Interprovincial Effects of Fiscal Decentralization on Financial Decentralization in China

By motivating local governments to fight for financial resources,China's tax sharing reform has affected the structure of financial decentralization and inflated local financial systems,thus spawning regional financial risks.Based on theoretical analysis and empirical evidence,this paper has arrived at the following findings:due to different policy objectives,central and local governments exhibit different fiscal and financial behaviors;public finance and financial sector have become financing instruments with certain convertibility under local economic growth framework;fiscal decentralization inevitably affects financial decentralization and lays the foundation for provincial fiscal disparities,resulting in a certain spatial effect of interprovincial fiscal variable;financial explicit centralization/implicit decentralization and fiscal centralization have fueled local competition for financial resources and resulted in correlation between the spatial effects of provincial financial and fiscal variables,and moreover,their mismatch has also spawned fiscal and financial risks on various fronts.Hence,setting clear boundaries of financial centralization and decentralization and ensuring local government fiscal accountability is the key to the prevention and mitigation of fiscal and financial risks in China.

Fiscal Decentralization,Financial Decentralization and Macroeconomic Governance

Improvement of the macroeconomic governance system as an important part of the national governance system is a key initiative to address major economic problems in the new era.The coordination and economic regulatory effects of fiscal and monetary policies are subject to the arrangements of fiscal and financial decentralization systems.Analysis revealed a mismatch between China’s fiscal income decentralization and fiscal spending decentralization,as manifested in the clear decentralization of fiscal revenue and vague decentralization of fiscal spending;in pursuing local economic stability,local governments seek other sources of revenue and compete for financial resources,as manifested in apparent financial centralization and implicit financial decentralization,causing financial decentralization to be inconsistent between various levels of government and between government and the market.The above-mentioned problems are reflected in mutual conversion between public finance and financial intermediation as two financial allocation methods and mutual transmission between fiscal and financial risks,making the case for enhancing coordination between fiscal and monetary policies.In creating a scientific macroeconomic governance system,therefore,we must establish clear local government responsibilities,reduce the proportion of local fiscal spending,clarify the orientations and relief boundary of fiscal and monetary policies,moderately decentralize financial powers,and give better play to the role of local governments in improving the quality of economic development and controlling major risks.

Impacts of financial decentralization on economic growth and inflation in China

Fiscal decentralization and promotion incentives are main elements that inspire local governments in China to compete for economic growth with each other;but this regime is only part of reason that local governments in China have more effects on economic cycle than their counterparts in other countries.The authors think that financial decentralization should be taken into account.Empirical results indicate that excess financial decentralization would cause high risk of inflation and economic overheating.After tax-sharing reform in 1994,the central government could adjust the boundary of financial decentralization and the local governments may borrow more money during the economic downturn.The authors suggest that a two-tiered financial supervisory system should be set up in the new round of financial reform and financial decentralization should be adjusted to the changing market economy in China.