Federalism and the Soft Budget Constraint

39 Pages Posted: 13 Feb 1999

See all articles by Yingyi Qian

Yingyi Qian

Tsinghua University - School of Economics & Management; Centre for Economic Policy Research (CEPR)

Gérard Roland

University of California, Berkeley - Department of Economics; Centre for Economic Policy Research (CEPR)

Abstract

The government's incentives to bail out inefficient projects are determined by the trade-off 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 Classification: E62, E63, H7, L30, P3

Suggested Citation

Qian, Yingyi and Roland, Gérard, Federalism and the Soft Budget Constraint. American Economic Review, Vol. 88, No. 5, 1998. Available at SSRN: https://ssrn.com/abstract=149988 or http://dx.doi.org/10.2139/ssrn.149988

Yingyi Qian (Contact Author)

Tsinghua University - School of Economics & Management

Beijing, 100084
China

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Gérard Roland

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-642-4321 (Phone)
510-642-6615 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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