Fiscal decentralization and the imbalance between consumption and investment in China

Abstract

This research aims to explore the influences of fiscal decentralization on the imbalance between consumption and investment from theoretical and empirical perspectives. First, it analyzes how fiscal decentralization affects the ratio of consumption to investment under the framework of endogenous growth theory. Findings demonstrate that fiscal decentralization and the ratio of consumption to investment display a U-shaped relationship. Then, it empirically explores this question with a panel of 31 administrative regions in China from 1998 to 2015. Findings further show that empirical results verify the correctness of the theoretical results. Results are tested for robustness using different methods. A clear understanding of this project may help the central government in China as well as local governments to determine the reasonable rate of consumption to investment via fiscal means.

This is a preview of subscription content, access via your institution.

Notes

  1. 1.

    The cost of centralization is less responsive to the preferences and needs of regions in choosing public services provided by the government (Oates 1972), which may be not conducive to the improvement of the social welfare level and then discourage household consumption. Moreover, public services are provided as the same per capita quantity to each region when regional public services are provided centrally (Lockwood 2002). Thus, judging whether public infrastructure is increased is difficult. Apparently, the relationship between centralization and the ratio of consumption to investment is uncertain.

  2. 2.

    Under political centralization context, the performance evaluation system of officials establishes the incentive structures for local governments, while economic decentralization gives local governments the necessary economic decision-making power to ensure the effectiveness of the incentive effects.

  3. 3.

    Following Wooldridge (2012), the fixed effects estimator is more efficient than the random effects estimator.

  4. 4.

    The purpose of logarithms is to reduce the volatility and heteroscedasticity of the data, and to facilitate subsequent measurement and analysis.

  5. 5.

    As discussed by Xu and Wang (2007), investment affects economic growth. Therefore, we consider the GDP per capita variable and its square term as endogenous variables.

References

  1. Barro RJ (1990) Government spending in a simple model of endogenous growth. J Polit Econ 98(5):103–125

    Google Scholar 

  2. Blanchard O, Shleifer A (2001) Federalism with and without political centralization: China versus Russia. IMF Staff Pap 48(4):171–179

    Google Scholar 

  3. Chen CH (2004) Fiscal decentralization, collusion and government size in China’s transitional economy. Appl Econ Lett 11(11):699–705

    Google Scholar 

  4. Dammon RM, Spatt CS, Zhang HH (2001) Optimal consumption and investment with capital gains taxes. Rev Financ Stud 14(3):583–616

    Google Scholar 

  5. Davoodi H, Zou H (1998) Fiscal decentralization and economic growth: a cross-country study. J Urban Econ 43(2):244–257

    Google Scholar 

  6. Diaz-Serranoa L, Rodríguez-Pose A (2015) Decentralization and the welfare state: what do citizens perceive? Soc Indic Res 120(2):411–435

    Google Scholar 

  7. Du J, Fang H, Jin X (2014) The “growth-first strategy” and the imbalance between consumption and investment in China. China Econ Rev 31:441–458

    Google Scholar 

  8. Faguet JP (2004) Does decentralization increase government responsiveness to local needs? Evidence from Bolivia. J Public Econ 88(4):867–893

    Google Scholar 

  9. Garzarelli G (2004) The theory of fiscal federalism as a theory of economic organization: assessment and prospectus. Working Paper, Department of Economics, Università Degli Studi di Roma, “La Sapienza”, Roman, Italy

  10. Gong L, Zou H (2002) Optimal taxation and intergovernmental transfer in a dynamic model with multiple levels of government. J Econ Dyn Control 26(12):1975–2003

    Google Scholar 

  11. Hayek FA (1945) The use of knowledge in society. Am Econ Rev 35(4):519–530

    Google Scholar 

  12. He Q (2015) Fiscal decentralization and environmental pollution: evidence from Chinese panel data. China Econ Rev 36:86–100

    Google Scholar 

  13. Jia J, Guo Q, Zhang J (2014) Fiscal decentralization and local expenditure policy in China. China Econ Rev 28:107–122

    Google Scholar 

  14. Jin J, Zou H (2005) Fiscal decentralization, revenue and expenditure assignments, and growth in China. J Asian Econ 16(6):1047–1064

    Google Scholar 

  15. Jin H, Qian Y, Weingast BR (2005) Regional decentralization and fiscal incentives: federalism, Chinese style. J Public Econ 89(9–10):1719–1742

    Google Scholar 

  16. Li H, Zhou LA (2005) Political turnover and economic performance: the incentive role of personnel control in China. J Public Econ 89(9):1743–1762

    Google Scholar 

  17. Liberati P, Sacchi A (2013) Tax decentralization and local government size. Public Choice 157(1–2):183–205

    Google Scholar 

  18. Lin JY, Liu Z (2000) Fiscal decentralization and economic growth in China. Econ Dev Cult Change 49(1):1–21

    Google Scholar 

  19. Liu LL, Li LM (2019) Effects of fiscal decentralisation on the environment: new evidence from China. Environ Sci Pollut Res 26(36):36878–36886

