Why inductive datatypes forbid types like `data Bad a = C (Bad a -> a)` where the type recursion occurs in front of ->?

The data type you gave is special in that it is an embedding of the untyped lambda calculus.

An example how such a data type allows us to inhabit any type is given in Turner, D.A. (2004-07-28), Total Functional Programming, sect. 3.1, page 758 in Rule 2: Type recursion must be covariant.

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