If you think as I do that there's a prior conjecture that the wealthy nations of the world,
the successful societies of the world owe their success at some level to some virtue of political institutions,
then it becomes interesting to study the origins of the political institutions of successful nations of Europe
that came to dominate the world in the colonial period.
And in particular you study the history of English institutions it becomes an interesting thing to do.
And as you trace back the history of English political institutions
I found historians point to primary central in the development of English institutions
after William the Conqueror of the Court of the Exchequer.
Even more fundamental than parliament in the English monarchy is the Court of the Exchequer.
And magnificently there is a dialogue,
a Latin dialogue written around 1180 by Richard FitzNigel
who ran the Exchequer under Henry II and his father ran it under Henry I.
So I want to give you a picture of what this is about and then we'll get into the model.
He says you should know that the Exchequer gets its name from-it's done on a chequered table cloth
and you knew it was about accounting, it still is.
And that pushing tokens on the table cloth- because he specifically says not everybody knows the new Arabic numerals,
and so he used tokens on a table cloth.
And there are a lot of very important people sitting around the table watching:
the Chancellor, the Bishop of Winchester, someone named Thomas Browne and his clerk.
His office didn't have a name yet, the chamberlain, the marshal, and then some technicians.
But he then says something very important, he says like a chequerboard or chessboard,
there is an important battle taking place, a struggle, a game.
And I'm a game theorist so I like this, between two people.
And to understand the foundations of institutions, of real institutions, of institutions that make a nation stronger or weaker,
we have to understand who are the two people who are struggling on this chessboard.
That's the essence of the matter, that's the point of the talk.
And I'll do a model that has nothing to do with this picture of chequerboard.
He draws it out actually in this translation from the Latin, but the answer is: There are no prizes for knowing.
It is the treasurer and the sheriff.
The treasurer is the agent of the central government, the sheriff is the agent of the government in the counties.
Sheriff is what we could equivalently call also a governor.
It was a count, in Latin "comes", the sheriff, the governor of a county or shire or province of England.
And there's a problem within the government of the central government,
the King of England controls England because he has agents in each of the provinces.
His primary representative in each province is the sheriff but controlling the sheriffs is a tricky matter.
It is difficult and you need institutions to help you control the sheriff
if you are going to rule England and that is the essence of the matter.
So the question I ask: What fundamental forces sustain the constitution of a political system?
Constitutional rules are ultimately going to be enforced by individuals and they have to have an incentive to enforce them.
So a political system can survive only if it solves basic agency problems in motivating its high officials.
I want to argue, just to place us: Where are we in economics?
Moral hazard problems are essential to the constitution of any political system.
The political system provides the courts that then sustain other organizations.
And ultimately: What does it all hang on? That's the question.
I want to try to give a picture.
High officials like sheriffs have big temptations.
I think it is simply an empirical fact that in every large scale political organization that is covering an extended area
there have been officials who had large power.
Not only governors but also in modern state ministers who control specialized ministries.
And high officials are going to ensue temptations to abuse their power;
they are going to use their power correctly only if they expect future rewards for loyal service.
That means of course, when you appoint someone to a powerful-what do I want you to think of?
We are going to try to think about a simple state.
I don't want to assume any complexity of the state.
I want you to imagine a monarchy or a dictatorship that has no structure except this one guy who's the boss.
Think of King Henry II of England around 1180 with his sheriffs.
Or later on, at the very end I will try to talk about soft budget constraints.
So we may think about the party boss of Janos Kornai's Hungary around 1970
the party boss of Hungary if I can approximate him as an autocrat and factory managers.
Because I want to relate to the soft budget constraint literature.
Think of there's a senior boss and perhaps many of the things I may say
have something to do also with large scale economic organizations like firms that are run by an entrepreneur.
And I'm happy with those connections.
It's easier to talk about a political institution, largely because the firm we often assume can sign contracts.
People in a firm can sign contracts that are enforced by the state.
