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Does Fiscal Decentralization Increase the Investment Rate? Evidence from Chinese Dynamic Panel Data

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Author Info

  • Qichun He

    (Central University of Finance and Economics)

  • Meng Sun

    (Beijing Normal University)

  • Heng-fu Zou

    (Development Research Group, World Bank)

Abstract

It is puzzling why China has one of the highest investment rates in the world. In 1994 China introduced a new fiscal system. Using this natural experiment and the dynamic provincial panel data during the following period 1995-2002, we find that fiscal decentralization has a significant, positive effect on the physical capital investment rate in both LSDV (Least squares dummy variables) and system GMM (Generalized method of moments) estimations. The results are robust to controlling for other variables, and province and time effects. China's political centralization has been maintained during its economic decentralization. The provincial officials are not elected by the local constituents, but appointed by the central government. The central government disciplines them by linking their promotion with the performance of the local economy. Therefore, it is rational for provincial officials to raise investment rates to maximize local growth and thereby their chance of promotion, explaining our findings.

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Bibliographic Info

Paper provided by China Economics and Management Academy, Central University of Finance and Economics in its series CEMA Working Papers with number 592.

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Length: 29 pages
Date of creation: Nov 2013
Date of revision:
Handle: RePEc:cuf:wpaper:592

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Web page: http://cema.cufe.edu.cn/
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Keywords: Fiscal decentralization; Investment rate; Dynamic Panel data;

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  1. Blundell, R. & Bond, S., 1995. "Initial Conditions and Moment Restrictions in Dynamic Panel Data Models," Economics Papers 104, Economics Group, Nuffield College, University of Oxford.
  2. Treisman, Daniel, 2000. "The causes of corruption: a cross-national study," Journal of Public Economics, Elsevier, vol. 76(3), pages 399-457, June.
  3. Yingyi Qian & Gerard Roland, . "Federalism and the Soft Budget Constraint," Working Papers 97045, Stanford University, Department of Economics.
  4. Wilson, John Douglas, 1999. "Theories of Tax Competition," National Tax Journal, National Tax Association, vol. 52(n. 2), pages 269-304, June.
  5. Fisman, Raymond & Gatti, Roberta, 2002. "Decentralization and corruption: evidence across countries," Journal of Public Economics, Elsevier, vol. 83(3), pages 325-345, March.
  6. Li, Hongbin & Zhou, Li-An, 2005. "Political turnover and economic performance: the incentive role of personnel control in China," Journal of Public Economics, Elsevier, vol. 89(9-10), pages 1743-1762, September.
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