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Chief Economic Advisor, the National Bank of Romania and visiting scholar in the Research Department, International Monetary Fund. The author would like to thank Guillermo Calvo, Eric Clifton, Mohsin S. Khan, Edouard Maciejewski, Jacek Rostowski and Theodor Stolojan for useful comments and discussions. Thanks are due also to Steve Altheim, Dan Berg, Farid Dhanji, Monica Hargraves, Tricia Gallagher, Juhan Jaakson, Stephen Canner, William McCleary, John McDowell and Andreas Tsantis who provided helpful suggestions. The author bears sole responsibility for the views expressed in this paper.
“…the soft-budget constraint did change its dynamics because individual firms in general strengthened their positions vis-á-vis other economic agents as well as the authorities. They no longer have to bargain for new credits or subsidies, or tax reliefs. Their behavior can rather be described in terms of fait accompli. They do not pay, but nonpayment is not their problem; it is the problem of those who do not receive their due” (P. Jasinski, 1992, p. 32).
The moderating Influence of arrears on the decline of output can, itself, be moderated by an increase of the demand for transactionary balances. However, this counter-moderating effect has to be judged in conjunction with the reduction of the demand for speculative and precautionary balances.
If the equation of exchange (PY - MV) is put in a dynamic form by using logarithms: p + y - m + v; where p, y, m and v are the rates of change in prices, output, money supply and money velocity, respectively. When monetary policy is tightened, m - o, and (p + y) is above zero, v needs to be positive in order to alleviate the expected decline of output. In this case arrears appear as if they modify money velocity. If arrears are considered temporary quasi-inside money and velocity is kept constant, the relationship becomes: p + y - m(c, a), where c is cash and bank credit and a represents arrears. When c-o because of dear money policy, p + y - a.
Aside from new money injection, this would be the only way to make the shift of LM to LM1 durable.
This idea is developed in Section IV, which argues that exports can be viewed as a side effect of arrears and as a constraining factor on them.
See C. Senik-Leygonie and G. Hughes (1992) for an investigation of the size of negative value-added sectors in the former Soviet Union. In Romania, copper and lead mines in the northern part of the country, are known to be notoriously negative value-added activities.
One reason, for instance, is the smaller tax base for subsidizing those who lost their jobs; therefore, this base has to be taxed more heavily.
In particular, due to the highly inflationary domestic environment, and the likely scarcity of foreign exchange reserves. In Poland, the temporary relative success of using the exchange rate as a nominal anchor relied on a very substantial devaluation (overshooting).
There were signs of a systemic problem and the U.S. Brady Plan was, partially, a policy response to those signs. Almost all major banks needed recapitalization because of their bad loans to Latin America, in particular. But the overall policy response remained, essentially, a case-by-case approach.
In the Czech Republic, many companies are locked in a circle of bad debt caused by unpaid bills from customers…Officials fear that many other companies could be affected if major companies are allowed to go bankrupt (P. Blum, 1993, p. 2).
Defining policy credibility in post-command economies needs qualification since, with the exception of Hungary and Poland, there is no history of stabilization attempts. Without such a history agents react according to entrenched behavioral patterns, not on the basis of learning from past policies and their eventual reversal. Certainly, when wide ranging bailouts make up a policy goal, reversing the history in favor of stabilization starts off on the wrong foot and policy credibility is impaired from the very beginning. But still, one can pose the question: under what circumstances is policy credibility a realistic policy trait and what policy choices favor its attainment?
“The Romanian economy was one of the most tightly controlled and centralized in Eastern Europe. The Ceausesçu regime deprived the country of the experience of any significant economic reform, leaving the administration tied to a Stalinist model that had by that time been abandoned by almost all other countries in the region.” (D.G. Demekas, M.S. Khan, 1991, p. 8).
Arrears, as temporary quasi-Inside money, can compensate the reduction of domestic bank credit for a while only. Over time, arrears become ever more constraining and an inflow of real liquidity (foreign exchange) is triggered.
