The paradox of recentralization: implicit fiscal decentralization and local government debt in China

Abstract

We examine whether China’s 2014 local government debt-swap program, intended to centralize fiscal control and eliminate off-budget borrowing, paradoxically reinforced subnational fiscal autonomy through implicit fiscal decentralization. Exploiting cross-sectional variation in debt levels identified by the 2013 national audit and employing a difference-in-differences design, we examine how the programme affected infrastructure-related land supply and local financing behaviour. We find that the debt-swap programme significantly increased the supply area of infrastructure land while exerting little effect on land prices, consistent with a supply-side expansion rather than demand shocks. Mechanism analyses show that the programme alleviated repayment pressure and facilitated renewed borrowing through local government financing vehicles, thereby expanding local indebtedness despite the central government’s objective of curbing it. In contrast, we find only limited improvements in expenditure efficiency, fiscal revenue, and GDP. Overall, these findings suggest that the debt-swap programme primarily reshaped intertemporal fiscal constraints rather than imposing durable fiscal discipline. More broadly, the results highlight an institutional paradox of recentralization: policies aimed at constraining subnational borrowing may unintentionally expand local fiscal capacity through alternative channels, thereby reinforcing implicit fiscal decentralization.