Jurisdiction Competition, Land Revenue and Local Government Debt Risk in China. Weida Kuang. (School of Business, Renmin University of China)

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1 Jurisdicion Compeion, Land evenue and Local Governmen Deb isk in China Weida Kuang (School of Business, enmin Universy of China Absrac: Local governmen deb risk has become a lasing and severe issue in China due o jurisdicion compeion. Based on jurisdicion compeion heory developed by Tiebou (1956, his paper consrucs a local deb model o expound local governmen behavior from he perspecives of public good compeion and public land collaeral. Theoreical proposions show ha curren local deb risk is posively associaed wh fuure land revenue and fuure cenral governmen bailou, whereas curren local deb risk is negaively associaed wh curren land revenue and fuure cenral governmen bailou. Neverheless, relaionship beween local deb risk and local public good compeion is differen due o local governmen preference. Employing he local deb daabases of China s 30 provinces during he period , we find ha he lagged and curren land revenue and cenral governmen fiscal ransfer significanly and posively impac local deb risk and local deb solvency. Hence, volaily of land revenue and cenral governmen bailou are val o local deb risks. Second, eacher amoun per capa and medical employees per capa are significanly posive wh local deb risk, while heir impacs are less han ha of land revenue and cenral governmen fiscal ransfer. Thus, jurisdicion compleion conribues o local deb risk. Urban road line lengh per capa and urban waer line lengh per capal, however, are significanly negaively associaed wh local deb risk, which is converse o our heoreical proposion. Key words: jurisdicion compeion, public good, land revenue, local governmen deb risk, cenral governmen fiscal ransfer Weida Kuang Professor of eal Esae Finance and Economics Deparmen of Finance, School of Business, enmin Universy of China (UC, Associae Direcor, Cener for eal Esae esearch, UC 59 Zhongguancun Sree, Haidian Disric, Beijing, , P..China Tel: (O

2 1. Inroducion 1.1 Background The risk of local deb in China keeps sharply rising recenly, albe local deb plays an imporan role in urban infrasrucure consrucion, capal aracion and economic developmen. According o he No.32 announcemen of he Naional Aud Office of China, up o he end of June 2013, local governmens a all levels bear he responsibily for he deb paymen of 20, billion yuan, guaranee responsibily for he obligaion of 2, billion yuan and bailou responsibily for he deb of 6, billion yuan, accouning for 53.22% of he GDP of 2013 (56,884.5 billion yuan in oal, whereas he deb raio of he end of 2012 is merely 39.43% (See Table 1. 1 In paricular, while he global financial crisis occurs, in order o realize he arge growh, he large-scale local debs are issued by he Minisry of Finance of China and local governmens, which leads o higher deb raios in some regions. In erms of he No.32 announcemen of he Naional Aud Office of China, a he end of June 2013, he oal deb balance of province, prefecure and couny-level governmens is 10, billion yuan, an increase of 3, billion yuan compared wh 2010, which implies 19.97% of he annual average increase. The growh raes of local deb a province, prefecure and couny-levels were 14.41%, 17.36% and 26.59% respecively over he period of A he end of 2012, he number of local governmens whose deb raios exceed 100% is 3, 99, 195 and 3,465 respecively, a province, prefecure, couny and own levels. In addion, here 2 province-level governmens, 31 prefecure-level governmens, 29 couny-level governmens and 148 own-level governmens have o borrow new debs for he paymen of old debs a a percenage of more han 20%, respecively. Employing he deb daabase of a Chinese Wesern province during he period , Miu and Fu (2012 find ha local governmen deb risk shows a long-erm growh rend and he shor-erm volaily afer Overall, local deb risk no only exiss, bu also exacerbaes in many regions. Thus, is pressing for China o preven local deb crisis. Table 1 Scale of Sovereign Debs in China Un: 100 million yuan Year Gov. esponsibily Coningen Liabily level for Deb Guaranee esponsibily Bailou esponsibily Paymen 2012 Cenral Local Toal June, Cenral Local Toal On he oher hand, he scale and paymen of local deb rely heavily on land revenue, whereas he growh of land revenue decreases, which undermines deb solvency of local governmens. In erms of he No.32 announcemen of he Naional Aud Office of China, a he end of 2012, 11 province-level governmens, 316 prefecure-level governmens and 1,396 couny-level governmens commed o pay 3, billion yuan wh land revenue, accouning for 37.23% 1 hp://www.cnao.gov.cn/main/aricleshow_arid_1335.hm

