32637 The Newsletter About Reforming Economies Beyond Transition January--March 2005 · Volume 16, No. 1 http://www.worldbank.org/transitionnewsletter Barriers to entrepreneurship Theme of the Issue: Entrepreneurship and Barriers to Entry Policymakers in country after country Pages 3--21 are trying to foster entry. Yet many ques tions remain about which government poli cies can help create a favorable business climate for entrepreneurship. Is a great number of small firms in a country, such as Italy, a sign of low entry barriers? Why do Russian entrepreneurs: tell me who your startups grow more slowly in some coun friends and family are... tries? How does enforcement of entry reg ulations affect new firm creation? Leora Klapper and Luc Laeven of the World Bank, When studying the determinants of entrepreneurship, social scientists and Raghuram Rajan of the IMF provide emphasize three sets of variables: institutions, social networks, and per answers to these and other questions after sonal characteristics. Although all three seem relevant, there remains no conducting an extensive empirical analysis clear consensus on why people become entrepreneurs. This makes it diffi of more than 3 million firms in Eastern and cult to devise policies that will encourage entrepreneurial development. Western Europe. They find that some regu Simeon Djankov (the World Bank), Gerard Roland, Edward Miguel and lations worsen welfare and hamper firm Yingui Qian (all from the University of California at Berkeley), and expansion, while others are beneficial to Ekaterina Zhuravskaya (CEFIR/NES in Moscow) have embarked on a large entrepreneurship. study of entrepreneurship that will encompass five countries with signifi cant economic potential in the coming decades: China, Russia, Brazil, India, Page 6 and Nigeria. In this issue we present the results of the pilot study in Russia, based on 2,000 interviews in seven cities. Page 3 Creative destruction in industrialized Banking deregulation promotes "creative and developing countries destruction" In many countries around the world, banking sectors In all countries, firms undergo significant changes over remain heavily regulated, and the state intervenes directly or time, through resource reallocation among existing firms and indirectly in banks' lending decisions. Marianne Bertrand firm entry and exit. Eric Bartelsman (Free University (Chicago Graduate School of Business), Antoinette Schoar Amsterdam and Tinbergen Institute), John Haltiwanger (MIT) and David Thesmar (Ecole Nationale de la Statistique (University of Maryland and the Census Bureau) and Stefano et de l'Administration Economique, Paris) investigate the Scarpetta (the World Bank) analyze the magnitude of firm cre consequences of the 1985 French banking sector deregula ation and destruction and the effect of "creative destruction" tion on firm behavior and industry structure. They identify on productivity in 24 industrialized and developing countries. several important effects on firm behavior, product markets They find that "creative destruction" has played an especially and allocative efficiency, implying that a more efficient important role in transition economies, where new firms not banking sector plays an important role in fostering a only displaced obsolete incumbents but also filled in new mar Schumpeterian process of "creative destruction". kets and, for a time, faced a relatively low level of competition. Page 9 Page 12 2 · BeyondTransition -- The Newsletter About Reforming Economies What's Inside Theme of the Issue: Doing Business -- 2005: Entrepreneuship and Barriers to Entry Removing obstacles to growth Simeon Djankov 16 Russian entrepreneurs: tell me who your friends and family are... Russia's small business climate Simeon Djankov, Gerard Roland, Edward Miguel, continues to improve Yingui Qian, and Ekaterina Zhuravskaya 3 Oleg Zamulin 18 Entrepreneurs in Latvia: a few pieces Russian customs: a barrier to foreign trade, of the puzzle investments and entry? Vyacheslav Dombrovsky 5 Ksenia Yudaeva and Konstantin Kozlov 19 Barriers to entrepreneurship Leora Klapper, Luc Laeven, Discussion and Raghuram Rajan 6 Representatives of SME organiazations Business owners' growth expectations in Lithuania, Romania, Slovakia and Russia in Lithuania talk about entrepreneurship 20 Ruta Aidis and Tomasz Mickiewicz 8 Banking deregulation promotes New Findings "creative destruction" Marianne Bertrand, Antoinette Schoar, Who bears the cost of Russia's military draft? and David Thesmar 9 Michael Lokshin and Ruslan Yemtsov 22 No exit? How transition paths differ: enterprise William Tompson 11 performance in Russia and China Sumon Bhaumik and Saul Estrin 24 Creative destruction in industrial and developing countries India's reform attracts interest in Beijing Eric Bartelsman, John Haltiwanger Suman Bery 25 and Stefano Scarpetta 12 Lobbying on entry World Bank \ IMF Agenda 26 Enrico Perotti and Paolo Volpin 13 New Books and Working Papers 28 What makes small firms grow? Evidence from Romania Conference Diary 30 David Brown, John Earle and Dana Lup 14 Bibliography of Selected Articles 31 Financing conditions for small and medium enterprises in the new EU member states Ulrich Volz 15 The main theme of the next issue forthcoming in June: Poverty and Growth The World Bank· 3 Theme of the Issue: Entrepreneurship and Barriers to Entry Russian entrepreneurs: tell me who your friends and family are... Simeon Djankov, Gerard Roland, Edward Miguel, Yingui Qian, and Ekaterina Zhuravskaya I t is increasingly recognized that entrepreneurship plays a and/or have only recently embraced the capitalist system, we crucial role for successful economic development. are able to study entrepreneurship as it emerges, rather than in Schumpeterian analysis advances the view that entre the relative stability of highly developed economies. preneurial dynamism is the key to innovation and growth. Russia is a particularly interesting case, as entrepreneurship Why does entrepreneurship thrive in certain societies and was not legally allowed in the country until 1992, with the not in others? When studying the determinants of entrepre exception of so-called cooperative (de facto private) enterpris- neurship, social scientists emphasize three sets of variables: es created under Gorbachev. Russia's institutional environment institutions, social networks, and personal characteristics. has been highly volatile, with large regional variations and The results of 2,000 interviews in seven cities across Russia weak institutional support for the market economy in many provide evidence in all the three areas, with