Production bottlenecks and congestion externalities during the transition to a market economy

The paper develops a model of production bottlenecks in the context of stochastic input requirements and a high opportunity cost of holding inventories. Once budget constraints are hardened and credit markets begin to function properly, bottlenecks are likely to become prevalent in the state sector, where the creditworthiness of enterprises is limited by outdated production technologies. The analysis recognizes that producers have incentives to form pooling arrangements, supported potentially by market mechanisms, for reallocating stocks of critical inputs. Such arrangements, however, do not eliminate the externalities associated with bottlenecks, which rise nonlinearly with the opportunity cost of holding inventories. The analysis suggests a case for subsidizing the costs of critical inputs for the state sector, but not for the new private sector. The optimal subsidy declines as the private sector grows and should be "financed" by taxing wages in the state sector, which will strengthen incentives for workers to move.