Does Fiscal Vertical Imbalance Enhance the Economic Resilience of Chinese Cities?

Abstract

This study constructs an econometric model and empirically examines the impact of fiscal vertical imbalance on local economic resilience using panel data from prefecture-level and above cities across China from 2007 to 2022. The findings show that fiscal vertical imbalance significantly enhances local economic resilience. A further mechanism analysis demonstrates that fiscal vertical imbalance effectively improves the adaptability and recovery capacity of local economies by increasing government investment, reducing tax burdens, and promoting industrial structure upgrading. Additionally, this study highlights that this positive effect is particularly pronounced in central and western regions and cities with lower administrative levels. The empirical results provide robust evidence to support China’s fiscal system reform, contributing to the sustainable development of regional economies.

1. Introduction

In the process of economic and social development, various shocks bring inevitable challenges [1]; these include external shocks, such as public health disasters, and internal dilemmas, such as industrial structure lock-in. Economic resilience manifests as a series of continuous responses exhibited by cities when facing shocks, encompassing early warning and resistance before shocks, response and adaptation during shocks, and recovery and transformation after shocks [2]. Economic resilience is not only related to a city’s ability to cope with short-term shocks but is also closely linked to long-term sustainable development. Research shows that economic resilience can support urban sustainable development by optimizing resource allocation, promoting industrial upgrading, and improving public service levels [3,4]. As the core areas of economic activities, the economic resilience of cities not only affects their own sustainable development but also has profound implications for sustainable development goals at the regional and national levels. Therefore, enhancing urban economic resilience is both a necessity for addressing short-term economic fluctuations and the key to achieving long-term sustainable development.

In China, research on urban economic resilience holds particular importance. Since the reform and opening-up, China’s economy has not only achieved rapid growth but has also demonstrated remarkable stability in the face of external challenges. This significant “resilience” has formed a solid foundation for China’s socio-economic development. However, China’s unique fiscal system—particularly the phenomenon of fiscal vertical imbalance—provides a distinctive context for studying urban economic resilience. Fiscal vertical imbalance may significantly enhance a city’s economic resilience in the face of internal and external shocks by influencing the policy tools and resource-allocation capabilities of local governments. This study aims to explore this issue, revealing the mechanisms through which fiscal vertical imbalance affects urban economic resilience, thereby providing policy insights and theoretical support for achieving sustainable economic development.

Natural disasters and economic crises have consistently affected urban development in recent years, and the diverse nature of these shocks has resulted in a variety of urban evolutionary pathways, thus attracting widespread attention. Research on economic resilience has coalesced around three key areas: First, defining economic resilience. Equilibrium theory hypothesizes that economic resilience is the capacity of a system to return to its initial equilibrium state or to transition to a new equilibrium following a disruption [5]. From this perspective, economic resilience represents the ability to maintain state stability, including engineering resilience and ecological resilience. Conversely, evolutionary theory suggests that economic resilience is a process of ongoing adaptive change and innovative pathway development in the economic system, driven by the interaction of shocks and numerous other factors [6,7]. Therefore, evolutionary theory views economic resilience as the ability to ensure long-term development and sustainability, which includes evolutionary resilience. Second, measuring and evaluating economic resilience. Current methodological approaches include the sensitivity index method [8], the comprehensive index evaluation method [9], and the trade flow method [10]. These diverse entry points to research result in the selection of different methods. The sensitivity index method, for instance, concentrates on measuring economic fluctuations resulting from shocks, whereas the comprehensive index evaluation method characterizes the overall response process to disturbances or emphasizes the differences in reactions across various dimensions. Third, assessing the factors that affect economic resilience. Current research indicates that worker skills, knowledge structures, economic clustering, economic openness, industrial composition, innovation levels, and human capital all significantly affect economic resilience [11,12,13,14,15]. The research on influencing factors has primarily concentrated on market-related aspects. Future research should expand to incorporate institutional factors, particularly when analyzing the economic resilience of Chinese cities. A relevant analysis requires paying attention to China’s unique fiscal and taxation structures in the context of central–local government relations. This system, as a central component of national governance, not only governs the distribution of authority and responsibility between national and local levels but also plays a crucial role in the responsiveness and long-term viability of urban economies.

Since the 1994 implementation of the tax-sharing system reform, the fiscal relationship between China’s central and local governments has followed a path of significant change. This significant adjustment in the fiscal system has established clear guidelines for responsibilities and expenditure-sharing between central and local governments in the fiscal domain while offering local governments broader fiscal operational autonomy. Additionally, to achieve the set economic development goals, the shift in power distribution toward localities has moved forward at a fast pace, bringing about the “decentralization of management authority”. Nevertheless, this pattern of “centralization of fiscal decision-making power and decentralization of management responsibility” has created a mismatch between fiscal revenue and expenditure with an “endogenous fiscal resource gap”, which has further accentuated the vertical imbalance in the fiscal system [16]. The economic implications of fiscal vertical imbalance have drawn significant attention in academic communities. Certain studies suggest that fiscal vertical imbalance can drive local governments to enhance resource allocation in their limited fiscal revenue autonomy, thus reducing predatory market intervention [17]. The central government can effectively guide local governments through well-structured reward and punishment mechanisms, motivating them to fulfill their responsibilities in order to achieve established economic policy goals [18]. While fiscal vertical imbalance is regarded as a key regulatory instrument in the decentralized governance model, it can also skew the revenue and expenditure patterns of local governments with decreased operational efficiency and negatively affect long-term economic stability [19]. Considering local governments’ comparative limitations in tax collection and debt-financing capabilities, when confronted with challenging circumstances such as external economic shocks, they typically look to the central government to shoulder the “fiscal bottom line” responsibility [20,21]. From a long-term standpoint, this mindset will gradually weaken the budgetary rigidity constraints on local governments, thus limiting fiscal discipline and increasing their likelihood of pursuing high-risk investment projects [22,23]. Not only will this situation compromise the quality and efficiency of public goods and service delivery [24], but it will also introduce numerous negative effects to the long-term stable development of the urban economy.

