Soft Budget Constraints Essay

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Marxism-Leninism is dead in Europe. However, this huge and important work explains in great detail why it is dead, and why it died when and how it did. Putting this 700 page books thesis in one sentence: Marxism died because of soft budget constraints which, themselves, derive from the mono-party system in charge of the economy. This is the basic argument and thesis of this present work.

This review will contain three parts: first, an elementary description of some of the basic ideological concepts of Marxism as Kornai understands them, second, the more technical economic issues brought up in the book that place these ideological concepts into a more functional economic explanation, and lastly, a conclusion that seeks to tie the two approaches together. Hence, this review will go from the most general to the more detailed, ending with some kind of a synthesis between the two.

I. Soviet-style Marxism, Some Basics Before any real understanding of socialism and its failures can be reached, the basic rhetorical and intellectual apparatus of the system needs to be fully explained. Since it is really his explanation for the failures of the system, the first issue Kornai brings up is that of democratic centralism. This is another way of understanding the nature of party control and dominance over every element in socialist society.

Democratic centralism means that the party has its lower lever heads elected by the body of the party membership, but that the lower elements of the party are responsible to the higher in a simple but strict hierarchy of command (34). Hence, there is one real decision making body, that is, the higher parts of the party structure (in Moscow in the USSR, for example) that made the plans for the rest of the system throughout the USSR. But the real functioning of this system is based on the bureaucratic centralism and hierarchy that runs the entire country, society and personal life of its members (36).

All is political, hence all is bureaucratic. Since Marx held that all is labor, all comes from labor, and labor is the basis of politics, then all that a man does is political and as a result, amenable to centralized and bureaucratic control. This basic logical design means that the party is placed over all, and tightly centralized around an ideological and bureaucratic center at the capital. What this actually means in practice is that the state becomes an appendage of the party.

The state, in the classical soviet system is the vehicle for the execution of the partys desires (37). In other words, the legislative power is the party in itself, and the executive is the state and all its coercive agencies of authority. The party, in other words, is the ideological center of all social life, while the state is its bureaucratic executive branch. This means for most socialist states that there is a great degree of duplication between the state and the party, since both serve the same ends, at least ideally (38).

Therefore, it seems as if the party serves as the ideological watchdog of the state, making certain that the state and the bureaucracy does not develop interests of its own, a task that the socialist parties have singularly failed in carrying out, in fact, this state interest in an indirect way is one of this authors important causes for the failure of the system, a concept that will be dealt with in more detail later. But this says very little about the relationship among the state, the party and the people.

This has become the Achilles heel of the socialist system and itself, is a major symptom (but not a cause) of the failure of the regime. There is a necessary gap between the workings of the party and its highly centralized bureaucracy on the one hand, and the population on the other. This gap has traditionally been closed by two things: propaganda and terror, and all Marxist states have relied on these two pillars to one degree or another with no exceptions (45). The party seeks to impose itself upon the population through its propaganda and the use of terror tactics when appropriate to eliminate opposition.

But since the system holds that it serves the interest of labor and those who work for a living, the Marxist state is necessarily totalitarian in its organization (46). Since the state and its party engine has taken upon itself the responsibility for eliminating capitalist relations within a society, it then has the self-appointed right to remake all social elements of society, from the family to the locality to the government itself, right down to the factory floor. Hence, the state is totalitarian in that it seeks the regulation of all elements of social life.

Kornai makes it clear that one very important part of this totalitarian society is that the bureaucracy, whether party based or state based, is not itself responsible to any real legal authority or set of rules. Part of the totalitarian mindset here is its ideological basis, where all functions of the state apparatus can be justified on the basis of some ideological need (47). The party rejects such things as the rule of law by dismissing it as bourgeois legalism and holding that the party is the working class and hence, can do what it will in promoting its own interest against reactionary or counterrevolutionary elements in society.

