The rise of “consumer cities” in China

Matthew E. Kahn, Siqi Zheng 14 April 2009

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China’s population is rapidly urbanising. The share of the population living in cities in China increased from 28% in 1990 to 44% in 2006. The annual real wage of an average urban worker in 2006 was four times higher than in 1990.

Increasing labour mobility in urban China is pushing Chinese cities towards a system of open cities. In 2007, there were 36 cities with a population of two million or greater. Rural to urban migration is responsible for roughly 70% of China’s urban population growth (Zhang and Song 2003). The binding force of the “hukou” (household residential registration) system on labour mobility has been weakening over time. Migrants without hukou are allowed to work in cities. There is no hukou restriction on buying housing units.1 This institutional transition allows us to examine a set of questions at the intersection of urban economics, growth theory, and environmental economics in one of the world’s most important nations.

Open cities

According to urban economics theory, in an open system of cities, differences in land rents and wages across cities must reflect differences in urban productivity or in urban amenities (quality of life). Using a unique panel dataset for 35 major Chinese cities, we explore how productivity differences and non-market quality of life differences enter home prices. Our study adds to the large urban hedonic compensating differentials literature (see Roback 1982, Gyourko and Tracy 1991, Albouy 2008). Very few studies have examined such issues in developing countries. Berger, Blomquist and Peter (2008) use cross-sectional hedonic methods to investigate the determinants of quality of life in Russian cities.

City size and home prices

Similar to cities in the US, larger Chinese cities have higher home prices and higher wages. Figure 1 presents a map of China highlighting the names, locations and relative population sizes of 35 cities in our sample. These 35 major cities represent all municipalities directly under the federal government, provincial capital cities, and quasi provincial capital cities in China. Figure 2 presents a graph of the log of city average home prices as a function of the log of city population size. The simple regression line highlights which cities (such as Beijing, Shanghai, Guangzhou and Shenzhen) have higher than average home prices even controlling for city population size. The urban economics literature would posit that such a rental price premium reflects both non-market amenity effects and city-specific productivity effects. Figure 3 presents a similar graph placing the log of city average wages on the vertical axis.

Figure 1. 35 major Chinese cities

Figure 2 Home price and city population

Figure 3 City labour income and city population

Our research seeks to explain this cross-city variation in rents and wages and examine within-city home price dynamics over the years 1997 to 2006. We choose 1997 as the starting point because that year marked the end of the state-provided housing welfare system and the beginning of a private housing market boom. A unique feature of our research is our access to a high-quality housing price index for 35 major Chinese cities.2

In our research, we focus on foreign direct investment (FDI) as a leading indicator of city productivity. FDI has been the main source of production technology transfer, which has driven the phenomenal growth of China’s manufacturing exports over the last 30 years. China has become the third-largest exporter in the world with a trade surplus in 2006 of $177.5 billion. In terms of FDI, by 2005 Chinese inward FDI flows had reached $72 billion, up from an average of $30 billion between 1990 and 2000. The stock of FDI has increased similarly, rising from $20 billion in 1990 to $317 billion in 2005 (Cole, et. al., 2008).

Using the panel aspect of our city data set, we document that home prices in Chinese cities do rise in response to local labour demand increases and FDI inflows. These price responses in the face of rising local demand are even larger for cities featuring an inelastic housing supply. Our findings are consistent with results from the US literature – demand shifts have a greater impact on local housing prices in markets with more inelastic supply (Glaeser, Gyourko and Saks 2006).

Urban air pollution and the transition from “producer cities” to “consumer cities”

The US literature examining the role of non-market local public goods has emphasised the importance of climate and environmental amenities as determinants of cross-city wage and rental differentials (Costa and Kahn 2003, Chay and Greenstone 2005). Given the worldwide media coverage of China’s environmental challenges, we devote special attention to urban air pollution (ambient particulates and sulphur dioxide) as indicators of urban quality of life. Chinese cities are ranked among the most polluted places in the world. For instance, Beijing’s average ambient particulates level (for PM10 – particles of 10 micrometers or less) is roughly four times higher than in Los Angeles. China is also the largest emitter of sulphur dioxide in the world today. The World Bank estimates that the total health cost of air pollution in China equals 3.8% of GDP (World Bank, 2007). As documented by US researchers, major US cities have made the transition from “producer cities” to “consumer cities” (see Glaeser, Kolko and Saiz 2001). Are Chinese cities now intentionally or unintentionally starting to make a similar transition?