But people within the state we don't assume can sign contracts that are enforceable by any higher authority.
So we better get to the basics here.
I'm going to build on the work of Becker and Stigler and Shapiro and Stiglitz on dynamic moral hazard.
One of the things that people have learnt in these models and I'll show it soon
is that in keeping people honest over the long run or keeping people exerting effort over the long run
it helps to back-load the rewards.
The promise of distant future rewards,
of a big reward at the end of your career can be used to motivate good behaviour all through your career.
Whereas once I've paid you for your good service today that can't be used as motivation for good service tomorrow.
So back-loading rewards means that the leader is going to take on a debt to his officials.
Sheriffs have enormous power to enrich themselves if they behave corruptly or govern badly.
They therefore have to be well rewarded and the rewards should be back-loaded.
Future rewards are great.
And the longer distant future you actually pay them, the better, as far as you are concerned but when you are King Henry II.
But that means you are a debtor to your officials.
And that is what I want to focus on.
I want to probe the fact that a political leader who-
and Becker and Stigler in their 1974 paper on dynamic moral hazard explicitly talking about a magistrate who could be corrupt.
And they explicitly say:
We'll assume there's no problem in judging at the end when they are paid this big end-of-life reward at retirement.
There's no question about whether they will be rewarded if they have a good record.
If they have a bad record, they will not be rewarded.
But if they have a good record, they will be well rewarded.
But of course the state as personified by the King would prefer to say bad record and you don't get rewarded because it's a debt.
Anybody who has a debt prefers to repudiate that debt if you could get away with it.
So I want to emphasize high officials that are going to be well rewarded, it's going to be back-loaded.
So the state is going to owe them a large debt.
And that means furthermore they must lose credit when there is evidence of maleficence.
And I'm going to look at a model unlike the early models of Shapiro and Stiglitz and Akerlof and Katz and Becker and Stigler.
I'm going to allow that even when they behave well, there's a positive rate of crisis, of bad occurrence.
The rate of bad events of crisis is just greater when they are corrupt.
But people are going to have to be fired sometimes because of maleficence.
But the leader wants to find maleficence because that means he doesn't have to pay these back-loaded debts.
That means the leader must be trusted to judge his high officials.
That I want to emphasize is the primary asset that defines a leader.
A political leader must be like a banker whose debts are valued as rewards for current service.
And in some sense you could turn that on its head and say bankers are intrinsically political.
A good banker is intrinsically political.
Judgments of high officials are going to require close,
close scrutiny in an institution that the leader is going to have to create.
That's another paper at some point, where I do that in more detail.
So the high government officials should not fear being cheated and replaced.
The problem of replacing the sheriffs...
I'm going to show you that agency problems are going to cause the leader to govern through a closed aristocracy.
Not based on any theory of innate inequality, the aristocrats are not any better than anyone else in this little model.
But based on actually an innate equality assumption that commoners aren't any better than aristocrats and that there's a cost,
a political economic agency cost every time you dismiss one of your high officials.
And because of that you are going to minimize turnover in the running of the efficient state.
So, time for the model.
This is an extension of the Becker-Stigler in 1974 and Shapiro-Stiglitz in 1982, the dynamic moral hazard model.
I think of this in continuous time and up there in brackets at the top I've listed all the parameters, seven parameters.
So I need to tell you what all those parameters are and then try to remind you.
That's the model.
D is something new, in fact I've got actual numbers, let me use an actual numerical example.
But obviously in the paper on my website the formula is in full generality or derived.
So say D which is five and whatever these numbers are, is the expected pay-off for a governor who rebels.
I have to say it's an agency problem.
We are trying to motivate someone like a sheriff, a factor manager in Hungary, a sheriff in medieval England.
I'm just going to use the word governor, try to make this governor female and the leader male.
The governor she has three options at every continuous point in time,
she can behave well, she can misbehave which is being corrupt or there's a third option: She can rebel.
Now rebelling is you are trying to become an independent county
or perhaps you are looting your Provence as fast as you can and then running away to France across the channel.