Hence, the party has nothing holding it back from dominating the whole of society as it pleases. But it should be clear by now that the party is justified as the representative of the working class in the ideological construction of Marx and Lenin. There is one way of viewing society, and that is through the lens of Marxist dialectical materialism, the concept that all social change, that is, all history, derives from the constant development of new technologies and the privileged classes that have access to them.

This is history in the Marxist view, and there is no other permitted. The Leninist state justifies itself by holding that is not just the representative of the working class, but of history itself, and that the socialist state is the very manifestation of history and the final working out of its apocalyptic ends. The socialist state is messianic at its very root, seeking nothing less than the liberation of all mankind from the shackles of capitalism and ignorance (50). The promises made to the population under Marxism are mufti-fold and are work discussing in detail.

Marx believed himself to be the end of the Enlightenment, bringing to fruition all the promises of the scientific and technological revolution by placing all the fruits of science at the behest of the working class as a unit. All the scientific revolution was was the use of human mental power, through labor, to make nature subservient to man. Hence, man was no longer the slave to nature, but a god, a god that was no longer dependent on nature, but can harness it for his own ends.

Only when this god like status was given to all people (not just a well connected elite) can history be said to have ended, and the truly human life to be fully manifest. Marx called himself a scientist in good Enlightenment fashion, in that he was no utopian dreamer: he sees in history the movement of classes to the point where in the 19th century, there were only two: the proletariat and the bourgeoisie, the owners of capital, those products of Enlightenment genius, and selling them at a profit.

The defeat of the property owners and the socializing of property meant the end of classes, the end of history and hence, the end of conflict, since all wars are the result of economic competition among classes. Nothing less did Marx promise the world, but only so far as the revolutionary vanguard took power as the dictatorship of the proletariat. More prosaically, the communist parties promised an agricultural, semi-feudal society, whether Chinese or Russian or Cuban, a quick rise to economic power, mechanization, literacy and even great power status.

One need not be a Marxist to hold these ideas, but there is a pedestrian side to the communist mind that Kornai stresses, a side that holds bread and butter issues more important than the utopian theorizing of the younger Marx (53). The basic idea of the communist promise to the underdeveloped world is technology, electrification and the fruits of the Enlightenment. This movement from the agricultural and rural to the urban and technical was considered universal in human history, and the party was placed as a highly literate and educated vanguard to bring about the enlightenment of the masses.

In terms of these more prosaic issues, the basic strategy of the communist party relative to the underdeveloped society was the domination of several key industries, industries that were at the basis of all other labor. For Russia under Stalin, this was the heavy industries, that is, oil, steel, mining, energy, agriculture and transport. These things were the foundation of any enlightened society and economy, and hence, they were the key both to development and domination (71).

Put differently, this means that if the state was to direct its investment to these foundational industries, then it is clear that it can be more tolerant of private ownership elsewhere. This private ownership would be at the behest of the state regardless, since the state owns the basic inputs of the economy regardless. As a result, heavy industry, an obsession of Stalin, became a method of control for the rest of the economy and society. The state industries serve as the basic income for the state itself.

There is no such thing as taxes paid to the state, the factory and its products were, in some respect, the state itself. The state functioned by setting production targets from the bureaucracy to the factory, and these targets were basically a primitive kind of budget. It is the state that decides what is to be made, and what it is going to pay for the product (73). The coordination of production takes the form of the plan, dominated completely by the state and though information sharing among various agencies of the government, under the eye of the party itself (98).

To conclude this first section, Marxism in the Soviet model is a messianic mentality that sees political ideology as the end of history. History is made up of classes, classes come into existence as the educated come to dominate the means of production, and hence, control the profit of this production. But as history develops, the number of classes become fewer and fewer leading to the possibility of the elimination of economic, and hence political, conflict and warfare.

