In a coauthored article for The Journal of Finance, Yi Huang, Associate Professor of International Economics at the Graduate Institute, finds that in China, between 2006 and 2013, local public debt crowded out the investment of private companies by limiting their funding opportunities while keeping state-owned companies’ investment unchanged.
What made it worthwhile to write this article on the Chinese local public debt?
China reacted to the global financial crisis with a massive fiscal stimulus package, funded mainly by the issuance of local government debt and focused largely on public investment. This surge in investment was achieved by injecting enormous financial resources into state‐owned firms: the leverage of state‐owned manufacturing firms rose from 57.5% during the first quarter of 2008 (pre- crisis) to 61.5% in the first quarter of 2010, while for private‐sector manufacturing firms, it slipped from 59% to 57%.
Most studies have addressed the financial stability implications of these policies, but our paper is the first to explore the real effect of the stimulus by focusing on firm investment, and to take into account the fact that the stimulus was largely funded via the issuance of local government debt.
Based upon this new approach, what contributions does your article make to the literature on the effect of government debt on investment and growth?
At first glance, the fiscal stimulus after 2009 was a resounding success – China escaped the Great Recession and became one of the main drivers of world economic growth. However, our estimates suggest that the massive increase in local government debt had an adverse impact on investment by private manufacturing firms. As these firms are much more productive than their state‐owned counterparts, this reallocation of investment from the private to the public sector could undercut China’s long‐run growth potential, especially in the regions in which local governments issued the largest amount of debt.
Most of the existing literature has focused on how government spending can crowd out investment by increasing interest rates. This is the first paper to explore crowding out due to credit rationing, due to the presence of financial frictions and market segmentation in China’s capital markets.
What are the implications of your findings within the context of the sovereign-bank nexus in China and beyond?
By increasing the share of public debt in banks’ asset portfolios, this policy strengthened the bank‐sovereign nexus in China, which creates the potential for serious risks to systemic stability in the future, as the euro-area sovereign debt crisis has forcefully demonstrated.
Lastly, how was your experience of working with different academic economists on this article?
In economics, we believe in the efficiency gains from the division of labor and teamwork. I much appreciated and learned a lot by collaborating with global experts in economics such as my two senior coauthors as well as with junior researchers around the world. So far, I have been working not only with economists but also with scholars in the areas of data science, marketing and politics.
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Full citation of the article:
Huang, Yi, Marco Pagano, and Ugo Panizza. “Local Crowding‐Out in China.” The Journal of Finance 75, no. 6 (December 2020): 2855–98. https://doi.org/10.1111/jofi.12966.
Interview by Buğra Güngör, PhD Candidate in International Relations and Political Science; editing by Nathalie Tanner, Research Office.
Banner picture: excerpt from an image by WHYFRAME/Shutterstock.com.