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Local crowding out in China
(2019)
In China, between 2006 and 2013, local public debt crowded out the investment of private firms by tightening their funding constraints, while leaving state-owned firms’ investment unaffected. We establish this result using a purpose-built dataset for Chinese local public debt. Private firms invest less in cities with more public debt, the reduction in investment being larger for firms located farther from banks in other cities or more dependent on external funding. Moreover, in cities where public debt is high, private firms’ investment is more sensitive to internal cash flow, also when cash-flow sensitivity is estimated jointly with the probability of being credit-constrained.
When markets are incomplete, social security can partially insure against idiosyncratic and aggregate risks. We incorporate both risks into an analytically tractable model with two overlapping generations. We derive the equilibrium dynamics in closed form and show that joint presence of both risks leads to over-proportional risk exposure for households. This implies that the whole benefit from insurance through social security is greater than the sum of the benefits from insurance against each of the two risks in isolation. We measure this through interaction effects which appear even though the two risks are orthogonal by construction. While the interactions unambiguously increase the welfare benefits from insurance, they can in- or decrease the welfare costs from crowding out of capital formation. The net effect depends on the relative strengths of the opposing forces.
When markets are incomplete, social security can partially insure against idiosyncratic and aggregate risks. We incorporate both risks into an analytically tractable model with two overlapping generations and demonstrate that they interact over the life-cycle. The interactions appear even though the two risks are orthogonal and they amplify the welfare consequences of introducing social security. On the one hand, the interactions increase the welfare benefits from insurance. On the other hand, they can in- or decrease the welfare costs from crowding out of capital formation. This ambiguous effect on crowding out means that the net effect of these two channels is positive, hence the interactions of risks increase the total welfare benefits of social security.