Infrastructure Requirements in the Area of Bankruptcy Law

Infrastructure requirements have long played an important role in the development debate. Until recently these requirements referred to the need for improvements in roads, railways, electricity supply, telecommunications and the like. Lack of such infrastructure was seen as an important cause of a country's relative poverty. Investments in physical infrastructure seem not to have had the desired growth effects in developing countries, however. The search for the root cause of economic development has led the mainstream of economists to the system of rules for economic activity. The attention to rules and institutions became wide-spread only after the fall of communism, although Nobel prizes had been awarded to Friedrich Hayek and Gunnar Myrdahl in 1974, and Ronald Coase in 1983 for their contributions to institutional and political economics. These prices represented a recognition that institutional and political economics help explain important aspects of the organization of economic activity, but few economists took the additional step to analyze institutional factors as root causes of development and growth. An exception was Douglas North, who received the Nobel prize in 1993 after the fall communism and a renewed interest in institutional economics. This interest was to a large extent sparked by the formerly centrally planned economies' failure to start growing. Economic research began to focus on social institutions in general, and the legal system in particular, defining and securing property rights, enabling trade, and providing incentives for economic activity. Among social institutions the legal system is most directly subject to change, at least with respect to the letter of the law. Thus it is natural that policy-oriented economists would emphasize legal reform to enhance incentives leading to economic growth. Economic growth requires that old activities are phased out to make room for new ones, and that economic resources are reallocated from activities that are no longer profitable. This reallocation can occur within a variety of organizational structures, but the failure of projects and firms must be seen as an inherent aspect of growth process. The Asian crisis and a large number of more or less severe banking crises in a variety of countries during the last decades have led to questions about the ability of economic systems to deal with wide-spread failure of firms. Caprio and Klingebiel (1996) refer to the lack of procedures for banks to settle and recover claims on distressed firms as a cause of lingering and recurring banking crisis in many countries. Krugman (1994) noted before the crisis that investments kept flowing to projects of questionable value in many Asian countries. A mechanism for abandonment of non-profitable projects seemed to be missing. In the Eastern European transition economies state-owned enterprises or formerly state-owned large enterprises producing negative value could not be closed down in an orderly fashion. Laws, procedures, and court capacity was missing. Bankruptcy law was implemented in several of countries with mixed results as will be discussed below. While there may have been too few bankruptcies in Asia and Eastern Europe the argument in the Swedish policy debate after the banking crisis in the early 90s was that there were too many bankruptcies of viable firms, and that the recession therefore became unnecessarily deep. These experiences indicate that the procedures for dealing with insolvent firms may affect economic growth, and the depth and duration of crises. These procedures, and the institutions and organizations involved are viewed as the "infrastructure for bankruptcy" in this paper. At the center of the discussion stands insolvency law for firms and the court systems supporting the law, but the bankruptcy infrastructure could be considered to be much broader including or relating to a broad array of formal law and informal procedures. Informal procedures for insolvency are as important as the law and they necessarily involve banks as the major creditors. Therefore, law and regulation for financial institutions may be considered an aspect of the infrastructure for bankruptcy. From banks' point of view insolvency procedure is only one aspect of debt recovery. The procedures for debt recovery include security enforcement, which depend on property rights registration and enforcement. Other stakeholders than banks are also affected by a firm's insolvency. Employees, customers, suppliers, the state, and of course shareholders may have a stake and some kind of claim on a firm's assets. Insolvency essentially means that formal and informal contractual relations with some or all of the firm's stakeholders must be breached. Thus the variety of laws regulating contractual relations among stakeholders interact with insolvency procedures. Although bankruptcy is not a criminal offense, and debtors' prisons have been abandoned in most countries, criminal law relating to civil fraud and corruption has a bearing on insolvency procedures. Finally, personal bankruptcy procedures may affect insolvency procedures for firms even under limited liability, because a firm's owners' personal guarantees may be required by creditors. We will not cover all these aspects of the "bankruptcy-related" infrastructure but we focus, as noted on formal and informal insolvency procedures. Insolvency law will be used as a term covering both bankruptcy law and explicit law for restructuring of firms without change of ownership. Thus, bankruptcy always implies that a firm as a whole, or its assets, are offered for sale to new owners. While lawyers often focus on fairness and equity in their discussion of insolvency law, economists are concerned with economic efficiency, growth, and business cycle fluctuations. Wood (1995) notes that there are wide differences in insolvency law among countries based on differences in legal doctrines, but there is no obvious relation between legal doctrine and economic growth or economic wealth. Insolvencies happen everywhere but practices vary with respect to law, informal procedures, effectiveness, and predictability of procedures. Lack of bankruptcies does not necessarily mean lack of insolvency procedures. Informal work-outs are common, and informal procedures are well established in many countries. On the other hand, the existence of insolvency law does not necessarily imply that it has much influence on procedures, and in some countries procedures are neither well established nor predictable. Legal traditions and cultural factors affect the attitude to bankruptcy, and procedures for dealing with insolvency. Political factors affecting objectives of formal law and informal procedures vary, as well, across countries and time. Political influences on the banking system, and concentrated ownership of corporations forming strong vested interests can affect the allocation of credit and state subsidies in such a way that insolvency procedures are seriously undermined. We return to these issues. The paper proceeds in Section 2 with a discussion of the economic role of insolvency procedures for efficiency of resource allocation, economic growth, and the depth and duration of crises. Efficiency of procedures are discussed further in Section 3 where a distinction is made between ex ante (at the time financial commitments are made) and ex post (at the time of insolvency) efficiency. The purpose of Section 4 is to classify procedures in an economically meaningful way. It is common to distinguish between creditor-and debtor oriented procedures. More interesting from an economic viewpoint is whether procedures tend to lead to "excessive survival" or "excessive shut-downs" of firms. These distinctions do not necessarily coincide. In Section 5, we look at the wide differences in restructuring laws across countries. Stylized facts about the performance of laws in different countries in terms restructuring vs shut-down, and survival vs shutdown are presented in Section 6.. Stylized facts from developing countries point to the important issue of enforcement of law. Two aspects of enforcement are discussed in Section 6. First, the legal system may be ineffective in its application of existing law. Second, political influences on the banking system in particular may render insolvency procedures irrelevant. The strongest policy implications refer to enforcement. This and other aspects of design of formal insolvency procedures and their associated infrastructure are discussed in Section 8. The basic question whether or why insolvency law is needed at all is also asked.