This “softness” can be viewed at as a relative “absence of ability to transform goods into one another in world markets at the initial world prices” (P. Desai and J. Bhagwati, 1979, p. 359). Often, low exportability (specific for “soft” goods) can turn into no exportability because of technology and quality-related constraints.
As was argued in subsection 11.2, arrears can, in fact, dichotomize the payment system and make wage disbursement the main (or the only) money-based transaction; this helps enterprises cope with the upward pressure of wages.
“Recession-hit companies now speak of a crisis within a business community unable or unwilling to break free from a vicious circle of overdue debt,.. The European Commission has just launched an investigation into late payment, which is spreading contagiously throughout the Community” (M. Cassell, 1993, p. 17).
Romania’s experience is telling in this respect: Law 15 of August 1990, on “Restructuring of State Economic Units” devolved power by creating confusion as to the owners of enterprise assets. In this way collusion phenomena were encouraged, management contracts were easily avoided by managers and, ultimately, the attributes of the state--as the owner of the still unprivatized property--were devoid of substance.
The “managerial revolution” that took place in the publicly-owned companies (regies autonomes) in France, in the 1980s may suggest avenues for action, though the scale and problematic in post-command economies are, comparatively overwhelming because of the different surrounding environment for the individual companies.
In the case of Romania, for instance, a McKinsey study found that the concentration of bad debts is fairly significant within the troubled industrial sectors. The metallurgy, chemical/petrochemical and machine-building industries are dominated by large vertically integrated companies accounting for the majority of the problem. The study found that for the three industrial sectors mentioned 112 large companies account for 77 percent of bad debts. And the three industrial sectors account for 45 percent of the bad asset problem of all commercial companies, though they comprise only 24 percent of the lending.
The Polish experience is relevant as to this political dimension and the pitfalls of concentrating the tasks to a single agency.
Like the State Ownership Fund (SOF) In Romania.
There are frequent cases when managers favor a worsening in the way enterprises function so that an eventual management buy-out will be eased financially. But, there is enough ground to assume that seeing this members of the work force would not stay idle and would force them out of power; workers actually operate as “managers-monitors”. Therefore, it seems that it would pay for managers to accept a deal (with the state as the owner of the enterprise) that would reward them with concrete stakes in the future of the company, to the extent they improve its financial standing. In a nutshell this philosophy says “why run down a company in order to buy it for nothing and risk losing it all (including reputation) by being ousted, instead of turning into an important share holder (stake-holder) of a possibly prosperous company”?
A problem could emerge with this conversion. Implicit subsidies are ex post and their size is an uncertain quantity, potentially unlimited. Explicit subsidies are ex ante so they are a known, limited in quantity. There is a danger, that if the economy gets less stable--because of various shocks, including politically-motivated policy decisions--the mix of subsidies could mean both a substantially higher fiscal deficit and very high inflation.
“Controls are more likely to be useful the larger is the desired reduction in inflation and the more serious is the credibility problem” (P. Persson, S. van Wijnbergen, 1993, p. 81).
Industrial policy is critical for bridging the gap between the effectiveness of controlling demand and stimulating supply. When supply responsiveness is pretty low, endangering the sustainability of stabilization efforts, industrial policy should correlate incomes-control measures with industrial restructuring (including privatization), which are undertaken by authorities on the basis of information provided by markets.
One qualification is, however, necessary in this respect. When these units are represented by producers of intermediate goods, the switching to other suppliers could involve significant costs to certain customers of those producers. But these costs are a one-time affair, as against the flow of subsidizing negative value-added activities.
One can compare it with the turnaround of several Latin American countries (Argentina and especially Mexico) In the 1980s, or the progress of Turkey over the same period. One should not downplay, however, the role of surging world markets, driven by a consumption-led recovery of the U.S. economy, in facilitating that transition. This contrasts strongly with the exogenous shocks that have struck the transforming economies.
The cases of the steel processing industry and of agriculture make big headlines.