fiscal decentralization and economic growth in china, 1994–2002
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Fiscal Decentralization and EconomicGrowth in China, 1994–2002Ying Ding aa Graduate School of Economics , Osaka University , JapanPublished online: 06 Feb 2008.
To cite this article: Ying Ding (2007) Fiscal Decentralization and Economic Growth inChina, 1994–2002, Journal of Chinese Economic and Business Studies, 5:3, 243-260, DOI:10.1080/14765280701656682
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Journal of Chinese Economic and Business Studies
Vol. 5, No. 3, 243–260, November 2007
Fiscal Decentralization and EconomicGrowth in China, 1994–2002
YING DINGGraduate School of Economics, Osaka University, Japan
ABSTRACT The question of whether fiscal decentralization has affected economic growth sincethe 1994 fiscal reform in China is interesting to both policy makers and economists. Using asimple model of endogenous growth that incorporates spending by different levels of government,and a panel data set for 30 provinces for the period of 1994–2002, this paper finds that fiscaldecentralization contributes significantly to economic growth. This finding is consistent with thetheoretical prediction that fiscal decentralization can increase economic efficiency. In addition,this paper attempts to investigate how the relationship between fiscal decentralization andprovincial growth differs in the different regions considered. For this purpose, the 30 Chineseprovinces and regions are categorized into three conventional economic belts that comprise theeastern, central, and western areas. This study finds that the effects of fiscal decentralization oneconomic growth vary among these three regions.
KEY WORDS: Fiscal decentralization, economic growth, Chinese economy
JEL CLASSIFICATIONS: E62, H2, H5, O4, R5
Introduction
Many countries have embarked on various types of fiscal decentralization, which isseen as a means of enhancing the efficiency of government and promoting economicdevelopment (Oates, 1993). In particular, the effect of fiscal decentralization oneconomic growth has been a key topic of a number of conventional theoreticalstudies and recent empirical studies in the field of economics.
Some studies have tried to test the effect of fiscal decentralization on economicgrowth empirically. For example, using a province-level panel data set for China forthe period of 1978–1992, Zhang & Zou (1998) found that fiscal decentralizationreduces provincial economic growth. Davoodi & Zou (1998) examined a panel dataset for 46 developing and developed countries covering the period 1970–1989 andfound a negative relationship between fiscal decentralization and economic growthfor developing countries but no relationship for developed countries. Using a time-series data set for the United States covering the period of 1948–1994, Xie et al.(1999) showed that further fiscal decentralization may be detrimental to growth. Incontrast, Lin & Liu (2000) examined a province-level panel data set for China
Correspondence Address: Ying Ding, Graduate School of Economics, Osaka University, 1-7
Machikaneyama-cho, Toyonaka, Osaka 565-0043, Japan. Email: [email protected]
1476-5284 Print/1476-5292 Online/07/030243–260 � 2007 The Chinese Economic Association-UK
DOI: 10.1080/14765280701656682
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covering the period 1970–1993 and suggested that fiscal decentralization makes apositive contribution to the growth process. Akai & Sakata (2002) considered a dataset for the United States for the period 1992–1996 and found that fiscaldecentralization contributes to economic growth. Jin & Zou (2005) used a paneldata set for China covering the period 1979–1999. They find that provincialeconomic growth is negatively associated with expenditure decentralization andpositively associated with revenue decentralization in the 1979–1993 phase. However,they show that the provincial economic growth rate has no statistically significantassociation with expenditure decentralization and is negatively (rather thanpositively) and highly significantly associated with revenue decentralization in the1994–1999 phase.
Notwithstanding the large number of existing studies on Chinese fiscaldecentralization, an important aspect of this process, namely the fiscal reforminitiated in 1994, has not been examined adequately. Hence, this study aims toidentify the true effect that fiscal decentralization has had on economic growth sincethe 1994 fiscal reform, and it proposes an appropriate measurement method for thispurpose.
In China, a fiscal decentralization policy was initially implemented in 1980, but itsdetails have changed many times, and a clear departure from the previous approachoccurred in 1994 (Bahl, 1999).1 Since the 1994 fiscal reform, the role played by fiscaldecentralization in Chinese economic growth has not been adequately examined.Based on a data set for 30 provinces for the period of 1994–2002 and appropriatedefinitions of fiscal decentralization in China, this paper investigates the real effect offiscal decentralization.2 The results indicate that fiscal decentralization contributedto economic growth during this period, which is consistent with relevant theoreticalpredictions.
Measurement of Fiscal Decentralization
As fiscal decentralization is multidimensional, there are many facets of a country’sfiscal affairs that can be decentralized, to various degrees. For this reason, it isdifficult to capture all aspects of fiscal decentralization. In general, in the field ofeconomics, fiscal decentralization is interpreted as the devolution of the fiscalresponsibilities of a central government to local governments (Akai & Sakata, 2002).
Some of the existing approaches for measuring Chinese fiscal decentralizationinclude the following. Zhang & Zou (1998) measured fiscal decentralization as therelative government spending by the central and local governments. Lin & Liu (2000)measured the degree of fiscal decentralization as the marginal retention rate of thebudgetary revenue collected locally by provincial governments. Ma (1997) measuredthe degree of fiscal decentralization as the average share of the governmentalbudgetary revenue retained by a province. Although such proxies are appealing, theyhave failed to capture the character of fiscal decentralization as it has occurred sincethe fiscal reform of 1994, in that this reform eliminated the variation in the shares ofbudgetary revenue that are retained by provincial governments. Jin & Zou (2005)used both provincial expenditures and total revenue shares as proxies for fiscaldecentralization.
