In Memory of Janos Kornai: The Contradictions of a Surplus Economy

Janos Kornai passed away on October 18, 2021, at 93. Kornai was an extraordinarily interesting economist and a sharp critic of state socialism in Eastern Europe. He was more than an economist: he was a deep thinker who thought about the method and the political basis of economic systems. He was always hard to categorize with an extraordinary breadth of knowledge. Kornai engaged with Fred Lee and Joan Robinson in the same breath as he would with Greg Mankiw. He spent his final years grappling with the problem of capitalism and what world the fall of the Soviet system brought. I think Kornai's work on capitalism is ultimately at his most brilliant, and maybe most frustrating. In particular, the part of Kornai I want to focus on is his diagnosis of capitalism as the exact opposite of the state socialist system. Where one is a "surplus economy," the other is a "deficit economy." I think this contrast is both correct but also raises a lot of productive problems.  

When you hear the name Janos Kornai and are a bit aware of his work, the phrase "soft budget constraint" immediately comes to mind. The term soft budget constraint is a straightforward concept for analyzing the distributional dynamics of the socialist economic system as it existed in the former USSR and its Eastern European satellites. Kornai's work argued that the prevalent shortage of goods that characterized these economies resulted from the lack of an exit mechanism for firms. Without bankruptcy, the socialist firm would produce for production's sake rather than to satisfy the market. The household, on the other hand, has a "hard budget constraint." It cannot purchase what does not exist and thus works as a subsidy for the soft budget constraint. This is how Kornai describes the essence of state socialism as being a shortage economy.

Kornai's statements might seem self-obvious to many observers, but there are, and were real theoretical and political stakes in the argument. Kornai developed his views in response to economists in the East and West, who were attempting to analyze the problems of socialist economies through neo-classical general equilibrium. In his early career, Kornai was one such economist. He and his colleagues around the Eastern Bloc worked on reforms to improve price setting to create the basis for a "market socialist" economy, where social priorities would come from price-setting rather than directives. Some Western economists also argued that one could apply the tools of supply and demand analysis to show that the reason for goods shortages in the socialist economies was because of a disequilibrium that could be resolved through price changes.

Kornai went another way. In his break with equilibrium analysis, Kornai argued that comparing a system to an ideal supply and demand erased the relevant features of that system. Mobilizing the language of "systems analysis" popular in the socialist world at the time, Kornai argued that we should approach the economy as a set of feedback loops, which essentially were set by institutions. As such, Kornai built an "ideal-type" for a Soviet-style socialist economy as having a logic of shortage built into its core. Thus, the solution was political, and because of that, reform was impossible. You had to scrap state socialism as a whole to get rid of the shortage economy.

Kornai used the same analytical tools he deployed on socialism to study the dynamics of a capitalist economy. Kornai was an instinctual Schumpeterian. He believed that the core of the capitalist economy was the competitive process which made the ideal type of capitalism "a surplus economy." The drive for profit, Kornai concludes, is responsible for overproduction, which in turn drives the need to innovate. The capitalist, in her need to differentiate products and cut costs relative to her competitors, will develop and install new technologies. These dynamics pointed to the fundamental condition of capitalism: a surplus economy. In other words, capitalism's essential nature is that supply will always run ahead of demand. Kornai outlines his political economy of capitalism in an essay titled "The Surplus Economy" in his book Dynamism, Rivalry, and the Surplus Economy: Two Essays on the Nature of Capitalism, from which I will draw upon in the rest of this post unless links specify otherwise.

Thus, despite his hostility to Soviet-style regimes, Kornai's Schumpeterian inclinations made him an opponent of shock therapy. He believed that both rapid price reforms and privatization were counterproductive. Instead, newly marketized economies should pursue creating a private sector that could exist in parallel to the old state sector and, eventually, eclipse it through competition.

Kornai also acknowledges that capitalism has apparent problems. In his essay on the surplus economy, he engages with Joan Robinson's theories of monopoly competition. Kornai also understands that, in practice, capitalist firms will seek monopoly conditions, and to do so, they will keep surplus capacity on hand. Second, he also acknowledges Michal Kalecki's argument that individualist capitalists' interest in lowering costs will often contradict the interest of capitalists as a whole in sustaining wages so that they have customers.  Kornai believes both these concerns lend credence to the characterization of capitalism as a surplus economy. Monopolistic competition, he argues, means that firms will always have spare capacity for more supply. Moreover, he understands that the Kaleckian coordination problem will usually settle to the advantage of the individual capitalist rather than capitalists as a whole. However, this would mean that capitalist profit motives would drive them to increase productivity to make up for falling profits, which, in turn, would eventually raise wages and spur a virtuous cycle.

These assumptions allow Kornai to dismiss the long-run effects of demand on supply. In his model of capitalism, supply increases are autonomous, coming from the competitive nature of the system itself. Therefore, the problems of capitalism that he identifies are only those of overproduction and excess capacity. Kornai came to economics through the reading of Marx and despite his breaks with him, is still a very classical economist. Thus, Kornai is very ready to violate the tenents of free-market economics to correct the problems of overproduction and its associated downturns. In addition to supporting the welfare state and anti-monopoly policy,, Kornai argues for:

"The application of medium and long-term planning. Not the failed socialist system of imperative planning, but updated forms of indicative planning on the lines of those once used in France. After requisite experimentation, this may contribute to better coordination of new capacity and expected demand, and perhaps deter the heads of large corporations from undertaking mammoth investments that only increase the idle capacity in their industries further."