a particularly regions. Corruption, racketeering, bureaucratic harassment, strong effect coming from social networks. The study is part and poorly developed financial intermediaries have all nega- of a larger project to be conducted in five large developing and transition countries -- China, Russia, Brazil, India, and tively impacted the development of the private sector. Nigeria. The pilot study carried out in Russia in 2003--2004 cov- ered seven cities (including Moscow) in four different regions. Social scientists have proposed numerous explanations to We defined an entrepreneur as an owner or a co-owner of a account for cross-country differences in entrepreneurial activi- business with five or more employees. The sample included ty, falling generally into three categories. An institutional per- both entrepreneurs and non-entrepreneurs in order to under- spective, favored by economists and political economists, stand how these groups differ in terms of individual character- focuses on the role of economic, political, and legal institutions istics; non-entrepreneurs mirrored the sample of entrepreneurs in fostering entrepreneurship. Particularly relevant are credit with respect to age, gender and educational attainment. In markets and the protection of property rights: credit con- addition, 150 non-entrepreneurs were surveyed without regard straints make it impossible for the relatively poor to borrow to demographic characteristics. funds to start up a business, and insufficiently strong property Finally, a random sample of 1,200 respondents allowed us rights may not provide entrepreneurs with the necessary incen- to determine the rough proportion of entrepreneurs across tives. cities. We find a considerable variation in the cities surveyed, A second perspective emphasizes sociological variables, with the lowest proportion of self-employed and entrepreneurs such as social norms, values, and social networks, including in Nizhny Novgorod (6%) and Moscow (8%) and the highest relatives, friends, and social groups. in Taganrog (18%). The third perspective emphasizes the individual characteris- tics of entrepreneurs, such as a personal need for achievement, Entrepreneurs wealthier, healthier and happier self-confidence, self-reliance, and attitudes toward risk. Although all three perspectives seem relevant, there remains Controlling for individual age, gender, education, and loca- no clear consensus on the determinants of entrepreneurship. tion, we find that: This makes it difficult to devise policies to encourage entrepre- · Entrepreneurs are more likely to be married and tend neurial development in any given country. For example, relax- to have slightly more children (1.3 vs. 1.2 in non-entrepre- ing credit constraints may not be of much help if the main neurs' families); obstacle to entrepreneurship lies in the insecurity of property · Entrepreneurs seem to have been better students in rights. Similarly, financial and legal reforms may not achieve secondary school (or so they like to recall), and indeed they much if the roots of entrepreneurial potential lie in cultural fac- scored higher in a test of cognitive ability (see the figure); tors and personal traits. · Entrepreneurs are wealthier, they spend a smaller pro- Our project studies entrepreneurship from all three per- portion of income on food, are more likely to own a home, a spectives, using a new data set from several developing and car and a computer: only 5% do not own either a car or a transition countries. The choice of countries is explained by computer, compared to 48% among non-entrepreneurs; their potential economic power in the coming decades, as well · Entrepreneurs are healthier and more physically as size, which allows exploration of regional variations in insti- active, although this might be due to higher-than-average tutions and culture. As these countries are unevenly developed income and wealth; they are also happier and more successful: 4 · Beyond Transition -- The Newsletter About Reforming Economies 73% consider themselves successful, compared to about 40% business, so family effects played a role through other, less of non-entrepreneurs; direct channels. · Entrepreneurs are more mobile, both professionally Beyond the family, one's social circle in general, e.g. friends and geographically; from childhood and adolescence, seem to affect one's decision · Entrepreneurs like what they do and are less likely to to become an entrepreneur. In our survey, respondents were substitute work for leisure even when offered compensation asked to remember five such friends and then report how many equal to 500 times per capita GDP: only 18% would choose to of these have become entrepreneurs. Out of each entrepre- retire then, compared to 47% of non-entrepreneurs. neur's group of five friends, 1.2 had started a business them- selves, compared to only 0.6 for non-entrepreneurs. Although Who is more likely to become an entrepreneur? making a causal claim about the effect of social interactions on the basis of such data is problematic, it is nonetheless signifi- Two factors increase the probability of becoming an entre- cant that more than a quarter of entrepreneurs in our sample preneur. First, having a father and mother who have complet- claim that friends who became entrepreneurs influenced their ed higher education -- by 4.7 and 20.4 percentage points, own career decisions. respectively. Second, the presence of a businessperson among Cultural differences and values are found to play less of a close relatives and friends from adolescence -- by 5.6 and 2.9 role than expected. Entrepreneurs attach more value to work, percentage points, respectively. Location-specific effects were intellectual achievement, power and politics than non-entre- weighted out to control for differences in institutional environ- preneurs. In regards to family, friends, leisure, religion, service ments. Yet, individual perceptions of the business climate mat- to others, financial security, health, and freedom, they tend to ter for career choice: lower perceived levels of corruption and share the values of non-entrepreneurs. a more benign public attitude towards entrepreneurship increase the probability that an individual will become an Two types of entrepreneurs entrepreneur. Looking at family background, we find that the parents of Our analysis further reveals that there are two major cate- an entrepreneur were almost twice as likely to have higher gories of entrepreneurs: one is what we call "entrepreneurs by degrees and good jobs than non-entrepreneurs' parents, and opportunity", the other "entrepreneurs by