local GDP. Therefore, we would expect that city leaders with stronger career concerns will be more likely to expand the city outward. This is the first prediction of our model. The city leader also sets the density constraints of land use (i.e., regulatory FAR schedule) in the city. In doing so, she takes into account of the value of land considering various benefits and costs including the possible externality of high density development. Our theory shows that, if we hold housing demand factors such as income and population constant, the FAR schedule is lower as the city's boundary expands outward. This reflects a trade-off between the city's outward and upward expansion. Combining the first prediction of the model that city leaders with higher career-concern intensity tend to expand the city more outwardly, we derive the second prediction of the model: city leaders with higher career-concern intensity tend to set lower regulatory FARs. Our empirical analysis utilizes the database on residential land transactions provided by the China Index Academy. The sample for our analysis covers over 30,000 completed residential land transactions (including residential mixed with commercial land) in 202 Chinese cities during and contains detailed information on prices, sale date, total area, FAR upper limits and location on each transacted parcel of residential land. The outward dimension of urban land development is usually measured in the current literature by the change in total urban land area (e.g., Brueckner and Fansler, 1983; McGrath, 2005; Deng, Huang, Rozelle, Uchida, 2008; Lichtenberg and Ding, 2009). A serious limitation of the above measure lies in its inability to distinguish between urban land developments that fill in open space between existing developments within the city boundary and those at the city edge that push the urban boundary further 4

5 away from the city core. The latter case is precisely the outward expansion of the urban boundary that we examine in this paper. Taking advantage of our micro-level land data, which contains information on the geographic coordinates for each land parcel, we calculate the distance from each land parcel to the city center and develop a measure of outward development based on the top percentiles in the distribution of the distances to the city center of all the land parcels. We match the land transaction data with the personal data on city leaders taking office in about two hundred cities matched with our land sample during the same time period. Based on each leader's initial age and political hierarchy level at the start of her or his office term, we estimate the leader s ex ante likelihood of getting promoted, independent of her or his ex post economic performance during the term, and define it as the leader's career-concern intensity. We then empirically examine the relationship between a city leader's careerconcern intensity and the spatial pattern of urban land development. We find that a onestandard-deviation increase in the leader's career-concern intensity leads to an 11 km extra outward urban expansion, a 41% increase relative to the sample average. According to our theory, the key mechanism that drives this positive relationship is a land-fiscal mechanism. Specifically, by selling more land at the city edge, the city government can gather more land sale revenues, which help finance the construction of urban infrastructure. This in turn stimulates economic growth. We find evidence that indicates that an extra 12 km of average outward expansion of urban land generates extra land sale revenues of 10 billion RMB, and increases total local GDP by 45 billion RMB, amounting to 84% and 20% of their sample averages respectively. In addition, we find that that a one-standard-deviation increase in the leader's career-concern intensity lowers the FAR level by 0.04, which explains 12% of the variations in FAR across city leaders. The above analyses focus on residential land because its sales accounted for nearly three quarters of total land revenues for local governments and land sale revenues are at the heart of our political economy story about urban land development. As a supplementary analysis, we also examine the patterns of both industrial and commercial land development. We find that industrial land exhibits an outward expansion pattern similar to that of residential land; that is, during the terms of higher-incentive city leaders, more industrial land is developed at the city edge. This evidence implies that the outward expansion of residential land complements that of industrial land in 5

6 promoting the city s GDP growth, which strengthens the logic of our political economy story. By contrast, commercial land development has no such pattern in relation to the local leaders career-concern intensity. Our paper contributes to the literature by explicitly studying how city leaders as city developers play an important role in shaping the pattern of urban land development. China s unique institutional background provides an interesting context for us to explore this issue. Chinese city governments are responsible for stimulating local economic growth, providing public goods, and promoting urbanization. Because the promotion of city leaders is closely related to their cities economic performance, city leaders with strong career concerns will naturally adopt land development policies that are favorable to local economic growth. Unlike U.S. homeowners, China s homeowners have relatively weak ability to affect land use regulations. Our paper adds to the existing literature 2 by offering an important complementary channel through which land development regulations are determined. Moreover, our dataset demonstrates rich variations across cities and over time, enabling us to identify this channel. Our paper also relates to the literature concerning the role of local public finance in land policies. One frequently discussed motive for land use regulations in the literature is fiscal externality on the provision of local public goods (e.g., Epple, Romer and Filimon, 1988; Calabrese, Epple and Romano, 2007). More recently, Henderson and Venable (2009) demonstrate that revenues from land development play an important role in the dynamic formation of cities. Using a panel dataset from coastal provinces in China, Lichtenberg and Ding (2009) find evidence for the role of fiscal incentives in expanding the area of urban land. Han and Kung (2015) show that fiscal pressures induced by a tax-sharing reform tend to push the urban land area to grow more in China. Our paper enriches this literature by introducing the role of local leaders career incentives in driving land sales and shaping land development patterns, and also by explicitly demonstrating the trade-off between upward and outward expansion of urban space. There is a small yet growing body of literature on land development and regulations in urban China (Deng et al.,2008; Lichtenberg and Ding, 2009; Brueckner et al., 2016; Cai, Wang,and Zhang, 2016). However, none of these studies addresses how city leaders make decisions regarding urban land development policies. 2 See Gyourko and Molloy (2015) for a comprehensive review. 6

