Soft Budget Constraint Theories: From Centralization to the Market

Posted: 20 Jul 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

Abstract

This paper surveys the theoretical literature on the effect of soft budget constraints on economies in transition from centralization to capitalism; it also reviews our understanding of soft budget constraints in general. It focuses on the conception of the soft budget constraint syndrome as a commitment problem. We show that the two features of soft budget constraints 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 soft budget constraints also have an influence on major issues in economics, such as the determination of the boundaries and capital structure of a firm. Finally, we show that soft budget constraints theory sheds light on financial crises and economic growth.

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

JEL Classification: D2, D8, G2, G3, H7, L2, O3, P2, P3

Suggested Citation

Maskin, Eric S. and Xu, Chenggang, Soft Budget Constraint Theories: From Centralization to the Market. Available at SSRN: https://ssrn.com/abstract=264851

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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