In summary, the academic community remains divided on the effects of fiscal decentralization and fiscal vertical imbalance on urban economic resilience, with some studies presenting contrasting perspectives. Utilizing a sample of Chinese prefecture-level cities from 2007 to 2022, this study evaluates the effect of fiscal vertical imbalance on the economic resilience of these cities. The findings indicate that fiscal vertical imbalance significantly strengthens the economic resilience of Chinese cities. This conclusion holds true even after addressing potential endogeneity issues and conducting rigorous robustness checks. Further analysis indicates that fiscal vertical imbalance primarily strengthens the economic resilience of Chinese cities by reducing tax burdens, facilitating industrial restructuring, and raising local government investment. Moreover, the positive effect of fiscal vertical imbalance on urban resilience is especially significant in central and western regions and cities with a lower administrative status.

This study makes three primary contributions: First, it broadens the research on the effects of local government fiscal vertical imbalance. While traditional fiscal decentralization theory primarily centers on areas such as economic growth, technological innovation, and industrial advancement, this study utilizes fiscal decentralization theory to appraise regional economic resilience. This novel approach offers a new analytical tool for understanding how the fiscal system molds the economic resilience of Chinese cities, thereby extending the application of fiscal decentralization theory in contemporary economics. Second, it addresses a gap in the literature on the effect of intergovernmental fiscal relations on urban resilience. While prior research has extensively analyzed diverse factors of urban resilience, limited literature has analyzed the role of intergovernmental fiscal relations. By connecting macro-level fiscal relations with local resilience, this study seeks to explain how fiscal vertical imbalance affects local resilience through multiple channels. Finally, the main findings of this study may carry significant policy implications. They can assist policymakers in better understanding the impact of fiscal vertical imbalance on urban economic resilience, thereby optimizing the design of fiscal systems. The research results can also provide practical guidance for local governments, helping them to more effectively respond to internal and external shocks and to enhance economic resilience. Additionally, the framework and conclusions of this study can serve as references for other developing countries, particularly in the areas of fiscal decentralization and urban sustainable development.

The structure of this paper is as follows: the Section 2 discusses the mechanisms through which fiscal vertical imbalance affects urban economic resilience; the Section 3 presents the empirical research design of this study; the Section 4 provides the empirical results and their analysis; and the Section 5 concludes with empirical findings and policy recommendations.

2. Mechanism of Action

Throughout the advancement of the tax-sharing system reform, both the responsibilities and scope of fiscal expenditure between central and local governments have experienced a comprehensive redefinition, which has granted local governments a moderate level of fiscal management authority. Simultaneously, as local governments actively work toward achieving economic growth objectives, their actual power has significantly expanded at its core, a phenomenon that can be described as “power decentralization”. In this model, the structure of “centralized fiscal power and decentralized management responsibility” naturally results in a mismatch between local government fiscal revenue and expenditure, creating a fiscal gap and therefore intensifying the vertical imbalance in the fiscal system. This systemic imbalance fundamentally affects the decision-making patterns of local governments and indirectly affects regional economic performance.

Firstly, the availability of transfer payments additionally means that local government expenditure can be funded not only by its internal revenue but also by fiscal pressure on other regions that set up a “shared pool”. Meanwhile, this fiscal vertical imbalance has the effect of increasing the elasticity of local government budgets, thus leading local governments to tend to expand their fiscal expenditure. In China’s unique governance system represented by decentralization and promotion by officials, local governments’ attempts to spend more on investment due to fiscal vertical imbalances are due to the receipt of transfer payments. In a decentralized governance system, local governments are essential for promoting investment in infrastructure and public services, which is critical to driving the growth and development of local businesses. Specifically, the developed infrastructure enables an enhanced, efficient operating environment for firms, lowers transaction costs, and improves firm competitiveness, thereby enhancing firm investment conditions and operational efficiency. Moreover, a well-developed infrastructure and a strong institutional environment are fundamental in attracting external investments, as they can offer the necessary physical conditions and guarantee the stability and transparency of policies that constitute two key considerations for external companies. Therefore, local public expenditures on infrastructure and social services simultaneously encourage local enterprise development and augment the ability of the local economy to cope with external shocks by attracting extra investment and strengthening the economic resilience of the whole region.

