1. Introduction
China has recently experienced two pressures that have drawn significant international attention: slowed economic development and a substantial increase in local government debt (LGD) [
1]. The Chinese government executed a CNY 4 trillion (equivalent to EUR 586 billion) fiscal stimulus plan starting during the financial crisis of 2008, promoting economic recovery while causing a sharp increase in public debt [
2]. According to the National Audit Office of China, in 2013, the LGD balance was CNY 17.89 trillion (equivalent to EUR 2.62 trillion), while the central government’s debt balance was CNY 12.38 trillion (equivalent to EUR 1.81 trillion), with the scale of LGD exceeding that of the central government debt. Currently, improving green total factor productivity (GTFP) is a key step toward achieving sustainable economic development in China, which is in the midst of a crucial transition from the country’s previous crude development to green and sustainable development [
3]. Therefore, a scientific assessment of the impact of LGD expansion on GTFP can not only provide a basis for the governance of public debt but also clarify potential obstacle factors for promoting green economic development.
The existing studies on public debt have mainly focused on the relationship between government debt and economic variables such as economic growth [
4,
5,
6,
7], capital allocation efficiency [
8,
9], inflation [
10,
11], market interest rates [
12], and financial risk [
13], with less research on environmental effects. Fodha and Seegmuller (2014) [
14] constructed a two-period overlapping generations theoretical model demonstrating how increased public debt used to fund environmental-protection initiatives can enhance environmental quality. Clootens (2017) [
15] discovered that public debt has a favorable impact on environmental quality up to a particular debt level and turns negative if the ratio is exceeded. Zhang and Zhao (2018) [
16] discovered that the increased quantity of government debt causes local governments to weaken the rigor of environmental rules to draw private investment, to alleviate debt pressure, and to collect funding for debt servicing, which worsens environmental pollution. Carratù et al. (2019) [
17], based on 24 European countries’ panel data from 1996 to 2015, empirically found a nonlinear effect of public debt on air pollution. Chen et al. (2022) [
18], based on Chinese provincial panel data, empirically found that rising LGD levels exacerbate corporate financing constraints, which in turn undermine corporate GI capacity.
Although there is a lot of literature on the relationship between public debt and economic growth, and environmental pollution, on the one hand, there is still a research gap on the impact of public debt on GTFP; on the other hand, most of the existing literature analyzes the impact of public debt at the national and provincial levels, and few studies analyze the impact of public debt at the city level. Therefore, this paper explores the impact of LGD on GTFP based on urban panel data from 2010 to 2019 using a fixed-effects panel model. The results show that LGD expansion significantly inhibits GTFP in China.
The main contributions of this paper are as follows: first, the existing studies mainly pay close attention to the economic costs of public debt, while limited studies on the environmental effects of public debt only study the effects of environmental quality and pollution. This paper considers the combined economic and environmental effects of public debt and examines how LGD affects GTFP, which enriches the relevant studies. Second, most existing studies have been conducted at the national and provincial levels, ignoring the differences between individual cities; this paper provides a more detailed analysis based on the empirical study of panel data of 271 cities in China. Third, most of the existing literature studies the direct mechanism of LGD on environmental pollution, with little attention to the important mediating mechanism of green innovation (GI). This paper incorporates the level of GI into the analytical framework, reveals how LGD influences GTFP, and conducts a mechanism test, which helps to find out how public debt affects green development. Finally, the level of financial market development (FMD) is introduced as a moderating variable to show that FMD can effectively lessen the negative influence of LGD on GTFP and provide new ideas for the government to manage public debt.
The paper is structured as follows:
Section 2 presents the theoretical analysis and research hypotheses of the paper;
Section 3 presents empirical model and methodology;
Section 4 presents definitions of variable and data Sources;
Section 5 presents the empirical results and analysis; and
Section 6 presents the research conclusions and recommendations.
2. Theoretical Analysis and Research Hypotheses
China passed a tax-sharing reform in 1994 that stripped local governments of their ability to levy taxes, causing a sharp decrease in local government revenues [
19,
20]. Since the promotion of government officials is related to the local economic performance of their tenure [
21], in the context of facing fiscal pressure, officials who are eager to create promotion performance during their tenure will increase public spending to promote economic growth and achieve economic growth goals by raising debt. This development model of increasing public capital expenditure through large-scale debt by local governments can promote short-term economic growth. Nevertheless, it can inhibit long-term economic growth [
9,
22], which is not conducive to sustainable economic development. Moreover, LGD expansion can reduce the allocation efficiency of capital markets [
8]; cause a capital mismatch between industries, firms, and regions [
23]; and inhibit GTFP.
