POLICY BURDEN，MORAL HAZARD Justin Yifu Lin NO. E2006004 April 4, 2006
Abstract: We present a model of policy burden and soft budget constraint (SBC) that explains many stylized facts in socialist and transition economies. We find that under information asymmetry, policy burdens will lead to the moral hazards of the SOE managers and hence the low efficiency of SOEs; and when competition increases to certain degree, policy burdens will definitely result in the SBC problems. Privatization will not necessarily eradicate the SBCs of firms; on the contrary, a privatized firm with policy burdens will be more likely to bring the SBCs and ask for more subsidies from the state than a SOE under the same condition. We also show that in socialist and transition economies, when SOEs bear policy burdens, a restriction of the control power of SOE managers by the state, as a second-best institutional arrangement, may improve the efficiency of SOEs and the social welfare.
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