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THE SOFT BUDGET CONSTRAINT^
The soft budget constraint is a syndrome that was identified and studied by Janos Kornai in his analysis of centrally planned economies (see, Kornai, 1980). The syndrome is said to arise when a seemingly unprofitable enterprise is bailed out by the government or the enterprise's creditors. In other words, the enterprise is not held to a fixed budget, but finds its budget constraint "softened" by the infusion of additional credit when it is on the verge of failure. Kornai viewed the soft budget constraint as a crucial ingredient for explaining the salient features of socialist economic performance, in particular, the pervasiveness of shortages.
One interesting puzzle is why centrally planned economies have been particularly susceptible to the influence of the soft budget constraint; the capitalist world is hardly immune, as the recent financial crisis in Asia attests, but on the whole it has proved less vulnerable. Indeed, the very origin of the soft budget constraint and the mechanism by which it gives rise to shortages and other undesirable effects are also obviously important questions.
Although Kornai's work has long been well known and appreciated, answers to these associated theoretical questions have been hazarded only recently. In Maskin (1996), I surveyed some of the initial efforts in this direction, including Mathias Dewatripont and Maskin ( 1995 ), which argues that centralization of credit can give rise to soft budget constraints because it facilitates the refinancing of projects that should never have been funded in the first place; Yingyi Qian (1994), who shows how such refinancing may have contributed to the recurrent shortages suffered by the Soviet bloc economies; Qian and Chenggang Xu (1998), who demonstrate that soft budget constraints can help explain the relatively poor performance of the Soviet Union in developing new technology; Ilya Segal (1998), who places blame for soft budget constraints on the centralization of production; and David Li (1998), who models the idea that soft budget constraints may be linked to public ownership of capital. Mark Schaffer ( 1989) and Steven Goldfeld and Richard Quandt (1988) also model the soft budget constraint but do not attempt to explain its contrasting effects in centrally planned and market economies.
In this paper, I examine some theoretical analyses undertaken since...