ABSTRACT
This chapter proposes a “Carrot and Stick” incentive mechanism to allow local governments to issue debts but remain subject to stringent fiscal rules. To prevent excessive debt issuing, it shows that some effective fiscal rules, which are akin to those adopted by the United States, be required for Chinese provinces as well. In addition to fiscal rules, there should also be a local government bankruptcy law to allow orderly resolution of local government debt. The chapter examines the debt problem of local governments in China. It discusses the balanced-budget rules of the United States and the implications of stringent fiscal rules on US macroeconomic management and a sequencing strategy to develop China’s municipal bond market. The chapter assesses whether Chinese provinces are fiscally sound enough to issue provincial government bonds. China’s national governance structure can be categorized as a unitary system in which the power is mostly held by a central authority with local and regional governments having limited autonomy.
