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2.4 The Soft Budget Constraint

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China’s Economic Transformation Part 1: Economic Reform and Growth in China

Гонконгский университет науки и технологий

4.8 (оценок: 48) | Зарегистрировано учащихся: 3.7K

In 1978, after nearly 30 years of socialist planning under Mao Zedong, China was one of the world’s poorest countries, saddled with an inefficient, inward-looking economy. Today, China is an upper-middle income country and the world’s largest trading nation, contributing more to global economic growth than any other nation. How could such a remarkable transformation take place? This course will examine in detail the reforms that have contributed to China’s economic development and the current challenges facing the Chinese economy. After completing this course, you will be able to: - describe the origin and consequences of China’s key economic reforms since 1978; - explain how features of China’s fiscal and financial systems have impacted development outcomes; - assess the extent to which China has integrated itself into the global economy and the consequences of such integration for China and other countries; - explain the importance of different sources of economic growth during different periods since 1978; and - critically assess the economic and policy challenges facing China going forward. This course does not offer certificate at the moment. Course Overview video: https://youtu.be/YBkhpvWUoIw

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Рецензии

4.8 (оценок: 48)

5 stars
40 ratings
4 stars
8 ratings

SJ

Sep 16, 2018

Very Good course Gives a broader idea about the Chiese economy and some of the most important reforms and policies during the transformation period.

GG

Nov 12, 2017

great course , very clear , well explained and mr park was really a great professor . waiting for the part 2

Из урока

Module 2: Fiscal and Financial System Reform

In this module, we will focus on China's fiscal and financial system reform.

2.1 Fiscal and Financial System Reform – An Introduction3:45

2.2 Fiscal Decentralization: Pros and Cons9:57

2.3 Reforming the Fiscal System8:25

2.4 The Soft Budget Constraint11:07

2.5 Reforming the Financial System13:11

2.6 Shadow Banking: Threat or Opportunity?9:49

2.7 Fiscal and Financial System Reform – Module Summary2:20

Преподаватели

Albert Park
Director of the Institute for Emerging Market Studies, Chair Professor of Social Science and Professor of Economics

Текст видео

[MUSIC]

The soft budget constraint is a key problem facing the performance of China's

state-owned banks.

In this presentation I want to talk about defining what is a soft budget constraint.

And then the incentive problem that underlies it.

And finally talk about ways in which it is possible to harden budget constraints.

The soft budget constraint was originally coined by Janos Kornai,

a Hungarian economist, who noticed and

observed that this was a fundamental can send the problem affecting social systems.

He defined the soft budget constraint as the softening of the budget constraint

that occurs when the strict relationship between expenditure and

earnings has been relaxed.

Because excess of expenditure over earnings

will be paid by some other institution typically by the state.

Now economist are used to think about a budget constraint if we're a household or

an individual and we're trying to purchase goods.

We know that we only have fix amount of funds that can be used to

purchase those goods, and this defines the feasible set of consumption choices.

But if it's possible to spend beyond those means,

then almost anything becomes possible and it becomes very hard

to be disciplined in terms of the spending choices that are made.

Kornai continues, a further condition of softening is that the decision

maker expects such external financial assistance with high probability, and

this probability is built firmly into his behavior.

And here Kornai's decision maker is really the firm

manager who is borrowing from the banks.

That because they know that the bank is going to subsidize them or

bail them out if their have a problem, this affects their decisions.

They're going to take excessive risk or not worry about excessive losses.

Now, there are different dimensions of this soft budget constraint problem.

The recipients of the subsidies can be enterprises,

which we're going to focus on in this presentation, or

they can be local governments, or other organizations that are getting subsidies.

The providers of the subsidies are usually the governments,

but can also be the banks, which is, in our case,

the state owned banks connected to the governments or other economic agents.

And the ways in which the subsidy is provided

can be through different channels.

It can be through direct subsidies from the government budget,

it can be through tax rebates or differential tax rates,

it can be through credit bank loans which is what we're going to focus on.

And finally, it can be through administrative pricing,

you can get favorable prices as a way of supporting enterprises.

In China, the key soft budget constraint problem

is state bank lending to state-owned enterprises.

And here you can see a figure which gives you a sense of

the complexity of the relationships that you can have both fiscal subsidies or

financial support through loans from the upper level governments to the local

governments comes and then, down to the enterprises.

The local governments, in terms of the financial side really means the local

branches of state-owned banks.

