Notes on In the Game
Micro Level
In China, the government doesn’t just influence how the “pie” is distributed — it participates in making it. So we can’t discuss economics apart from government.
Local Government Powers and Functions
To understand governance and operational models, we must first understand how power and resources are distributed within the government system. This distribution depends on two key institutional characteristics: central-local relations and vertical-horizontal segmentation. Central-local relations concern the overall balance of power between central and local governments; vertical-horizontal segmentation means local departments simultaneously answer to both their vertical superior departments and horizontal local governments, facing dual constraints.
Based on these two characteristics, local government power allocation can be examined from three perspectives: from the externality perspective, if public services only affect the locality, they can be handled locally; if externalities exist, higher-level coordination is needed. From the information perspective, the side with information advantages holds greater de facto authority, so superiors often invest heavily in gathering lower-level information. From the incentive compatibility perspective, matters unrelated or contrary to local development goals tend toward vertical leadership, while those aligned with local development tend to be delegated locally.
Under these principles, local governments enjoy extremely broad powers in attracting investment and developing the economy, allowing them to deeply participate in resource production and distribution.
Finance and Government Behavior
Economic development requires not just administrative authority but fiscal authority. From 1985–1993, fiscal contracting caused central revenue’s share to decline steadily, prompting the tax-sharing reform of 1994, which increased central revenue but drastically reduced local fiscal resources.
The reform didn’t change local governments’ economic development mandate but reduced their disposable fiscal sources. Locals had to find alternative funding — thus began the era of land finance. Simply put, land finance means local governments rely on land-use rights transfer revenue to sustain fiscal spending.
In 1998, two events transformed the real estate market: first, work-unit housing allocation ended, meaning people now had to buy their own homes — launching the real estate era. Second, the revised Land Administration Law took effect, giving local governments authority over land sales with revenues staying local. Local governments could restrict residential/commercial land supply and earn monopoly profits from ever-rising land prices.
Some regions implemented land finance — subsidizing industrial land for investment attraction while restricting residential land, letting housing prices drive land prices. Regions unable to rely on land finance faced fiscal difficulties and growing inter-regional inequality, requiring central transfer payments and continued fiscal reforms like rural tax reform and county-level fiscal management.
Government Investment, Financing, and Debt
Land’s true power lies not in land finance itself but in the bank credit and other capital leveraged through land as collateral. Land finance grafted onto capital markets with leverage becomes land financialization, snowballing to drive rapid economic expansion.
Governments establish local government financing vehicles (LGFVs, or “city investment companies”), using future land revenues as collateral to leverage massive bank loans for urbanization and industrialization investments. Government investment flows in two directions: infrastructure investment and industrial investment. Infrastructure investment involves LGFVs developing land then handing it to government for investment attraction, or enterprises handling everything from development to investment with government paying for use — the PPP (Public-Private Partnership) model.
However, the land financialization model poses problems. At the micro level, it increases local government debt risk. Beyond explicit on-balance-sheet liabilities, the greater concern is LGFV “implicit debt.” During economic booms, land appreciation covers repayment; during downturns with falling land prices, severe debt problems emerge.
Current reform measures include replacing LGFV debt with government bonds, converting LGFVs into ordinary state-owned enterprises, preventing further capital inflows, and constraining officials’ investment impulses. Fundamentally, under the current system, both local officials and ordinary government workers have very strong incentives to develop the economy, leading to both over-investment and systematic “official-business collusion” corruption. Therefore, deeper reform should streamline administration and shift from a production-investment government to a service-oriented government.
Government’s Role in Industrialization
China’s economic reform emerged from a planned economy where government controlled vast resources critical to industrial development — land, banks, universities, research institutions — inevitably leading to deep government participation in industrialization.
The second direction of government investment is industrial investment — supporting and subsidizing specific enterprises. Additionally, governments establish industrial guidance funds, creating investment companies or entrusting market-oriented fund managers as “funds of funds” that invest in other funds, which then invest in unlisted company equity, channeling social capital toward strategic emerging industries.
The book details specific examples of local government industrial investment through BOE and photovoltaic industry development, which I won’t elaborate here.
Macro Level
The above describes micro-level impacts of the land financialization model. Below are macro-level impacts.
