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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 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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Citations

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Cited by:
  1. Alberto Cavaliere & Simona Scabrosetti, 2008. "Privatization And Efficiency: From Principals And Agents To Political Economy," Journal of Economic Surveys, Wiley Blackwell, vol. 22(4), pages 685-710, 09.
  2. Nelly Exbrayat & Thierry Madiès & Stéphane Riou, 2014. "Bailout policy in a globalized economy," Working Papers halshs-00925006, HAL.
  3. Eggleston, Karen, 2008. "Soft budget constraints and the property rights theory of ownership," Economics Letters, Elsevier, vol. 100(3), pages 425-427, September.
  4. 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.
  5. 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.
  6. Enrique Gilles, 2010. "Political intervention in economic activity," DOCUMENTOS DE TRABAJO 007180, UNIVERSIDAD DEL ROSARIO.
  7. Baskaran, Thushyanthan, 2013. "Do bailouts buy votes? Evidence from a panel of Hessian municipalities," MPRA Paper 48228, University Library of Munich, Germany.
  8. 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.

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