The Role of Soft Budget Constraints in the Development of the Chinese Solar Industry

Abstract: The role of soft budget constraints in the development of new industries is ambiguous. On the one hand, they may accelerate growth by raising investment and intensifying competition. On the other, they may dull incentives to cut costs, raise efficiency and innovate. This article will explore this question in the context of the Chinese solar photovoltaics (PV) industry. I will test two hypotheses. One is that soft budget constraints have a negative effect on innovation, and that the innovation that has occurred in China is thanks to foreign or domestic investors who enforce discipline. The other hypothesis is that soft budget constraints support innovation, based on the idea that competition between local governments and their client firms in contemporary China resemble competition between business groups (keiretsu) in postwar Japan. The study will be based on secondary sources about the Chinese PV industry, including academic articles, trade publications and business reports. Focus will be on the relation between firms, local governments, the central government and various financial entities, domestic and foreign. Interactions between different levels of jurisdiction will be central. By studying the trajectory of the largest Chinese PV producers from 1999 - 2019, I aim to ascertain whether soft budget constraints helped or hurt innovation in the industry. Implications are relevant for policies to promote carbon industries to mitigate climate change.