Soft Budget Constraint Reconsidered

Abstract

This paper demonstrates that Kornai's original concept of the soft budget constraint (SBC) as a theoretical innovation in micro-theory disguises income redistributions that are essentially macroeconomic relationships. The SBC also postulates a competitive market economy as the benchmark of hard budget constraint (HBC) and efficiency. A recent formal theory explains the SBC as a component of profit-maximizing strategic behaviour. From this perspective, the SBC can be integrated into the new microeconomics, but it loses its specific institutional connotation and its macroeconomic dimension. The SBC is thus included in ubiquitous market-type relationships, particularly complete (optimal) contractual arrangements.

János Kornai and general equilibrium theory

“…While the application of the standard microeconomic budget constraint (or Kornai's HBC) does not require any transfer between individual economic units, the SBC implies macroeconomic income redistribution. This makes it difficult to understand why Kornai classifies his concept only within micro theory (Vahabi, 2014). Nevertheless, the treatment of budget constraint as an empirical fact is an entirely heterodox original concept that is in conflict with both notions of budget constraint in standard microeconomics, i.e.…”

“…By contrast, for Kornai, soft budget constraint is an empirical fact generated by institutional constraints. The theoretical synthesis between formal and institutional explanations of the soft budget constraint as suggested by Kornai, Maskin and Roland (2003) is theoretically incoherent since the concept of soft budget constraint is not the same in exogenous and endogenous explanations (Vahabi, 2014). A 'half-in', 'half-out' of mainstream 'synthesis' is rather a source of confusion obfuscating the heterodox message of Kornai's original concept of SBC.…”

“…As I have argued in several papers (see for example, Vahabi, 2001Vahabi, , 2005Vahabi, , 2014, this type of comparative studies of economic systems has two major shortcomings.…”

“…Since the pioneering work of Dewatripont and Maskin (1995), an abundant body of formal literature has explained the SBC endogenously through adverse selection, moral hazard, and rentseeking (for detailed surveys, see Maskin, 1996;Kornai, Maskin and Roland, 2003;Vahabi, 2001Vahabi, , 2005Vahabi, , 2014. The SBC is thus integrated into the new microeconomics as a special case of time inconsistency.…”

The soft budget constraint problem and hard budget solution of outward reinsurance markets for providing insurance to local economy against natural disaster

“…Akai (2003) is a reference that includes Japan. For a recent survey, see Vahabi (2014). In our above study, we used the incomplete contract theory as a soft budget constraint problem and theoretically discussed it relating to the inefficiency of government organizations and that in financing.…”