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A Political Economy Theory of the Soft Budget Constraint

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Author Info
Robinson, James A
Torvik, Ragnar

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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 a political economy model where politicians cannot 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 that otherwise they would not be able to do. This encourages such entrepreneurs to vote for them. Though the soft budget constraint may induce economic inefficiency, it may be politically rational because it influences the outcomes of elections. In consequence, even when information is complete, politicians may fund bad projects that they anticipate they will have to bail out in the future.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5274.

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Date of creation: Oct 2005
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Handle: RePEc:cpr:ceprdp:5274

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Keywords: development; investment; political economy;

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Find related papers by JEL classification:
H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
O20 - Economic Development, Technological Change, and Growth - - Development Planning and Policy - - - General

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  1. Alberto Cavaliere, 2006. "Privatization and Efficiency: from Principals and Agents to Political Economy," Working Papers 2006.99, Fondazione Eni Enrico Mattei. [Downloadable!]
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