Ⅳ．Looking for an Alternative Control Mechanism to Local Governments' Behavior
A．The Existing Politic Control Mechanism
In consideration of the moral hazard, in order to avoid local governments' “soft budget constraint”that will lead to a surge of local debt risk, to introduce some kind of external control mechanism to limit the excessive debt of local governments has become a necessary choice．For a long time, the relation in central and local governments ensures that the central government has enough authority to control local governments' behavior and to realize a relative “hard budget constraint”．However, with the improving of the rule of law in central-local relation, the existing political control mechanism may face a failure, because the central government will no longer has a dominant position in central-local relation, national governance emphasis on rules rather than simple political authority．Hence, as a result, with the weakening of the central political control mechanism, “soft budget constraint”problem in local governments will be a hot potato, and the risk of excessive debts will still exist and even deteriorate．This is the “trap”that has been called in this paper．However, the author is not to oppose improving the rule-of-law of their relation, but to stress that in order to avoid the “trap”, we need to find an alternative control mechanism to restrain local governments' excessive borrowing and to achieve “hard budget constraint”goals, to create the conditions for “fiscal federalism maintained by market”.
Recalling the past thirty years, the relationship between central and local in China is in a dynamic evolution process, and we can find that the political control mechanism used by the central government to locals actually demonstrates China's past experience, which is the combination of the political centralization and economic decentralization．The economic decentralization ensures the passion of the local governments, while the political centralization is a kind of external constraints, avoiding to “catch the fish by draining the pool”．In scholars' point of view, the reason that the decentralized reform in China and Russia has an opposite result is due to the fact that China's economic decentralization is conducted under the centralized politics, the central government has enough authority to constraint local governments' behavior, while Russia's economic decentralization is conducted under the political liberalization.[1]
In the process of decentralization of powers in the central and local governments in China, the central government has put down some administrative power and financial power, but the central government depends on its authority over personnel appointment for local officials to control the investment behavior of local officials, thereby to effectively control the macroeconomic regulation and control.[2]And the control of the local officials by the central government is not only exercised by the local officials' illegal behavior to block its promotion, but also by raising promotion competition between local officials at the same level．In order to obtain promotions, local officials have to meet the central policy goals.[3]These competitions will give the central government an advantageous position on controlling and negotiation．By controlling personnel appointment and launching competition between the officials, the central government can indirect control over the local financial resources．Based on such a political structure, it not only can stimulate local officials to race to the top, but also can “brake”in time and control the local fiscal risk．In the studies of central-local relation, some scholars propose an expression of “Political Contract System”, which refers to the higher level governments making administrative tasks in the politics, economy, culture, ecology, Party building and so on, to decompose these tasks into a number of indicators and contract them out to the lower level governments, and the reward and punishments are made according to the completion situation.[4]It is obvious that this “Political Contract System”is not based on the law, but stipulated on the specific period．It is in line with the political logic of “subordinates obey the superior”and “the whole party obeys the central”, and it can also be regarded as an effective control mechanism for local governments' behavior, and can prevent the excessive borrowing in local financing.
We can notice that the deployment of the cleaning of local financing platform companies after 2010, it is obvious that the implementation of the legal systems does not play a central role in it; a series of “red documents”declared the beginning and the continuing of this movement．While the central government does not care about whether local governments' behaviors has violated The Guaranty Law, the various agreements signed between banks and local governments based on The Contract Law are valid, or local financing platform companies have been unveiled in the process of the repayment of debts based on the protection of creditors of the companies, the key points proposed by the central government are to effectively use political control mechanism to “warn”and “constrain”the financing behavior of local governments．The Notice of the State Council on Issues Concerning the Administration of Local Governments' Financing Platform Companies (the State Council, No.19 〔2010〕) has stipulated that “all people's governments and all relevant departments shall proceed on the basis of the overall situation, maintain the Scientific Outlook on Development and a proper attitude toward their own performance, fully recognize the importance and urgency of the administration over financial platform companies, reach a common understanding, strengthen leadership, carefully make arrangements and diligently and effectively implement the administration according to the actual needs of their respective regions and departments．The Ministry of Finance, the National Development and Reform Commission, the People's Bank of China, the China Banking Regulatory Commission and other departments and institutions shall put more effort into formulating specific implementing schemes, improve relevant policies, and strengthen the guidance and supervision over the administration．The Ministry of Finance shall, in conjunction with relevant departments, speed up the establishment of the debt management information system for financial platform companies and the systems for accounting and statistics reporting as well as the system for regularly reporting of debt information about financial platform companies to carry out overall administration and dynamic monitoring and controlling over debts of financial platform companies．The audit departments shall strengthen the supervision over the audit of financial platform companies．All people's governments and all relevant departments shall conduct research and establish the mechanism for scale administration and risk early-warning of debts of local governments, and include revenues and expenditures of debts of local governments in their budget administration, thereby gradually creating a debt financing mechanism for local governments which adapts to the socialist market economy, is administered in a standardized manner, and runs efficiently.”
