Journal Article

Innovation and Bureaucracy Under Soft and Hard Budget Constraints

Yingyi Qian and Chenggang Xu

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 65, issue 1, pages 151-164
Published in print January 1998 | ISSN: 0034-6527
Published online January 1998 | e-ISSN: 1467-937X | DOI:
Innovation and Bureaucracy Under Soft and Hard Budget Constraints

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Because of the inherent uncertainty, promotion of innovation critically depends on screening mechanisms to select projects. This paper studies the relationship between bureaucracy and financial constraints as two such mechanisms. The lack of commitment to hard financial constraints interferes with its ex post screening capability; ex ante bureaucratic screening is optimally chosen as a substitute. However, bureaucracy makes mistakes by rejecting promising projects and delays innovation, and the efficiency loss due to soft financial constraints increases as prior knowledge becomes worse and as research stage investment requirements become lower. In a centralized economy, bureaucracy may reduce the number of parallel projects, particularly for projects with higher uncertainties and less research stage requirements. This theory fits much of the evidence and in particular it explains why the computer industry, but not the nuclear or aerospace industries, has fared so poorly in centralized economies.

Journal Article.  0 words. 

Subjects: Economics

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