3 of 9, billion yuan of he oal responsible debs a hree levels. In recen years, he enforcemen of China s land ender, aucion and lising sysem, along wh he rising housing price and land price, leads o he rising land revenue. Land revenue has increased o 3210 billion yuan in 2011 from 130 billion yuan in 2001 a an annual rae of 146%. Neverheless, in 2010, China s cenral governmen implemened ighening policies like purchase number resricion, ineres rae enhancemen and morgage lending limaion o curb housing price, which resuls in falling land revenue growh, rising deb paymen pressure and exacerbaing local governmen deb risk. Excep for Tibe, he raios of land revenue o fiscal revenue in 30 provinces of China decrease from 48.9% in 2010 o 36.3% in In paricular, a grea deal of local governmens are experiencing fiscal defic and limed land reserve, hey have o raise land prices. If price bubble burss, deb solvency of local governmens plummes, local deb crisis will occur (Hong and Guo, Accordingly, Wang (2009 argues ha land revenue is unsable and unsusainable, which is no able o become a reliable source for deb paymen. For his reason, exploring he relaionship beween land revenue and local deb crisis is pivoal o preven local deb crisis in China. 1.2 Leraure review The exising leraure has sudied local deb crisis from four aspecs of causes, consequences, governance and conagion. Firs of all, a sream of leraure sudies causes of local deb crisis. Some of hem heoreically expound causes of local deb crisis. Cole and Kehoe (1996 develop a hree-secor recursive model of consumers, bankers and governmens, which indicaes ha he opimal sraegy for governmens is o repay heir old debs if hey can sell new debs, oherwise hey defauls. However, wheher governmens defaul exiss a crisis zone, which depends on deb maury. Cuadra and Sapriza (2008 consruc a wo-secor game model of sovereign governmens and foreign lenders and verify ha lengh of enure of ruling pary and degree of conflic beween differen paries affec sovereign ineres rae and defaul rae. Facchini and Tesa (2008 develop a wo-period model of public goods provided by federal governmen and sae governmens and documen ha is opimal no o borrow when sae governmens confron a hard budge consrain; if bail-ou commmen of federal governmen is no credible, provision of local public goods by local debs exceeds firs bes provision of public goods a firs sage; when sae defauls have a negaive exernaly on federaion, federal bail-ou may be in place while saes are likely o run budge defics and benef from he bail-ou. Based on agency heory, Chang and Chen (2013 develop a pary behavior model and esify ha economic growh helps o reduce expansive fiscal policy, while he governmen runs defics and accumulaes more debs in downurns. When public suppor is driven up by non-economic facors, he need for he use of expansive fiscal policies disappears. A policymaker who gains more pay is resrained from excessive public spending. Unforunaely, he above four heoreical models don consider he impac of local governmens compeion on local deb risk. Moreover, hey focus on he effecs of fiscal revenue while neglec he effecs of governmen collaeral. Anoher body of leraure empirically invesigaes he causes of local deb crisis. Though many economiss analyze he causes of China s local deb crisis from polical, economic and financial poins of view ( Lin e al, 2005; Tsui, 2011; Liu and Huang, 2012; Sun, 2013, He and Man (2012 employ a daase of 340

4 financing plaform firms of local governmens during he period of 2002 o 2010, and find ha land revenue is significanly posive associaed wh local deb size, whereas hey don consider he impac of variaion of land price and deb size on local deb crisis. Second, a sand of leraure examines consequences of local deb crisis. Using an unbalanced panel daabase of 154 counries from 1970 o 2008, Furceri and Zdzienicka (2012 find ha deb crises significanly reduce oupu by abou 10 percen afer eigh years, while deb crises end o be more derimenal han banking and currency crises. Employing a panel daabase of 155 counries during he period , Afonso and Jalles (2013 find ha deb raio(deb/gdp has negaive effecs on economic growh and producivy, whereas deb maury is posive associaed wh he economic growh and producivy for he OECD counries. Using he hisorical daase spanning from 1800 o 2008, einhar and ogoff (2013 find ha cenral governmen deb afer hree years of banking crisis increases by approximaely 86%, he fiscal burden of banking crisis exends beyond he cos of he bailous and sysemaic banking crises are ypically preceded by asse price bubbles, large capal inflows and cred booms. Using he banking daabases of Indonesia, Malaysia, Philippine, Thailand and Souh Korea during he period of , Benmelech and Dvir (2013 find ha deb obligaions issued hree years prior o Eas Asian financial crisis have a negaive effec on he probabily of bank failure, which implies shor-erm deb is reflecion of disress in financial insuions raher han causes. Employing he daily OTC daabases of five srike prices of European-syle dollar-euro opion across from January 2, 2006 o April 30, 2010, Hui and Chung (2011 invesigae he impac of sovereign deb crisis on volaily in EUO and find ha when srike prices of he opions urn ino ou-of-he-money from in-he-money, he currency opion volaily is monoonously posive relaed wh sovereign CDS spread and informaion flow from he sovereign CDS marke o he currency opion marke. Using he daabases of 378 imporan banks from Bankscope, sock price from DaaSream and MSCI indices during he period of , Hoque (2013 finds ha shor-erm funding significanly increases bank performance in cred crisis; banks wh higher capal, angible equy, depos and lower agency problem perform beer in sovereign deb crisis. Using Greek daabase of sovereign deb from January 2005 o June 2011, Bhano e al. (2013 find ha sovereign yield spreads are posively associaed wh negaive abnormal reurns on financial socks in he Porugal, Spain and Neherlands. These abnormal reurns are driven in par by raings downgrades and oher unfavorable news announcemens abou Greece. A counry s sock reurns can be conagious via news evens. Employing Hecke (2013 collecs daase of 13 EMU counries and nominal ineres raes on 10-year governmen bonds from IMF s Inernaional Finance Saisics during , find ha deb accumulaion by subnaional governmens (SNG spills over ono sovereign risk premiums when he resricions on SNG borrowing are weak and when invesors believe ha subsovereign debs are backed by he cener. Third, a body of leraure focuses on he governance of local deb crisis. Using he daase of 44 counries of IMF s Governmen Financial Saisics regarding subnaional borrowing regimes and fiscal oucomes over he period , Singh and Plekhanov (2005 assess marke discipline, adminisraive consrains, rule-based conrols and cooperaive arrangemens and believe ha no single insuional arrangemen is opimal, he appropriaeness of specific arrangemens depends on he degree of verical fiscal imbalance, he exisence of any bailou preceden, and he qualy

