The Contrasting Impacts of Chinese Local Government Debt on Firm’s Total Factor Productivity: Crowding-Out vs Crowding-In

This study investigates the contrasting impacts of local government debt on firm total factor productivity (TFP). Using a general equilibrium model and a panel dataset of Chinese firms from 2015 to 2019, we uncover that local government debt affects TFP via opposing crowding-out and crowding-in effects, mediated by firm financing constraints and R&D spending. Debt management efficiency is a vital determinant of these contrasting effects: efficiently managed debt (local government bonds) relaxes financing constraints and stimulates R&D, positively affecting TFP, while inefficiently managed debt (municipal investment bonds) tightens constraints and hampers R&D, negatively affecting TFP. Empirical results reveal heterogeneous impacts, with both crowding-in and crowding-out effects most pronounced among structurally disadvantaged firms (financially constrained and small firms in less developed regions). This study contributes by uncovering the contrasting effects of local government debt on TFP and offers policy insights on optimizing public debt financing to maximize productivity in emerging economies.