Soft Budget Constraint Theories: From Centralization to the Market

49 Pages Posted: 26 Mar 2001

See all articles by Eric Maskin

Eric Maskin

Princeton University - Department of Economics; Harvard University - Department of Economics; Massachusetts Institute of Technology (MIT) - Department of Economics

Chenggang Xu

University of Hong Kong

Multiple version iconThere are 3 versions of this paper

Date Written: March 2001

Abstract

This Paper surveys the theoretical literature on the effect of soft budget constraints (SBC) on economies in transition from centralization to capitalism; it also reviews our understanding of SBC in general. It focuses on the conception of the SBC syndrome as a commitment problem. We show that the two features of SBC in centralized economies ex post renegotiation of firms? financial plans and a close administrative relationship between firms and the centre are intrinsically related. We examine a series of theories (based on the commitment-problem approach) that explain shortage, lack of innovation in centralized economies, devolution, and banking reform in transition economies. Moreover, we argue that SBC also bear on major issues in economics, such as the determination of the boundaries and capital structure of a firm. Finally, we show that SBC theory sheds light on financial crises and economic growth.

Keywords: Banking and finance, centralized economy, renegotiation, soft budget constraint, theory of the firm, transition

JEL Classification: D20, D80, G20, G30, H70, L20, O30, P20, P30

Suggested Citation

Maskin, Eric S. and Xu, Chenggang, Soft Budget Constraint Theories: From Centralization to the Market (March 2001). Available at SSRN: https://ssrn.com/abstract=264383

Eric S. Maskin (Contact Author)

Princeton University - Department of Economics ( email )

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Chenggang Xu

University of Hong Kong ( email )

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