From plan to market : patterns of transition

In analyzing the transitional experience of countries in Central and Eastern Europe (CEE) and the former Soviet Union (FSU), the authors find strong common patterns for countries at similar stages of reform despite differences in initial conditions. To establish rankings, the authors create a reform index combining the intensity and duration of economic liberalization. Freeing domestic prices is one element of reform captured by the index; it was needed to enable governments to cut subsidies and restore macroeconomic balance. Other dimensions of reform captured by the index are liberalization of external trade, including foreign currency convertibility, and facilitation of private sector entry through privatization of state enterprises and improvements in the environment for private sector development. Some countries moved faster on reform than others, and one major reason appeared to have been the pace of political liberalization. Liberalization has, indeed, encouraged capital and labor to reallocate from industry toward services, many of which were previously repressed; and the repressed sectors fueled the return to positive growth in fast reformers. For slow reformers, the main problem in achieving stabilization has been the continued monetization of fiscal and quasi-fiscal deficits, associated with attempts to maintain employment in the old system. Among the policy implications are: 1) stabilization is a priority for the resumption of growth, and this requires extensive liberalization; 2) stabilization is made difficult by output contractions in the early stages of liberalization, by limited external financing, and by very large depreciations of the real exchange rate; and 3) there is no evidence that a slower pace of reform strengthens the fiscal position of slow reformers; their consolidated fiscal and quasi-fiscal deficits are quite high.Insurance&Risk Mitigation,Economic Conditions and Volatility,Environmental Economics&Policies,Economic Theory&Research,Insurance Law,Economic Conditions and Volatility,Economic Theory&Research,Environmental Economics&Policies,Insurance&Risk Mitigation,Insurance Law

