Integrating Capacity and Autonomy in Evaluating the Quality of Governance: A Case of China’s Capital 

Markets and Local Debt Crisis

The quality of governance is an important concept in studying economic growth and social welfare in developing and transition countries. Although somewhat controversial, there are clearly defined broad approaches or interactions to evaluate the quality of government. Fukuyama proposes an ideal type of governance quality model that could illustrate optimal levels of autonomy for differing levels of capacity. Gaining insights from his perspective, this research examines China’s experience with fiscal decentralization by focusing on the evolution of its current local government debt crisis. This research aims to explain the changing fiscal relationship between the central and local governments and analyze the roles and interactions of capacity, discretion, and accountability in China’s local governments. Although the central government has shown proactiveness in promoting local capital markets and has exerted efforts in regulating the local debt financing, the paper argues that without advancing tax reform and local discretion while increasing ways to create accountability and improve capacity within local governments, the debt market will not operate as expected. As a result, local governments and residences still rely heavily on the center to support balancing their fiscal budgets.