5 of fiscal reporing. Freedman e al. (2010 examines he shor-run muliplier effec of fiscal simulus measures and long-run crowding-ou effecs of higher deb raios in his financial crisis. They find mulipliers of wo-year simulus range from 0.2 o 2.2. A 10 percenage poin increase in he US deb o GDP raio raises he US ax burden and world real ineres raes in he long run, hereby reducing US and res of he world oupu by percen and percen, respecively. Enderlein e al. (2012 consruc 9 indicaors of governmen acions and negoiaion behavior and analyze a sample of deb defauling daa from 31 developing counries and emerging counries over he period They find polical insuions significanly affec governmen coercive behavior, while economic and financial facors play a minor role. By suding fiscal consolidaion episodes in 21 OECD counries from , Heylen e al. (2013 find ha fiscal consolidaion programs conribue o lower public deb raio, he more efficien governmens adop he programs, he more effecive in bringing down deb raio. Lasly, a family of leraure invesigaes conagion effecs of local deb crisis. Using a daily marke-closing ineres rae spread daase of sovereign deb of 34 counries and US from January 1, 1991 o December 31, 2000, Gande and Parsley (2005 examine he spillover effecs of sovereign deb marke and find posive raings evens abroad have no discernible impac on sovereign spreads, whereas negaive raings evens are associaed wh an increase in spreads. Thus, he spillover effec is asymmeric. Using daily daa of 15 EMU counries over he period of , Grammaikos and Vermeulen (2012 use GACH models o idenify he ransmed channels of he financial and sovereign deb crises and find ha non-financials of US raher han financials ransm o Europe, while sovereign deb crisis has a significan effec on European sock reurns a las sage of crisis. On he conrary,using he daase from 31 eveloped and emerging economies during he period , Beirne and Frazscher (2013 explore he pricing and conagion of European sovereign deb risk and find here exiss fundamenals conagion, fundamenals are he main explanaions for he rise in sovereign risk, bu regional spillovers and conagion are less imporan. Using he daabase for 48 European banks from Thomson Daasream in 2010, Mink and Haan (2013 invesigae he conagion effec of news abou Greece sovereign deb and s bailou on bank sock abnormal reurn. They find ha only news abou Greek bailou leads o conagion effec of bank sock abnormal reurns, whereas news abou Greece doesn. The findings imply ha marke cares more abou European governmens willingness o bailou raher han he Greek defaul ransmission. Employing he daabase of daily frequency of yields on 10-year governmen bonds issued by five EMU counries (i.e. Greece, Ireland, Ialy, Porugal and Spain from 1 January 1999 unil 31 December 2010, Gómez-Puig and Sosvilla-ivero (2013 find sovereign crisis in one counry ransms o ohers hrough he banking sysem in a case of increased inernaional financial acivy in he euro area; macroeconomic imbalances lead o governmen deb devaluaion and rising sovereign spreads; he privae secor s indebedness has been suggesed as he main causes of deb crises in Ireland and Spain. Using he daabase of Eurozone counries during he period , Grauwe and Ji (2013 find ha deb spreads of he peripheral Eurozone counries is posively associaed wh negaive self-fulfilling marke senimens,which shows no connecion o higher deb o GDP raios and fiscal space variables. This indicaes ha Eurozone counries are more fragile and more suscepible o self-fulfilling liquidy crises han sand-alone couny.

6 In sum, he exan heoreical models fail o consider he effecs of jurisdicion compeion on local deb crisis. In addion, hey don ake he collaeral effecs of governmen asses ino accoun. The remainder of his paper is organized as follows: based on jurisdicion compeion, Secion 3 develops a local deb model combining wh governmen s collaeral land revenue. Secion 4 uilizes China s local deb daabases o invesigae he effec of jurisdicion compeion and volaily of land revenue on local deb risk. Secion 5 presens conclusions and policy implicaions. 2. The Model In order o analyze he effecs of jurisdicion compeion and governmen collaeral asses on local deb risk, based on jurisdicion compeion model of Tiebou (1956 and pary-agen model of Chang and Chen (2013, his paper views public land revenue as governmen collaeral asse and develops a local deb model combining jurisdicion compeion and governmen collaeral asses. 2.1 Assumpions For simplicy, we assume: (1 here exiss a single-pary governmen of polical regime and local governmens are agens of cenral governmen; (2 only wo counerpars of local governmens exis a he same level;(3local officials compee for promoion and local governmens compee for local public goods and household consumpion; (4 compeion of local governmens for local public goods is characerized by Courno compeion and expecaion for supply of public goods is raional; (5 X of common goods is numeraire, s price is sandardized ino 1; (6 local governmens and local officials share he same uily funcion; (7 local governmens uily funcion is logarhmically addive. (8 enure of local official is T ; (9 ime discoun facor of local officials is η ; (10 local governmens can repay old debs by issuing new debs wh an ineres rae r ; (11 here is only income ax levied on household, and ax rae is τ ; (12 public land is owned by local governmens and can be collaeralized for debs; (13 cenral governmen can bailous local governmens via fiscal ransfer. 2.2 Model Seup Under he regime of single-pary governmen, local officials have o perform beer han heir rivals for promoions. According o assumpion (3, he uily funcion of local officials can be wren as: UOG [ ( G, X X ], where OG ( G, X X represens he promoion opporunies of local officials. Promoion opporuny hinges on he comparisons of local public goods provision ( G G and household consumpion ( X X 2. In addion, i and j sand for compeing local governmens a he same level, respecively. Accordingly, curren fiscal expendure includes curren expendure of public goods and deb repaymen in previous period. As public land can be aken as collaeral for local deb financing, land revenue sponaneously can be used o repay local debs. Consequenly, curren fiscal revenue consiss of ax, land revenue and curren deb obligaion. Thus, budge consrains of local governmens are 2 For simplicy,we ake he difference of local GDP ( Y Y and local public goods ( insead of heir raios ( Y Y, G G as jurisdicion compeion. G G

