<p>This thesis seeks to provide an extensive theoretical framework for the potential incentive</p><p>effects from debt relief. The objective is achieved by integrating the positive incentive</p><p>model by Krugman with a negative incentive framework developed by drawing on the</p><p>theories of a soft budget constraint. The analysis shows that the existence of bailouts</p><p>offers the possibility that debt relief can produce negative incentives for the debtor</p><p>instead of positive incentives for improved performance. Taking on a game theoretical</p><p>perspective suggests that strategic behavior in the interaction between the debtor and the</p><p>creditor can increase the likelihood of a specific incentive effect to prevail. Such an</p><p>interactive game also highlights the importance for the creditor to obtain reliable</p><p>information about the behavior of the debtor.</p>

This thesis seeks to provide an extensive theoretical framework for the potential incentive effects from debt relief. The objective is achieved by integrating the positive incentive model by Krugman with a negative incentive framework developed by drawing on the theories of a soft budget constraint. The analysis shows that the existence of bailouts offers the possibility that debt relief can produce negative incentives for the debtor instead of positive incentives for improved performance. Taking on a game theoretical perspective suggests that strategic behavior in the interaction between the debtor and the creditor can increase the likelihood of a specific incentive effect to prevail. Such an interactive game also highlights the importance for the creditor to obtain reliable information about the behavior of the debtor.

In this paper the Helpman-Hanson model is estimated using Swedish municipality level data. The Helpman-Hanson model builds on Krugman’s contributions to the NEG theory but makes use of a housing sector instead of the usual agricultural sector. The Helpman-Hanson equation is optimized both in levels and in first differences and the results confirm a positive relationship between wages and market potential, although the effect of transport costs on the distribution of wages turns out to be non-existent. Additionally, all of the estimated structural parameter values end up within the consistency ranges required by theory and most of them, except for a very large estimate for the elasticity of substitution, fall in line with previous research.