Can digital finance development improve balanced regional investment allocations in developing countries? — The evidence from China

Abstract

This paper studies the effects of digital finance development on cross-regional capital movement and the directions of capital flows using Chinese provincial data from 2011 to 2020. The results show that digital finance development breaks the “spatial barrel effect” of savings and investment allocation in the traditional finance system, thus improving cross-regional capital mobility. We identify two opposite effects of digital finance development on the direction of capital flows. The “endogenous capital return effect” draws the capital from less-developed areas to developed areas due to the higher return of capital in developed areas. The “credit market quality improvement effect” leads the capital to flow in the opposite direction because digital finance improves the credit market quality in less-developed regions. The former dominates the latter, thus worsening the imbalanced regional investment allocations. The results remain in various robustness checks. It implies that, although digital finance development in China is inclusive and has independent impacts on capital allocation outside the traditional financial system, it cannot wholly solve the existing structural problems that institutional reforms should further address.