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SOFT BUDGET CONSTRAINTS SBC

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Title: SOFT BUDGET CONSTRAINTS SBC


1
SOFT BUDGET CONSTRAINTS (SBC) RESTRUCTURING OF
FIRMS IN TRANSITION ECONOMIES
2
Introduction
  • Production structure was distorted compared to
    market economies
  • Relative overdevelopment of heavy (e.g. military)
    industry vs underdevelopment of services
  • Biased toward few big firms and against small
    firms
  • High capital intensity but obsolete equipment
  • Low quality products
  • Labour and input hoarding

3
Table 1 Sectoral Allocation of Labour in OECD
and CPEs (percentage shares)
Source OECD
4
Table 2. Distribution of Employment in Industry
by Size of Firms (Percentage shares)
Source OECD. Data for West Germany, France and
Italy are from 1987, for the GDR from 1988 and
for the other countries from 1989.
5
Restructuring
  • With transition ?Need change of structure and
    organisation of production plus in most cases
    ownership
  • Reduce labour (especially low productivity labour
    and close down obsolete plants
  • Change products and product quality
  • Change capital equipment
  • Change managers
  • ? higher output, quality and productivity
  • ? also unemployment state sector and potentially
    overall although future recovery

6
Initial and Deep Restructuring
  • Initial Restructuring
  • Shedding off labour that does not directly
    contribute to the production process (social
    networks)
  • Wage cuts in order to meet hard budget constraints
  • Deep Restructuring
  • Adoption of modern technologies
  • Re-training of management and workers
  • Replacing the inefficient production workers with
    the more efficient ones
  • Modernisation of obsolete equipment

7
Obstacles to Deep Restructuring
  • 1. Those whose jobs are at risk will oppose
    restructuring
  • unskilled managers
  • workers at obsolete plants
  • 2. Restructuring is likely to require large
    financial expenditures
  • capital equipment of state firms is obsolete
  • financing replacement from retained earnings
    difficult no well-defined rights for future
    profits
  • 3. Privatisation mode (e.g.insiders), lobbies,
    political commitment, unemployment compensation

Individuals dont like HBC (hard budget
constraints)
8
Soft Budget Constraints(SBC)
9
A question for you
10
Soft budget constraints
  • Definition
  • The government cannot commit not to bail out
    loss-making firms.

11
SBCs different views
  • Paternalistic attitude of the state (Kornai,
    1980)

The state will rescue a failing firm because it
is unwilling to accept the social consequences of
its closure. The SBC was introduced by
Kornai(1980) to explain shortages in socialist
economies with price mechanisms, e.g., the market
socialist system introduced in Hungary in 1968.
12
SBCs different views
  • Political economy incentives, bargaining between
    enterpreneurs and politicians (Schleifer and
    Vishny, 1994)
  • Dynamic commitment problem not to refinance in
    the presence of a sunk investment and in the
    presence of asymmetric information (Dewatripont
    and Maskin, 1995)

13
Why are SBCs a problem?
  • It may prevent unprofitable firms from
    restructuring the threat of bankruptcy is not
    credible and hence incentives to restructure are
    absent
  • SBCs may be an obstacle to the process of sector
    reallocation continued subsidies to loss-making
    firms may prevent private firms from bidding
    efficiently for workers employed in inefficient
    SOEs.
  • Macroeconomic stability may be jeopardized
    because government expenditures are not under
    control in the presence of SBCs

14
Measures for SBCs
  • Net Bank Financing SBCs
  • the firm suffers from SBCs if it obtains new
    (bank) loans despite the fact that it is
    loss-making
  • Credit Related SBCs
  • the firm suffers from SBCs if it is loss-making
    and enjoys more credit days than the average
    profit-making firm receives, reflecting an
    inability to pay.
  • Government subsidies and tax arrears

15
Budgetary Subsidies in Central and Eastern Europe
(percent of GDP)
16
Budgetary Subsidies in CEE - statistical analysis
Two things should be noticed 1)The size of SBC
is rather low in most transition economies, given
that under socialism they were in the 25 percent
range. (IMF-led macro stabilization programs)
2)Subsidies were and are still important in
Russia and Ukraine.
  • Subsidies to enterprises are not necessarily a
    measure of SBC.
  • Nevertheless, given the past history in
    government-firm relationships, one can presume a
    rather strong correlation between SBC and the
    extent of subsidies.

