After the Tax-Sharing Reform in 1994, the debt governance of Chinese local government has been characterized by tool innovation, administrative mobilization, and credit allocation, forming the overall incentive-oriented governance mode centered over economic construction. Debt financing incentives have become an indispensable theoretical part of interpreting the Chinese miracle.

As socialism with Chinese characteristics has entered a new era, the economy has shifted from high-speed growth to high-quality development, with the connotation of debt governance of local government undergoing profound change towards a people-centered and performance-oriented governance mode gradually and steadily. Following the new governance concept of harmony, sharing, and coordination, China will continue to lead the local government debt governance in the new era by relying on its institutional advantages, and maintain the strategic focus of supply-side structural reform to ensure high-quality and sustainable economic development.

I. Historical orientation of local government debt governance

The debt governance of local government originated from the Tax-Sharing Reform in 1994. The Tax-Sharing Reform implants the institutional arrangement of upward transfer of financial power and delegating to the local government of administrative power into the vertical decentralization of authority framework, guaranteeing the strategic public goods supply concerning overall development and providing financial support for the coordinated development of regions. However, the imbalanced vertical decentralization of authority framework leads to a mismatch of local fiscal revenues and expenditures, which in turn has put the grassroots governments under severe pressure of levying due to the demonstration extension effects of the sub-provincial system design. To alleviate the difficulties of local fiscal revenue and expenditure and guide local governments to actively engage in economic construction, China has developed the incentive-oriented traditional debt governance mode, which has effectively guaranteed the public investment strength in the stage of high economic growth.

Specifically, the incentive-oriented debt governance mode mainly expands off-balance-sheet financing channels for local governments to engage in construction and pursue development by setting up local financing platform companies. Different from Western countries, the heads of financing platforms are generally selected from the reserve cadres of local Party and government offices rather than appointed from professional managers, which makes the financing tool innovation of Chinese local governments more equipped with the administrative mobilization ability of endogenous institution.

To encourage platform companies to raise construction funds, China has further introduced a competition mechanism into a decentralized framework, to determine the political promotion prospects of local officials by financing capacity and economic performance. Driving debt competition with political achievements has become a typical institutional feature of the traditional debt governance mode. Based on the development strategic consensus, local governments at all levels compete to obtain credit resources through platform companies and concentrate efforts on supporting municipal project construction. The financing platform lending has broken through the bottleneck of infrastructure construction in a rapid growth stage and accumulated lots of public assets with medium and long-term return potential, bringing about moderately advanced and well-equipped infrastructure for China against other emerging markets.

The trinity of tool innovation, administrative mobilization, and credit allocation has shaped the incentive-oriented debt governance mode for a big country. From the perspective of governance efficiency, the incentive-oriented governance mode makes China a large developing country marked by public investment, which can effectively concentrate social idle resources and achieve inter-period allocation and intergenerational equity of infrastructure costs. Infrastructure construction has promoted the cross-regional flow of labor, capital, and other production factors, continuously improving the efficiency of market resource allocation. Embraced by institutional advantages, the incentive-oriented governance mode not only creates conditions for regional connectivity but also provides counter-cyclical operation space during the financial crisis impact period, sustaining the high economic growth of large developing countries from the demand side. Debt financing incentives in the framework of decentralized governance have become an indispensable theoretical content to construe the Chinese miracle.

II. Institutional transformation of local government debt governance

Incentive and control are always two sides of the system design. While acknowledging the historical contribution of the traditional mode, we should also be soberly aware that the incentive-oriented governance mode, after all, has excluded local debt financing from budget supervision for a long time, implying moral risks and mismatch distortions induced by soft budget constraints. Specifically, the mismatch distortion is highlighted in time and space dimensions.

First, in the temporal dimension, since the tenure of local officials in a given jurisdiction may not overlap with the debt service period of the off-balance-sheet loans, the maturity mismatch prompts local officials to borrow large sums off-balance-sheet debts during their tenure in the hope of increasing the probability of political promotion. Secondly, in the spatial dimension, due to the inter-governmental credit endorsement implied in the incentive-oriented governance mode, the inland provinces that are farther away from the eastern coastline tend to have a stronger preference for debt financing.

