Trade Wars

Janos Kornai’s warning for the post-pandemic world

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

If the pandemic has taught us anything, it’s that slowdowns are essentially optional. Rich world governments have been able to protect household and business balance sheets from the most severe disruptions since World War II simply by printing money.

How to use this new knowledge? Anyone who seriously thinks about the potential risks and rewards of the policy mix that could be described as “full Keynesianism” should consider the ideas of 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 was prohibited. The result was not a paradise for workers or anyone else, but instead what Kornai called a “scarcity economy” of wasteful producers and destitute consumers.

For Kornai, the essential characteristic of “capitalist” economies is that companies face “severe budgetary constraints”. If they don’t get enough money from their operations, they have to raise funds from banks or capital markets. And if they can’t raise money, they go bankrupt.

This constraint forces producers to conform to the wishes of consumers. Businesses can only survive if they are able to provide the goods and services that people want at prices that they can afford. At the same time, companies also need to focus on efficiency and cost control so that they can cover their own expenses. Kornai believed that these imperatives stimulate competition that leads to innovation, productivity gains and sustainable increases in living standards.

Hungary and the other “socialist” economies, by contrast, were characterized by what Kornai called “soft budget constraints”. Businesses never have to worry about breaking even, let alone generating profits. Instead, they knew they had unlimited financial support from the government. They could still “afford” to employ workers, invest in physical capital and accumulate raw materials. It didn’t matter whether any of these activities had real value.

This removed the incentive to innovate to meet customer needs and reduce costs. Consumers have been forced to adapt to the whims of producers. And since managers were personally rewarded based on the declared size of their business – but not through other metrics such as value creation – they were highly motivated to get as big as possible by accumulating workers, land and resources. material inputs. To use Kornai’s word, business demand was “insatiable” even as their production of useful goods and services was constrained by the weak incentives built into the system.

Chronic shortages have resulted. There was no inflation in the classic sense of increasing consumer prices, because these prices were either explicitly or implicitly set by the state. But ordinary people felt the pressure in various ways.

They had to spend an inordinate amount of time waiting for the things they wanted, whether it was a decent apartment, a new appliance, or even just groceries. Even then, many consumer goods and services were simply not available. Workers have been severely limited in their ability to change jobs or demand higher wages. And the state has violently suppressed other forms of union activism, such as 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 would likely have approved of the extraordinary measures taken to preserve household and business incomes over the past 18 months, including wage subsidies, forgivable loans, moratoriums on foreclosures and eviction bans. But it is possible to imagine how we could inadvertently catch the “soft budget constraint syndrome”, as Kornai puts it, in the aftermath of the coronavirus.

The danger for Kornai is that one-off emergency measures will become routine. What would the world be like if consumers and businesses came to believe that governments would react with the same force every time the economy slows down?

Certainly, we would all probably be better off if there was less self-insurance in bad weather and more reliance on a strong and reliable public safety net. But it’s also easy to see how exploring the possibilities revealed by the pandemic could potentially create a new set of social issues as expectations and behaviors adjust. Undermining the incentives that make workers and businesses productive would end up making it worse for everyone.