The innovative incentive effect of local government debt management: Evidence from China

Timely settlement of public-sector arrears is a critical yet often overlooked lever for corporate innovation across both advanced and emerging economies. Using panel data of A-share listed private firms in China from 2012 to 2020, we examine the impact of a national supervisory campaign to clear government arrears on corporate innovation. Exploiting this policy as a quasi-natural experiment, we employ a difference-in-differences (DID) design, synthetic control methods, and machine-learning–based causal inference techniques. Our findings show that clearing government arrears significantly increases private firms' innovation output. The effect is particularly strong for financially constrained firms, for firms with higher pre-policy innovation intensity, and for those located in fiscally stressed regions. Mechanism analyses suggest that debt repayment alleviates firms' financing constraints and expands market opportunities, thereby stimulating research and development activities. Additional evidence from elastic-net–augmented synthetic control and matrix completion approaches confirms the robustness of our results at the provincial level. Overall, our study highlights that local government debt management not only mitigates the risks of arrears but also fosters corporate innovation by easing liquidity constraints. Our findings underscore the significance of timely public payments for securing fiscal discipline and unlocking private-sector innovation globally.