Secondly, in the structure of autonomous governance, local governments not only have great fiscal responsibilities but are also greatly influenced by heavy career-promotion incentives. These factors act in conjunction and may motivate local governments to strategically adjust and optimize the tax and financial support strategies that they offer to enterprises. On the one hand, in light of the uneven distribution of fiscal resources across different regions, local self-governments with weak fiscal autonomy may attempt to shift some of their tax responsibilities through inter-regional tax sharing. This strategy can economize on revenues and expenditures to a certain degree but is also likely to result in local authorities becoming over-reliant on central government fiscal transfers, thereby straining the incentive structure. This distortion of incentive structures may take the form of weakening enthusiasm in local governments to collect and administer taxes or an excessive tendency to attract and support local industries by offering tax incentives. Specifically, local governments may pursue a policy of “tax competition”, utilizing the reduction in enterprise tax burdens and operating costs as a means to stimulate enterprise production and investment vitality, thereby driving the prosperity of the local employment market and the growth of consumer demand. This approach indeed facilitates the local economic system to enhance its adaptability and resilience in the short run, simultaneously helping the local economy recover and grow.

Finally, in a decentralized governance structure, fiscal vertical imbalance motivates local governments to pursue fiscal autonomy, which they utilize as a strategic plan to encourage regional diversification and sustainable economic development. In this strategic framework, it is expected that local governments will be able to expand their fiscal revenue bases by proactively pursuing business environment improvement and foreign capital investment, thus preparing themselves for the modernization transformation and upgrading of local industries. Such measures are critical in increasing the competitiveness of the local economy and in deepening the transformation and upgrading of traditional industries, as well as nurturing and boosting new ones. In addition, a vertical disaggregation of government fiscal relations may play a constructive role in promoting industrial structure improvement and change by increasing competitive tendencies between government units. In view of scarce budgetary resources, to enhance the economy by utilizing more investors and personnel, subnational units may implement more appealing and reasonable fiscal incentive programs. Accordingly, all these competitive situations cause local governments to actively engage as they advance in industrial upgrading and promote the more efficient allocation and optimization of resources across regions. This facilitates the flow of resources from inefficient fields to efficient fields, thereby giving birth to new economic growth points and poles, which is also the basis for supporting the economy to remain resilient and achieve sustainable and stable growth.

However, fiscal vertical imbalance may also entail various risks, such as an increased fiscal dependency of local governments and issues of soft budget constraints. Local governments may become overly reliant on central government transfers to meet their fiscal expenditure needs, thereby undermining their fiscal autonomy and tax-collection incentives. This dependency could lead to a lack of independence in fiscal decision-making, which may hinder effective local economic governance. Simultaneously, soft budget constraints may encourage local governments to adopt overly aggressive investment strategies, leading to unnecessary public projects, fiscal deficits, and debt risks. Furthermore, in pursuit of GDP growth, local governments may neglect social welfare, resulting in overheated investments, investment bubbles, and overcapacity, thereby weakening their ability to respond to risks and external economic shocks.

Despite these risks, within a moderate range, fiscal vertical imbalance can still exert a positive influence on local economic resilience through the aforementioned mechanisms. For instance, when local governments effectively utilize transfer payments for infrastructure development and public service improvements, they can significantly enhance the competitiveness and attractiveness of the local economy, strengthening its adaptability and recovery capacity. Additionally, by optimizing industrial structures and promoting economic diversification, local governments can achieve sustainable economic growth, thereby mitigating some of the negative effects of fiscal vertical imbalance. Therefore, the key lies in balancing the advantages and disadvantages of fiscal vertical imbalance through sound policy design and effective governance mechanisms to achieve the high-quality development of the local economy. Therefore, this study proposed the following hypothesis:

Hypothesis H1:

Within a moderate range, fiscal vertical imbalance can positively promote the enhancement of the economic resilience of Chinese cities; that is, the higher the degree of fiscal vertical imbalance (within the bearable range), the stronger the resilience often shown by the local economy.

3. Research Design

3.1. Econometric Model

Building upon the work of Tóth et al. [25] and other scholars, this study employed the following econometric model to appraise the effect of vertical fiscal imbalance on the economic resilience of Chinese cities:

$${\mathrm{Res}}_{it}={\alpha }_0+{\alpha }_{1}VF{I}_{it-1}+{\alpha }_{3}Control{s}_{it}+{\mu }_i+{\lambda }_t+{\epsilon }_{it}$$

(1)

Here, i and t represent the prefecture-level city and time. μ_i denotes the city fixed effect, λ_t expresses the time fixed effect, and μ_i,t refers to the error term, reflecting other random factors not included in the model.

3.2. Variable Selection and Description

The dependent variable is economic resilience (Res_i,t). Following the methodology of Martin et al. [26], this study calculated the economic resilience of Chinese cities by comparing the actual economic output of prefecture-level cities to their projected output. More accurately, the projected local economic output is calculated as follows:

$$(\Delta GD{P}_i^{t+k}{)}^{expectation}=\sum _{d}GD{P}_{id}^t·g_N^{t+k}$$

(2)

Here, ΔGDP_i represents the expected change in the economic output of city i during the resistance or recovery period (t, t + k); GDP_id denotes the economic output of industry d in city i in year t; and gN expresses the change rate of national economic output during the period (t, t + k). The formula for calculating economic resilience is as follows:

$$\mathrm{Re}{\mathrm{s}}_i={\displaystyle \frac{\Delta GD{P}_i-(\Delta GD{P}_i{)}^{expectation}}{\left|(\Delta GD{P}_i{)}^{expectation}\right|}}$$

(3)

The core independent variable is the fiscal vertical imbalance indicator (VFI). Drawing on the measurement approach of Jia et al. [27], this study evaluated the current state of vertical fiscal imbalance in China. Taking into account key factors such as fiscal revenue and expenditure decentralization, as well as fiscal revenue and expenditure discrepancies, the degree of the fiscal vertical imbalance for each city is quantitatively evaluated according to the following formula:

Fiscal Vertical Imbalance (VFI) = 1 − Fiscal Revenue Decentralization/Fiscal Expenditure Decentralization × (1 − Fiscal Revenue-Expenditure Gap Rate)

The degree of fiscal revenue decentralization is calculated as the ratio between the local government’s per capita public budget revenue and the combined per capita public budget revenues of both local and central governments.

