This paper attributes shortages of goods in socialist economies to the soft financial constraints that firms in such economies face. A 'soft budget constraint' problem arises when the state bank is unable to make a credible commitment not to refinance bad projects once some investment costs are...

The government's incentives to bail out inefficient projects are determined by the trade-off between political benefits and economic costs, the latter depending on the decentralization of government. Two effects of federalism are derived: first, fiscal competition among local governments under...