University of Rijeka Faculty of Economics – Partner in EU Integration Jean Monnet Ad personam Chair

University of Antwerp Jean Monnet Centre of Excellence

University of Ljubljana – Faculty of Economics – Chair Jean Monnet Institute CEDIMES Paris

CEDIMES Rijeka University of Belgrade – Faculty of Economics University of Sarajevo – Faculty of Economics

University "St. Cyril and Methodius" in Skopje – Faculty of Economics University of Podgorica – Faculty of Economics

University of Dokuz Eylül - Faculty of Economics and Administrative Sciences "Aleksandër Moisiu" University of Durrës

Ternopil National Economic University Academy of Public Administration Chişinău University of Priština, Faculty of Economics

ECONOMIC INTEGRATIONS, COMPETITION AND

COOPERATION

Conference Proceedings

Editors: Vinko Kandžija Andrej Kumar

Editors: Vinko Kandžija Andrej Kumar

ECONOMIC INTEGRATIONS, COMPETITION AND COOPERATION Accession of the Western Balkan Countries to the European Union

Editorial Board:

Skender Ahmeti University of Priština, Faculty of Economics, Kosovo Claude Albagli University of Paris XII (Val de Marne), France

Heri Bezić University of Rijeka, Faculty of Economics, Croatia Alain Bienaymé University of Paris IX (Dauphine), France Borislav Boričić University of Belgrade, Faculty of Economics, Serbia

Bardhyl Ceku "Alexandër Moisiu" University of Durres, Albania Evrard Claessens University of Antwerpen, Europacentrum Jean Monnet, Belgium Maria Delivanis CEDIMES Komotini, Greece

Ljubomir Drakulevski University "St. Cyril & Methodius" in Skopje, Faculty of Economics, Macedonia Milorad Jovović University of Podgorica, Faculty of Economics, Montenegro

Yevhen P. Kachan Ternopil National Economic University, Ukraine Vasile Marina Academy of Public Administration Chişinău, Moldova Mit'hat Mema "Alexandër Moisiu" University of Durres, Albania

Dušan Mramor University of Ljubljana, Faculty of Economics, Slovenia Mario Pines University of Trieste, Italy

Christos Pitelis University of Cambridge, UK Alain Redslob University of Pantheon-Assas (Paris II), France

Željko Šain University of Sarajevo, Faculty of Economics, Bosnia & Herzegovina Öcal Usta University of Dokuz Eylül, Faculty of Economics and Business Administration,

Turkey

Publisher and General Editor: University of Rijeka, Faculty of Economics, Ivana Filipovića 4, HR-51000 Rijeka, Croatia

For the Publisher: Heri Bezić Technical Editor: Vinko Zaninović First Edition (2013): 200 copies

Design by: Tomislav Galović

ISBN 978-953-7813-16-1

A CIP catalogue record for this book is available from the University Library in Rijeka under number 130230017

CONTENTS

INTRODUCTION.............................................................................................................. XI

PART I: THEORY AND PRACTICE OF ECONOMIC INTEGRATION

Hrvoje Jošić Mislav Jošić WELFARE ENHANCING CUSTOMS UNION: KEMP-WAN ISSUE.......................3

Nina Ponikvar Katja Zajc Kejžar Barbara Mörec FINANCIAL CRISIS AND FINANCIAL CONSTRAINTS OF THE FIRMS: THE ROLE OF FIRM-SPECIFIC AND INDUSTRY-SPECIFIC FACTORS........... 10

Mario Pines MONETARY AND FISCAL POLICIES: LIMITS, FALLOUTS AND REMEDIES.........................................................................................................................26

Jean-Pierre Olsem CLEAR FEATURES AND UNCERTAINTIES IN THE DAWNING NEW ECONOMIC SYSTEM......................................................................................................41

Hrvoje Jošić Mislav Jošić STATIC AND DYNAMIC EFFECTS OF CUSTOMS UNION CREATION..............53

Jernej Mencinger Aleksander Aristovnik Miroslav Verbič PUBLIC DEBT, DEBT TRAP AND ECONOMIC GROWTH: AN EMPIRICAL INVESTIGATION FOR THE EUROPEAN UNIONAND OECD COUNTRIES...............................................................................................66

Radmila Jovančević Tomislav Globan THE IMPACT OF FDI FLOWS ON ECONOMIC CONVERGENCE IN CENTRAL AND EASTERN EUROPE...........................................................................79

III

PART II: REGULATORY ENVIRONMENT OF THE EU;EU AND NATIONAL PERSPECTIVE

Nevia Čičin-Šain Sonja Cindori PROPOSED AMENDMENTS TO THE EU TAXATION SYSTEM OF INCOME DERIVING FROM INTEREST................................................................97

Sanja Gongeta COMBATING LATE PAYMENTS IN COMMERCIAL TRANSACTIONS – THE CASE OF CROATIA................................................................................................116

Barbara Mörec Lea Peterka THE MANDATORY MULTILATERAL SET-OFF OF PAYABLES AND RECEIVABLES IN SLOVENIA – A CASE STUDY.....................................................128

Renata Perić Emina Jerković PERSONAL INCOME TAX SYSTEM: PROVISIONS REGARDING FAIRNESS AND EQUALITY..........................................................................................143

Antonija Zubović Mihaela Braut Filipović SIGNIFICANCE OF THE CISG FOR FRANCHISING AND DISTRIBUTION AGREEMENTS IN THE EU MARKET.........................................................................154

Edita Čulinović Herc Nikolina Grković IMPACT OF THE MADOFF SCANDAL ON THE FORTHCOMING UCITS V DIRECTIVE...................................................................................................... 168

PART III: WESTERN BALKANS; TRADE, COOPERATION AND EUINTEGRATION PERSPECTIVE

Jiří Dušek Lubomír Pána CURRENT SITUATION OF TURKEY’S ACCESSION TO THE EUROPEAN UNION.........................................................................................................185

Nebojša Savić Goran Pitić Snežana Konjikušić COMPETITIVENESS OF WESTERN BALKANS IN THE PROCESS OF EU INTEGRATION.................................................................................................................195

IV

Gligor Bishev Dragica Odzaklieska EFFECTS OF THE GLOBAL ECONOMIC CRISIS ON THE ECONOMIES OF THE WESTERN BALKANS......................................................................................210

Boban Stojanović Jelena Stanković Vesna Janković-Milić EUROPEAN INTEGRATION INFLUENCE ON BUSINESS CLIMATE IN SERBIA - PERCEPTIONS AND EXPECTATIONS OF BUSINESS COMMUNITY....................................................................................................................221

Bogdana Vujnović-Gligorić Sanel Jakupović Nataša Zrilić BOSNIA AND HERZEGOVINA IN THE PROCESS OF FINANCIAL LIBERALIZATION...........................................................................................................235

PART IV: EU ENLARGEMENTS IN BUSINESS PERSPECTIVE

Anita Radman Peša Sanjin Stanković THE ROLE OF MoU AND ITS INSTRUMENTS BETWEEN CENTRAL BANKS OF TRANSITIONAL COUNTRIES AND INTERNATIONAL BANKS IN THE LIGHT OF FINANCIAL INTEGRATION......................................................247

Edita Bečić Matej Lahovnik AGENCY THEORY AND FRANCHISING: A LITERATURE REVIEW.................258

Dragan Mišetić Marko Tomljanović Tomislav Kandžija THE ROLE OF MANAGEMENT IN THE ACCESSION PROCESS OF B&H TO THE EU.............................................................................................................................. 268

Vera Boronenko Jelena Lonska WHY BUSINESS SUPPORT INSTRUMENTS ARE NOT WIDELY USED BY SMEs? CASE OF LATVIA...............................................................................................287

Mirko Palić Ivan Kovač Boris Sruk COOPERATIVE BUYING AS A SOURCE OF COMPETITIVE ADVANTAGE ON THE CROATIAN FMCG RETAIL MARKET.......................................................306

V

Hrvoje Katunar Dara Ljubić VALUE OF CAPITAL IN FAIR VALUE MEASUREMENT......................................314

PART V: CHALLENGES OF THE EU ENLARGEMENT

Gordana Đurović Nikola Milović EU ENLARGEMENT POLICY FRAMEWORK FOR THE WESTERN BALKANS: SIX “C” PRINCIPLES AND THE NEW NEGOTIATING RULES…...325

Aleksander Aristovnik TECHNICAL EFFICIENCY OF PRIMARY EDUCATION: A COMPARATIVE ANALYSIS OF EU AND OECD COUNTRIES..........................339

Marino Golob Martin Golob EU ACCESSION OF THE REPUBLIC OF CROATIA AND ITS IMPLICATIONS ON THE CROATIAN INSURANCE MARKET.............................348