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This study measures fiscal decentralization from the perspectives of bothexpenditure decentralization and revenue decentralization. This paper employs sixalternative decentralization indicators: (1) the amount of consolidated provincialspending relative to that of consolidated central spending (DCCS); (2) the amount ofprovincial budgetary spending relative to that of central budgetary spending(DCBS); (3) the amount of provincial extra-budgetary spending relative to that ofcentral extra-budgetary spending (DCEBS); (4) the amount of consolidatedprovincial revenue relative to that of consolidated central revenue (DCCR); (5) theamount of provincial budgetary revenue relative to that of central budgetary revenue(DCBR); and (6) the amount of provincial extra-budgetary revenue relative to thatof central extra-budgetary revenue (DCEBR).
Changes in the Fiscal Decentralization of China
Overall Fiscal System
Between 1980 and 1993, the central and provincial fiscal relationship was theso-called ‘fiscal contraction system’ (caizheng chengbao zhi). Under the fiscalcontraction system, the intergovernmental fiscal relationship was based on a complexset of negotiated contracts. The revenue system was subsequently modified in 1985and in 1988.
Beginning in 1994, the ‘fiscal contraction system’ was replaced by the ‘separatingtax system’.3 An important difference from the previous reform was that fiscalassignments were explicit in the tax regulations and were not subject to negotiation(Arora & Norregaard, 1997). Provincial governments have relied more on their ownrevenue since the 1994 fiscal reform, and the clear delineation of revenue assignmenthas been expected to impose greater discipline on all levels of government withregard to their spending decisions. As a result, the central-local governmentrelationship has become more transparent, and each level of government has becomemore accountable.
The Changing Nature of Fiscal Spending by the Central and Local Governments
In China, official government spending (revenue) may be divided into threecategories: budgetary spending (revenue), extra-budgetary spending (revenue), andconsolidated spending (revenue), which is the sum of budgetary and extra-budgetaryspending (revenue) (Zhang & Zou, 1998).4
From the perspectives of budgetary, extra-budgetary, and consolidated spending,Figure 1 illustrates the changing nature of the fiscal spending of the central and localgovernments. The ratio of provincial budgetary spending to total budgetaryspending rose from 52.6% in 1978 to 69.29% in 2002, due to the revision of therevenue system. Moreover, the share of revenue retained by the provinces rose in1985, and the share of provincial spending also rose thereafter.5
The ratio of central and provincial extra-budgetary spending to total extra-budgetary spending rose from 59.1% in 1982 to 91.61% in 2002. In 1993 and 1996,the scope of extra-budgetary spending changed and was no longer consistent withthat of previous years. The development of extra-budgetary financing indicates the
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tolerance of the central government toward the initiatives of the provinces withrespect to the provision of local public services.
The ratio of consolidated provincial spending to consolidated total spending rosecontinuously after 1985. The share of provincial spending was observed to increasedistinctly following the 1994 fiscal reform.
The Changing Nature of the Fiscal Revenue of the Central and Local Governments
One of the goals of the 1994 fiscal reform was to increase the amount of centralgovernment revenue relative to that of total budgetary revenue. Figure 2 illustratesthe changing nature of the fiscal revenue of the central and local governments. Theratio of central fiscal budgetary revenue to total budgetary revenue rose from 22% in1993 to 55% after 1994.6 Figure 2 illustrates that the 1994 fiscal reform increased therelative importance of the central government. However, the share of consolidatedprovincial revenue still exceeds that of consolidated central government revenue.
Fiscal Decentralization from the Provincial Perspective
During the period from 1994 to 2002, great variations in fiscal decentralization couldbe observed across the provinces. As presented in Table 1, the average ratio of
Changes in central and provincial fiscal spending
0
10
20
30
40
50
60
70
80
90
100
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
year
Source: China Statistical Yearbook (various issues).
Sha
re
central budgetary spending provincial budgetary spendingcentral extra-budgetary spending- provincial extra-budgetary spendingcentral consolidated spending provincial consolidated spending
10
20
Figure 1. Spending shares
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consolidated provincial government expenditure to consolidated central fiscal
expenditure (DCCS) was only 1.48% in Xizang but was 28% in Guangdong. The
average ratio of provincial budgetary spending to central budgetary spending
(DCBS) was 0.40% in Ningxia, compared with 7.27% in Guangdong. The average
ratio of provincial extra-budgetary spending to central extra-budgetary spending
(DCEBS) also differed greatly across the provinces. For example, that of Qinghai
was 2.64%, while that of Guangdong was 95.62%.An even greater difference across the provinces occurred with respect to revenue.
For example, the average ratio of consolidated provincial government revenue to
consolidated central government revenue (DCCR) was only 0.35% in Qinghai but
was 53.63% in Beijing. The average ratio of provincial budgetary revenue to central
budgetary revenue (DCBR) was 0.24% in Qinghai, compared with 12.48% in
Guangdong. The average ratio of provincial extra-budgetary revenue to central extra-
budgetary revenue (DCEBR) was 2.41% in Qinghai but was 107.63% in Jiangsu.The above discussion suggests that the 1994 fiscal reform in China precipitated
fiscal decentralization with regard to both spending and revenue. After the reform
Changes in central and provincial fiscal revenue
0
10
20
30
40
50
60
70
80
90
100
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
year
Sha
re
central budgetary revenue provincial budgetary revenuecentral extra-budgetary revenue- provincial extra-budgetary revenue-central consolidated revenue provincial consolidated revenue
Source: China Statistical Yearbook (various issues).
Figure 2. Revenue shares
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was implemented in 1994, the provincial share of fiscal spending increased. Inaddition, fiscal decentralization varied both across time and across the provinces.
