Abstract
Before the story of the soft budget constraint can be told, the analytical framework that gives structure to this story must be established. The soft budget constraint is our central metaphor. Institutions form another, which is almost as crucial. We shall define the soft budget constraint as an institution and thereafter use a third metaphor — an invisible-hand explanation — to tell the story of the emergence, persistence and logic of the soft budget constraint.
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References
As noted by Jasinski (1993), footnote 3, p. 3, ‘A full bibliography of what Kornai wrote on the soft budget constraint would have to include almost everything he published since 1979’.
The degree of softness may, for instance, be relatively higher in sectors to which the state attaches particular priority. Davis (1989) has shown that the medical system, which was given relatively low priority in the former Soviet Union, faced fairly hard budget constraints, while Ericson (1988) suggests that they were relatively soft in the highly prioritised military sector. Kornai (1992), p. 143, footnote 20, notes that large firms tend to face softer budget constraints than small firms. See also Qian and Roland (1994). For further discussion on the degree of budget softness, see for instance Gomulka (1985) and Scott (1990).
This literature is largely inspired by Dewatripont and Maskin (1989), and later versions, eventually published in a revised form (1995); it includes, for instance, Berglöf and Roland (1994), Hardy (1992), Qian (1994) and Qian and Roland (1994), and more recently, for example Huang and Xu (1999), Maskin and Xu (1999). See also Lindbeck and Weibull (1988).
As pointed out by and Qian and Roland (1994), p. 1, ‘Time inconsistency is at the heart of the soft budget constraint problem’.
Kornai (1990b), pp. 22–23. For a more detailed discussion of the budget-softening characteristics of external assistance, see also Eriksson (1993), pp. 19–21.
See Komai (1986c), p. 43, and (1980), p. 308. Scott (1990), pp. 120–122, notes that action in the control sphere is identical to rent-seeking or directly unproductive profit-seeking activity.
See Kornai (1986b) and Scott (1990) on the degree of patemalism and its relationship with the soft budget constraint.
See Kornai (1990b), p. 35, and (1992), pp. 501–502, which also refers to several empirical studies on the subject.
Besides, when losses are compensated for, profits are often taxed away in a discretionary manner. On the ‘levelling’ of profits between Hungarian state-owned enterprises, see Komai and Matits (1984). When the firm is unable to benefit from its profits, incentives to spend all available resources are reinforced. Cf. Hare (1989), pp. 56–57, Kornai (1992), p. 146, and Nagaoka and Atiyas (1990), p. 15.
Komai (1979). A debate on the character and interpretation of shortages or excess demand in socialist economies has taken place between Komai and adherents of the so-called disequilibrium school. For a survey of the debate, see van Brabant (1990) and a conference volume edited by Davis and Charemza (1989). A related debate concerns the relevance of the soft budget constraint for the prevalence of shortages in socialist economies. Kornai introduced the concept of the soft budget constraint to explain these persistent shortages. However, other factors have been forwarded as explanations. See Gomulka (1985), Kornai (1985), Hare (1989), Bajt (1991) and Jasinski (1993). Besides, certain authors, notably Gomulka (1985), consider efficiency loss rather than shortages to be the main consequence of the soft budget constraint.
Magee and Quandt (1994) explore theoretically how the soft budget constraint may lead to a higher than normal demand for inputs. Cf. Qian (1994).
See Xu and Qian (1992) for a theoretical examination of the relationships between the soft budget constraint, investment and innovation.
A thorough discussion of shortages and inflation, their causes, including the soft budget constraint, and the relationship between them in the socialist system is provided by Kornai (1992), Chapters 11–12, pp. 228–301.
As suggested by empirical studies, discussed in the previous chapter. 3a Hay etal. (1994), pp. 325–326.
As suggested by Nagaoka and Atiyas (1990), p. 10; and by Shleifer and Vishny (1994), referred to by Qian and Roland (1994), p. 3, footnote 4.
