DP11489 Local Crowding Out in China

Author(s): Yi Huang, Marco Pagano, Ugo Panizza
Publication Date: September 2016
Date Revised: February 2019
Keyword(s): China, credit constraints, Crowding out, investment, Local public debt
JEL(s): E22, H63, H74, L60, O16
Programme Areas: Financial Economics, International Macroeconomics and Finance, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11489

In China, local public debt issuance between 2006 and 2013 crowded out investment by private manufacturing firms by tightening their funding constraints, while it did not affect state-owned and foreign firms. Using novel data for local public debt issuance, we establish this result in three ways. First, local public debt is inversely correlated with the city-level investment ratio of domestic private manufacturing firms. Instrumental variable regressions indicate that this link is causal. Second, local public debt has a larger negative effect on investment by private firms in industries more dependent on external funding. Finally, in cities with high government debt, firm-level investment is more sensitive to internal funding, also when this sensitivity is estimated jointly with the firm's likelihood of being credit-constrained. Altogether, these results suggest that the massive public debt issuance associated with the post-2008 fiscal stimulus curtailed private investment thus weakening China's long-term growth prospects.