Local fiscal pressure and new firm entry

Local governments typically implement various policies to attract new enterprises to their jurisdictions. However, under fiscal constraints, some of their behavioral changes may impact the willingness of new businesses to establish themselves locally and could even lead to counterproductive outcomes. This study, utilizing data from prefecture-level cities in China, identifies a negative correlation between local government fiscal pressure and the entry of new enterprises. This conclusion withstands a series of robustness tests. After eliminating potential competing mechanisms, it is found that during periods of fiscal difficulty, local governments channel more financial resources towards large local enterprises to achieve their objectives. Such biased guidance diminishes credit availability for small and medium-sized enterprises, consequently inhibiting the formation of new enterprises. Heterogeneity analysis reveals that this suppressive effect is less pronounced in regions with higher levels of inclusive financial development or lower degrees of government intervention, and when considering only the entry of non-state-owned enterprises. Spatial econometric analysis demonstrates an “expulsion effect,” where regions with higher fiscal pressure drive newly established enterprises to areas with lower fiscal pressure. Our research provides empirical evidence for the theory of the governmental “interventionist hand” and reveals the corresponding consequences. It thereby offers insights and reflections for governments on how to effectively facilitate local entrepreneurship, as well as ensuring proactive and viable policies amid fiscal constraints.