Local governments key to China's macro stimulus policy effectiveness
Prof. Yang Ruilong of Renmin University of China: Local governments' shrinking investment, expenditure & growth-driving capacities call for reform to maximize the impact of macro stimulus policies
China passed a new law today to reassure private entrepreneurs and encourage their investment and operations. From the perspective of your host, the most intriguing party in interactions with private enterprises in China is the local government.
Over the past two decades, local governments, for various reasons, have been deeply involved in local economic activities, with blurred boundaries between the market and the government, leading to a uniquely complex "government-business relationship" in China.
Today's newsletter focuses on local governments. Leading Chinese economists believes that the challenges faced by local governments deserve more attention.
On April 26th, China Macroeconomy Forum (CMF) at Renmin University of China hosted a quarterly seminar titled "China's Macroeconomy: Proactively Advancing (积极进取的中国宏观经济)," which discussed the current macroeconomic situation in China. Six scholars shared their thoughts during the session.
Yang Ruilong (杨瑞龙), Professor at Renmin University of China and co-founder of China Macroeconomy Forum discussed the proactive role played by local governments in China’s macroeconomic stimulus policies.
Yang argued that the central and local governments in China should not be discussed within the same administrative framework. One reason many struggle to understand China is their inability to grasp the complexity of the local governments.
He noted that the 4-trillion-yuan stimulus plan in 2008 had its impact amplified through local governments. However, today, local governments are generally grappling with insufficient expenditure capacity, with some struggling to secure funding even within their designated responsibilities. (Overall, the central government spends much less but collects significantly more revenue.)
Prof. Yang noted that the four key roles/functions of local governments are shrinking: first, driving economic growth; second, investment; third, expenditure capacity; and fourth, stimulating business investment. He believes that this contraction has, to some extent, undermined the effectiveness of macroeconomic stimulus policies.
Finally, he called for a shift in the development model, reform of performance evaluation criteria, and a reevaluation of the allocation of fiscal and administrative powers between the central and local governments.
The live video of this seminar can be accessed here. As Professor Yang's presentation largely followed his slides, your host has translated the slides for your convenience, with some formatting adjustments made to enhance readability.
Local Governments: Key to Stimulus Policy Effectiveness
The 2025 GDP growth target is set at 5%—truly an ambitious "reach-for-it" goal. To counter the potential impacts of Trump's tariff war on China’s exports and investment, consensus has emerged on boosting confidence, strengthening domestic efforts, and intensifying stimulus measures
Implement a comprehensive macro‐policy package to expand domestic demand, covering both investment and consumption.
While debates persist on whether stimulus should focus on investment or consumption, investment-driven approaches—particularly in infrastructure and public services during economic downturns—prove more direct and effective for short-term growth stabilization. Government investment includes both central and local components.
2022 Fiscal Revenue & Expenditure Breakdown:
Revenue: Central (46.6%) vs. Local (53.4%)
Expenditure: Central (13.6%) vs. Local (86.4%)
Local Governments' Critical Role:
Their spending capacity directly affects the efficacy of central stimulus policies. Evidence shows declining investment multipliers: from 6.45 (2019) to 1.95 (2022) and 1.65 (2023), largely due to weakened local fiscal matching capabilities.
Some localities struggle to secure even basic operational funds within their administrative authority.
Stimulus must prioritize efficiency over sheer intensity, leveraging local governments' role as amplifiers of policy effects.
I. The indispensable role of local governments in amplifying the effects of macro‐stimulus policies
My analysis of the "Kunshan case*" led to the conceptualization of the "middle-proliferation model of institutional change." I was also among the earliest proponents of the "Political Tournament Theory" in this context.
*Kunshan Municipal Government officials take the political risk to create a self-funded development zone without the authority of the superior
Chinese Local Governments vs. Western Counterparts:
In the West, local governments act as administrative agents of the central government, with clearly boundaries separating them from market activities; they neither intervene in nor participate in microeconomic operations.
In China, local governments serve dual roles: they are not only administrative agents but also participants in local economic development, collaborating with enterprises to drive institutional innovation. The blurred boundary between local government and market has given rise to a uniquely complex Chinese-style "government‐business relationship."
1. Strong motivation for economic development:
Local officials are highly incentivized to pursue GDP growth as a pathway to political advancement.
Local governments function not only as government bodies but also as "corporate groups," with GDP as their primary objective, fostering intense inter-regional competition.
2. Proactive investment facilitation:
To gain an edge in attracting investments, local governments aggressively improve infrastructure and public services, creating a business-friendly environment.
3. Spontaneous institutional innovation:
By competing for reform priorities, they establish "institutional highlands" (policy advantages), shaping distinctive government-business dynamics that spur corporate investment.
