The soft budget constraint in China

This paper identifies five factors affecting the degree of softness or hardness of budget constraints of enterprises in China. Budget constraints become harder: (1) under fiscal decentralization and competition between regions; (2) under more competitive labor and product markets reducing employment rents; (3) when there is a smaller number of enterprises within each jurisdiction. On the other hand, budget constraints become softer: (1) under monetary decentralization; (2) when enterprises have a larger size and social costs of layoffs are convex. We use these results to explain why township-village enterprises have harder budget constraints than state-owned enterprises.