3.1. Research Hypothesis
EPU means that economic agents are uncertain about whether the current economic policy will change. Thus, from the source of generation, EPU rises rapidly in the process of dramatic adjustments and frequent changes in economic policy [
4]. When EPU is high, the government needs many financial resources to support the implementation of various economic policies. Most economic policies involve economic stimulus programs, economic restructuring and industrial restructuring. These policies are led by governments, so they consume many financial resources. Usually, local governments have stable revenues, and if expenditures for policy implementation increase, then the government has to raise debt to meet funding needs [
20,
21]. Therefore, EPU leads to a decrease in the fiscal sustainability of local governments.
EPU shocks can have a negative impact on economic activity [
7,
8,
9,
10]. A slowdown in economic trends lead to a decline in tax revenues [
33]. Falling revenues can lead to lower fiscal sustainability. At the same time, due to the declining trend of the economy, the government may stimulate the economy by expanding the size of the deficit, for example, by increasing fiscal spending, reducing taxes and increasing debt [
22,
43]. An increase in the size of the deficit can also reduce the fiscal sustainability of local governments. Therefore, based on the above theoretical analysis, the first hypothesis is proposed.
Hypothesis 1 (H1).
EPU has a negative impact on local fiscal sustainability.
Social science studies do not attempt to investigate (1) factual proof established by a natural science study, or (2) NON-RELATED variables. Because of this nature, the alternative hypothesis is always referred to as the Working or Functional Hypothesis, which has the direction of an investigation in establishing a social science phenomenon (Senthilnathan) [
44].
The social financing scale refers to the total amount of funds obtained from the financial system by the agents of the real economy [
24]. The social financing scale can comprehensively reflect not only a financial system’s financial support to the real economy but also the scale of financing in the real economy. The scale of financing in the real economy indicates the level of activity in the real economy [
45]. The agents of the real economy mainly refer to corporations and residents. Therefore, this paper analyzes the mediating effect of the social financing scale in EPU affecting fiscal sustainability from two aspects. These two perspectives are the investment and financing behavior of firms and the saving and consumption behavior of residents, respectively. As shown in
Figure 1.
From the perspective of residents’ saving and consumption, economic uncertainty can inhibit residents’ consumption and increase the incentive to save. This is because residents need more cash flow to cope with the risks associated with economic uncertainty. Therefore, residents’ precautionary motive to save become stronger [
46,
47,
48]. This can lead to more cash flow to the financial sector than to the real economy sector, thus reducing the social financing scale. EPU can lead to an increased level of information asymmetry. Residents are often unaware of changes in the prices of consumer goods, especially durable goods such as housing and transportation. This can inhibit their consumption behavior and financing needs [
49]. This leads to a reduction in the size of financing from the financial system for residents, that is, a reduction in the social financing scale. In addition, the decline in residents’ consumption leads to a decline in social consumption. This will inevitably lead to a decline in the production willingness of the supply side of departments. This can restrain the motivation of the real sector to expand production, leading to a decline in the scale of enterprise investment and financing. A decline in the enterprise financing scale refers to a decline in the capital scale obtained by enterprises from the financial system, that is, a decline in the social financing scale.
From the perspective of corporate financing behavior, EPU increases corporate financing costs and inhibits corporate financing behavior, thus negatively impacting the social financing scale. According to the risk compensation theory, rising EPU increases the likelihood of enterprise default and bankruptcy. Therefore, investors inevitably increase the cost of financing to compensate for the risk they take to obtain a risk premium [
50]. The increase in financing costs decreases the amount of corporate financing. In China, the main source of financing for microeconomic agents is banks. To cope with shocks from uncertainty and to prevent an increase in their own risk, banks become more cautious in granting loans, reduce the size of loans and improve their operations by implementing tight credit policies [
51,
52], which can reduce the social financing scale.
In terms of corporate investment behavior, an increase in EPU can lead to a reduction in the corporate investment scale. An increase in EPU leads to an increase in corporate financing costs, which inhibits the investment activities of corporate entities [
26,
27]. A reduction in investment activity reduces the demand for funds by corporations, thus reducing the social financing scale. According to the real options theory, an enterprise’s investment behavior can be treated as a series of options [
53]. When a corporation is hit by major economic uncertainty, it chooses to avoid risk by reducing its investment due to the uncertainty of future returns. The purpose of reducing current investment is to obtain more relevant information during the waiting period to reduce the potential for larger losses. The reduction in investment opportunities leads directly to a decrease in the amount of capital demanded by corporations. In addition, corporations choose to reduce their debt financing to avoid the risk of not being able to repay their loans on time [
54]. Therefore, the scale of corporate financing from the financial system has decreased, that is, the social financing scale has decreased. Accordingly, the following hypothesis is formulated.
