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A political economy theory of the soft budget constraint

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  • Robinson, James A.
  • Torvik, Ragnar

Abstract

Why do soft budget constraints exist and persist? In this paper we argue that the prevalence of soft budget constraints can be best explained by the political desirability of softness. We develop an infinite horizon political economy model where neither democratic nor autocratic politicians can commit to policies that are not ex post optimal. We show that because of the dynamic commitment problem inherent in the soft budget constraint, politicians can in essence commit to make transfers to entrepreneurs which otherwise they would not be able to do. This encourages such entrepreneurs to support them politically. Though the soft budget constraint may induce economic inefficiency, it may be politically rational because it influences the probability of political survival. In consequence, even when information is complete, politicians may fund bad projects which they anticipate they will have to bail out in the future. We show that, maybe somewhat surprisingly, dictators who are less likely to lose power, are more likely to use the soft budget constraint as a strategy to gain political support.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 53 (2009)
Issue (Month): 7 (October)
Pages: 786-798

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Handle: RePEc:eee:eecrev:v:53:y:2009:i:7:p:786-798

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Keywords: Political economy Investment Development;

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Citations

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Cited by:
  1. Leopoldo Fergusson & James A. Robinson & Ragnar Torvik & Juan F. Vargas, 2012. "The Need for Enemies," NBER Working Papers 18313, National Bureau of Economic Research, Inc.
  2. Alberto Cavaliere, 2006. "Privatization and Efficiency: from Principals and Agents to Political Economy," Working Papers 2006.99, Fondazione Eni Enrico Mattei.
  3. Enrique Gilles, 2010. "Political intervention in economic activity," DOCUMENTOS DE TRABAJO 007180, UNIVERSIDAD DEL ROSARIO.
  4. Nelly Exbrayat & Thierry Madiès & Stéphane Riou, 2013. "Abram Bergson," Working Papers 1340, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure.
  5. Karolina Kaiser & Emmanuelle Taugourdeau, 2010. "The Timing of Elections in Federations : A Disciplining Device against Soft Budget Constraints ?," Documents de travail du Centre d'Economie de la Sorbonne 10036, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
  6. Thushyanthan Baskaran, 2013. "Do bailouts buy votes? Evidence from a panel of Hessian municipalities," Economics of Governance, Springer, vol. 14(3), pages 257-278, August.
  7. Nelly Exbrayat & Thierry Madiès & Stéphane Riou, 2014. "Bailout policy in a globalized economy," Working Papers halshs-00925006, HAL.
  8. Eggleston, Karen, 2008. "Soft budget constraints and the property rights theory of ownership," Economics Letters, Elsevier, vol. 100(3), pages 425-427, September.

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