Andy Xie:

Powerful interest groups have paralyzed China’s macro-economic policy, with ominous long-term consequences. Local governments consider high land prices their lifeline. State-owned enterprises don’t want interest rates to rise. Exporters are vehemently against currency appreciation. China’s macro policies have been reduced to psychotherapy, relying on sound bites and small technical moves to scare speculators. In the meantime, inflation continues to pick up momentum. Unless the central government bites the bullet and makes choices, the economy might experience a disruptive adjustment in the foreseeable future.
The first key point is that local governments have become dependent on the property sector for revenue as profits from manufacturing decline and spending needs to rise. Attracting industry has been the main means of economic development and fiscal revenue for two decades. Coastal provinces grew rich by nurturing export-oriented industries. But the economics has changed in the past five years. Rising costs have sharply curtailed manufacturers’ profits, and most local governments now offer subsidies to attract industries. The real revenue has shifted to property.

The dependency on high land prices for property tax revenue is certainly not unique to China. Madison’s 2010-2011 budget will increase property taxes by about 10%, due to spending growth, declining redistributed state tax dollars and a decline in local property values.