7 The rest of the paper is organized as follows. Section 2 is a brief description of the institutional background of land development as well as of local leaders' career incentives in China. In Section 3, we present a simple theory that demonstrates the decision-making process of city leaders with regard to urban land development. Section 4 discusses the data and the main variables. We present our primary empirical results regarding the outward expansion of residential land in Section 5. In Section 6, we show the empirical results regarding land use intensity. Section 7 briefly discusses the development patterns of industrial and commercial land. Section 8 concludes. 2. Institutional Background 2.1 Urban Land Development Regulations in China Land quota and urban growth control In the 1980s and early 1990s, there was an unprecedented loss of arable land in China due to large-scale industrialization and urbanization. The sizable decline in arable land strengthened concerns about China s food security. 3 In the meantime, the conflicts between local governments and farmers due to insufficient compensation for rural-tourban land conversion have intensified sharply. In order to keep urban land expansion under control, the central government amended the Land Administrative Law in 1998 and enacted a new set of arable land protection provisions aimed at prohibiting any additional loss of cultivated land. In the same year, a new ministry, the Ministry of Land and Resources of the People s Republic of China, was established to strengthen the central government s control over land development. Since 1998, an urban land quota system has been implemented via a hierarchical, top-down planning process. The central government makes the nation s long-term land development plan. The first plan covered the period from 1997 through The plan dictates the maximum amount of newly developed urban land for each province in the long term as well as the minimum amount of arable rural land in reserve. Given these two important constraints, provincial governments make their own long-term plans for land development and allocate land use quotas to cities under their administrative control. In addition, provincial governments also make short-term (five-year or annual) land development plans that provide more detailed guidelines. 3 At the beginning of the economic reforms, in 1978, the cultivated rural land per capita in China was only 1.55 mu, far lower than that in the U.S. 7

8 The provincial government will further allocate the land quotas to each city in its jusriducation, following some general guidelines set by the central government. For example, a city s land quota should be propostional to the city s GDP and predicted future population gowth. However, a city s land quota can be subject to some degree of bargaining and negotiation with the provincial government, but the bargaining process is often costly, and sometime even involves the central government. 4 The city governments make decisions regarding the size and location of land to be developed in a city. When land development involves conversion of rural land to urban land, the conversion must be approved by the upper-level government. If the conversion is within the quota constraints imposed by the upper-level government, then it is relatively easy to obtain approval for the application. Otherwise, the city government has to make extra efforts to lobby the upper-level government (sometimes even the central government) for extension of the land quota. 5 When land conversion is involved, the city government has to compensate the farmers who currently use the land. By China s Land Administration Law, the total compensation fees should not exceed 30 times the average annual value of product generated from the land within the three years before the conversion. 6 This is typically far below the market value of the land at the city edge, which can be 500 times higher than the compensation fees (Zhu, 2004; Zhang, 2007; Liu, Chen and Zhao, 2012). This is partly because there is large heterogeneity in the productivity of agricultural land. At the city edge, farmers often plant specific agricultural products (organic vegetables, fruits etc.) and run sight-seeing farms (e.g., fresh fruits pickups) that cater to the need of residents in the cities nearby and obtain much higher returns than the average return of agricultural land based on which the compensation fee is calculated. The under compensation to farmers also reflects that in China, farmers usaually have weak political power versus city governments. Naturally, insufficient compensation led to discontent among farmers and protests. However, in most cases, the farmers are politically weak and have to obey the rules set by the local governments. This is why 4 A system of transferrable development rights may help achieve a more efficient allocation of land. However, such a system is still in its early experimental stage in a couple of provinces (e.g., Zhejiang province) in very recent years. 5 China s Land Administration Law (1998) requires that any conversion of farm land to non-agricultural use be approved by higher level authorities and be offset by conversion or reclamation of other land to agricultural use so that the amount of land used for agriculture, adjusted for quality, remains constant (Ding, 2003; Lichtenberg and Ding, 2008). 6 The law stipulates that the compensation fee can be increased to more than 30 times the upper bound under some special circumstances. However, local governments are generally unwilling to do so. 8

