1 / 16

Chapter 3

Chapter 3. Soft Budget Constraints. A question for you. Soft budget constraints . Definition: The government cannot commit not to bail out loss-making firms. SBCs: different views. Paternalistic attitude of the state (Kornai, 1980)

kaleb
Download Presentation

Chapter 3

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 3 Soft Budget Constraints

  2. A question for you

  3. Soft budget constraints • Definition: The government cannot commit not to bail out loss-making firms.

  4. SBCs: different views • Paternalistic attitude of the state (Kornai, 1980) • 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)

  5. 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

  6. How serious is the problem?

  7. Which firms are concerned?

  8. Conclusions • Soft budget constraints persist in several forms: • net bank financing, i.e. soft credit conditions • tax arrears (also to social security) • wage arrears • trade arrears (e.g. state utility suppliers)

  9. A game theoretical explanation of SBCs • Bg, Bp > 0 • Bl < 0 • Rg > 1 • Rp+ Bp < 2 • distribution of good and bad projects in general () is commonly known but the specific project under consideration is only known to the E at first; the G finds out about the project’s type only at the end of period 1 • the G has a ‘broad’ welfare function: it cares about the taxable returns it can appropriate (Ri) and it cares about the welfare of its citizens (Bi) • no pay-offs after 1 period in case the project turns out to be bad

  10. 3 questions we need to answer • Is E going to submit/not to submit • the good project • the bad project • Is G going to finance/not to finance • remember G doesn’t know whether the project is good or bad • Is G going to refinance/liquidate in case the project turns out to be bad

  11. Summarising • The proportion of good projects () has to be sufficiently big for the G to choose to finance whichever project is being presented (good or bad) to it to get funded. • SBCs are expected if • Rp + Bp - 2 > L + Bl -1 • bad projects are submitted and are subsequently refinanced • this typically holds if L is low (due to capital market imperfections, outdated capital stock, …) • HBCs are expected if • Rp + Bp - 2 < L + Bl -1 • bad projects arenot submitted, only good projects are submitted • HBCs can be promoted through demonopolisation and through privatisation

  12. Promoting HBCs • Demonopolisation • Rp () + Bp - 2 < L + Bl - 1 • Privatisation • welfare function of the government becomes less ‘broad’ • Rp - 2 < L - 1 (Bp > 0 & Bl < 0)

  13. Paper: On the causes of SBCs: Firm-level evidence from Bulgaria and Romania • Hypotheses that are tested: • 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 • Measurement of the variables: • concentration ratio within the sector (pos. related to monopol.) • import penetration ratio within the sector (pos. related to comp.) • firm-level data on ownership • firm-level data on employment • firm-level data on SBCs

  14. 2 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.

  15. Empirical work • SBCi,t =  + 1herfi,t-1 + 2importi,t-1 + 3empli,t + 4statei,t + 5foreigni,t + 6municipi,t + 7insider + Tt=2 timet + i + I,t • i -> large and medium sized manufacturing firms in Bulgaria and Romania • t -> time period 1995-1999 • regressions for the entire sample of firms and for firms with negative profits only • * refers to a statistically significant effect

  16. Empirical results • Competition decreases the likelihood for SBCs to be present • Privatisation makes SBCs less likely to occur • Big firms can be ‘too big to fail’ and enjoy SBCs when they are loss-making • Policy implications!

More Related