The National and Regional Effects of Fiscal Decentralisation in China

Fiscal decentralisation has played a significant role in the development of China’s economy over the past three decades. Yet there has been only limited analysis of the way in which decentralisation might affect variables such as welfare, output and income at the aggregate level and none at the regional level. This paper makes a contribution to redressing this lack by analysing the aggregate and regional effects of various policies which aim to change the balance between fiscal activities of the national and regional governments. We do this within a small theoretical model designed to capture some of the features of the Chinese economy. The model is solved numerically based on a parameterisation using Chinese data. We analyse four different simulations, all of which involve a cut in central government expenditure and a transfer of resources to the regional governments. The policies which we simulate differ according to the assumed reaction of the regional governments: (1)they adjust expenditure on the consumption good, (2) they adjust infrastructure expenditure, (3) they maximise the welfare of the representative citizen, and (4) they maximise the size of their own budget. We find that the aggregate economic effects of decentralisation depend on the precise nature of the policy and that aggregate benefits may often mask a deterioration in the inter-regional distribution of those benefits.