Mirko Tatalović Jasmin Bajić Srećko Šimunović FITTING THE FLEET AND THE SERVICE TO THE SEE MARKET DEMAND FUTURE OF SMALL EUROPEAN AIRLINES.........................................356

PART VI: LA THÉORIE ET LA PRATIQUE DE L’INTÉGRATIONÉCONOMIQUE

Maria Negreponti-Delivanis LA FIN DE LA ZONE EURO: LE NORD DE L’EUROPE CONTRE SON SUD......371

Srdjan Redzepagic Jovan Zafiroski Vinko Kandžija LE MECHANISME DE SUPERVISION UNIQUE – LE PREMIER PAS VERS UNE UNION BANCAIRE EFFICACE............................................................................388

Elisabeth du Réau L’UNION EUROPEENNE ET LES BALKANS, ENJEUX GEOPOLITIQUES ET PROCESSUS D’ADHESION......................................................................................400

Alain Redslob UNION EUROPEENNE, CAP SUR 2020. AMBITIONS ET CONTRAINTES..........412

VI

Mohamed Bouhezza Salah Salhi LE PARTENARIAT AVEC L’UE : CAS DE L’ALGÉRIE.........................................423

Jean-Paul Guichard LE SCENARIO DE LA FIN DES FIRMES MULTINATIONALES...........................443

PART VII: INTEGRATION POLICIES: CASE STUDIES

Srdjan Redzepagic Xavier Richet Vinko Kandžija CATCHING-UP AND INTEGRATION IN NEW AND FUTURE EU MEMBER STATES THROUGH FDI.................................................................................................453

Ivan Tolić Christian Panjol Tuflija Marko Tomljanović URBAN POLICIES AND POLICY OF CITY PUBLIC TRANSPORT OF THE REPUBLIC OF CROATIA IN THE LIGHT OF POTENTIAL USE OF EU FUNDS...........................................................................................................473

Heri Bezić Tomislav Galović REVEALED COMPARATIVE ADVANTAGES OF THE PHARMACEUTICAL INDUSTRY IN A GROUP OF SELECTED COUNTRIES...........................................487

Alen Host Vinko Zaninović Tina Mirkov REAL CONVERGENCE AND PERSPECTIVE OF INTEGRATION – THE ANALYSIS OF THE CROATIAN INTRA-INDUSTRY TRADE.......................504

PART VIII: TRADE LIBERALIZATION AND REGIONAL COOPERATION

Irena Kikerkova TRADE LIBERALIZATION UNDER CEFTA 2006 – THE CHALLENGE OF ELIMINATION OF NONTRADE BARIERS.................................................................535

Jiří Dušek IMPACT OF WTO MEMBERSHIP AND EU MEMBERSHIP ON FOREIGN TRADE OF THE CZECH REPUBLIC........................................................548

VII

Michele Bertoni Bruno De Rosa Guido Grisi MANAGERIAL CONTROL AND COST ACCOUNTING SYSTEMS IN NATIONAL HEALTH CARE SERVICES: A CASE STUDY......................................560

Željana Aljinović Barać Tina Vuko Tonči Vučak EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY: EVIDENCE FROM CROATIA......................................................578

PART IX: WORKSHOP for Doctoral Students of Central and South-EastEuropean PhD Network (CESEENET)

Kenan Spaho CORPORATE SOCIAL RESPONSIBILITY, KEY FACTOR OF COMPANY SUCCESS............................................................................................................................593

Miha Cimperman MODELING THE PROCESS OF ELDERLY TELEMEDICINE SERVICES ACCEPTANCE..................................................................................................................603

Dario Maradin Nina Ponikvar Ljerka Cerović RENEWABLE ELECTRICITY IN CROATIA AND SLOVENIA FROM THE ASPECT OF THE EU ENERGY AND CLIMATE TARGETS FOR 2020.................610

Tanja Fatur THE ANALYSIS OF CAUSALITY BETWEEN GDP, CO2 EMISSIONS AND RENEWABLE ENERGY CONSUMPTION: THE CASE OF CROATIA..................623

Metka Kogovšek Mojca Kogovšek GLOBALIZATION AND HIGHER EDUCATION: A NEW PARADIGM FOR EDUCATIONAL MANAGEMENT.................................................................................636

Mojca Kogovšek Metka Kogovšek HUMAN CAPITAL AS THE SOURCE OF GREATEST COMPETITIVE ADVANTAGE IN KNOWLEDGE SOCIETY: AGEING WORKFORCE AND SKILL SHORTAGES........................................................................................................650

VIII

Aleksandar Zdravković STOCHASTIC APPROACH TO DEBT SUSTAINABILITY ANALYSIS APPLIED TO SERBIA......................................................................................................662

PART X: ROUND TABLE “ABSORPTION EXPERIENCE OF SLOVENIAAND SEE COUNTRIES”

Alen Host Vladimira Ivandić ABSORPTION CAPACITIES FOR EU FUNDS……………………………………... 679

Tomislav Kandžija Marko Tomljanović CONVERGENCE INSTRUMENTS OF WESTERN BALKAN COUNTRIES….… 694

Margarita Shivergueva L’ABSORPTION DES FONDS STRUCTURELS ET LA COMPETITIVITE DE L’ECONOMIE BULGARE…………………….………………………………………. 713

Jamila Jaganjac USE OF PRE-ACCESSION FUNDS AND EXPERIENCES IN IMPLEMENTATION OF WB COUNTRIES……………....………………………… 727

PART XI: WORKSHOP “ABSORPTION EXPERIENCE OF CROATIA ANDWESTERN BALKAN COUNTRIES”

Ivana Maletić Davor Vašiček Jelena Kandžija CROATIAN EXPERIENCE IN MANAGEMENT AND ABSORPTION OF THE EU PRE-ACCESSION FUNDS…………………………………..………………………

737

Margarita Shivergueva L’ABSORPTION DES FONDS STRUCTURELS ET LA COMPÉTITIVITÉ DE LA ÉCONOMIE BULGARE………………………………….…………………………

755

Lucica Matei Corina Lazar LA RATIONALISATION ADMINISTRATIVE ET LA PERFORMANCE ECONOMIQUE DANS CERTAINS ÉTATS DE L’EUROPE DU SUD-EST…….... 774

IX

Vladimira Ivandić Igor Cvečić EU FUNDS ABSORPTION PROBLEMS – EXPERIENCE SO FAR………………. 791

Vinko Kandžija Marko Tomljanović Tomislav Kandžija POSSIBLE ECONOMIC EFFECTS OF EU CONVERGENCE INSTRUMENTS ON WESTERN BALKANS COUNTRIES…………………………………………….

808

Jamila Jaganjac BOSNIA AND HERZEGOVINA EXPERIENCE IN THE PROCESS OF INTRODUCING DECENTRALIZED IMPLEMENTATION SYSTEM – FROM IPA I TO IPA II……………………………………………………………..................... 821

X

INTRODUCTION

With the beginning of the world financial crisis in autumn 2008, the EU started to slide into increasingly complex economic, monetary, sovereign debt and formal functioning crises. What at first sight seemed just as a financial market crisis “imported” from the USA, gradually developed into a complex crisis of the EU functioning and its future. In the second part of 2012, the EU financial and economic crises are still present in their full and growing complexity. The impacts of the EU crisis brought about a strong unemployment growth in a number of EU member states. The crisis is further characterized by low, decreasing or even negative growth rates. The slow economic growth in EU is combined with the PIIGS group sovereign debt crisis. Unfortunately, the sovereign debt crisis gradually spread further to Slovenia, Cyprus and even some other EU members. The so-called core EU countries, in addition to the problems of the EU periphery, started to experience increasing economic slowdown in 2012. To the surprise of many, the general neo-liberal approach mostly focused on fast and strong reduction in national budget expenses, has not brought positive results neither within the EU core countries nor within the EU periphery. In the Netherlands, for example, the third quarter of 2012 brought a sharp drop in economic growth as well as in Germany, where it is also slowing down.

The policies and proposals to solve EU growth, employment, monetary, financial, and integration functional problems are based on strategies developed and advocated by the central EU nations, predominantly Germany, France, and Great Britain. The vision on how to handle the crises in France was partially amended after the 2012 presidential election. The neo-liberal attitude was partially replaced by more state intervention hoping to support the new economic growth. Nevertheless, towards the end of 2012, the main concept of the economic policies proposed for solving the complex EU crisis is still based on the so called neo-liberal approach.

