An interesting twitter debate between Alan Beattie and Frances Coppola, regarding the connection between Greek “structural reforms” and the macro-economy.
Alan argues that shortening business-to-business payment terms and improving contract enforcement should just generally be a good thing and shouldn’t have any macro effects in the short term.
Frances retorts that it’s always cash flow that causes businesses to fail, and anything that tightens cash flow will cause more business failures as the first-round effect.
Alan responds that companies who benefit from going slow on payments are usually just well-connected rent seekers and that they’re exploiting ones that have more potential upside.
I think we can be a bit more precise here. If money gets rid of the need for a double coincidence of wants, finance gets rid of the need for a double coincidence of timing. I don’t necessarily need to wait to sell in order to buy, if I can use trade credit, for example. One of the earliest known financial instruments is just a bill issued by one business that gives the customer 30 or 90 days or whatever to pay, and can be assigned to someone else.
The point here is to increase the value of economic activity that you can carry out before you have to draw on your working capital to pay a bill in cash. The presumption is that businesses are usually constrained by their cash flow, and trade credit is a way of relaxing this constraint and using their holdings of cash more intensively. In that sense, it’s a social mechanism that increases the money supply by increasing the velocity of circulation.
It’s possible to create a huge credit bubble based just on this financial technology – Kindleberger is full of them – even if the cash paid in final settlement is gold or silver or big rocks.
If we now intervene in some way and insist that people settle up their accounts, for cash, faster, what happens? Well, one way of looking at it is that all this informal credit is non-monetary economic activity. Now, it has to become monetised, which means that the demand for money has increased sharply. Another way of looking at it was the one I hinted at earlier. If we count the trade credit as an increase in the supply of money, then either the rest of the money supply must expand to accommodate it, or else the money supply must shrink.
Whether we look at this as an increase in the demand for money, or a reduction of the supply of money, it does mean that the marginal borrower’s interest rate is going up, possibly dramatically, and they also face liquidity risk. Here’s your contraction.
Now of course this can be solved; monetary policy can change.
In practice, the most likely route by which the outstanding bills get monetised is through a bank, because where else do you go to get cash? We can get around this problem if the banking sector’s balance sheet expands enough to take on the outstanding trade credit, or alternatively, if the monetary authority puts more money into circulation. (This is the same thing, in a sense – imagine an economy with one bank.)
The first option means that the banks may need more capital, because they are taking up a bigger share of outstanding risks, the second, that monetary policy must be adjusted. In fact, taking up the first option will probably involve some of the second, as the banks bring more paper into the central bank discount window. But if the banking sector is structurally constrained in some way, and the monetary authority is located in some other country, well, yes, the reform will be contractionary. Better, it will be contractionary, full stop, unless someone does something to counter it.
It’s true, as Alan Beattie says, that slow payment might be one of the ways rent-seekers exploit their suppliers. Anyone who’s ever been involved with a small business will know that there are a lot of unreliable payers out there. However, this is true of the UK and probably of Finland. It’s also idiosyncratically true, not the sort of thing easily accessible by airport-to-hotel reformers. And it’s more true that small businesses will be more likely to run out of cash, if there’s a general drive to collect on bills quicker, than big ones.
The classic mechanism of an economic crisis in an economy that runs on store credit is set out very well in Kindleberger. Chains of bills, representing the outstanding volumes at risk, grow until something happens and causes the marginal creditor to demand cash money. Then a cascade-failure of bankruptcies occurs. It is not obvious, to say the least, that this is desirable.
Yes, this reform is contractionary, and implementing it requires that the monetary authority pushes against the contraction.