7 G l changed ino: p G+ (1 + r D 1 = pl+ τy + D, where D denoes new local deb obligaions a ime ; l p and L denoe land ransfer price and ransfer area a ime, respecively; G p is he price of public goods a ime and Y denoes local GDP a ime. In addion, as land can be collaeralized, curren local deb obligaion is he increasing funcion of fuure land revenue, namely, D ( pl > 0. More specifically, curren local deb obligaions can be D = η pl + η p L + η p L + + η p L ( η1, η2, η n > 0. In expressed as: n + n + n erms of assumpion (4, he reacion funcion of public goods supplied by governmen i o e governmen j can be wren as: G = f( G, where e G denoes he expecaion of governmen i on public goods supply of governmen j. Similarly, he reacion funcion of public e goods supplied by governmen j o governmen i can be wren as: G = f( G. Meanwhile, we can obain: G e =, G e = G, where G and G public goods by governmens i equilibrium can be expressed as: G denoe he opimal supply of local and j, respecively. Hence, public goods price of Courno p G = G k + G consume all afer-ax income, we can ge X = (1 τ Y., where k > 0. Finally, because households To sum up, he uily funcion of represenaive governmen i can be expressed as: T Max ( 1 X X G G η α + β X, G = 1 [ ln( ln( ] ( αβ>, 0 l l s.. P G + (1 + r D 1 = PL + τy + D, PG + (1 + rd 1 = PL + τy + D G G P G = G k + G ( k > 0, X = (1 τ Y, X = (1 τ Y From he firs order condion, yields: k[(2 α + β G + βg ]( G G D PL PL Y Y r D D D l l = ( ( (1 ( β ( G + G (1 Equaion 1 indicaes ha he opimal scale of local debs no only relies on he difference of local public goods ( G G, bu also depends on he differences of land ransfer revenue l ( PL PL, GDP ( Y Y and lagged deb size ( D 1 D 1 beween local governmens. l

8 In he ligh of Equaion 1, we can obain he scale of lagged local debs: D k[(2 α + β G + βg] ( G G ( PL PL + ( Y Y + ( D D l l 1 = + + D 2 1 β (1 + r( G + G (1 + r (2 Equaion 2 implies ha he scale of lagged local debs is no only posively associaed wh he difference of curren local deb, bu also posively associaed wh he differences of curren land revenue, public goods and GDP beween local governmens. In oher words, local governmens will increase heir curren debs in he even ha hey can expec heir fuure land revenue, public goods and GDP are greaer han ha of heir rivals. Similarly, variaion of local deb is as follows: k[(2 α + β G + βg ]( G G D = PL PL Y Y + r D D + D l l ( ( ( β ( G + G Comparing Equaion 3 wh Equaion 1, local governmens increase heir deb obligaion provided ha heir rivals increase deb, (3 To analyze local deb risk, we divide Equaions 1-3 by Y a boh sides, and obain hress compeive deb raios 3 : k[(2 α + β G + βg ]( g g d d ( pl p l (1 y (1 r( d d d l l = β ( G + G k[(2 α + β G + βg] ( g g ( pl p l + (1 y + ( d d l l 1 d 1 = + 2 β (1 + r( G + G (1 + r k[(2 α + β G + βg ]( g g d d = ( pl pl (1 y + rd ( d l l β ( G + G (4 (5 (6 where d, d and d 1denoe curren deb raio, variaion of deb raio and lagged deb raio of governmen i, respecively; g and g denoe he opimal expendure raios of public goods G ( Y G and Y by governmens i and j, respecively ; l pl and pl l denoe land revenue l PL raios ( Y l PL and Y d and d 1 are lagged deb raios; ; 1 y and d denoe GDP raio Y ( Y D and rival s deb o own GDP ( Y. 2.3 Proposions 3 This paper refers he differences of deb raios as o compeive deb raios (hereinafer he same.

