Inertial credit and opportunistic arrears in transition

In a transition economy, enterprise restructuring may exhibit a Laffer-curve response to tighter credit as a result of rational collective inertia. In the presence of a rigid production structure, unenforceable contracts and high adjustment costs, a contraction in credit finance subtracts more liquidity than enterprises can generate internally. Because unrestructured firms are forced to extend trade credit to illiquid buyers, an increase in their number increases the availability of forced supplier credit, in turn increasing the attractiveness of inertial behavior. As trade credit cannot be enforced, a critical mass of trade and wage arrears causes pressure for a collective bailout, thus validating inertial behavior even by reformable firms. (C) 1998 Elsevier Science B.V. All rights reserved.