1. J. Kornai - The Soft Budget Constraint Presented by Aleksandra Ilijevska and Igor Bereznanin

2. Janois Kornai  Hungarian economist, noted for his analysis and criticism of the economies of Eastern European Communist states.  Primary fields of interest: Comparative economics of socialism and capitalism, post-socialist transition, the recent political and economic changes in Hungary.  Research Topics: The reform of the welfare state, the reform of the health sector, institutional transformation, macroeconomic adjustment and stabilization programs in transition economics

3. The Soft Budget Constraint phenomena  It is associated with the Paternalistic Role of the State towards economic organization (e.g. State-owned and private firms). It reflects in a financial form a deeper socio-economic phenomenon: State  protective father / insurance company; Firm  child / insured party  Firm with Soft Budget Constraint has: Horizontal dimension  costumers and suppliers Vertical dimension  State

4. Budget constraint concept  Refers to to the behaviour of the decision-maker  adjust his expenditures to his financial resources, covering his expenses from the income generated by selling his output  Primarly is a constraint on demand  based on expectations on his futre financial situation when the actual expenditure will occur «The softening of the budget constraint appears when the strict relationship between expenditure and earnings has been relaxed, because excess expenditure over earnings will be paid by some other institution, tipicaally the State»  On the contrary, a hard budget constraint refears to a spending limit that cannot be exceeded without drastic consequences for the firm.

5. . P1. P2 A and B: commodities P1: actual expenditure P2: next period actual expenditure original budget constraint expendable budget constraint A B

6. Soften Budget Constraint of a Firm through 4 ways:  Soft subsidies  by national or local governments. Subsidies are soft if they are negotiable, subject to bargaining, lobbying,…  Soft taxation  taxation is soft if the rules are negotiable, subject to bargaining, political pressure. Fulfillment of tax obligation can have exemptions, postponements, leaks.  Soft credit  credit system is soft if the fulfillment of a credit contract is not imposed. It is used to assist firms in chronic financial trouble, without real hope of repayment of the debt.  Soft administrative prices  applied when price is set by bureaucratic institution. It is soft if it adjusts the price to costs

7. Consequences of the SBC Impact on price responsiveness  demand is vertical and not determined by the price;  decrease of the elasticity of demand of all alternative inputs;  SBC diminishes the firm’s sensitivity tward the interest rate, exchange rate, rigidity of prices, wages,... THE GENERAL PRICE RESPONSIVENESS OF THE FIRM DECLINES

8. Consequences of the SBC efficiency  Cannot be ahieved when input-output combinations do not adjust to price signals;  Attention of the firm is in the offices of the bureaucracy, where they are assisted in case of financial troubles, rather than in the market  performance and efforts are weaker;  Dynamic adjustment  no need for a firm to behave in an entreprenual manner. The firm seeks for external assistance and the State is like an insurance company;  SCHUMPETER, constructive destruction  SBC firm against it, rejecting innovation and development

9. Consequences of the SBC creation of excess demand  The firm’s demand for inputs is unconstrained  no compulsory limit on demand for inputs and on investments;  If the firm with SBC and a tendency to run-away demand for imputs is large enough to have a strong effect on total demand, than the system becomes a shortage economy  Total Revenues < Total Costs  even in this case the firm can survive, having an external assistance.

10. Experience in socialist economies  Yugoslavia  System of social ownership (BOAL – economic unit)  Ways to solve financial problems – subsidies and credits from the banks owned by BOALs.  Interesting way of solving liquidity problems – interfirm credits (promissory notes)  “Obligations are undertaken without the intention to keep them; sanctions for violations are lax or non-existent, which allows the unchecked growth of transactions without payment”. / A. Bajt

11. Experience in socialist economies  Hungary  Far reaching reshuffling of profits among all individual firms (276 kinds of taxes and subsidies)  Profitability cannot have any reasonable meaning due to the vast use of redistribution  The lower is original profitability, the higher is the chance to get large subsidy and pay smaller tax  egalitarian redistribution – every second HP firm is downgraded to LP, and 9 out of 10 LM firms are upgraded

12. Experience in socialist economies  China  Introduction of profit-retention scheme which evolved into profit- contract system  Bargaining over profit replaced bargaining over plan  Latest stage is tax-for-profit system with the introduction of adjustment taxes  Enterprises are responsible for profits, but not for losses

13. Experience in mixed economies  Non-private firms owned by central or local governments  Nationalization due to the ailing status of private firm  Policy to keep the price of certain goods or services artificially low  Public investment projects  Overly optimistic cost estimates are made, cost overrun is covered from public sources  Financial assistance to private businesses in trouble  Becomes soft budget constraint when the decision-maker expects external assistance with high probability

14. Experience in mixed economies  Privately owned commercial banks  In many countries subject to special governmental control (safety of deposits). They are less worried to make risky loans.  Non-profit institutions  Idea to be self-sufficient, but often run into financial troubles (health- care, universities).  Local governments  External assistance depends on bargaining, high chances to receive it.  Same for the ministries

15. Forces that create soft-budget constraints  Protection of jobs  Protection of domestic production against foreign competition  Redistributive objectives (fairness, social justice, solidarity)  Demand for security and stability  Objectives that have no market value – decided by political process  Ultimately – demand for the state to become protector, responsible for welfare, self reinforcing tendency of bureaucratization.