The EU population and even the politicians, in more and more member states, are increasingly questioning the actual ability of the EU to further create and secure national welfare growth. Countries with problems of sovereign debt and unemployment and even those relatively successful EU member states are faced with an increasing number of citizens expressing their disappointment or are even rejecting the economic and employment results brought about by the functioning of the EU integration in last few years. The growing disappointment towards the EU achievements in combating the crises among the citizens of the EU presents a danger for the stability and sustainability of the EU in the future.

XI

There are two evident levels of actions and activities necessary to change the negative trends. One level encompasses analyzing and providing explanations on the different specific aspects of the functioning of EU integration. These aspects include business development opportunities, realities of the EU internal market operation and impacts, methodologies and model implementations aimed at getting better insight into the general EU economy as well as the specific functioning of national economies and other specific questions regarding formal institutional change, enlargement or deepening of the EU. Besides such specific and important topics which should considerably help national governments and the EU to improve efficiency of their actions in dealing with the crisis, there is a second level of needed changes in improving EU and national efficiency in their coping with the crisis. This second level is related to the doctrinal approach of the EU and national attitude in terms of the level of economic action in overcoming the crisis. The available data and results of previous years show and prove that the neo-liberal doctrinal approach in solving the EU crisis was not effective. The concept is related to the supply-side economics or to the so-called Reaganomics, dating from the 1980s, when it was first implemented. The present neo-liberal approach used in EU economic practices was developed and implemented in the period when impacts of economic globalization started to be recognized. Theodor Levitt, in his famous 1983 article, was the first to point to the changes created by economic globalization. Among other, these changes included fast technological change and growing importance of innovations and productivity growth, which in addition, to the growing openness of national economies lead to an increasing and more complex competitive environment. Combining this description of economic impact created by globalization and Schumpeter’s book from 19421, we might suggest that the neo-liberal doctrine used in the EU today is not best suited for solving current problems. Schumpeter stressed the importance of institutions, entrepreneurship, and technology as the three major engines in economic growth and success. These elements are important in the functioning of global economy and are not a part of the neo-liberal approach used in EU practice. Today, based on Schumpeter, innovation economics is being increasingly appreciated as the doctrine on which to successfully lead the economy in the globalized world.

In this monograph, we have collected papers which are important as they allow for a better understanding and eventually faster improvement and solutions to EU problems regarding both mentioned levels. The majority of articles analyze a number of very specific topics and problems related to the EU deepening and enlargement developments in the wake of the global and EU crises. A smaller number of articles is related to the issues of assessing and viewing the potentials of the mentioned new Innovation Economics doctrine as the conceptual background for coping with the different aspects of

1 Schumpeter, Joseph; Capitalism, Socialism, and Democracy , New York: Harper, 1942

XII

the EU crisis. Among these papers there are also those discussing the formal and legislative EU environment. They refer to the aspect of institutional efficiency, which is one of the cornerstones in the today’s understanding of Innovation Economics. We hope that the collected and published articles within this book will provide an insight and thus a better understanding of a number of specific developments in the EU as well as those in EU candidate and potential candidate countries. The articles will hopefully additionally help develop critical and objective attitude towards present policies used in the EU crisis. We hope that the book will stimulate development and creation of new ideas and a vision of a brighter and more economically effective future of the European Union.

Vinko Kandžija Andrej Kumar

Rijeka – Ljubljana, November 2012

XIII

PART I

THEORY AND PRACTICE OF

ECONOMIC INTEGRATION

Mislav Jošić University of Zagreb, Faculty of Economics and Business, Zagreb, Croatia Hrvoje Jošić University of Zagreb, Faculty of Economics and Business, Zagreb, Croatia

WELFARE ENHANCING CUSTOMS UNION: KEMP-WAN ISSUE

ABSTRACT This paper ponders all aspects of Customs Union (CU) formation in order to explain welfare effects on countries involved. Viner's classical model of FTA/CU creation leaves more space for interpretation of welfare issues due to ambiguity of trade creation and trade diversion effects. An absence of tariffs in intra trade guarantees positive welfare effects for integrating countries through higher volume of trade. On the other side, trade diversion from the most efficient producer outside the CU to the less efficient producer in the CU leads to suboptimal allocation of scarce resources. Net effects are the ones that count and are the sum of trade creation and trade diversion effects. In this respect Kemp-Wan theorem is introduced as a mean of achieving Pareto improvement through free trade and lumpsum compensation scheme for all countries that form Customs Union and the world itself. According to Kemp-Wan proposition there exists common tariff vector that leads to competitive equilibrium in which each individual country is not worse off than before the customs union creation. Although theoretically feasible compensation scheme through transfers lacks political approval due to the fact that not all countries would be willing to make trade concessions without reciprocity. Special emphasis in this paper is set on accession of the Western Balkan countries to the European Union and possible consequences that may arise. Moreover, the case of Croatia is analysed as a most probable EU country member in a near future. Keywords: customs union, trade creation, trade diversion, Kemp-Wan theorem,

lumpsum transfers JEL classification: F14, F15 1. INTRODUCTION The need for country integration in one common trade area started with the research lead by Canadian economics Jacob Viner, an advocate of Chicago School of Economics. His first paper on the issue of customs union formation was published in 1950 (Viner, 1950) as a result of new trade rules incorporated in GATT in 1948. So far, tariffs were used as a common tool of protection in international trade resulting in

3

distortions in the goods and input markets as well. International trade theory suggests that free trade should be the first best solution for all countries involved in trade. In this respect competitive markets lead by Mr. Smith’s “invisible hand” should allocate resources in a Pareto optimal way. This postulate is known as the First fundamental theorem of welfare economics and is valid only under certain assumptions. These assumptions rely on ideal conditions that aren’t always met in practice.

Positive effects of trade integrations are known as trade creation effects that arise as a result of tariff nullification. Lowering tariffs to zero level in intra trade also lowers import prices of goods meeting the perfect market hypothesis. Trade creation effect displaces domestic production of goods from the less efficient to the most efficient producer of goods and thus redistributes real income from less efficient country to the most effective country according to Stolper-Samuelson theorem. Negative effect can be seen through the prism of trade diversion effects. Formation of FTA, or Customs Union specifically, diverts part of the trade from the most efficient country outside the union to the less efficient producer in the union. This diversion of outputs is merely a result of artificial change in prices through tariff nullification without any change in productivity levels or factor abundance in a country. In this way trade flows are directed by affecting the prices of tradable goods. With common external tariff rate set to the goods flow from the outside non-member countries it isn’t possible to violate the rules of origins principle. In this paper we ponder on all aspects of trade policy resulting in welfare changes caused by trade shifting.

How can one nation be left unharmed if all others experience improvement in national welfare due to trade creation effects seriously reconsiders the Second fundamental theorem of welfare economics. Is it really possible to make one better off without someone being worse off? In order to solve this dilemma compensation scheme can be introduced by enacting lump-sum transfers to those countries with net welfare losses from customs union formation. The work of Murray Kemp and Henry Wan (1976) in the area of compensation might give us a solution to the welfare redistribution problem. In the following text static analysis will be provided through Viner’s general equilibrium model of customs union formation. Let us assume there are two countries (A and B) involved in customs union formation where the third one (country C) is partner country outside the CU with the lowest price of production. Eliminating tariff barriers between country A and country B leads to trade creating and trade diversion effects graphically shown in Figure 1.

4

Figure 1: Viner’s model of customs union formation

Source: Authors

Country A is importing CD amount of goods at the price %)1( cC tP + from Country C which is the most efficient producer of the same good. With existing tariffs government collects budget revenues shaded by rectangle c . If Country A and Country B form a customs union tariffs are levied and intra trade is increased to the extent that

imports equal FG . These imports now come from Country B that has higher costs of

production but lower price which is perplexing and paradoxical at the same time. This increase in volume of trade is called trade creating effect which substantially increases consumer’s surplus, decreases producer’s surplus and nullifies government revenues. Net effect represents welfare gains shown as shaded triangles b and d that are known as Harberger’s triangles. Along with positive effects there are some concerns regarding the trade flows that are diverted from the most efficient producer outside the union to the less efficient producer in the union, i.e. from Country C to Country B. Rectangle e represents trade diversion effects that is interpreted as a loss of national welfare due to suboptimal reallocation of production inputs. According to Jacob Viner customs union has positive effect on national welfare as long as trade creating effects dominate trade diversion effects. Because all member countries of customs union share common tariffs to the outside countries, it is possible for some members to have higher efficiency losses than gains. In order to maintain the same level of welfare for integrating countries some kind of compensation mechanism is needed to improve disequilibrium situation. The solution to this problem is formulated by Murray Kemp and Henry Wan.