The degree of fiscal expenditure decentralization is measured as the ratio between the local government’s per capita public budget expenditure and the combined per capita public budget expenditures of both local and central governments.

The local fiscal revenue–expenditure gap rate is determined by taking the difference between local public budget expenditures and local public budget revenues and then dividing this difference by local public budget expenditures.

FRE = (Local Fiscal Expenditure − Local Fiscal Revenue)/Local Fiscal Expenditure

The control variables (mainly consisting of those described below) incorporate several key dimensions. The first dimension is the log difference of the per capita real gross domestic product (GDP) of prefecture-level cities (Pgdp), which functions as a key primary indicator when assessing the actual level of regional economic development. The second dimension is the degree/extent of external economic contact relationships, which is quantitatively evaluated via the proportion ratio of foreign direct investment to regional GDP (Open). The third dimension is population density (Density), which describes the degree concentration levels of the population distribution density across the region. In addition, the degree level of financial development (Load) serves as another crucial control variable, which is measured through the ratio of the year-end financial institution loan balance to GDP, offering insights into the region’s financial service capacity capabilities and its overall financial standing. Furthermore, the control variables also consist of the urbanization rate (Urban), which is calculated as the proportion ratio of permanent urban residents to the total permanent population, thus offering a measure of the region’s urbanization process. This study also takes into account the proportions of both the secondary industry (Ind2) and the tertiary industry (Ind3), which are used to measure the relative proportion shares of these sectors in the regional industrial structure, thus offering a detailed picture of the region’s economic and industrial structure composition.

Considering data accessibility and related factors, after filtering certain city samples, this study finally incorporated 246 prefecture-level and above cities in China from 2007 to 2022 as research subjects. For this study, data were sourced from statistical data published by official sources, including the “China City Statistical Yearbook” and local city statistical yearbooks. When data points were missing, this study implemented appropriate data-completion methods using technical approaches such as linear interpolation.

According to the descriptive statistical analysis presented in

Table 1. Descriptive statistics of variables.

Variable	Obs	Mean	Std. Dev.	Min	Max
Res	3398	0.000	0.004	−0.0081	0.0075
VFI	3398	1.184	0.627	0.2225	2.4941
Pgdp	3398	1.107	0.614	−1.0541	3.5883
Open	3398	0.088	0.140	−0.1053	0.5022
Density	3398	0.045	0.028	0.0063	0.1013
Ind2	3398	0.471	0.092	0.2941	0.644
Ind3	3398	0.414	0.091	0.2618	0.6014
Urban	3398	0.465	0.163	0.1944	0.8062
Load	3398	0.972	0.499	0.4098	2.246

Note: (1) In order to alleviate the potential impact of inflation factors on the regression results, this study used the provincial CPI price index to adjust all monetary measured variables to the price level of 2000. (2) In order to reduce the potential interference of outliers on the regression analysis results, this study carried out 5% and 95% truncation processing for all continuous variables.

, the sample mean of urban economic resilience (Res) stands at 0, accompanied by a standard deviation of 0.004, with values ranging from −0.0081 to 0.0075; the sample mean of fiscal vertical imbalance (VFI) measures at 1.184, with a standard deviation of 0.627, and the values are between 0.2225 and 2.491. These statistical data point to a high degree of variability across the sampled cities in both the economic resilience and fiscal vertical imbalance dimensions. Such significant differences highlight the importance of assessing the factors underlying these differences.

3.3. Stationarity Test of Variables

To ensure the robustness of the empirical analysis and avoid the problem of spurious regression, we conducted a rigorous stationarity test on the variables in the panel data. Stationarity is a crucial prerequisite in time-series analysis. Only when the variables are stationary can the validity and reliability of regression analysis and causality tests be guaranteed, thus avoiding the spurious regression phenomenon caused by non-stationary variables. Therefore, we employed the Fisher unit-root test to examine the stationarity of the variables in the panel data. The Fisher unit-root test is a comprehensive method that combines the p-values from individual unit-root tests for each cross-section, thereby providing a holistic and robust assessment of stationarity across the entire panel. This method effectively avoids the biases that may arise from single cross-sectional tests and ensures the reliability of the test results.

As shown in

Table 2. Fisher’s test.

Variable	P	Z	L*	Pm
Res_C1	36,484.218 ***	−120.051 ***	−164.168 ***	232.089 ***
VFI_R1	11,453.599 ***	−8.738 ***	−11.026 ***	14.558 ***
ROA	17,754.331 ***	−44.401 ***	−65.089 ***	99.96 ***
Lev	14,441.722 ***	−19.779 ***	−39.364 ***	70.735 ***
Assets	14,495.543 ***	−1.013	−21.848 ***	65.081 ***
Age	8569.405 ***	21.891	23.755	15.835 ***
Board	14,932.244 ***	−29.691 ***	−50.819 ***	75.062 ***
SOE	11,273.062 ***	−18.777 ***	−19.554 ***	42.78 ***
SIE	16,209.621 ***	−26.855 ***	−29.939 ***	49.149 ***
TIE	16,639.095 ***	−26.706 ***	−30.342 ***	52.273 ***
Loan	23,435.515 ***	−52.906 ***	−67.114 ***	101.704 ***

Note: (1) The null hypothesis (H₀) of the Fisher’s test is that unit roots exist; (2) *** p < 0.01.

