Sustaining Production Chains Through Financial Linkages

The importance of sectoral linkages and complementarities for economic development are timeless themes, discussed in the classics of the subject such as Wassily Leontief (1936) and Albert O. Hirschman (1958). In the same spirit, development economists have studied the technological challenges in sustaining complex production processes. The O-ring theory of Michael Kremer (1993) and the role of intermediate goods and complementarity discussed by Antonio Ciccone (2002) and Charles I. Jones (2011) are examples. As well as technological constraints, incentive and hold-up problems that operate within the production chain may also restrict complex production processes. A glaring example is the breakdown of production chains in the postSoviet economies in the 1990s. Olivier Blanchard and Kremer (1997) and Dalia Marin and Monika Schnitzer (2005) attribute the drastic fall in output to hold-up problems and the recursive nature of the rent-seeking along the production chain that undermined pre-existing production chains of the Soviet-era command economy. In the same spirit, our focus will be on the incentive problems faced by firms in a production chain and the financial counterparts of the relationships between firms as suppliers and customers. Firms hold large interlocking claims and obligations through inter-firm credit, with accounts receivable exceeding 20% of corporate assets in many countries (on which more below). However, far from being a measure of inefficiency, such large claims may have an economic rationale. The chain of interlocking claims and obligations that arise from delays in settling transactions bind the interests of indi-