SARAH MCCAMMON, HOST:
A lot of Chinese cities don't make money through taxation. Instead, they sell land. It's a financial model that's made cities rich. It's also created a lot of debt that China now wants to limit.
NPR's Emily Feng visits one city that's experiencing this.
EMILY FENG, BYLINE: The city of Nanning, in tropical Guangxi province, was once effectively a cluster of villages just four decades ago. Today, those villages still exist, but they've been swallowed up by fast-growing city around them. Visit Nanning today, and you'll find dozens of what's called chengzhongcun - urban villages. And in the rush to urbanize, these villages, too, became crowded with high-rise buildings.
LUO: (Non-English language spoken).
FENG: Miss Luo remembers how Macun, or Ma village, used to be surrounded by fields of water spinach. Like other residents in this piece, she didn't want to give her full name for fear of political sensitivities because the villages are constantly under threat of demolition.
LUO: (Through interpreter) In the mid-1980s, much of the village land was expropriated by the local government to build public roads and government offices.
FENG: Today, these urban villages are a warren of cheap housing. And around them, the city was also undergoing a dramatic buildup. It all began with a change in tax law in 1994 that sent most tax revenue to the central government, leaving local governments with very little cash.
DINNY MCMAHON: Now, things become problematic for the local governments because they have so many policy pressures placed upon them.
FENG: This is Dinny McMahon, the author of the book "China's Great Wall Of Debt." He explains local governments scrambled to find new ways to raise money. And they settled on selling land to build infrastructure - specifically new skyscrapers and train stations and highways.
MCMAHON: They build things borrowing from the banks. The banks lend to them because they have land as collateral. And then when it comes time to pay down those loans, it comes from the local governments selling the land to property developers. And that is kind of this cycle of finance between the banks, the property sector and the local governments.
FENG: The local governments paid for all this shiny new stuff with its ample land reserves because the state effectively owns all land in China. And developers and new property owners made money and supported the economy. Nanning is an active participant in this cycle. According to consultancy Rhodium Group, the city is one of the most vulnerable in China to debt risks because Nanning currently holds debts equal to more than 14 times its entire annual revenue - debts they plan to pay back by selling more land.
Logan Wright, the Rhodium analyst who spearheaded this report, explains that everyone considered this kind of land financing to be fail-proof because it was effectively guaranteed by the government.
LOGAN WRIGHT: Most people believed essentially that the property market was too big to fail, that local governments would - in times of stress needed to sell land and, therefore, they had to support the market.
FENG: Local governments do have strict limits on how much debt they can take out. To get around this, they create state-controlled shell companies to take out those loans on their behalf, thus keeping the debt off their books. Many analysts call these shell entities local government financing vehicles. And these vehicles aren't all bad. They helped finance the construction of essential public infrastructure.
Miss Lu, a seamstress, repairs a pair of pants as she remembers what it was like when she moved into Wanxiu urban village 15 years ago.
LU: (Through interpreter) Conditions now are much better. Before, there were open gutters. Now the village is serviced by metro stations and paved roads.
FENG: This whole debt-juggling act worked while economic growth was high and the price of land kept growing so governments could continue to pay off their debts. What changed this year was Beijing finally began enforcing a policy called the three red lines, which were hard caps on how much debt property developers could take on. That meant developers, like the embattled Evergrande Group, are buying less land. Local governments saw land sale revenues plunge by as much as 40% month on month, meaning they now also struggle to pay back their debts - much of it on China's bond market.
WRIGHT: Therefore, you could see a, you know, wave of contagion throughout the bond market if those start defaulting in larger volumes, as basically investors will have to start looking around at risks - at local governments themselves.
FENG: Several property developers - not just Evergrande - are teetering on the edge of default. And local governments are facing some tough years ahead as they face mounting debts they have no way to pay. China has been trying to tamp down on property speculation and shadowy debt for years.
So economic commentators like Lizzie Li are asking, why is Beijing cracking down now on the property sector?
LIZZIE LEE: China is sort of at the threshold of another era - when the disadvantages of that kind of runaway growth became more apparent, especially in terms of income inequality.
FENG: And next year, Chinese leader Xi Jinping heads a Communist Party enclave, where he'll likely extend his rule. Getting the property sector and debt under control before then will be a priority. In Nanning, none of these financial risks are visible. Instead, glassy shopping malls and sprawling apartment complexes are a testament to the power of land finance. Yet symptoms of China's economic slowdown are being felt.
Miss Li, a fruit seller, says she's hurting for business.
LI: (Through interpreter) All the workers moved away. There's no work and few new building projects.
FENG: Signs advertising empty apartments for rent are ubiquitous in the urban villages. Many shops have closed. Nanning city statistics show the volume of real estate sold dropped more than 47% in the city in November, compared to the same time the year before - all signs the invisible mechanisms that power this economy of 1.4 billion people are changing.
Emily Feng, NPR News, Nanning, China.
(SOUNDBITE OF GOLD PANDA'S "WE WORK NIGHTS") Transcript provided by NPR, Copyright NPR.