necessity". The first they were also wealthier. Interestingly, though, while the group became business owners because they seized an oppor- fathers of entrepreneurs were more likely to have been a direc- tunity. In the Schumpeterian sense, these are the only true tor (19% for entrepreneurs vs. 11.4% for non-entrepreneurs), entrepreneurs. The second category became business owners the opposite is true for mothers (2.5% vs. 8.1% for non-entre- primarily because they lost a job or the industry they worked preneurs). A significantly higher proportion of entrepreneurs' for declined. fathers -- nearly 50% -- were members of the Communist Family networks have a positive effect only on the proba- Party, as compared to 35% for non-entrepreneurs. bility of becoming an "opportunity entrepreneur" and have a The social environment in general and social networks in negative effect on "entrepreneurs by necessity". Government particular seem to play an even bigger role. While the likeli- officials' perceived favorable attitude toward entrepreneurs hood that a grandparent was an entrepreneur is negligible for increases the chances that an individual will take a business both groups -- not surprising in a formerly communist coun- opportunity, while reducing the chances that he/she will start a try -- the proportion of close relatives who have run a business business out of necessity. at some point since 1986, when the first private enterprises were allowed, is more than double for entrepreneurs. Note that Why do more people not become entrepreneurs? Three only 5% of the entrepreneurs in our sample inherited a family main reasons given by non-entrepreneurs are insufficient Differences between entrepreneurs and non-entrepreneurs (selected characteristics) Male, % Secondary special education or higher, % Spend >50% of household income on food,% Good school grades, % Short term recall test (cognitive ability), index Own a car, % Job mobility, index Geographical mobility, index Quit job if won $2mln Risk loving, % Would not quit because want more Good health, % money, % Happy, % 0 20 40 60 80 100 0 10 20 30 40 50 60 70 80 90 100 Nonentrepreneurs Nonentrepreneurs Entrepreneurs Entrepreneurs The World Bank· 5 Conclusions The results of the pilot survey suggest that social networks, i.e. having entrepreneurs among family members and friends, is the most important variable affecting the decision to become an entrepreneur. Certain personal characteristics, such as aca- demic success, cognitive ability, personal confidence, greed, and risk-taking are also important determinants of entrepre- neurship, echoing the claims of Schumpeter. Weak institutions play some role in discouraging people from starting or expand- ing an enterprise, but not a crucial one. Cultural differences do not seem to be of great importance in Russia. The limited number of cities and regions in the pilot study makes it difficult to generalize about the impact of regional institutional and cultural differences on entrepreneurship. This is a topic we will explore in the larger survey, which will cover - "Darling, our baby's just sold his toy truck to a wider range of regions in Russia. The findings will then be a playmate!" compared to survey results in other countries. funds, a lack of entrepreneurial skills, and risk aversion. The Simeon Djankov is a program manager at the World Bank's latter two are individual characteristics. Lack of money can be Research Department; Gerard Roland, Yingui Qian, and interpreted both as a credit constraint and as a lack of drive to Edward Miguel are professors at the University of California, raise funds. Thus, it seems that individual characteristics play Berkeley; and Ekaterina Zhuravskaya is the academic director an important role in the decision to become an entrepreneur. of CEFIR at NES, Moscow. Full text of the paper can be Confidence in starting one's own business is boosted by having viewed at http://www1.worldbank.org/finance/assets/images/ entrepreneurs in one's family and among one's friends. EntrepreneurshipRussia.pdf Entrepreneurs in Latvia: a few pieces of the puzzle How does entrepreneurial activity in Latvia compare to GEM average of 11.5%. That entrepreneurship in Latvia is other countries? We attempt to answer the question by com- male-dominated (65%) comes as no surprise and does not dif- piling and analyzing data for 2004 that are compatible with fer markedly from most other countries. that of the Global Entrepreneurship Monitor (GEM). The lat- As many as 84% of Latvian entrepreneurs work in the serv- ter creates measures of entrepreneurial activity by conducting ice sector, primarily in trade, construction, transport and com- adult population surveys in 41 participating countries. The munications. Of the new businesses started, 12% were in man- GEM National Survey for Latvia will be conducted for the first ufacturing and only 4% were in agriculture. The service sector time in 2005, and our study can be considered its forerunner. accounted for 72.9% of Latvia's GDP in 2003, so we might In estimating the extent of entrepreneurial activity in Latvia, predict that the contribution of this sector to the national econ- we rely on the Enterprise Register data, provided by Lursoft. omy will grow in the future. Consistent with our expectations, From a known pool of 12,377 registered new-firm entrepre- the capital, Riga, is the hub of economic activity, with 67% of neurs (defined as an owner-manager of a firm less than 3.5 years all enterprises registered in the area. old), we drew a simple random sample of 2,000 individuals. Nearly all firms are limited liability companies, and 42% of We find that, compared to most other countries, the level of entrepreneurs are sole owners. Only a third of all entrepre- entrepreneurial activity in Latvia is very low. The New Firm neurs have taken long-term loans from banks or other finan- Prevalence Index, defined as the number of new-firm entrepre- cial institutions, suggesting that firm growth is financed pri- neurs per 100 of population aged 18 to 64, is a mere 0.8. This marily from own funds or informal sources. is comparable to such countries as Croatia, France, Japan, Entrepreneurship is widely believed to be a major driving Russia, and Poland, but remains well behind the world's most force behind innovation and economic growth. Our findings entrepreneurial countries, such as China (7.4). suggest that Latvian policymakers need to take measures to A typical entrepreneur is a 39 year-old ethnic Latvian male foster entrepreneurship, otherwise the economy's recent high who works in the wholesale or retail trade sector. Latvian growth rates will be difficult to sustain. entrepreneurs are somewhat older than their peers in other GEM-surveyed countries, where most entrepreneurs are in the Vyacheslav Dombrovsky is a research fellow with the Baltic 25-34 age group. Young people (18--24) are underrepresented International Centre for Economic Policy Studies in Riga, Latvia, in Latvia compared to other countries, with only 5% of young and assistant professor at the Stockholm School of Economics. Latvians engaged in entrepreneurial activity, compared to the The study received financial support from Telia Sonera. 