9 developing rural land at the city edge is lucrative to city governments: they can auction off the land at a much higher price after conversion. By contrast, brownfield development near city centers usually involves high compensation fees (close to market value) paid to urban residents, which makes the net revenues from such development relatively low. City governments can bypass the quota constraints on land conversion in various ways (Xie, 2015). They typically figure out legitimate reasons to persuade the higher governments to grant extra land use quotas after their short-term quotas are used up. These reasons may include creating a college town at the city edge, building a cultural and historic town (which typically requires relatively low FAR) or developing a hightech industrial park. As a result of these exceptions, the long-term land quota of land conversion is often exhausted years before the end of the plan. For example, by 2004, Shandong and Zhejiang provinces had used up 80% and 99% (respectively) of the total land quota of the long-term plan of The zeal of local governments for urban land development placed tremendous pressure on the central government when making the next long-term development plan. Meanwhile, the city governments actively engage in lobbying and bargaining with the upper-level governments for favorable treatment in the next long-term plan, which may effectively legalize their current urban expansion beyond the quota constraints set by the old plan. In addition, sometimes the city governments even tolerate some small-scale land development at the city edge without any approval from the upper governments. In general, going beyond the quota constraint is possible, but at considerable cost. Costs include lengthy bargaining, proposing creative rationales for extra quotas, and networking with upper-level government officials. After rural land is converted to urban land, it is at the disposal of the city government. By law, all urban land is owned by the state. Since 1988, the use rights of vacant urban land parcels have been allocated through leaseholds by city land bureaus. In the 1990s, most use rights allocations were done by negotiation between developers and government officials. To control the widespread corruption in such negotiated land deals, the Ministry of National Land and Resources banned negotiated sales on August 31, Since then, all urban leasehold sales for private development have been conducted through public auctions. Land auctions are held by local land bureaus, with details of all transactions posted online and publicly available. All land sale revenues are turned in to the city treasury. 9

10 Land use intensity restrictions Now let us turn to regulations on the intensity of land use. The authority that is in charge of land use planning and general guideline setting is the city land reserve and allocation committee, whose members include the city s key leaders and bureau directors from relevant government agencies. Apparently the city leaders have decisive voices in urban planning and land development strategies. After setting up the urban development strategies and guidelines, the committee typically delegates to the city s urban planning bureau the routine decisions, such as use type and details of development restrictions (e.g., regulatory FAR limit, building height, green area rate, etc.) for each parcel of land to be auctioned. When designing land use restrictions, urban planning bureaus aim to maximize the value of land by weighing various benefits and costs including the possible congestion costs caused by high-density development. The FAR regulation is one of the most important land use regulations in urban China. By law, any land parcel must have a designated regulatory FAR level before it can be auctioned off. Also, after the land is developed, the city s planning bureau is required to complete an official inspection of the residential project before it is put up for sale, in order to ensure compliance with the FAR regulation. In most cases, the FAR regulation takes the form of an upper-bound constraint on the ratio of a building s total floor area to the lot size on which the building is to be constructed. As Cai, Wang, and Zhang (2016) show, even though the FAR constraints can be adjusted under certain circumstances, they are largely binding in urban China. Therefore, FAR regulations play an important role in shaping the urban spatial patterns of Chinese cities. We use the regulatory FAR upper limits to measure the land use intensity, which, intuitively, can be thought of as the upward dimension of urban land development. 2.2 Local Leaders Career Concerns and Land-Finance Policies Prefecture cities are under the supervision and control of provinces. In China's centralized personnel system, it is the upper-level committee of the Communist Party that determines the promotion of local leaders. The top leaders at the prefecture level include the party secretary and the city mayor. The party secretary is more powerful than city mayor due to the ruling position of the Chinese Communist Party. The regional economic performance is one of the key performance indicators used by the superior to evaluate local leaders (Li and Zhou, 2005; Xu, 2011; Yao and Zhang, 2015). Since the 10

