A Political Economy Theory of the Soft Budget Constraint

30 Pages Posted: 18 May 2006 Last revised: 28 Aug 2022

See all articles by James A. Robinson

James A. Robinson

Harvard University - Department of Government; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Ragnar Torvik

Norwegian University of Science and Technology (NTNU) - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: April 2006

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 which 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 which they anticipate they will have to bail out in the future.

Suggested Citation

Robinson, James A. and Torvik, Ragnar, A Political Economy Theory of the Soft Budget Constraint (April 2006). NBER Working Paper No. w12133, Available at SSRN: https://ssrn.com/abstract=896462

James A. Robinson (Contact Author)

Harvard University - Department of Government ( email )

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Ragnar Torvik

Norwegian University of Science and Technology (NTNU) - Department of Economics ( email )

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Norway
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