Local government debt becomes more vital now and is under the fire of supervisory authorities. Not only the central government has its eye on this issue, financial institutions also do. While opinions widely vary, how many people know exactly the true situation of local government debt? Or, how many people know the formation mechanism of China's local government debt beyond numbers?
Although China's local government debt is enormous, its formation mechanism is very complicated.
1, There is some inequality between administrative power and financial power. China relies heavily on county-level governments. Whether it's trivial or important, issues are not solvable without local governments that are below county-level. However, local governments below county-level have little financial power. Resources are ripped off by every level of governments, which make them insufficient when they reach people who are in charge. As a result, local governments need to borrow from all sources. Otherwise, they would not get anything done.
2. Macroeconomic debt increased substantially. From the macroeconomic perspective, many macro policies are necessary, such as ecological environment policy. But such policies are not profitable in the short-term. Policies that are profitable in the long-term require local governments to spend money in a short period of time. The contradiction between long-term and short-term must be solved by raising debt, which causes the addition to local government debt.
3. Higher level authorities set requirements but local governments must spend money from their own budget. It's not about should or shouldn't, it's about the mismatch between pressure from reality and the appropriate mechanism. Take poverty alleviation as an example, towns that have impoverished people are already financially strained, under the pressure of completing the task, local governments are forced to borrow debt. Some towns can barely afford the salaries of their clerks, but the progress of poverty alleviation moves quickly.
4. Disadvantage of industrial policy. China prefers industrial policy more than others. The central government incentivizes, encourages and financially support some suspicious industries. Instead, financial support as such actually serves as a scheme. In return, local governments must spend much more money on these industries, which consequently increase their debt level. It is not negotiable for them, otherwise they won't even have the money that the central government will give.
5. Local governments act rashly and follow the wrong trend. To prosper the economy, their risk is raising their debt level. However, this is just an issue of their own, not an objective reason.
6. The aftermath of high-speed infrastructure development. High-speed infrastructure development is, in fact a long-term gain. Development in advance is very general in the field of infrastructure and a disciplinary problem. Thus, for infrastructure development, operating account is more important than the investment account. An infrastructure development investment without profits must be subsidized by the government. The local governments' aggregate debt will grow bigger if they were not subsidized at the appropriate time.
7. The feedback mechanism of the economic downturn. There are two perspectives of local government debt. On one hand, when there is economic growth, financial deficit reflects the debt. No need to worry since economic growth ensures the debt will be paid back. On the other hand, when there is no economic growth and the economy enters the "New Normal", these debts need to be reconsidered from the view of fiscal revenue.
8. Tasks: Every issue is about money. Governments below county-level face many problems that the chief officer must be responsible for. These problems start to pile up on one another. All needs to be paid, solved and done with, which offer no alternatives but to raise debt. In addition, some governments are in worse condition since they cannot raise debt. Not long ago, a local government of a small town in Shandong province has been exposed to borrowing money from its employees. It's not difficult to imagine the situation of local governments.
These problems involve the contradiction between administrative power and financial power; the contradiction between short-term and long-term profits and the contradiction between development and stabilization. China's tax-sharing system decides that provinces and counties are independent of the central government. Except for transfer payments, everything that the central government needs to take care of millions of people. If issues that concern millions of people grow substantially, financial power and resources cannot be passed along to local governments, the situation of local governments will be worse. Moreover, it's difficult to change the conditions of local government so they will be more severe. We used to say "development is the absolute truth". Now, for local governments, it became "must seek development". They must seek development so that there is a chance for the debt crisis to be relieved. No development, the debt crisis is a dead end and will only get worse. These mechanism problems cannot be solved by mere financial screening and rectification.
Final Analysis Conclusion:
In conclusion, the solution is what we have been saying for the last 10 years, "Every problem in China is the problem of growth". We cannot rush into anything, especially when the tension is high. We must be steady, time may solve many problems.