Case in Point: The 4-trillion-yuan stimulus plan in 2008 saw its effects magnified through state-owned enterprises and local governments.
II. The Contraction Effect of Local Governments: A Key Factor Offsetting Macro Stimulus Policies
Declining marginal efficiency of macroeconomic policies is an undeniable reality. Despite increasing stimulus intensity, the effectiveness continues to weaken—a phenomenon partly driven by local governments’ reduced motivation and capacity to amplify or align with central stimulus policies.
1. Shrinking role of local governments in driving economic growth. Local governments’ pursuit of GDP growth has long relied on the "ratchet effect" (incremental targets) rather than genuine initiative. Due to asymmetric incentives and constraints, officials now face a dilemma:
Risk aversion: Fear of violating rules, offending stakeholders, or facing whistleblowing discourages innovation.
Inaction paradox: "Doing more invites more scrutiny; doing nothing is also penalized." Safety and avoiding blame become top priorities.
Superficial compliance: "Document-to-document" and "meeting-to-meeting" formalism prevails, while substantive reforms stall.
Result: Weakened momentum for local economic development.
2. Shrinking investment capacity of local governments. Local governments have traditionally been key drivers of infrastructure and public service investments, fostering regional growth. However:
Collapse of land finance due to the property market downturn.
Lifelong accountability for hidden debt, locking down off-balance-sheet financing models.
Fiscal strain: Declining disposable income amid economic slowdowns.
Result: Diminished ability to execute large-scale investments.
3. Shrinking spending capacity of local governments.
In 2024, China’s expenditure in the national general public budget rose by 3.6%, with central government spending up 6.5% but local government spending up only 3.2%, markedly below the central growth rate.
In 2023, the broad fiscal gap across 31 provincial-level regions reached RMB 14.60 trillion, with most provinces facing substantial shortfalls. These gaps were primarily filled through central transfers and government bond issuance. The weakened spending power of local governments directly impacts investment and consumption.
4. Shrinking role of local government in driving corporate investment.
Historically, "government-business collusion" helped secure reform privileges (e.g., tax breaks) to attract investment. However:
Substantive incentives in pilot reform zones have dwindled.
With fiscal gaps persisting despite transfers and bonds, local governments increasingly rely on non-tax revenues (e.g., fines, fees).
Data trend: Tax revenues fell from 85.3% (2018) to 81.8% (2022) of total income, while non-tax revenues rose from 14.7% to 18.2%. In 2024, non-tax revenues surged 25.4% (vs. a 3.4% drop in tax revenues).
Penalties as a growing share: Fines now dominate non-tax revenues (e.g., government funds, asset usage fees). While China's tax cuts were designed to boost the economy, many businesses find their benefits undermined by rising local-level penalty charges. This expansion of non-tax revenue is crowding out corporate investment as firms divert funds to cover these growing charges.
Conclusion: This contraction effect partially offsets the impact of macroeconomic stimulus policies.
III. The impact of Trump's trade war cannot be fully offset without the active role of local governments
For stimulus policies to effectively counter the Trump trade war's impact, we need to look beyond just boosting business investment and consumer spending—local governments have to step up role too.
1. Reshape the incentive mechanism that drives local governments' economic development.
The previous model of inter-local government competition, "government-business collusion," and the unhealthy government-business relations have led to numerous problems. Addressing these issues requires anti-corruption measures, debt accountability, and stricter discipline.
At the same time, it is essential to shift the development paradigm and reinvigorate local governments' motivation for economic growth. Given China's current stage of economic development, the role of local governments remains indispensable. However, whether GDP should continue to serve as a key performance metric warrants further study.
2. Balance incentives and constraints for local officials
Local officials face a growing list of strict accountability rules—including many "one-strike" veto policies—with intense pressure to avoid mistakes. But the reward system hasn't kept pace, leaving them overly cautious.
Strengthen incentives to offset excessive caution.
Define clear "red lines" and "safe zones" with tolerance for trial-and-error.
3. Realign fiscal rights and administrative authorities between central and local governments
In 2024, local governments shouldered 86% of expenditure with only 54% of revenue, exacerbating fiscal gaps. Critical steps include:
Reforming fiscal systems (rebalancing revenue-sharing).
Improving debt-resolution mechanisms.
4. Enhance local governments' role in building modern industrial systems
National modernization strategies (e.g., industrial upgrading, "new quality productive forces") rely on local implementation. Models like Suzhou's industrial transformation and Kunshan's "Coffee Kingdom" offer blueprints.5. Expand market-based financing tools
Leverage PPPs and other instruments to bolster local investment capacity.Conclusion: China's medium-to-long-term growth prospects remain promising.