Empirical Analysis
Empirical Model
Following Davoodi & Zou (1998), the growth regression may be written as follows:7
Git ¼ �i þ �t þ �1Decentralizationit þ �ixit þ uit ð1Þ
where
i¼ provincial index, where i¼ 1, . . . , 30,t¼ time index, where t¼ 1, . . . , 9,
Git¼ growth rate of the gross provincial product during 1994–2002,�i¼ vector of i-1(¼29) provincial fixed-effects (provincial dummies),
Table 1. Fiscal decentralization by province, 1994–2002
Province DCCS DCBS DCEBS DCCR DCBR DCEBR
Beijing 10.28 2.53 44.74 53.63 4.27 43.27Tianjin 5.01 1.27 18.07 23.48 1.93 16.50Hebei 11.34 2.76 46.34 5.53 3.68 43.27Shan xi 6.84 1.54 34.79 3.41 1.91 33.71Neimenggu 5.72 1.60 13.67 1.92 1.38 12.96Liaoning 14.70 3.60 59.34 7.37 4.97 57.01Jilin 6.82 1.75 23.97 2.67 1.73 22.47Heilongjiang 9.54 2.48 31.88 4.09 2.91 29.58Shanghai 14.56 3.96 43.63 8.65 7.10 44.81Jiangsu 18.45 3.79 118.59 10.48 5.93 107.63Zhejiang 14.12 2.79 91.42 8.12 4.31 84.73Anhui 8.76 2.09 39.05 4.19 2.65 36.20Fujian 10.58 2.24 62.65 5.96 3.45 58.68Jiangxi 6.64 1.57 31.48 3.03 1.79 29.62Shandong 18.21 4.13 94.90 9.97 6.32 88.45Henan 12.50 2.95 60.55 5.98 3.72 55.42Hubei 9.70 2.45 39.93 4.54 3.04 38.71Hunan 11.28 2.47 62.55 5.33 2.92 56.29Guangdong 28.00 7.27 95.62 16.23 12.48 95.65Guangxi 8.00 1.89 35.53 3.74 2.24 34.02Hainan 2.02 0.51 7.34 0.98 0.69 6.82Sichuan 14.34 3.35 65.77 6.83 4.06 62.10Guizhou 4.79 1.30 14.05 1.78 1.22 13.46Yunnan 10.86 3.03 27.36 3.90 2.88 25.89Xizang 1.48 0.48 0.62 3.05 0.77 0.66Shanxi 6.28 1.62 22.97 2.55 1.68 21.28Gansu 4.40 1.19 13.39 1.50 0.98 12.16Qinghai 1.52 0.44 2.64 0.35 0.24 2.41Ningxi 1.47 0.40 4.21 0.47 0.31 3.88Xinjiang 5.24 1.36 17.73 1.93 1.19 17.19
Sources: China Statistical Yearbook (various issues); Finance Year Book of China, 1995–2004.
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�t¼ year dummies,uit¼ error term, which is assumed to be normally distributed,xit¼ set of controls variables for provincial investment, the labor
force growth rate, the degree of openness, and provincialinflation.
Decentralization¼ vector of fiscal decentralization measures for expendituredecentralization and revenue decentralization: DCCS, DCBS,DCEBS, DCCR, DCBR, and DCEBR.
Data and Variables
The empirical estimation uses annual data for the period of 1994–2002 for 30Chinese provinces. The dependent variable is the growth rate of the gross provincialproduct, measured as an annual percentage and denoted by G. Following Zhang &Zou (1998, 2005), the independent variables are defined as in Table 2.
First, the six indicators of fiscal decentralization are introduced into the regressionas alternative independent variables to test the effect of fiscal decentralization oneconomic growth; the effect of fiscal decentralization on economic growth is ofprimary concern. The economic theory developed by Oates (1993) predicts that fiscaldecentralization should contribute to economic growth; that is, this paper expects�1>0.
Table 2. Variable definitions
Independent Variable Definition
DCCS Degree of fiscal decentralization, measured as the ratio ofconsolidated provincial spending to consolidated central spending.
DCBS Degree of fiscal decentralization, measured as the ratio of provincialbudgetary spending to central budgetary spending.
DCEBS Degree of fiscal decentralization, measured as the ratio of provincialextra-budgetary spending to central extra-budgetary spending.
DCCR Degree of fiscal decentralization, measured as the ratio ofconsolidated provincial revenue to consolidated central revenue.
DCBR Degree of fiscal decentralization, measured as the ratio of provincialbudgetary revenue to central budgetary revenue.
DCEBR Degree of fiscal decentralization, measured as the ratio of provincialextra-budgetary revenue to central extra-budgetary revenue.
OPEN Degree of openness of the provincial economy, measured as the shareof the total volume of foreign trade (the sum of exports andimports) in provincial income.
I Growth ratio of fixed asset investment.CT Effects of distortion at the national level. These are the same in all
provinces and are measured as central tax revenues, as apercentage of total GDP.
PT Effects of distortion at the provincial level, measured as provincial(collected) tax revenues, as a percentage of total provincial GDP.
R Inflation rate, measured as the overall retail price index in eachprovince.
POP Growth rate of the population.
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Second, two tax variables (CT and PT) are employed to examine the effect of taxdistortions created by the central and provincial governments. Tax rates are used asaggregate measures of the distortions introduced by the governments in financingtheir spending (Zhang & Zou, 2005). It is expected that higher tax rates correspondto greater economic distortions by the fiscal system (Barro, 1990).
This set of control variables is consistent with the set of variables used by Zhang &Zou (1998). The control variables used in this paper include: (1) physical and humancapital investments, measured as the growth rate of fixed asset investment (I); and (2)the growth rate of the population (POP). So that the results are robust acrossdifferent specifications of the regression equations, the growth rate of the populationis used as an explanatory variable in a sensitivity analysis.