So the important thing is, I want to put a floor on how badly you can treat these governors in your medieval England
because they have this parameter D equals five which is their expected present discounted value of a rebellion
which would be immediately visible but they can get it and run away.
Or get this expected value of rebelling and trying to become independent.
Now I'm going to assume that that's a lot of money because a province is a big rich place,
candidates for governor have only limited assets.
A for assets, and the crucial assumption is that what anybody can pay is less than that.
If there were already people wandering around your kingdom who are as rich as anybody could be by looting a province,
then there would be no problem.
I want to talk about that, that assumption A less than D is what drives everything.
But I think in this application it's realistic.
In communist Hungary in 1970 there weren't a lot of rich people wandering around.
And there were factories which had the option if you managed them, you could loot them pretty quickly and get some wealth.
The leader cannot directly observe whether the governor is behaving or misbehaving.
So rebellion is sort of a one time act.
But at every point in time you can also in secret be corrupt, misbehaviour it's called on this slide.
So all the leader sees is costly crisis that occur as a Poisson process with some low rate alpha, I'd say 0.1.
So you get a crisis once every ten years on average if the governor is behaving well.
Or 0.3 like once every three and a third years where you expect a crisis on average if the governor is being corrupt.
But you can't see that and beta and alpha are strictly ranked and both bigger than zero.
Misbehaviour gives the governor additional benefits worth gamma which in this case is one.
So gamma is a flow per unit time to convert unit time, D is the present discounted value of a one time act.
You convert flows into present discounted values but the discount rate will say five percent, one-twentieth per annum, per year.
Now, I have said what I'm really interested in.
I would like to give you a model that just sensitizes you, makes you very sensitive to the problem of trusting the leader.
Of the high officials trusting the leader.
To do that properly I should make the leader a decision maker with incentives and a moral hazard model
where a leader can even cheat them or not cheat them.
And I found that too hard.
I want to give a talk that I can do in 40 minutes and I couldn't write that paper.
So I'm going to give you the very cheapest way of doing it.
We are teaching students.
Get what you need in there in an attractable way is better than leaving it out.
That's the point.
So this is a cheap way of doing it, it's an intellectually cheap way of doing this, but at least it's tractable and it's there.
H stands for the upper bound on what the leader can be trusted to owe a governor.
And I'm just going to assume that's a parameter, that's a constant.
It actually should depend on lots of things such as that the leader is in debt to many governors
that may make the leader more prone to a kind of general default and try to change staff.
So this H is standing in for the moral hazard that if you were a governor
and you had risen to a position where the head of state owed you more than this,
you would expect that he would find some way to get out of it.
I should say Saint-Simon's essays on the court of Louis XIV in France
make it clear that Louis was constantly trying to scheme to get out senior aristocrats.
And who are the senior aristocrats that he's trying to manipulate out of the centre of power?
They are people who served his father or grandfather.
They are people to whom the dynasty owes a big debt and he doesn't like that.
He'd rather elevate other people and I'm sure that's a regular aspect.
So this H is the upper bound on what we can owe these people.
Later on I'm going to introduce a parameter L which will be the cost of crisis.
But as in the Shapiro-Stiglitz, Becker-Stigler tradition
I'm simply going to assume that the costs of crisis and rebellions to the leader are very large.
So large that the leader always wants governors to behave well and to never rebel.
So the question I'm going to ask is: How do we minimize the expected costs to the leader,
the expected present discounted value to the leader of providing incentives for the governor to always be a non-corrupt,
well behaving, non-rebellious governor.
To remind you at the top what the seven parameters are and their numerical values.
And here I'm just going to describe to you the optimal solution.
A formal statement of feasibility that recurs from equations and so on is the optional slide No.9.
If there is a question, I can show.
But it's in the paper.
In this short presentation let me just describe the optimal solution verbally.
Have I described the problem?
Let me say one thing I think I forgot to say that is very important.