B．Looking for an Alternative Control Mechanism
However, this kind of political control mechanism, established based on the non-rule-of-law relation between the central government and the local governments, can play a role in specific institutional environment．Gradually improving the legal transformation in central-local relation is the process of legalizing, institutionalizing and clarifying the boundary of the central-local power, and this change will inevitably lead to reducing the functions of the existing top-down political control mechanism．In this case, we must find an alternative mechanism to encourage local governments to realize “hard budget constraint”, otherwise, the purpose to solve the problem of local debt will poles apart.
Theoretically, the external control mechanism in local government debt financing behavior is either from the political system or from the financial market．Looking at the political system, the existing control mechanism has been gradually weakened, people will naturally think to attract the local residents to the government's control mechanism, while this kind of control mechanism in theory can be divided into “vote with their hands”and “vote with their feet”．The political system of “voting with their hands”in local residents (economics theory calls them as the local government clients) has a strong dependence on the control mechanism of democracy and a parliamentary system, however, it must be doubtful that the pattern of “one man, one vote”could inhibit the excessive financing behavior of the agent (local government)．We can see that in many countries, the excessive welfare under the democracy is the result of the conspiracy between the government and the residents, but it is in the expense of the long-term sustainability of fiscal system (the unsubsidized debt crisis is a typical example).What's more, today in China, whether the mechanism of “vote with hands”can exist and run effectively is still a question．As to the finance theory mechanism of “vote with feet”, due to the self-interested individuals' people will select better residential districts to show its preference for public goods, the different local governments will have competition relations to meet the requirements of residents (or enterprises) in order to “stay”them．If people can freely “vote with their feet”in many jurisdictions, it will form different and internal citizen preference districts, so that the Pareto Efficiency can be reached.[5]Specifically, the local governments should consider the willingness of their residents and companies when they conduct debt financing, but the excessive financing may encourage the residents and companies to move to other areas thus reducing the local tax sources．In consideration of this, the local governments have a motivation to suppress their own financing demands．However, to make “voting with feet”plays a dominant role in future financing behavior of the local government, it still needs some other factors, such as migration of population and flow of capital between regions．China is now not completely satisfied with these conditions．Moreover, the factors, which influence the population and capital flows, are complicated, while local governments' debt is only one factor for residents and companies to consider．At present, the high debt area is perhaps the highly dense with local residents and enterprises.
In fact, the dominant theory of fiscal decentralization through “voting with hands”and “voting with feet”mechanism to encourage and constrain local government behavior to improve local public welfare are not supported by China's circumstances．After studying the fiscal decentralization reform since 1978 and compulsory education development, some scholars found the relationship between fiscal decentralization did not increase the supply of primary compulsory education, and local governments tended to pursue capital investment, rather than spending on public goods or quasi-public goods.[6]This can explain the shortage of supply because the compulsory education as a purely local administrative matter is handed to local governments and therefore the central government is asked to take greater responsibilities than ever.[7]
C．The Legal Path of Making the Recessive Debts of Local Government Explicit
When we are looking for an alternative control mechanism for local governments' debts, it is difficult to find a feasible path from the political system, so we have to find the breakthrough in the financial markets．In short, the first thing is to make recessive debts become explicit through updating the current legal system, and let the local government debts fully displayed in front of the financial markets．The rational investors in financial markets will determine the possibility of the local governments' financing．While at the system level, we should empower the rights of issuing bonds in local governments based on the revision of the budget laws and regulations, improve the transparency of local government debts, reduce the risk of moral hazard in financial markets, and use the market mechanism to effectively control the behavior of local government debts.
