Federalism and the Soft Budget Constraint

Yingyi Qian and Gérard Roland

Working Papers from Stanford University, Department of Economics

Abstract: October 1997, (Forthcoming, American Economic Review)

The government's incentives to bail out inefficient projects are determined by the tradeoff 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 E62, E63, H7, L30, P3)

Key Words: Soft Budget Constraints, Federalism, Decentralization, Competition, China

Keywords: Soft Budget Constraints; Federalism; Decentralization; Competition; China (search for similar items in EconPapers)
JEL-codes: E62 E63 H7 L30 P3 (search for similar items in EconPapers)
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Citations: View citations in EconPapers (16)

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Journal Article: Federalism and the Soft Budget Constraint (1998)
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