5

According to Kemp and Wan (1976) it is always possible to have Pareto improvement for individual countries in integration that will not negatively affect outside countries. Full compensation scheme generates implicit costs that are to be calculated in net effects of customs union formation. 2. KEMP-WAN POSTULATE The Kemp-Wan proposition is independent on a number of countries involved, their size or development levels and as such is very useful in the analysis of customs union formation.. The Kemp-Wan proposition (Kemp, Wan, 1976) states: “Consider any competitive world trading equilibrium, with any number of countries and commodities, and with no restrictions whatever on the tariffs and other commodity taxes of individual countries, and with costs of transport fully recognized. Now let any subset of the countries form a customs union. Than there exists a common tariff vector and a system of lump-sum compensatory payments, involving only members of the union, such that there is an associated tariff-ridden competitive equilibrium in which each individual, whether a member of the union or not, is not worse off than before the formation of the union.“ If we assume there are n countries in the world willing to form a customs union then there is a finite number of steps possible to differentiate any welfare change between these steps. Every step leads to a new, enlarged customs union where no country is worse off than before its creation. The last step leads to the world that is one large customs union and no outsiders aside that could generate welfare losses in terms of trade diversion effects. The formal proof of Kemp-Wan theorem is based on a second fundamental theorem of welfare economics analysed in details by Debreu (1959). The pioneering work by Jacob Viner in 1950 was highly contributed by Lipsey (1957) with the introduction of Second Best Solution (SBS) in customs union creation. Lipsey assumed that there’s always a unique solution which is not always Pareto optimal but can be Pareto improving. Dixit and Norman (1980) extend the analysis by showing that Pareto improvement in Kemp-Wan model can be made without the use of lump–sum compensation. Furthermore, they suggest taxes on intra trade of goods and use of subsidies. Panagariya and Krishna (2002) gave their contribution to the analysis of Kemp-Wan theorem by applying it to FTA creation. If any number of countries freeze their tariffs to the rest of the world countries along with lump-sum transfers and correct use of rules of origin it is indeed possible to have Pareto improvement. 3. IMPLICATIONS OF WESTERN BALKAN COUNTRIES ACCESSION TO THE EU Is the Kemp-Wan applicable in practice and how it should be used properly is the key question of this paper. Will Western Balkan countries benefit from customs union creation while leaving CEFTA is also a legitimate question. Some of the raised issues of Kemp-Wan proposition are the direct result of failure to communicate the following problems:

• How do we decide who will be our trading partners?

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• The lack of political agreement to compensate on countries that do notexperience Pareto improvement in customs union creation.

• The complexity of tariff structures when choosing a common external tariff.• Implicit costs associated to compensation and the need of financing them.

Current research in the area of trade creation and trade diversion effects associated with Western Balkan countries is mostly based on gravity model approach along with the use of factor proportion model. Current EU27 member countries differ among themselves in terms of relative factor abundance. Most of the new acceding countries are relatively abundant in labour which makes them attractive for labour intensive production with labour as a relatively cheaper factor of production. The structure of trade is also based on differences in relative abundance according to Heckscher-Ohlin’s neoclassical model of trade.

In the last enlargement step Bulgaria and Romania joined European Union in 2007 while simultaneously leaving CEFTA that is mostly constituted of Western Balkan countries (Croatia, Macedonia, Albania, Bosnia and Herzegovina, Montenegro, Serbia and Kosovo). Western Balkans enlargement issue was recognized at the European Council summit in Thessaloniki in 2003 where potential problems and probable solutions were identified. All Western Balkan countries had to sign Stabilisation and Association Agreement (SAA) before starting the negotiation process. Current EU enlargement process is focused on Croatia that is to enter European Union on 1st of July, 2013. As of today the following Western Balkan countries are recognized as official candidates: Iceland, Macedonia, Montenegro, Serbia and Turkey while Albania, Bosnia and Herzegovina and Kosovo remain potential candidates.

Bulgaria and Romania, two subsequent countries that joined EU on 1st of January, 2007 were forced to leave CEFTA changing their position in the integration from free trade area (CEFTA) to customs union (EU). Expected trade flows according to Viner’s static model of CU formation should reflect in both trade creation and trade diversion effects. On contrary, empirical findings for Bulgaria and Romania do not corroborate theory which is shown in the tables below.

Table 1: Trade creation and trade diversion effects in Bulgaria (2007-2012)

Partner country 2007 imports in bn EUR

2012 imports in bn EUR

2012/2007 change

CEFTA 1,6 2,3 43,7% EU27 12,9 14,9 16,7% World 21,9 24,3 11,3% Total share in World imports CEFTA 7,2% 9,3% EU27 58,5% 61,3% Rest of the World 34,4% 29,4%

Source: Eurostat

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Table 2: Trade creation and trade diversion effects in Romania (2007-2012)

Partner country 2007 imports in bn EUR

2012 imports in bn EUR

2012/2007 change

CEFTA 1,2 2,3 99,5% EU27 36,6 40,1 9,6% World 51,3 51,7 0,8% Total share in World imports CEFTA 5,3% 9,5% EU27 71,3% 77,5% Rest of the World 23,4% 13,0% Source: Eurostat According to data gathered from Eurostat both countries have experienced an increase in total imports in selected period. Bulgaria increased its imports from EU27 member countries by 16.7% as a result of liberalised trade regime and zero intra trade tariffs. This effect is the direct result of trade creation effect. The same country didn’t experience trade diversion effect from CEFTA countries as expected, but from the rest of the world1 countries instead. Thus, net effect in Bulgaria is strictly positive due to an absence of trade diversion effect. The same conclusion can be made for Romania. Romania increased its imports from both EU27 and CEFTA countries increasing the total imports share from 76.6% to 87.0% consequently leading to trade diversion effects only from the rest of the world countries. In the case of these two countries Kemp-Wan compensation scheme is nonessential and customs union formation results only in positive welfare changes for acceding countries. Today’s EU trade policy is based on WTO principles of multilateralism and nondiscrimination in international trade. All members of WTO (EU members included) have agreed to lower their tariff barriers against other trading partners in order to achieve higher volume of trade, and consequently higher national welfare. EU currently stands for world’s first exporter accounting for 15.5% of world trade in goods and is ranked first as the FDI recipient with €241.7 bn inflow of funds (EC, 2013). Regional trade agreements made with rest of the world FTAs and persistent EU enlargement process lead to trade creation effects while some of the trade is diverted due to common external tariff imposed on imports outside the EU. The possibility of compensating welfare losses in Kemp-Wan context is not considered in the official EU trade policy nor is it being implemented in the world trade system through WTO rounds of negotiations. 4. CONCLUSION World trade order governed by WTO insists on lifting trade barriers and replacing the existing ones with tariffs. The final result in this process would be a creation of one large customs union where there will be no preferential treatment in trade nor there will

1 Excluding EU27 and CEFTA member countries

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be discrimination against others. Today’s world trade trends reflect in FTA creation where multilateral agreements overlap. This “spaghetti bowl” results in distortion effects where different tariff rates apply to outside countries. Customs union as a more advanced type of economic integration goes further with introducing common external tariff vector. Positive welfare gains known as trade creation effects are usually complemented with trade diversion effects. Part of the trade is diverted from the most efficient producer of the good outside the union to the less efficient producer of the same homogeneous output inside the union. This leads to suboptimal allocation of scarce resources and unwanted loss of national welfare. Lumpsum transfers and appropriate compensation scheme used to compensate losing countries is in the heart of Kemp-Wan proposition. A possibility to compensate country with negative net gains from customs union formation is always a challenge. According to Kemp and Wan it is always possible to have Pareto improvement for individual countries in integration that will not negatively affect outside countries. Forming economic integrations doesn’t necessarily result in negative net gains in practice. Empirical findings that exhibit only trade creation effects make Kemp-Wan suggestions inapplicable and impractical. The case of Western Balkans countries questions static effects of Viner’s model and opens up space for further investigation in the area of international trade.

REFERENCES

Debreu, G. (1959) “Theory of Value”, Wiley, New York.

Dixit, A. and Norman, V. (1980) “Theory of international trade: A dual, general equilibrium approach”, Cambridge University Press.

European Commission (2013) The European Union Trade Policy [online]. Available at: http://trade.ec.europa.eu/doclib/docs/2011/august/tradoc_148181.pdf [04/10/2013].

Eurostat (2013) International Trade Statistics [online]. Available at: http://epp.eurostat.ec.europa.eu/portal/page/portal/international_trade/data/database [04/10/2013].

Kemp, M. C. and Wan, H. Jr. (1976) "An Elementary Proposition Concerning the Formation of Customs Unions", Journal of International Economics 6, (February), pp. 95-97.

