Fiscal Decentralization or Centralization: Diverging Paths of Chinese Cities

• DOI: http://doi.org/10.1111/cwe.12282
• Date: 01 May 2019
• Author: Shiming Yang
• Published date: 01 May 2019

China & World Economy / 102–125, Vol. 27, No. 3, 2019

102

©2019 Institute of World Economics and Politics, Chinese Academy of Social Sciences

*Shiming Yang, PhD Candidate, University of Southern California, USA. Email: shimingy@usc.edu. This

article beneted from discussion during the “CIS (Center for International Studies) Working Paper Series”

seminar at University of Southern California. The author thanks the anonymous reviewers for their comments.

Fiscal Decentralization or Centralization: Diverging

Paths of Chinese Cities

Shiming Yang*

Abstract

If fiscal decentralization promotes growth, why do some regions decentralize more

than others? This article identifies the growing divergence of fiscal centralization

among Chinese cities and explains it in a public nance framework. It argues that scal

decentralization and its economy-liberalizing effect entail signicant short-term scal

risk. The more a locality relies on uncompetitive business ownership for scal revenue,

the less likely scal decentralization is to occur. This article compiles a dataset of 20

provincial capitals between 1999 and 2016 to test for the connection between a city’s tax

base and its scal centralization level. It then pairs two “most similar” cities to trace

how scal security concerns drove their scal and economic policies apart. This article

adds a micro-level perspective to the literature on scal federalism. By pointing out the

scal constraints confronting local governments, it offers a new angle to understand the

different growth paths of Chinese cities.

Key words: developing country, economic growth, scal decentralization, state-owned

enterprise

JEL codes: E62, H2, H7, O1

I. Introduction

Adjustment in intergovernmental power, usually manifested as political decentralization

or centralization, is a major topic in political science. Since the 1980s, many emerging

countries have embraced scal decentralization in the hope of spurring growth. According

to fiscal federalism theories, fiscal decentralization empowers local governments to

efciently allocate resources for growth and encourages competition across sectors and

regions. Numerous studies have explored the relationship between scal decentralization

and economic development, testing whether scal decentralization leads to efciency

gains (Martinez-Vasquez and McNab, 2003; Martinez, et al., 2018).

Fiscal Decentralization or Centralization 103

©2019 Institute of World Economics and Politics, Chinese Academy of Social Sciences

A less explored question, however, is: Why have some regions seen more fiscal

decentralization than others? Moreover, why has fiscal decentralization prompted

economic development in some regions but not others? Existing studies focused

predominantly on the consequences rather than the causes of fiscal decentralization,

and empirical studies on the growth-inducing effect of fiscal decentralization have

produced no consensus (Martinez-Vasquez and McNab, 2003). This article contends that

economies can vary markedly in their inclination toward scal decentralization, and that

the success of scal decentralization largely hinges on the local conditions before these

scal policies are implemented. Therefore, knowing when scal decentralization occurs

can help infer its effect on the local economy.

In this paper I argue that scal security concerns may inuence local government

decisions on scal decentralization. Fiscal decentralization is essentially an economy-

liberalizing policy. However, economic liberalization may introduce considerable risk

to local scal revenue. Fiscal revenue directly affects governmental operation and the

provision of public goods, and government is incentivized to choose a developmental

strategy and corresponding scal policies that guarantee the uninterrupted ow of scal

revenue. Hence, if the tax base of an economy is vulnerable to the destabilizing force of

economic liberalization, the government is more likely to choose a conservative growth

path. This paper hypothesizes that scal decentralization is less likely to occur if a given

economy’s tax revenue is primarily sourced from sectors that would be disadvantaged

by economic liberalization.

This paper studies the variation in fiscal decentralization levels across provincial

capitals in China. China has been a front-runner in the literature on scal federalism in

developing countries. Scholars have attributed China’s economic takeoff to the scal and

administrative decentralization of central to local governments, which fostered a new

group of growth-favoring “entrepreneurs” that built a market economy with Chinese

characteristics (Oi, 1995; Montinola. et al., 1996; Lin and Liu, 2000). To this day,

however, the growing divergence in scal decentralization across provincial capitals has

yet to be recognized. Indeed, these growth centers of China are supposed to see the most

scal decentralization, contrary to what we actually observe. Fiscal decentralization within

these provincial capitals, therefore, presents a micro-level picture of scal federalism thus

far absent in the literature. Moreover, unlike many studies that focused on the early stage

of China’s development (1978–2000), this article examines a more recent period starting

after the central–local revenue sharing scheme was redefined in 1994, in which local

governments and businesses face very different challenges than in the preceding period.

The contribution of this article goes beyond China and speaks to the experience

of many developing countries that have used fiscal decentralization to liberalize