Economic growth in South Africa since 1994

South Africa's democratic transition in 1994 created expectations of a dramatic turnaround in the economic performance. Trade and financial sanctions and internal political opposition to the apartheid government had contributed to the poorest ten-year growth performance (1984 - 1993) since the Second World War and the removal of these constraints was widely expected to transform the country's economic performance. This paper measures the realised performance of the economy over this decade along a number of dimensions, including: economic growth, its constituent parts and proximate causes and economic stability.economic growth, South Africa, 1994

Limits of Policy Intervention in a World of Neoliberal Mechanism Designs: Paradoxes of the Global Crisis

The current global context poses several paradoxes: the recovery from the 2009 recession was not a recovery; investment, normally driven by profit rates, is lagging and not leading economic activity; the crisis is global but debate involves sub-global levels; and public safety-nets, which have helped to stabilize national income, are being cut. These paradoxes can be traced, in part, to the impact of the “truce” that followed the Keynesian-Monetarist controversy on economists’ ideas about policy activism. This implicit “truce” has removed activist macro policy from discussion, and shifted attention toward institutions as mechanisms for solving game-theoretic coordination problems. Policy activism then centers on how the “agents” (nations) can achieve optimal use of their available resources (or optimal access to resources) at the global level; and this involves creating and fine-tuning compacts – neoliberal mechanism designs – that can capture rents and attract globally mobile capital. This approach leads economists to see the key problem in the current global crisis as fixing broken neoliberal mechanisms. However, a global economy dominated by mechanisms that feed on aggregate demand without generating it faces the prospect of stagnation or collapse.Neoliberal mechanism design, Policy activism, Keynesian- Monetarist controversy, Globalization, Capital mobility, Hyman Minsky, Bradford De Long

The Case of the Missing Market: The Bond Market and Why It Matters for Financial Development

Over the last decade interest in the role of finance in economic growth has revived. Building from the pioneering work of Goldsmith (1965) and the insights of Shaw (1973) and McKinnon (1973), the more recent work examines the role of financial institutions and financial markets in corporate governance and the consequent implications for economic growth and development. Levine (1997) and Stulz (2000) have provided excellent reviews of this literature and Allen and Gale (2000) have extended it by developing a framework for comparing bank-based financial systems with market-based financial systems. Although the literature addresses "capital markets," on closer inspection the main focus is really equity markets. Bond markets are almost completely overlooked. Although the omission of the bond market is not defended in the literature, one could argue that it does little violence to reality. As Table 1 shows, in most emerging economies in Asia, bond markets are very small relative to the banking system or equity markets. Moreover, the most striking theoretical results flow from a comparison of debt contracts with equity contracts and at a high level of abstraction bank lending can proxy for all debt. In any event, data are much more readily available for equity markets and the banking system than for bond markets, even in the United States.

Payroll taxes for financing training in developing countries

In most developing countries, the major programs of vocational training and manpower-skill development are financed from general revenues. Increasingly, however, earmarked payroll taxes are employed to finance training. This paper summarizes international experience with these payroll taxes, drawing the distinction between the more traditional revenue raising schemes on the lines of the Latin American model and the newer levy-grant schemes. Drawing upon experience of payroll taxes in advanced economies it discusses the incidence of these taxes in developing countries and presents an economic rationale for their growing use, as part of a reverse social security scheme. The paper concludes that the desirability of using payroll taxes to finance training, compared to other alternatives available to developing country governments, is likely to be contingent upon the stage of a country's development.Public Sector Economics&Finance,Economic Theory&Research,Environmental Economics&Policies,Tertiary Education,Labor Standards

Trade finance in crisis : should developing countries establish export credit agencies ?