Compare this proposition with the case of perfect information. If the state knew in advance that refinancing of a bad project would not be worthwhile, sunk costs would be genuinely sunk, which according to theory implies that they would have no opportunity value and therefore no bearing on refmancing decisions.
Nagaoka and Atiyas (1990), p. 10. Cf. Lin and Tan (1999), who trace the roots of the soft budget constraint to the ‘accountability problem’ of the state.
As reflected, for instance, in thematic issues of the American Economic Review (1999), Japan and the World Economy (1996) and the Journal of Comparative Economics (1998).
Komai (1998), referred to by Bai and Wang (1999), Maskin (1996) and (1999). 5I By Li (1992) and (1998), and Segal (1998).
See, for instance, Verdery (1993) for an analysis of the fall of the socialist system. Kornai (1992), P. 384, footnote 1, provides references on the tensions within the system.
On the affinity between ownership forms and co-ordination mechanisms, see Kornai (1990a) and (1992), pp. 447–450 and 497–500.
See, for instance, Begg and Portes (1992), p. 8, Raiser (1992), pp. 35–36, and (1993), pp. 266–267, and Zhang and Sjöberg (1992), pp. 33–34. Buch et al. (1994), p. 43, provide additional references.
See, for instance, Berglöf and Roland (1994). Nagaoka and Atiyas (1990), pp. 12–16, provide several arguments, but their focus is on the pre-transition period.
Besides, given the accumulated debts, it may be difficult to assess a firm’s future profitability potential.
Begg and Portes (1992), pp. 7–12 (quotation from p. 11), partly referring to Mitchell (1992).
See Kornai (1986c), pp. 46–47, and (1990b), pp. 36–41.
As shown in Chapter 1, there are studies suggesting that soft budget constraints prevail in developing countries. Kornai (19906), p. 41.
Zhang (1997), pp. 75–109, found that collective - as opposed to non-collective - rural enterprises under local government ownership in China faced basically soft budget constraints despite the hard budget constraints of the local governments, partly because the firms were able to seek soft funding elsewhere.
See, for instance, Bardhan (1989), Eggertsson (1990), Gunnarsson (1991), Knudsen (1993), Langlois (1986c) and Raaschou-Nielsen (1988).
Raaschou-Nielsen (1988), p. viii; free translation from the Danish. Schotter (1981), p. 11.
Later, Schotter (1986), pp. 118–119, makes a distinction between the two views on institutions, by letting them represent two basically different approaches within institutional economics, and he finally defines social institutions as sets of rules.
Cf. Hayek (1973), p. 43, according to whom a ‘regularity, of course, means simply that the elements behave according to rules’.
Simon (1982b), p. 390; emphasis added. Cf. the position, common within the study of comparative economic systems, that an economic system consists of a set of interdependent, mutually consistent and reinforcing parts (Grosfeld, 1990, p. 7), and Komai’s affinity between ownership forms and co-ordination mechanisms discussed above.
Such institutional ‘disequilibrium’ is, according to North (1990), pp. 87–90, passim, characterised by tensions between formal and informal rules. However, in other cases, change in formal rules involves an adaptation to already prevailing formal rules, and thus brings consistency between them.
The first type of uncertainty, about ‘which pregiven state will obtain’, is referred to by Langlois (1986b), p. 228, as parametric, while he calls the latter type, uncertainty about ‘which states are possible’, structural.
Heiner (1986), p. 60, quotes Hey (1979), p. 232, to illustrate the problem. Often ‘the optimization problems that… agents are supposed to be solving… are so complicated that the economic theorist… probably spent several months finding the solution’.
‘A rule of action is rational if, by following that rule, an agent maximizes his expected utility.’ (Rowe, 1989, pp. 4–5.)
‘Aspirations are expectations - adjusted in the long run to realities - of the result that can reasonably be attained.’ (Simon, 19826, p. 399.) For details, see Simon (1972), p. 168, (1976), pp. 133 and 136, (1978b), p. 10 ff., and (1979), pp. 502–503.