If the fruits of the enlightenment were spread to all working peoples, whose product these fruits are in the first place, then all real cause for conflict would cease. But the only way the old mentality can be destroyed is through the terror and democratic centralism, a euphemism for the rule of the party in all things. The party justifies itself through this philosophy of history and the end of the enlightenment project as developing a true social science that mirrors the natural science of the present age.

This social science will lead to a situation where mankind will live to serve the community, to become a multi-dimensional being, taking advantage of all technological developments in order to escape the capitalist division of labor that has so distorted the way people think and that has justified competition and violence in the past. By eliminating class divisions, the revolution will eliminate all reason for warfare and social strife, and permit a truly human way of life through equality and the shared access to technology. II. Some Issues in the Failure of the Plan

For Kornai, the bureaucratic-terror control network that lies at the heart of all socialist systems is viable, and it is viable because it is coherent. This is a point to keep in mind, since it will arise again later in reference to reform socialism, or market socialism a misnomer at best. Nevertheless, due to the coherence of the system, with terror as the mortar of the edifice, it was able to withstand the test of time, at least in the medium term. In other words, the author here holds that the system was coherent only insofar as terror and the authoritarian state was in place to enforce its dictates.

This and this alone was the basis of communisms staying power. However, the reliance on power and force might work for the medium term (several generations) but not for the long term. It should be kept in mind that this book was written before Marxism fell in Europe and hence, should be taken as a highly accurate prediction of Marxisms coming fall and the reasons for it. While it was published in 1992, the body of the work was written in earlier essays and books from the author, only coherently brought together in this book at a later time.

This, if nothing else, shows this to be one of the most prophetic books of the 20th century and one of the few to accurately predict the fall of Communism. But the nature of the failure is rather simple: the endless shortages that this system inherently produces eventually creates splits between the population and the ruling classes. It does not take long before the creation of shortages in the most basic goods leads to substantial cleavages between the state and the population.

The communist state is a state like any other, and stymies its own productive capacity in the name of socialist ideology. This section will be dedicated to explaining exactly what that means. One of the main problems in the state controlled system is the problem of information (127). This is central in the respect that since managers of state run enterprises only have the state to answer to, it has been very rare to get an accurate accounting of the productive capacities of these same enterprises.

If the management of an enterprise seeks to lessen the amount of work that the state will impose upon it, there is every incentive to lower the pubic accounting of the enterprises capacity, This was done regularly in the USSR throughout its short history (128). In other words, the connection economically between the enterprise and the state was political perception, not profit or market share. Hence, a skillful manager needed only to downplay what the factory can create, and hence receive lower targets.

Even more common, the enterprise might inflate its production abilities as the general plan comes to fruition, hence fooling the party in its evaluation of a specific sector. Since there was no market to regulate production, rent seeking more than anything else became the way of doing business. In some states, notably Yugoslavia and the authors native Hungary, there was an attempt to regulate production by introducing market reforms relative to state owned industry.

This became a comic farce according to the author in that the state run enterprises, controlled by the state and its political functionaries, did not actually work in the market, but still remained attached to the state and its favors. Hence, market reform throughout the Soviet bloc did nothing but exemplify the problems of the system itself, that only in the command structure did the totalitarian system make sense, and hence, showed its incoherence when market reforms were introduced.

Hence, the system only worked if the state and its terror apparatus created the forced growth model that this author was the first to identify the system exists in and through the state and its agencies of coercion (360-365). Putting it simply at this stage, the problems of shortages and the institutionalized rent seeking that so dominated economic behavior in socialist states, led to the crisis of confidence that could only be dealt with through terror. For this author, terror was more than the arbitrary application of violence upon a bewildered population, but was an institution and an economic force in its own right.

This is a specific contribution of this book that should not be under-emphasized. Terror was a form of economic growth in that it took the place of market incentives, and Kornai makes it clear that terror was not arbitrary, but used to mobilize resources for the sake of heavy industry. It was an economic institution rather than a mere means to hold on to power. This is central and serves as an important subtext of the entire book. Since the terror state was a coherent part of a larger whole, market reforms make little sense.

