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Janos Kornai’s warning for the post-pandemic world

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The writer is publisher of The Overshoot research service and co-author of Trade Wars are Class Wars

If the pandemic has taught us anything, it is that downturns are essentially optional. Governments across the rich world were able to protect household and corporate balance sheets from the most severe disruption since the second world war simply by printing money.

How should we use this new knowledge? Anyone thinking seriously about the potential risks and rewards of the policy mix that might be called “full Keynesianism” should consider the ideas of the economist Janos Kornai, who died last month.

Kornai grew up in Hungary and spent much of his life in the Soviet satellite, which gave him first-hand experience of a society where “full employment” was the norm and the business cycle had been outlawed. The result was not a paradise for workers or anyone else, but instead what Kornai called a “shortage economy” of wasteful producers and deprived consumers.

For Kornai, the essential feature of the “capitalist” economies is that businesses face “hard budget constraints”. If they do not make money enough from their operations, they need to raise funds from banks or the capital markets. And if they can’t raise funds, they go bust.

This constraint forces producers to conform to the desires of consumers. Companies cannot survive unless they are able to provide the goods and services that people want at prices they can afford. At the same time, businesses also have to be focused on efficiency and cost control so that they can cover their own expenses. Kornai believed these imperatives drive competition that leads to innovation, productivity gains, and sustainable increases in living standards.

Hungary and the other “socialist” economies, by contrast, were characterised by what Kornai called “soft budget constraints”. Enterprises never had to worry about breaking even, much less generating profits. Instead, they knew that they had unlimited financial support from the government. They could always “afford” to employ workers, invest in physical capital and accumulate raw materials. It did not matter whether any of that activity was actually valuable.

That removed the incentive to innovate to meet the needs of customers and to hold down costs. Consumers were forced to adapt to the whims of producers. And since managers were personally rewarded based on the reported size of their enterprise — but not by other metrics such as value generation — they were highly motivated to get as big as possible by hoarding workers, land, and material inputs. To use Kornai’s word, enterprises’ demand was “insatiable” even as their production of useful goods and services was limited by the weak incentives embedded in the system.

Chronic shortages were the result. There was not inflation in the conventional sense of rising consumer prices, because those prices were either explicitly or implicitly set by the state. But ordinary people felt the squeeze in a variety of ways.

They had to spend inordinate amounts of time waiting for things they wanted, whether it was a decent apartment, a new appliance, or even just groceries. Even then, many consumer goods and services simply were not available. Workers were severely restricted in their ability to change jobs or ask for higher pay. And the state violently suppressed other forms of labour activism such adversarial unions and strikes.

The rich democracies of the 2020s are a world apart from the Eastern bloc of the 1970s that inspired Kornai’s work. In fact, Kornai probably would have approved of the extraordinary measures taken to preserve household and business incomes over the past 18 months, including wage subsidies, forgivable loans, foreclosure moratoriums, and eviction bans. But it is possible to imagine how we might inadvertently catch the “soft budget constraint syndrome”, as Kornai put it, in the aftermath of the coronavirus.

The danger, for Kornai, is that one-time emergency measures become routine. What would the world look like if consumers and businesses came to believe that governments would respond with similar force every time the economy turned down?

To be sure, we would probably all be better off if there were less self-insurance for bad times and a greater reliance on a robust and reliable public safety net. But it is also easy to see how exploring the possibilities revealed by the pandemic could potentially create a new set of social problems as expectations and behaviours adjusted. Undermining the incentives that make workers and businesses productive would ultimately make everyone worse off.


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