11 establishment of mandatory retirement age in the early 1980s, age has become critical to career advancement. When a local leader approaches the retirement age, he or she is less likely to be promoted. This retirement system has been enforced rather strictly in the past decades. The retirement age varies with the hierarchical level of local officials. The retirement age of a prefecture-level official is 60 while that of a province-level official is This means that both age and hierarchical levels are important determinants of promotion, other things being equal. Given a local official s current age and hierarchical level, her distance from the glass ceiling of retirement can easily be estimated. Local leaders who are far away from the glass ceiling should have high career-concern intensity. If a local leader is nearing the retirement age, she will have little incentive to work hard to improve local economic performance. Since the late 1970s, China has gone through several waves of fiscal reforms in an effort to decentralize its fiscal system and fiscal management (Zhang and Zou, 1998). Fiscal decentralization led to the perpetually declining share of central fiscal income, which led the central government to act to turn this tide. In 1994, the tax-sharing reform was implemented and consequently 75 percent of value-added tax, the largest source of tax revenue, goes to the central government. Corporate income tax, which was originally designated as a local tax in 1994, was reclassified as a shared tax between the central and local governments after As a result of repeated rearrangements of tax revenues in favor of the central government, local governments felt increasing fiscal pressures. Against this backdrop, land sale revenues rose to prominence and became the major source of extra-budgetary income for local governments. In the past two decades, city governments have increasingly relied on land-leasing revenues to finance urban public goods provision such as infrastructure investment (World Bank, 2012), which in turn can help boost local GDP growth. Some studies show that the ratio of land sale revenues to local fiscal revenues of prefecture city governments increased from 10% in 1999 to nearly 60% in 2005 (Han and Kung, 2015). It is worth mentioning that about three quarters of land sale revenues come from the sale of residential land. City governments tend to deliberately lower the sale prices of industrial land in order to attract the entry of new firms, which again may enhance GDP growth. 7 The political hierarchy levels at which a city leader may stand include prefecture level, deputy-province level, province level or above. 11

12 3. A Simple Model In this section, we present a theoretical framework to demonstrate how city leaders make decisions regarding urban land development. We derive testable predictions from this framework. Our model assumes a mono-centric city with linear form. 8 All workers commute to the Central Business District (CBD) to work. We assume free migration across cities. 9 A. Individual An individual worker s utility comes from housing services as well as from consumption of a composite good of all other commodities. An individual worker s objective function is as follows: max uxr ( ( ), hr ( )) xr ( ) hr ( ) x( r), h( r) st.. w x( r) h( r) p( r) 2tr, (1) where r indicates the location where the worker lives, hr () is housing consumption, x() r is consumption of the composite good, w is wage income, t is commuting cost per unit distance, and p() r is unit floor area house price at location r. Solving the individual s utility maximization and considering the location equilibrium condition, we have (1 ) ( w 2 tr) pr () V where V is the individual worker s indirect utility and, (2) (1 )( w 2 tr) hr ( ). (3) pr ( ) B. Firm Assume the city's production is conducted by a representative firm. The firm's production function is Y AGL, (4) where A is technology, G is public infrastructure provided by the city government, 8 See Duranton and Puga (2015) for a comprehensive review on urban land use in a mono-centric city framework. 9 Adding migration friction to the model does not change the main predictions of our theory. 12

13 and L is labor. 10 Here, public infrastructure not only includes transport infrastructure, 11 but also includes the construction and operation of industrial or technology parks as well as the extension of electricity, gas and other utility services to those parks that help facilitate the clustering of firms and industries. In general, G improves the total factor productivity. We assume that the firm sells products in the national market and there is free trade among cities. The product price is normalized to be 1. Prefect competition among firms gives zero profit, which implies that w AG. (5) Eq. (5) pins down the wage rate. Suppose each worker provides 1 unit of labor. When the labor market clears, L=N, where N is the city s population size. C. Build upward: floor-to-area ratio Informed by the institutional background in urban China as discussed in Section 2, we assume that the city government delegates an agent to set the floor-to-area ratio F ( r ) for land development at each location r. In making the decision, the agent aims to maximize the value per unit of land; that is, F() r argmax p() r F q( F) F. (6) F The construction cost per unit floor area is qf ( ). The construction cost qf ( ) increases monotonically with F. For example, foundation costs may increase with building height. These costs may also include expenditures incurred in correcting negative externalities such as noise and traffic jams that arise from high-density development. Note that the assignment of FAR by the agent is similar to what a private developer would do (DiPasquale and Wheaton, 1996), except that the agent considers the possible externality costs. Let the construction cost per unit floor area be qf ( ) F, 0. Then from (6), the optimal FAR level is 10 For simplicity, we do not include capital in the production function because it is not the focus of this paper. One can easily incorporate capital into the model by assuming an infinite elastic supply of capital to the city from the national capital market. This would complicate the model solution without providing further insights. 11 In a developing economy like China, transport infrastructure can help improve a city s access to both domestic and international markets, which plays an important role in driving regional economic growth (Baum-Snow et al., 2017). 13

