Jiaolong: Sichuan's Privately-run City

Some local governments in China are letting private corporations develop new cities and provide public services

The rapid urbanization of China since the beginning of the reform and opening-up era is rightly seen as one of the megatrends of the 20th and 21st centuries. The main urbanization pattern of local government-driven urbanization is increasingly well known, albeit in part due to the arising financial, incentive and displacement issues when the local government confiscates rural land from farmers and develops the land for urban and industrial use. 

Lesser known are cases involve an increasingly common scheme of private sector-driven urbanization in China. In this case, private sector actors take charge of the coordination and development process of urbanization.

Companies such as China Fortune Land Development (CFLD) are developing industrial towns as private-public partnerships (PPP) with local governments. CFLD has developed around 100 industrial towns mostly in China with a few in South East Asia.

CFLD recently came into the public spotlight due to its critical financial situation which mirrors one of many of the large conventional real estate developments in China. CFLD and its PPP model have also become the object of academic research (see e.g., ‘Towards Urban economic vibrancy – patterns and practices in Asia’s new cities’ by Siqi Zheng and Zhengzhen Tan and ‘Rising private city operators in contemporary China: A study of the CFLD model’ by Yongli Jiao and Yang Yu). 

Besides the PPP model, there is also a fully privatized model in which the local government signs a concession agreement with a private firm responsible for developing and operating the city including the provision of public services and receipt of taxes.

This fully privatized model is still little studied and known outside of China, but the Journal for Special Jurisdictions is about to publish a special volume on the topic of these Chinese private cities later this year.

One of the main success cases of this model is Jiaolong. 

Qian Lu is an Associate Professor at the School of Economics, Central University of Finance and Economics in Beijing, China. In his 2016 paper on “the contractual nature of the city” he looks into Jiaolong, located just outside of Chengdu, which was built and operated by a business corporation.

In his pioneering research into this topic, he details the legal and institutional arrangements of this alternative form of private sector-led urbanization. Qian kindly took the time to talk to ChinaTalk about his research.

By Sebastian Reil, a logistics and foreign direct investment specialist currently working in business development for a leading European freight railway.

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The contractual nature of the city

Sebastian Reil: Your paper on “the contractual nature of the city” shows how private companies working as city developers and coordinators can facilitate urbanization by reducing transaction costs using the case study of Jiaolong in Sichuan. Can you introduce the story of Jiaolong to our readers?

Qian Lu: Jiaolong is an industrial park located in Shuangliu County of Chengdu, the capital city of Sichuan Province in western China. Today there are around 100,000 people living in Jiaolong. It occupies an area of just 4.3 square km and has a population density of 25,000 per square km, making it much denser than most urban areas in China. Jiaolong’s annual value of production surpasses 50 billion yuan ($7 billion US) and it contributes an annual of 0.7 billion yuan ($100 million) in taxes.

But about 20 years ago, in Jiaolong there was mostly farmland for growing crops, with only a few farmers living in small villages. There were no factories, apartments or shopping malls. How did Jiaolong develop so fast in such a short time?

Lu: The key is the arrival of a private business developer, Jiaolong Co, which rented land from farmers, invested in infrastructure such as roads and a sewage treatment plant, provided public services such as primary and middle schools, and built standard manufacturing factories, residential apartments and shopping malls to rent them out.

These manufacturing firms attract industrial workers from all over Sichuan. The increase in population contributed to the development of the service sector and, ultimately, the industrial park became a city. 

Reil: How does the standard urbanization process work in China and how does the Jiaolong model differ from that?

Lu: In most cases, the local city government is in charge of investing in building a new city. To develop a city, the government makes land and city plans, takes farmers’ land, invests in city infrastructure, sells land to housing developers and manufacturers, and provides public services such as police stations, hospitals, schools and universities. By holding the monopoly power of coercion, the government can pool together resources by fiat and hold transaction costs low. 

Jiaolong's model differs from the above standard urbanization process in that it did not rely on coercion, but instead on market coordination through signing various contracts with the government, farmers, developers, manufacturers and citizens.

Jiaolong is the central contractor for this series of contracts, which enables it to simplify the contractual web and reduce coordination costs in the urbanization process.

