Concept and origins
Kornai (1980) observed that socialist state firms were rescued with subsidies, credit and tax relief when they made losses, weakening incentives to cut costs. Their budget limit was 'soft'. Kornai (1986) argued this drove chronic shortage and inefficiency.
Why it arises
Dewatripont and Maskin (1995) showed that once a lender has sunk funds, refinancing a failing project is better ex post, so a no-bailout promise is not credible. Anticipating this, firms take less care, similar to moral hazard. Maskin (1999) summarised this theoretical work.
Applications and remedies
Kornai, Maskin and Roland (2003) extended the concept to too-big-to-fail banks, hospitals and local governments. Rodden and colleagues (2003) compared subnational borrowing in expectation of bailouts, and Qian and Roland (1998) argued fiscal federalism can harden constraints via interjurisdictional competition. Remedies include no-bailout rules, bankruptcy regimes and decentralisation.
FAQ
- What is the soft budget constraint in simple terms?
- When an organisation expects someone to cover its losses, it stops keeping to its budget.
- How does it relate to too big to fail?
- Firms too big to let fail can expect rescue, a classic case of soft budgets.
Sources reviewed: 2026-10-26
References
- Kornai, J. (1980). Economics of shortage. North-Holland. The book where Kornai first introduced the concept.
- Kornai, J. (1986). The soft budget constraint. Kyklos, 39(1), 3–30. Kornai's systematic statement of the concept.
- Dewatripont, M., & Maskin, E. (1995). Credit and efficiency in centralized and decentralized economies. The Review of Economic Studies, 62(4), 541–555. The dynamic commitment model of soft budgets.
- Qian, Y., & Roland, G. (1998). Federalism and the soft budget constraint. American Economic Review, 88(5), 1143–1162. How federalism can harden budget constraints.
- Maskin, E. S. (1999). Recent theoretical work on the soft budget constraint. American Economic Review, 89(2), 421–425. A short overview of theoretical work.
- Kornai, J., Maskin, E., & Roland, G. (2003). Understanding the soft budget constraint. Journal of Economic Literature, 41(4), 1095–1136. The landmark review extending the concept beyond socialism.
- Rodden, J. A., Eskeland, G. S., & Litvack, J. (Eds.). (2003). Fiscal decentralization and the challenge of hard budget constraints. MIT Press. Comparative cases of subnational bailouts.