I'm going to assume that these crisis occur at random points in time.
So as long as the alpha rate in any short interval of time of length epsilon-
there's an alpha times epsilon probability that the crisis will occur if the governor is behaving well.
If the governor is corrupt, it's a beta times epsilon probability, in any short epsilon period of time.
When a crisis occurs, I will assume that the governor observes it immediately and the king or the prince,
the leader observes that the central government observes it with a tiny delay, an infinitesimal delay.
One structure that I should have mentioned that governors can be called for brief periods to the centre,
to the palace, to the leader's court, to the prince's court.
And in that period, when you are actually at the court, you can't rebel.
So it's a continuous time model for a variety of technical reasons.
But think about when a crisis occurs in a very short time, afterwards the leader can be called to the court.
The governor has the decision: Shall I rebel? I see a crisis.
Shall I rebel or not? If I don't rebel, I might be called to court.
Shall I go to court or shall I rebel? If I go to court, I then can't rebel while I'm in court.
I'm sitting in the king's court and a decision can be made at that time whether to send me back or to dismiss me,
possibly to be rewarded after dismissal, possibly to be punished and tortured after dismissal.
All of that can happen.
And those sequences happen very rapidly in no time in the model but in sequence, in infinitesimal time.
So, as it is common in these models, the optimal solution can be described,
I'm assuming everybody's risk neutral and discounts at the same rate, governors and princes.
The dynamic state without loss of generality can be summarized by the governor's credit,
that is the governor has an expected present discounted value of future pay.
I just realized there was one of the seven parameters I didn't mention.
That was on the previous slide.
Gamma is the continuous time benefit of corrupt behaviour.
I did mention it, the hidden benefit of corrupt behaviour.
That is the temptation and the cost of corruption is that it increases the probability of crisis
which are very costly to the state.
And the state wants to reduce them.
So, we are going to say at any point in time in the optimal policy some U(t),
is actually the expected present discounted value of all future pay to the governor at time t or infinitesimally before time t.
When the sequence of events occurs U(t), think of it, is being the present discounted value just before time t,
for a governor who's incumbent in office.
To deter misbehaviour the governor must expect her credit to drop by an amount that deters misbehaviour.
How much is that? Well, the formula is, I call it the tau, the penalty tau for each crisis that she must suffer is...
Beta minus alpha times epsilon is epsilon times beta minus alpha times epsilon is the increase in probability of crisis
that you get when you are corrupt.
The benefit you get for being corrupt over a short interval time epsilon is gamma times epsilon.
So beta minus alpha times tau has to be at least gamma
in order for the expected cost of being penalized
because of the increased probability of crisis to be greater than the secret benefits you get from being corrupt.
So, gamma divided by the quantity beta minus alpha is the amount we must penalize
after every crisis or else the governor will be corrupt and my little parameter turns out to be five.
Five was also the value of rebellion by coincidence.
So, to avoid rebellion we are going to need-we don't want rebellion ever,
but the problem with rebellion and by the way if you read Roman history
you know it's just after there's been a local crisis in the province and the local boss is worried.
The local governor is worried or the general who's governing a province.
So, if the rebellions are going to happen,
they are going to happen after the governor has just experienced a crisis and knows she's about to be punished.
So U(t) minus tau which is what her expected value must be infinitesimally after the crisis can't be less than D.
The D is the value of the rebellion.
So, that means for a governor who's sitting in the province U(t) always has to be at least D plus tau.
D is five in my little model and tau is five, so five and five is ten.
That is the lowest amount anybody can ever have as expected as credit or debt, credit for the governor and debt to the prince.
The prince must owe the governor an expected present discounted value of ten at all times under the system
or else she would rebel, she the governor would rebel after the next crisis.
A new governor has to get some initial credit.
Now I'll tell you about the optimal solution.
When you bring in a new governor you are going to have to bring in the new governor with a terms of reward
that have a present discounted value of this number.
I'm going to call this G now, G for good.
How good does life have to be for a governor?
