Soft Budget Constraints: When Someone Else Pays, Accountability Changes

Soft Budget Constraints: When Someone Else Pays, Accountability Changes Companies often have over-budget projects. A project originally budgeted at 10 million has spent 8 million halfway through. The manager says, “We have already spent so much. Would stopping now not waste even more?” Headquarters approves another 5 million. Three months later, things still are not working. “We are so close. We cannot let everything go to waste.” Another 5 million is approved. More commonly, the company and project eventually run out of money without success. But the manager writes a better report: “We explored a path, accumulated experience, and developed the team.” This happens when the people spending the money are not the ones who ultimately pay. ----- The Hungarian economist János Kornai first proposed the “soft budget constraint” in the early “1989 s.” Studying state-owned enterprises in Hungary and Yugoslavia, he observed a common anomaly: “Some firms are extremely inefficient and lose money every year. Market forces should have bankrupted them a hundred times over, yet they do not die.” Verification note: Kornai distinguished hard and soft budget constraints in a 1979 Econometrica article and published “The Soft Budget Constraint” in Kyklos in 1986. The original’s “early 1989 s” is incorrect. Why? The state will not let them fail. However much they lose, someone above finds a way to keep them alive: tax exemptions, cheap loans, or direct subsidies. Someone will ultimately fill the hole. A budget is meant to be a hard constraint: operate within your means, and leave the market when the money is gone. Persistent losses indicate a flawed business model that consumes rather than creates value. Such firms should disappear, making room for value creators. That is the natural order. But if you expect rescue after every loss, your budget becomes only a soft constraint. Kornai found that the higher the perceived probability of outside rescue, the softer the constraint. If you believe someone will intervene when things go wrong, every decision becomes more willing to borrow, take risks, and disregard cost. Even after stern advance promises of “no bailouts,” decision-makers often conclude at the critical moment that rescue is necessary and break their word. Your loss is your failure. But if you can turn that loss into a systemic problem, it becomes an ability to make others pay. Small failures learn from the market; large failures teach the market a lesson. ----- To enjoy soft budget constraints and spend other people’s money freely, master two forms of storytelling. The first is making a commotion: describe your own failure as everyone’s problem. “Without more funding, the system will stop.” “If you let us fail now, all previous investment will be wasted.” “If you do not rescue us, suppliers will demand payment, workers will lose jobs, customers will complain, and leaders will struggle to explain it.” What matters is not reasoning but volume. Some resources are allocated according to how much noise you make. The crying child gets milk not because it is hungrier but because everyone in the house hears its hunger. The second is packaging: present your interests as the security of the whole. “We are not a loss-making business; we are a pillar industry supporting tens of thousands of livelihoods.” “This is not excess capacity; it is a strategic reserve protecting supply-chain security.” “We are not asking for subsidies; we are protecting jobs, livelihoods, and social stability.” Turn “I lost money” into “You will have trouble if you do not save me,” and “I want more” into “You need me to exist.” Inefficiency becomes leverage, failure becomes a credential, and both become the next resource application. Those who live within their means and bear their own failures become marginal players without systemic importance. ----- Grand narratives fear accounting. One question—“Who pays?”—can clarify much. Stability, employment, livelihoods, supply-chain security, systemic risk: these matter, but these broad labels do not specify beneficiaries or accountable parties. Be alert when someone invokes them: they are preparing to spend someone else’s money. #萬維鋼現代思維工具100講 ---- Robin: “One way to identify a responsible founder is to compare proposed budgets with revenue and expense performance. Often sales are harder than expected and revenue misses target, while operating expenses readily exceed budget. Losses grow, and fundraising follows. Investors then test how well earlier promises were fulfilled. Founders must protect their reputation and track record so they do not back themselves into a dead end.”