9 From Equaion 1-6, we can derive Proposion 1: ( d d Proposion 1:If all he above assumpions hold, hen < 0, l l ( pl pl ( d d ( d d ( d d > 0, < 0 ; > 0 ; if l l ( pl ( pl pl ( d d 1 1 l l pl 1 1 αβ - G < 3α + β G, hen ( d d ( d 1d 1 ( d d > 0, < 0, > 0 ; if ( g g ( g g ( g g αβ - G > 3α + β G, hen ( d d ( d 1d 1 < 0, > 0, ( g g ( g g ( d d < 0 ( g g Proposion 1 implies ha he higher he curren land revenue raio is, he less he local deb raio and he local deb risk. Second, in order o repay debs, he more he lagged local debs are, he more he curren local debs are. Third, if αβ - G < 3α + β G, which implies α < β, he uily of local public goods is more han ha of GDP, hen he resuling spread of raios of curren local public goods provision is posively associaed wh he spreads of curren local deb raios, bu negaively associaed wh he spreads of lagged local deb raios. Apparenly, local deb risk runs αβ - G in line wh local public expendure raios. Conversely, if > 3α + β G, which implies α > β, he uily of pubic goods is less han ha of GDP. Thus, local deb raios and local deb risks are decreasing wh raios of local public goods provision. The above model does no ake he relaion beween cenral governmen and local governmens ino accoun. Under local deb crisis, if cenral governmen could bailou, local governmens confron sof budge consrains; if no, budge consrains of local governmens are hard. Thus, he model above refers o as local deb model wh hard budge consrains. While budge consrains are sof, local governmens end o be over-indebedness, which easily give rise o local deb crisis. When local governmens could expec cenral governmen bailous, curren local debs are increasing funcion of fuure cenral bailous ( B, ha is D ( B > 0. Specifically, curren local debs can be wren as: D = λ0b + λ1b 1+ λ2b λ B + + N + N, where λ, λ, λ > 0. Thus, budge consrains of local governmens have been changed ino: 1 2 N l P G + (1 + r D = PL + τy + D + B, P g + (1 + rd 1 = PL + τy + D + B. l G 1 G On he oher hand, wheher cenral governmen can bailou no only relies on s fiscal resources, bu also depends on s financing capacy. We furher assume ha he maximum of fiscal ransfer from cenral governmen is B, hen B + B B. In erms of Equaions 2 and 3, we can obain

10 he opimal local deb spreads under sof budge consrains: k[(2 α + β G + βg ]( G G D D ( PL PL ( Y Y ( B B (1 r( D D D l l = β ( G + G k[(2 α + β G + βg] ( G G ( PL PL + ( Y Y + ( D D + ( B B l l 1 D 1 = + 2 β (1 + r( G + G (1 + r k[(2 α + β G + βg ]( G G D D = ( PL PL ( Y Y ( B B + r( D D l l β ( G + G (7 (8 (9 Similarly, dividing Equaions 7-9 byy, compeive deb raios under sof budge consrains can be derived: k[(2 α + β G + βg ]( g g d d ( pl pl (1 y ( b b (1 r( d d d l l = β ( G + G k[(2 α + β G + βg] ( g g ( pl p l + (1 y + ( b b + ( d d l l 1 d 1 = + 2 β (1 + r( G + G (1 + r k[(2 α + β G + βg ]( g g d d = ( pl pl (1 y ( b b + rd ( d l l β ( G + G (10 (11 (12 where B b andb sand for fiscal ransfer raios of cenral governmen ( Y and B Y. In he ligh of Equaions 7-12, we can derive Proposion 2. Proposion 2: if all he above assumpions hold and cenral governmen bailous, hen ( d d < 0, ( b b ( d d < 0, ( b b ( d 1d 1 > 0 ( b b Proposion 2 implies ha compeive raios of curren local deb are negaively associaed wh compeive raio of curren cenral fiscal ransfer, bu posively associaed wh compeive raio of forward cenral fiscal ransfer. In oher words, while local governmens could expec heir fiscal ransfers are more han ha of heir compeors, local deb risk would increase. 3. Empirical Tess 3.1 Daa Since he cy-level daabases of local debs and land revenue prior o 2001 are no available, we assemble he province-level daases of land ransfer and local debs of 30 provinces (excep for Tibe in China from 2001 o Province-level daabases of local debs solely conain new debs and repaymen of principal and ineres, bu no accumulaive deb. New debs merely include corporae bonds (i.e. financing plaform firms of local governmens, loans convering from naional debs and local governmen bonds issued by he Minisry of Finance, while no

11 include bank loans. According o he No.32 announcemen of he Naional Aud Office of China, ill he end of June 2013, bank loans accoun for 50.76% of local debs (5, billion Yuan/1, billion Yuan. Thus, we collec a supplemenary daase of repaymen of principal and ineres of local debs, bu missing daa of The loans from naional debs and local governmen debs issued by Minisry of Finance daa are gahered from China Finance Yearbook ( , repaymen daa comes from respecive Saisical Yearbook of 30 provinces and corporae bonds daa is from WIND daabase. The daa of land ransfer includes land ransfer area and land ransfer revenue collecing from China Land esources Yearbook ( We also collec budgeary revenue from China Urban Saisical Yearbook ( For public goods, we assemble he lenghs of newly-buil urban road per capa, volume of mass rans, number of eachers per capa and number of sanary insues per housand come from respecive Saisical Yearbook of 30 provinces and China Urban Saisical Yearbook ( Descripive Analysis Table 1 shows ha new debs increase slowly prior o 2009, rising from billion yuan in 2001 o billion yuan in 2007 wh an annual rae of 31.30%. Afer he global financial crisis in 2008, China s cenral governmen issued local bonds 200 billion yuan o bailou, which leads o he rapid growh of new local debs since The size of local deb rockes by 4.76 imes from billion yuan o billion yuan. Meanwhile, he rapid growh of local debs expedes deb repaymen, increasing from billion yuan in 2006 o billion yuan in 2009 wh annual growh rae of 107%. Land revenue and budgeary revenue end o increase year by year. Due o he global financial crisis, land revenue decreases by 16.06%, from billion yuan in 2007 o billion yuan in Table 1 Scale of new local debs and fiscal revenue in China during un:100 million yuan year Land Budgeary Toal fiscal Loans from naional Corporae Toal debs Deb revenue(a revenue(b revenue bonds and local bonds ( F=D+ repayme (C=A+B governmen debs (E E n(g (D