Hypothesis 2 (H2). EPU has a negative impact on the social financing scale.
This paper analyzes the mediating role of the social financing scale in the relationship between EPU and fiscal sustainability from two perspectives. There is the decrease in fiscal revenue and the increase in fiscal expenditure and debt, respectively, because a reduction in the social financing scale leads to a reduction in fiscal revenue and an increase in fiscal expenditure and debt. Based on the assumption of a balanced government budget [
55], a decrease in fiscal revenue and increase in fiscal expenditure and debt will reduce fiscal sustainability [
56].
The fiscal revenues of local governments in China are mainly derived from tax revenues, government funding revenues, and state-owned capital management revenues [
20]. Therefore, a decrease in these three types of revenue inevitably leads to a decrease in overall revenue, which reduces fiscal sustainability. From the perspective of tax revenue, EPU not only reduces the investment and financing scale of corporations but also reduces residents’ savings and consumption [
57], therefore reducing the tax base by making tax revenue smaller and lowering fiscal revenue [
58]. In terms of governmental fund revenues, the increase in EPU reduces corporate investment and financing activities and residents’ consumption of durable goods such as housing [
49]. This can lead to a decline in the demand for commercial and residential land. A decrease in demand for land use reduces government revenue from land concessions [
59]. Land concessions are the main source of governmental fund revenues.
From the perspective of state-owned capital operating revenues, EPU can reduce the social financing scale and decrease the operating performance of banks. Since most banks in China are state-controlled banks, a decline in bank income can lead to the decline of local government revenue. In addition, EPU decreases consumption by residents and reduces the operating performance of nonfinancial state-owned corporations, ultimately reducing the fiscal revenue of local governments. Therefore, EPU can have an impact on fiscal revenues through the social financing scale, which in turn affects fiscal sustainability.
The increase in EPU reduces the social financing scale and slows economic growth. To maintain economic growth, a government implements active fiscal policies and economic stimulus programs, which require significant fiscal spending [
60]. Since the budget for fiscal spending is rigid, local governments cannot support active fiscal policy or economic stimulus programs by reducing spending. Therefore, governments must stimulate the economy by raising massive debt. Gopalakrishnan confirms that the extent of government financial support is associated with lower loan financing for corporations during periods of uncertainty [
61]. The higher the fiscal expenditure and the larger the debt of local governments, the lower fiscal sustainability.
In summary, the increase in EPU leads to a decrease in the social financing scale. The social financing scale can lead to a decrease in fiscal revenues and an expansion of fiscal spending and debt. Ultimately, it reduces fiscal sustainability. Accordingly, the following hypothesis is formulated.
Hypothesis 3 (H3). The social financing scale has a mediating effect on EPU and local fiscal sustainability.
3.2. Research Variables
Referring to Li and Du [
20], we use effective fiscal space to measure the fiscal sustainability (
) of local governments. The formula is as follows:
where indices
i and
t indicate provinces and years, respectively,
indicates the debt ratio ceiling,
indicates the actual debt ratio, and
fe indicates fiscal expenditure efficiency. We use DEA to calculate
fe because the efficiency of fiscal expenditure is a multi-input and multi-output efficiency model. Fiscal expenditure includes not only general public expenditure but also government human capital and the expenditure of China’s state-owned enterprises. Output is mainly expressed in per capita GDP.
Drawing on Ghosh [
19], we consider the realistic existence of fiscal adjustment costs in the analysis of government debt sustainability and incorporate the effects of macroeconomic uncertainty [
62]. In the context of economic prosperity, a nonlinear fiscal response function is set up as follows.
where
indicates the deficit ratio,
indicates the debt ratio of
t − 1,
indicates a function of
,
indicates economic changes, and
indicates possible factors other than the debt ratio that affect the deficit ratio.
Drawing on Bohn’s [
18] approach to analyze fiscal sustainability, Ghosh et al. [
19] estimate the nonlinear relationship between basic fiscal surplus and the government debt ratio by introducing the cubic function of the government debt ratio. The cubic function can better fit the phenomenon of financial drain. The function
is assumed to be continuously differentiable.
According to Bohn [
18], when the current government debt balance is equal to the debt balance of the previous period and its accumulated interest minus the current basic fiscal surplus, the government’s intertemporal financing budget constraints are met.
where
indicates the government debt balance at the end of period
t,
St indicates the government basic fiscal surplus at the end of period
t, and
indicates the debt interest rate. In accordance with Bohn [
18], we focus on the ratio of government debt to GDP rather than the absolute value of government debt, so both sides of Equation (4) are divided by GDP at the same time.
where
indicates the GDP rate of increase; let
. Since
, Formula (5) is changed to:
Formula (6) is a dynamic equation of the government debt ratio. The dynamic change in the government debt ratio is mainly determined by the debt interest rate, economic growth rate and basic fiscal surplus rate. If > 0, the government debt ratio in the next period will rise; otherwise, it will fall.