The most critical contracts are the ones signed with the local government to specify tax sharing and city planning authority. Tax-sharing with the government motivates Jiaolong to invest in infrastructure and provide public services. It also motivates the Shuangliu government to protect the property rights of manufacturers and citizens residing in the industrial park.

The contracts which transfer planning rights and land-use rights enable the entrepreneur of Jiaolong to carry out his vision. These contracts endogenized the externality of infrastructure building and urban development that typically existed in the developing world. Jiaolong offers a case of a contract-based rather than coercion-based approach to urbanization. 

Reil: You take a Coasean view on the nature of the city which emphasizes the role of transaction costs. In that view what constitutes a city and what is the role of central coordination?

Lu: Coase emphasized the role of transaction costs in forming various institutional arrangements, including organizations, markets, and laws. I extended his idea to understand cities. From a micro perspective, a city is organized by a series of contracts, either through the market or within organizations.

For example, we sign labor contracts with business firms, which means we have to travel to firms to do our job at a specific time and place. People also sign other contracts with people and organizations, such as schools, doctors, hospitals, police and the government. Our daily life in cities is organized through a web of contracts. 

We see different types of cities existing in the developed and developing world. The most important differences among cities in different societies are contractual structures and degrees of government involvement in defining property rights.

The real question is under what conditions one type of contractual arrangement emerges. Following Coase, I propose that the minimization of transaction costs leads to the emergence of different structures of contracts in cities. 

On the margin, if the cost of organizing an additional transaction (or the exchange or redefinition of property rights) is smaller by contracting with the government than contracting with private corporations, the government will organize more transactions. Otherwise, private corporations will organize more transactions.

What factors determine these transaction costs? Special locations, culture, histories, entrepreneurs, and public opinions can certainly influence the contractual choice. But to discover regularity, we need to understand the legal and political institutions underlying the basic resource allocations. 

Under certain institutional constraints, contract structures with a central contractor could minimize transaction costs. A central contractor could oversee city planning, acquire farmers’ land, invest in infrastructure, sell land-use rights, and provide public services such as schools, hospitals and police security. In return, a central contractor receives income from selling land and acquiring tax.

This contractual arrangement would give the central contractor incentives to invest in public infrastructure and receive the benefits from its investment. Therefore, it could reduce the problem of the lack of infrastructure investment that commonly exists in the developing world. 

Tax sharing between the government and the private sector

Reil: Which aspects does the contract between the Shuangliu County government and Jiaolong Co cover and how did it achieve interest alignment between the parties? What role does the tax sharing agreement play? Which public functions is Jiaolong Co handling and which ones remain with the county government? 

Lu: In 2003, Jiaolong Co signed an investment contract with Shuangliu Government. The contract gave Jiaolong planning rights and shares of tax revenues. The contract consists of the following contents: 

(1) Investment intensity 

Jiaolong Co must invest 1 billion yuan over three time periods in the development zone. The planning area must accommodate more than 400 firms, provide an annual tax revenue of more than 0.3 billion yuan, and achieve a GDP of 6 billion yuan. Firms in Jiaolong must register their businesses and pay taxes in Shuangliu. 

(2) Infrastructure building 

Jiaolong Co must build a sewage treatment plant, a 6,000-ton water plant, and a 10,000 kvA switch plant. Jiaolong must design and build pipe networks with a 30-meter broad road (including road greens on both sides of the street).

Jiaolong must build a 10 kv power station, providing all the power supply systems and underground cable networks. Due to the high investment risk and low returns of the infrastructure investment, Jiaolong must (with qualifications) design and build all plants, office buildings and apartments in line with proper standards. 

(3) Authorization of planning rights 

The Master Plan of Jiaolong must conform to the Master Plan of Shuangliu County. Jiaolong should make plans and put everything on record with relevant government agencies. 

(4) Tax sharing 

The Shuangliu government should reward Jiaolong with 25 % of the tax revenues received by the government (after taking off the reimbursement for firms) if the promised tax rate of 100 yuan per square meter is realized in Jiaolong and reward Jiaolong with 20 % of the tax revenues if the realized tax rate is 80 yuan per square meter".