12 平 均 Table 2 displays ha he raio of new debs o budgeary revenue (TDTT, land revenue and oal fiscal revenue grow quickly afer he 2008 financial crisis. However, he raio of new debs o land revenue (TDTL is less han 26% excep for 2001, 2002 and As menioned above, we assume ha new debs accoun half of he oal debs. If new debs are collaeralized on land and repaid by land revenue, hen he TDTL says below he line of 52% since 2009, he local deb risk is under conrol. Similarly, as he raio of repaymen of principal and ineres o land revenue (PDTL is 2.56% on average and s max is 23.47% in 2001, he local debs also can be solven. Therefore, oal revenue composed of budgeary revenue and land revenue has a sronger capabily o repay debs. Besides, he raio of new debs o GDP (TDTGDP sharply rises from 0.35% in 2008 o 1.65% in 2009 afer he global crisis. Alhough TDTGDP is small, will rise in he even of accumulaive local debs. Table 2 aios of new debs o fiscal revenue for China during un:% Year TDTGDP TDTF TDTL TDTT PDTF PDTL PDTT Mean Noe : (1TDTF and PDTF denoe raio of newly-issued local governmen debs o local budgeary revenue and raio of repaymen of principal and ineres o budgeary revenue, respecively;(2 TDTL and PDTL denoe raio of newly-issued local debs o local land revenue and raio of repaymen of principal and ineres o land revenue, respecively; (3 TDTT PDTT denoe raio of newly-issued local debs o oal fiscal revenue and raio of repaymen of principal and ineres o oal fiscal revenue, respecively Table 3 indicaes he provinces whose TDTLs exceed 50% include Qinghai, Ningxia, Hainan, Gansu and Heilongjiang wh TDTLS of %, %, 82.00%, 70.81% and 50.85%, respecively. The provinces whose PDTLs surpass 10% are Qinghai and Ningxia wh PDTLs of 18.75% and 10.24%, respecively. I is noeworhy ha new debs accoun around half of oal new debs. Hence, local deb risks in provinces menioned above is raher severe should maury of local debs approaches. Thus, he risks of newly-issued local debs concenrae on Midwesern China, while he TDTLs and PDTLs in developed Easern China like Beijing, Shanghai, Guangdong, are smaller as well as he local deb risks.

13 Table 3 aios of new local debs and repaymen of principal and ineres o fiscal revenue of 30 provinces in China during un:% provin Beiji Tianj Heb Shanxi Inner Liaoni Jilin Heilongji Shang Jiang Zhejia Anh Fujia Jianx Shand ce ng in ei Mong ng ang hai su ng ui n i ong olia TDTL TDTT PDTL PDTT Provi Hena Hub Hun Guangd Guang Haina Chongq Sichuan Guizh Yunn Shanx Gan Qing Ning Xinjia nce n ei an ong xi n ing ou an i su hai xia ng TDTL TDTT PDTL PDTT Table 4 depics ha excep for Tibe, he raio of land revenue o budgeary revenue (LTF ends o go up as a whole wh a mean of 90.95% and a maximum of % in Thus, land revenue nearly equals o budgeary revenue. Similarly, he raio of land revenue o oal fiscal revenue (LTTF is inclined o rise as a whole wh a mean of 41.90% and a maximum of 55.68% in Thus, land revenue is referred o as second public finance corresponding o non-land revenue and is crucial o local fiscal revenue in China. Table 4 aios of Land revenue o fiscal revenue for China during un:%

14 Year Average LTF LTTF Noe LTF LTF denoe raios of land revenue o budgeary revenue and land revenue o oal revenue, respecively. Table 5 exhibs ha hireen provinces whose LTFs are more han 100% include Zhejiang, Yunnan, Sichuan, Jiangxi, Qinghai, Jiangsu, Anhui, Chongqing, Hainan, Hebei, Fujian, Shandong and Hubei. Eleven provinces of heir LTFs beween 50% and 100% are Hunan, Guangxi, Liaoning, Ningxia, Shanxi, Guizhou, Jilin, Tianjin, Inner Mongolia, Henan and Shanxi. Only six provinces (i.e. Beijing, Shanghai, Guangdong, Heilongjiang, Xinjiang and Gansu have heir LTFs lower han 40%. As a resul, LTF of 80% of he provinces is greaer han 50 percen. In erms of LTTF, six provinces of Zhejiang, Jiangxi, Sichuan, Jiangsu, Yunnan and Hebei have heir raios higher han 50%. Nine provinces of Fujian, Chongqing, Shandong, Henan, Hubei, Hunan, Guangxi, Liaoning and Ningxia have heir raios beween 40% and 50%. However, developed regions like Beijing, Shanghai and Guangdong possess heir raios lower han 26 percen. For his reason, less developed regions hinge much more on land revenue. Table 5 aios of land revenue o fiscal revenue of 30 provinces in China during Un:% provin Beiji Tianj Heb Shanxi Inner Liaoni Jilin Heilongji Shang Jiang Zhejia Anh Fujia Jianx Shand ce ng in ei Mong ng ang hai su ng ui n i ong olia LTF LTT F 7 8 Provi Hena Hub Hun Guangd Guang Haina Chongq Sichuan Guizh Yunn Shanx Gan Qing Ning Xinjia nce n ei an ong xi n ing ou an i su hai xia ng LTF LTT F Empirical Tess

