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ABSTRACT In 2009 and 2010, China undertook a fiscal stimulus program worth 4 trillion yuan, roughly equivalent to 11 percent of its annual GDP. This program was largely financed by off-balance-sheet companies-known as local financing vehicles-that both borrowed and spent on behalf of local governments. These companies have continued to grow since the stimulus program concluded at the end of 2010; their spending has accounted for roughly 10 percent of GDP each year, with an increasing share used for what are essentially commercial projects. And their spending has likely been responsible for an increase of 5 percentage points in the aggregate investment rate and for part of the decline of 7 to 8 percentage points in the current account surplus since 2008. We argue that local governments have used their new access to financial resources to facilitate favored businesses' access to capital, which potentially worsens the overall efficiency of capital allocation. The long-run effect of offbalance-sheet spending by local governments may be a permanent decline in the growth rate of aggregate productivity and GDP.
In November 2008, in the depths of the global financial crisis, China announced with great fanfare a fiscal stimulus program worth 4 trillion yuan, to be spent by 2010. In response to the announcement of this program, Dominique Strauss-Kahn, then the managing director of the International Monetary Fund, said that "it will have an influence not only on the world economy in supporting demand but also a lot of influence on the Chinese economy itself, and I think it is good news for correcting imbalances" (Barboza 2008). The program funds, amounting to about 11 percent of China's annual GDP, were mostly to be spent on infrastructure projects in 2009 and 2010. Many people viewed the program as playing an important role in preventing the worldwide recession from getting worse. Paul Krugman wrote in 2010 that China had engaged in a "much more aggressive stimulus than any Western nation-and it has worked out well" (Krugman 2010).
The goal of this paper is twofold. First, we analyze the institutional details of how China financed its fiscal stimulus program. We show that the stimulus was implemented by local governments and was mostly financed through the relaxation of the financial...