Working Paper: CEPR ID: DP2715
Authors: Eric Maskin; Chenggang Xu
Abstract: This Paper surveys the theoretical literature on the effect of soft budget constraints (SBC) on economies in transition from centralization to capitalism; it also reviews our understanding of SBC in general. It focuses on the conception of the SBC syndrome as a commitment problem. We show that the two features of SBC in centralized economies ex post renegotiation of firms’ financial plans and a close administrative relationship between firms and the centre are intrinsically related. We examine a series of theories (based on the commitment-problem approach) that explain shortage, lack of innovation in centralized economies, devolution, and banking reform in transition economies. Moreover, we argue that SBC also bear on major issues in economics, such as the determination of the boundaries and capital structure of a firm. Finally, we show that SBC theory sheds light on financial crises and economic growth.
Keywords: banking and finance; centralized economy; renegotiation; soft budget constraint; theory of the firm; transition
JEL Codes: D20; D80; G20; G30; H70; L20; P20; P30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| soft budget constraints (SBC) (H60) | efficiency of state sectors (H76) |
| soft budget constraints (SBC) (H60) | expectations of state-firm managers (L21) |
| soft budget constraints (SBC) (H60) | inefficient outcomes (D61) |
| unenforceability of bankruptcy threats (K35) | soft budget constraints (SBC) (H60) |
| centralized credit (E58) | financing of slow projects (G32) |
| decentralized credit (E51) | prevention of refinancing of unprofitable projects (G32) |
| decentralized economies (P19) | less prone to soft budget constraints (SBC) (H72) |
| reforms aimed at decentralization (H77) | harden budget constraints (H60) |
| banking reforms (G28) | harden budget constraints (H60) |