From the perspective of debt repayment, excessive expansion of LGD will cause increased pressure on LGD service. Making local officials increase fiscal revenue, on the one hand, may relax entry restrictions on highly polluting enterprises, attracting more polluting enterprises to invest locally; on the other hand, they may relax environmental regulation of local enterprises, lowering their environmental treatment costs and increasing their profits, but will exacerbate the local environmental pollution problems [
24]. In addition, land lease income is an important source of debt service and interest payment for local governments [
25,
26], and the resulting large-scale industrial land development will lead to increased pollution emissions, which will intensify environmental pollution and is detrimental to the green development. Based on this, the following hypothesis is proposed.
H1. LGD can significantly inhibit GTFP.
The level of GI is an important driver of GTFP growth [
27]. However, GI projects are characterized by long cycles, costs, and high uncertainty [
28], and financing constraints are the primary challenge inhibiting GI activities [
29]. LGD can exacerbate the problem of financing constraints for GI projects. First, LGD financing can reduce the number of funds available to support GI activities. In the credit market, the government owns high-quality assets such as land ownership, which is more favored by bank collateral [
30], and more importantly, the government may preferentially obtain credit funds from banks through administrative intervention [
31]. Therefore, banks will prioritize local government financing and squeeze out the financing demand for GI projects. On the other hand, LGD financing will push up the financing cost of GI projects. The interest rate of municipal investment bonds issued by financing platforms usually pushes up the market’s risk-free rate [
32], and bank loans often use it as an important reference for loan rates [
33], which forces GI investments to push up the financing cost to obtain bank loans. The crowding out of financing demand and the increase in financing cost will exacerbate the financing constraint problem and force a reduction in the financing demand, which in turn inhibits GI projects. Based on this, the following hypothesis is proposed.
H2. GI mediates the role of LGD and GTFP.
Furthermore, we investigate whether raising the level of FMD in cities will lessen the detrimental effects of rising LGD on GTFP. First, the further development of the financial market would improve financial resource mismatch [
34] and alleviate the financing constraint problem, thus mitigating the inhibitory influence of LGD on GTFP. Bank credit serves as the primary source of funding for local governments and businesses in China [
35]. Credit discrimination is a constant problem for private sectors, and local governments can squeeze out private enterprise investment, resulting in financial resource mismatch and GTFP loss [
34]. Along with the increase in the level of FMD, financial regulation will be strengthened, which will reduce credit discrimination in the private sector, enhance the effectiveness of credit fund allocation, and reduce GTFP losses. Second, increased FMD will intensify the competition among banks [
36]. More bank competition will lead to an increase in credit supply [
37], which would lessen the negative impact of LGD on GTFP. In addition, the banking industry’s increased competition will give the demand side of lending more negotiating power, which may secure longer financing terms and lower financing costs, further mitigating the negative effects. Based on the above analysis, the following hypotheses are proposed.
H3. The adverse effects of LGD on GTFP can be mitigated by the growth of FMD.
6. Conclusions and Policy Implications
Green development has recently taken center stage in China’s economy. This study explored the effect of LGD financing on GTFP based on data from 271 Chinese cities between 2010 and 2019. The following are the primary conclusions: First, the GTFP of cities decreases as LGD increases. In China’s central and western areas, where cities have higher debt levels, this negative correlation is particularly pronounced. Second, LGD decreases urban GTFP by lowering the amount of urban GI, and GI is a mediating factor. Finally, the environmental deterrent effect of LGD is significantly moderated by the increase in development in urban financial markets, i.e., FMD aids in mitigating the detrimental effect of LGD on urban GTFP.
The recommendations made in this study are based on the previous findings. First, given that Chinese LGD might hinder urban GI and inhibit GTFP, to foster long-term growth of China’s green economy, the government should focus on mitigating risks associated with LGD, preventing its heedless expansion, enhancing its governance of LGD, and putting in place a reliable LGD financing system. Second, FMD can effectively mitigate the detrimental impact of LGD on GTFP. Chinese authorities should accelerate the reform of the financial market, optimize the financial market environment, correct the distortion of financial resources, and guide the capital “out of government and into the real world” to promote economic growth; on the other hand, they should encourage green finance, green credit, and other innovative models to support the development of China’s low-carbon transition. Finally, local governments have a greater impact on the suppression of GTFP in less-developed cities and cities with higher debt levels, which generally have lower debt repayment and governance capacity. Therefore, in specific government debt governance measures, the Chinese government should take into account the heterogeneous impacts of cities in different regions and debt levels, implement differentiated policies, and increase environmental governance characteristic indicators to reduce debt risks while promoting coordinated and sustainable development of environmental protection and the economy.