6 · Beyond Transition -- The Newsletter About Reforming Economies Barriers to entrepreneurship Leora Klapper, Luc Laeven, and Raghuram Rajan P olicymakers in country after country are trying to and reincorporation of larger state-owned firms following implement policies that will foster entry. Take, for transition. On average, 63% of new firms have fewer than 10 example, the debate in continental Europe on the lack employees, 23% have 10--50 employees, 12% have 50--250 of home grown venture capital for promoting new firm cre employees and 2% have more than 250 employees. The largest ation in high tech industries. Yet many questions remain new firms are likely to be existing firms that reincorporate fol- about which government policies can help foster a business lowing a merger or acquisition. climate favorable to entrepreneurship. Our empirical analy sis of more than 3 million firms in Europe confirms that How do bureaucratic regulations affect entrepreneurship? bureaucratic entry regulations are neither benign nor wel fare improving. Entry regulations hamper the creation of The early debate on corporations emphasized the possibili- new firms, especially in industries that naturally should have ty that crooks might register with little capital and dupe unsus- high entry. Value added per employee in such industries grows more slowly, and older firms are slower to expand and pecting investors or consumers. According to this view, entry thus remain smaller. Such are the adverse effects of the lack regulations serve the public interest by preventing fraud. By of competition from new entrants. Regulations beneficial to contrast, a long literature from Adam Smith to Joseph Stigler entrepreneurship are those that improve access to finance describes regulations as devices to protect the private interests and protect property rights. of industry incumbents or regulators. To address the problem of causality, i.e. the possibility that Some facts about entrepreneurship are striking. For in countries with generally low entrepreneurship people may instance, one might expect that Italy, with its myriad small not be sufficiently motivated to press for the repeal of archaic firms, should have tremendous new firm creation (we use "new regulations, we focus on cross-industry, cross-country interac- firm creation", "entry", and "entrepreneurship" interchange- tion effects. In particular, we test whether entry is relatively ably). Actually, new firms (up to 2 years of age) as a portion of lower in "naturally high entry" industries in countries with the total number of firms is only 3.5%, compared to 13.5% on excessive bureaucratic regulations. average for other European countries in the G-7. We therefore need to know what entry would look like if Our study suggests an explanation for such low levels of there were few artificial or infrastructural barriers to entry, entry: the average direct cost of fulfilling the bureaucratic reg- such as rigid labor regulation or poor access to financing. ulations for setting up a new business in Italy is a huge 20% of Under the assumption that these barriers are low in the United per capita GNP, compared to the average of 10% for other States (entry costs in the U.S. are just 0.5% of per capita GNP, European G-7 countries. compared to the European average of 20%), we would expect the rate of entry in an industry in the United States to be a good Entry rates higher in Eastern Europe proxy for the "natural" propensity for entry in that industry. The "natural" propensity reflects technological barriers like Our analysis is based on the Amadeus database, a new, economies of scale or incumbent organizational efficiencies comprehensive database on private and publicly traded firms obtained from experience. Of course, there is a degree of hero- in 34 countries in Eastern and Western Europe. Having exclud- ism in assuming that entry in the United States does not suffer ed countries with incomplete coverage and poor data quality, from artificial barriers. Nevertheless, all that is important is as well as certain industries (such as the agriculture, mining, that the rank ordering of entry in the U.S. corresponds to the utility, finance, and public sectors), we end up with a sample of rank ordering of natural barriers across industries and carries almost 3.4 million firms in 21 countries. over to other countries. We find that the average share of new firms is 13.3%. This Both in Europe and the U.S., we find high entry rates in the figure ranges from 19.2% in Lithuania to 3.5% in Italy (see the computer and communications industries and low entry rates table). Overall, the share of new firms in Eastern European in infrastructure-related sectors. countries is 15.7%, compared to 11.9% in Western Europe. This difference reflects the recent emergence of a large number Findings: Barriers to entry slow down business growth of private firms in the transition economies. The direct costs of setting up a new business, expressed as Growth in value added is relatively lower in naturally high- a percentage of per capita GNP in US dollars, vary from an entry industries in a country with substantial bureaucratic bar- excessive 86% in Hungary to just 1% in Finland and the UK, riers to entry. There may be two explanations for this finding: with the average at 20%. slower growth could be attributed to incumbents having more Most of the entering firms are small. Interestingly, we find monopoly power and restricting quantities, or incumbents may a greater proportion of new, larger firms in the Eastern be less efficient as they are less subject to the discipline of com- European countries. This may reflect continued privatization petition. We find evidence for the latter explanation: older The World Bank · 7 firms in naturally high-entry industries grow relatively more plier trade credit, and measures of banking and capital mar- slowly in countries with high bureaucratic barriers, while the ket development. relative growth of young firms is indistinguishable. Since age As