A THEORY OF SHORTAGE IN SOCIALIST ECONOMIES BASED ON THE SOFT BUDGET CONSTRAINT

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 sunk. In such a situation, if a consumer good is also demanded by firms as an input and the seller cannot separate firms from households, the high market-clearing price would lead to welfare losses because too many bad projects would start and crowd out household consumption.