Government size, institutional quality, and capital flows across regions in China: a specific exploration on the failure of capital flows across Shanhai Pass

Using panel data of 31 provinces during 1997-2014 in China, this paper fills the void of examining the determinants of capital flows across regions within China specific attention is given to the role of government size in capital flows across Shanhai Pass. Based on the fixed-effect model, the impactors of classical capital flows are tested. While government size is the main hinder impeding capital flows, capital return, institutional quality, human capital is conducive to capital inflow. However, when the components of the aggregate government expenditures is divided into two parts of productive expenditures on physical infrastructure and on education, it is proved that productive expenditures on physical infrastructure negatively correlate with capital inflows. In particular, there is strong impact of Lucas paradox that is the negative correlation of TFP and GDP growth with capital inflows; more importantly, lagged saving rate has a significantly positive impact on capital inflows namely the Feldstein-Horioka puzzle indicates the severe capital market segmentation. Overall, the main findings are that oversized government, especially government expenditures on physical infrastructure are major impediments to china s capital inflows among regions. Therefore, it is urgent to let market play a fundamental role in resource allocation, especially capital allocation. Acknowledgement : This research was supported by the Major Program of the National Social Science Foundation of China (Grant No.14 ZDA070) and by the Fundamental Research Funds for the Central Universities 2017.