C E R T CENTRE FOR ECONOMIC REFORM AND T RANSFORMATION Department of Economics, Heriot-Watt University, Riccarton, Edinburgh, EH14 4AS Tel: 0131 451 3483/3486 Fax: 0131 451 3498 E-Mail: ecocert@hw.ac.uk World-Wide Web: http://www.hw.ac.uk/ecoWWW/cert/certhp.htm Do firms in transition have soft budget constraints? A reconsideration of concepts and evidence * Mark E. Schaffer Centre for Economic Reform and Transformation, Department of Economics, Heriot-Watt University, Edinburgh, UK December 1997 A bstract This paper first examines various definitions of Kornai’s soft budget constraint (SBC) and the difficulties involved in interpreting data on losses, subsidies and financing, and then considers selective evidence from transition economies. Stocks of overdue trade credit are no larger than in Western economies and firms in transition economies (TEs) typically impose hard budget constraints on each other. Banks have not been a systematic source of SBCs as often as is sometimes argued on the basis of data on classified loans; in 1992 Hungarian banks were imposing hard budget constraints on firms at the same time that they were classifying large volumes of their loans as bad. Tax arrears have emerged as a major source, and in the rapidly reforming TEs, the major source, of SBC’s. JEL classification: P31, P34, G21, G30. Keywords: soft budget constraint, transition economies, trade credit, bad debt, tax arrears. Acknowledgements * This is a revised version of a paper prepared for the CERT/Phare-ACE conference on Bank and Enterprise Restructuring in Central and Eastern Europe, Edinburgh, 2-3 May 1997. The work for this paper formed part of the EU- funded Phare-ACE research project P-94-0739-R and the World Bank research project on Enterprise Behavior and Economic Reform in Central and Eastern Europe. Seminar audiences at the Chinese Economic Association Conference, Oxford University, the ESRC workshop on industrial economics, the London School of Economics, the Center for Political Studies and Comparative Analysis in Bucharest, University College Galway, and the EERC-Russia Annual Conference provided useful comments. Janet Mitchell helped with a number of suggestions. I would like to thank my colleagues Gilles Alfandari, John Bonin, and Qimiao Fan, with whom I have worked over a number of years on the topics covered in this paper. John Bonin gets an extra measure of thanks for his many constructive comments on an earlier draft of this paper. The usual caveat applies.