Besfamille , Martin and Lockwood, Ben (2004) Are hard budget constraints for sub-national governments always efficient? Working Paper. University of Warwick, Department of Economics, Coventry.

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Abstract

In fiscally decentralized countries, sub-national governments (SNGs) may face soft budget constraints and consequently invest and borrow too much. The policy literature claims that, with competitive capital markets and central governments imposing hard budget contraints (HBCs), inefficient investment by SNGs should not arise. We present a model where this is not the case: HBCs can be too "hard" and discourage investment that is socially efficient. The model combines a dynamic commitment problem in Kornai, Maskin and Roland (2004) for central government with a moral hazard problem between central and SNG. The HBC over-incentivises the SNG to provide effort by penalizing it too much for project failure, thus leading ultimately to the possibility that socially efficient projects may not be undertaken.

Item Type:	Working or Discussion Paper (Working Paper)
Subjects:	J Political Science > JA Political science (General) H Social Sciences > HJ Public Finance
Divisions:	Faculty of Social Sciences > Economics
Library of Congress Subject Headings (LCSH):	Decentralization in government, Central-local government relations, Federal government -- Economic aspects, Local budgets
Series Name:	Warwick economic research papers
Publisher:	University of Warwick, Department of Economics
Place of Publication:	Coventry
Date:	21 October 2004
Number:	No.717
Number of Pages:	26
Status:	Not Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/1473

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