15 4.1 Economeric Model Seing To examine he effecs of jurisdicion compeions on curren local deb risk, we develop a compeive deb raio model for local governmens in he ligh of Proposions 1 and 2. d d = κ + κ ( d d + κ ( p l p l + κ ( b b + κ ( L L κ ( WL WL + κ ( BV BV + κ ( TN TN + κ ( DN DN + ε (13 In realy, local governmens a he same level are ypically more han wo. To illusrae jurisdicion compeion, we inroduce average values of all explanaory variables as rivals variables. Hence, d denoes average value of TDTGDP of all provinces a year ; pl sands for land revenue o GDP raio of province i in year ; pl is he mean of pl of all provinces; b is he mean raio of fiscal ransfer o GDP of all province in year ; L represens he mean of urban road line lengh per capa in year ; WL denoes he mean of urban waer line lengh per capa in year ; BV denoes he mean of urban bus volume per capa in year ; TN is he mean of eachers per housand persons and DN is he mean of medical employees per housand per housand persons in year. In Equaion 13, as he lagged dependen variable is associaed wh he error erm, he esimaed resuls of OLS, E and FE are biased. In order o avoid spurious regression, his paper adops sysem GMM (SYS-GMM esimaor posed by Arellano and Bover(1995 and Blundell and Bover(1998. Besides, since local debs migh be endogenous wh land revenue and fiscal ransfer, ( p l pl and ( b b are reaed as endogenous variables while he oher variables are views as exogenous variables in he process of esimaion. Table 6 repors he descripive analysis of main variables. To explore he effecs of collaeral asses and cenral governmen bailous, we insue a compeive deb raio model for local governmens in erms of Proposions 1 and 2. d d = γ + γ ( d d + γ ( p l p l + γ ( b b + γ ( L L γ ( WL WL + γ ( BV BV + γ ( TN TN + γ ( DN DN + µ (14

16 By virue of Hausman ess, we employ FE model o esimae Equaion 14. Table 6 Descripive analysis of main variables Variables Max Min Mean S.E Obs. d p l b L WL BV TN DN d pl b L WL BV TN DN Un roo ess and coinegraion ess To eliminae spurious regression, un roo ess are required o conduc. In general, un roo ess of panel daa comprise of homogeneous and heerogeneous panel un roo ess. The former refers o LLC es (Levin e al., 2002, he laer includes IPS es (Im e al., 2003, Fisher-ADF and Fisher-PP ess (Maddala and Wu, This paper employs hese four un roo ess. Table 7 indicaes ha he oher variables are saionary wh excepion of d d, b b and DN DN. Table 7 Un roo ess of panel variables Variables Level Equaion Difference Equaion Levin-Lin IPS Fisher-ADF Fisher-PP Levin-Lin IPS Fisher-ADF Fisher-PP d d ( ( ( *** ( *** ( *** ( *** ( *** (0.00 p l pl *** ( *** ( *** ( *** (0.00

17 b b -1.90** ( ( ( ( *** ( *** ( *** ( *** (0.00 L L -9.46*** ( ( ** ( ** (0.04 WL WL -6.65** ( ( * ( * (0.08 BV BV *** ( *** ( *** ( *** (0.00 TN TN -8.84*** ( ( *** ( *** (0.00 DN DN ( ( ( ( *** ( *** ( *** ( *** (0.00 Noe: (1he numbers in parenheses are p values; (2 ***, ** and *denoe he significance levels of 1%, 5% and 10% respecively (hereinafer; (3he esimaed equaion conains he inercep, he lagged variables and he ime rend erm. Alhough all he difference variables are seady, a coinegraion es should be conduced beween dependen and independen variables. We employ panel coinegraion ess proposed by Weserlund (2007 o implemen he ess. Table 8 shows ha wo saisics of G and P rejec he null hypohesis of no coinegraion, albe Ga and Pa receive he null hypohesis. Thus, we opion he level equaion for esimaion. Table 8 Coinegraion ess of mulivariaes Saisics Values Z value P value G Ga P Pa Noe : (1null hypohesis is no coinegraion ; (2he esimaed equaion includes he inercep, he lagged variables and he ime rend erm. 4.3 esuls Table 9 shows ha he coefficien signs of principle independen variables are consisen wh he heoreical Proposions. Sargan ess documen ha insrumenal variables of endogenous variables are valid. The oucomes of A(1 and A(2 esify ha here is no serial correlaion, which is in line wh he auocorrelaion hypohesis of Arellano and Bover( In erms of model 1, firs of all, he greaer is he difference of land revenue raio and s mean, he greaer is he difference of local debs and s mean. This implies he local deb risk increases wh he percenage of local governmens land collaeral asses. Second, he cenral fiscal ransfer has he same effecs of local debs as land revenue. I also indicaes ha he local deb risk rises wh he percenage of cenral fiscal ransfer. I is noeworhy ha, conrary o he Proposions, he greaer curren land revenue and fiscal ransfer are, he higher he local deb risk is. Consequenly, local governmens will be over-indebed and he local deb risk rises provided ha land revenue and s