Lipsey, R. G. (1957) “The theory of customs unions: trade diversion and welfare”, Economica 24 (93): pp. 40-46.

Panagariya, A. and Krishna, P. (2002) “On necessarily welfare-enhancing free trade areas”, Journal of International Economics, Elsevier, vol. 57 (2), pp. 353. – 367.

Viner, J. (1950) “The Customs Union Issue”, New York: Carnegie Endowment for International Peace.

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http://trade.ec.europa.eu/doclib/docs/2011/august/tradoc_148181.pdfhttp://epp.eurostat.ec.europa.eu/portal/page/portal/international_trade/data/database

Nina Ponikvar University of Ljubljana, Faculty of Economics, Ljubljana, Slovenia Katja Zajc Kejžar University of Ljubljana, Faculty of Economics, Ljubljana, Slovenia Barbara Mörec University of Ljubljana, Faculty of Economics, Ljubljana, Slovenia

FINANCIAL CRISIS AND FINANCIAL CONSTRAINTS OF THE FIRMS: THE ROLE OF FIRM-SPECIFIC AND INDUSTRY-

SPECIFIC FACTORS

ABSTRACT

Based on the data from the financial statements for the population of Slovenian firms in the period 2006-2011 this paper analyses the determinants of the firms’ financial constraints in the wake of the financial crisis. The results on standard FC determinants are in line with theoretical predictions and previous empirical findings. Accordingly, firm size, ownership, productivity, export orientation are factors that impact firm’s financial situation. Exporters are on average 2.9 percentage points less likely to become highly financially constrained compared to non-exporters and public firms turn out to be around 3 percentage points less likely to become financially challenged compared to private firms. Firm size and labour productivity positively affect firm’s financial health. Financial constraints of Slovenian firms have significantly increased during financial crisis, i.e. from 2009 onwards but differently across industries.

Keywords: financial constraints, industry factors, firm characteristics, economic crisis

JEL classification: G32, L25, C23, C25

1. INTRODUCTION

In the recent decades it has been recognised in the empirical literature that firm finance carry important implications for firm performance either in terms of firm growth, profitability or even firm survival. During the recent financial crisis, firms in general have been reporting acute problems of access to finance. On the one hand, the deteriorated profitability of firms resulting from the economic crisis has led to decrease in availability of the internal financial sources while tightened credit standards on loans to non-financial corporations reduces accessibility of external funds. Because access to finance is widely perceived as a crucial factor for firms to maintain their day-to-day business as well to achieve growth in the long run, the worsened accessibility of financial sources may pose a major threat to the economy as a whole.

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Based on the data from the financial statements for the population of Slovenian firms in the period 2006-2011 this paper analyses how the financial crisis affected the financial constraints of the manufacturing and service firms. More specifically, we investigate (i) the firm characteristics that affect financial constraints of Slovenian manufacturing and service sector firms, (ii) industries in which the financial constraints are most severe, and (iii) how the recent financial crisis changed the average financial constraints of Slovenian firms. Namely, theoretical and empirical literature shows a strong link between financial constraints and firms age and size (Kumar and Francisco, 2005; Artola and Genre, 2011; Hutchinson and Xavier, 2006), its presence on foreign markets (Silva, 2011 and Wagner, 2012) and industrial environment (Arteta and Hale, 2008). We measure firms’ financial health according to the methodology first proposed by Musso and Schiavo (2008) and extended by Bellone et al (2010). We construct a synthetic index from seven different variables that carry important information relative to the existence of financial constraints to the firm. They are (i) firm size, (ii) profitability, (iii) liquidity, (iv) cash-flow generating ability (v) firm solvency, (vi) trade credit over total assets, and (vii) debt repaying ability. Such a measure of firm’s financial health is time-varying and continuous; it acknowledges the multiple features of financial constraints and captures different degrees of financial constraints (Silva, 2011). In order to identify the factors determining the financial health of firms from the manufacturing and service sector in Slovenia, we estimate the firm-level financial constraints model using a panel data econometric model which is applied to the dataset that covers the whole population of firms registered in Slovenia. We apply the panel data fixed effects estimator as well as ordered probit model. 2. FINANCIAL CONSTRAINTS AND ITS DETERMINANTS 2.1. Theoretical framework In the neoclassical financial theoretical framework, complete information is available to all participants in the perfect capital markets, all firms have equal access to capital markets, any desired investment project can be financed and the firms’ responses to changes in the cost of capital or tax-based investment incentives differ only due to differences in investment demand. In such circumstances, a firm’s ability to obtain financial funds, firm’s growth and its investment decisions are independent of its current financial condition such as internal liquidity, indebtedness or dividend payments (Hall and Jorgenson, 1967; Modigliani and Miller, 1958). In the real world, however, the access to financial markets is not the universal and equal for all firms, since firms face uncertain prospects and operate in imperfect or incomplete capital markets, where internal funds bring a cost advantage over external funds, with the latter also being called a ‘financing hierarchy’ (Fazzari, Hubbard and Petersen, 1988). The body of literature investigating the existence and the determinants of financing constraints is already very large and based on different theoretical considerations: transaction costs, the asymmetry of information, the agency problem, the cost of financial distress, the tax effects, and the pecking order theory.

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One of the oldest and perhaps most obvious explanations of the financing hierarchy is based on the transaction costs of issuing debt and/or equity. These costs include compensation for the dealer placing the issue, registration fees, legal, accounting printing costs, taxes (Oliner and Rudebusch, 1992). Additionally, the accessibility of external funds is conditioned on revealing firm’s strategic orientation by proposing investment projects to external financial sources (Sawyer, 1981). However, empirical tests show that transaction costs in their narrow meaning, including only dealer provisions, fees, physical costs and taxes, usually do not explain the hierarchy of finance (Oliner and Rudebusch, 1992). The most popular explanation of financing hierarchy stresses the information problems in capital markets. The fundamental insight comes from Akerlof’s (1970) analysis of the ‘lemons’ problem. The focus is on the potential asymmetry of information between the firm’s managers and outside suppliers of finance about the quality of the firm’s investment project and the behaviour of its managers. When the management has information about a project’s returns but the investors do not have relevant knowledge about the competence of the managerial team and the true project’s profitability, the investors (debt or/and equity providers) cannot distinguish between good and bad projects (adverse selection). They evaluate every project by some average project outcome (Oliner and Rudebusch, 1992). The cost of financing such projects with external funds exceeds that of financing with internal funds because of this asymmetry of information. The difference in the costs of internal and external financing, caused by such asymmetric information, represents the ‘lemons premium’(Akerlof, 1970). Empirical studies give strong evidence of information asymmetries being an important source of the financing hierarchy (e.g. Athey and Reeser, 2000; Oliner and Rudebusch, 1992). With asymmetric information, the firm’s owners, represented by managers also have some scope to pursue their own interests at the expense of the firm’s other stakeholders, especially debt holders. As shown in Jensen and Meckling (1976), the agency problems that arise from these conflicts of interest can boost the cost of obtaining external finance. The greater the debt-equity ratio, the more managers’ incentives may diverge from the interests of the creditors. To protect themselves, creditors usually demand covenants that restrict management behaviour in various ways. These restrictions and the monitoring required for enforcement constitute the agency costs of debt. Keynes (1936) analysed a similar phenomenon, which he called the ‘lender’s risk’. As investments increase, holding the firm’s internal financial resources fixed, the debt leverage will rise and lenders will require a higher interest rate to compensate for the increasing risk of default. As a result, the cost of new debt and equity may differ substantially from the opportunity (implicit) cost of internal finance generated through the cash flow and retained earnings (Fazzari, Hubbard and Petersen, 1988). The rationing of lending caused by informational asymmetry is also confirmed in empirical studies such as those by Bond and Meghir (1994), Levine (1997) and Van Ees et al. (1997). In the trade-off model between potential bankruptcy costs and agency costs Fama and French (2002) incorporated tax effect on debt-equity ratio, first introduced by Miller (1977) and later upgraded by De Angelo and Masulis (1980). They concluded taxes

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can have offsetting effects on capital structure decisions. On one hand unlike dividend payments interest payments are tax deductible and consequently corporate income tax encourages debt financing. At the same time various tax allowances and loss carry forwards reduces the advantage of indebtedness. If investors (equity or debt holders) are simultaneously subject to personal income tax, which frequently taxes interest more heavily than capital gains, firms would be more inclined towards capital issue. Firm’s optimal capital structure is therefore dependent on firm-specific circumstances and tax provisions applicable to the investors.

