Reflections on the Microeconomic Basis for Soft Budget Constraint in the Market Economy1

Lin Guangbin
Chinese Institute for Actuarial Sciences, Central University of Finance & Economics, Beijing

 
Abstract: Historical analysis of the market economy indicates that soft budget constraint is becoming increasingly pervasive and broad-rooted. Using an analysis of micro-level entities in the market economy, this paper describes how soft constraint derives from interdependence among corporations, banks, and the government. Soft constraint is explained in relation to changes in concentrated shareholding ownership, the increasing dominance of the financial sector, and financial insurance. We conclude: 1) concentrated shareholding ownership and institutionalized soft budget constraint create sub-optimal allocation of resources in the market economy; 2) neoclassical microeconomic principles cannot explain the economic actions of organizations in the market economy and should be revised; 3) externalities associated with soft budget constraint have spread across the globe to become both the cause and primary effect of cyclic global financial and economic crises. Hence, the government, banks, and the corporate sector must work together to overhaul supervisory mechanisms. On a global level, governments must collaborate to build a new international economic order. Correcting imbalances in international reserve currencies and fortifying administration of cross-national economic organizations will mitigate the effects of soft budget constraint.
Key words: market economy, micro-level entities, soft budget constraint, externalities, economic crises

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