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Free to Fail

Creative Destruction Revisited

Hugh van der Mandele and Arjen C. van Witteloostuijn

This challenging book tackles one of the most fundamental questions in economics: Why are commercial organizations more efficient than organizations in the public domain?
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Chapter 9: The soft constraint syndrome

Creative Destruction Revisited

Hugh van der Mandele and Arjen C. van Witteloostuijn


One requirement for smooth operation of a market economy is financial discipline. This means enforcing four simple rules: (i) Let buyers abide by their sales agreements and pay for their purchases. (ii) Let debtors observe their credit agreements and pay their debts. (iii) Let taxpayers pay their taxes. (iv) Let firms cover costs out of revenues. In a consolidated market economy, there is a legal obligation to comply with the first three rules. Compliance with the fourth is imposed by the nature of an economy based on private property. Persistent losses lead sooner or later to ruin and an exit from commercial life (Kornai, 1998, p. 533). János Kornai wrote these lines in the course of developing his theory of the soft budget constraint syndrome, potentially one of the most fruitful theories in the field of economic policy. In the context of this book’s argument, Kornai’s theory of the soft budget constraint syndrome is a natural complement to Williamson’s theory of organizational control loss. As we will explain below in greater detail, it is this pair of theories that offers a powerful explanation for the puzzles that we seek to solve in this book. But before we can return to these puzzles, we must first introduce this second leg in our central argument – that is, Kornai’s theory of the soft budget constraint syndrome.

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