In view of the double mismatch distortion implied in the traditional governance mode, after the socialism with Chinese characteristics has entered a new era, the central government has explicitly stripped the government financing function of local platform companies, banned inter-government credit endorsement under the principle of no bailout, and granted provinces (municipalities and autonomous regions) the right to issue bonds and finance on the balance sheet according to the new Budget Law.The inclusion of local government debt into ceiling budget management has three important implications, first, to remove data constraints, promote financial transparency, and curb the disorderly expansion of debt scale; second, to regulate borrowing behaviors to avoid excessive concentration of debt financing; third, to innovate the development concept by incorporating financing risks and investment performance into a new system for government performance appraisal.

The intensive introduction of regulatory measures indicates that, as China's economy shifts from high-speed growth to high-quality development, local government debt governance will be transformed from the traditional economy-centered and incentive-oriented governance mode to a new people-centered and performance-oriented one in line with the trend. The transformation of governance orientation further highlights the institutional advantages of socialist power. In the transformation process, China has systematically promoted the pilot expansion of bond issuance by local government, effectively maintaining economic security and social stability. Promoting governance transformation with the people as the center and giving full play to the capacities of intergovernmental organizations, mobilization and coordination have become an important experience for China to achieve win-win combat on stabilizing growth and preventing risks, with global significance for emerging markets in coping with the crisis impact.

III. Connotation of local government debt governance

We should grasp the strategic connotation of local government debt governance in the new era and provide a decision-making basis for the performance-oriented governance mode. The people-centered local government debt governance in the new era is materialized as harmony, people's wellbeing, sharing, and coordination.

First, aiming to balance economic incentive and risk control, harmonious governance not only focuses on making up development weakness and correcting allocation distortion with debt financing but also firmly establishes bottom-line thinking, to fight against major risks and ensure economic security and social stability. This requires, on the one hand, insistence on opening the front door to guide debt funds to follow the project and ensure the balance between project income and financing. On the other hand, we should exert to close the back door to prohibit local governments from deriving generic off-balance sheet debts through illegal channels to undermine the security of financial operations.

Second, the governance of the people's livelihood emphasizes the structure optimization of debt investment, expanding from the accumulation of public capital that the old infrastructure relied on to human capital, scientific and technological capital, and ecological capital fields. Among them, the construction of livelihood projects such as health and education undertakings is to prove workers' health literacy and knowledge and skills; Investment in new infrastructure, including digital transformation and smart upgrading, etc, fosters new growth impetus and creates new job opportunities. Special plans for environmental improvement and ecological restoration promote energy conservation, emissions reduction, and cleaner production and improve people's wellbeing. The strategic expansion in the field of debt investment reflects the new development concept of people-oriented and drives the virtuous cycle of government debt and economic development.

Third, sharing governance will play the institutional advantages of the socialist system for ensuring the whole country works together and promote national regional integration through vertical interactive decision-making to achieve inclusive and shared development in all regions. Under the decentralized governance framework, the central government selects treasury bond investment projects and guides local governments to allocate debt financing to major livelihood projects, coordinated development of regional growth poles and whole industrial chain layout, etc. Based on resource endowments, people's livelihood needs, and financial conditions, local governments establish screening and withdrawing mechanisms for debt investment projects, explore institutional systems and path models for regional integrative development, and gradually realize development convergence over regional connectivity.

Fourth, collaborative governance requires breaking down the barriers of departments, institutions, and disciplines and gathering wisdom in government, enterprises, and academia to exert policy synergy. Given the transmission and transfer of debt risks in the entity sector, finance and financial institutions should strengthen management synergy and increase the effectiveness of the macro-policy adjustment. With the orderly improvement of budget transparency, the big data monitoring platform running through local governments below the provincial level will promote the hierarchical linkage management on debt risks. Research institutes, rating agencies, and university think tanks should carry out independent evaluations to further broaden the horizon of social supervision and boost the implementation of performance accountability mechanisms.

In recent years, local governments have completed the ice-breaking move by issuing debt and liberalizing the right of all provinces, municipalities directly under the central government, and autonomous regions on issuing bonds and financing. To adapt to the transformation of the real economy from high-speed growth to high-quality development, local government debt governance has gradually become standardized, transparent and institutionalized. Leading local government debt governance in the new era with the advantages of the socialist system is not only a practical demand to deepen the supply-side structural reform and continue to release the dividends of deep-water reform but also an integral requirement to improve the decentralized governance framework among governments and promote the modernization of national governance system and governance capacity.

Source: Official account of Social Sciences in China Press

Source: Chinese Social Sciences Today