18 collaeral effecs are keeping enhancing. Similarly, under a single-pary sysem, he growh of cenral fiscal ransfer would have he same effecs resuling in over-indebedness and higher local deb risk. Third, as opposed o he Proposions, he deviaion of urban road lengh per capa from s mean and he deviaion of urban waer line lengh per capa from s mean are negaively associaed wh he deviaion of local debs from s mean. As a maer of fac, local debs for he consrucions of urban road and waer line can be repaid by charging in China, implying local deb risk can be reduced. Conforming o our Proposions, he discrepancy of eachers per housand persons and s mean as well as he gap of medical employees per housand persons and s mean have a posive effec in local debs, albe he coefficien of he laer is insignifican. Accordingly, jurisdicion compeion of public goods will exacerbae local deb crisis. However, among all he explanaory variables, land revenue is he mos imporan facor followed by cenral fiscal ransfer. Table 9 The GMM esimaed resuls of curren local debs for 30 provinces in China during Variables d d d 0.34*** 1 d ( *** pl pl ( *** b b ( *** L L ( *** WL WL ( BV BV ( *** TN TN ( *** DN DN (2.61 Consan (-0.57 Wald Chi Sargan Value (1.00 A(1-3.06*** (0.00 A( (0.92 Obs. 300

19 Noe : he numbers in parenheses of A( 1, A( 2 and Sargan value are p values (hereinafer. Table 10, he deviaions of forward land revenue raio and cenral fiscal ransfer raio from heir mean have posive effecs in he deviaion of curren local deb raio from s mean. Hence, local governmens end o borrow excess debs and resul in higher local deb risk should hey could expec he raios of fuure land revenue and cenral fiscal ransfer increase. However, as for public goods, only urban waer line per capa is significanly correlaed. Similarly, jurisdicion compeion aggregaes local deb risk as well. Table 10 he FE esimaed resuls of lagged local debs for 30 provinces in China s during Variables ( d 1 d d d p l pl b L b L WL WL BV BV TN DN TN DN 0.25*** ( * ( ** ( ( * ( ( ( (0.90 Consan (-0.00 Wald Chi sq: whin 0.12 beween 0.54 overall 0.33 Obs Conclusions and policy implicaions Local deb risk has become a severe problem since ax-sharing reform beween cenral governmen and local governmens in In paricular, afer marke-orienaion reform of land in 2002, local governmen can borrow collaeralized on land and repay he debs by land ransfer

20 revenue, which may expose remendous risks o local debs. Based on jurisdicion compeion, land collaeral asse and cenral fiscal ransfer, his paper develops a local deb model and uilizes province-level daases of local debs and land marke during o esify he Proposions. Theoreical proposions demonsrae ha curren land revenue raio is negaively associaed wh curren local deb raio and local deb risk, while lagged local debs are posively associaed wh curren local debs. If αβ - G < 3α + β G goods provision, oherwise decreases if, local deb risk increases wh raios of local public αβ - G > 3α + β G. Local deb risk increases in he even ha a local governmen expecs can obain more fiscal ransfer from he cenral governmen han s rival. The empirical resuls show ha here exiss a vicious cycle beween local deb risk and land venue and cenral fiscal ransfer. In oher words, he greaer curren land revenue and fiscal ransfer are, he higher he local deb risk is. Thus, provided ha land revenue is ascending, collaeral effecs of land become sronger, local governmens incline o excessive indebedness and local deb risk rises. Similarly, cenral fiscal ransfer enhancemen has he same effecs resuling in boos of local deb risk. Second, he higher he raios of forward land revenue and fiscal ransfer are, he higher he curren local deb risk is. Hence, if local governmens could expec he augmen of heir fuure land revenue and fiscal ransfer, hey end o borrow excess debs, which lead o higher local deb risks. Third, conrary o he Proposions, he raios of urban road lengh per capa and urban waer line lengh per capa are negaively associaed wh local deb risk. De faco, local debs for road and waer consrucion can be repaid by charging in China, which resuls in lower local deb risk. In addion, eachers per housand persons and medical employees per housand persons have posive effecs on local deb risk, while only urban waer line per capa is significanly associaed in he lagged deb risk model. As a resul, jurisdicion compeion deerioraes local deb crisis. Accordingly, o preven local deb crisis, China s cenral governmen should firs conrol he volaily of land revenue, hen curail down fiscal ransfer and reinforce hard budge consrains of local governmens, finally alleviae vicious compeion across local governmens. eferences: Afonso, Anónio, João Tovar Jalles, Growh and producivy: The role of governmen deb, Inernaional eview of Economics and Finance, 25, 2013, Beirne, John, Marcel Frazscher, The pricing of sovereign risk and conagion during he European sovereign deb crisis, Journal of Inernaional Money and Finance, 34, 2013, Benmelech,Efraim, Eyal Dvir, Does Shor-Term Deb Increase Vulnerabily o Crisis? Evidence from he Eas Asian Financial Crisis, Journal of Inernaional Economics, 89, 2013, Bhano, K., Burns, N., Huner, D., Williams, M., News Spillovers from he Greek Deb Crisis: Impac on he Eurozone Financial Secor, Journal of Banking & Finance, 2013, forhcoming.

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