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The Transition of Local Government Financing Platforms in China: Risks, Incentives, and Regulations

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  • Changlin Luo

    (School of Economics and Management, Beijing Forestry University)

Abstract

In this paper, we build on the Dewatripont-Tirole (2012) model and argue that leverage caps can be used as an instrument to regulate the deeply indebted local government financing platforms in China. The key incentive scheme places different leverage caps on different types of platforms, and the control right shifts from the government to the debt holder if the cap is exceeded. We also propose different means to tackle a moderate macroeconomic shock, including ex ante adjustment of the cap, ex post debt rollover, and debt-toequity conversion. Direct governmental bailout is necessary when the shock is sufficiently large. In this case, we calculate the upper bound of the bailout that the central government is willing to provide, and show that it increases with the long-term prospect for the economy after the shock.

Suggested Citation

  • Changlin Luo, 2019. "The Transition of Local Government Financing Platforms in China: Risks, Incentives, and Regulations," Annals of Economics and Finance, Society for AEF, vol. 20(1), pages 221-245, May.
    • Handle: RePEc:cuf:journl:y:2019:v:20:i:1:luo
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    References listed on IDEAS

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    Cited by:

    1. Changlin Luo, 2023. "Monopolized Land Supply and Excessive Leverage of Local Governments in China," Annals of Economics and Finance, Society for AEF, vol. 24(2), pages 309-328, November.
    2. Xiao-Li Gong & Jin-Yan Lu & Xiong Xiong & Wei Zhang, 2022. "Higher-order dynamic effects of uncertainty risk under thick-tailed stochastic volatility," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 8(1), pages 1-22, December.

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