The governor has to have at least the rebellion pay-off plus one penalty for one crisis.
That's how good it has to be for a governor and obviously you don't want to pay more than that.
I haven't told you where the pay is, the present credit has to be at least that.
Now there's going to be a problem, at some point the bankruptcy constraint comes in.
At some point the credit goes below the lower bound.
So, when U(t) minus tau is less than G something has to happen.
We have to penalize the person.
And I'm telling you, the optimal solution is going to be that after a crisis if U(t) minus tau is less than G.
That means that after the penalty your expected value has gone.
As governor you have gone from U(t).
U(t) minus tau that's less than G.
So you can't be there for another crisis.
Another crisis you'll rebel, so I immediately call you into the court and we have a trial.
And in the optimal solution with probability U(t) minus tau divided by G you are reinstated at value G.
At the minimum value, you go back to the province just like a new governor.
Or else you are dismissed.
Zero I should have said is the expected present discounted value of a person who is outside of office.
And so you become a regular peasant like all the rest of us.
And you get what we call zero.
When do we actually pay the person? We have to actually pay them.
The optimal solution-if you've studied these dynamic models,
this won't surprise you-the optimal solution is to back-load the pay as much as possible.
Which means whenever the credit is less than H, so first of all notice H,
the upper bound on what the prince can owe his governors cannot be less than G or else there will be rebellion.
There will be rebellion after the first crisis, there's no way to motivate non-rebellious,
non-corrupt behaviour unless H is G or bigger.
When the credit bound is not reached, don't pay the governor anything, just increase credit.
Which is going to accumulate actually at rate delta times U(t).
That's the interest on what I owe you.
And this alpha tau is you are being subjected to a regular risk of being punished and expected value
and I have to compensate you for that.
So your credit is just going to go up.
But when the upper bound is reached, then I'm going to pay you the same formula.
So, what's the story?
You get appointed, you don't get paid anything until your credit builds up to a certain level
and then we treat you very, very well.
Obviously this comes from the assumption that the governors are risk neutral,
if you had some sort of concave utility for continuous time consumption, it would be much more complicated.
But that's the story.
The leader's credit bound therefore is going to be regularly binding on the optimal solution.
The important technical result I want to tell you,
is that increasing H always strictly decreases the leader's expected discounted costs ex ante.
But ex post that's going to mean that the leader is going to incur, if H is a very large number, if H goes to infinity,
the bound is going to be that the leader ex post after a long time is going to be owing a great deal to his officials.
Here's my numerical example.
In some sense we are going to get a theory of dynastic decline.
I've got the leader's expected V, the value function depends on the current incumbent governor's credit, that's the first graph.
The second graph is the cumulative distribution in the steady state.
In a new regime, when a state is just founded by, say William the Conqueror,
all governors are newly appointed and we are not paying them anything.
H was 25 here, you have to get them started at least 10, 25 is three penalties above 10.
And in the new regime he doesn't have to pay them anything,
the state has a lot of central resources because everything is on future promise.
But ex post actually the state becomes quite poor
because in the long run it turns out the steady state of applying this incentive scheme.
With 40% probability governors in the long run are going to be at their upper bound and they are going to be paid a lot of money.
And you can see that it's about 15% probability of a governor being one penalty below this steady...
the upper bound where she gets rewarded.
Two penalties has another 2%, it's a tiny fraction, only 1% probability of being one penalty below.
It's only this probability which would lead to an event where the governor would be at any risk of being dismissed.
So if the turnover rate in the steady state is whatever-
I can't even read how small that number is, three ten thousands or something like that per annum.
So, that's my story about the aristocracy.
What's happened here? Here it says the leader's expected present discounted value at the time of the first appointment.
V(G) is the expected value when you have a governor who has owed the minimal amount, a new appointee.
And A is the amount that they paid you for promotion to office.
They pay you their assets.
And as the upper bound is increased, decreases, eventually for the higher upper bounds beyond 25
don't make much difference because there's so little turnover.