    Google Scholar 

  20. Liu LL, Ding DH, He J (2019) Fiscal decentralization, economic growth, and haze pollution decoupling effects: a simple model and evidence from China. Comput Econ 54(4):1423–1441

    Google Scholar 

  21. Lockwood B (2002) Distributive politics and the costs of centralization. Rev Econ Stud 69(2):313–337

    Google Scholar 

  22. Maskin E, Qian Y, Xu C (2000) Incentives, scale economies, and organization forms. Rev Econ Stud 67(6):359–378

    Google Scholar 

  23. Montinola G, Qian Y, Weingast BR (1995) Federalism, Chinese style: the political basis for economic success in China. World Polit 48(1):50–81

    Google Scholar 

  24. Musgrave R (1959) Public finance. McGraw Hill, New York

    Google Scholar 

  25. Oates WE (1972) Fiscal federalism. Harcourt Brace Jovanovich, New York

    Google Scholar 

  26. Oates WE (2005) Toward a second-generation theory of fiscal federalism. Int Tax Public Finance 12(4):349–373

    Google Scholar 

  27. Pesaran MH (2004) General diagnostic tests for cross section dependence in panels. Cambridge Working Papers in Economics No. 0435, University of Cambridge, Cambridge, June

  28. Pesaran MH (2007) A simple panel unit root test in the presence of cross-section dependence. J Appl Econ 22(2):265–312

    Google Scholar 

  29. Qian Y, Weingast BR (1997) Federalism as a commitment to preserving market incentives. J Econ Perspect 11(4):83–92

    Google Scholar 

  30. Qian Y, Xu C (1993) Why China’s economic reforms differ: the M-form hierarchy and entry/expansion of the non-state sector. Econ Transit 1(2):135–170

    Google Scholar 

  31. Qiao B, Martinez-Vazquez J, Xu Y (2008) The tradeoff between growth and equity in decentralization policy: China’s experience. J Dev Econ 86(1):112–128

    Google Scholar 

  32. Rodden J (2003) Reviving Leviathan: fiscal federalism and the growth of government. Int Org 57(4):695–730

    Google Scholar 

  33. Rodríguez-Pose A, Sandall R (2008) From identity to the economy: analysing the evolution of the decentralisation discourse. Environ Plan C Gov Policy 26(1):54–72

    Google Scholar 

  34. Rubinfeld D (1987) Economics of the local public sector. In: Auerbach AJ, Feldstein M (eds) Handbook of public economics, vol II. Elsevier, New York

    Google Scholar 

  35. Sadorsky P (2013) Do urbanization and industrialization affect energy intensity in developing countries? Energy Econ 37(4):52–59

    Google Scholar 

  36. Shen C, Jin J, Zou H (2012) Fiscal decentralization in China: history, impact, challenges and next steps. Ann Econ Finance 13(1):1–51

    Google Scholar 

  37. Tiebout CM (1956) A pure theory of local expenditures. J Polit Econ 64(5):416–424

    Google Scholar 

  38. Turnovsky SJ, Fisher WH (1995) The composition of government expenditure and its consequences for macroeconomic performance. J Econ Dyn Control 19(4):747–786

    Google Scholar 

  39. Wang W, Zheng X, Zhao Z (2011) Fiscal reform and public education spending: a quasi-natural experiment of fiscal decentralization in China. J Fed 42(2):334–356

    Google Scholar 

  40. Weingast BR (2014) Second generation fiscal federalism: political aspects of decentralization and economic development. World Dev 53:14–25

    Google Scholar 

  41. Wooldridge J (2012) Introductory econometrics: a modern approach, 5th edn. South-Western College Publishing, Cincinnati

    Google Scholar 

  42. Wu Y, Heerink N (2016) Foreign direct investment, fiscal decentralization and land conflicts in China. China Econ Rev 38:92–107

    Google Scholar 

  43. Xu C (2011) The fundamental institutions of China’s reforms and development. J Econ Lit 49(4):1076–1151

    Google Scholar 

  44. Xu G, Wang R (2007) The effect of foreign direct investment on domestic capital formation, trade, and economic growth in a transition economy: evidence from China. Glob Econ J 7(2):1–23

    Google Scholar 

  45. Yang T (2012) Aggregate savings and external imbalances in China. J Econ Perspect 26(4):125–146

    Google Scholar 

  46. Yang Z (2016) Tax reform, fiscal decentralization, and regional economic growth: new evidence from China. Econ Model 59:520–528

    Google Scholar 

  47. Zhang T, Zou H (1998) Fiscal decentralization, public spending, and economic growth in China. J Public Econ 67(2):221–240

    Google Scholar 

Download references

Acknowledgements

We express our genuine appreciation to the Natural Science Foundation of Jiangsu Province of China (Grant No. BK20190792) for supporting this study. We also would like to thank the Journal Editor and Professor Hong Sok Brian Kim for all the support provided during the editorial process.

Author information

Affiliations

Authors

Corresponding author

Correspondence to Liangliang Liu.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Liu, L. Fiscal decentralization and the imbalance between consumption and investment in China. Ann Reg Sci 66, 1–17 (2021). https://doi.org/10.1007/s00168-020-01006-1

Download citation

JEL Classification

  • E25
  • H77