All Commentary
Monday, April 1, 1991

Book Review: The Road To A Free Economy by Janos Kornai

W. W. Norton & Company, 500 Fifth Avenue, New York, NY 10110 • 1990 • 224 pages • $16.95 cloth

The heady events of 1989 in Eastern Europe have given way to the sober reality of the 1990s. The road from serfdom will not be easy. As Czechoslovak Foreign Minister Jiri Dienstbier recently said: “It was easier to make a revolution than to write 600 to 800 laws to create a market economy.” (The Wall Street Journal, September 18,1990)

Perhaps the biggest problem is the advice of Western “experts” who warn East Europeans of the dangers of free markets. Most Western economists are convinced that the formerly socialist economies simply pursued the planning principle too vigorously, thus confronting the bureaucracy with an overly complex task. In addition, they maintain, in those cases where partial marketization did occur, East European economists didn’t learn how to manage their economies effectively. With the right institutional framework—a central bank, a Federal Trade Commission, an Environmental Protection Agency, and so on—the economy could be managed efficiently, and the vagaries of unfettered markets could be controlled.

Moreover, Western institutions, such as the World Bank and the International Monetary Fund, continue to provide aid for the planning and management of economic development to some 75 governments around the world, including those in Eastern Europe. The IMF has committed $2 billion since February 1990 to Poland, Yugoslavia, and Hungary; the World Bank plans to lend between $7 and $8 billion to East European gov ernments over the next three years. A new European Bank for Reconstruction and Development has been formed, and President Bush has pledged $1.2 billion in U.S. funds.

This all flies in the face of the overwhelming failures of government economic planning and foreign aid programs. The very aid packages offered, by subsidizing existing political/economic structures, would undermine the revolutionary transformation that is needed if the formerly Communist economies are to get on their feet.

There are, fortunately, some clear thinkers on this matter..One of the best is Janos Kornai of Harvard University and the Hungarian Academy of Sciences. Professor Kornai, one of the’ leading scholars of the socialist economy and a longtime reform economist in Hungary, explains the deep structural problems that Socialist economies face. He then offers an uncompromising solution to those problems.

According to Kornai, the fundamental problem confronting socialist economies is that socialist enterprises encounter only “soft” budget constraints. By this he means that state subsidies destroy any profit incentive for socialist firms to act in an economic fashion. Instead, political rationales govern the allocation of resources, and problems of bureaucratic management result.

But Kornai’s argument is not that the government should somehow try: to harden the budget by tinkering with incentive schemes. He wouldn’t, for example, substitute profit targets for gross-output targets or bonus schemes. Such tinkering with the industrial system doesn’t work, he stresses. Effective “hard” budget constraints are possible only in a market economy with the rights of private ownership secured by the rule of law. The idea of markets without property rights is an illusion. The idea of “market socialism,” Kornai concludes, has revealed itself in theory and practice to be a “fiasco.”

In reaching this conclusion, Kornai correctly recognizes that this was a point emphasized by the great classical liberal economists of this century, Ludwig von Mises and F. A. Hayek. Not only does he acknowledge his intellectual predecessors, he adopts a basically classical liberal agenda as a model for the transition to free markets. As he states: “There is no need for hundreds of new regulations that fuss over significant modifications of the bureaucratic restrictions on the private sector, and vacillate over whether to yield at one point or to maintain curbs at the other. It would be more expedient to approach the issue from the opposite direction, by giving unambiguous and emphatic statutory force to the principle that the private sector has unrestricted scope in the economy.” (emphasis added)

Kornai refers to his program as a “surgery” and argues that reform must be accomplished in one stroke. The program entails, on the micro-economic side, the establishment of a constitutional right to private property, freedom of entry, and unrestricted market pricing to guide exchange and production. On the macro-economic side, Kornai argues for a program that: (1) stops inflation, (2) balances the budget, and (3) eliminates price and production subsidies.

One may disagree with Kornai on specifics of his program—for example, his qualifications concerning externalities, his arguments about managing macro-demand, and his call for continued Western aid. But his overall vision of the transformation process is the closest thing to a classical liberal program for Eastern Europe yet available. Even the much lauded 500-day plan of the Soviet economist Stanislav Shatalin pales in comparison with Kornai’s vision of economic liberalization; One only hopes, for the fate of the people climbing out of the Communist rubble, that Kornai’s words get through. []

Peter Z Boettke, Assistant Professor of Economics, New York University, is the author of The Political Economy of Soviet Socialism: The Formative Years, 1918-1928 (Kluwer Academic Publishers, 1990).

  • Peter Boettke is a Professor of Economics and Philosophy at George Mason University and director of the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center. He is a member of the FEE Faculty Network.