(5) Government obligation 

The Shuangliu Government should organize a committee consisting of leading government officials in various departments responsible for providing Jiaolong with quality services and relevant preferential policy. The government should also assist Jiaolong Co in its dealing with nearby villages and public administrations on issues such as taxation, public security, environment protection, and industrial and commercial services. 

The contract signed by the government and Jiaolong clearly defines the rights and obligations of Jiaolong and local government, and also aligns the interest between the county government and Jiaolong.

The contract specifies that Jiaolong should achieve the investment and development targets, and build infrastructure. In return, Jiaolong obtains planning rights, tax sharing and coordination services from the government. The acquisition of planning rights and the tax sharing mechanism are crucial in Jiaolong’s development. 

Tax sharing plays a crucial role in aligning the interests of different parties involved. The Shuangliu Government, Jiaolong Co and firms settling in Jiaolong share the tax created by manufacturing firms, which are assisted by infrastructure invested by Jiaolong and public services provided by the government.

Tax sharing contracts enable the government, Jiaolong and the firms to share the benefit of urbanization and motivate each party to maximize the total rent generated from the land. 

The government has incentives to provide public services and property rights protection for Jiaolong and the firms. The government also built an arterial road and residential districts around Jiaolong to facilitate transportation and appreciation of land value.

The government committee coordinates government administrations, provides “one station” registering services and tries to solve issues in power supply, schooling and land acquisition. Tax sharing contracts endogenize the externality of infrastructure investment and motivate Jiaolong to provide an attractive business environment, improve infrastructure, and offer property services.

Now, the government is still the public good provider on a city-wide scale providing subways, and also controlling political power and coercive facilities such as police stations. But within Jiaolong park, most public services are transferred to Jiaolong Co, including basic infrastructure investment and public services such as schooling, organization of business and residential zones and environment protection. 

The problem with industrial parks for small business owners

Reil: Among others, the contract committed Jiaolong Co to attract a minimum of 400 businesses to the area. How was Jiaolong able to attract such a large number of investors in a short period? 

Lu: First, the location is quite good. It is close to one of the airports. But more importantly, Jiaolong does not exclude any small business firms as long as they do not break environmental codes. Most industrial parks in China are run by the government, which requires a certain criterion to exclude certain firms and industries.

First, the government requires state-owned industrial parks to attract firms satisfying certain requirements on fixed investment, tax contribution, job creation or technology advances. Small business firms cannot satisfy these requirements.

Second, the government also encourages state-owned industrial parks to first attract business from a given list of industries that government wants to promote. The overall result is that smaller firms are not able to find a place in a state-owned industrial park.

Given so many small business entrepreneurs in China are either labor-intensive or without high-tech components, and given strict policies restricting manufacturing production outside industrial parks, it is pretty difficult for these small businesses to find a place where they can be accommodated.

Jiaolong does not discriminate against small businesses by their size or industry, and therefore is quite attractive for small businesses. 

Third, Jiaolong provides quite good public infrastructure and business services. For example, Jiaolong provides a water cleaning system to reduce pollution generated by factories, which reduces the costs faced by these small manufacturing firms. 

Reil: You refer to Hayek’s use of knowledge in society to explain the success of private business-led urbanization. Can you explain how an entrepreneur in this case was able to make use of knowledge that was not available to the government? 

Lu: Entrepreneurs in a certain industry generally have more specific local knowledge of an industry than the government. So the problem is how to make these entrepreneurs use of their knowledge and make decisions in city development. 

One crucial way that Jiaolong was able to use its entrepreneurs’ knowledge was to acquire planning rights through contracting with the government. The maximization of land rent in such a small area required Jiaolong to acquire planning rights to efficiently allocate land among different usages.

Industrial upgrading and population concentration also led to the fluctuation of rents and adjustment of land use. The investment contract transferred planning rights from the government to Jiaolong so that its entrepreneur Yujiao Huang could use his knowledge and vision for more efficient planning according to market price signals. 

In 2010, as more and more people moved to Jiaolong, Huang foresaw the increasing demand for entertainment and leisure. He built the first five-star movie theater in Shuangliu County and it now ranks in the top five for the Pacific Chain all over China.

