Infrastructure investment in China: A model of local government choice under land financing

What factors contribute to high - even excessive - investment in public infrastructure? One explanation identified in the literature is fiscal decentralization and resulting competition for mobile capital among localities. We elaborate on this explanation for the Chinese context by developing a model of local public infrastructure investment with land financing. We show that public infrastructure investment increases when local governments are able to capture returns from investment in land improvement. We further find that the “polarization effect” associated with fiscal decentralization by Cai and Treisman (2005) can be exacerbated when local governments are able to capture the returns from land improvement. Finally, we note that while land financing can provide a stimulus for local development, this may come at the expense of a diminished share of spending on social welfare programs and other public consumption goods.