There are other example of soft budget constraints,

other than Chinese state-owned banks and

enterprises one might just be parents spoiling their children.

If children can always ask for money, and the parents never know how to say no,

they're going to be spoiled, they're not going to really know the limits, and

it could lead to excessive spending by the child.

Another good example is the too big to fail problems encountered

during the global financial crisis where very large banks who's

bankruptcy could have spill over effects to the rest of the financial market and

the economy, the real economy were allowed to be bailed out by the government

because the downside to the economy was too great to allow this to happen.

And finally there are also other examples where governments and not just in

socialist countries but even in more capitalist systems where the governments

just decide these companies are too big or too important to allow them to fail.

So, a good example is the US Government bailout of Chrysler Corporation to

prevent unemployment of a very large number workers also after the global

financial crisis.

In each of these cases the recipients of these subsidies

will anticipate that they'll get the support.

And this could lead to a problem of moral hazard, which is just a description

of the incentive problem that people will not really act

responsibly if they know they're going to be rescued by the government or by banks.

Let's look at the problem a bit more formally, in terms of the incentives

facing the firm manager when it anticipates that it's going to have

a soft budget constraint or have a subsidy provided to it in the event of failure.

We can think of a firm making an effort decision,

how hard to really try to be profitable.

And that effort decision can lead to project success

the greater the effort the more probability assess.

And of course, the less effort,

the more probability that you'll have financial distress.

Now, if the project encounters financial problems

the bank has this decision about whether to bail out firm.

It can decide just to allow the firm to fail and

this is often the most efficient choice the bank can make.

Why throw good money after bad money?

And of course, this will lead to the failure of the project or,

it can decide to bail out the firm, and

provide additional financing to support the project.

And this may lead to a partial success, which

is beneficial, of course, to the firm and avoids maybe some bad outcomes,

loss of jobs, loss of revenue that the government may be worried about.

And the key feedback mechanism here is that once the firms anticipate that

this bail out is going to occur, then they are going to now anticipate that

their own effort decision even if there is financial distress is not going to lead to

project failure but going to lead to some intermediate perhaps acceptable outcome

and this is going to lead them to actually exert less effort to start with.

And so the sub budget constraint problem leads to

poorer performance by the firms and more bad loans by the banks.

Now how can we harden budget constraints in the context of China's banking system?

Well, there are different ways.

The first thing that China tried to do was to modify the managerial incentives

of bank loan officers.

To tell the bank officials that

you really have to make sure that your loans are repaid.

And you can do that of course just by linking promotion or

bonuses to repayment rates or the profits of the bank.

Or you can do what did in the mid 1990s,

which is to establish a loan responsibility system where

each loan officer was actually responsible for the repayment of every loan.

So if the Loan was not repaid, that loan officer actually would suffer

a very large kind of fine or consequence personally, for

any un-repaid loan.

Now that sounds like a good idea in principle but

the problem is that it's pretty easy in a growing economy to hide bad loans.

So it's actually difficult to know the true quality of lending.

Even if on paper, it seems as if all the loans are being repaid,

it could be that banks are just providing new loans to pay off old loans and

the quality of loans is actually deteriorating.

Only if there's an owner of the equity of the bank who really cares

about the true profitability of those loans

will there be a strong incentive to weed out this type of behavior.

Another thing you can do is create more competitive labor and

product markets to reduce the rents to employment in SOEs.

In other words, if workers in state enterprises are being treated about

the same as in other enterprises in a very competitive labor market,

it's not a big deal to allow one enterprise to fail because those workers

are going to find similar pay or other benefits in other jobs.

Whereas if enterprises provide much better paying positions

then people will really fight to protect

the current jobs as opposed to being forced to find worse quality jobs.

And finally or

next you can just refuse to provide subsidies, but this is not credible.

Once the firm is earning losses,

if the government really does care about employment and

revenues it's going to still want to bailout the firm, even if before it

happened they insist they wouldn't, that's just not a credible threat.

And that's the key point of the soft budget constraint problem.

Now, another way to do this is to try to make banks more profit oriented.

And you can do that by reforming the ownership of the bank and

China has done this a little bit by trying to allow for

some parts of the ownership to be publicly listed or to be owned by private firms,

but most of the control is still with the state.

Finally, it’s worth pointing out that even if all of these things are done,

even in a market environment there's no 100% solution to the soft

budget constraint problems as we saw in the bailouts of large firms and

large banks in western countries after the Great Financial Crisis.

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