Dr. Kornai looked at shortages and constraints in his two volume set, Economics of Shortage And he points out that a producing firm has both real-world constraints and man-made constraints. And he uses the analogy and terminology of linear programs. The real-world constraints are technological or chemical or physical. If one is making Sulfuric Acid, one needs a mole of Sulfur and a mole and a half oxygen2 and a mole of water. And other technological and manufacturing processes need specific amounts of energy or other input. This is a hard constraint and no amount of cajoling or lawmaking or begging other humans will change that. But the constraint that a firm must make as much money as outgo can be soft. Loans can be extended in a capitalist country, or it can be simply allowed to write checks without any balance--that is, to effectively print money. And, of course, we know that sovereign nations do the latter. And in general a firm does not produce more than it can sell. Although that too can be waived, at least until it runs out of room to put its output. In a capitalist country, the demand constraint is usually the issue for a firm. In a socialist country, it cannot get enough input goods to produce as much as it could sell to its customers.
Kornai talked movingly of the effect of shortages in Chapter Two. A firm that cannot get enough of a part for a given output, might produce something else, might use a substitute and produce a lower quality good. It might attempt to make the missing part in its own shops with idle workers. It has slack, resources that it woudl normally use, but it cannot because of the shorting of one material. These Mr. Kornai refer to as slack. Companies hoard things they may need so as not to be shortdown when there is shortage. And a chronic shortages of goods, means that one of the slacks is labor. Thus, workers are in the demoralizing situation of coming in day after day and not being useful. In Hungary, Dr. Kornai's home country, most workshops will sell up to whatever resource is the bottle neck. And, "it is rather exceptional for the producer to refrain from expanding production solely because the product is unsaleable." If there are buyers who obviously want the product, are queueing up for it symbolically or for real, it is hard to resist their 'voice.' And buyers can complain to top management or government officials when businesses appear to be hording and not producing up to their limit. And each workshop is itself queueing up for resources it needs so it is empathetic with the above. A business adjusts its technology and manufacturing methods in response to frequent shortages of input X instead of a business buying a new machine in response to the increase of price of something, say labor. A money economy is more impersonal. It "presumably" means managers are under less stress and find it simpler in a money economy. Managers making a decision don't look at the relative frequency of hitting resource constraints. They look at cost calculations and expectations. And I would add they may use the signals from financial products like corn futures to make those decisions. But Dr. Kornai does not cite any evidence that looking at actual resource limitations is not more meaningful than looking at prices. From the Computer Science literature, one can look at the ability to approximate the optimal via a market mechanism both with and without money. And is the "shock" of not being able to get Input A a better or worse method of deciding on buying a new machine than looking at an increasing cost and having the shock of not being able to pay a bank loan or having a bank call a loan that you had for thirty years.
And this concern about soft constraints is true in socialist governments transitioning to Market Reforms, Japanese Keiretsu and Korean Jaebol which bail out divisions that are making losses, now in the context of a soft constraint on a budget or money or bail out or government loan.
And he mentions the phrase "too big to fail" there. Recently, Dr. Kornai provided a list of bail outs from 1980 to 2008, from Indonesia to the United States.
Empirical evidence from countries transitioning to the market economy such as Russian, China and Bulgaria showed that firms with hard budget constraints (HBC's) mean that firms layoff workers ("shed suplus labor") and restructure in bad times. And he cites studies from developing countries and problems of SBC on enterprises.
And the article discusses when a central bank such as the Federal Reserve should lend or bail out banks. The rules say they should loan to solvent but illiquid banks. This theory goes back to 1873. And they show that such policies of bailing out large institutions may even be efficient.
Would participatory democracy harden or soften budget constraints. A juror chosen randomly wouldn't have the prestige or "cover-your-ass" reasons mentioned in the article. They won't have an incentive to hide a bad decision extending credit to a company many years ago. However, the human concern for the people who would be laid off if the firm failed would definitely be there. And the human concern for the economic dislocation for a large firm going out of business. Should we allow these to influence our economic decisions. And in some sense, the share economy belies the need for budget constraints, hard or soft. Firms don't have debts; they simply pay to their workers and their investors a certain percentage of their income. They go out of business when all their workers leave them because they can get better income elsewhere.
The article says that the soft-budget-constraint problem is caused by the government not being able to credibly to say that it will not bail out projects that turn out to be poor. They note that possibly when the project was started, it appeared to make sense. The question is what to do when they see later that it wasn't profitable. They could say with twenty-twenty hind site that they would not fund it again. However, money was already put into pouring a foundation for a building, starting a SynFuels corporation or a Superconducting Supercollider., a Eurotunnel or a huge steel plant. Dr. Kornoi, said that the concerns is the desire of a 'parternalistic' government to avoid socially and politically cost of layoff. Will a representative government be more or less likely to pull the plug than a sortition jury? Would a sortition jury be better able to make decisions that lead to layoffs than politicians that answer to public opinion and of course elections?
What are the reasons to avoid Soft Budget Constraints:
- Investing in poor enterprises crowds out the production of goods for consumption. This is a bad thing if consumers truly don't have the things they "need." On the other hand, it might make sense to invest more in socially useful enterprises, especially if many of these are into particular projects than for consumers to consume frivolous goods. In other words, idle woerkers could insulate buildings, even if the return on their time would be very low, as long as the energy to make the insulation itself is less than the energy that it saves.
- If the government expects to keep many inefficient enterprises afloat, that makes it will be less likely to take a risk on an innovative project. The government would be unable to stop it (That reminds me of employers who won't hire, or won't hire a possible risk, because they know they won't have the stomach to fire a poor employee.)
The authors close with a caution. "The SBC literature may give the impression that hardness is 'good' and softness is 'bad'" "Neverthless, a responsible decision about whether, say an indebted corporation should be rescued can be reached only after consideration of all direct and indirect consequences. And what combination of traditional government, traditional market forces, rules and regulations for government, and sortition can best do this.