Local Public Debt and Return on Capital: Evidence from New Debt Data and the Triple Mechanism Test
JI Yunyang, MAO Jie, WEN Xueting
School of Economics and Trade, Hunan University; School of International Business and Economics, University of International Business and Economics; Taikang Asset Management Co., Ltd
Summary:
For China, preventing systemic economic risks while achieving high-quality economic development has become a general objective. Debt-financed investment by local governments is one popular tool for stabilizing economic growth and supply-side structural reform. Local government debt has been expanding on a massive scale since the 2008 financial crisis. By the end of 2019, local public debt had risen to 21.3 trillion yuan, more than double the amount in 2013. At the same time, macro returns on capital have been falling. According to the calculations of Bai Chong ’en and Zhang Qiong (2014), since 1993, China's return on capital has been on a downward trend, especially since 2008. Compared with the beginning of reform and opening up, return on capital dropped by 11.3 percentage points in 2013. To explain this, we empirically test the effect of local public debt expansion on return on capital and regional heterogeneity by using matching data on local public debt and return on capital at the prefecture-level city level, and examine the three mechanisms of the effect. In the past decade, when promoting economic development, local governments have increasingly relied on debt-based investment and financing. The resulting huge public debt greatly loosens local governments' budget constraints, but at the same time it occupies a large amount of credit capital, which will inevitably lead to capital misallocation if investment efficiency is low or other more productive types of investment are crowded out. From the perspective of the local public debt operating process (i.e., financing - investment - repayment), in the financing stage, large-scale borrowing by local governments may crowd out the credit resources of banks, thus raising the cost of credit capital of enterprises within the jurisdiction, leading to a crowding out effect. Second, in the investment stage, local government debt funds are mainly used for infrastructure construction. If infrastructure investment has low efficiency, this also indirectly indicates the low efficiency of local government debt fund expenditure. Finally, in the repayment stage, the widespread phenomenon of using land sales to pay off debts and land financing will encourage local governments to push up house prices and develop real estate; however, when capital is excessively concentrated in real estate, this will aggravate the economic structural imbalance and capital mismatch between industries. To put it simply, local public debt has an effect on capital mismatch through the crowding out of micro-enterprise investment and financing, the efficiency of infrastructure investment, and the capital concentration of real estate, and thus affects the return on capital. This paper makes three contributions to the literature. First, in terms of data, it uses matching data of the new calibre of public debt and return on capital at the prefecture level to conduct regression analysis, and provides more representative basic data for empirical analysis. Second, in terms of content, although the literature discusses various factors that affect China's return on capital, it does not consider the effect of China's expansion of local public debt on the influence of return on capital. This article makes up for this research gap and enriches the literature by identifying the influencing factors of return on capital. Third, in terms of mechanism, this paper takes capital mismatch as a logical starting point and comprehensively analyzes the intermediary mechanism of local public debt affecting the return on capital from three perspectives: the efficiency of infrastructure investment, the proportion of investment in real estate, and the crowding out effect of enterprise investment. It provides new evidence to understand the internal correlation between local public debt and return on capital. The main conclusions of this paper are as follows. First, the expansion of local public debt significantly reduces the return on capital. Second, the negative impact of local public debt on return on capital is mainly realized through three mechanisms: reducing the efficiency of infrastructure investment, increasing the proportion of real estate investment, and squeezing out corporate investment. In short, the expansion of local public debt leads to a decline in the efficiency of capital allocation. Third, the negative impact of local public debt on return on capital is more obvious in non-urban agglomerations, non-large and non-medium-sized cities, and cities with greater dependence on land financing. These conclusions are of great significance for understanding China's economic growth model, and provide policy reference for deepening the reform of the investment and financing system of local governments. In the future, we should pay greater attention to the performance management and efficiency of debt funds to promote high-quality economic development.
冀云阳, 毛捷, 文雪婷. 地方公共债务与资本回报率——来自新口径债务数据和三重机制检验的经验证据[J]. 金融研究, 2021, 492(6): 1-20.
JI Yunyang, MAO Jie, WEN Xueting. Local Public Debt and Return on Capital: Evidence from New Debt Data and the Triple Mechanism Test. Journal of Financial Research, 2021, 492(6): 1-20.
