Four Myths about local Infrastructure Investment in China

It has become commonplace to discuss the China’s local government debt crisis and wasteful infrastructure spending. While there are problems in the way local governments are financing and spending money in China, they do not herald an immediate crisis. The feeling of immediate crisis is fueled by several misconceptions listed below. These misconceptions serve only to distract attention away from the more important debate over the reforms necessary to improve the efficiency of local fiscal resources allocation.

1. Local infrastructure investment is only financed by debt

The rapid growth in local government debt obligations has led many to believe that borrowing is the only source of financing for local infrastructure investments. This is not the case. If we look at infrastructure investment at the municipal level, bank credit is only one of several prominent sources of financing. As discussed in a previous post, municipal infrastructure investment is the narrowest measure of national infrastructure investment but a good measure of investment at the local level.  In recent years bank loans have been one of the major sources of financing for municipal infrastructure investment but are not the majority source of financing. The more profound breakthrough in infrastructure financing is the rapid growth of on-budget fiscal revenues as a source of financing. In addition, extra budgetary revenues – such as land transfer fees – known as “self-raised funds” also play a prominent role in financing municipal infrastructure.

Sources of Municipal

2. Debt financing for local infrastructure is a problem

Another common misconception is that using debt to finance infrastructure is a problem. In fact debt financing for infrastructure is commonplace. Debt is an important vehicle for matching the short term cost of infrastructure with the long term benefits. The United States has one of the largest municipal debt markets in the world. Outside of the U.S, many countries borrow from banks to support local governments. A study by the World Bank on Managing Subnational Credit and Default risks suggests a “competitive and diversified subnational credit market” is an optimal direction for developing markets.

3. China has too many “white elephants”

It is widely believed that most of infrastructure investments in recent years – particularly those during the 2009 stimulus program – have been “white elephants.” Although it is true that many infrastructure projects – subway systems – do not generate profits and would struggle to pay back the principal on loans without fiscal injection that does not mean that these funds were wasted. Many infrastructure projects will provide positive externalities to the Chinese economy in the long run.

Composition of municipal

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