Yves here. I am sure readers will find it rich that “too big to fail” and other forms of socialism for the rich have regularly been depicted as horrors of “macroeconomic populism” because large enterprises weren’t allowed to go bankrupt. Zombification was widespread in Japan when its real estate bubble imploded, and the US was well down that path even before the Covid-19 bailouts. The Financial Times’ editorial board saw fit to warn about the rise of zombie companies in June:
Money has never been cheaper. Governments and central banks have acted quickly to make it both plentiful and accessible to support companies through the pandemic downturn. The cure, however, has a sting in its tail. As policymakers begin to unwind job retention schemes and other support measures the concern is that economic recovery will be held back by a proliferation of debt-laden companies shuffling across a corporate twilight zone: a whole generation of zombies.
This is no new phenomenon. Even before the Covid-19 crisis, a decade of low interest rates helped to fuel a rise in the number of “living dead”: companies unable to cover their debt-servicing costs from profits in the long term. Leverage in the corporate sector has increased significantly since 2008. Deutsche Bank Securities estimates the zombies’ share of US companies alone has roughly tripled since the financial crisis to more than 18 per cent.
By Vladimir Popov, a Research Director at the Dialogue of Civilizations Research Institute in Berlin and Jomo Kwame Sundaram, a former economics professor, who was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. Originally published at InterPress Service
In recent decades, many contemporary macroeconomic and financial problems have been blamed on ‘soft budget constraints’ (SBCs), with the term becoming quite popular in the economics lexicon, financial media and political discourse.
Soft Budget Constraints
Originally coined four decades ago to purportedly describe the economic roots of problems in centrally planned ‘socialist’ economies, it was soon also invoked for ostensibly dirigiste developing countries accused of ‘macroeconomic populism’ and ‘industrial policy’
It has since assumed a double life, invoked on one (microeconomic) hand to discipline large enterprises not maximising shareholder value by investing too much for the medium and long-term, and on the other (macroeconomic) hand to control ‘irresponsible’ governments running budget deficits.
First formulated by Harvard economist Janos Kornai from Hungary to explain economic behaviour in ‘socialist’ economies said to be characterised by shortage, the term was soon widely used in the literature on economic transitions from centrally planned ‘socialism’ to market capitalism.
The original claim was that state-owned enterprises (SOEs) in socialist countries were not allowed to fail even when unprofitable. According to him, such SOEs were almost always bailed out with financial subsidies or by other means. True, SOEs in socialist economies never went out of business as there were no bankruptcies.
But although such legal bankruptcy provisions were undoubtedly lacking, SOEs were often disciplined by other means in such ‘centrally planned’ economies: national budget provisioning under central planning was almost always strictly limited, managements could be changed, or enterprises required to reform.
Nevertheless, poor enterprise management and losses were blamed on SBCs. With enterprise losses assumed to result in national level budgetary indiscipline, SBCs at both levels were presumed to be related.
Hence, permanent government budget deficits, debt accumulation, high inflation and other macroeconomic imbalances were presumed to be associated with pervasive enterprise level SBCs and losses.
Global neoliberal economic ascendance from the 1980s increasingly invoked SBCs to explain economic problems at both micro and macro levels in non-socialist economies, such as the financial difficulties of US auto giant Chrysler in the 1980s and various macro-financial crises since.
Shortages and SBCs
The SBC notion was directly linked by Kornai to the ‘shortage economy’, another notion associated with him from the 1980s, with both portrayed as characteristic of centrally planned socialist economies.
When a government covers the losses of all unprofitable SOEs with a national fiscal SBC — a practice presumed to be widespread — both wages and profits exceed the value of output, causing both consumer and investment demand to exceed supply in such ‘shortage’ economies.
As enterprises are not constrained from increasing demand for resources, shortages emerge. Shortages are inevitable if prices are controlled and cannot rise to clear markets. But SBCs do not inevitably lead to shortages as market price increases can eliminate them.
