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Federalism and the Soft Budget Constraint

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Author Info
Qian, Yingyi
Roland, Gerard

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Abstract

The government's incentives to bail out inefficient projects are determined by the trade-off 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'). The authors' analysis is used to interpret China's recent experience of transition to a market economy. Copyright 1998 by American Economic Association.

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Publisher Info
Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 88 (1998)
Issue (Month): 5 (December)
Pages: 1143-62
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Handle: RePEc:aea:aecrev:v:88:y:1998:i:5:p:1143-62

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  1. Wildasin, David E., 1997. "Externalities and bailouts : hard and soft budget constraints in intergovernmental fiscal relations," Policy Research Working Paper Series 1843, The World Bank. [Downloadable!]
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This page was last updated on 2009-10-31.

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