1. Introductory Presentation ECONOMIC DEVELOPMENT OF EASTERN EUROPE By: Robert Danilczuk Dariush Pourhosseini Sean McDermott Steve Sheath Peter Wietlicki

2. Question  Would moving to a market economy from a planned economy harden the budget constraint?

3. Understanding soft budget constraint Janos Kornai et.al Stylized explanation of SBC syndrome BC (budget constraint) organization and S- organization (supporting) BC organization makes loss and S- organization helps it out with its financial problems (bailout) Motivations (e.g.. To recoup past investment, economic spoillover effect i.e. chain of bankruptcies) Review of different models and empirical results for the SBC

4. Credit and Efficiency in Centralized and Decentralized Economies - M. DEWATRIPONT and E. MASKIN Asymetric Information. - Creditors do not know which projects are good or bad. Centralized economy- banks refinance due to significant sunk costs and social surplus. Decentralized economy- bad projects may not be refinanced. This Provides financial discipline This model contains the basis of the ‘soft budget constraint’ problem.

5. FEDERALISM AND THE SOFT BUDGET CONSTRAINT YINGYI QIAN AND GERARD ROLAND The Model Firm can either privitise,restructurise or wait for support depending on the expected response of the government Assumptions Each region of a country is equal Little restrictions to capital flow between regions Small mobility of capital between countries Fiscal decentralization leads to hardening budget constraint Regional competition for foreign capital Local government not willing to subside (or bailout) enterprises Higher wellfare level (firms pay more in taxes) Allocative distortion Will only be true if the effect of competition for monetary grants exceeds the softening effect of increasing budget due to monetary finance The cost of Fiscal decentralization and monetary centralization is inflation Fiscal centralization softens the budget constraint The cost of bailing out less then its benefit Under investment Less allocative distortion

6. Machiavellian Privatisation (2002) What is “Machiavellianism”’: “The political doctrine of Machiavelli, which denies the relevance of morality in political affairs and holds that craft and deceit are justified in pursuing and maintaining political power”  Assumptions: 1. Political Party needs to Right wing/ Market Orientated 2. Inequality must be present in the economy, Median income< Average mean income 3. Shares need to be allocated evenly or more towards to median voters If the privatisation has been successful the political views of the median voters should have been shifted towards the right, hopefully causing the Right wing party to be elected.

7. Machiavellian Privatisation (2002) Examples of situations where Machiavellian privatisation may have occurred

8. Any Questions? (Seriously ask Pete something he’s like proper clever) Appendix  Machiavellian Privatization- Bruno Biais and Enrico Perotti  Creating a Market Economy in Eastern Europe: The Case of Poland -  Understanding the Soft Budget Constraint - János Kornai, Eric Maskin, Gérard Roland  Federalism and the Soft Budget Constraint – Yingyi Qian, Gerard Roland