Comment on “Fiscal Prudence and Growth Sustainability: An Analysis of China's Public Debts”

• Date: 01 December 2012
• Published date: 01 December 2012
• Author: Chi Hung Kwan
• DOI: http://doi.org/10.1111/j.1748-3131.2012.01235.x

Comment on “Fiscal Prudence and Growth

Sustainability: An Analysis of China’s

Public Debts”

Chi Hung KWAN†

Nomura Institute of Capital Markets Research

JEL codes: H61, H63, H74

Fan and Lv (2012) have convincingly argued that China’s public debt, including borrow-

ings by local governments, is relatively small and manageable. They have also correctly

pointed out that over the last 10 years, while debt owed by local governments has surged,

the government’s contingent liabilities, which take into account the need to use public

funds to bail out state-owned banks with large nonperforming loans, have declined

sharply. I have little disagreement with Fan and Lv’s conclusions, and my comments,

which cover four major issues, are meant to clarify some details.

My first comment relates to centralization versus decentralization. Fan and Lv argue

that China has a centralized fiscal system (de jure) based on the facts that top local offi-

cials are appointed by the central authority, tax revenues largely accrue to the central

government, and the central government monopolizes the right to issue debt to the

public. However, some economists have argued that China has a decentralized system (de

facto) based on the facts that local government expenditures are very large relative to the

central government expenditure, formula-based equalization transfers are relatively

small, revenues from land sales make up a large share of total local government revenues,

and borrowing by local government “financing platforms” helps to fund infrastructure

projects. Even if we accept that China has a centralized fiscal system,based on the case of

Japan, which has a centralized fiscal system but is running one of the largest budget defi-

cits in the world, I still have some doubts about whether centralization necessarily means

fiscal prudence (small budget deficits and public debt) as argued by Fan and Lv.

There is also a debate over whether decentralization favors economic growth. On the

pro side, fiscal decentralization promotes competition among local governments, and it

acts as a major force of economic development in China. On the con side, fiscal decen-

tralization fragments the national market, encourages local protectionism, induces

duplicated investment, and, hence,negatively affects economic growth.

Second, I would put more emphasis on land prices and pension liabilities as major

determinants of fiscal balances and, thus, the size of the public debt. A fall in land prices

affects the fiscal position of local governments in the following two ways. On the one

hand, it leads to a decline in their revenue, since proceeds from land sales are a major

source of revenue for local governments. On the other hand, some local government

†Correspondence: Chi Hung Kwan, Nomura Institute of Capital Markets Research,Urbannet Ote-

machi Building, 2-2-2, Otemachi, Chiyoda-ku, Tokyo 100-8130, Japan. Email: s-kan@nicmr.com

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doi: 10.1111/j.1748-3131.2012.01235.x Asian Economic Policy Review (2012) 7, 221–222

© 2012 The Author

Asian Economic Policy Review © 2012 Japan Center for Economic Research 221