Investing like conglomerates: is diversification a blessing or curse for China’s local governments?
We examine government investment in business by studying Chinese local government financing vehicles (LGFVs), an often-criticised funding and investment channel. We find an inverted U-shaped relationship between LGFV diversification and subsequent local economic growth confirmed by identification using policy, regulatory, and enforcement events. The inverted U-shape is stronger when local economic development or government indebtedness is higher. Diversification appears to crowd out private investment and reflects career concerns and decision-making biases of local political leaders. LGFV business returns display similar inverted U-shapes. Thus, local government industrial diversification is associated with bad outcomes only if extensive and funded by heavy borrowing.
