From Paul Gregory and Robert Stuart, COMPARATIVE ECONOMIC SYSTEMS,
4th Edition, 1992, pp. 121-122


Kornai: Socialism and Shortage

     Hayek and Mises emphasized the complexity and incentive
problems of socialism.  The Hungarian economist Janos Kornai has
focused on the inherent tendency of socialist economies to operate
under conditions of shortage.  Kornai's major work, The Economics
of Shortage, was published in 1980.  In this and other works,
Kornai provided a theoretical explanation for the inability of
socialist economies to avoid shortages.
     Kornai argues that the planned socialist economic system is a
system of shortage, where shortage is a systemic, perpetual, and
self-reproducing condition." Others have argued that persistent
shortages or excess demand in the socialist systems is a function
of readily identifiable, though not necessarily easily corrected,
forces.  Consumer goods are simply not a high priority but rather
are supplanted by producer goods and military production. 
Furthermore, errors in planning, inadequate incentives, and other
system characteristics lead to continuing shortages.
     From a very different perspective, Kornai argues that the
economy of shortages arises from the nature of the enterprise in
the planned socialist system." The socialist enterprise operates
under fundamentally different rules from the capitalist enterprise. 
The capitalist enterprise is motivated to maximize profits.  It
makes its input and output decisions on the basis of prices
established in markets.  As a profit maximizer, the capitalist
enterprise has little incentive to overdemand resources.  If it
employs more resources than technology requires, its profits
suffer.  The capitalist enterprise experiences a hard budget
constraint.  Faced with input prices and output prices, the
capitalist enterprise must cover its costs while earning an
acceptable rate of return on invested capital.  If it fails to meet
its budget constraint, the capitalist firm will fail in the long
run.  The capitalist firm must live within its means.  The hard
budget constraint polices capitalist enterprise activities and
effectively eliminates shortage (in the sense of excess demand for
inputs).
     The socialist firm operates in a supply-constrained economy. 
Socialist planners have as their objective the rapid expansion of
outputs, and they tend to judge the performance of socialist
enterprises on the basis of rates of output expansion.  The manner
in which socialist enterprises select inputs to meet their output
objectives is of less importance than the output targets
themselves.  Although socialist enterprises face prices for inputs
and outputs, their resource allocation decisions are aimed at
meeting output targets.  Relative prices play only a minor role.
     The capitalist enterprise that fails to live within its means
is punished by bankruptcy.  The socialist enterprise that fails to
cover costs plus a rate of return on the state's invested capital
does not suffer the same consequences.  Socialist planners value
enterprises for their outputs; socialist enterprises that make
losses remain in business by virtue of state subsidies. 
Accordingly, socialist enterprises face a soft budget constraint. 
Socialist enterprises can live beyond their means, if necessary,
over the long run.
     The hard budget constraint forces capitalist enterprises to
limit their demands for inputs.  The soft budget constraint on
socialist enterprises fails to reward them for restricting their
input demands.  Hence the socialist system generates continuous
excess demands for inputs.  The supply of inputs falls chronically
short of the demand for inputs, and persistent shortages or
imbalances result.
     Economic systems must allocate resources in an orderly
fashion.  Persistent imbalances and chronic shortages detract from
the orderly allocation of resources.  With imbalances, those who
obtain resources may be those who will not put them to their best
and highest use.  Kornai's analysis of socialism is related to the
complexity and motivation issues raised by Mises and Hayek. 
Kornai's conclusion is that the socialist motivation system and
inattention to relative prices disrupt the orderly allocation of
resources under socialism.