predicted, entry is higher in industries that depend heav- should not affect the incentive to restrict quantities, older firms ily on external finance in countries that have better financial working in a more competitive environment in countries with development. What is particularly interesting is that entry is low entry barriers become relatively more efficient and contin- relatively higher in industries that depend on trade credit ue to grow. financing in countries with greater extension of trade credit, As a suggestive comparison, we plot average value added even after controlling for the traditional effects of financial for firms in different age groups for two countries, high entry- development. Supplier credit turns out to be an important aid barrier Italy and low entry-barrier United Kingdom. Across all to entrepreneurship. industries, firms start out larger when young in Italy, but grow more slowly, such that firms in the United Kingdom are about Other regulations are important twice as large by age ten. This suggests Italy has small firms not because there is too much entry, but perhaps because there is There are other regulations and aspects of the business too little! environment that might affect entry, such as protection of intel- It turns out that entry barriers are more effective in pre- lectual property, labor regulations, and the effects of taxes. Our venting firm creation in high-income countries, suggesting that examination reveals that: their purpose is not to screen out the untrustworthy, or that · Labor regulation hampers entry in labor-intensive low-income countries have other natural barriers that prevent industries. The cost of compliance with regulations may inhib- firm creation. More interestingly, entry barriers are effective in it entry through fixed components, which are costly for small retarding entry only in the least corrupt countries, implying businesses. Small firms may not be able to afford to keep their that their purpose may well be to protect incumbents and their employees through downturns and thus might "underhire" in rents. the face of strict labor regulations; · Better property right protection in a country promotes Access to finance stimulates entry entry in R&D-intensive industries. New entrants that do not have the organizational structure, finance, or intellectual capi- Liquidity constraints hinder people from starting busi- tal to create a significant first mover advantage and dissuade nesses, so entry rates should be lower in countries with less potential imitators might have a greater incentive to do developed financial systems. We also expect that access to research if they know it will be legally protected; and finance is especially important for new firms in industries · Entry is significantly higher in high-entry industries in that require a lot of external financing. Bank credit is likely countries where tax rates on corporate income are much lower to be the most important form of financing for small firms, than those on personal income. That is, higher taxes work but we also examine access to start-up capital, such as sup- much as regulatory barriers. Conclusions Table: Entry rates, number of required procedures and entry costs, selected countries Policymakers should note Country % of Number of Entry cost Private Credit that competition has discipli- new firms entry (% of per (% of per procedures capita GNP) nary effects that outweigh any capita GNP) possible screening benefits from entry restrictions. Moves Bulgaria 8.60 10 14.41 19.30 to reduce bureaucratic entry Czech Republic 11.55 10 8.22 58.48 regulations will help their Finland 11.13 5 1.16 56.34 countries. Interestingly, entry France 14.68 15 14.30 84.07 regulations especially hurt Germany 12.34 10 15.69 112.03 countries that are more devel- Hungary 17.38 8 85.87 23.84 oped and less corrupt, i.e. Italy 3.46 16 20.02 60.13 where existing entry regula- Latvia 18.16 7 42.34 11.22 tions are most effectively Poland 12.04 11 25.46 16.89 enforced. This is an interest- Romania 17.97 16 15.31 9.87 ing example of a situation UK 15.01 5 1.43 120.27 where more advanced coun- tries have "bad" institutions. Average, Western Europe 11.92 8.85 15.50 80.84 Average, transition countries 15.67 10.29 28.15 21.80 Note: the analysis is limited to 1998--1999 to avoid potential survivorship bias 8 · Beyond Transition -- The Newsletter About Reforming Economies However, it is by no means obvious that the best way to encourage entry and competition is to eliminate all regulation. Regulations that expand access to finance and strengthen prop- erty rights help the creation of new firms, and their absence can be an effective entry barrier. Leora Klapper is a senior economist at the Development Research Group, and Luc Laeven is a senior financial econo- mist in the Financial Sector Department of the World Bank. Raghuram Rajan is the economic counselor and director of research at the International Monetary Fund. This paper's find- ings, interpretations, and conclusions are entirely those of the authors and do not necessarily represent the views of the World Bank, the IMF, their Executive Directors, or the countries they represent. The full text of the paper can be viewed at http://www.nber.org/papers/w10380. Business owners' growth expectations in Lithuania In Lithuania, as in other transition countries, private · Gender: women entrepreneurs have higher enterprise mushroomed in the early 1990s. However, the growth aspirations than their male counterparts. growth trend in the number of enterprises was reversed in The firm's size has a clearly important but non-linear the mid 1990s, and in just two years -- from the begin- impact on growth aspirations. Small- and medium-size ning of 1999 to the end of 2000 -- the number of regis- companies (with fewer than 70 employees) expect to tered small and medium-sized (SME) enterprises grow, while micro-firms and the self-employed express lit- decreased from 81,600 to 52,000. tle interest in developing their business.This confirms ear- Whereas in transition countries most large private lier research that businesses without employees are more firms sprung up through a shift of resources from state to likely to represent hidden unemployment than a form of private hands through privatisation, in advanced western true entrepreneurship. On the other hand, the owners of countries large private firms emerged through the growth the largest companies in the survey also do not expect to of privately-owned enterprises. As privatisation does not grow. necessary modify organisational routines and capacities A second theme relates to