It is assumed that the government debt ratio in phase m-1 reaches the maximum. To conform to the government’s intertemporal financing constraints, the government debt ratio in period m should not increase.
Therefore, when the debt ratio in phase
m − 1 reaches the maximum, the maximum value of
is 0.
Substitute Formulas (3) and (8) into Formula (2) to obtain Formula (9).
where the coefficients of
,
,
,
and
are calculated by fitting the nonlinear financial response function according to the historical data of each province.
,
,
,
and
are obtained by calculating the mean value according to historical data. Then, Formula (9) is transformed into a cubic equation. We can obtain the equilibrium point of government debt
and the upper limit of government debt
.
Scholars from Stanford University and the University of Chicago jointly published the EPU index [
4]. The index is based on the content of news reports, and it covers major economies around the world. Baker [
4] selected the South China Morning Post (SCMP) in Hong Kong as a news story retrieval platform and constructed an index of Chinese EPU based on text retrieval and filtering methods. It has been empirically demonstrated that the index has good continuity and time variability and can accurately reflect the degree of EPU [
28]. In this paper, we adopt the approach of extracting the annual arithmetic mean to transform monthly EPU into annual EPU.
The social financing scale (SR) is an indicator that comprehensively reflects the financial support to the real economy. It refers to the total amount of funds obtained by the real economy from the financial system in a certain period of time [
24]. The social financing scale can comprehensively reflect not only the financial system’s financial support to the real economy but also the scale of financing in the real economy. This indicator consists of the following 11 indicators, including RMB loans, foreign currency loans (converted to RMB), entrusted loans, trust loans, undiscounted bank acceptance bills, corporate bonds, domestic stock financing for nonfinancial corporations, insurance company compensation, investment properties, local microfinance companies and loans from local lending companies. The data for this indicator are compiled by the People’s Bank of China (the central bank of China); thus, the data come from the People’s Bank of China website.
This paper selects the influencing factors of local fiscal sustainability based on the following principles. First, these variables have been used by domestic and foreign scholars in related studies. Second, the influencing factors are determined not only by the Chinese system and national conditions but also by actual economic conditions. Third, related data are available. On this basis, the following control variables are selected, drawing on previous studies. As shown in
Table 1: (1) GDP growth rate (GGDP); (2) The fiscal deficit (FG) is the annual fiscal expenditure of local government minus annual fiscal revenue. The following variables refer to Li [
20]: (3) Transfer payments (TRANSFER) represent central subsidy revenue; (4) Fiscal decentralization (FD) is the ratio of public budget revenue per capita in each province to the sum of public budget revenue per capita of each province and public budget revenue per capita of the central government; (5) The debt burden ratio (DEBT) is the ratio of the accumulated debt balance to GDP; (6) The urbanization rate (URBAN) is the ratio of urban population to total population; (7) The fixed asset investment growth rate (FIG) is the growth rate of fixed asset investment in each province; (8) The land concession revenue share (LTF) identifies the ratio of land concession revenue to public budget revenue.
3.3. Research Methods & Models
Our research sample is a standard panel data structure that contains two dimensions: province and year. Therefore, the empirical analysis is based on a classical Two-way Fixed Effects Regression Estimator, which is suitable for panel data analysis. Suppose that we have a panel data set of N units and T time periods, then our panel data is the balanced panel data set. Let
Xi,t and
Yi,t represent the binary treatment indicator and observed outcome variables for unit
i at time
t, respectively. We consider the following two-way linear fixed effects regression model [
63].
For I = 1, 2…, N and t = 1, 2…, T where and are unit and time fixed effects, respectively.
To test the direct impact of EPU on local fiscal sustainability, the following model is constructed by referring to Li for the selection of control variables [
20]:
where indices
i and
t indicate provinces and years, respectively.
is a dummy variable for year that controls for possible time effects in EPU and SUSTAIN.
is a dummy variable for province to control for possible regional heterogeneity in EPU and SUSTAIN. Standard errors are always clustered at the province level to correct for potential cross-sectional and serial correlation in error term
[
64].
To test Hypothesis 2, we set Formula (12) based on Formula (11) when the control variables are unchanged:
To test Hypothesis 3, we select the social financing scale as a mediation variable to test the mediating effect. Formula (12) is set as follows: