Estimating local fiscal multipliers using political connections

Associate Professor, Renmin University of China. http://sf.ruc.edu.cn/info/1241/8097.htm

We use political connections between the central and local governments of China to identify the impact of government spending on the private sector. Our key innovation is to use changes in ministers of Chinese State Council as a source of exogenous variation in city-level intergovernmental transfers and hence fiscal expenditures. We find: (1) the local fiscal multiplier is estimated around 3.88 and there are no significant spillover effects; (2) local effective tax rates do not respond to such fiscal expansions; (3) private firms, instead of state owned enterprises (SOEs), are benefited more from such fiscal shocks; (4) the increase of output comes from firms’ employment expansions rather than capital investments. Our results contrast the conventional view that Chinese fiscal expansion works through SOEs, suggesting new considerations in evaluating the impact of government expenditure.