Due to SBCs, enterprises are presumed to increase investment and production until they encounter non-financial resource constraints in the form of shortages. But no explanations have been offered as to why these should necessarily occur, either in theory or in practice.
Rather, this claim is based on the presumption that SOE managers are primarily, if not solely interested in maximizing output or growth rates. This presumption is widely believed by economists to be realistic, although there is no systematic evidence that this was indeed the case.
Selective Industrial Policy
Enterprise level losses over several years were also presumed to be due to SBCs, rather than the result of a deliberate policy of selective encouragement of and support for particular sectors, technological initiatives and enterprises.
In fact, such support for strategic industries and enterprises was not widespread, let alone pervasive, and did not cause major government budget deficits. Such selective industrial policy is thus easily, but misleadingly depicted as a classic cause of enterprise-level SBCs.
Such selective subsidization may or may not succeed in accelerating progressive structural transformation, but was certainly neither an intrinsic or pervasive feature of centrally planned socialist economies, and even more misleadingly, a major cause of pervasive SBCs.
In East Asia, promotion of export-oriented manufacturing and new high-tech industries contributed to successful catch-up growth and structural transformation. But such targeted subsidization conditional on meeting performance criteria did not involve national level or macroeconomic SBCs.
The problem in the USSR and East European countries was not subsidization per se, but rather, indefinite, even increasing protection through higher domestic prices for manufactures — as part of import substituting industrialization policy — perpetually protecting manufacturing SOEs not effectively compelled to become more competitive.
Budget Constraints in ‘Socialist’ Economies
In the Soviet Union after the Second World War, from the 1947 monetary reform until the 1987 Gorbachev perestroika reforms, budget deficits and debt were kept low and transparent. Open and hidden annual inflation rates remained in the single digits, often lower than in Western countries.
In fact, budget constraints in ‘socialist’ economies were ‘stricter’ than in most developing countries, and no less ‘hard’ than in many developed countries. SBCs in ‘socialist’ economies were not all-pervasive, as often claimed, but selective, e.g., involving subsidization of some enterprises or industries at the expense of others.
Budget constraints under central planning were mostly much stricter than in market economies at similar levels of development. SOE losses could contribute to government budget deficits, but were mostly modest under ‘socialism’, with both open and hidden inflation relatively low.
Various political factors shaped macroeconomic policy choices during the 1990s’ transitions. Previously ‘hard’ budget constraints ‘softened’ dramatically in many East European countries and former Soviet republics, resulting in fast growing budget deficits and high inflation.
The new combination of weak states facing rivalrous powerful interest groups caused governments to ‘kick the can down the road’, with deficits, debt, inflationary financing, overvalued exchange rates as well as domestic fuel and energy prices below world levels.
Hence, SBCs were just one type of economic policy, rare in ‘socialist’ countries, but found in many developing countries, especially in Latin America and Sub-Saharan Africa, and ironically, in transition economies, especially in the former USSR, from the 1990s.
This is not what one would expect, given the “narrative” in the U S of A about socialism:
“Budget constraints under central planning were mostly much stricter than in market economies at similar levels of development. SOE losses could contribute to government budget deficits, but were mostly modest under ‘socialism’, with both open and hidden inflation relatively low.”
I also will note that I have various IRAs and SEPs (from the whole absurd U.S. defined-contribution pension system). I have had more than half of the money in socially responsible mutual funds, which are managed much more tightly, given their own stated investment standards.
Hey, maybe there’s something to this “social” stuff, Margaret Thatcher notwithstanding.
As with discussion of other isms, attacking the perceptions may be helpful. Find out what people think and why, then address those head-on. You may find that, as with so many issues, opinions are ill-formed based on mistaken or incomplete understanding of whatever is under discussion, or due to deliberate misinformation.
People don’t like X. So, what is it about X that they don’t like, and why?
Because their neighbor had a scary story about it?
Or they heard about it on the ‘news’, or should that be “news”?
The answers may surprise the interviewer and interviewee.
I’m really not understanding how economic sanctions, current and past, are never included countries’ economic performance.
