Arrears in a Transition Economy: the Mechanism of Contagion

The arrears issue has long been one of the gravest unresolved problems in the Russian economy. With stabilisation of public finances and the onset of economic growth in recent years, the severity of this problem has markedly decreased, but it is too early to claim that it has been completely resolved. This paper analyses macroeconomic aspects of arrears in terms of the hypothesis that arrears are a way of providing hidden subsidies to inefficient production companies. The results of the study point to such negative effects of arrears on the economy as decline in consumption, decrease in demand for real cash balances, encouragement of barter and offsets, veiling of the initial sources of arrears, and distortion of normal market responses to the debtor's financial problems. The latter is connected to the fact that problems of insolvent firms and entire sectors in the conditions of a system of non-payments are not confined to specific economic agents but are multiplied and spread throughout the economy, creating financial problems for other firms and sectors as well. As some sectors of the economy do not accept delays in payment for delivered products, generation of overdue payables in one sector may result in demand constraints and consumption decline in other sectors. In an environment where wage arrears are tolerated, households automatically become a creditor of insolvent sectors, reducing their own consumption. Offsets do not have any effect on the established system of hidden subsidies, as they decrease accumulated arrears only in the short term. As to barter, it can be viewed as a system of compulsory consumption of goods manufactured by domestic producers.