Jiaolong also built the first modern shopping mall in Shuangliu. Even though it is not located in the center of Shuangliu County, it attracts consumers from other cities in Sichuan because the shopping mall also houses an aquarium and a natural ice rink.

With many years of business experience, Huang has a keen vision for urban development. If Jiaolong did not acquire the planning rights from the government, Huang’s vision could not have been fully utilized. 

The development and upgrading of Jiaolong is the result of the combination of Huang’s business vision and market price signals. The foundation of it was the transfer of planning rights from the Shuanglu government through the investment contract signed with the government. 

Jiaolong versus its government-developed neighbor

Reil: Xihanggang Economic Zone is a government-developed land area just a few kilometers away from Jiaolong. How does the development record of these two areas compare to each other?

Lu: Xihanggang Economic Zone is closer to the airport than Jiaolong, but its population density, city development level and economic performance are much weaker.

In 2014 about 400 business firms were residing in the zone, which contributes a value of production of around $10 billion and $2 billion in tax revenue.

It is built on an area of 60 square km, and a workforce of about 80,000 people. In the same year, Jiaolong contributed value of production of $3 billion and $70 million in taxes. And that’s in an area of 4 square km with a 100,000-strong workforce.

Comparing the taxation per square km, we have $14 million for Jiaolong and $3 for Xihanggang. Comparing employment per square km, we have 30,000 for Jiaolong and 1,300 for Xihanggang.

In other words, taxation per unit area for Xihanggang is 23% that of Jiaolong, and the employment per unit area for Xihanggang is about 4.4%.

Reil: CFLD is a Chinese company that operates over 100 new towns. How do the Jiaolong model and the CFLD model differ? 

Lu: Mostly the differences are specific contract arrangements with local government. CFLD signed a PPP contract with the local government, which required the local government to acquire land from farmers and pay CFLD for its first-stage infrastructure investment. This generates debts for the local government and accounts receivables for CFLD. This does not look good for either side.

But Jiaolong acquired land from local farmers through rental contracts so local government does not have debt obligations to Jiaolong. Another difference is that CFLD required local governments to pay it an industrial service fee of about 45% of the investment made by businesses brought there by CFLD.

Jiaolong does not need to pay this money because it signed a tax-sharing contract with the government rather than debt contracts or contracts with investment subsidies. 

Reil: How can a government select the right firm or entrepreneur to develop and run a city under such a scheme? 

Lu: The government needs to create a market for trading city planning rights. The business which bids the highest value for the planning rights can then take the development rights of the city, and acquire the right to sign tax-sharing contracts with the government.

The business which values the land most win these rights. If a business fails in the development process, it can then sell these rights to other developers. It is just like developing an office building or a residential apartment, which in general is organized by the market. 

Reil: What are the advantages and challenges compared to the standard urbanization process in China with the government taking the land from farmers and developing it? Are there other parts of China that copied the Jiaolong model?

Lu: Major advantages of the Jiaolong model include less use of coercion and therefore higher benefits for farmers. There’s also more efficient organization and fast development of industrial parks, as the competition and clearly defined property rights often force industrial parks to promote better services to attract business.

The Jiaolong model has more efficient city planning and more efficient use of resources such as land and space, due to the profit maximization incentives by private industrial park developer.

And finally, there’s less public deficit or debt for local government because the government does not need to invest as much in infrastructure, public schools and other public services.

But there are disadvantages too, including more transaction costs involved in acquiring farmers’ land due to the lack of coercive power, and a higher risk of entrepreneurs running away, and facing business failures and private debt due to heavy investment.

There are also political risks due to the change of government officials who might not like this model, as well as legal risks if Chinese laws forbid land transactions by private parties or private planning. 

There are actually several cases in which private developers are major city developers and substitute part of the role of government through PPP or other contractual arrangements.

The most famous one is CFLD, but its work is mostly concentrated in counties surrounding Beijing. Another one of the biggest developers, Country Garden, also runs several similar projects, and there are also some smaller private industrial parks doing the same.

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Thanks for reading,

Jordan