17
Government subsidies and tax arrears
  • In the rapidly reforming TEsbudgetary subsidies
    are usually concentrated in a small number of
    sectors that are typically subject to low fixed
    prices.
  • The main route by which budget constraints are
    softened in the rapidly reforming TEs, and one of
    the main routes by which they are softened in the
    slower reformers, is via tax arrears.

18
Tax arrears definition and forms
  • Tax arrears are taxes that have been accrued and
    have come due but have not been paid.
  • The tax arrears problem in TE takes two forms
  • tax arrears accumulated by distressed firms
  • tax arrears as a focus for lobbying by profitable
    firms or firms in general.

SBC
19
Tax arrears as SBC
  • Why do the tax authorities tolerate the
    accumulation of tax arrears in distressed firms?

So, do firms in transition countries have soft
budget constraints? The evidence is far from
complete, but it seems to be that loss-making
firms in TEs are sometimes able to extract
subsidies and get rescued.
20
Paper On the causes of SBCs Firm-level evidence
from Bulgaria and Romania
  • Hypotheses that were tested and confirmed
  • more competition promotes HBCs
  • privatisation makes SBCs less likely to occur
  • big firms can be too big to fail and enjoy more
    SBCs in case of difficulties

21
Privatization and Restructuring of Firms in
Post-Privatization Period A Lesson Learned
from Slovenia
22
The main topic
  • ISSUES
  • The effects of privatization on firms
    performance.
  • Insider vs. outsider owned firms. Which group of
    owners is more efficient?
  • The importance of initial conditions and trade
    orientation

The main hypothesis The process of restructuring
of Slovene firms was affected by uderdeveloped
institutional structure.
23
Model of Restructuring
INSTITUTIONAL FRAMEWORK
FIRM-LEVEL CHARACTERISTICS
RESTRUCTURING
DEFENSIVE
STRATEGIC
24
The evolution of institutional framework
The process of transition in Slovenia
  • Evolutionary path characterized by stabilisation
    policy with restrictive monetary and fiscal
    policies
  • Floating exchange rate
  • Relatively slow process of ownership
    transformation and gradual changes in
    implementing market environment
  • Export demand as the most important factor of
    growth

25
The evolution of institutional framework, cont.
BUT
  • Microeconomic reforms have been proceeding slowly
    impeding corporate restructuring.
  • Some of reforms (i.e. on the labor market)
    started yet very late.

The further development of market and
institutional structure represents one of the
most important factors for future growth.
26
The Bargaining Over Excessive Cash Flow
Wages
Total revenues -material costs -depreciation -tax
?
Investment
27
Empirical specification
  • Standard models augmented by
  • Internal funds hypothesis
  • Bargaining hypothesis
  • Ownership structure
  • Supervisory board structure
  • Privatization method
  • Trade orientation
  • Industry region

Firm-level characteristics
28
Data
SAMPLE 157 Large and Medium-Sized Slovene
Firms In 2000, the average firm in the sample
employ 538 employees, has labor costs that
constitute 85 of value added, achieves a ratio
of sales to tangible capital of 2.8 and sells 58
of its production on domestic market. PERIOD
1996-2000 SOURCE Questionnaires Agency of
Payment
29
Data, cont.
30
The evolution of the ownership structure
31
The evolution of the Supervisory Board structure
32
Managerial characteristics
33
Fixed and Soft Capital Investment
In of total revenues
34
Results
  • Investment in fixed capital
  • Internal funds have impacts on investment in the
    short run but not on the long run (investment
    opportunities!!!)
  • Ownership structure doesnt matter
  • No bargaining

35
Results, cont.
  • Investment in RD
  • Internal funds have impacts on investment in the
    short run and on the long run
  • 90 of RD financed by internal funds
  • Ownership structure matters (are FDI positive for
    RD?)

36
Results, cont.
  • Investment in marketing
  • Internal funds have impacts on investment in the
    short run and on the long run
  • Adjust quickly to the desired level
  • Bargaining confirmed
  • Trade orientation matters

37
Results, cont.
  • Investment in training
  • Does training represent investment or source of
    additional remuneration?

38
What has happened with managers?
Reasons for management turnover in the 19982002
period (Knezevic, Domadenik, Prasnikar, 2007)
Source ISEE research (2003) and own calculations.
39
Discussion and Implications
  • Limited defensive and relatively successful
    strategic restructuring
  • Lack of institutional reforms (especially on
    labor and capital markets)
  • State should withdraw from economy faster and
    abandon its paternalistic role
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