Working Paper: CEPR ID: DP1013
Authors: Yingyi Qian; Gerard Roland
Abstract: The majority of enterprises in China are controlled by local governments at the provincial, city, county, township and village levels. We study the effect of regional decentralization on soft budget constraints in these enterprises. We show that fiscal competition under (foreign) capital mobility may be effective in hardening enterprises' budget constraints. Decentralization of monetary authority leads to a softening of local governments' budget constraints, however, as well as those of enterprises. Fiscal decentralization combined with monetary centralization (i.e. fiscal federalism) may achieve not only hard budget constraint but also the objective of monetary restraint. We also examine the effect of labour and product market conditions on soft budget constraints. We apply our model to explain harder budget constraints of the enterprises controlled by lower-level governments of townships and villages in China.
Keywords: China; Soft Budget Constraint; Federalism; Decentralization; Economic Transition
JEL Codes: E62; E63; H7; L30; P3; P5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal competition under foreign capital mobility (F21) | harden budget constraints (H60) |
| Fiscal decentralization + monetary centralization (E63) | harden budget constraints (H60) |
| Decentralization of monetary authority (E42) | soften budget constraints (H60) |
| Fiscal competition (H39) | opportunity cost of subsidizing inefficient enterprises (H23) |
| Lower employee rents in competitive labor markets (J29) | harder budget constraints (H60) |
| Higher concentration of enterprises under one jurisdiction (R32) | softer budget constraints (H60) |
| Fiscal competition (H39) | budget constraints (H60) |
| Fiscal decentralization + monetary centralization (E63) | monetary restraint (E63) |