Another important determinant of growth is openness to international trade,which is measured as the ratio of imports plus exports to GDP at the provincial level.It is conventional to hypothesize that a positive relation exists between openness andgrowth, on the grounds that international competition improves resource allocationvia exports and that more advanced technology from industrialized countries can beobtained via imports (Feder, 1983).
This paper incorporates the potential effect of macroeconomic instability oneconomic growth by using the inflation rate (R) at the provincial level as a proxy forthis variable. Inflation can have either a positive or a negative effect on growth(Zhang & Zou, 2005).
All the data used in this paper are from the following sources: the China StatisticalAbstract 1995–2003; the China Statistical Yearbook (various issues); ComprehensiveStatistical Data and Materials on 50 Years of New China; and the Finance YearBook of China, 1995–2004.8
As the scope of extra-budgetary spending and revenue changed in 1996, it wasthereafter not comparable with that of earlier years. Therefore, a subset of the paneldata set used contains extra-budgetary spending and revenue indices (DCEBS,DCEBR) for the period from 1997 to 2002. Thus, the panel data set for the 30provinces covers the periods of 1994–2002 and 1997–2002 separately, although thesame methodology is used in each case.
These variables are included in the regressions in logarithmic form after beingtransformed via natural logarithms.9
A potential source of bias is the presence of multicollinearity in the data. Table 3presents the correlations among the independent variables. It is apparent that the sixalternative decentralization indicators are highly correlated with each other.However, the other independent variables are less correlated.
Results
Basic Results for the Nation
The results for the six different indicators of fiscal decentralization are presentedin Table 4 (all the variables are transformed using natural logarithms). Theprimary finding is that the provincial economic growth rate has a positive andstatistically significant association with the estimated coefficient on fiscaldecentralization. That is, the results suggest that further expenditure and revenue
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decentralization should promote growth. It is important to note that this findingis consistent with the theoretical prediction of Oates (1993), and with theempirical results of Akai & Sakata (2002). It contradicts Zhang & Zou’s (1998)result, and this difference may stem from the fact that they used a differentsample period. Because different periods should be characterized by differentfiscal reforms, the sign of the effect of such reforms is likely to differ acrossperiods. The results of this paper also contradict those of Jin & Zou (2005). Inthis case, the difference arises because these authors used both a different dataset and different fiscal decentralization indicators.10
The first column of Table 4 reveals that fiscal decentralization (DCCS) has apositive effect on economic growth. To test the robustness of the regression results,models that omit POP are also estimated (Column 2 of Table 4); however, theestimates hardly vary in this case. In terms of the same indicator (DCCS) for the1997–2002 period (Columns 9 and 10 of Table 4), the effect of fiscal decentralizationon growth remains positive and highly statistically significant. Thus, these regressionresults are robust.
Columns 3 and 4 of the table report that the indicator DCBS has a positive andsignificant effect on economic growth. A similar effect is found for the extra-budgetary expenditure decentralization indicator DCEBS, although the associationis weaker than for DCCS and DCBS. A possible explanation for this difference isthat the amount of budgetary expenditure exceeds extra-budgetary expenditurein China.
Columns 5, 6, 11, and 12 present the results for the revenue decentralizationindicator DCCR for the periods of 1994–2002 and 1997–2002; they indicate thatrevenue decentralization has a positive and significant effect on economic growth.For the other revenue decentralization indicators, DCBR (Columns 7 and 8) andDCEBR (Columns 15 and 16), the estimation results hardly vary.
The effects of the control variables are also as expected. The investment rateexhibits a positive association with economic growth. This means that investment
Table 3. Correlations among the independent variables
Variable DCCS DCBS DCEBS DCCR DCBR DCEBR CT R OPEN I PT POP
DCCS 1.000
DCBS 0.966 1.000
DCEBS 0.742 0.547 1.000
DCCR 0.910 0.877 0.697 1.000
DCBR 0.923 0.945 0.613 0.910 1.000
DCEBR 0.747 0.589 0.983 0.714 0.624 1.000
CT �0.116 �0.083 �0.028 �0.132 �0.063 �0.127 1.000
R 0.031 0.007 �0.340 �0.068 �0.058 �0.319 �0.427 1.000
OPEN 0.519 0.573 0.244 0.566 0.691 0.258 0.006 0.036 1.000
I 0.057 0.061 0.010 0.060 0.042 0.036 �0.077 �0.011 �0.057 1.000
PT �0.076 �0.067 �0.059 0.022 0.094 �0.056 �0.042 0.074 0.047 0.080 1.000
POP �0.260 �0.226 �0.313 �0.219 �0.240 �0.286 �0.281 0.330 �0.125 �0.005 0.102 1.000
Sources: China Statistical Abstract (Beijing: China Statistics Press, 1995–2003); China Statistical Yearbook
(various issues); Comprehensive Statistical Data and Materials on 50 Years of New China; Finance Year
Book of China, 1995–2004.
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Table
4.