Finally, pecking order theory (established by Myers and Majluf, 1984) integrates transaction costs theory and the asymmetry of information model to explain the firms’ financing hierarchy. Namely, firms rank various financing sources by their cost, generated for various reasons already described by both theories. Commonly, firms’ capital structure follow pecking order theory if they rather use internal than external financing and – in case they use external financing – they rather use debt than equity financing. However, there is a alternative definition of pecking order theory which builds on behaviour finance theory. So Petersen and Schulman (1987, in Hussain, Millman & Matlay, 2006) claim owners of small firms, who are at the same time managers, would rather omit profitable investment than to release the control of the firm.

Thus in the circumstances of imperfect information and uncertainty the importance of the internal earnings for financing investments derives not only from the limited attainability or high costs of the external finance due to the lender’s risk, but also from the alleviation of the possible negative outcome of investing and thus a smaller borrower’s risk and – in case of SMEs – the propensity of owners/managers towards creditors. Because investing is connected to risk, internal financial sources can alleviate the consequences of unexpected unfavourable results of investment activity.

2.2. Determinants of financial constraints

Since the late 1980s, a large number of empirical studies have addressed the issue of financial constraints, mainly in order to study the relation between firm investment and the availability of internal funds. Indeed, large and convincing evidence exists showing that, when a standard investment equation is augmented with cash flow availability, the fit of the equation improves (Musso and Schiavo, 2008). Theory and empirical evidence suggest that credit constraints are tighter for those firms expected to face relatively severe asymmetries of information. These firms are also the ones that depend more on the availability of internal funds. Firms which suffer less from asymmetric information and are thus more creditworthy rely less on internal funds to finance their investments (Fazzari, Hubbard and Petersen, 1988; Oliner and Rudebusch, 1992; Natke, 1999).

In practise, the asymmetry of information is a consequence of the behaviour of banks and financial institutions which are much more reluctant to finance firms for which they do not have sufficient information on their disposal. These firms are usually developing, young and small firms that are almost without performance history. On the other hand, well-established larger firms have already demonstrated their ability to run

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successful projects and to make a profit. It is therefore easier and cheaper for large firms than for small firms to raise external funds, thus lowering the need for retained earnings to finance investment (Scherer and Ross, 1990). Further, very large, well-known firms are often considered to be less influenced by asymmetric information effect because they typically have greater experience in the capital market, can credibly enter long-term relationships and offer a lower average cost of obtaining required information (Athey and Reeser, 2000). The importance of size and age as a determinant of financial constraints is established also in Bougheas et al. (2006), using UK manufacturing firms from 1989 to 1999, Colluzi et al. (2009) and Canton et al. (2010) for EU firms in 2006. These authors all found that being young or small increases significantly the probability of facing financing obstacles and older firms perceive external financing as being less difficult. Based on the data collected during the recent economic crisis, Artola and Genre (2011) find that in the EU, firms who really experienced a credit crunch tended to be small and young, confirming the fact that SMEs tend to suffer more when credit standards are tightened.

Furthermore, financial constraint could be influenced by firm’s ownership structure. There is no unanimous view whether ownership structure improve or hinder firm’s ability to obtain external financing. Artola and Genre (2011)) claim that state ownership reduces firm’s value due to repeated politicians’ interference and consequently imposes additional costs to external financing. On the other hand Blanchard and Shleifer (2000) claim state ownership reduce financial constraints due to preferential treatment by other market participants, e.g. banks.

The importance of internal financial funds also differs across industries. Worthington (1995) reported that the importance of internal financial funds for investment spending is greater for durable goods industries than for non-durable goods industries and, second, that the cash flow’s effect in significantly larger in industries with high sunk costs than in those with low sunk costs. The latter could suggest that the availability of external finance is less important when the assets being financed are highly specific or are sunk and are thus less likely to be financed by a source external to the firm.

Exporting status is another firm characteristic that is arguably related to financial health of a firm. While there is strong empirical support for positive relationship observed between firms’ financial health and their export status (e.g. Campa and Shaver, 2002; Guariglia and Mateut, 2010), the direction of causality is not that a clear-cut. On one hand, Greenaway, Guariglia and Kneller (2007) find that export participation improves firm’s ex-post financial health; at least in case of continuous exporters while fail to confirm, similarly as Stiebale (2011) that firms enjoying better ex-ante financial health are more likely to start exporting. Several reasons for lower financial constraints of exporters are listed in the literature (e.g. in Campa and Shaver, 2002; Greenaway, et.al, 2007). Firstly, exporters are in a superior position to diversify their sources of financing and the associated risks since they have access to both internal and international financial markets. Secondly, the fact that a firm is an exporter also provides a signal that the firm is sufficiently productive to generate enough profits in foreign markets to recover the sunk costs, which in turn increases the likelihood that the firm will be able to service its external debt, and further relaxes the liquidity constraints that it faces. Finally, exporting firms are less tied to the domestic cycles, and less subject to those

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financial constraints induced by tight monetary policy and recessions in their home country. On the contrary, Bellone et.al (2011) provide evidence in favour of self-selecting of financially healthier firms into exporting. They find that firms starting to export display a significant ex-ante financial advantage compared to their non-exporting counterparts. Such result is in line with Chaney’s (2005) theoretical prediction that limited access to external financial funds may prevent some firms that could otherwise profitably enter foreign markets from selling their products abroad. As stressed by Greenaway, et.al (2007) since staring of exporting involves an initial fixed investment, export market participation decisions are likely to be affected by financial variables in the same manner as investment in fixed capital. However, credit constraints seem to be more important in determining the extensive margin of trade in terms of number of newly served destinations than for intensive margin of trade (Muûls, 2008; Askenazy et.al, 2011). 2.3. Measurement of financial constraints Although theory is relatively straightforward when it comes to their definition, financial constraints are not directly observable in practise. Consequently different measures are applied as proxies. On the one hand, several microeconomic studies use survey data, where firms and individuals provide their perception on financial constraints (e.g. Artola and Genre, 2011, Kumar and Francisco, 2005, overview in Musso and Schiavo, 2008) and are thus based on self-assessment together with all its disadvantages. The other empirical approach to detect financial constraints is based on segmentation of firms into groups based on one or more different criteria, such as dividend policy, size, age, and membership in a group of conglomerate, existence of bond rating or concentration of ownership (see Musso and Schiavo, 2008, for a comprehensive review of these studies). One of the main weaknesses of these studies is first its time invariance, second, when dividend policy is concerned, the analysis is restricted to quoted firms, which are usually also larger and more mature. In defining financial constraints we follow the methodology first proposed by Musso and Schiavo (2008) and extended by Bellone et.al (2010), who constructed a synthetic index from seven dimensions of financial status of the firm, i.e. firm size, its profitability, liquidity, cash flow generating ability, firm’s solvency, share of trade credit, and ability of repaying debt. Such a measure of firm’s financial health acknowledges multiple features of financial constraints and captures different degrees of financial constraints (Silva, 2011). 3. DATA AND METHODOLOGY

3.1. Data and descriptive statistics Our data source is the database of Slovenian firms’ financial statements collected by the Agency of the Republic of Slovenia for Public Legal Records and Related Services (APLR). The database covers the whole population of firms registered in Slovenia

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since reporting financial statements’ data is obligatory for all business entities registered in Slovenia. Our analysis is based on the financial statements of Slovenian firms in the 2006-2011 period and includes 313,537 observations for 71,771 different firms.

Table 1: Firms by economic sectors in Slovenia in the 2008-2011 period

NACE Economic sector 2008 2011 Index

11/08 No. % No. %

A Agriculture, forestry and fishing 356 0.68 372 0.64 104.5

B Mining and quarrying 66 0.13 72 0.12 109.1

C Manufacturing 6,676 12.84 7,033 12.17 105.3

D Electricity, gas, steam and air conditioning supply

206 0.40 531 0.92 257.8

E Water supply, sewerage, waste management and remediation activities

260 0.50 314 0.54 120.8

F Construction 6,746 12.97 6,943 12.01 102.9

G Wholesale and retail trade, repair of motor vehicles and motorcycles

13,456 25.88 14,263 24.68 106.0

H Transportation and storage 2,253 4.33 2,643 4.57 117.3

I Accommodation and food service activities 2,318 4.46 2,641 4.57 113.9

J Information and communication 2,571 4.94 3,157 5.46 122.8

K Financial and insurance activities 1,044 2.01 1,182 2.05 113.2

L Real estate activities 1,725 3.32 1,891 3.27 109.6

M Professional, scientific and technical activities

10,183 19.58 11,866 20.53 116.5

N Administrative and support service activities 1,456 2.80 1,756 3.04 120.6

O-U Other sectors 2,681 5.16 3,134 5.42 116.9

A-U Total 51,997 100.0 57,798 100.0 111.2 Source: APLR and own calculations Table 1 shows the structure of the analysed dataset according to the NACE classification of industries. In the 2008-2011 period, the number of firms in Slovenia increased by 11 percent. Economic sectors, in which the number of firms increased by more, include activities related to energy, water and waste management, transport, tourism, information and communication services, financial, insurance and real estate activities, professional, scientific, technical, administrative and support service activities. Table 2 shows the size structure of the Slovenian economy. While the number of micro and small firms increased throughout the investigated period, number of large firms decreased for almost 8 percent. Number of medium sized firms remained almost unaltered.