the link between business and improve performance, the emergence and growth of owners' perceptions of barriers and their growth expecta- SMEs is of special importance, not only for their poten- tions. Generally, the barriers ranked highest are not tial to generate wealth and jobs, but also for its ability to always those associated with slower growth. Our study foster innovation, experimentation and adaptation in the finds that both taxation and corruption are significant new business environment. barriers to the growth aspirations of SMEs. Corruption is Our survey of 399 owners of small and medium-size not ranked high amongst barriers, although where expe- companies in Lithuania investigates why some business rienced it negatively affects entrepreneurs motivation to owners expect their firms to expand, while others do not. grow. Interestingly, neither access to finance nor demand- Following recent trends in the literature, we use business related barriers (such as low purchasing power and delays owner perceptions and focus on expectations of future in payment by clients) seem to matter significantly for growth, measured as the increase in both turnover and growth outlook. These represent standard constraints in employment. market economies. While troublesome for entrepreneurs, We find that the following factors have a positive they may be overcome by appropriate business strategies, effect on growth expectations: such as the increasing credibility of external providers of finance and better addressing demand. · The owner has higher education; · The owner has private business experience, i.e. `learning by doing' either through previous work or addi- Ruta Aidis is a lecturer at University College London tional entrepreneurial experience; and the University of Amsterdam. Tomasz Mickiewicz is · The firm has export experience (though the a senior lecturer at University College London. The full result may be sensitive to the timing of the survey, con- text of the authors' joint paper can be viewed at ducted two years after the Russian crisis); http://www.ssees.ac.uk/economic.htm. The World Bank· 9 Banking deregulation promotes "creative destruction" Marianne Bertrand, Antoinette Schoar and David Thesmar M any economies around the world have heavily reg rates would be used to match the supply and demand of capi- ulated banking sectors, with the state intervening tal for each type of project. in banks' lending decisions, either through state Most loan subsidies were eliminated, with the exception of ownership of banks, regulatory limits on competition, or some loans provided to "small" firms (with total sales below subsidies. The deregulation of the French banking industry in US$150 mln). Moreover, the Treasury-controlled deposit net- the mid 1980s reduced government interference and work no longer held a monopoly on the distribution of these allowed French banks to compete more freely on the credit loans. Credit growth limits were gradually removed and market. The deregulation had several efficiency enhancing replaced by a system of reserve requirements against deposits. consequences for the real sector: banks were less willing to The 1985 Banking Act partially unified a myriad of banking bail out poorly performing firms, some of which had to exit; regulations, helping the market become more transparent and firms were forced to cut costs and restructure; and product conducive to fair competition. Banks also faced more competi- markets became more competitive as more entries occurred. A more efficient banking sector therefore plays an important tion from other providers of external finance, such as the bond role in fostering a Schumpeterian process of "creative and equity markets. destruction". The French experience provides important les sons and an encouraging example for transition countries Consequences of reform contemplating liberalizing their banking sectors. According to data from the Bank of France, the ratio of Our study investigates the effects of banking sector deregu- total debt to assets, as high as 70% in the early 1980s, went lation on firm behavior and industry structure. The analysis is down by 20% and remained stable around 50% until 1996. based on a dataset of 15,000 firm observations per year for the This decrease in leverage can only partly be explained by the period 1978--1999. While the analysis is restricted to a single rise in real interest rates that took place in the late 1980s. country, the scope of pre-reform regulation in France mirrors Another consequence was a change in banks' behavior. The the experience of many other countries with regulated banking reforms signaled that the Treasury was willing to let market sectors. In this regard, the French reform is quite representative forces shape the credit market landscape for the long run. of the multiple changes other countries would have to perform These new conditions forced banks to change their lending to liberalize their banking sectors. practices and undergo internal restructuring. A survey con- ducted in 1985 among French bankers showed that bank man- French banking prior to the 1985 reform agers increasingly focused on reducing costs, controlling risks and introducing tighter performance monitoring. The greater After World War II, the French financial sector had been competitive pressures were most intensely felt by banks in the under the centralized control of the Treasury, whose general Treasury network, as these banks lost their privileged access to aim was to channel deposits into priority industries. To control deposit and loan markets. The Treasury network's share of the credit market, the Treasury set up a deposit network, con- total deposits decreased by 28% between 1985 and 1990, and sisting of several selected banks, which had a monopoly over its share of loans went down by 25%. the distribution of subsidized loans allocated by the Treasury. Banks outside the network faced monthly ceilings on credit What effect did these regulatory changes have on the real growth. So, while the deposit network under the Treasury's economy and on firm behavior? control could expand credit almost without limit, banks that were not part of that network were asphyxiated. By 1979, sub- Firms forced to change capital structure sidized loans amounted to nearly half of all new loans granted to the private sector. Our analysis shows that, after the reform, firms experi- With a growing number of loan subsidy programs, the cred- enced a drop in debt (see table). For firms in an industry at the it market was becoming progressively more opaque, with dif- 75th percentile of the