Panel
data
resultsforthenation
Cross
sectionsandtimeseries
(1994–2002)
Cross
sectionsandtimeseries
(1997–2002)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
(14)
(15)
(16)
DCCS
0.276
0.221
0.581
0.404
(3.120)***
(2.650)***
(5.620)***
(4.420)***
DCBS
0.270
0.197
(2.750)***
(2.310)**
DCEBC
0.033
0.035
(2.810)***
(2.970)***
DCCR
0.044
0.045
0.034
0.036
(2.600)***
(2.590)***
(2.520)***
(2.680)***
DCBR
0.043
0.044
(2.430)***
(2.430)***
DCEBR
0.031
0.033
(2.600)***
(2.770)***
OPEN
0.060
0.056
0.063
0.057
0.043
0.041
0.043
0.040
0.143
0.167
0.057
0.054
0.056
0.051
0.058
0.054
(1.070)
(1.030)
(1.100)
(0.292)
(2.220)**
(2.130)**
(2.160)**
(2.050)þþ
(1.790)*
(2.100)**
(3.600)***
(3.480)***
(3.370)***
(3.160)***
(3.630)***
(3.500)***
I0.072
0.069
0.062
0.062
0.073
0.069
0.073
0.069
0.033
0.033
0.055
0.040
0.047
0.042
0.047
0.042
(6.060)***
(6.210)***
(4.880)***
(5.210)***
(6.190)***
(6.300)***
(6.160)***
(6.250)***
(2.400)
(2.490)***
(3.980)***(3.240)***
(3.530)***
(3.340)***
(3.510)***
(3.330)***
R1.199
1.178
1.013
1.040
1.099
1.129
1.086
1.115
0.789
1.062
1.984
2.051
2.088
2.165
1.999
2.071
(4.540)***
(4.870)
(3.970)***
(4.400)***
(5.210)***
(5.760)***
(5.150)***
(5.690)***
(1.130)
(1.530)
(2.900)***(3.140)***
(3.040)***
(3.300)***
(2.910)***
(3.160)***
CT
0.087
0.066
0.015
0.013
0.017
0.021
0.003
0.008
0.207
0.143
0.039
0.049
0.027
0.036
0.055
0.066
(1.140)
(0.920)
(0.210)
(0.200)
(0.260)
(0.340)
(0.050)
(0.130)
(2.950)***
(2.110)**
(0.670)
(0.910)
(0.470)
(0.670)
(0.900)
(1.180)
PT
0.070
0.078
0.072
0.081
0.025
0.032
0.023
0.030
�0.242
�0.122
�0.099
�0.086
�0.099
�0.087
�0.099
�0.090
(1.750)*
(2.020)**
(1.810)*
(2.090)**
(0.680)
(0.890)
(0.610)
(0.800)
(1.570)
(0.810)
(1.670)
(1.460)
(1.620)
(1.440)
(1.670)
(1.510)
POP
0.000
�0.005
0.002
0.002
0.017
0.002
0.002
0.002
(0.001)
(0.190)
(0.140)
(0.080)
(0.810)
(0.130)
(0.030)
(0.130)
Constant
�4.509
�4.241
�3.413
�3.417
�3.264
�3.405
�3.145
�3.282
�2.845
�3.993
�7.115
�7.452
�7.489
�7.861
�7.204
�7.567
(3.550)***
(3.630)***
(2.910)***
(3.120)***
(3.220)***
(3.560)***
(3.110)***
(3.440)***
(0.920)
(1.300)
(2.250)**
(2.470)***
(2.360)**
(2.590)***
(2.270)**
(2.500)***
HN
test
(p-value)
0.000
0.054
0.000
0.000
0.001
0.223
0.004
0.337
0.000
0.000
0.066
0.045
0.07
0.082
0.100
0.050
Ftest
(p-value)
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.013
0.000
0.012
0.004
0.016
0.003
HN-W
utest
(p-value)
0.727
0.711
0.859
0.869
0.806
0.805
0.622
0.624
0.850
0.859
0.100
0.120
0.299
0.305
0.100
0.120
R-sq:within
0.375
0.290
0.380
0.314
0.370
0.287
0.362
0.286
0.284
0.229
0.177
0.145
0.168
0.133
0.165
0.130
between
0.302
0.198
0.289
0.181
0.284
0.212
0.271
0.222
0.320
0.192
0.351
0.189
0.342
0.214
0.309
0.151
overall
0.205
0.180
0.199
0.148
0.220
0.253
0.218
0.257
0.142
0.100
0.163
0.124
0.148
0.121
0.153
0.112
Sample
size
212
212
212
212
212
212
212
212
163
163
163
163
163
163
163
163
Notes:
Thenumbersin
parentheses
are
theabsolute
values
ofthet-statistics.
Asterisksindicate
variableswhose
coefficients
are
significantatthe10%
(*),5%
(**),and1%
(***)levels.
HN
test
(p-value):
Hausm
anstatisticsfortestingtherandom-effectsmodelagainstthefixed-effectsmodel.HN-W
u(p-value):Wu–Hausm
anstatisticfortestingtheexogeneity
ofthefiscaldecentralizationindexes.Ftest(p-value):
F-statistic
fortestingthepooledregressionagainst
thefixed-effects
model.
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plays an important role in economic growth. It is perhaps unsurprising thateconomic growth has no statistically significant association with the populationgrowth rate, given that China has put into effect a policy stating that couples cannothave more than one child.
Openness also appears to have the expected positive effect on the economic growthrate. The inflation rate is positively related to provincial growth, and the associationis highly statistically significant. This positive effect stems from the potential ofinflation to promote saving and investment.
To test the robustness of these regression results, models omitting POP are alsoestimated; however, the resulting estimates hardly vary.
This paper also investigates the possibility of exogeneity problems in the data.Although the results of the regression analyses indicate that fiscal decentralization isstrongly associated with income growth, it is arguable that the direction of thiscausality may go from the latter to the former: poor provinces with low growth ratesmay tend to be recipients of fiscal transfers from the central government, whereasricher provinces with high growth rates may be more likely to be given greater fiscalfreedom. If this were case, then all the estimates would suffer from an endogeneitybias and, therefore, be inconsistent. First, the fiscal decentralization indicators arequite stable. Since the 1994 fiscal reform, the scope of the spending and revenue ofthe central and local governments has been defined clearly. Second, this paper usesinstrumental variables to correct for the potential endogeneity of the fiscaldecentralization variables. These instrumental variables include the ratio ofprovincial budgetary and extra-budgetary spending to provincial GDP. A relevantHausman test fails to reject the hypothesis that the fiscal decentralization indicatorsare exogenous to the model.