What's going on here? Every time a new governor has to have an expected credit of 10.
But I said they only had assets of one,
that means every time you appoint a new governor you are essentially incurring a present discounted of value of debt of 9,
an unfunded liability of 9.
In fact, King Henry II could have turned the whole thing over to a Swiss bank
where every time he hires a new sheriff or a new governor he deposits 9 with the Swiss bank,
the Swiss bank runs the operation until something happens where the guy is dismissed.
And then you make a new deposit when you bring the new guy in.
When I do the accounting that way, the Swiss bank is just breaking even
because 9 is the present discounted value of the new governor's expected pay and reward.
And that's what this bank is paying out.
They have the same delta discount rate.
It becomes clear the goal of a well-designed policy is to minimize turnover because they can't pay for the value.
These officers are so valuable and nobody out there can pay for them.
It's interesting the minimal level what I have here...
At the minimal level that is consistent with the solution paying one.
But they have a dismissal rate of 5%.
Actually the expected payout is a little more than one with 25.
So there's a dynastic decline or a greater expense.
Empires have fallen when emperors were not trusted at this level.
And I would argue that those two historical events in Rome and the Ming Dynasty are similar to the event that H declines below G.
There's a debt liability of G minus A every time you appoint a new guy.
So you want to minimize expected turnover.
The nice thing about the deferred pay,
the intuitive reason why the H upper bound is binding is-
by paying a lot and then saying if you are being paid at this high upper bound but then you are penalized, you go to H minus tau.
Basically, what I'm talking about is: Instead of dismissing you, I'm just suspending pay for a period.
And if you can keep the crisis to a low rate, you will grow back up and start getting paid again.
Suspension of pay for a seated governor is a much better way of motivating than dismissing.
But unfortunately there is a lower bound on what they can expect.
You can't keep penalizing forever.
The other important point however is that the leader is not indifferent.
At the low end I said the optimal policy is to do a randomized dismissal.
The leader is not indifferent, the leader actually prefers to dismiss.
What's the difference, if I reinstate you, I have what I call V(G), the value of having a governor G.
If I dismiss you, I bring in another governor who's at the same credit level G,
but that outsider is going to pay us A, once A is positive.
In the Shapiro-Stiglitz model A was zero.
In the Becker-Stigler model A was G.
I've chosen A bigger than zero but less than G.
And that's what makes it interesting.
Because A is bigger than zero, because A is less than G
there's a positive incentive to minimize turnover that Akerlof and Katz didn't find, they had alpha also equal to zero.
I get an incentive to-there is a positive rate of dismissal of governors but the king prefers to dismiss all the governors.
But if you were going to dismiss all the governors, then the governor would rebel after crisis.
So that's why an institution needs to be created.
What institution? Who can constrain the sovereign prince?
Or within the story I've been telling, then it's getting outside the model but it's within the story.
If all governors lost faith in the prince, then there would be universal rebellion and the prince would be out of business.
So the obvious thing is, you want a large subset of the aristocracy to be watching your transactions with the governors.
You the prince have to dismiss governors at court,
meaning in front of a group of courtiers who are themselves connected with the other high agents of the state
or a good subset of them.
And that's why there was a circle of people watching as the sheriff settles accounts with the centre.
Because when the king goes after a sheriff everybody has to agree that proper procedures are being followed.
Whether there's something randomized.
There's a note at the bottom: Randomized dismissal is better than severance pay essentially because A is less than G.
Severance pay would cause you to have more turnover.
On the other hand punishing doesn't help.
If you punish, you are going to have to compensate.
Torturing former governors doesn't help because you are going to have to compensate them anyway.
Tolerating corruption-what happens if I keep the king's cost of rebellion very, very high?
But let's reduce the assumption that there's an infinite cost of these crisis.
Let's say the crisis are called L parameter.
I'm going to call it 9, it's an interesting number.
It's important that alpha times L, that's the cost rate when you good behave, plus gamma,
the benefits that the governor could get.