New data on export insurance and guarantees suggest that publicly backed export credit agencies have played a role to prevent a complete drying up of trade finance markets during the current financial crisis. Given that export credit agencies are mainly located in advanced and emerging economies, the question arises whether developing countries that are not equipped with these agencies should establish their own agencies to support exporting firms and avoid trade finance shortages in times of crisis. This paper highlights a number of issues requiring attention in the decision whether to establish such specialized financial institutions. It concludes that developing countries should consider export credit agencies only when certain pre-requirements in terms of financial capacity, institutional capability, and governance are met.Debt Markets,Emerging Markets,Access to Finance,Banks&Banking Reform,Financial Intermediation

Political economy of policy reform in Turkey in the 1980s

Turkey's adjustment experience was a tremendous success in terms of structurally reorienting the economy. The share of output for export rose from 5 percent in 1979 to 23 percent in 1989, and real output roughly doubled. The financial markets opened and have developed depth and sophistication. The program failed to reduce fiscal deficits, inflation, income inequality, and the size of the inefficient public enterprise sector, but the transformation of trade and finance fundamentally altered the context of the problems, changing their effects on the private sector and changing the government's options for dealing with them. The first phase of economic adjustment was sustained, although not initiated, in an authoritarian context, but the Turks restored democracy when the agenda for reform was incomplete. The Motherland Party (ANAP) won office on the platform of economic success and eventally lost partly because of the failure of economic policy. ANAP's electoral defeat in 1991 did not mean, however, the demise of the pro-structural adjustment or the pro-liberalization coalitions. The long period of ANAP rule helped consolidate reforms to such a degree that all of the principal parties agreed on a broadly similar economic program. The ideological differences between the left and the right - a state-directed versus a marked-oriented economy - substantially diminished. The reforms of the early 1980s greatly reduced the importance of rent-seeking, particularly through foreign trade, but patronage politics became widespread again in the second half of the decade. The initial strength ANAP derived from privileged access to state resources progressively became a disadvantage, creating resentment and reaction among the populace. One source of discontent was the over-invoicing of exports (that is, fictitious exports), designed to take advantage of favorable export subsidies, and the government's failure to discipline or penalize the companies involved. This jeopardized attempts to build a pro-export coalition, and some key features of import substitution continued. The authors attribute the failure of Turkey's macroeconomic policies in the late 1980s to the government's failure tocultivate popular support for macroeconomic stability; to the top bureaucrats'lack of autonomy to counteract political pressures to expand the fiscal deficit; and to the continuation of top-down individualistic linkages between policymakers and key economic interests.National Governance,Parliamentary Government,Politics and Government,Environmental Economics&Policies,Economic Theory&Research

Beyond Keynesianism : global infrastructure investments in times of crisis

As the world recovers only slowly from the 2008 financial crisis and Europe is facing a looming debt crisis, concerns have increased that the"new normal"-- a period of high unemployment, low returns on investment, high risks, and low growth -- may become protracted in advanced economies. If growth remains weak, unemployment rates and debt levels will be slow to recede. Consequently, the global recovery may continue to be fragile for years to come. What the world needs now is a growth-lifting strategy. This strategy could take the form of a global infrastructure initiative. Since debt levels are high, governments in the United States and Europe could increase demand and support growth through investments in bottleneck-releasing infrastructure projects that are self-financing. An infrastructure initiative should, however, go beyond the borders of advanced countries and include developing countries. Economic and social returns to infrastructure investments tend to be high in developing countries, which have become increasingly important drivers of global growth. At the same time, infrastructure investments require capital goods, most of which are produced in high-income countries. Scaling up infrastructure investment in developing countries could therefore help generate a virtuous cycle in support of a global recovery.Transport Economics Policy&Planning,Debt Markets,Banks&Banking Reform,Emerging Markets,Access to Finance