How can a country ‘graduate’ from procyclical fiscal policy? Evidence from China

In this study, we analyse the cyclicality of fiscal policies in China during the period 1978-2013. We find that the cyclicality of local government spending in China significantly affects the cyclicality of total government spending. We find that local budgetary government spending was strongly pro-cyclical during the 1980s, but it became counter-cyclical with respect to nationwide output fluctuations and non-cyclical with respect to region-specific output shocks in the mid-1990s. We argue that these are likely to be consequences of the 1994 fiscal reform, which revamped the fiscal relations between the central and local governments, reduced the pro-cyclicality of local government budgetary revenue and brought in counter-cyclical intergovernmental transfers. Findings of this study contribute to the debate on how developing and emerging countries, in particular those with federal fiscal structures, could reduce the pro-cyclicality of their fiscal policies.

Clemens Fuest and Jing Xing. CBT Working Paper 15/14