Bureaucratic Control and the Soft Budget Constraint

In the hierarchy of China's state sector, both before and during the current reform period, government bureaucrats select and supervise state-owned enterprise (SOE) managers. The incentive problem of SOE managers has been studied carefully, but that of the bureaucrats has not. This paper uses a model to show that the agency problem of the bureaucrat leads to the persistence of the soft-budget constraint (SBC) in the state sector. This suggests that the problem of SBC is unlikely to go away even when other familiar reasons contributing to the SBC disappear, e.g., concern about employment