(This essay was published in Hong Kong Economic Journal on 21 September 2016.)

 

Newly elected lawmaker Eddie Chu Hoi-dick has declared war on land corruption deals in the New Territories and vowed to fight “government-developer-rural-triad cronyism.” He wants to make land deals more transparent, permit greater democratic participation in the cause of greater social justice, especially for rural squatters, and champion a lifestyle of rural tranquility.

 

A rural leader has retorted that this is not “cronyism” but “cooperation”.

 

Recently Chu reported to the police that his life and his family’s safety have been criminally threatened. This is a very serious threat to law and order and basic governance.

 

Apparently his work has inconvenienced certain rural interests in a big way. There are news reports suggesting an intimidating picture of dodgy landlords and their thugs trying to squeeze every penny out of the land they possess. It is correct to say rural landlords in the New Territories do not have many friends in town even though they are a formidable political force.

 

Many among the environmentalists and conservationists are incensed at these landlords who have allowed green farmland that has fallen into disuse to be turned into storage sites for container boxes. To them such “brown land” is an unseemly sight and hazardous for health, safety and traffic.

 

Rural landowners also share the blame for driving up housing prices because the “small house policy” has further reduced land availability. Recent attempts to sell these units (or their development rights) for profit in contravention of the law have added to their negative image.

 

Although the number of cases processed each year is small (about a thousand), the estimated number of eligible villagers is quite large. In 2003 the Heung Yee Kuk estimated there were 240,000, but updated figures are not available.

 

It is not surprising that those who stand up to the powers of the landed interests in the New Territories receive populist applause and support. And this is the appeal of Eddie Chu, who just won the highest number of votes in the recent election. His primary supporters are rural squatters whose homes and livelihood are being affected by development. But support also comes from some individual small landowners who are dissatisfied with the domineering style of the rural leadership.

 

Nonetheless, the true economic nature of the rural land development challenge in the New Territories needs to be better understood if a solution that is in the long-term interests of all is to be devised. This is especially important since Hong Kong has an acute shortage of housing and most land in the New Territories is agricultural land.

 

When the British took over the New Territories in 1899, they were met with stiff resistance. The indigenous inhabitants waged a Six-Day War against the British, in which over 500 Chinese were killed (the population at the time was about 100,000).

 

The British government decided they could not displace so many people as they had done on Hong Kong Island. To prevent future resistance, the British made concessions to placate the indigenous inhabitants with regards to land use, land inheritance, and marriage laws. Arrangements were made so that residents could prove ownership and be given title to their land registered under the Block Government Lease (formerly called Block Crown Lease). The leases are standard straightforward documents. Their two most important covenants are:

 

(1) The lessee shall not allow nor convert any ground to be demised as agricultural or garden ground into use for building purposes other than for the proper occupation as agricultural or garden ground.

 

(2) The lessee shall not erect or construct any building or structure of any description on the said demised premises.

 

Agricultural land use would become a subject of some contention over time as urban land ran out and the demand for the acquisition of agricultural land for conversion into other uses grew.

 

The first occasion occurred with government policy to build satellite towns and public housing estates in the 1970s. This proved to be a very tricky process because of the need to solve two problems simultaneously: (1) setting an appropriate land use conversion premium, and (2) assembling small plots in the presence of holdout.

 

Since a major purchaser of agricultural land was the government, negotiations were very difficult. The two parties were always pitched in an adversarial zero-sum game. The government was also vulnerable to setting land use conversion premiums that would form precedents for future transactions. Government needed a mechanism for setting prices and middlemen for assembling small and scattered plots of land.

 

The Letters A and B schemes provided a market-oriented mechanism through which government could rely upon middlemen and market forces to facilitate land conversion and sales. The Small House Policy also provided a form of compensation consistent with the idea that the land alienated had an agricultural use and the inhabitants were farmers.

 

The second occasion occurred when the demand for vacant land for parking container boxes in the New Territories exploded after China’s opening. In the 1980s the government had sought to restrict the lots under the Block Government Lease to agricultural uses but lost a number of court cases.

 

The Hong Kong Court of Appeal held that “The use of the land as listed in the schedule to the Crown lease was descriptive only. The purpose of the schedule was to identify the lands to which the lease related. If the schedule had been intended to be other than description it would not have been necessary to include in the body of the lease restrictions on building without a license. It would be absurd to construe the lease so as to compel a lessee to maintain a lot as a broken latrine for 75 years.”

 

The effect of the decision was that land described as agricultural under the Block Government Lease could be used for any purpose that did not require a building. This meant that the government could no longer control the use of agricultural land. The government’s only recourse was the planning option, which was implemented with new statutory planning legislation for rural areas in the New Territories in 1991.

 

The court decision in effect embodied an important element that is unique to the common law tradition. Nobel economist Professor Ronald Coase pioneered the idea of how institutions, in particular legal institutions, would tend to adopt rules so that the people who place the highest value on a good or service will get to use it.

 

This is what markets would normally do, but it is also a feature of the common law. The Block Government Lease appeared to be a stumbling block that prevented agricultural land from being used for commercial purposes. Yet the Court of Appeal, in trying to see the law as a fairly consistent whole, determined in favor of widened usage. Such willingness to see new light and provide fresh interpretations is the great living attribute of common law.