, the p-values of all test statistics are less than 0.01. This result indicates that, at the 1% significance level, we can strongly reject the null hypothesis of the existence of unit roots for the four test statistics (P, Z, L*, and Pm). In other words, these variables in the panel data are free of unit roots and can be deemed stationary. This conclusion lays a solid foundation for subsequent analyses. Stationary variables mean that they do not exhibit persistent and irregular fluctuations in the time series but rather maintain stable means and variances, which makes them suitable for further regression analysis and causality tests.

More importantly, by confirming the stationarity of the variables, we have effectively ruled out the possibility of spurious regression. In time-series analysis, if variables are non-stationary, conducting regression analysis directly may lead to spurious regression problems, where the model shows significant statistical relationships that do not actually exist. However, since we have confirmed the stationarity of the variables through the Fisher unit-root test, we can be confident that the subsequent regression analysis and causality tests are based on stationary variables. This avoids the problem of spurious regression and ensures the scientific validity and effectiveness of the analysis results.

4. Empirical Results and Analysi

4.1. Benchmark Regression

This study first empirically analyzed how fiscal vertical imbalance affects the economic resilience of prefecture-level cities, utilizing the benchmark econometric model (Equation (1)), with the results reported in

Table 3. Benchmark regression models.

Model	(1)	(2)
	Res	Res
VFI	0.0209	0.0846 **
	(0.60)	(2.19)
Pgdp		−0.0012 **
		(−2.34)
Open		−0.0036 ***
		(−3.91)
Density		−0.0944 ***
		(−3.14)
Ind2		0.0219 ***
		(5.39)
Ind3		0.0143 ***
		(3.24)
Urban		0.00179
		(1.04)
Load		−0.0004
		(−0.91)
Constant	−0.0001	−0.0116 ***
	(−0.38)	(−3.05)
Year FE	Y	Y
City FE	Y	Y
N	3570	3397
R2	0.109	0.130
F	0.362	8.526

Note: (1) The values in parentheses are t-values; (2) ** p < 0.05, *** p < 0.01.

. The preliminary model estimation (Column (1)) incorporated only the core explanatory variable without the control variables, deriving a positive but insignificant regression coefficient. Then, in the further estimation of the model (Column (2)), a series of control variables that may affect the economic resilience of Chinese cities were introduced. This model analysis indicated that the regression coefficient of the key explanatory variable exhibited a significant positive effect at the 5% significance level. These findings point to a positive effect of fiscal vertical imbalance on the economic resilience of Chinese cities, offering a preliminary empirical backing for Hypothesis H1.

4.2. Endogeneity Test

While we made efforts in the benchmark regression model to factor in a range of issues at the regional level and to strengthen the model by incorporating both individual and time-fixed effects, it is possible that endogeneity issues arise when exploring the relationship between fiscal vertical imbalance and the economic resilience of Chinese cities. To model and rectify this, scientific approaches must be used. Additionally, in regions with a lower level of economic development, the recovery power of the local economy is also evidently lower. Therefore, to encourage the economy, it is possible that local authorities would increase fiscal spending, as this would facilitate the recovery of the economy, though it would worsen the fiscal vertical imbalance, thereby creating a reverse causal relationship. In addition, certain unincorporated latent variables may affect the relationship between fiscal vertical imbalance and the economic resilience of Chinese cities behind the scenes, thus compounding the endogeneity problem. To address these issues, this study used two types of robustness verification methods: the instrumental variable method and the propensity score matching (PSM) method. In the first case, an instrumental variable was used—a variable that is closely associated with the endogenous explanatory variable but does not have any correlation with the error term. This acts as a facilitator in removing the effect of endogeneity from internally estimated models. The PSM reduces the possible selection bias in the results of this study by matching the treatment and control groups as closely as possible in terms of pre-defined characteristics. The inclusion of these methods allows for the presentation of firm empirical strategies to ensure the reliability of this study’s conclusions.

First, we employed the instrumental variable method for our analysis. To address the endogeneity problem in the benchmark regression that could result from reverse causality, we implemented the instrumental variable method. Drawing from Wang Xiaolong and Yu Long [28], we utilized the average fiscal vertical imbalance of other cities in the same province as the instrumental variable (denoted as IV1). On the one hand, cities in the same province have identical provincial governments, share similar political environments, and maintain close interconnections with each other. Accordingly, the fiscal imbalance level of the target city demonstrates a strong correlation, and IV1 satisfies the relevance condition of the instrumental variable. On the other hand, as policy spillover effects remain limited in scale and administrative jurisdiction is accurately implemented, the target city primarily responds to its own fiscal policies, and the fiscal imbalance status of other cities hardly affects the economic resilience of the target city. Therefore, IV1 fulfills the exogeneity condition of the instrumental variable. In addition, Bartik IV demonstrates favorable properties and has received widespread application in numerous studies. Following the research of Bartik [29] and Goldsmith-Pinkham et al. [30], we employed Bartik IV as the instrumental variable for fiscal vertical imbalance (denoted as IV2). To minimize the potential issue of weak instrumental variables and enhance estimation efficiency, we followed the research of Huang Qunhui et al. [31] and Bo Peiwen and Zhang Yun [32], applying both IV1 and IV2 instrumental variables for IV-2SLS estimation. The first column of

Table 4. Alleviating endogeneity issues.

