Investment Promotion, Fiscal Competition and Economic Growth Sustainability

Abstract

Local governments in China build development zones to attract investment. We develop a model of fiscal competition to examine investment promotion under centralization and decentralization. Our study shows that even when perfect information is not available, under the condition of an indivisible investment, a central government achieves the optimal investment in development zones and the best tax ratio for maximizing total welfare, whereas decentralized decision-making easily results in infrastructure overinvestment and tax erosion, which does harm to economic growth sustainability.