From Disintegration to Reintegration by The World Bank

Author:The World Bank
Language: eng
Format: epub
ISBN: 9780821361979
Publisher: The International Bank for Reconstruction and Development / The World Bank

In-Country Barriers to Exit: “Soft Budget Constraints”

Worldwide, “soft budget constraints” are the main mechanism through which unviable firms remain in the market.12 There is abundant evidence over the course of the Region’s transition suggesting that soft budget constraints impede the exit of money-losing firms from the Region.13 Through greater fiscal and financial discipline (“hardening” of budget constraints), failing or value-subtracting firms in the Region have faced incentives to restructure or exit the market. The more difficult it is for such firms to go out of business, the less likely it is that the domestic market structure is competitive or that resources are allocated efficiently. Value-subtracting firms tie up productive assets, and in this way their presence deters entry of new business start-ups, distorts resource allocation, and constrains firm performance, including integration into the international market-place. Here, we investigate soft budgets arising from two factors: (i) arrears in taxes, wages and social payments, utility payments, and payables to input suppliers and (ii) subsidies.

Recent survey data indicate that the incidence of arrears is greatest among firms in Central Asia and other CIS countries, although firms elsewhere in the Region also face this problem. Box 4.1 illustrates such a case involving an SEE firm in Republika Srpska. Across firms of different ownership forms, arrears are lowest among firms with significant private ownership, including those that are integrated internationally—that is, foreign-invested businesses. Significantly, there is evidence for the Region that in the countries where arrears are larger, the export performance (measured by the share of exports in GDP) is lower (see figure 4.6). This reaffirms the direct linkage between behind-the-border conditions and success in international integration among the countries in the Region: where there is a lack of domestic competition, firms’ abilities to penetrate foreign markets are dulled.

Box 4.1 Arrears as Constraints on Firm Performance in SEE

The case of a large furniture manufacturer in Republika Srpska provides an illustration of how a poor business climate can hinder exports. Labor regulations and unresolved ownership status are the key factors affecting the performance of the firm in question. The company carries on its books 550 employees, of whom only 150–250 actually work. The company has been in arrears with pension contributions since 2000, which makes its workers ineligible for retirement. Moreover, political constraints prevent the company from laying off employees. There is little hope that the company will be privatized, as its total debt exceeds the market value of its assets by more than 50 percent. The company is in debt to the state, the IFC, and a commercial bank. Moreover, it has wage arrears and owes money to its suppliers. Currently, a large portion of its transactions take the form of barter. The unresolved labor situation leads to a vicious cycle: keeping the waitlisted workers on the books raises the arrears vis-à-vis the state and thus decreases the chances of privatization taking place. While the company’s experience and reputation would allow it to receive additional orders from large multinationals, such as IKEA, fulfilling such orders is not possible because of a lack of working capital.

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