Fiscal Sustainability of China’s Provincial Governments: A Non-Stationary Panel Data Analysis”

Applying non-stationary panel data approach to the expenditures and revenues of China’s provincial governments for the period 1994-2013, we investigate whether there exists a long-run relationship between these two budget variables that would limit fiscal deficits and, consequently, debt, to a sustainable level. Considering the tax-sharing system instituted in 1994, we also include transfers from and to the central government in the analysis. Results from recent second-generation panel unit root and cointegration tests that account for cross-sectional dependence suggest that provinces in the central and western regions do not achieve fiscal sustainability on their own or even with central government transfers. Provinces in the more developed eastern region overall achieve fiscal sustainability in the weak form. Only the government budget in Jiangsu, Tianjin, Zhejiang, and, to a lesser extent, Shanghai is strictly sustainable on its own. These results bear important policy implications for China’s macroeconomic stability.