Fiscal Decentralization And Economic Growth In China

It has been a long time for the issue on the relationship between fiscal decentralization and economic growth, which has brought out various theories. Although there is some classic theories and a general analysis framework so far, it is no doubt that different arguments exist concerning the same problem but in transitional countries, especially in China, a vast transitional and developing country. The important academic and realistic significance drives me to explore this topic.First of all, literature review concerning fiscal decentralization and economic growth involves the traditional western theory of fiscal decentralization and recent relative theory. Then this paper traces China's fiscal decentralization reforms, and discusses the necessity of fiscal decentralization. Based on the theory of medium demand effect of economic growth with respect to fiscal decentralization, this paper models the inter-government fiscal relationship since 1978 as a benchmark, and provides a two-stage empirical research on China's reforms of fiscal decentralization. The result shows that fiscal decentralization inevitably emerges with economic growth in China under the comprehensive effect of burden of central fiscal expenditure, fiscal overload of state-owned enterprises, finance surplus of local governments, and constraints of central government.Then, the necessity of China's fiscal decentralization are discussed and analyzed. The evolution of China's political system and the fiscal decentralization reform process are comprehensively reviewed. This paper also evaluated the tax distribution system and fiscal decentralization before and after the China's opening-up.This paper also focuses on mechanisms of resource allocation and institutional environments of fiscal decentralization in the context of economic growth. With regard to the mechanisms of resource allocation, fiscal decentralization contributes to the stabilization of China's economy and accelerates the process of approach to market economy. Concerning the mechanisms of institutional environments, it also advances the transformation of local governments in China, which causes market segmentation and inter-government competition to some extent.A positive research follows, which gets involved in the relationship between fiscal decentralization and economic growth in China. Granger Causality Test indicates that economic growth is Granger cause of fiscal decentralization in China from 1982 to 2005, which confirms medium demand effect to some extent. According to linear regression, fiscal decentralization during the period from 1982 to 2005 imposes negative effect on China's economic growth, while nonlinear regression shows that the curve of fiscal decentralization wiht respect to economic growth from 1982 to 2005 takes an abnormal U shape with the lowest degree of fiscal decentralization, DCU, 75.53%. The current degree of fiscal decentralization in China is just around the DCU, which implies that increase in degree of fiscal decentralization will be conducive to China's economic growth, obviously contradictory to the results of linear regression. To identify the nonlinear relationship further, fiscal decentralization index, DC, is adjusted to extra-budgetary fiscal decentralization index, DCX. Nonlinear regression of economic growth on DCX from 1994 to 2005 concludes that the nonlinear correlation curve between DCX and economic growth is an inverse U shape with the optimal fiscal decentralization degree as 82.13%. But China's DCX has been above the optimal decentralization, DCE, since reforms of tax distribution system in 1994 except in 1996. Thus according to the inverse U shape curve, China increases fiscal decentralization degree, especially increasing the proportion of local government extra-budgetary expenditure to the whole expenditure of China, will influence negatively economic growth.This dissertation concludes that China's fiscal decentralization goes far beyond the reasonable area due to lack of system, which in turn imposes negative effect on economic growth. If China attempts to impose positive effect on economic growth by way of fiscal decentralization, it is necessary to balance the degree of fiscal decentralization, system supply and economic growth. Furthermore, the possible solution would involve in setting specific game rules of inter-government, decreasing extra-budgetary fund of local governments, enhancing the institutions of public finance and fiscal expenditure, and standardizing inter-government transfer payment system.