Bundling of social and private goods and the soft budget constraint problem

Firms in socialist and transitional economies are often obliged to provide social goods at the same time that they are competing with private firms. This paper analyzes the impact of such bundling on the provision of private and social goods focussing on the inability of politicians to commit not to bail out firms experiencing financial trouble. This soft budget constraint problem results in firms not becoming efficient in the private goods market. We show that more competition in the private goods market can lead to less efficiency in such environments. As a potential solution to the soft budget constraint problem, we consider unbundling, i.e., the separation of social good provision from the private good, and analyze the benefits and the costs. (C) 2004 Association for Comparative Economic Studies. Published by Elsevier Inc. All rights reserved.