In the process of revising the Budget Law, the participants from all walks of life have different opinions on whether to allow local governments to issue bonds, the preliminary amendment draft of the Budget Law, which had been submitted to the Standing Committee of the National People's Congress in December 2011, stipulated clearly that local governments have debt financing rights, and the State Council carries out “quota management regulations”over local governments．The local debt quota set by the State Council should be approved by the National People's Congress．But in June 2012, the second review amendment draft of the Budget Law, submitted to the Standing Committee of the National People's Congress, had removed the local government debt regulations, and reiterated that unless otherwise specified in the law and the State Council the local governments, may not issue bonds．This change is likely to mean that lawmakers and the public are worried about local governments to issue bonds, and afraid that this authorization would open a Pandora's Box and make local debt out of control．Some scholars opposed the revision of Budget Law of giving local government rights to issue bonds.[8]But in fact, this concern is not justified, because we need to be clear that whether the local government can borrow debts does not depend on the Budget Law．The Budget Law does not allow local governments to issue bonds before 2014, but it did not affect local governments' financing behavior．In addition to letting local investment companies issue corporate bonds or letting financing platform companies obtain bank loans, with the strengthening of the central government control over local government debt management, the commercial bank's tightened credit of local government and its financing platform companies, some local government have recently created the “innovative”approaches like trust loan, financing lease and after-sale leaseback, issuing financial products, BT (build and transfer), mat endowment construction, and even illegal fund-raising.[9]The regulations of the Budget Law are not directly applied to the reality of the economic activities．These regulations, which are meant to restrict or prohibit local government borrowing debts, are just encouraging local governments to take advantage of the trading patterns that can evade the financial regulations．The negative consequence will follow suit: financing behavior of local government is completely outside the framework of the laws．There is no doubt that the social costs are greatly increased in restraining and controlling them.
So, rather than letting local governments take recessive debt responsibilities by evading this Law, the local debts are advised to be made transparent in the public financial market, and the investors will have opportunities to fully and comprehensively understand the local government debt．The market will control the scale of local government financing．The Budget Law (2014) has clearly stipulated that local governments have rights to issue bonds．Article 35 stipulates that “Partial funds for construction investment indispensable to the budget of a province, autonomous region or municipality directly under the Central Government as approved by the State Council may be raised by issuing local government bonds and the scale of the debts so raised shall be reported by the State Council to the National People's Congress or its Standing Committee for approval”.[10]To a large extent, this is a measure to reduce the moral hazard, because the former bonds were issued by the central government, but now it belongs to the local governments to issue bonds．This change marks that local governments independently bear responsibilities in the market, an effective institutional path to realize “hard budget constraint”in local governments.[11]In order to coordinate the implementation of the Budget Law, the State Council promulgated “Opinions of the State Council on Strengthening the Management of Local Government Debts”(the State Council, No.43 〔2014〕) on October 2, 2014, which declares that “Local governments shall be responsible for repaying the debts they borrow, and in principle the Central Government shall not bail out local governments”; the Ministry of Finance released “Interim Measures for the Management of Issuing General Bonds by Local Governments”(the Ministry of Finance, No.64 〔2015〕) on March 15, 2015, Article 5 further confirms that the principle of “pay off by themselves”．Thus, it has been clear that local governments independently bear legal liabilities to pay off its debt．If local governments comply with these regulations substantially in the future, it can avoid the moral hazard of the debtors and investors due to the explicit and recessive guarantee of these debts.
To let countless financial market investors to constrain the local government financing behaviors, bring the transparent and efficient market mechanisms into full play, and use real-time financial product price signals to “discover”the local government's credit status, and then make market pressure on local government behavior choice in the future is an effective mechanism to overcome the bottleneck problems of “soft budget constraints”．Whether the local debts have a huge risk or it will cause crisis are not necessarily answered by the government's spokesmen, an effectively operating market and the price signals will give answers.[12]Compared with the relationship between the government and taxpayers, governments as borrowers in financial market and investors are more likely to form an equal relation.[13]Furthermore, under an effective market, the pricing in bond market can provide a more quantitative evaluation standard to government governance performance, and encourage the district people be actively involved in the operation of the mechanism of democratic politics; in turn, as the demand side of capital in financial market, in order to ensure sufficient government credit and low financing cost, the governments need to use many incentives to restrain financial risks which may have negative effects on financing behavior．All these are positive factors to help a country gradually promote the construction of constitutionalism.