Differences in Regional Fiscal Decentralization: the Eastern, Central, and WesternAreas
Given the results of the Hausman test, for most of the models considered, fixedeffects are accepted. Therefore, provincial fixed effects are present in the data. Infact, there is great variation in both fiscal decentralization and economic growththroughout China (see Table 1). From a historical point of view, the coastal areashad already become more developed than the interior areas by the time of thereform. Although the Chinese government substantially supported the interior areas,its achievements were limited at best. In order to examine the effect of fiscaldecentralization on economic growth in the different regions of China, this papercategorizes the 30 Chinese provinces and regions into three conventional economicbelts, namely, the eastern, central, and western areas.11 The eastern area is, onaverage, the most decentralized among the three areas and tends to have the highestGDP growth rate.
The estimated models and estimation method are consistent with those used forthe nation. Since the effect of distortions at the national level (represented by thecontrol variable CT) is similar for all provinces, it is not appropriate to test fordifferences across the three provinces. Therefore, the control variable CT is not usedin this section. The degree of openness, measured as the total of exports and imports,as a percentage of provincial GDP, is likewise inappropriate for use in this context,
Fiscal Decentralization and Economic Growth in China 253
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since that of the eastern area may be exaggerated, while that of the western area maybe too little.
The panel estimation results for the eastern, central, and western areas arepresented in Tables 5–7, respectively. The primary finding is that fiscaldecentralization had different effects on economic growth in the three areas duringthe sample period.
For the eastern area (Table 5), the economic growth rate is positively andsignificantly associated with expenditure decentralization and positively butinsignificantly associated with revenue decentralization.
For the central area (Table 6), the provincial economic growth rate is positivelyand statistically significantly associated with the estimated coefficient on fiscaldecentralization.
For the western area (Table 7), the economic growth rate is positively andsignificantly associated with expenditure decentralization but is negatively andinsignificantly associated with revenue decentralization.
In summary, no association appears to be present for the extra-budgetary fiscaldecentralization indicators (DCEBS and DCEBR) in the eastern and western areas.Therefore, extra-budgetary revenue and spending are not suitable proxies for fiscaldecentralization. Since the provinces enjoy great freedom with respect to the amountof their extra-budgetary spending and revenue, it is difficult for the centralgovernment to measure this amount accurately.
In addition, expenditure decentralization tends to have a greater positive effect oneconomic growth than does revenue decentralization. Perhaps the most importantexplanation of this result is that expenditure is typically far more decentralized thanrevenue in most of the provinces (see Table 1).
The control variables also have the expected effect, and their effects inthe provinces are consistent with their effect in the nation as a whole. Investmenthas the expected effect on economic growth, but the magnitude of this associationis the smallest for the western area. It is perhaps not surprising that the westernarea lacks investment. Economic growth remains insignificantly associated withthe rate of population growth. The inflation rate is positively related toprovincial growth, and this association is highly consistent and significant for allthree areas.
This paper attempts to investigate the driving force behind the effect of fiscaldecentralization on economic growth, which varies from place to place in China.Two questions, in particular, present themselves.
First, why is there no significant association between revenue decentralization andgrowth for the eastern area? This paper offers several explanations: (1) excessivespending by provincial governments on inappropriate projects may have lead toinefficiency, even if the expenditure assignments were optimal; (2) the efficiency gainsfrom fiscal decentralization, perhaps the strongest argument in its favor, may nothave materialized for the eastern area during the sample period, as revenue andspending decisions by local governments may still have been constrained by thecentral government.
Second, why is no significant association present between revenue decentralizationand economic growth for the western area? Possible reasons include: (1) the westernarea was so poor that fiscal revenues were insufficient to meet the demands of the
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Table
5.
Panel
data
resultsfortheeasternarea
1994–2002
1997–2002
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
DCCS
0.090
0.071
(1.730)�
(1.660)�
DCBS
0.053
(1.940)�
DCEBS
0.028
(0.860)
DCCR
0.042
0.034
(0.870)
(0.900)
DCBR
0.017
(0.330)
DCEBR
0.018
(0.640)
I0.074
0.074
0.076
0.076
0.072
0.076
0.077
0.078
(4.550)���
(4.400)���
(4.630)���
(4.630)���
(3.970)���
(4.120)���
(4.190)���
(4.250)���
R1.075
1.064
1.082
1.088
0.886
0.908
1.080
0.972
(3.290)���
(3.200)���
(3.260)���
(3.260)���
(0.830)
(0.790)
(0.990)
(0.840)
PT
�0.080
�0.076
�0.079
�0.070
0.062
0.062
0.048
0.060
(0.760)
(0.710)
(0.740)
(0.630)
(0.590)
(0.600)
(0.470)
(0.590)
POP
0.012
0.011
0.011
0.112
0.035
0.034
0.036
0.035
(0.310)
(0.330)
(0.320)
(0.370)
(1.280)
(1.210)
(1.260)
(1.210)
Constant
�2.853
�2.712
�2.755
�2.761
�2.307
�2.358
�3.062
�2.614
(1.800)�
(1.690)�
(1.71)�
(1.710)�
(0.470)
(0.450)
(0.610)
(0.500)
HN
test
(p-value)
0.849
0.843
0.992
0.666
0.214
0.857
0.881
0.845
Ftest
(p-value)
0.000
0.001
0.000
0.000
0.000
0.002
0.002
0.002
HN-W
utest
(p-value)
0.153
0.085
0.160
0.120
0.664
0.142
0.42
0.314
R-sq:within
0.536
0.444
0.515
0.514
0.398
0.342
0.349
0.341
between
0.483
0.375
0.501
0.461
0.242
0.312
0.284
0.288
overal
0.412
0.390
0.426
0.416
0.229
0.235
0.227
0.221
Sample
size
76
82
76
76
54
54
54
54
Note:See
thenote
forTable
4.
