A Comparative Study On Soft Budget Constraint Of Local Government

Before1990s, economists mainly studied the benefits from fiscal decentralization.Although they made many achievements, the costs from fiscal decentralization wasignored in some extent. The practice of fiscal decentralization in the real world showedthat the performance of it were different among countries.In some countries such as theU.S, fiscal decentralization prompted economic growth, but in other countries such asBrazil, the outcome was instability of macro-economy. Facing this problem, economistshad to deepen the existed research, and must pay much more attention on the features offiscal institution and its affects on national economy. Among these researches, someeconomists focused on the accumulating debts of public sector, they put some theory toexplain this serious problem. Relative studies suggested that the soft budget constraintsof subnational government was the factor which led to debt crisis.The existed research works on soft budget constraints of subnational government arereviewed comprehensively in this paper. The approaches, methods and conclusions inthese works are introduced. These works which explained the role some factors played inthe formation of soft budget constraints of subnational government and its effects frommany aspects. We acknowledge the achievements in existed works, and believe theseworks can contribute to the understanding of benefits and costs from fiscaldecentralization, to realize the shortcomings in some fiscal institutions, to enrich thetheory of soft budget constraint. Meanwhile，there are some aspects that should beimproved. The most important aspect is short of comparative analysis.Since1980s, China has began the reform of fiscal institution. The existing structurehas formed through adjustments. What are the roles played by the fiscal decentralization?The consensus seemed not to be builded among economists. Some economists took theopinion that the reform contributed to the economic growth. Some economists found thedefects in the fiscal institutions, such as the expenditure power which were not madeclear among different levels of government, the transfer payment between governmentwhich was not normalized, the fiscal imbalance between local and national governments.These defects led to soft budget constraints and accumulating debts of local government.Based on above mentioned reasons, the author attempts to carry on a research on softbudget constraint of subnational government from comparative perspective. By the deductive method, a model concerning the fiscal decisions of centralgovernment and subnational government were put forward. First, a model in which thecentral and subnational government faced hard budget constraints was conducted, thenbased on the simple model, focused on the problem of budget constraint softened ofsubnational government when central government had the discretionary power ontransfer payment between governments. From the model, we found that explaining thephenomenon of soft budget constraint of subnational government required specifying twofactors: the subnational government’s expectation for bailout from central governmentand the consideration of central politician for the benefits and costs from bailout. Theeconomic theory indicates that institutions play a key role in the process of expectationformation and the person’s consideration of outcomes brought out by their behavior. Sothe paper approached the problem from institutional perspective. Fiscal and politicalinstitution are very important in explaining the fiscal behavior of governments. For thisreason, a framework for comparative analysis used to show the roles of fiscal andpolitical institution played in the formation of soft budget constraint in different countrieswas established.Among countries, there exists many differences in the fiscal and political institution,comparative analysis should be conducted on the base of standard classification.According the studies from economics and politics, the problems which should be solvedin the design of fiscal institution, we clarified the patterns of decentralization.Depend on the framework and classification, the author studied four patterns ofdecentralization. First, the U.S. and Germany were considered. From the political aspect,the two countries share common features: highly decentralized legislative power. Butfrom the structure of fiscal institution, there were great differences. For the U.S., fiscalinstitution was efficiency oriented. For Germany, fiscal institution was equation oriented.The extent of soft budget constraint of subnational government in the two countriesfaced was studied, and analyzed why in the U.S., budget constraint of subnationalgovernment was hard, why in Germany, budget constraint was soft. Second, along thesame line with above analysis, Australia and Canada were studied. In Canada, thelegislative power was highly centralized, the same power was highly decentralized inAustralia. But fiscal institutions in the two countries were equation oriented. We analyzed the extend and the reason of soft budget of subnational government in Canada andAustralia.In China, judged by the number of civil servants, expenses of public administrationand debts incurred by subnational and local government, the budget constraint of localgovernment can be considered soft. Proceeds with the features of decentralization inChina, the author pointed out why there existed soft budget constraint of localgovernment. The answers include: lacking supervision of the public in the process ofmaking and enforcing fiscal policy, the dual-track approach in enforcing decisions andfiscal income centralized in the hand of upper government, the responsibilities of fiscalexpenditure not clarified clearly. In addition, the soft budget constraints faced by localgovernments, local financing platforms and commercial banks reinforced each other, ledto soften the budget constraint of local government further. In the end, the author offeredsome suggestions about hardening budget constraint of local government.