To answer this question, we estimate pooled cross-sectional hedonic regressions. We find that cities with higher particulate levels, all else equal, have lower home prices. We report evidence that this capitalisation effect has grown over time. If China’s growing urban middle and upper class demand high quality of life, then this will accelerate the transition of its cities from being producer cities towards consumer cities.

Our research presents novel results on explaining cross-city variation in ambient pollution levels. Figure 4 shows the particulate (PM10) and sulphur dioxide (SO2) concentrations in 2003 and 2006 across 30 cities. The average pollution level slightly declined over this time span, despite ongoing population and per-capita income growth. Given that China’s cities have average annual incomes below the “turning point” of roughly $8,000 estimated by Grossman and Krueger in their seminal 1995 environmental Kuznets curve paper, it may seem surprising that China’s cities have achieved a reduction in pollution during a time of growth. Based on city-level regressions of ambient pollution on a polynomial of city per-capita income, we estimate an environmental Kuznets curve shape for Chinese cities (Figure 5). The per capita income turning point in the PM10 curve is $2,000. For the sulphur dioxide and income relationship, we estimate a turning point at roughly $2,100. Eight of the cities in our sample exceeded this level in 2006. This is encouraging evidence that ongoing growth in Chinese cities may help to improve urban air pollution levels. Urban air pollution dynamics in China’s growing cities offers an excellent test of Dasgupta et al.’s (2002) optimistic thesis that the environmental Kuznets curve’s turning point is shifting down over time.

Figure 4. Particulate and sulphur dioxide concentrations

Figure 5. PM10 and SO2 environmental Kuznets curves for Chinese cities

The “pollution havens” hypothesis would further posit that, since China’s cities attract FDI that promotes heavy manufacturing, such inflows should further degrade air pollution in these growing cities. A more optimistic view would posit that if FDI leads cities to modernise their factories and invest in pollution control then emissions could decline in the city, making FDI negatively correlated with ambient pollution levels (Wheeler et. al. 2001). We test these claims by estimating regressions of ambient air pollution on city FDI inflows and control variables. Using a city’s geography and proximity to exporting ports as instruments for FDI (since FDI is more likely to flow to Eastern coastal cities), we find robust evidence that cities with higher FDI inflows have lower ambient air pollution levels.

Conclusion

Our analysis of newly available data on home prices across China’s major cities suggests that “green amenities” are capitalised into cross-city housing prices and that this marginal valuation is rising over time. Cities experiencing inflows of FDI have lower air pollution levels than observationally identical cities.

Our research documents some suggestive evidence that the implicit hedonic price of clean air is rising over time. Our new estimates of the air pollution/income relationship provide evidence consistent with the environmental Kuznets curve prediction. We estimate a turning point (i.e. an income level above which a city’s air pollution and its per-capita income are negatively correlated) at a surprisingly low level of income. This is good news for those who hope that China can enjoy the “win-win” of economic development and improved environmental performance. As documented by US researchers, major US cities have made the transition from “producer cities” to “consumer cities” (see Glaeser, Kolko and Saiz 2001). Although Chinese cities are still dirty, they may now be starting to make a similar transition. Beijing’s 2008 push to close dirty factories to create “blue skies” for the Summer Olympics may foreshadow a long-run trend.

Our research suggests a promising line of research related to rising environmental amenity demand in Chinese cities (see Zheng and Kahn 2008). Future research should examine whether rising Chinese per-capita income increases the demand for environmental goods and environmental regulation. Such investigations may need better data and techniques, such as individual-level panel data to estimate behavioural models of the demand for non-market local public goods like environmental quality.