14 pr ( ) Fr ( ). (7) 2 D. Build outward: the benchmark case where the market determines the urban boundary Let us first look at the benchmark case where it is not the city government, but the market force that drives urban outward expansion. In this case, the city government does not assume the developer role. Private developers choose which land to develop. They obtain land from current users through competitive bidding. Land at any location r is developed only when it can generate non-negative profits. Competition among developers bids up the land price at each location such that in equilibrium, the marginal revenue from developing land at each location equals the unit land price, denoted as pl (). The urban boundary S is thus determined by the following condition: psfs ( ) ( ) qfs ( ( )) FS ( ) p( S) p. (8) The left-hand side of the above equation is the marginal revenue of urban land development at the city edge. The right-hand side is the price of land at the city edge, which is equal to p ; that is, the agricultural rent at the city edge. In equilibrium, this equality must hold. The city government collects land sales tax at a rate t. The tax revenues are all used to finance urban public infrastructure G. Thus the government s budget constraint is S S S 0 l 0 0 G t p() rdr t prfrdr () () qfr ( ()) Frdr (). (9) Also note that in equilibrium, free migration across cities implies that V v, (10) and the housing market clearance implies that S F( r) dr N. (11) 0 hr ( ) Combining the above three equations (9)-(11) with equations (2), (3), (5) and (7), we can solve for the equilibrium for this benchmark case. Let us denote the equilibrium urban boundary in this benchmark case as S 0. l E. Build outward: the planning case where the city government assumes the role of 14

15 developer Now let us turn to the case where the city government behaves as a developer and sets the urban boundary. In making a decision regarding urban boundary, a city leader considers her own pay-offs which derive from the success of her political career. If promoted, the city leader s payoff is K 0 ; otherwise, her payoff is zero. All the revenues from land development are collected by the city government and are all used to finance urban public infrastructure, G, which will improve the city s total factor productivity and boost GDP growth. Because greater fiscal revenues can help her political career, the city leader has incentive to grab more revenues from land development. The net revenues from land development are equal to the total house value minus the land compensation cost and construction cost. 12 Compensation costs are unavoidable in land development. Such costs typically include the costs of demolishing existing structures and compensating current residents. In our model, we use a continuous function, cr ( ) government s budget constraint is, to measure the compensation costs. As such, the S S S G prfrdr () () qfr ( ()) Frdr () crdr () 0 0. (12) 0 Developing land near the CBD usually involves much higher compensation costs (close to the land market value) than developing land far away from the CBD (Zhu, 2004; Zhang, 2007; Liu, Chen and Zhao, 2012). Thus, we assume that cr ( ) decreases with r. In particular, at the city edge, to convert farm land to urban land, the city government is only required to pay the farmers a compensation cost that is far below the market value of the land (for reasons please see discussions in Section 2.1). Thus if the city edge is still at the previous market equilibrium S 0, the LHS of equation (8), which is the marginal revenue from land development, would exceed the compensation costs. 13 Intuitively, this will induce city governments that crave additional revenue to 12 In urban China, the city government is the monopoly supplier of city land. It holds auctions to sell long-term leaseholds of land to private developers. Through competitive bidding, these land sales can grab the developers profits from land development. 13 For illustrative purposes, suppose that the tax rate in the benchmark case and the compensation cost schedule in the planning case are such that the total government fiscal revenue of the planning case is the same as that of the benchmark market equilibrium if the city edge is set at. Because the fiscal revenues are all used to finance public infrastructure, this means the productivity and wage income (see equation (5)) is the same in the two cases as well, which in turn leads to the same house prices and FAR levels (see equations (2) and (7)). Simple calculations then show that the LHS of equation (8) is the same for the two cases. According to the definition of the benchmark market equilibrium, the LHS of equation (8) 15