Model	(1)	(2)	(3)
	VFI	Res	Res
VFI		0.252 ***	0.0922 **
		(3.72)	(2.27)
IV1	−0.0360 ***
	(−31.21)
IV2	0.596 ***
	(38.49)
Constant	Y	Y	Y
Controls	Y	Y	Y
Year FE	Y	Y	Y
City FE	Y	Y	Y
Anderson canon LM		1092.46 ***
Cragg–Donald Wald F		746.311 ***
Sargan statistic		4.715 **
N	3346	3346	3101
R2		0.015	0.146
F	746.31 ***	9.197	7.734

Note: (1) The values in parentheses are t-values; (2) ** p < 0.05, *** p < 0.01.

presents the regression analysis results from the first stage of the instrumental variable method. IV1 produces significantly negative results, while IV2 demonstrates significantly positive results, both at the 1% level, with the first-stage F value reaching 746.31, significantly exceeding 10. These findings indicate a strong correlation between the instrumental and endogenous variables, a good model fit, and the absence of weak instrumental variable issues. The second column of Table 4 displays the regression analysis results from the second stage, where the VFI coefficient demonstrates significant positive values at the 1% significance level. This outcome indicates that, even after addressing potential endogeneity, fiscal imbalance continues to significantly strengthen economic resilience, offering additional support for the robustness of our benchmark conclusion. Additionally, the Anderson canon LM statistic, Cragg–Donald Wald F statistic, and Sargan statistic all exhibit significance at a minimum 5% level, confirming that our selected instrumental variables are free from issues of unidentifiability, weakness, and over-identification while demonstrating sound estimation properties.

Second, this study adopted the PSM strategy to additionally minimize the potential influence of city-specific characteristic differences on the research results. During the specific implementation, the city samples were categorized into a group with a high fiscal vertical imbalance (regarded as the experimental group) and a group with a low fiscal vertical imbalance (regarded as the control group) based on the median value of the fiscal vertical imbalance index. In the matching phase, building upon the control variables incorporated into Model (1), we applied a one-to-one nearest neighbor matching approach to the experimental group city samples, where matching objects could be utilized multiple times. Following the application of the PSM method, we incorporated the grouping dummy variable into the regression model to assess the treatment effect. As indicated in the third column of Table 4, the positive effect of fiscal vertical imbalance on economic resilience maintains significant statistics even when city-level individual characteristics are controlled for. This finding additionally confirms that fiscal vertical imbalance actively functions in improving the economic resilience of Chinese cities by optimizing the financing environment and strengthening innovation support.

4.3. Robustness Test

4.3.1. Replacement of Explanatory Variables

To further verify the robustness of the core variables, this study employed the fiscal expenditure gap rate as an alternative measure and conducted another regression analysis. The fiscal expenditure gap rate, which represents the proportion of the difference between public budget expenditure and revenue in relation to public budget expenditure, directly demonstrates the fiscal pressure conditions of local governments. Column (1) of

Table 5. Robustness test models.

Models	(1)	(2)	(3)	(4)
	Res	Res	Res	Res
VFI_		0.108 ***	0.101 **	0.0846 *
		(2.72)	(2.25)	(1.93)
VFI_R1	0.0925 *
	(1.75)
Constant	−0.0114 ***	−0.0131 ***	−0.0177 ***	−0.0116 ***
	(−2.95)	(−3.22)	(−3.95)	(−2.86)
Controls	Y	Y	Y	Y
Year FE	Y	Y	Y	Y
City FE	Y	Y	Y	Y
N	3397	3001	2908	3397
R2	0.129	0.131	0.155	0.130
F	8.305	10.070	7.547	6.743

Notes: (1) The values in parentheses are t-values; (2) * p < 0.1, ** p < 0.05, *** p < 0.01. (3) The first column uses the alternative variable VFI_R1 for regression; the second column excludes municipalities directly under the central government and provincial capital cities; the third column excludes samples during the pandemic period; and the fourth column uses robust standard errors.

presents the regression results with this replacement variable, additionally confirming that fiscal vertical imbalance has a significant and positive effect on the economic resilience of Chinese cities.

4.3.2. Exclusion of Municipalities Directly Under the Central Government and Deputy Provincial Cities

Considering that municipalities directly under the central government and deputy provincial cities exhibit significant differences in their economic management and social affairs from ordinary prefecture-level cities, these special administrative-level cities are likely to exhibit varying characteristics in their fiscal behavior, which could potentially affect the accuracy of our research results. To ensure the accuracy and reliability of our research conclusions, we opted to exclude sample data from these cities. The sample regression analysis results following this screening process (see Column (2) of Table 5 indicate that, even after removing the particular influence of municipalities directly under the central government and deputy provincial cities, the positive effect of fiscal vertical imbalance on the economic resilience of Chinese cities remains significant.

4.3.3. Exclusion of Pandemic Period Samples

The COVID-19 pandemic inflicted an unprecedented shock to the global economy, with its extensive reach and deep degree of impact surpassing those of any previous economic crisis. The pandemic’s effects on regional economies demonstrate unique characteristics, with its impact objects, spatial coverage, and transmission mechanisms significantly differing from those of traditional economic shocks. As such, to obtain a more accurate assessment of how fiscal vertical imbalance affects the economic resilience of Chinese cities, we chose to exclude sample data from the pandemic period. The regression results presented in Column (3) continue to support the core hypothesis of this study.

