János Kornai, one of the best-known Hungarian economists of the twentieth century, has passed away on 18th October at the age of 93. His work remains highly influential even today, not only among those interested in studying comparative economic systems and the transition, but also among mainstream economists. In memoriam of his life and work, his main ideas about the socialist economy, shortages and the budget constraint are discussed on the columns of the Hungarian Conservative.
János Kornai’s life did not start easy – he was born into a Hungarian-Jewish family in 1928 and by the time he celebrated his sixteenth birthday, he had lost several of his family members in the Holocaust. Like many at the time, he also believed that the antidote to the horrors of the radical right is Marxist ideology – so as a young man, he became a communist. He encountered the inefficiency of socialist central planning relatively early in his career while working as a journalist at Szabad Nép[1], but his young enthusiasm and devotion to the Marxist ideology prevented him from recognising that the witnessed inefficiency is a structural failure of the regime – and not the consequence of the disinterested laziness of individuals as he believed at the time.
He broke with Marxism only in 1956, after which he was swiftly removed from his position at the newspaper. Ousted from the profession, for about a decade, he was employed well below his professional capabilities. He spent his time actively though – self-educated himself of western economic thought. As he got familiar with Western economic theory, he could better formulate his own ideas about socialist central planning. His first major book, Anti-Equilibrium, was published in 1971. It was written against the general consensus in Western academia saying that centrally planned market economies can similarly be modelled by the equilibrium theory. Although a thorough work, it did not bring him fame, but with the softening of the one-party dictatorship in Hungary, he was readmitted to academia, and it allowed him to publish a book he became famous for – the Economics of Shortage.
The Economics of Shortage was published in 1980, and it is the most complete theory of centrally planned markets[2]ever produced by an academic. Despite the censorship Kornai faced, the book systematically explains the nature and fallacies of planned socialist’s regimes. He was very conscious of the dos and don’ts of publishing – later in his autobiography he detailed the ideas he knew he could not put on paper – most notably the irreformability of socialist’s systems.
The most well-known idea of the Economics of Shortage is the soft budget constraint, which Kornai used to explain the structural failure of planned economies – that is the presence of shortages. The soft budget constraint means that whatever financial risks and steps a firm takes, an agent – in the case of socialist markets, the government – will step up to compensate for any loss made by the firm. It is opposed to the hard budget constraint, which means that the firm is liable for the loss it produces. Soft budget constraint means that the company has easy access to government subsidies and it characterizes planned economies, while free market economies operate on the hard budget constraint, which means that loss-making firms are driven out of market.
Kornai uses the soft budget constraint to elaborate on and explain the presence of shortages in socialist economies
He argues that the knowledge that the firm’s loss is compensated by the government increases the firm’s demand for inputs. There is no risk involved in having excess slack (he uses the word ‘slack’ for its objective connotation, it is not yet a waste, that is an unused slack, but it is not a reserve either, because it may or may not end up being used), there is no economic incentive to wait with the purchase of inputs until their price level decreases – the firm has certain knowledge that no matter how bad economic decisions it takes, its losses will be compensated by the government. The increased demand for goods, or ‘suction’ on the market, as Kornai puts it, creates shortages.
An additional important point that Kornai raises is that shortages are cumulative. As shortages regularly start to occur, economic agents start to prepare for future shortages by piling up even more slack. The excess slack creates more shortages on the market and disables certain producers to make their outputs, which further deepens the shortage. The shortage manifests itself on the consumer good market, as well. Since to a large extent, the same goods are consumed by households and by firms as well, the constant suction of goods by firms creates shortages on the market of household goods too.
Following the publication of the Economics of Shortage, Kornai received an invitation from Harvard University, where he spent the subsequent two decades of his life teaching. Freed from censorship, he could finally openly write about the regimes of East Central Europe. This gave birth to The Socialist System and The Road to a Free Economy among many other of his books. In 2002, he left Harvard University and returned to his homeland, Hungary. He remained active even in the last years of his life.
[1] Roland Gérard, ‘A Review of Janos Kornai”. In: Journal of Economic Literature, March 2008, 146p.
[2] Rolad Gérard, ‘A Review of Janos Kornai’. In: Journal of Economic Literature, March 2008, 147p.