16 expand their city boundaries beyond S 0. Specifically, the decision process is as follows. Let us use the city s total output Y to capture economic performance in the model. We use a parameter to capture a city leader s career-concern intensity, which depends on her personal characteristics such as age and hierarchical level when taking office. The higher is, the further away the local leader is from the career glass ceiling, so the leader is more intensely concerned with her career. As such, we define the city leader s promotion likelihood function as f ( Y ), with f '( ) 0. So the leader s promotion likelihood is an increasing function of the product of her career-concern intensity and her ex post economic performance. 14 When the career-concern intensity is higher, improving performance can increase the leader s chance of promotion more effectively. The city leader faces a trade-off. On the one hand, expanding the city outward can bring in more fiscal revenues so as to finance public infrastructure and accommodate more people in the city, which in turn boosts GDP growth. On the other hand, pushing the urban boundary outward usually requires the city leader to seek more urban land quotas from the upper-level government, which is costly. As discussed in section 2.1, when the central government realized that the city governments costs of obtaining land at the city edge were much lower than the market value of land, it started making longterm plans for urban land development that set quotas of rural-to-urban land conversion for each province. In these plans, the provincial governments allocate these quotas across cities and over time. Such quota constraints are represented by constraints on the city s boundary S in our model. Suppose that the provincial government sets the city boundary constraint at the 15 benchmark market equilibrium boundary S 0. This reflects the fact that when equals the land market value at the city edge, therefore, we can conclude that the LHS of equation (8) is higher than the compensation cost in the planning case. 14 In China s political system, the likelihood of promotion of a politician hinges on both the politician s personal conditions prior to her taking office and her ex-post performance during the term. The two factors are complementary to each other. People may be concerned that a leader s effort may decrease with her ex-ante promotion chance when her ex-ante chance gets sufficiently high as documented in the literature on western political regimes (e.g., Besley, Persson and Sturm, 2010; Sole-Olle and Viladecans- Marsal, 2012). To explore this nonlinear effect of λ on the choice of the spatial pattern of urban land development by the city leader, we run regressions that include both λ and its quadratic term. We also draw non-parametric graphs of the relationships between the spatial patterns of urban land development and our measure of λ. We find no evidence of such nonlinear effect due to the prior chance of promotion. 15 In our simulation, we suppose that the city boundary constraint is set by the upper-level government at the benchmark level of the market equilibrium. Our model s main predictions are robust to other choices of. 16

17 provincial governmens allocate land quotas to cities, they consider the fundamentals of the urban economy, which is consistent with the insititutional background discussed in section 2.1. If a city leader wants to expand the spatial boundary of her city beyond S 0, she needs to lobby the upper-level governments. In this sense, such boundary constraints are not strictly binding but are subject to costly bargaining. As described in Section 2.1, Chinese city leaders use various ways in practice to seek additional quota and push the urban boundary outward. The lobbying efforts for more urban land quota are reflected in the effort cost function, denoted as E( SS ; 0). We assume that these lobbying costs increase with S when the city expansion goes beyond the boundary constraint S 0. Specifically, we define the effort costs of the city leader as 0, if S S0 ESS ( ; 0 ), (13) e ( S S0), if S S0 where 0, 0, and e 0. The city leader's objective function is described as follows: max f( AGN) K E( S; S ) S st.. 0 () i G prfrdr () () qfr ( ()) Frdr () crdr () ( ii) V v ( iii) S Fr () dr N 0 hr () S S S (14) In (14), (i) is the city government s budget constraint, (ii) is the intercity spatial equilibrium condition under free migration, and (iii) means that the total housing supply should accommodate the total housing demand. F. Solution and simulation Plugging equations (2), (3), (5), and (7) into (14), we can derive the first-order conditions for S. With the first-order conditions, we can solve for four unknown variables, i.e., S, G, N and Y. These fully characterize the equilibrium. Since an analytical solution is impossible to obtain, we use reasonable parameters to conduct simulations. From the simulations, we can do comparative statics and demonstrate how urban land development patterns are determined by relevant factors. Figure 3 shows that stronger career concerns drive a city leader to expand the city 17