4.3.4. Use of Robust Standard Errors

When heteroscedasticity is present in data, conventional standard errors might not offer reliable estimation results. Accordingly, we implemented robust standard errors in our regression analysis. These robust standard errors function independently of the homoscedasticity assumption and yield more accurate parameter estimates and reliable statistical inferences. The regression results utilizing robust standard errors, as presented in Column (4) of Table 5, offer additional validation for the hypothesis of this study.

4.4. Mechanism Verification

4.4.1. Local Government Investment

In analyzing the effect of fiscal vertical imbalance on economic resilience, this study specifically evaluated the role of the local government investment mechanism. We utilized fixed asset investment in urban construction (FInvest) as the proxy variable for measuring regional infrastructure investment, conducting an analysis based on the data presented in Column (1) of

Table 6. Mechanism test models.

Model	(1)	(2)	(3)
	FInvest	Tax	Industry_Level
VFI	0.0903 ***	−0.0395 ***	0.0619 ***
	(3.22)	(−23.40)	(4.06)
Constant	−0.178	0.136 ***	1.275 ***
	(−0.69)	(8.84)	(9.17)
Controls	Y	Y	Y
Year FE	Y	Y	Y
City FE	Y	Y	Y
N	3874	3885	3885
R2	0.566	0.701	0.915
F	24.870	109.600	363.800

Note: (1) The values in parentheses are t-values; (2) *** p < 0.01.

. Our results show that the independent variable VFI (fiscal vertical imbalance index) exhibits significant positive values, demonstrating that fiscal vertical imbalance significantly drives an increase in local government infrastructure investment. This observation aligns with the research findings of Chu Deyin and Shao Jiao [33], who found that fiscal vertical imbalance directs local government expenditure patterns toward economic infrastructure construction.

4.4.2. Tax Effort

Our research evaluates tax effort levels by analyzing the relationship between actual and potential tax revenues. To estimate the potential tax revenue, we adopted the research methodology of Chu Deyin and Shao Jiao [33], implementing a multiple linear regression model for predictions. An analysis of the data in Column (2) of Table 6 shows that the independent variable VFI has significant negative values, suggesting that fiscal vertical imbalance reduces local governments’ tax efforts. This points to how the “public pool” effect associated with fiscal vertical imbalance potentially reduces local governments’ motivation for tax collection.

4.4.3. Industrial Structure Transformation and Upgrading

To verify the pathway of industrial structure transformation and upgrading, we employed the ratio of the tertiary industry to the secondary industry (Industry_Level) as our proxy variable. The findings presented in Column (3) of Table 6 demonstrate that fiscal vertical imbalance actively motivates local governments to advance the transformation and upgrading of the urban industrial structure, thereby strengthening the city’s economic resilience. This result demonstrates that fiscal vertical imbalance contributes positively to improving local economic adaptability and recovery capabilities through its role in advancing industrial structure optimization and upgrading.

4.5. Heterogeneity Analysis

4.5.1. Regional Heterogeneity

This study further explored the manner in which fiscal vertical imbalance affects the economy of different cities in China, considering regional differences. The matrices are presented below. The results in the prepared figures indicate that the eastern region (Column 1) containing Chinese cities was not statistically significantly affected by the vertical imbalance. Additionally, Columns 2 and 3 indicate that both the central and western regions (Column 2) passed the test, with a vertical imbalance of over one percent. This finding indicates the regional heterogeneity of the effect of fiscal vertical imbalance on economic resilience. This study further proposed that the differences in fiscal transfer payments between the eastern, central, and western regions may be the key causal factors of this phenomenon. Specifically, the eastern region, with a strong economic foundation, may rely more on market mechanisms and its own financial strength, and enterprises may be less affected by fiscal vertical imbalance. In comparison, the central and western regions may be more dependent on central government fiscal support; therefore, fiscal vertical imbalance may have a more direct effect on the economic resilience of these regions.

4.5.2. Administrative-Level Heterogeneity

Due to differences in administrative levels, cities demonstrate significant differences in national policy support, etc. These differences affect how fiscal vertical imbalance affects the economic resilience of Chinese cities, and they give rise to heterogeneous characteristics. While the robustness test, conducted by excluding sample data from municipalities directly under the central government and deputy provincial cities, confirmed the stability of this study’s conclusions, the observed shifts in the coefficient values during this process necessitate further examination. To more closely appraise the accurate role of the administrative level in the relationship between fiscal vertical imbalance and the economic resilience of Chinese cities, this study separated the sample group into cities with high and low administrative levels based on whether they have attained a deputy provincial status or higher. Sub-sample regression analyses were then performed for each group. The regression results are presented in Columns (3) and (4) of

Table 7. Heterogeneity analysis models.

Model	(1)	(2)	(3)	(4)
	East	Non-East	Surrounding	Central
VFI	0.0048	0.114 ***	0.0878 **	−1.000 **
	(0.08)	(2.61)	(2.26)	(−2.38)
Constant	−0.0195 ***	−0.00266	−0.00846 **	−0.0646 **
	(−2.97)	(−0.63)	(−2.15)	(−2.29)
Controls	Y	Y	Y	Y
Year FE	Y	Y	Y	Y
City FE	Y	Y	Y	Y
N	1317	2080	3290	107
R2	0.397	0.207	0.131	0.407
F	3.871	9.427	8.641	2.296

Note: (1) The values in parentheses are t-values; (2) ** p < 0.05, *** p < 0.01.