References

Albouy, David 2008. The Unequal Geographic Burden of Federal Taxation, NBER Working Papers 13995.
Au, Chun-Chung and Henderson, J. Vernon. 2006. How Migration Restrictions Limit Agglomeration and Productivity in China. Journal of Development Economics, 80(2): 350-388.
Berger, M.C., G.C. Blomquist, and K.S. Peter. 2008. Compensating Differentials in Emerging Labor and Housing Markets: Estimates of Quality of Life in Russian Cities. Journal of Urban Economics, 63(1), 25-55.
Chay, K. C. and M. Greenstone. 2005. Does Air Quality Matter? Evidence from the Housing Market. Journal of Political Economy, 113(2), 376-424.
Cole, Matthew, Robert Elliott and Jing Zhang. 2008. Corruption, Governance and FDI Location in China : A Province-Level Analysis. Working paper, Department of Economics, College of Liberal Arts and Sciences, University of Connecticut
Costa, Dora. L and Matthew E. Kahn. 2003. The Rising Price of Non-Market Goods. American Economic Review Papers and Proceedings, 227-232.
Dasgupta, S., Laplante, B., Wang, H. and Wheeler, D. (2002). Confronting the Environmental Kuznets Curve. The Journal of Economic Perspectives, 16(1), 147-168.
Glaeser, Edward, Joseph Gyourko and Raven Saks. 2005. Why Is Manhattan So Expensive? Regulation and the Rise in House Prices. Journal of Law and Economics, 48(2), 331-369.
Glaeser, Edward, Jed Kolko and Albert Saiz 2001 Consumer City. Journal of Economic Geography, 1(1) 27-50.
Grossman, G. M. and A. B. Krueger. 1995. Economic Growth and the Environment. The Quarterly Journal of Economics, 110(2), 353-377.
Gyourko, Joseph and Joseph Tracy. 1991. The Structure of Local Pubic Finance and the Quality of Life. Journal of Political Economy, 99, 774-806.
Roback, J. 1982. Wages, Rents, and the Quality of Life. The Journal of Political Economy, 90(6), 1257-1278.
Wheeler, D. 2001. Racing to the Bottom? Foreign Investment and Air Pollution in Developing Countries. Journal of Environment and Development, 10(3), 225– 45.
World Bank. 2007. Cost of Pollution in China: Economic Estimates of Physical Damages.
Zhang, K.H. and S. F. Song. 2003. Rural-Urban Migration and Urbanization in China: Evidence from Time-Series and Cross-Section Analyses. China Economic Review, 14 (4), 386-400.
Zheng, Siqi, Matthew E. Kahn. 2008. Land and Residential Property Markets in a Booming Economy: New Evidence from Beijing. Journal of Urban Economics, 63(2), 2008, 743-757.
Zheng, Siqi, Matthew E. Kahn, and Liu Hongyu. 2009. Towards a System of Open Cities in China: Home Prices, FDI Flows and Air Quality in 35 Major Cities, NBER Working Paper #14571


1 However, hukou still remains an impediment to efficient urban agglomeration (Au and Henderson, 2007). Migrants without hukou are credit constrained and lack the access to urban social security benefits such as education, public housing, and health services.
2 The construction of this city housing price index is based on the real transaction prices of all newly-constructed housing units in a city. The municipal housing authority keeps all the transaction contracts of these units in a database. The contract contains the information on the transaction price (RMB/square meter), the dwelling’s physical attributes (unit size, floor number, building structure type, decoration status, etc.) and its detailed address, from which locational attributes (distance to the city center, distance to the closest subway stop, etc.) can be derived.

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Topics:  Development Environment

Tags:  China, pollution, cities, green amenities, environmental Kuznets curve

Professor at the UCLA Institute of the Environment, the UCLA Department of Economics and the UCLA Department of Public Policy

Associate Professor at the Institute of Real Estate Studies, Tsinghua University