Case-by-case maximisation entails the risk of making the wrong choice, as noted by Vanberg (1993), pp. 177178, referring to Heiner (1983), (1987) and (1990), whereas rule following entails the risk of missing preferred exceptions.
Cf. Vanberg (1993), p. 172, who distinguishes between rule following as ‘an attribute of individual human behaviour’ and ‘the role of rules in coordinating human social interaction’.
Langlois (1986b), p. 237, recognises that ‘institutions have an informational-support function’. Cf. Nelson and Winter (1982), referred to by Knudsen (1993), p. 293. ‘Routines are repositories of knowledge concerning how a firm can “do” different things.’ See also Schotter (1981), p. 109.
The uncertainty facing decision makers due to the C-D gap can also be seen as a reflection of high costs of information (and computation), and rule following is then a solution to this problem. Hence, mles reduce information costs. Cf. transaction cost economics: it is costly to transact essentially because information is costly. See Eggertsson (1990), p. 15, according to whom the resulting transaction costs include search and bargaining costs, costs associated with the making, monitoring and enforcement of contracts and with the protection of property rights. Român (1995), pp. 33–36, distinguishes between co-ordination costs (for acquiring, processing and exchanging information) and motivation costs (for specification, observation, verification and enforcement of an agreement), and briefly surveys transaction cost economics (pp. 25–26.) See also North (1990), pp. 27–35.
For instance, by Schelling (1960), referred to by Knudsen (1993), p. 287.
Within the production sphere, for instance, institutions affect, according to North (1990), pp. 64–66, both transaction costs and traditional production costs - the latter by influencing the technology employed.
For examples on how the ownership structure of firms may influence economic outcomes, see Eggertsson (1990), Chapter 5.
Cf. North (1990), p. 9, who talks about efficient and inefficient institutions. In North (1993), p. 252, he defines inefficient institutions (property rights) ‘simply as rules which do not produce increases in output’. This example reflects the problem associated with the meaning and use of these concepts once institutions are introduced into economic analysis. For a brief presentation of the arguments and a discussion, see Eggertsson (1990), pp. 2025. Demsetz (1969), referred to by Eggertsson (1990), p. 21, for instance, argues that talking about inefficiency and similar concepts is ‘misleading and ambiguous unless the outcome that they describe can be improved upon’. Given institutional interdependence, ceteris paribus assumptions thus make little sense. Cf. Vromen’s (1995, p. 174) interpretation of Menger (1985). ‘The welfare effects of some institution thus cannot be judged in isolation. The effects depend crucially on the other institutions that exists in society… the whole of which they are part.’
As argued in Chapter 1, this would amount to a purely functionalist explanation. The issue will be further discussed in the following section.
Knudsen (1993), p. 288, referring to Elster, without specifying the source further.
The distinction between formal and informal institutions is partly arbitrary. A formal institution may, in fact, be a reflection of how an informal institution, spontaneously evolved in society, at a certain point in time gains official recognition by being formalised, for instance, into a law. Cf. Sugden (1986), p. 5.
Cf. Rowe (1989), p. 5, according to whom ‘social institutions are in fact nothing more than agents rationally following rules of action, and being believed by other agents to do so’.
Classical references on path dependence (of technological change) are, for instance, Arthur (1988) and David (1985). For brief presentations, see Knudsen (1993), pp. 290–291, and North (1990), Chapter 11, passim.
Alchian (1950) is a classical reference. Others are Hayek (1978) and (1988), and Nelson and Winter (1982).
Knudsen (1993), p. 278. See Vromen (1995), pp. 119–121, for a discussion of the dissimilarities between natural selection and adaptive learning.
Cf. Vromen (1995), p. 107, who distinguishes between natural selection and adaptive learning as two ‘evolutionary “feedback” mechanisms’.
Bush (1988), p. 153, who notes that the direction of causality may also be the opposite: institutional change accelerating the process of echnological development.
Hence, he satisfies himself with less. Similarly, if he achieves or surpasses his aspiration them upwards. He learns. And he wants more.
