The Dark Side of the Chinese Fiscal Stimulus: Evidence from Local Government Debt
by Yi Huang, Marco Pagano, Ugo Panizza , VoxChina
China reacted to the global financial crisis with a massive fiscal stimulus. In November 2008, the government announced a package worth 4 trillion Yuan (approximately 590 billion USD). The plan was implemented immediately and most of the funds were channeled through local governments. The stimulus package focused on investment. In 2009, the growth rate of fixed capital formation nearly doubled with respect to the pre-crisis period and the contribution of fixed investment to Chinese GDP growth was close to 90 percent (Wen and Wu, 2014). This surge in investment was achieved by injecting financial resources into state-owned firms and local infrastructure projects. There is evidence that under the stimulus plan, new bank credit was disproportionately given to state-owned firms rather than to more productive private firms (Deng, Morck, Wu, and Yeung, 2015; Cong and Ponticelli, 2016; Ho, Li, Tian, and Zhu, 2016; Bai, Hsieh, and Song, 2016; and Ru, Gao, Townsend, and Yan, 2017).
At first glance, the stimulus was a resounding success. China escaped the Great Recession and became one of the main drivers of world economic growth (Wen and Wu, 2014, and Ouyang and Peng, 2015, among others). However, this was at the cost of exacerbating a long-standing problem in China’s economy; namely, that high-productivity private firms fund their investment out of internal savings while low-productivity state-owned firms survive thanks to easier access to credit (Song, Storesletten, and Zilibotti, 2011). In a recent paper (Huang, Pagano, and Panizza, 2016), we show that the massive increase in local government debt that resulted from the stimulus package did indeed crowd out investment by private manufacturing firms.
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