Project Syndicate Op-ed
This oped, just published in Project Syndicate memorializes Janos Kornai. I never met Janos but we published a couple of pieces he wrote for Capitalism and Society which I edited. I had the privilege of corresponding with him then. His Hungary’s U-Turn was a cry from the heart. I prodded him to conclude with a recommendation, but he sensibly and politely declined.
I had also meant to use “Subtle” instead of “Selective” but goofed up on that!
December 31 2021
MEDFORD, MASSACHUSETTS – Likening today’s capitalist economies to the communist bloc of yesteryear may seem far-fetched. What could the free market possibly have in common with Soviet-style central planning? In fact, the comparison increasingly offers useful insights into what has become of the winning side since the end of the Cold War.
Consider the “soft budget constraints” that socialist state-owned enterprises (SOEs) used to enjoy and that turned out to be one of the main reasons why Soviet-bloc economies failed. Similar financial conditions are becoming pervasive in capitalist America.
As the Hungarian Marxist apostate János Kornai famously argued, SOEs could ignore losses and consumer preferences because they could always count on the state to keep them afloat. Kornai’s thesis was popular with the Chinese reformers of the 1980s: seeking to make SOEs more responsive to the market, they “hardened” companies’ budget constraints. By contrast, capitalist America seems to be on the same misbegotten path as the Soviet economies. Though it is starting from a different place, the result is the same. Budget constraints are softening, and capital is increasingly being funneled toward the fashionable and the well-connected fantasists and schemers.
To be sure, borrowing can, up to a point, energize capitalist enterprises. Contrary to what one reads in introductory economics textbooks, real-world consumers’ budgets aren’t capped, and venturesome consumers can borrow to pay for the next new hot item. By consuming beyond their means, they boost the demand for iPhones and Teslas, creating incentives for innovators.
Likewise, Tesla and other upstart businesses often rely on external funding, not profits, to advance their innovations, just as governments issue bonds to help pay for highways, bridges, harbors, and airports. Savers also benefit. Instead of stuffing surplus cash into mattresses, they can profitably cover the financing needs of consumers, businesses, and governments.
But too much financial flexibility can be toxic. Though individuals, businesses, and governments can reasonably predict next month’s wages, revenues, and tax receipts (respectively), they can only guess at their capacity to meet obligations many years from now. The more optimistic one’s forecast, the greater one’s willingness to spend beyond one’s current means or invest more than just one’s retained earnings.
In principle, financiers’ due diligence should impose countervailing limits on this overextension. But estimating creditworthiness and investment returns is not an exact science, and competition in the financial sector can produce a race to the bottom as borrowers flock to the most lenient creditors.
Moreover, fractional banking and fiat money can further soften financing constraints. Banks do not lend out only the savings of their depositors; they leverage those deposits several-fold. And central bankers have even more potent powers to create funds out of thin air.
As traditional financing constraints have weakened in recent decades, the growth in households and businesses’ debt has exceeded the growth in their incomes and profits by a wide margin. Similarly, the growth in the US government’s debt – now exceeding $29 trillion – boggles the imagination. Yet while borrowing has jumped, interest rates have plummeted, encouraging even more borrowing and imprudent lending.
These lax lending standards have apparently spilled over into equity markets. Last year, some four million self-described “apes” bought billions of dollars of AMC stock, saving the movie theater chain from bankruptcy. Celebrities now float SPACs (special purpose acquisition companies) with a strangely effective pitch: “Give us your money, but we won’t tell you what for.” Hedge funds and private-equity firms have piled into venture capital (VC). Valuations have soared – nearly 340 new businesses raised funding at valuations exceeding $1 billion in 2021. And, the kind of due diligence that once took months has been compressed to days – or even to just hours with some “spray-and-pray” VCs.
This combination of manic investing and careless lending has not emerged spontaneously or resulted from the complacency that comes with an extended period of stability, as Hyman Minsky, the great theorist of financial crises, argued. The collapse of the internet bubble in 2000 and the global financial crisis eight years later should still be fresh in most financiers’ and investors’ memories. The problem, rather, is that central bankers have deliberately incited indiscriminate lending and “risk-on” trading on a historically unprecedented scale.
Worse, while central bankers have apparently dropped plenty of proverbial “helicopter money,” the funds have not been evenly spread. Monetary policies have been designed to lower credit standards, thereby favoring feckless borrowers. The central bank-furnished liquidity that has been pouring into stock markets has found its way to fashionable “meme” and SPAC stocks (in addition to a few trillion-dollar Big Tech firms). VCs favor well-connected founders with shiny resumes. Yet as they bid up the most glamorous ventures’ valuations, they fund less than 0.5% of all US start-ups. One well-known VC firm has even started a fund dedicated to buying cryptocurrencies.
Savers who are too sensible to speculate have fallen behind. So, too, have the businesses that resisted the temptation of cheap money. Under current conditions, their less prudent competitors can pay more for scarce employees and other resources.
What kind of reckoning capitalism faces – or when – is impossible to predict. In the end, Kornai’s Hungary failed slowly, not suddenly. It and other Soviet-style economies that fed the “investment hunger” of favored SOEs kept shop shelves bare of the goods that consumers wanted and that less-connected producers might have supplied. In the absence of wartime or 1970s-style price controls of the kind imposed by President Richard Nixon, such shortages and rationing regimes seem unlikely in the capitalist West. The current inflationary surge may yet subside as supply-chain bottlenecks ease, while the US Federal Reserve forestalls another financial meltdown.
But staunchly defending stock markets simply extends the state-sponsored misallocation of capital. And, unfortunately, the current crop of central bankers seem to lack the resolve that enabled the late Paul Volcker to harden financial constraints when he led the Fed four decades ago.