MODEL OF AN ECONOMY WITH WIDESPREAD CORPORATE INSOLVENCY
THE PROBLEM OF SECONDARY INSOLVENCY
A serious problem which the Czech economy had previously experienced in the early 1990s resurfaced in 2008 — "secondary" corporate insolvency.
Secondary insolvency is the situation where a debtor is unable to meet its obligations because one or more of its customers is insolvent. A proportion of debtors become "non-payers” i.e. entities with overdue debts.
The primary cause of the widespread secondary insolvency in the 1990s was the difficult situation of companies privatized by direct methods "on debt”. This gave rise to high initial debt levels and also high financial costs.[1]
Late payment of debts was initially tolerated by banks (which is why this period is sometimes referred to as "banking socialism") and by trading partners. To begin with, state-owned banks (i.e. the majority of banks) did not want to hinder the economic transformation process and willingly provided loans even to ailing companies. This ended when loan defaults started to put the banks themselves in danger. In 1993, discretionary constraints on the volume of bank loans were introduced. By then, however, most businesses were insolvent and it was difficult for banks to distinguish between primary and secondary insolvency.
Another cause of secondary insolvency was poor legislation, which (especially in the early days be for e a bankruptcy law was adopted[2]) did not give companies enough options to enforce their claims. The strongly monopolistic structure (inherited from the centrally planned economy) also played a role, as companies often had no alternative markets and were dependent on the survival of their sole customer.
The insolvency in the Czech economy in the early 1990s also had macroeconomic causes — declining economic efficiency combined with budget spending cuts in 1993.[3]
The problem of widespread secondary insolvency in the Czech economy reemerged in 2 008.[4] More and more firms got into difficulties paying their debts on time and the volume of overdue debt increased sharply.[5] The cause of this snowball effect was similar to that in the early 1990s — a sudden decrease in banks' willingness to lend (albeit for different reasons — this time fears about the oncoming crisis).[6]
A firm has options to deal with secondary insolvency:
• insurance with a specialized insurance company offering bad debt insurance cover. However, there are very few such specialized insurers at present[7] and the low supply is leading to relatively high premiums;
• a bank bridging loan to deal with problems caused by unpaid claims. The problem is that the bank will often not grant such credit.[8] Even if it does, the creditor will be left with both a doubtful debt (with high collection costs) and a new loan with the bank;
• a change in the VAT payment regime (as proposed by the Chamber of Commerce in January 2009);
• discounts for paying on time.
The third option can be viewed (and has been proposed) as a temporary measure. The first two options are dependent on unrestricted availability of funds both now and in the future. If secondary insolvency keeps growing and banks keep heading for a credit crunch (which will also affect insurance companies), we will be left only with the fourth option, i.e. discounts for paying on time.
As in the 1990s, there will be dual pricing and two types of firms in the economy — "non-payers" and "payers" (firms that duly meet their obligations). Each company will decide what to do with its output, i.e. whether to sell it:
• to non-payers at a higher price (which will boost the company's book profit), or
• to payers at a lower price (which will boost funds available for wages and other immediate payments).
From the microeconomic perspective, in an economy where secondary insolvency is widespread firms are under pressure from two sides: one the one hand they need cash to pay wages and meet other immediate obligations, and on the other hand they are trying to avoid book losses, which could cause the bank to lose patience with overdue loan payments.
The decision on the distribution of output between paying and non-paying customers is therefore a two-criteria problem that is difficult to solve by standard microeconomics in the homo economicus paradigm. Our generalized micro-economic model allows us to find a compromise. However, it does not involve vector optimization. There is just one criterion: maximization of the probability of survival, i.e. maximization of the probability of simultaneous avoidance of all risks to the agent's economic survival.
- [1] See Mlčoch, L.: Privatizace bez kapitálu. Finance a úvěr 54, 11–12(2004): 560–63.
- [2] See Hlaváček, J., Tůma, Z.: Bankruptcy in the Czech Economy. In Bankruptcy and the Post-Communist Economies of East Central Europe, K. Mizsei. New York: Institute for East-West Studies, 1993.
- [3] See Bulíř, A.: Platební neschopnost: problém “reálné” nebo “peněžní” ekonomiky? Politická ekonomie 42, 2(1994): 155–70.
- [4] See Mertlík, P.: Česku hrozí druhotná platební neschopnost firem. (radio.cz/cz /clanek/111897 [08-01-2009 07:00 UTC]), or Dvořák, J.: Platit faktury včas se moc nenosí. (mesec.cz/clanky/platit-faktury-vcas-se-moc-nenosi/ [15-02-2009 08:11 UTC]).
- [5] According to Petr Kužel, President of the Czech Chamber of Commerce (see komora.cz /hk-cr/hlavni-zpravy/art_28565 [16-02-2009 11:20 UTC]), “According to the latest figures claims were up by 40 per cent and past-due claims by as much as 50 per cent at the start of 2009.”
- [6] “Banks bear part of the blame for the current situation. With their restrictive policies and choking of funds for the business sector they are making the situation worse for businesses. It's a vicious circle and there's no escape.” (ibid.)
- [7] At the start of 2009 only four insurers were providing such insurance in the Czech Republic: Atradius, Coface Austria Kreditversicherung, Euler Hermes and Komerční úvěrová pojišťovna EGAP.
- [8] The government also feels that credit needs to be made more available to SMEs. In February 2009 it increased the bank loan guarantee capacity of the Czech-Moravian Guarantee and Development Bank by CZK 3 billion. This is intended to make banks more willing to lend. For this instrument to be effective, the amount needs to be raised considerably.