pre-reform banking dependence distri- ferent interest rates for different programs. At the same time, bution (banking dependence is defined as average debt in each banks were increasingly accumulating non-performing loans. industry between 1978 and 1983), bank debt fell seven per- In the beginning of the 1980s the French banking industry was centage points further than for firms in a 25th percentile indus- so heavily regulated that interest rates played almost no role in try. Firms compensated this loss by increasing equity finance the allocation of capital. It also became more and more difficult and, to a larger extent, through trade credits. Nevertheless, the to assess the cost of these loans to the state budget. cost of capital for firms in bank-dependent industries In the fall of 1984, the socialist government announced a increased. This effect was especially pronounced for worse-per- drastic reversal of policy. The goal was to transform the finan- forming firms, indicating that banks became more selective in cial system into a decentralized credit market, where interest their lending behavior. 10 · Beyond Transition -- The Newsletter About Reforming Economies Banks change lending behavior More dynamic and competitive industry structure Were banks more willing to "bail out" poorly performing As poorly performing incumbents no longer received easy firms before or after the reform? We find that banks became access to cheap bank loans, some had trouble surviving. more conservative in their lending decisions, especially in those Consequently, this lowered the barriers to entry for prospective sectors that had been most reliant on banks. But increased con- entrants. servatism by itself is not a sign of better capital allocation, since Asset creation through new entries increased by about 26% banks may inefficiently screen out firms that are experiencing more in industries at the 75th percentile of the pre-reform temporary difficulties but are profitable in the long run. banking dependence distribution than in industries at the 25th Our analysis confirms that banks' lending behavior percentile. Importantly, most of the economic impact came changed considerably with respect to poorly performing firms, from newly created firms. Thus, the distortions in lending implying that banks were no longer willing to lend to the same before the reform had a negative impact on competition by extent to poor performers. creating effective barriers to entry in the real economy. Another interesting fact is that before the reform, the rela- The more dynamic and competitive structure of industry is tionship between new bank loans and a firm's future perform- associated with lower market concentration. Indeed, two dif- ance (measured as a change in return on assets) was negative! ferent measures of concentration, a Herfindahl index and a This relationship did change after the reform, reflecting a measure of the market share of the five largest firms in each change in the explicit functions of banks, which now put more industry and year, confirm that concentration decreased, espe- emphasis on the credit quality of borrowers when determining cially in bank-dependent sectors. Thus, the market share of the loan size and interest rates. This also likely reflects a switch five largest firms in an industry at the 75th percentile was three from an operating environment plagued by distorted interest to four percentage points lower than in an industry at the 25th rates to a more market-oriented environment. percentile. Higher reallocation rates are often interpreted as a sign of a Firms pressured to restructure more competitive and efficient business environment. This view goes back to Schumpeter's idea of processes of"creative destruc- Firms responded to the reform by cutting costs and restruc- tion". However, an increase in the turnover rate of firms need turing activities, as they faced stronger incentives to strengthen not imply higher efficiency, if firms are wrongly forced to exit. their credit rating: To investigate whether the post-reform increase in asset · Average wages fell substantially, with a particularly reallocation is symptomatic of an increase in allocative effi- pronounced impact on bank-dependent sectors: wages fell 4% ciency, we return to the firm-level data. We find that further among industries at the 75th percentile of the pre- · Worse performing firms were more likely to exit; reform banking dependence distribution compared to indus- · Better performing firms had higher market shares tries at the 25th percentile. Somewhat surprisingly, average within their respective industries after the banking reform; wages declined more strongly among the better performing · Bank-dependent sectors increased employment after firms. deregulation; · Firms, especially weak performers, outsourced part of · Labor cost per worker fell, and value-added per work- their operations to other firms. er increased in bank-dependent sectors. While all firms improved performance, better-performing improved further. One can conclude that worse-performing Conclusions firms were forced to shut down. Our study identifies several important effects of banking deregulation on the real economy and on firm Table. Selected firm characteristics, 1978--1999 behavior. Specifically, after deregulation: · Firms in more bank-dependent sectors Before 1985, After 1985, are forced to change their capital structure, cut- mean mean ting debt and turning to trade credit and equity finance; Bank debt 0.48 0.42 · Banks improve their monitoring and Trade credit 0.31 0.27 screening abilities and are less willing to bail out Capital cost 0.07 0.09 poorly performing firms; · Firms have to cut costs (e.g. lowering Return on assets, ROA 0.07 0.17 wages and increasing outsourcing) and restruc- Sales (1980 francs) 92.6 112.3 ture; Total assets (1980 francs) 95.5 132.7 · Market concentration decreases, prod- Employment 203.6 188.5 uct markets become more competitive; · More new entries occur, and new firms Average wage (1980 francs) 67.52 79.20 create more assets and jobs. The World Bank· 11 Distortions in bank lending create artificial barriers to entry Marianne Bertrand is professor of economics at the in the real economy. New entrants may be discouraged by University of Chicago Graduate School of Business. Antoinette incumbent firms' easy access to cheap credit. Once banks Schoar is assistant professor of finance at MIT. David Thesmar become less willing to provide such cheap credit to poorly per- is professor of economics at Ecole Nationale de la Statistique et forming firms, prospective new entrants find it more