How would the USA have performed over the decades with economic sanctioms flying at it from all directions?
Here’s a weird answer: possibly really, really well. This is a huge country with all possible natural resources/advantages (plenty of coastline, year round warm areas as well as temperate zones). Top colleges.
The major difference would, I think, be the absence of billionaires. No threat of offshoring, a lot of living within its means.
The US self economic-sanctioned itself, if you peer at it from a different direction than usually expressed, during its 100yr rise from nowhere to top dog.
Let us rephrase the question. How would the US have fared if cordoned, contained, and subject to sanctions from all around after it was transformed in rubble and a great percentage of its population was killed and lost the majority of its means of production?
So how do you analyze the merry-go-round?. Both socialist and free marketeers seem to suffer the same brick wall of reality. Resources. MMT bases its economics on this basic universal fact. So that’s a huge advantage. While everybody else sinks in their own quicksand of denial. “Selective Industrial Policy?” It’s “Soft Budgetary Constraints” by another name. Every country does it. I’d say it is to their credit that SOEs are not interested in “maximum output” because is too absurd for words. Really, Soft Budgetary Constraints sound as benign as Soddy’s “stabilization fluctuations” to me. The winner-take-all imperative has become obscene. And accounting practices so that everything “balances out” in monetary units? – don’t get me started. Apologies to very astute thinkers like RM. I’m all for good taxation. So long as it doesn’t condone unsustainable practices. So I’d just like to ask, before it’s too late – What is the end game? Does anybody have a clue?
It reminds me of a Yeltsin era joke:
Socialism is only bad if the help goes to poor people. When you are a billionaire, it’s just expected. First get the government to give you a billion dollars, then start a hedge fund with the money.
Im not an economist, but this strikes me as a lot of nonsense. Eastern Europe in the 90ies did not have budget deficits because of some strange phantom policy of “soft budget constraints”. What a concept. Eastern Europe and the former Soviet block in the 90ies (so called “transiiion years”) for the must part were rapaciously plundered, when so called “credit millionaires” were allowed by cronies in power to get rich and buy dollars by the truckload which crushed the currency (see Bulgaria, Russia, Ukraine, I think Romania, Serbia too, also Poland), as well as the precipitous loss of all COMECON markets and being forced to buy energy and commodities at world dollar prices. That’ll ruin your budget regardless of your policies.
It had nothing nothing to do with policy much less with something that could be called SBC. Unless we are trying to dress up the naked truth in platitudes to show that what happened was the result of some level of competence, rather than outright plunder.
Like my bosses at work, apparently reputable economists seem to build work output and promotions on hand waving and hot acronyms.
Just my modest opinion.
Vladimir Popov should know better, because he was there and still works in Russia.
Where might I find some Isopropyl alcohol, is there an -ism to that query?
Just the free market, working its magic.
The Russians weren’t very good at central planning.
The US economy did much better than the Russian economy.
The Chinese are good at central planning.
Chinese central planning produces much higher growth rates than US economic liberalism.
Time for a re-think.
No need to tell US investors.
US investors love China and know it’s the best place to make real money.
George Soros, Bill Gates, Warren Buffett, Elon Musk, Jeff Bezos …..
Leave the money in private hands, so they can invest it in China.
What a good idea.
We had the same problem in Europe.
After WW2, more money was flowing into the US from European investors than was flowing from the US to Europe with the Marshall Plan.
Wealthy investors just want to maximise returns and are not concerned with national or regional interests.
If Europe was ever going to get re-built, the American Government would have to do it as European private capital kept flowing into the US to make the best returns.
No one understands the monetary system.
If they did, they would have seen what was going wrong during globalisation.
Milton Freidman rehashed 1920s economics and managed to pass it off as something new.
He didn’t fix any of its major problems.
Globalisations problems were baked in from the start.
This economics still has its 1920s problems.
1) It makes you think you are creating wealth by inflating asset prices
2) Bank credit flows into inflating asset prices, debt rises faster than GDP and you eventually get a financial crisis.