18 boundary more outwardly. Figure 4 helps us further understand the mechanism underlying such outward expansion. It shows a positive relationship between the city's spatial boundary and several economic outcomes in our model. The more a city expands outwardly, the greater its fiscal revenues, population and total output. These factors will enhance the city leader s chances of getting promoted. In addition, outward urban expansion has an implication on upward building intensity; i.e., the floor-to-area ratio. As a city s urban boundary expands outward, if we keep the wage and population of the city unchanged, individuals can have greater housing consumption. This implies that the individual s utility level increases. According to eq. (2), the housing price at each location declines. As a result, the FAR level at each location decreases too, according to eq. (7). This reflects a trade-off between outward and upward urban expansion. In sum, we have the following testable predictions. First, city leaders with high career incentives are more likely to expand the city outward. The underlying mechanism that drives this is that by doing so the city leader can generate more land sale revenues for financing public infrastructure, which in turn enhances her city s economic performance. Second, the land use intensity is lower for city leaders with higher career incentives due to the existence of a trade-off between a city s upward and outward expansion, after the housing demand factors such as wage and population are controlled for Data and Variable Construction 4.1 Measures for the Spatial Pattern of Urban Land Development To characterize the spatial pattern of urban land development, we exploit the database on all residential land transactions through public auction 17 provided by the 16 The model can be extended to allow for the possibility that a city leader may choose to deliberately lower the FAR below the market equilbirum level as defined in eq. (7). By doing so, on the one hand, the city would need to expand the boundary more in order to accommodate the population growth, which at the same time may bring in more land sales revenues. However, on the other hand, lowering FAR would result in lower land price per unit. Thus the overall effect on total land sale reveues is ambiguous in the equilbrium. Considering this extension of the model will not provide further insights but make the model more complicated. Therefore, we simply empirically test the relationship between FAR and city leaders career concern intensities due to the trade-off between outward and upward urban expansion after controlling for the demand factors. 17 The Chinese government passed a law in 2002 requiring all the land intended for business purposes 18

19 China Index Academy, China s largest independent think tank focusing on the real estate market. The sample for our analysis contains information on over 30,000 completed residential land transactions in 202 Chinese cities during the period Among the total of 202 cities in the sample, 198 are prefecture-level cities, and 4 are provincial-level cities (i.e., Beijing, Shanghai, Tianjin, and Chongqing). For each land parcel, we know the use type, land area, regulatory FAR, reserve price, selling price, transaction date, auction type, etc. As for outward urban development, we are essentially interested in measuring the extent to which a city s edge of urban land development is pushed further away from the city center. Taking advantage of the micro-level land data, we are able to do so with detailed geographic locations of the city s residential land developments. Specifically, we obtain the geographic coordinates for each land parcel from Using the coordinates, we calculate for each land parcel the distance to the city center. 19 Panel A of Table 1 shows the summary statistics of land distance to the city center by land transaction time and by region (i.e., coastal, central, northeast, southwest, or northwest). More than half of the residential land transactions happened in the coastal regions. Around the country, the average and 90th percentile in the distribution of the land distance to the city center were 15.5 and 35.7 km (respectively) during and they increased to 25.3 and 63.2 km (respectively) in the period from , which indicates a marked outward expansion of city boundaries over time. Across regions, one can see that coastal cities in general have more outward urban development than the nation s average. To investigate the relationship between outward development and local leaders career incentives, we measure the extent of outward development during the term of (including residential, commercial and industrial land) to be sold through public auction. This law was strictly enforced beginning in August We understand that there still exist some land transactions through negotiated sales instead of public auction. However, we note that most negotiated sales involve industrial land. Even for residential land sold through negotiations, the sale price is far below the market value (less than 100 RMB per sq. meter). This suggests that such negotiated sales are not for the purpose of creating fiscal revenues for the local government which is at the heart of this paper s story. Thus our land transaction data from public auctions is representative and suitable for the research purposes of this paper. 18 The original sample includes 36,058 residential land parcels with completed sales. 5,229 land parcels are dropped because their regulatory information (i.e., FAR) is missing. An additional 11 land parcels are dropped because the information on their geographic location is not available. Finally, 801 land parcels are dropped because they lack information on city leaders. The final study sample contains 30,017 residential land parcels. 19 We use the coordinates of the 1992 light center (i.e., the brightest cell at night in each city s central area) from Baum-Snow et al. (2016) to identify the actual city center. They suggest that despite the enormous increase of light over the past two decades, the light centers have remained unchanged. 19