Empowering through Courts: Judicial Centralization and Municipal Financing in China

Abstract

This study finds that reducing political influence over local courts weakens local government debt capacity. We establish this result by exploiting the staggered roll-out of a judicial centralization reform aimed at alleviating local court capture in China and find reduced judicial favoritism towards local governments post-reform. The majority of local government lawsuits are with contractors over government payment delays. The reform not only increases government lawsuit losses but also exposes their credit risk, as payment delays without court support signal government liquidity constraint. Investors respond by tightening lending and increasing interest rates, which curbs government spending.

Keywords: judicial centralization, court capture, lawsuit, public finance, information asymmetry, municipal corporate bond JEL classifications: G12

JEL Classification: G12, G30, H70, K40