Fiscal Decentralization and Economic Growth in China 255
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Table
6.
Panel
data
resultsforthecentralarea
1994–2002
1997–2002
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
DCCS
0.400
0.467
(2.099)���
(3.070)���
DCBS
0.695
(3.500)���
DCEBS
0.059
(1.750)�
DCCR
0.093
0.084
(1.700)�
(1.760)�
DCBR
0.086
(1.750)�
DCEBR
0.049
(1.780)�
I0.107
0.061
0.092
0.089
0.070
0.034
0.0396
0.367
(5.340)���
(2.870)���
(4.690)���
(4.480)���
(2.480)��
(1.280)
(1.440)
(1.340)
R1.789
1.666
1.565
1.531
3.126
3.764
3.886
3.859
(5.940)���
(5.830)���
(5.460)���
(5.280)���
(2.540)��
(3.340)���
(3.150)���
(3.400)���
PT
0.018
�0.019
�0.010
�0.006
�0.785
�0.067
�0.072
�0.594
(0.200)
(0.220)
(0.110)
(0.060)
(0.760)
(0.740)
(0.790)
(0.650)
POP
�0.041
�0.069
0.003
0.010
�0.078
0.022
�0.166
(0.059)
(0.990)
(1.620)
(0.080)
(0.280)
(1.760)�
(0.910)
(0.530)
(0.650)
Constant
�7.073
�6.731
�5.292
�5.099
�12.980
�15.175
�15.633
�15.591
(4.800)���
(4.920)���
(4.010)���
(3.820)���
(2.330)��
(2.930)���
(3.020)���
(2.990)���
HN
test
(p-value)
0.106
0.010
0.840
0.903
0.016
0.385
0.472
0.467
Ftest
(p-value)
0.020
0.001
0.090
0.100
0.090
0.1
0.05
0.110
HN-W
utest
(p-value)
0.981
0.909
0.273
0.684
0.130
0.200
0.110
0.080
R-sq:within
0.635
0.656
0.597
0.588
0.465
0.355
0.35
0.340
between
0.182
0.193
0.180
0.204
0.105
0.016
0.066
0.013
overall
0.451
0.363
0.540
0.538
0.219
0.282
0.282
0.272
Sample
size
70
70
70
70
49
49
49
49
Note:See
thenote
forTable
4.
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Table
7.
Panel
data
resultsforthewestern
area
1994–2002
1997–2002
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
DCCS
0.354
0.595
(2.180)��
(2.260)��
DCBS
0.638
(3.560)���
DCEBS
�0.012
(0.480)
DCCR
�0.021
�0.154
(1.080)
(0.550)
DCBR
�0.190
(0.970)
DCEBR
�0.015
(0.610)
I0.029
0.013
0.040
0.040
0.021
0.047
0.046
0.047
(1.160)
(0.540)
(1.730)�
(1.720)�
(0.720)
(1.830)�
(1.810)�
(1.820)�
R0.685
0.351
0.795
0.793
�0.856
1.447
0.384
1.488
(2.000)��
(2.060)��
(2.390)��
(2.380)��
(0.550)
(1.170)
(1.120)
(1.200)
PT
0.142
0.129
0.163
0.165
0.205
0.115
0.122
0.124
(2.990)���
(2.870)���
(3.560)���
(3.510)���
(0.500)
(0.730)
(0.770)
(0.810)
POP
�0.220
�0.043
�0.015
�0.140
�0.059
�0.011
�0.011
�0.011
(0.510)
(1.050)
(0.400)
(0.390)
(1.340)
(0.310)
(0.310)
(0.320)
Constant
�1.839
�5.510
�1.937
�1.941
4.838
�4.824
�4.574
�5.027
(1.180)
(0.350)
(1.290)
(1.290)
(0.710)
(0.850)
(0.810)
(0.880)
HN
test
(p-value)
0.080
0.007
0.000
0.000
0.027
0.878
0.849
0.798
Ftest
(p-value)
0.020
0.001
0.090
0.100
0.090
0.1
0.05
0.110
HN-W
utest
(p-value)
0.309
0.301
0.301
0.240
0.600
0.200
0.335
0.129
R-sq:within
0.361
0.439
0.411
0.389
0.270
0.136
0.138
0.141
between
0.148
0.171
0.158
0.029
0.015
0.135
0.129
0.118
overall
0.012
0.002
0.008
0.125
0.004
0.144
0.145
0.146
Sample
size
66
66
66
69
48
48
48
48
Note:See
thenote
forTable
4.
Fiscal Decentralization and Economic Growth in China 257
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people; or (2) the western area was more dependent on fiscal transfers from
the central government and, therefore, the decentralization indicators used for the
western area may be imperfect measures of fiscal decentralization.
Conclusion
This paper uses a simple endogenous growth model to examine how the degree of
fiscal decentralization affects the growth rate of the Chinese economy. Using a
provincial level panel data set for China’s 30 provinces for the period from 1994 to
2002, this paper examines whether fiscal decentralization has had any growth
impact following the 1994 fiscal reform. The results of this study suggest that the
provincial economic growth rate has a positive and statistically significant
association with the estimated coefficient on fiscal decentralization. This finding
provides evidence that fiscal decentralization contributes to economic growth.