The command economy, as the author repeatedly explains, is a coherent system of rule, mobilization and economic production. This should be stressed again, in that bureaucratic centralism and the prison camp system were economic institutions that created the regime of forced growth that led to the mobilization of millions of people in labor gangs on massive projects such as dams and canals (407-409). Terror was economic and used as an economic incentive for investment and labor control.

Since all economics was now political (apart of the basic axiomatic regime of Marxism in general) political terror was the economic equivalent of bankruptcy. One could be liquidated in the GULAG, or one can be sent to the unemployment line either way, the ends of economic discipline were served. Hence, growth preceded apace in every socialist country under these conditions, often fooling gullible academics in the west into believing that socialist economics actually worked and brought peoples to new lives and enlightened uses of technology.

Nevertheless, the real conclusion Kornai takes from this is that there are only two coherent understandings of economics in the world: the command economy, ideologically based and backed by a large terror and prison apparatus, and the libertarian free market, where the market served its own brand of terror in eliminating all those that the market deemed unfit for further economic procreation. The mixed economies, according to Kornai were weird hybrids doomed to eventual failure, since they attempt to bridge this unbridgeable gap between terror economics and market economics.

Mixed economies will lean to one direction or another, either to the growth of the state as a coercive economic agent, or towards the market that is equally coercive, just as terrifying, but leads to the murder of far fewer political dissidents. Like Hayek, the author here holds the west a stark choice. But since this author was involved in the mixed economy in Hungary just prior to Khrushchev 1956 invasion, he is an authority on these things that cannot be ignored.

Ultimately, Kornai rejects the concept of market socialism or the mixed economy (which for him are essentially one and the same) because he was one of the most important authors of the concept in the 1950s Soviet bloc. He rejects it because what he and his allies created before the invasion made no sense, it was a state run economy that sought to regulate production according to market norms. But since the market did not operate in the state sector by definition, it just provided managers with rent seeking strategies that were more stealthfully hidden from the general population.

The central issue here is the concept of soft budget constraints which for Kornai encapsulates the whole of the Marxist failure, and is really the central concept of the book. Hence, it should be dealt with as a logical argument in some detail (cf. 140-145). The basic premise is that accounting standards in socialist enterprises are inherently biased because the main concern is the political standing of the enterprise and the management team, not the inherent viability of the work involved.

The only real incentive is to the party organization at the local and central level and the plan that has been laid on the enterprise. Since the market does not operate, accounting procedures follow political considerations mainly. But the substantial definition of soft budget constraints that form the core of this work is that enterprises that are politically secure do not operate efficiently due to the fact that the state will always be there to bail out the enterprise.

Hence, there is no real strict accounting constraints so common in capitalist countries where shareholders demand the percentage of profit due to them. In socialist states, this strictness does not exist since politics rather than economic efficiency is the most important attribute of a successful firm (140-145). In more technical economic terms, the main component of the soft constraint is the typical outcome of a politicized economic system, that of rent seeking. Rent seeking is common wherever political considerations rather than profit/efficiency dominate the economic thinking of a system (218-220).

Managers and even floor supervisors are far more concerned with making the right party contacts at the local level that will ensure a smooth running of the firm, making sure all the firms mistakes can be blotted out with further subsidies and favors. At the same time, the party boss himself receives a share of the subsidy as a bribe of sorts, leading to a short term rent seeking haven, but a long term built in failure of economic rationality. In more macro-level terms, this means that the economic statistics of the USSR and similar socialist states was always distorted.

If the main incentive is to avoid the GULAG, then the primary concern is to fudge the budget numbers when answering to party officials so as to appear to be functioning property and efficiently. In capitalist countries, this could never be done at any large scale due to the very nature of market discipline. Without profits, bills cannot be paid. But in socialist states, what matters is the paper trail, the meeting of the local demands, often imposed arbitrarily and without any economic consideration whatever, of the nationally based plan (262-270).

