Soft budget constraints and state capitalism

By Sergei Guriev

Why are inefficient state-owned enterprises (SOEs) failing to be privatised? This paper takes the concept of the soft budget constraint (introduced by János Kornai) and applies it to state capitalism – that is, where the state owns major production assets but doesn’t interfere in price setting directly. It finds that bureaucrats supervising the failing enterprises prefer to keep them afloat and gamble on their resurrection; in contrast, privatisation would involve acknowledging the bureaucrats’ and SOEs’ failures. This preferential treatment of SOEs creates a competitive advantage against private firms and explains why, in state capitalism, privatisation may result in lower rather than higher productivity and therefore remain unpopular. This paper has been prepared for the special issue of Acta Oeconomica in honour of János Kornai.