. The findings indicate that fiscal vertical imbalance has a significant enhancing effect on the economic resilience of cities with a lower administrative level, while it negatively affects the economic resilience of cities with a higher administrative level.

5. Conclusions and Policy Recommendations

Finance stands as the cornerstone of national governance and plays a core role in resource allocation and market integration. As the national level actively promotes reforms regarding the division of financial power and expenditure responsibilities between central and local governments, a reasonable financial and taxation system has established itself as a key institutional guarantee for cultivating the high-quality development of local economies. Drawing upon panel data from prefecture-level and higher cities in China (2007 to 2022), this study conducted an empirical analysis on the relationship between fiscal vertical imbalance and the economic resilience of Chinese cities, arriving at the following core conclusions: Fiscal vertical imbalance has a significant positive effect on the economic resilience of Chinese cities, with this finding maintaining its stability across multiple robustness tests. Regarding the mechanism of action, fiscal vertical imbalance principally strengthens local economic resilience through expanded government investment, decreased tax burdens, and advancement in industrial structural optimization and upgrading. Through a heterogeneity analysis, we found that fiscal vertical imbalance impacts the economic resilience of various cities with heterogeneous characteristics. The enhancing effect of fiscal vertical imbalance on local city economic resilience proves more significant in cities with lower administrative levels and those situated in non-eastern regions; however, for cities with higher administrative levels, fiscal vertical imbalance might exercise a reverse inhibitory effect. Building upon these research conclusions, we put forward the following policy recommendations to optimize the financial system:

First, the reform of the fiscal transfer payment system should be deepened by enhancing payment standards, strengthening performance assessments, cultivating interregional collaboration, and improving fund oversight to ensure that fiscal resources are appropriately allocated to economically less developed regions and cities with lower administrative levels, thus cultivating balanced regional development and strengthening the economic stability of these areas. Second, considering the positive effect of fiscal vertical imbalance on enhancing the economic stability of Chinese cities, local governments should optimize the composition of fiscal expenditures, prioritize essential investments in infrastructure and public services, and implement cost–benefit analyses and project-evaluation procedures to enhance the effectiveness and returns of public investment, thereby establishing a robust foundation for sustained, long-term economic growth. Third, to reconcile tax reductions with fiscal health, local governments should enact structural tax reforms, adjust and optimize tax categories and rates, reduce the reliance on tax incentives, and strengthen interregional tax-coordination mechanisms to maintain a stable fiscal revenue and equitable competition in the regional economy. Fourth, local governments should develop detailed industrial modernization strategies and fiscal incentive programs, concentrate support on emerging industries and advanced technology sectors, and encourage corporate innovation through the creation of dedicated funds, tax breaks, research and development subsidies, and other measures, thereby advancing the optimization and advancement of industrial structure and enhancing the fundamental competitiveness and sustainable growth potential of the local economy. Fifth, central and local governments should collaboratively develop and implement regionally coordinated growth strategies, establish interregional financial cooperative mechanisms and resource-optimization and allocation systems, facilitate resource sharing and synergy, and achieve balanced growth across the regional economy while preventing extreme resource imbalances, guaranteeing that each region can attain coordinated and sustainable development in accordance with its unique characteristics.

Although fiscal decentralization policies have a positive effect on enhancing local economic resilience, they may also have some adverse consequences. For instance, excessive fiscal decentralization could intensify competition among local governments, leading to local protectionism and even inefficient resource allocation and imbalanced regional development. Additionally, with increased fiscal autonomy, local governments may face issues such as softened budget constraints and rising debt risks, which could threaten long-term economic stability. Therefore, when implementing fiscal decentralization policies, it is essential to ensure their positive effects through effective institutional design and policy coordination while mitigating potential negative impacts.

It is important to note that the findings of this study are primarily based on China’s tax system and fiscal structure; thus, they may not be directly applicable to other countries. Due to significant differences in tax systems, degrees of fiscal decentralization, and fiscal relationships between central and local governments across countries, the mechanisms and effects of fiscal vertical imbalance on economic resilience may vary depending on national contexts. For instance, in some countries, local governments may have greater fiscal autonomy, or their economic resilience may rely more on market mechanisms rather than government intervention. Therefore, the conclusions of this study need to be adapted to specific national conditions and should not be generalized to other countries without careful consideration.

Furthermore, although this study made some progress in exploring the relationship between fiscal vertical imbalance and urban economic resilience, several issues warrant further investigation: First, while this study primarily examined the mechanisms of fiscal vertical imbalance at the macro-level, future research could delve into the firm or industry level to analyze how fiscal vertical imbalance enhances economic resilience by influencing corporate behavior, resource-allocation efficiency, or technological innovation. Second, comparative studies could be conducted to contrast the relationship between fiscal vertical imbalance and economic resilience in China with that in other countries, exploring the similarities and differences in local government behavior under different fiscal systems, as well as the universality and specificity of the impact of fiscal vertical imbalance on economic resilience. Additionally, future research could investigate whether there is a nonlinear relationship between fiscal vertical imbalance and economic resilience, such as the existence of an “optimal” level of fiscal vertical imbalance beyond which economic resilience may decline.