Exploring Local Government Financing Strategies in China: A Capital Structure Perspective

Abstract

This study analyzes how local governments use external financing instruments to adjust their capital structure. External financing instruments (public debt and public-private partnership [PPP]) have become critical options for most local governments to deal with budget constraints. We construct an indicator of the external financing ratio (EFR) to measure local governments’ dependency on external financing instruments. Based on the pecking order and tradeoff capital structure theories, we utilize city-level panel data in China between 2015 and 2019 to investigate the financing strategies of local governments. We report two main findings. First, the financing strategies of China’s local governments follow the pecking order theory. In other words, internal financing has priority over debt and then PPP. Second, consistent with the tradeoff theory, China’s local governments continuously adjust to a target EFR. In addition, compared with debt financing, the adjustment of PPP financing is relatively inelastic. Our study emphasizes the importance of public financial management reinforced by local governments to prevent fiscal risks in the context of intensified financial stress.

Keywords:

• Capital structure
• debt
• local government finance
• public-private partnership

Acknowledgments

We would like to thank three anonymous referees and Kaifeng Yang (Editor-in-Chief) for their helpful comments and suggestions. We owe special thanks to Ying Yin for her assistance in the literature collection.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Additional information

Notes on contributors

Shikun Qin

Shikun Qin is a PhD candidate at the Central University of Finance and Economics. His primary field of research is public budgeting and finance, in particular how local governments respond to fiscal stress. He has published in journals such as Journal of Chinese Political Science, Applied Economics Letters, etc.

Weijie Luo

Dr. Weijie Luo is an associate professor in economics at the Central University of Finance and Economics (CUFE). Prior to joining CUFE, Dr. Luo was a visiting researcher in economics at the University of Cambridge, and worked as an associate lecturer in economics at the University of York, where he completed his PhD in economics. His research interests are in macroeconomics, political economy and economic policy. His research work has been published in journals such as Economics Letters, Pacific-Basin Finance Journal, Scottish Journal of Political Economy, etc. He is currently serving as an anonymous referee in journals such as International Review of Financial Analysis, North American Journal of Economics and Finance, World Development, etc.