Soft budget constraint (SBC) is irreconcilable with standard microeconomics since rational agents would never violate their budget constraints as either a book-keeping identity or a rational planning postulate (Say’s Principle). Con-trary to standard microeconomics, new microeconomics is based on the strategic behavior of agents interacting with other agents. The SBC can be integrated in new microeconomics as a more general dynamic commitment problem in which an agent can fail to take an efficient action, or can undertake an inefficient ac-tion because he knows that he will receive addiac-tional financing. Dewatripont – Maskin (1995) pioneered this endogenous explanation of SBC. They argued that the SBC syndrome occurs whenever a funding source (e.g., a bank or govern-ment) finds it impossible to keep an enterprise to a fiscal budget (i.e., whenever the enterprise can extract a bigger subsidy ex post or loan more than would have been considered efficient ex ante). In this sense, the SBC problem is not specific to socialist economies because the extent to which loss-making firms or projects are terminated or refinanced is also very relevant in capitalist (both developed or undeveloped) economies. In short, the time inconsistency of the Centre lies at the heart of the SBC syndrome: if the Centre were able to credibly commit not to subsidize a firm ex post, the firm would make more efficient ex ante decisions.
Hardening of the budget constraint then means creating conditions for a credible commitment not to refinance an agent.
Since the pioneering work of Dewatripont – Maskin (1995), an abundant body of formal literature has explained the SBC endogenously through adverse se-lection, moral hazard, and rent-seeking (for detailed surveys, see Maskin 1996;
Kornai et al. 2003; Vahabi 2001, 2005, 2014). The SBC is thus integrated into the new microeconomics as a special case of time inconsistency. Nonetheless, these endogenous versions of the SBC and Kornai’s exogenous version of the SBC as the ex post bailouts of loser firms by a paternalistic state still differ fundamen-tally. To clarify the difference, we can simply ask what would happen if, ex ante, the creditor knows with certainty that the firm will be a loss-maker.
In all endogenous models of the SBC, “if a creditor learns ex ante that the firm is definitely a ‘bad’ firm, it will refuse to finance it since to do so would be throwing money away. This is in sharp contrast to a model of ex post bailouts due to paternalism because in such a model the likelihood of obtaining financing is unaffected by ex ante revelation to the creditors that the firm is expected to be loss-making. If the firm is loss-making ex post, it is subsidized as a result of its situation and, consequently, the firm has a soft budget constraint” (Schaffer 1998:
84). In other words, Kornai and Maskin are not talking about the same thing.
While Maskin’s endogenous SBC fits within profit-maximizing behavior and is consistent with the new microeconomics, Kornai’s theory of the SBC is incon-sistent with profit-maximizing behavior. “In describing the behavior of the firm, we want to have a more general framework than the usual profit-maximizing pat-tern ... In addition, we apply – following Simon (1959) – the satisfying model of decision-making. This approach seems to be more general and realistic, and in the present model profit maximizing appears as a special case of the more general pattern” (Kornai – Weibull 1983b: 166).
For Maskin, soft budget constraint is the outcome of a choice related to strate-gic behavior of a maximizing agent in the absence of credible commitments. By contrast, for Kornai, soft budget constraint is an empirical fact generated by in-stitutional constraints. The theoretical synthesis between formal and inin-stitutional explanations of the soft budget constraint as suggested by Kornai et al. (2003) is theoretically incoherent since the concept of soft budget constraint is not the same in exogenous and endogenous explanations (Vahabi 2014). A half-in, half-out of mainstream synthesis is rather a source of confusion obfuscating the heterodox message of Kornai’s original concept of SBC.
6. CONCLUSION
Undoubtedly, Kornai is one of the eminent economists of the 21th century who demystified the socialist economy as a shortage economy. Bridging the Eastern and Western economists with regard to GET is only one of his contributions.
More importantly, he is one of the pioneers of system paradigm, and the inceptor of the concept of soft budget constraint that has been a major source of theoreti-cal inspiration and policy-making implications for many international organiza-tions (such as the IMF and the World Bank) during the post-socialist transition.
His ideas on investment hunger, the soft budget constraint, and state paternalism influenced the Chinese economic reform since the Bashan Conference in 1985 (Gewirtz 2017). It is not by chance that he could publish in all leading economic journals, orthodox or heterodox. It is surprising that the Nobel Prize has never been granted to a scholar whose name is closely associated with the intellectual preparation of the most important economic transition of the post-cold war pe-riod, namely the post-socialist transition.
Reviewing the chapter on Anti-Equilibrium in his auto-biography reveals some of the reasons behind this enigma: “I certainly caused several difficulties in my later career by writing and publishing Anti-Equilibrium. It was seen as unforgivable by some diehard, blinkered members of the neoclassical school”
(Kornai 2006: 195). In Kornai’s self-critical appraisal, his misleading critique of
GET was only one part of the story, but mainstream economics should also bear another part of the responsibility because it treated Kornai’s errors as unforgiv-able blasphemy: “In this chapter – as in other parts of the book – I have striven for honest introspection. I have tried to find out how much responsibility I bore for Anti-Equilibrium’s not achieving the effect I had expected it would. Among other things, this honesty gives me the moral basis to ask, ‘Can the lack of suc-cess be attributed only to me?’ It is not ill-feeling that makes me seek an answer to this question. I am speaking for many researchers when I broach the issues of the profession’s refusal to accept heavy criticism and of its shortness of memory;
that memory ought to honor the first appearance of important – primitive, clumsy, but nevertheless pioneering – new ideas” (ibid.: 197). The dogmatic and sectarian spirit of mainstream economics is a whole chapter that warrants a thorough study of the sociological and theoretical evolution of economists as a caste (Schumpeter 1954) and of the economic profession as institutionalized knowledge. In this con-cluding part, I would like to return to the cause of Kornai’s so-called failure.
Kornai’s intellectual honesty is exemplary; he always reexamines his earlier posi-tions and if he finds them wrong, he explicitly acknowledges them. It needs a lot of theoretical courage and personal integrity to admit that Hahn (1973) was right in his critique of Anti-Equilibrium. No-one could describe better than Kornai himself his relationship with mainstream economics: “On some questions I go with the stream, and in other cases I try to swim up the stream. This in, half-out situation sometimes causes conflicts” (Kornai 2006: 195). Is there any rela-tionship between Kornai’s half-in, half-out situation and his so-called failure?
It is true that although Kornai’s Anti-Equilibrium was very close to post-Key-nesian economics, he did not treat “equilibrium economics as irrelevant” (Kaldor 1972). He tried to bring together economic systems theory with equilibrium eco-nomics, and the outcome of this half-in, half-out position was nothing but a “fail-ure”. Kornai started with disequilibrium, then accepted Marshallian equilibrium, and finally ended up with Walrasian general equilibrium. In fact, this long jour-ney was related to his initial choice of taking equilibrium economics as relevant, although he never showed the relationship between GET and economic systems theory. Did Kornai need to entertain such a half-in position with GET to develop his theory of soft budget constraints? The same question can be raised again when he lends credence to a synthesis of formal and institutional theories of the SBC.
Kornai’s work is colossal and whatever his tactical choice in introducing his ideas, both orthodoxy and heterodoxy would need him to enrich the way they understand the economic world.
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