 

The Court of Appeal’s decision also had knock on effects on what would be an appropriate land use conversion premium for agricultural land under the Block Government Lease now that such land had a demonstrated commercial use. Landowners would be less willing to alienate their land at its agricultural value. The starting negotiation position between government and the landowners would be further apart. Getting the two parties to an agreed settlement would be far more difficult than it was on the first occasion without a change in government attitudes towards compensation for agricultural land that already had an accepted alternative commercial use as parking lots for container boxes.

 

If history offers any lesson, there is clearly a need to introduce a market mechanism for setting prices and for having middlemen involved in assembling land. The purpose of adopting this mechanism is to get the different parties to arrive at an agreeable market solution. This is perhaps what some stakeholders would call “cooperation.” The true essence behind a market solution is the respect of private property rights – the central feature of capitalist economic systems.

 

Market mechanisms could be found, but the politically charged environment today has made adopting such mechanisms suspect. As a consequence, it would be a miracle if land conversion and development could happen at all. But without market mechanisms, the transactions cost of negotiating land conversion transactions becomes very high. Delays also become the norm with the implication that housing prices would not come down. In the longer run, economic growth would also be adversely impacted.

 

Indeed one of the reasons why development has been so slow is because agricultural land conversion has been so slow since the 1980s. The process is mired in gridlock, providing indirect evidence that there just isn’t sufficient “cooperation” or even “cronyism.” The result is to widen the wedge between residential property prices and the construction price (see Figure below). This situation can be traced to the late 1980s when agricultural land in the New Territories began to have a more valuable commercial use. The wedge increased by 70% and has remained unchanged through both boom and bust periods.

 

 

What are the alternatives then?

 

Eminent Domain Approach

 

One approach is to follow the logic of Eddie Chu, who advocates democratic participation of all stakeholders to make a collective decision. There are two reservations about such an approach.

 

First, it would be foolish to believe that this could happen any time soon without radical political reform. Collective decision-making would depend on considerations far beyond agricultural land issues in the New Territories. Although an appropriate opening up of the political system to greater participation would be highly desirable, it still remains unclear when this would happen. Development in the New Territories should not be hostage to political reform, no matter how tempting it might be as a political strategy to force political reform. Sacrificing social and economic development goals in pursuit of political ideals is a deeply flawed historicist thinking often embraced by radicals, extremists and fanatics.

 

Second, if we assume that by some miracle radical political reform takes place in Hong Kong, making it possible for government to aggressively appropriate agricultural land under eminent domain, at compensation levels that are not acceptable to landowners, would this be a desirable solution?

 

This was a political solution that Lee Kuan Yew adopted when the People’s Action Party was voted into power in Singapore.  Such draconian steps would completely undermine the private property rights system of land ownership in Hong Kong, as we know it. And I believe it would fundamentally change the underlying economic system of Hong Kong in contravention of Article 5 in the Basic Law.

 

Land Rent Approach

 

Another approach would be to collect an annual land rent on agricultural land in the New Territories when land is converted into other uses, instead of negotiating a lump sum land conversion premium at the outset. In principle all agricultural land could be converted into residential, industrial or commercial land on demand in the future subject only to planning controls.

 

Future property owners building on newly converted agricultural land would pay an annual land rent to government assessed at a constant percentage of the market value of the property. The predetermined percentage could be different for residential, commercial or industrial uses of the land and be set with reference to historical relativities. This would remove the need for landowners and government to engage in costly and time-consuming negotiations to determine the conversion premium case by case. It would also be transparent to all.

 

Developers that bought land from landowners would have full knowledge of the future land rent chargeable. The market price for land would then be determined by competition. The issue of land assembly would still have to depend upon middlemen, but with full knowledge of the future land rent charges. The transactions cost of negotiation would therefore be significantly reduced.

 

The advantage of the land rent approach is to make land use conversion premiums and the prices of land sales fully transparent. The proper role of democratic participation is in the development planning consultation process. But development plans may not be successfully implemented if premiums and prices cannot be subsequently settled. Unsuccessful development plans would then have to be further modified even after extensive prior consultation. Greater transparency and predictability in conversion premiums and land prices can make it easier for development plans to be successfully implemented. Having democratic participation in the planning consultation stage would only be meaningful if plans could be subsequently implemented.

 

Rural Squatter Rights

 

 

The final issue that needs to be addressed is the recognition of rural squatter rights in the New Territories. The existing compensation mechanism for resettling rural squatters is based on urban resettlement. This recognizes the right to resettlement for loss of abode, but not of livelihood. The latter is a material concern for rural squatters if they are engaged in farming activities, in ways that are not applicable to urban squatters.

 

The government should be prepared to recognize rural squatter rights and also to consider how compensation for loss of livelihood can be taken into account explicitly. This would require consultation with stakeholders. One possible answer is to make development contingent on the provision of a choice between a cash compensation option or the right to continue farming activities in high-rise structures that would be built into the planning stage. To prevent opportunists from exploiting the new arrangement, the identity of bona fide rural squatters must be registered at the earliest possible stage.

 

A more market-oriented process will give far more scope for efficient and effective decentralized decision-making and make the development of the New Territories work in the interests of all parties. The benefits of fewer development delays will not only improve economic and social well being, but also make Hong Kong a less politically polarized city.

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