A Political Economy Theory of the Soft Budget Constraint

James Robinson and Ragnar Torvik

No 5274, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: 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 that 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 that they anticipate they will have to bail out in the future.

Keywords: Political economy; investment; Development (search for similar items in EconPapers)
JEL-codes: H20 H50 O20 (search for similar items in EconPapers)
Date: 2005-10
New Economics Papers: this item is included in nep-pbe and nep-pol
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Related works:
Journal Article: A political economy theory of the soft budget constraint (2009)
Working Paper: A Political Economy Theory of the Soft Budget Constraint (2006)
Working Paper: A Political Economy Theory of the Soft Budget Constraint (2005)
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