The Macroeconomics of Massive Giveaways

In a framework similar to the models of expectation on economic policy, we purpose a model where the government subsidizes firms privatized by massive giveaways to the managers who are empire- builders. The government injects funds because its aim is to avoid a drastic fall of output when a negative external macroshock hits the country. The consequence is that the economy can be locked into a soft budget constraint equilibrium and a path of underdevelopment. At the heart of the model there are i) the behavior of managers, ii) the macroshock and iii) the credibility of the government when it affirms that it stops subsidies. Therefore, we argue that the model explains why the soft budget constraint syndrome is worse in the CIS than in the Central European Countries: massive giveaways, largely used in the CIS, do not avoid that unproductive managers divert funds when an important macroshock hits the economy (worse in the CIS) and governments are not credible. Finally we derive from the model some policy recommendations: First, to create an economic union with Articles prohibiting any subsidies which favor unrestructured Firms; second, to privatize and restructure the banking system, i.e. to apply standard risk analysis technics in order to strengthen the budget constraint.