Central-local government fiscal relations and cyclicality of public spending: Evidence from China


In this study, we analyze how fiscal decentralization affects the cyclicality of government spending. We focus on China, which experienced fiscal decentralization during 1979–1993 and then partly centralized its revenue with the 1994 fiscal reform. By employing both time series and province-level panel data, we show that Chinese provincial and total government spending was strongly procyclical during the decentralization period before the reform, but both became significantly less procyclical with respect to nationwide output fluctuations after the reform. We suggest several channels through which the procyclicality of subnational government spending in decentralized fiscal federations could be restrained. We further find that less procyclical provincial government spending is associated with smaller output volatility.

Research Highlight 2016

How can a country ‘graduate’ from procyclical fiscal policy? Evidence from China

In this study, we analyse the cyclicality of fiscal policies in China during the period 1978-2013. We find that the cyclicality of local government spending in China significantly affects the cyclicality of total government spending. We find that local budgetary government spending was strongly pro-cyclical during the 1980s, but it became counter-cyclical with respect to nationwide output fluctuations and non-cyclical with respect to region-specific output shocks in the mid-1990s. We argue that these are likely to be consequences of the 1994 fiscal reform, which revamped the fiscal relations between the central and local governments, reduced the pro-cyclicality of local government budgetary revenue and brought in counter-cyclical intergovernmental transfers. Findings of this study contribute to the debate on how developing and emerging countries, in particular those with federal fiscal structures, could reduce the pro-cyclicality of their fiscal policies.