Incentives facing local governments in the absence of credible enforcement

We explore and build on some of the recent literature on the political economy of soft budget constraints. We show that in some limited cases, there is a welfare gain for the central government to guarantee critical investments, even if this results in a softening of the budget constraint at sub-national level. However, the general prescription against generating soft budget constraints remains a good guide to policy making. We also examine issues related to asymmetric information in relation to public-private partnerships (PPPs) that might lead to game-play and evading hard budget constraints. This has major consequences not just in Europe, but also in other parts of the world, where there is an increasing focus on the need for sustainable investment, and PPPs are seen as an easy solution to an increasingly difficult problem. The game-play needs to be addressed in contract design and the role of incentives that are governed by full information, non-distorting transfer systems and availability of own-source revenues at the margin, without which sanctions and strictures from higher levels of government are simply not credible.