Vanberg (1993), p. 174, refers to Commons’ view, noted by Biddle (1990), p. 37, that changes in the environment, our habits tend to be adjusted only after some delay.
Innovative behaviour leading to institutional change may also involve deliberate action, instance, to alter formal rules or renegotiation of contracts. Cf. North (1990), pp. 86–87.
On other occasions, he refers to the budget constraint as a behavioural regularity or a behavioural characteristic of the decision maker (the firm), and to the degree of softness of the budget constraint as a behavioural pattern. See Kornai (1986c), p. 36, Kornai (1990b), p. 21, and Kornai and Matits (1984), p. 225.
Cf. Kornai (1985), Figure 1, p. 50, where he defines the soft budget constraint as ‘expectation of external assistance in case of financial trouble’.
The strength of these expectations may vary with, for instance, the ease and speed by which financial accommodation occurs. Cf. Scott (1990) and Gomulka (1985).
Cf. Komai (1979), p. 807, according to whom the soft budget constraint does not result from a single event of bail-out, but when this behaviour becomes frequent and widespread, the firm’s expectations are strengthened and its budget constraint becomes soft.
The two parties involved in the repeated interaction are allowed to vary to some extent, for instance within the categories ‘the state’ and ‘the state-owned firms’. For instance, various state agencies may grant assistance to one state-owned firm, which repeatedly receives extemal finance, or one state agency may repeatedly grant
Just as he notes that the degree of budget softness can only be measured ordinally, not cardinally. (Kornai, I986c, p. 45.) A theoretical discussion on how to measure the degree of budget softness is provided by Gomulka (1985) and Scott (1990). For an example of how the soft budget constraint can be ‘observed’, see Kornai and Matits (1984), who examined financial data for Hungarian state enterprises for the period 19751980. A number of indicators were defined, related to different measures of profit, subsidies and investment.
Our reasons are pragmatic, motivated by this particular inquiry. We do not take a stand on principle in the controversy between advocates of satisficing versus optimising assumptions. For a presentation of the arguments and a discussion, see for instance Langlois (1986b), pp. 225–230.
Langlois and Csontos (1993) argue that this method eliminates part of the controversy between ‘neoclassical optimizers’ and ‘boundedly rational satisficers’ (p. 114).
As reflected in various Annual Reports by the Tanzania Audit Corporation (TAC), whose definition of commercial parastatals is, however, more narrow than ours. The TAC definition excludes, among other firms, many agricultural parastatals. See, for instance, Tanzania Audit Corporation (1992), pp. 26–55, passim.
The organisational structure, and the relationships within the bureaucracy of the state, the party and the parastatals, will be discussed in greater detail in Chapter III.
According to Alchian (1950), a certain kind of behavioural pattern may prevail regardless of the actors’ intentions, because the economic system acts as a mechanism that selects this behaviour as successful. For a discussion of attempts in the literature ‘to show that economic phenomena can be explained without any reference to preferences’, see Langlois (1986b), pp. 230–241 (quotation from p. 232).
Cf. North (1990), p. 25, who notes that in a strict socio-biological model, what motivates human action is maximisation of the survival potential.
As recognised not least by Etzioni (1988). See also, for instance, North (1990), pp. 20–22, and Williamson (1986), pp. 177–178.
Niskanen (1971) suggests that bureaucrats strive for budget maximisation because larger budgets increase these ‘three Ps’. (Godana, 1991, p. 30.)
Bates (1995), pp. 39–47, passim. See also Bates (1981), p. 2, referred to by Vromen (1995), p. 120.
Langlois (1986b), p. 236, adheres to the view held by both Popper (1965), 147, that it is precisely the unintended or undesigned social repercussions the social sciences should aim at explaining.
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Skoog, G.E. (2000). An Institutional Approach to the Soft Budget Constraint. In: The Soft Budget Constraint — The Emergence, Persistence and Logic of an Institution. Springer, Boston, MA. https://doi.org/10.1007/978-1-4757-6793-3_2
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