Of course, we need to realize that this design of constraint mechanism doesn't happen all at once; especially, the financial market is still not perfect in China now．When the investors who are involved in financial transactions and purchase local government debt securities are the financial institutions controlled by the local government, the ideal state of the financial market price signal mechanism and corresponding constraint mechanism will easily be weakened．There is a situation that can explain this．The interest rate of the local government debts, which is issued by the central government instead of the local governments, is lower than that of the treasury．One of the reasons is that the strategic arrangements by the financial institutions of the local government are to highlight the good image of the local government.[14]
In addition, the design of the legal system should also consider setting a limit of bonds buyers within the local area which can make the investors and local residents strengthen market control over local government's behavior．For example, Zhou Xiaochuan, the governor of the People's Bank of China, believes that after establishing the local government debt system in China, the local government debt should be mainly sold to local residents, because the local residents will decide to buy them based on their pensions, welfare and other, which will impose limits on the local government debts.[15]
To sum up, only by amending the Budget Law can the two elements of the local autonomy will be realized simultaneously, i.e．to ensure the local governments have autonomous power through independently issuing bonds, and to emphasize the responsibility autonomy of local governments through publicly issuing bonds and trading in financial market．In this case, the improvement of the rule of law of the administrative power in central-local relations can avoid the “trap”of the local government financing behavior to be out of control.
[1] See Oliver Blanchard ＆ Andrei Shleifer, Federalism With and Without Political Centralization: China Versus Russia, IMF Staff Papers, No.48, 2001.
[2] See Huang Yasheng, Inflation and Investment Controls in China: The Political Economy of Central-local Relations During the Reform Era, Cambridge University Press, 1996.
[3] See Zhou Li'an, The Transformation of Local Governments: Officials' Incentive and Governance, Shanghai People's Publishing House, 2008, pp.95-101.
[4] See Zhu Hanqing, The Political Economy Explanation of Local Governments' Behavior, Zhengzhou University Press, 2012, p.71.
[5] See Charles Tiebout, A Pure Theory of Local Expenditure, Journal of Political Economy, Vol.64, No.5, 1956, pp.416-424.
[6] See Qiao Baoyun, Fan Jianyong, Feng Xingyuan, China's Fiscal Decentralization and Primary Compulsory Education, The Chinese Academy of Social Sciences, Vol.3, 2005.
[7] See http://news.xinhuanet.com/2013lh/2013-03105/c-114898916.htm, visited on Jan.5, 2015.
[8] See Liu Jianwen, The Real Possibility of Issuing Bonds by Local Governments, Legal Science, Vol.10, 2012.
[9] See The Audit Results of Government Debts at 36 Local Governments (the announcement of National Audit Office: No.24, 2013), Jun.10, 2013.
[10] The decision marks the market financial system has begun to constraint the behavior of local governments.
[11] It is important to note that the reform of pushing local government debts change into explicitation is still incomplete and inadequate, so local governments still have the motivation to break through the limitation of recessive debts.
[12] See Eugene Fama, Random Walks in Stock Market Prices, Financial Analysts Journal, Vol.21, No.5, 1965, pp.55-59; Eugene Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, Journal of Finance, Vol.25, No.2, 1970, pp.383-417.
[13] See Zhang Jianwei, Constitutional Economics Analysis of Local Government Debts Management, Legal Science, Vol.10, 2012.
[14] See Zhou Junsheng, The Low Interest Rates in Local Governments' Debts Cannot Be Ignored, The Securities Times, Nov.23, 2011, the first A3 version.
[15] See Zhou Xiaochuan, To Go Out of the Crisis the Deadlock Need to Design the New Incentive Mechanism, Chinese Financial, Vol.8, 2012.