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On Rank-Size Distribution of Local Government Debt

Rank-size distributions of local government debt, regardless of the way in which data is categorized, namely, regions, types, or all local governments, are found not to be normally distributed but consistent with a mathematical principle known as power law. This implies that local government borrowings resemble complex adaptive system in a sense that they are self-organized and have positive feedbacks among each other, which could reach a critical point, causing a local government debt crisis that eventually may disrupt government’s fiscal and financial status as well as a country’s economic system. This kind of event is extremely difficult to predict in advance because it is an emergent phenomenon and scale-invariance. One cannot really tell beforehand what type or size of local government debt, or which local government would cause such a crisis. Therefore, rules and regulations designed to regulate and monitor local government borrowings, as well as manage risk of local government debt should emphasize on mitigation measure in addition to disciplinary measures. This study proposes a rule that requires each local government to maintain enough reserves so that it can service its debt. The rationale is that, in time of local government debt crisis, local government, indirectly affected by such a crisis, may encounter a problem of liquidity shortage and therefore not be able to pay principle and/or interest to its creditors. Having this mitigation measure in place therefore should not only lower the probability of local government debt’s default but also help build trust in the system.