Therefore at any given time in the life of a socialist economy, there is really no accurate accounting mechanism that can produce accurate economic statistics. The political domination of the economy means that political considerations dominate and hence, there are huge and often life-threatening incentives to make certain that the numbers come out right in the end. In addition, this rent seeking politicization of the economic process also leads to a socialist form of the boom and bust cycle, that which Kornai identifies as systematic over-investment.

Since industries in socialist states themselves are political symbols, the investment rationale is also symbolic. Thus, for Stalin, things like oil and steel were symbolic of his rule, the economic might of the USSR and its threat to western capitalists. Hence, the Stalinist system over invested in these symbolic and politically powerful industries, considered foundational in socialist thinking, are given the lions share of the central budgets investment funds. But this also means that factories and industrial regions in the former USSR were given far more investment funds than local supplies or manpower could bear.

But once this became apparent to socialist planners, there were cutbacks, which in turn led to further demands for the investment funds since, in the meantime, the industry or region had been adjusting, hiring more people, etc, in order to absorb the funds and its share of the economic plan (229-235). In other words, the communication and machinery of economic decision making never quite kept up with the adjustments being made by local industries, and this time lag is one of the main reasons for shortages and this irrational cycle of over and then, underinvestment (163-165).

The obvious result was a huge amount of waste, graft, rent seeking (since many bureaucrats benefited from this symbolic over-investment) thus was built into the system, really any system that depended on a plan to function. Therefore, the basic issues behind the soft budget constraint thesis at the center of this book is that all managers knew they were to be bailed out in the event they were no longer economically viable.

But since this often depended on making the right contacts or fudging the numbers skillfully, this in turn led to further waste and graft. Even at the shop floor level, workers could not be fired (except for political reasons) and hence, there was no discipline at the labor level either. Since workers would be paid regardless of the nature of their work, and they could not be removed, the work done was often shoddy and attitudes were often cynical.

Absenteeism was a common problem in socialist economies for this reason (204-206). Given the above, the macro-economic thesis of this work is then the following: in all socialist states, the above problems led most obviously to a chronic shortage in intermediate goods. Since the massive investments in heavy industry ensured a steady supply of those foundational goods, intermediate goods, that is, goods that were not of heavy industrial application or actual consumer goods, were always in short supply.

This might refer to fertilizer, tractors and certain kinds of tools that were in short supply. It is this macro-economic problem that ultimately led to several distortions in the system: first, the regular use of terror as a way to compensate for this; second, a constantly building level of cynicism and distrust for the system in general, and lastly, the inability to make the shift to consumer goods so long promised by the Khrushchev regime (229-231).

Put in a slightly different way, the misappropriation of investment funds and the endless rent seeking led to a situation where foundational goods were always in excellent supply, but there was not enough left over for intermediate goods, the goods necessary for a shift to a consumer economy. Therefore Khrushchevs attempt to imitate the west by introducing a consumer goods sector to eliminate public cynicism and distrust was a failure for very identifiable political reasons. This kind of shortage was built into the system.

Adding to this central thesis, the domination of the party over economic life led to the following results that westerners might call distortions, but in the logic of economic, day to day, prosaic communism, were props to the system: first, the complete politicization of economics. Industries were ranked according to their value to the state, and often, this value was dictated by the endless talk about catching up with the west. Hence, if Stalin wanted to catch up with western Europe in coal and steel, he needed to invest far more per unit created than westerners needed to invest. This was a central problem.

But even more, the domination of the party also meant that propaganda and terror was an inherent feature of the system itself, since this was the only source of actual economic discipline. Third, the dominance of the party meant that political contacts were more important than actual economic performance, and hence, rent seeking became the most important activity of shrewd managers. Therefore, the conclusion of the work itself is that the party control of the economy and its non-economic priorities eventually led to the shortage of intermediate goods that then forbade the USSR and allied states to even produce consumer goods.