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Table 2: Firms by size in Slovenia in the period 2006-2011

Firm size

2006 2008 2011 Index 11/08

Index 11/06 No. % No. % No. %

Micro 42,046 92.76 48,070 92.45 53,966 93.37 112.3 128.3

Small 1,784 3.94 2,390 4.60 2,397 4.15 100.3 134.4

Medium 745 1.64 763 1.47 740 1.28 97.0 99.3

Large 755 1.67 774 1.49 695 1.20 89.8 92.1

Total 45,330 100 51,997 100 57,798 100 111.2 127.5 Source: APLR and own calculations

Table 3: Ownership and export orientation of firms in the dataset

No. of

foreign* firms

Foreign firms in %

No. of state firms

State owned

firms in %

Exports in total

sales in %

Value added per employee in EUR

2006 4,452 9.82 450 0.99 9.1 32,098

2007 5,324 10.91 401 0.82 9.4 33,949

2008 5,937 11.41 394 0.76 9.6 32,705

2009 5,965 11.06 379 0.7 9.7 34,625

2010 6,051 10.85 366 0.66 9.9 32,955

2011 6,241 10.79 366 0.63 10.8 33,382

Index 11/06 140.2 109.9 81.3 63.6 118.7 104.0 Note: * 10 percentage foreign ownership threshold is considered Source: APLR and own calculations During the analysed period the number of firms with foreign ownership increased for 40 percent and their share among firms in Slovenia increased by 1 percentage point. At the same time the number of firms with state ownership decreased by almost 20 percent, while the average export orientation of Slovenian firms increased by almost 19 percent. However, the value added per employee in 2011 increased by only 4 percent relative to 2006, although in 2009, when it reached highest level in this period, it was almost 8 percent higher compared to the level of 2006. 3.2. Models specification and methodology The specification of the empirical model for the analysis of factors that determine financial constraints of a particular firm follows theory and empirical findings discussed above. Our model’s specification is thus:

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itttjjijt-

ijtijtijtijtijt

udyeardindustry

fdiEXordsizeFCindex

++++

+++++=

∑∑∑ −−−

.7.615

141312.10

public

tyProductiviln

βββ

βββββ (1)

where subscripts i, j and t refer to firms, industries and years, respectively. ln in variable names denotes that the variable enters the equation in its natural logarithm form. Following methodology proposed by Musso and Schiavo (2008), the dependent variable is a synthetic index of financial constraints (FCindex), constructed from seven different variables: (i) firm size, measured in terms of total assets, (ii) profitability in terms of return on total assets, (iii) liquidity as a ratio between current assets and current liabilities, (iv) cash flow generating ability in terms of a maximum amount of resources that a firm can devote to self-financing, corresponding to the sum of profits and depreciation, (v) firm solvency as own funds over total liabilities, measuring the ability by a firm to meet its long-term financial obligations, (vi) trade credit over total assets, and (vii) repaying ability, measured in terms of financial debt over cash flow. For each of the seven dimensions, a firm/year observation is placed in one of the quintiles of the firm distribution. Hence, each firm/year observation ends up with seven scores ranging from one to five. We use a simple sum of these seven scores to get a synthetic index of financial constraints, where smaller value of the index is related to financially more constrained firms. Musso and Schiavo (2008) use also other ways of combining seven scores and report the index of financial constraints to be very robust to the different ways to aggregate the information from the seven scores. uit is composed of uit=µi+νit, where µi is an unobserved individual-specific time-invariant effect which allows for heterogeneity in the means of the growth across individual firms and νit is a disturbance term. Among the most important firm characteristics that affect firm’s financial constraints the theories postulate firm’s size and age. In our model, we test for two different measures of firm size. First, firms are grouped into four size categories (dsize: micro, small, medium and large) based on three criteria average number of employees, sales revenues and the value of assets in line with European Commission’s recommendations concerning the definition of micro, small and medium-sized enterprises. Second, firm size is measured based on the number of employees (L). Due to the limitations of the applied dataset, we are not able to include age in the model specification. Firm productivity (Productivity) is defined in terms of value added per employee. The impact of firm ownership on its financial constricts is analysed by inclusion of two dummy variables; one for foreign firms (fdi), where 10 percent threshold of foreign ownership is considered, and one for public ownership (public). To test whether exporting affects financial constraints of firms, we include export orientation (EXor) or dummy variable for selling in foreign markets (exporter). To avoid likely endogeneity issue, firm-specific variables enter the model specification in a one year lag form. Time-specific individual-invariant effect is captured with the set of time dummies among regressors, while the time-invariant effect of industry is captured by set of industry dummy variables. Industry membership is defined based on 2-digit NACE Rev. 2 classification of industries. Since financial health of a firm is measured by a composed index, it is relatively hard to interpret the magnitude of estimated impact of various firm -, industry- and time-

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specific determinants on financial health of a firm. To facilitate the more comprehensive interpretation of our results we form three broad categories. We base the categorisation on FCindex and obtain three clearly ordered groups of firms (FCgroup) according to the severeness of their financial constraints. A firm is classified into group of “non-constrained firms” (FCgroup=1) if the value of its FCindex is equal to or higher than 28, moderately constrained firms (FCgroup=2) in case of FCindex between 14 and 28 and highly constrained firms (FCgroup=3) with FCindex less than 14. We use FCgroup variable as the dependent variable in an ordered probit model of firm’s financial constraints which we deem more appropriate than a linear regression model. Namely, in a linear regression a firm with FCgroup of 2 would be considered twice as financially constraint as one with FCgroup=1, whereas in the ordered probit model no such presumption of cardinality is made; FCgroup = 2 simply indicates higher financial constraints than FCgroup =1. Following Greene (2003), the basic notion underlying the ordered probit model is the existence of a latent continuous variable, FC∗, ranging from −∞ to +∞ and indicating the degree of financial constraints of a firm. This latent variable is related to a set of explanatory variables as specified in (1). We cannot observe FC* variable, but what we do observe is FCgroup which is related to FC* in the flowing way: FCgroup=1 if FC* ≤ µ1,

FCgroup=2 if µ1 < FC* ≤ µ2, FCgroup=3 if µ2≤ FC*, (2)

where µi are unobserved thresholds defining the boundary between the different levels of FC*. With the normal distribution we obtain the following probabilities:

Prob(FCgroup = 1) = Φ(µ1−β´x) Prob(FCgroup = 2) = Φ(µ2 − β´x) − Φ(µ1−β´x) Prob(FCgroup = 3) = 1 −Φ(μ2 − β´x). (3)

The value of the threshold μ is estimated as additional parameter of the model. Estimates are obtained by maximum likelihood. 4. RESULTS In table 4 we first report the results of the standard panel model estimation of (1). According to the results of Hausman test, we report only fixed effects model results. Results of the fixed effect estimation confirm that firm size and labour productivity are in general positively related to the degree of firm’s financial health. Yet, small firms are not significantly different in terms of their financial constraints compared to the group of micro firms, while medium and large firms exhibit similar difference compared to the benchmark group of micro firms. We fail to find significant impact of foreign and public ownership variables on financial constraints in fixed effects specification.

