Spatial Interaction of Local Government Debt: Evidence from China

The amount of local government debt has an important impact on the economic and social sustainability of a country. The rapid increase in local government debt in China over the past decade and the associated risks have profound implications for financial and economic sustainable development. While existing research has investigated governmental strategic interactions of tax and spending, little attention has been given to the spatial interaction of local government debt. This study employs Two-Regime Spatial Lag Models to investigate the spatial interaction of the debt among China's 332 prefectural-level local governments over the period of 2015 to 2019. The findings show significant interaction effects between neighbouring governments, both in the acquisition and utilisation of debt quotas, and the interaction during the acquisition process is higher than that during the utilisation process. In addition, the interaction between neighbouring governments within the same province is more pronounced than that between governments adjacent but located in different provinces. Furthermore, the interaction of special debt is more manifest than that of general debt. These findings pass various robustness tests. Additionally, the mechanism test shows that fiscal competition is one of the driving forces behind the observed interdependence of local governments' debt strategies.