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A Political Economy Theory of the Soft Budget Constraint

  • James A. Robinson

    ()

    (Department of Government, Harvard University)

  • Ragnar Torvik

    ()

    (Department of Economics, Norwegian University of Science and Technology)

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 which 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 which they anticipate they will have to bail out in the future.

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File URL: http://www.svt.ntnu.no/iso/WP/2005/9softbudgetres.pdf
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Paper provided by Department of Economics, Norwegian University of Science and Technology in its series Working Paper Series with number 5605.

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Length: 30 pages
Date of creation: 06 Aug 2005
Handle: RePEc:nst:samfok:5605
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