Heavy industry predominated over all. But this predominance of heavy industry developed from several things. It dominated because of the political priorities of the party and hence, these sectors were regularly over-invested. But from this derives rent seeking and hence, a cadre of well connected party members who then always had the ear of the planning committees in the capital. Hence, economic personnel formed clans, so to speak, self-interested, well connected elites that had a personal and professional stake in the regular over-investment in these heavy industries.

Therefore, even a well intentioned reformer could not reform the system even if the structural discipline was to be present. But this consideration, the development of economic clans, or cells of self interested elites that dominate planning and hence, institutionalize over-investment and subsidies, leads to the question of making socialism work. This question is a substantial part of this book in that the structural problems mentioned above make it impossible for socialism to work under any circumstances.

Kornai spends some time dealing with the market reforms of Titos Yugoslavia, seeing if self-management of enterprises, the lack of a central plan and even central oversight might not alleviate some of these problems (cf 460-470 and 511-513). What Kornai holds is that the empirical analysis of Titos self managed socialism shows equal failures to the straightforward command system. The problems are that the free market and self managed socialism of Yugoslavia leads to these economic clans competing in a perverse form of the market.

The market works, but it is not for goods and services in open competition, but party leaders (and in Yugoslavias case, ethnic leaders) vying for favors from the state and local party committees. As mentioned above, since Kornai was an architect of this sort of reform in Hungary, he is in an excellent position to see these same failures elsewhere. But there is one problem: it seems that the move to a market in places like Yugoslavia failed because of a mentality rather than a structural component of the system itself. Is it possible that socialism beginning from this mentality can succeed?

Kornai does not answer directly, but from other areas of the book, the answer is no. His reason for this is that the only form of discipline that can properly eliminate inefficient firms and incompetent leadership is the threat of bankruptcy. If this kind of discipline was introduced in a socialist economy, the economy would no longer be socialist and the states role would be reduced to enforcing contracts in good Anglo-liberal tradition. In other words, even a self managed set of enterprises in legitimate competition without state intervention would still lead to the development of economic oligarchies in the self managed system.

But since this book is purely empirical, there can really be no testing of that theory, since such an approach has not been tried. Every time a reform socialist movement has come to power, the elites that it has to work with are the same ones who benefited in the command economy. Hence, the idea of starting out with some form of economic self management is not yet available for empirical testing, but it is clear that Kornai is not in favor of such an experiment. III. Conclusion Concluding such a review as this is difficult. Much ground is covered skillfully and dispassionately in this work, bringing it all together is a problem.

However, if the reader keeps the role of the party centrally in mind, the conclusion and synthesis of the above ideas is possible and necessary to bring all these ideas together. When Marxists speak about public policy, they often speak in idealistic terms. Talk about equality and multi-dimensionality is very common, slogans meant to evoke poetic images and revolution ardor. However, the nature of this present work is to eliminate such rhetoric and go to the heart of the matter: the actual, day to day, micro-level analysis of empirical socialism: socialist as it actually works.

Hence, first of all, the work is often painful to read due to the large amount of bureaucratic detail necessary to make sense out of the structural problems of socialism. But this is an unavoidable byproduct of the empirical nature of this work. But for the sake of brevity, the building blocks of empirical socialism can be reduced to 5, and our conclusion will be based on these five pillars of socialism (cf. 360-370). The party. This is the central issue of the work. The state, as mentioned above, is the arm of the party, while the latter is the true legislative master of the state and the economy.

The party can be described as elitist, ideological, centralized, arrogant and occasionally, violent. It holds that it and it alone manifests the end of history, the process of man becoming god over his dominance of nature. Hence, the party can do no wrong, since, by definition, it is the voice of history, the working class and the final expression of the European enlightenment. The state. The state is to the party what the executive is to the legislative. It is the coercive arm of the party, and in theory, its temporary manifestation. Theoretically, the state in Marxism, that is,

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