The Impact Of Local Government Debt On Regional Industrial Growth: International Experience And China’s Mechanism

The amount of Chinese local government debt has surged dramatically since the financial crisis in 2008. This paper investigates the problem of Chinese government debt from two dimensions, that is, international experience and China’s domestic institution. Based on a historical panal data of 66 countries dating back to 1800, it was found that the surge and defaults of government debts around the world had significant and highly contagious outbreak, often with world wars, sharp fluctuations in commodity price and rapid changes of capital flows. China’s government debt, however, has its own transmission mechanism and economic function. To illustrate this mechanism, I develop an "industrial investor-local government" model to investigate the reason why it is difficult to prevent local officials from running into debt in the perspective of debt’s double investment-inducing effect. The model implies that local government debt, as a critical indicator of government’s ability of raising money, not only increases local industrial output directly but also attracts investment effectively by two channels, that is, by increasing investment of infrastructure and by lowering land price for industrial use, which together foster local industrial growth.In the theoretical model, industrial land market is introduced into the classical investment attracting model of local governments, using industrial land price as one of the main policy tools of local governments. I also modify the budget constraint by introducing local government debt and land leasing revenue. The model predicts that local government debt could effectively increase industrial investment but has little impact on industrial land price due to the effect of lowering land price in the supply side and boosting land price in the demand side. The empirical findings largely confirm the double investment-attracting effect of local government debt based on China’s prefectural-level panel data from 2003 to 2007.However, cities with different endowments might face different risks when pushing economic growth by raising debt:(1) cities with poor economic conditions and less endowments have comparative disadvantage in the competition for investment and their land leasing revenue in the near future might not be large enough to cover their historical debt; (2) cities with better endowments and better economic conditions, on the other hand, might suffer surging housing price due to their over-supply of industrial land and the ensuing shortage of residential land.