3) No one notices the private debt building up in the economy as neoclassical economics doesn’t consider debt.
When you use neoclassical economics, policymakers let the private debt-to-GDP ratio rise until they get a financial crisis.
Policymakers don’t realise it’s the money creation of bank loans that is making the economy boom as they head towards a financial crisis.
This is what made the 1920s roar.
At 25.30 mins you can see the super imposed private debt-to-GDP ratios.
When you use neoclassical economics, policymakers let the private debt-to-GDP ratio rise until they get a financial crisis.
1929 – US
1991 – Japan
2008 – US, UK and Euro-zone
The PBoC saw the Chinese Minsky Moment coming and you can too by looking at the chart above.
It’s pretty obvious no one knew what was really going on.
All the mistakes of globalisation have allowed heterodox economists to make enormous progress, e.g. MMT, Richard Werner, Steve Keen and Richard Koo.
Steve Keen is learning, and moving forwards all the time. He has now realised Richard Werner and MMT both have insights that add to the overall picture.
Steve Keen and Richard Werner both focussed on the private debt side.
MMT focussed on the public debt side.
I have been putting some comments on his Patreon site, to try and make him aware of Richard Koo.
As a former central banker at the Federal Reserve Bank of New York his knowledge helps to understand the link between the two. He knows things about the monetary system most economists don’t.
Current thinking on the monetary system is just hopelessly wrong.
What I don’t understand is how you can look at US policies (e.g., bigger is better) and not think gee, US business isn’t a planned affair.
Google, Amazon, Walmart, Facebook, Boeing, Comcast, Disney, Wells Fargo, Meditronic, Cargill, etc., etc., etc. Those companies didn’t get that big by accident and ultimately they serve a purpose. Same with hedge funds & vulture management companies, developers, etc. Whatever they do serve… well, it’s not accidental.
Spans every industry and is not limited to the US either.
I have to wonder if the ones most egregious to the environment, workers, surveillance, the community they exist in, etc. are the ones who fail upward and receive more handouts or simply rewards to their leaders than the others. After all they are essentially doing the US version of “DAWG’s work.” I wonder what doing a Michael Hudson styled balance of payments type study on those companies financials would reveal.
In retrospect, most people would kill for the annual two to three percent per annum growth that socialist economies sought and delivered–sneered at by development economists for decades–over the murderous highs and lows of the capitalist economies.
I cite from the article:
1. “‘socialist’ economies SAID to be characterised by shortage” [my stress]
MY REPLY: I lived in eastern Europe during Communism. ‘Socialist’ economies WERE INDEED characterised by shortage. It was typical for people to line up in front of shops and then ask “what are they selling?” They would buy whatever was available, because as Kornai explains [The authors obviously missed that part], they preferred any kind of merchandise to currency, since they had a chance to barter the merchandise later on for something they really needed.
2. According to Kornai, “such SOEs were almost always bailed out with financial subsidies or by other means. But although such legal bankruptcy provisions were undoubtedly lacking, SOEs were often disciplined by other means in such ‘centrally planned’ economies: national budget provisioning under central planning was almost always strictly limited, managements could be changed, or enterprises required to reform.”
MY REPLY: The authors mischaracterize Janos Kornai as a “Harvard economist”. That’s news to me. Perhaps he eventually snagged a job at Harvard, but Kornai started his economic career as a top planner in Hungary’s centrally planned economy, and he has first-hand knowledge of everything he writes about.
Consequently this second-guessing of Kornai by people who seem to be rank amateurs is absurd in the extreme. Vague conjectures about national budgets are no substitute for the decades of hands-on experience in the planning industry that Kornai has. Vladimir Popov is a MATHEMATICIAN. He wrote books called “Discrete complex reflection groups” and “Groups, generators, syzygies, and orbits in invariant theory”. He has no training in economics, much less any experience in economic planning.
Jomo Kwame Sundaram is an economist from Malaysia who has never seen the inside of a central planning bureau. He’s an international bureaucrat.
These people are obviously phonies.