Urbanization and Imbalance
First, urbanization’s emphasis on “land over people” drives up housing prices, increases household debt burden, and exacerbates income and wealth inequality.
Rising housing prices in the medium-to-long term result from strictly managed urban construction land quotas that can’t keep pace with population inflows, creating housing supply shortages. Higher prices mean heavier household debt.
Income inequality stems from insufficient urban public service provision preventing free labor mobility, making it difficult for low-skilled workers to establish themselves in cities. During rapid growth, low-income groups are less sensitive to wealth gaps, but once growth slows, social tolerance for inequality decreases.
Therefore, reform should shift focus from land to people — allowing construction land quotas to flow, breaking urban governments’ monopoly on residential land, reforming the household registration system, and increasing low-income groups’ mobility and options.
Debt and Risk
Second, investment attraction’s emphasis on “scale and expansion” increases corporate debt burden and overall economic debt and financial risk.
Debt causes trace to relaxed financial regulations after the financial crisis, with banks more willing to lend.
From the debtor (enterprise) perspective, LGFVs, state-owned enterprises, and real estate companies carry the heaviest debt. Their asset sell-offs to repay loans cause asset price declines, which increase bank non-performing loans, reduce lending willingness, break corporate funding chains, and trigger economic recession.
From the creditor (bank) perspective: first, large scale with high leverage; second, maturity mismatches between bank liabilities and assets create liquidity risk; third, most bank credit is collateralized by real estate or land, so during downturns banks become reluctant to lend, accelerating decline; fourth, bank risks transmit to other financial sectors, creating systemic risk. Banks establish shadow banking to evade regulation; once bubbles burst, the entire financial industry is affected.
Resolving debt has two parts: repaying existing debt and curbing new debt.
Repaying debt means either asset sales, spending cuts, or monetary expansion. The latter has three approaches: direct issuance, quantitative easing, and debt monetization.
Curbing new debt requires, beyond housing price controls and land finance restrictions, addressing the root cause: why do enterprises constantly borrow from banks? Following the principle “whoever makes investment decisions bears investment risk,” China’s investments are primarily government and SOE-led, so risks are also borne by government and its controlled financial institutions — banks. Because bank risk is ultimately government risk. Therefore, the fundamental measure is capital market reform — decentralizing power to markets, broadening direct financing channels, letting enterprises raise funds through equity and bonds.
Domestic and International Imbalance
Third, development strategy’s emphasis on “investment and production over consumption” creates structural economic imbalance.
Internally, the most prominent structural imbalance is insufficient consumption, partly due to excessive savings caused by family planning policies, insufficient social spending, and rising housing prices, and partly due to low household income share.
In early development stages, heavy capital investment effectively drives industrialization and growth. But at a certain point, this model causes overcapacity, debt risk (investment flowing into real estate, pushing up prices), excessive wealth gaps, and external imbalance (exports chronically exceeding imports).
However, US-China trade friction isn’t driven by Chinese exports’ impact on American employment, but by manufacturing’s rise threatening American technology dominance, combined with rising American political conservatism. This necessitates China building a dual circulation model centered on domestic circulation, strengthening the domestic market and achieving a virtuous cycle of “market → R&D → iteration → larger market.”
The key to this transformation is raising household income and consumption through three approaches: continuing urbanization to further develop the service sector; increasing social spending while reducing production-oriented spending; and developing direct financing channels to broaden household property income.
Government and Economic Development
The government’s past economic development core was introducing competition mechanisms — central coordination, local government competition. The evaluation standard was economic development performance.
This “political arena + market” system’s advantage is designing clear, effective promotion criteria that provide officials with extremely strong incentives to develop the economy. But it also produces local protectionism and corruption. Just as planned-economy-era government intervention characteristics carried into market reforms, this system leaves path dependency of prioritizing economy over social welfare.
When market mechanisms are still imperfect, government can supplement by mobilizing and allocating resources, buying time for market economy development. But as markets mature, government must timely adjust its role — reducing government investment spending, increasing social spending, and transitioning from a production-oriented to service-oriented government.
This transformation aligns with development economics’ general perspective: for developing countries, the key to productivity improvement is learning known technologies and management models. Once productivity reaches a certain level, the shift must go from organizational learning to exploration and innovation. Regardless of development model, different countries and regions will adapt based on their specific political and social realities.