This classical bias cuts two ways. Kornai rejects any idea of either a non-accelerating inflation rate of unemployment or any attempt to achieve full employment. Kornai argues that socialist economies were characterized by a labor shortage due to over-employment of individuals in certain roles and under employment in others. This again, comes back to the soft budget constraint. However, under capitalism there has to be a labor surplus since that is an easier factor to adjust than capital.

This classical bias is where I find Kornai most frustrating. Within his analysis, capitalism is an ideal type, and deviations from it are temporary. This means that a lack of demand cannot have an effect on supply in the long run. Because it is a surplus economy, capitalism will always create new innovation and productive capacity no matter the composition or level of demand. This is, in my opinion, is not true of capitalism in the twenty-first century.  

First, as Micheal Ellman points out in a very good article on Kornai's economics and methods, innovation is not an even process. During the First Industrial Revolution, most general-purpose technologies were introduced in the United Kingdom. In the second industrial revolution, and the third industrial revolution (or however else you want to periodize it), the lion's share of innovation happened in the United States. This doesn't mean that other states were not capitalist economies but rather that capitalist markets, for whatever reason, aren't enough to create innovative growth. In fact, as Marianna Mazzucato argues, the state has played an extremely active role in developing innovation. If I were to cut through the argument a bit more precisely, I would adapt Carlotta Perez's framework and argue that capitalist firms are better at deploying new technology once it is installed i.e. , developed than they are actually developing them. Innovations are difficult and rare but once they reach a critical point, they spread rapidly.

The existence of this critical point implies a difference between technical change and the choice of technique. Robinson argued that technical change is a somewhat random process that creates a menu of choices and the choice of technique is the deployment of those new technologies to actual production. This is where the importance of demand comes in. If firms know that they will need to produce more using less labor they will adopt new productive techniques. However, if there isn't the need to do so, then why change? As well, there is a linkage between demand and the cost of production. If demand is expanding, most of it is coming through the increased nominal purchasing power of wages. This means that as demand increases, so does the cost of production. In a healthy economy with no bottlenecks, Kornai's surplus effect should occur; firms will try to reduce labor costs by introducing new productive techniques. But we don't always live in that world. Demand shortfalls can last a very long time. We saw that in the prolonged recovery from the 2008 financial crisis.

Long term demand deficiencies can destroy capacity as firms struggle to be profitable under more difficult circumstances. Under extended periods of low demand, it makes more sense to cut costs than to incur new ones by increasing productivity. Since low demand also means a loose labor market, it is simply cheaper to hire more people at a lower wage than innovate. Because, as Kornai acknowledges, prices are sticky, this can last for a very long time. In what some might call a "liquidity trap" the surplus economy can break down and instead of managing surplus, capitalist firms fight over a smaller pie. In doing so, they do not innovate, but rather live off rents and cheap labor. This is good for the individual capitalists who like the rents but it is not good for capitalism as a system. The innovative power of capitalism breaks down and so does Kornai's typology.

If we are stuck in such an dynamic for a very long time, this breakdown of capitalism can have an effect on the economy's supply-side and its ability to meet rising demand. You get a cumulative process in which slow recovery in demand leads to an inability to create new supply. We just had a natural experiment in this. Pandemic-related fiscal policy rapidly accelerated the slow recovery from the 2008 financial crisis. However, this recovery in demand could not be instantly met with a recovery in supply because, for over a decade, the main goal of corporate America has been to cut costs rather than incur them. Ironically, Kornai celebrates "just in time" production as a welcome development to ward off the dangers of over-supply. However, in practice, these techniques got us to an economy of undersupply because they were used to cut costs in a low wage, low demand environment. The capitalist economy run by capitalists did not return to surplus by its very nature. It sat in a state of under-capacity for more than a decade!

So to conclude this rambling post, I think there are a few lessons one can take here. Kornai is an incredible thinker whose memory we should treasure. His tying together of politics as part of economics and a core of an economy as a system of relationships is masterful. However, I am a bit concerned about Kornai's myopia toward shortage and abundance as a conclusive way of understanding the political economy of distribution. Capitalist economies can indeed be shortage economies. Not to the same extent as the classical state socialist economies, but surplus does not define them at all times if left to their own devices.

I think a solution to the problem lies in moving away from hard and soft budget constraints, something Kornai himself did in his 1990s writings on state socialism, and moving toward studying the contours of demand and investment. This is closer to the work of Kalecki, who himself understood state socialism as a shortage economy. The difference though is for Kalecki this was just the result of underinvestment in certain goods rather than of hard and soft budgets. Kaleck, never fully formalized a way to get over that problem, either technically or politically. However, his own writing also tells us a lot about the multiple potentials of capitalism to produce either shortage or surplus. The issue that Kalecki forces us to confront is how we democratically manage investment in a way that doesn't lead to overproduction or under-investment. Here we can agree with Kornai that some kind of indicative planning might be needed to correct the fluctuations of investment but that it is not just a problem of overcapacity.

Yet, even with these problems, Kornai is useful. If we take his idea of "surplus economy" and "shortage economy" seriously the goal of macroeconomic policy is to sustain the path that sustains surplus. Capitalist planning exists but its goal is not to distribute scarce resources but to utilize surplus in a manner that is not destabilizing and thus reproduces itself, even at the level of full employment. In a vaccume, a capitalist economic planning is about managing surplus resources rather than scarce resources, even if the capitalist market is not willing to produce surplus at all times.