Think of gamma now as being a continuous time maintenance expense that when we are going to ask a governor to behave well,
we are going to have to pay gamma to the governor.
But the governor could steal that stream of maintenance expenditure.
The governor can either spend it properly or steal it.
And we can't tell the difference.
All that happens is, we see crisis at a higher rate in expected value if the maintenance budget is being stolen.
For simplicity let's let A equal zero but beta times L in my case is bigger than alpha L plus gamma,
that's the expected cost rate to the centre.
The maintenance budget puts the expected cost rate when you ask the governor to behave well
is less than just saying forget about maintenance, be corrupt,
we are not going to give you anything to compensate and we'll have lots of crisis.
That definitely is a higher cost rate, if beta L is bigger than alpha L plus gamma.
When L is sufficiently large-one thing I want about this new parameter is this inequality.
This inequality you can make L as big as you like and it will always be satisfied.
It's only small L where it goes wrong.
For my numbers the other parameters L bigger than five is what makes sure that corruption isn't the efficient solution.
There are two possibilities, I suggested 9- consider H a parameter for a moment.
Instead of 25, I think over here it is 25, and L is 9.
When L is sufficiently high, we have what I'm going to call a hard budget constraint, exactly the solution that I said before.
New governor comes in at 10 it was, D the rebellion, nobody comes in below D, D equals 5.
But we are going to start a D plus tau.
They come in at credit level 10 and we pay them a maintenance budget and we expect them to behave well.
If H gets smaller than a number that happens to the 12.4 which is bigger than 10 for this case, then it switches to what I would call the soft budget constraints.
What's hard budget constraint?
Hard budget constraint is that if, because the penalty after crisis, if the governor's credit drops below 10,
then we are going to have some possibility of dismissal or possible reinstatement at 10.
That's the hard budget constraint regime in Kornai's sense.
The soft budget constraint regime becomes optimal in other regions.
This is the only possibility.
The soft budget constraint is that you start the new governor at D, but then you can't penalize her after a crisis.
But then she's going to be corrupt, so you don't pay her the gamma maintenance budget.
And you just say: Take this, don't rebel but we expect you to not bother spending,
you are not going to bother spend the maintenance, we are not going to fund the maintenance budget.
You are going to be corrupt, and we tolerate a high level of crisis.
But we are going to pay you, your credit is going to increase.
We are not going to pay you any real money but your credit increases over time,
at delta times U until it gets bigger than G.
Now we can penalize you and so we start maintenance, so the maintenance budget begins.
So, the soft budget constraint regime-let me now call them not governors but managers in Hungary,
managers who are close to the looting level.
The rebellion or looting the factory level who have bad records or who are new, we don't expect much of them.
We don't give them a budget to fund good and proper maintenance but gradually they build up credit,
when it gets to be high enough, then we start paying them.
If it gets really high and reaches whatever H is and here it's 12.4,
then we start paying them a lot of money and give them more than just the value of what they can skim off.
So for the given H at 25, this is the graph of the leader's present discounted value here.
Between five and ten you can't get the manager to ever be good.
For this zone in here there will be some region but it takes about twelve years for a new manager to accumulate credit.
Or managers gone to the bottom to gradually accumulate credit.
So the point is with all of the parameters the same-
if in Austria managers can trust that they will be very well rewarded perhaps because they are given shares.
They can own shares in this enterprise and expect that the good behaviour will lead to-
they will be given options that have very high upside value.
There might be no firms managed with shoddy controls and high crisis rates.
Whereas in Hungary under the Soviet system
it's hard to promise high cash rewards to anyone with any of the managerial class because of soviet egalitarian ideology perhaps
that makes it impossible for the state to commit to high cash rewards.
Then you have large numbers of factories that are in the zone.
So the difference in H can make the difference between the hard budget constraint and the soft budget constraint.
There we will stop and there's my conclusions but it's better to ask questions.
Is there even a second for questions? I'm hungry for lunch...