Local Government Debt in China: Why Did It Emerge, How Should It Be Governed

The sustained expansion of local government debt in China is a key issue for understanding contemporary Chinese economic governance. Local government borrowing in China exhibits several distinctive characteristics that set it apart from those in Western countries: continuous debt expansion, a share of local debt far exceeding that of central government debt, the coexistence of explicit and implicit liabilities, and a high concentration of fund allocation in investment-oriented expenditures. This pattern is embedded in China's unique development model—where local governments deeply participate in and even lead economic growth—and has taken shape during the specific stage of rapid urbanization. Behind it lies a series of institutional arrangements with Chinese characteristics: the asymmetric distribution of fiscal authority between central and local governments, combined with growth pressures on local officials, creates endogenous incentives for borrowing; the unique land system and the government's de facto influence over financial resources grant local governments the objective capacity to mobilize funds on a large scale; and against the backdrop of sustained insufficient domestic demand, the “localized” implementation model of fiscal policy, which relies on subnational execution, further drives the accumulation of debt at the local level. The economic impact of local debt is notably phase-dependent. During periods of rapid urbanization, debt-financed public investment served a dual purpose: stabilizing the economy in the short term and fostering long-term growth. However, as the marginal returns on infrastructure investment diminish, crowding-out effects accumulate, and fiscal and financial risks become increasingly intertwined, the negative effects have become more pronounced in the current stage of development. Addressing the local debt issue fundamentally requires not only improving the debt management framework of “opening the front door and blocking the back door” but, more critically, promoting institutional realignment that aligns incentives. The core of this effort lies in rationalizing central-local fiscal relations and transforming government functions to establish a long-term mechanism. This is not only central to China’s current fiscal governance but also provides an important real-world reference for research on the Government and Economics.