In recent years, the rapid expansion of local government debt has made debt governance an important institutional arrangement for improving fiscal sustainability and enhancing the efficiency of public resource allocation. Against the backdrop of reforms in the division of fiscal powers and expenditure responsibilities between the central and local governments, this paper investigates whether and how local debt governance affects urban industrial upgrading, with particular attention to changes in local government expenditure behavior.

Using panel data from 210 prefecture-level cities in China from 2010 to 2019, this paper employs a DID approach to estimate the impact of local debt governance on urban industrial upgrading. The results indicate that local debt governance promotes urban industrial upgrading. Mechanism testing suggests that this effect mainly operates through improvements in the quality and efficiency of public expenditure. In particular, local debt governance encourages the expansion of new infrastructure investment and soft expenditures such as education, science and technology, and public services, while also promoting the optimization of total fiscal expenditure and enhancing expenditure efficiency. Further analysis shows that the path dependence of land-based urbanization embedded in the industry–city integration model, adaptive policy adjustments on the expenditure side, and intergovernmental transfer payments moderate the relationship between local debt governance and urban industrial upgrading. Heterogeneity analysis further reveals that the upgrading effect is more pronounced in cities with a permanent population of less than three million, located in the eastern region, with lower fiscal pressure, and with higher revealed comparative advantages.

This paper contributes to the literature in two main ways: First, it develops an analytical framework of “strategic environment–institutional supply–government behavior” to explain how local debt governance affects urban industrial upgrading through changes in the scale, structure, and efficiency of public expenditure. Second, it incorporates local government behavioral responses in fiscal resource allocation into the empirical analysis and identifies the boundary conditions of the upgrading effect through moderating mechanisms and heterogeneity analysis. By examining how public expenditure management promotes improvements in quality and efficiency, this paper provides theoretical insights and empirical evidence on the role of local debt governance in facilitating urban industrial upgrading, and offers policy implications for enhancing the systemic coherence, coordination, and differentiated implementation of fiscal reforms.