This is a new policy revealed recently. In the Chinese Economy class yesterday, Professor Xu talked about the increasing local debt of Chinese local governments. See reports by New York Times and Bloomberg, .
Before the fiscal reform implemented by Premier Zhu Rongji, Chinese central government had to negotiate with local governments about how much they hand their fiscal revenues to the central government. Normally, about one-third of the revenues are contributed to the central and two-thirds were kept by the municipal authorities. However, in the fiscal re-centralization by Premier Zhu Rongji, local governments were only allowed to keep one-third of their revenues.The revenues are greatly reduced, but the local governments have to provide the public services.
In China, local governments did not have the right to borrow from the bank. So the central government gave them the right to “convert” the agricultural land. Urbanization was pushed forward under this context. The provincial governments forced peasants to tear down their houses (which are not agricultural land) for urban use. The peasants were given low compensation, and the government sell the land to developers at a price 10 times higher than the compensation price.
The soft budget constraint problem also plays an important role in the mounting debts. The provincial governments believe that “someone will pay up the debt”, so they just spend whatever is in the budget.
The regional decentralization in China has facilitated the reform and opening up policy and allowed for the economic take-off of China. But it has also caused regional inequality and separation.