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Federalism and the Soft Budget Constraint

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Author Info
Yingyi Qian
Gerard Roland

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Abstract

October 1997, (Forthcoming, American Economic Review)

The government's incentives to bail out inefficient projects are determined by the tradeoff between political benefits and economic costs, the latter depending on the decentralization of government. Two effects of federalism are derived: First, fiscal competition among local governments under factor mobility increases the opportunity costs of bailout and thus serves as a commitment device (the "competition effect"). Second, monetary centralization, together with fiscal decentralization, induces a conflict of interests and thus may harden budget constraints and reduce inflation (the "checks and balance effect"). Our analysis is used to interpret China's recent experience of transition to a market economy. (JEL E62, E63, H7, L30, P3)

Key Words: Soft Budget Constraints, Federalism, Decentralization, Competition, China

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Paper provided by Stanford University, Department of Economics in its series Working Papers with number 97045.

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Handle: RePEc:wop:stanec:97045

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Related research
Keywords: Soft Budget Constraints; Federalism; Decentralization; Competition; China;

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Find related papers by JEL classification:
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
H7 - Public Economics - - State and Local Government; Intergovernmental Relations
L30 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - General
P3 - Economic Systems - - Socialist Institutions and Their Transitions

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  1. Wildasin, David E., 1997. "Externalities and bailouts : hard and soft budget constraints in intergovernmental fiscal relations," Policy Research Working Paper Series 1843, The World Bank. [Downloadable!]
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This page was last updated on 2009-10-31.

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