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Table 4: Fixed effects estimation of firms’ financial constraints model

Dependent variable FCindex Coef. Std. Err Size dummies small 0.125 (0.0926) medium 0.415** (0.178) large 0.447* (0.238) lnProductivity(-1) 0.217*** (0.0178) fdi(-1) -0.0572 (0.139) public 0.479 (0.294) EXor(-1) 0.216** (0.102) Year dummies 2008 -0.0744 (0.0593) 2009 -0.390*** (0.0593) 2010 -0.494*** (0.0593) 2011 -0.590*** (0.0595) Constant 20.46*** (0.424) Industry dummies INCLUDED

financially constrained (sign. negative industry effect)

Forestry and logging, Manufacture of wood and of products of wood and cork, except furniture, Accommodation, Creative, arts and entertainment activities

financially unconstrained (sign. positive industry effect)

Mining of metal ores, Wholesale and retail trade and repair of motor vehicles and motorcycles, Legal and accounting activities, Human health activities, Activities of membership organisations

N 162,283 Number of firms 44,418 R-squared 0.0640 F test that all u_i=0

F(44417, 117769) = 4.76*** (0.000)

Hausman test chi2(96) = 8247.61 Prob>chi2 = 0.0000

Results of the fixed effect estimation confirm that firm size and labour productivity are in general positively related to the degree of firm’s financial health. Yet, small firms are not significantly different in terms of their financial constraints compared to the group of micro firms, while medium and large firms exhibit similar advantage compared to the benchmark group of micro firms. We fail to find significant impact of foreign and public ownership variables on financial constraints in fixed effects specification. However, when firms are grouped into three classes according to the severeness of their financial constraints, publicly owned firms turn to be less

20

financially challenged. This finding is in line with Blanchard and Shleifer (2000), who argue that state ownership reduces financial constraints due to preferential treatment by other market participants, e.g. banks. The significant impact of firm’s share of sales in exporting markets on firm’s financial constraints is in line with Greenaway et.al, (2007) supporting evidence on the prediction that exporters face smaller financial constraints. As a result of the recent financial and economic crisis, during the investigated period average financial conditions in the Slovenian economy have worsened. The negative sign of the year dummy regression coefficients confirm the negative effect of financial crisis on financial constraints of firms, while the increasing absolute size of these coefficients from 2009 onwards indicate the growing deterioration of financial health of Slovenian firms throughout this period. Yet, the worsening of the access to finance was not the same for all firms across all economic sectors and industries. From the estimated time-invariant industry-specific effect, measured by regression coefficients of set of industry dummy variables (Table 4) it is evident, that the degree of financial constraints of some industries significantly deviates from others. When all other determinants of financial constraints are controlled for, industries that exhibit superior financial health are the following 2-digit NACE industries: 02-Forestry and logging, 16-Manufacture of wood and of products of wood and cork, except furniture, 55-Accommodation, and 90-Creative, arts and entertainment activities. On the contrary, firms from industries 7-Mining of metal ores, 45-Wholesale and retail trade and repair of motor vehicles and motorcycles, 69-Legal and accounting activities, 86-Human health activities, and 94-Activities of membership organisations are found to be in weaker financial position than firms with equal characteristics from other industries. In order to release the assumption of cardinality of the dependent variable and increase the comprehensiveness of our results, we show also results of the ordered probit estimation. Model specification (1) from Table 5 is identical to the specification of the fixed effects estimation from Table 4, while specification (2) uses alternative specification of size and export status to test the robustness of the model. Results of ordered probit estimation confirm results of fixed effects model estimates with respect to significance and direction of all determinants of financial constraints that are considered in our model. Exporters are on average 2.9 percentage points less likely to become highly financially constrained compared to non-exporters. Probability that public firms, i.e. with state ownership, will become highly financially constrained, is 2.5 to 3.4 percentage points lower compared to privately owned firms, while the effect of foreign ownership is not statistically significant. Increase in firm’s productivity for 1 percent decreases the likelihood of becoming highly financially constraint for 6.6 percentage points. Results also show that the increase in employment for additional 10 employees means 0.2 percentage points lower probability of becoming severely financially constrained. Marginal annul effects, measuring the change in probability of firms becoming highly financially constrained, show that the most critical year with respect to firm financial constraints was 2009, although also 2010 and 2011 show tight financial conditions. In these three years probability of Slovenian firms being critically financially constrained was 1.2 to 1.6 percentage points higher than in 2007 all else being equal.

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Table 5: Ordered probit estimation of firms’ financial constraints model

Dependent variable FCgroup

Coef. (Std. Err.)

Average marginal

effects (dy/dx)

Coef. (Std. Err.)

Average marginal

effects (dy/dx) Pr(FCgroup=3) Pr(FCgroup=3)

(1) (1) (2) (2) L(-1) -0.000164**

(7.51e-05) -0.00002** (0.13e-06)

Size dummies small -0.306***

(0.0203) -0.031*** ( 0.0017)

medium -0.287*** (0.0346)

-0.029*** (0.0029)

large 0.107*** (0.0408)

0.014*** (0.0058)

lnProductivity(-1) -0.555*** (0.00695)

-0.067*** (0.0009)

-0.546*** (0.00683)

-0.066*** (0.0009)

fdi(-1) 0.0039 (0.0180)

0.0005 (0.0022)

-0.00214 (0.0178)

-0.0003 (0.0022)

public -0.208*** (0.0561)

-0.025*** (0.0068)

-0.283*** (0.0567)

-0.034*** (0.0069)

EXor(-1) -0.208*** (0.0206)

-0.025*** (0.0025)

exporter(-1) -0.241*** (0.0101)

-0.029*** (0.0013)

Year dummies 2008 0.0562***

(0.00823) 0.006*** (0.0009)

0.0537*** (0.00822)

0.006*** (0.0009)

2009 0.136*** (0.00875)

0.016*** (0.0011)

0.132*** (0.00873)

0.016*** (0.0011)

2010 0.0863*** (0.00893)

0.010*** (0.0010)

0.0839*** (0.00892)

0.0098*** (0.0010)

2011 0.101*** (0.00915)

0.0118*** (0.0011)

0.100*** (0.00913)

0.012*** (0.0011)

cut1(µ1) -6.705*** -6.657*** (0.0700) (0.0686)

cut2 (µ2) -3.903*** -3.852*** (0.0668) (0.0655)

pseudo R2 0.1118 0.1121 Log (pseudo-) likelihood -96468.226 -96640.655 N 162,283 162,598

Note: Robust standard errors in parentheses dy/dx for factor levels is the discrete change from the base level. *** p

previous empirical findings. Accordingly, firm size, ownership, productivity, export orientation are factors that impact firm’s financial situation. Exporters are on average 2.9 percentage points less likely to become highly financially constrained compared to non-exporters and public firms turn out to be around 3 percentage points less likely to become financially challenged compared to private firms. Firm size and labour productivity positively affect firm’s financial health. Further, the financial situation of Slovenian firms on average deteriorated from 2009 onwards, although financial constraints did not increase equally across all economic sectors and industries. Our results show that in the investigated period, when all other determinants of financial constraints are controlled for, industries with superior financial health are the following 2-digit NACE industries: 02-Forestry and logging, 16-Manufacture of wood and of products of wood and cork, except furniture, 55-Accommodation, and 90-Creative, arts and entertainment activities. On the contrary, firms from industries 7-Mining of metal ores, 45-Wholesale and retail trade and repair of motor vehicles and motorcycles, 69-Legal and accounting activities, 86-Human health activities, and 94-Activities of membership organisations are found to be in weaker financial position than firms with equal characteristics from other industries. Because Slovenian economic crisis is to a large extent related to banking crisis, banking sector revival seem to be crucial for improving financial health of Slovenian firms. Nevertheless, our results suggest that economic policy should also focus on promoting firm’s growth, both in terms of employment and productivity with support of innovative practises and employment stimulation. REFERENCES Akerlof, G. A. (1970), The Market for Lemons: Quality Uncertainty of the Market Mechanism, Quarterly

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http://cobiss3.izum.si/scripts/cobiss?ukaz=FFRM&mode=5&id=1419045820221233&PF1=AU&PF2=TI&PF3=PY&PF4=KW&CS=a&PF5=CB&run=yes&SS1=%22Sawyer,%20Malcolm%20C.%22http://weblinks2.epnet.com/externalframe.asp?tb=1&_ua=%5F0&_ug=sid+9B27AA89%2DD6AF%2D4AE3%2DA9B5%2D35931A153FE6%40sessionmgr2+dbs+buh+cp+1+B369&_us=frn+1+hd+False+or+Date+fh+False+ss+SO+sm+ES+sl+%2D1+dstb+ES+ri+KAAACB1D00077981+AF2A&_uh=btn+Y+A152&_uso=hd+False+tg%5B0+%2D+st%5B0+%2Dworthington++paula+db%5B0+%2Dbuh+op%5B0+%2D+3538&fi=buh_9504213936_AN&lpdf=true&pdfs=663K&bk=R&tn=6&tp=PC&es=cs%5Fclient%2Easp%3FT%3DP%26P%3DAN%26K%3D9504213936%26rn%3D3%26db%3Dbuh%26is%3D00221821%26sc%3DR%26S%3DR%26D%3Dbuh%26title

Mario Pines University of Trieste, Faculty of Economics, Trieste, Italy

MONETARY AND FISCAL POLICIES: LIMITS, FALLOUTS AND REMEDIES

ABSTRACT Financial and Economic development trough integration processes is a complex and slow event, in which market fallouts and policy actions are intricately linked, unpredictable and hardly manageable as well. While local market factors perform a primary role and hold up responsibility in shaping the single financial market, policymakers need to understa