The structural slowdown in China’s economy is starting to cause waves in Beijing, prompting trenchant questions about what the government should do about it. Premier Li Keqiang has recently played down the expectation that there is much the government could or should do, saying that China must rely more on “market mechanisms”. This is, in effect, an acknowledgment of a contradiction in China’s economic model.

Local governments and state enterprises, pillars of that model and its investment-driven growth, have become the agents of both the downswing in growth and increased concerns about financial risk. Fixing this problem, as Mr Li suggested, would be transformational, if the party can do it. Driven by vigorous internal competition and a considerable degree of political autonomy, local governments play a pivotal role in promoting local economic, investment and political interests, and delivering economic growth. Despite strong demands for greater provision of public services, local officials are incentivised by reward and patronage to focus on gross domestic product. Local government spending, however, is having less traction with the economy.

Local government borrowing has tripled since 2007, doubling as a share of GDP to about 30 per cent. Their finances have been weakened by rising social spending, faltering revenues from land sales, diminishing or negative returns on their investments and deteriorating cash flows. They are having to borrow more to refinance maturing debt, service existing debt and replenish working capital. Many wonder if Chinese local governments might be the next “subprime”.