It is important to note, in addition, that this finding is consistent with the
theoretical prediction of Oates (1993) but contradicts the empirical results of the
existing literature.12 These new findings result from the use of a new, more
appropriate data set.In addition, this paper attempts to investigate how the relationship between fiscal
decentralization and provincial growth differs in the different regions of China. For
this purpose, the 30 Chinese provinces and regions are grouped into three
conventional economic belts, namely the eastern, central, and western areas. The
results suggest that the effects of fiscal decentralization on economic growth vary
across these three areas.For the central area, the provincial economic growth rate is positively and
statistically significantly associated with the estimated coefficient on fiscal
decentralization. For the eastern area, the economic growth rate has a positive,
significant association with expenditure decentralization and a positive but
insignificant association with revenue decentralization. For the western area, the
economic growth rate is positive and significantly associated with expenditure
decentralization, but is negatively and insignificantly associated with revenue
decentralization.This empirical investigation is highly relevant to current policy debates on the
allocation of fiscal revenue and the assignment of revenue expenditure among
the central and provincial governments in China. This study suggests that it is crucial
for China to formulate and develop a fiscal decentralization policy in order to
achieve the important goal of economic development.These findings have some implications for China’s fiscal reforms. First,
intergovernmental fiscal relations are correlated with other structural reforms
promoting economic growth. Therefore, the effects of decentralization on growth
vary from place to place. Second, the 1994 fiscal reform contributed to the alleviation
of some of the problems created by the previous system of intergovernmental fiscal
relations. Therefore, it can be inferred that the 1994 fiscal reform was more thorough
than previous reforms.
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Acknowledgements
The author would like to thank Professor Atoda Naosumi of the Graduate School ofBusiness and Commerce at Keio University and Professor Maekawa Satoko of the
Faculty of Economics at Kansai University for helpful comments and suggestions.The author is also grateful to the participants of the COE/JEPA Joint International
Conference in Kobe, the Fifth China Economics Annual Conference at XiamenUniversity, and the 62nd Conference of the Japan Fiscal Association at Hitotsubashi
University for their useful comments. The author takes responsibility for anyremaining errors.
Notes
1See the first part of the third section.2China comprises 22 provinces (Hebei, Shanxi, Liaoning, Jilin, Heilongjiang, Jiangsu, Zhejiang,
Anhui, Fujian, Jiangxi, Shandong, Henan, Hubei, Hunan, Guangdong, Hainan, Sichuan, Guizhou,
Yunnan, Shanxi, Gansu, and Qinghai), four autonomous municipalities under the direct control of
the central government (Beijing, Tianjing, Shanghai, and Chongqing), and five autonomous regions
(Guangxi, Inner Mongolia, Ningxia, Xinjiang, and Tibet). Chongqing was created in 1997 and is
not included in this paper; therefore, this paper considers 30 provinces in total.3The fiscal relationship between the central government and the provinces has been reshaped, as the
previous revenue-contraction system has been replaced with a separating tax system. Under the new
system, local revenue has been redefined as revenue from local taxes and the local portion of shared
taxes (Bahl, 1999). The major local taxes are now income taxes from all enterprises other than those
of the central government, business taxes from the sales of services, and personal income taxes.
The most important shared tax is the value added tax (VAT), of which 25% accrues uniformly to
the provincial governments. The post-1994 phase of the reform has eliminated the variations in the
revenue sharing rules that were present during the 1980–1993 phase. The sharing of tax revenues
between the central government and the provinces has become automatic and occurs in the same
way for all of the provinces (Jin et al., 2005).4Extra-budgetary spending is financed by extra-budgetary revenues, which are made up of rights and
fees for public services. In the last few years, a part of extra-budgetary revenue has derived from the
sale of land. Despite their origin, such revenues are nonetheless of a budgetary nature, since
the provinces formally anticipate their collection and spending, and they are officially known to the
central government (Jeanneney & Hua, 2004). Extra-budgetary spending is mainly directed toward
the priority capital projects of local governments and toward the finance of local budget deficits.
It is generally accepted that provinces enjoy great freedom with regard to the amount of their
extra-budgetary spending.5The revenue-sharing system was modified, first in 1985 (with the intention of raising the share of
revenue retained by poorer regions), and then in 1988 (when the tax efforts of richer regions
flagged), with the intention of raising the revenue share of these regions as well. As a result of the
changes in 1985 and 1988, the terms under which revenue was divided between the central and local
governments came to differ across localities, and this division began to involve bargaining to a
greater extent (Arora & Norregaard, 1997).6The objectives of the 1994 fiscal reform were: (1) to simplify and rationalize the tax structure by
reducing the number of tax categories and tax rates, consolidating the tax burden on the taxpayer,
and cutting down on tax exemptions; (2) to raise the revenue- to-GDP ratio; (3) to raise the central-
to-total budgetary revenue ratio; and (4) to manage the central-local revenue share on a more
transparent, objective basis by shifting the negotiation of general revenues to a separating tax
system.7Davoodi & Zou (1998) follow Barro (1990).
Fiscal Decentralization and Economic Growth in China 259
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8Sets of data on budgetary spending and revenues are published regularly in the China Statistical
Abstract, whereas extra-budgetary expenditures and revenues can be found in the Finance Year
Book of China, 1995–2004.9 It is the same as Akai & Sakata (2002).
10 Jin & Zou (2005) use a panel data set for China covering the period 1979–1999, they define the ratio
of province spending (revenue) to total spending (revenue), which is the sum of provincial and
central spending (revenue) as measurement of fiscal decentralization.11Under this classification, the eastern (coastal) area includes Beijing, Tianjin, Hebei, Liaoning,
Shanghai, Jiangsu, Zhejiang, Shandong, Fujian, Guangdong, Guangxi, and Hainan. The central
area consists of Shanxi, Inner Mongolia, Jilin, Heilongjiang, Anhui, Jiangxi, Henan, Hubei, and
Hunan. The western area includes Sichuan, Guiuzgou, Yunan, Tibet, Shaanxi, Gansu, Qinghai,
Ningxia, and Xinjiang.12 It is should be emphasized that the three decentralization indicators resemble those of Zhang & Zou
(1998) but apply to a different sample period. The results of this paper contradict the empirical
results of Zhang & Zou (1998).
References
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