attractive de l'Administration Economique, Paris. The article draws on to come in and compete with incumbents. A more efficient the authors' paper "Banking Deregulation and Industry banking sector therefore plays an important role in fostering Structure: Evidence from the French Banking Reforms of the Schumpeterian process of "creative destruction" that has 1985", available at http://www1.worldbank.org/finance/assets/ been theoretically, and increasingly, empirically linked to high- images/france_draft16_try_antoinette_schoar.pdf. er economic growth. No Exit? Regulation of entry in banking -- including minimum from financial speculation and tax `optimization' to money- capital requirements and so-called `fit and proper' entry laundering and outright fraud. tests -- is a more or less standard part of the regulatory Nor did exit mechanisms work well. In part, this simply framework. The primary justification for regulating entry reflected the reluctance of the CBR to act decisively to wind (and, indeed, for regulating banks' activities generally) is the up failed banks. However, it also reflected the absence until avoidance of systemic risk. Regulating entry can also help 1999 of a law on the bankruptcy of credit organizations. strengthen investor protection and the efficiency of interme- Even after its adoption, this law achieved little until it was diation by promoting confidence in, and trust within, the further amended in 2003--04. The general laws on bank- sector. Efficient exit is essential for the same reason: unsafe ruptcy, adopted in 1992 and 1998, were wholly inadequate, and unsound banks pose a threat to the system and need to not least because they required, inter alia, that the court be rendered sound or removed promptly. consider individually each creditor claim contested by the Until recently, the regulatory framework governing debtor. Banks were able to stall proceedings merely by chal- Russia's banking sector reflected neither of these require- lenging thousands of the claims against them. Even after the ments. The regime governing entry was, until well into the adoption of a law concerned specifically with the bankrupt- 1990s, excessively liberal, while there were substantial de cy of banks, the cumbersome and generally inefficient (from jure and de facto obstacles to efficient exit. The rules have creditors' perspective) procedures for liquidating failed since changed dramatically, but the legacies of the past con- banks left many in legal limbo for years, allowing insiders tinue to complicate the job of the Central Bank of Russia to siphon off assets before creditors' claims were met (at any (CBR). given time, there are several hundred such `bank-corpses' in Hundreds of banks emerged in the final years of the the sector). Soviet era under the very permissive provisions of the Law Matters have improved greatly in recent years. Entry on Cooperatives. Politicians challenging central power used requirements for new banks have become much tougher, the lax entry regime then in force to undermine the financial while the mechanisms for liquidating failed institutions have power of the all-Union authorities, while managers and been streamlined. The number of banks has gradually bureaucrats quickly discovered the rents that could be declined, and average capitalization has risen. However, the derived from running a bank. At the time, many of the new CBR has been unable to apply the entry requirements banks could write credits on the so-called inter-branch retroactively, while the turbulence provoked by its interven- turnover (i.e. creating money), effectively acting as minia- tion in Sodbiznesbank in May 2004 highlights the continu- ture central banks in their own right. ing risks associated with liquidating problem banks. In a This rapid growth continued into the post-Soviet period, sector characterized by low transparency and little trust as high inflation made it easy for would-be bankers to meet (whether it be trust among banks or trust in the authorities), minimum capital requirements. As late as 1994, a new bank every intervention risks setting off a chain of unintended needed only $65,000 in charter capital. Moreover, banks consequences. The CBR is still struggling to overcome the were allowed to include all manner of illiquid (and often sector's history of easy entry and no exit. rapidly depreciating) assets in their calculations of `tier-2 capital'. As a result, the CBR in the early 1990s found its William Tompson is a senior economist in the Non- limited supervisory capacities overstretched: the sector com- Member Economies Division of the Economics Department prised more than 2,500 banks. Most were severely under- of the OECD. The opinions expressed in this comment are capitalized, and the vast majority did little actual banking, those of the author and do not necessarily reflect the views being primarily concerned with other activities, ranging of the OECD or its member states. 12 · Beyond Transition -- The Newsletter About Reforming Economies Creative destruction in industrial and developing countries Eric Bartelsman, John Haltiwanger and Stefano Scarpetta F irms in all countries undergo significant changes over Both entering and exiting firms tend to be small, at 20-- time, as resources are continuously reallocated across 60% of the average size of incumbents, so firm flows affect existing firms, and markets are affected by the entry of only 5% to 10% of total employment. This may suggest that new firms and the exit of obsolete ones. Our analysis of 24 entry is relatively easy, but many small newcomers fail before industrial and developing countries shows that, on average, reaching an efficient scale of production. 10--20% of firms enter and exit each year. But market selec As noted earlier, in transition economies firm entry greatly tion is harsh, and about 20% to 40% of new firms fail within exceeds firm exit. New firms not only displace obsolete incum- their first two years. This process of creative destruction bents, but also fill new markets that were either nonexistent or affects an economy's productivity both directly, shifting poorly populated in the past. However, the large flows seen in resources towards more productive uses, and indirectly, the beginning declined as the transition moved forward and through increased competition, encouraging incumbents to reached levels similar to other countries. enhance productivity. Transition economies show an even more impressive process of creative destruction, with more Turnover rates vary significantly across sectors: they are firms entering and exiting the market, and a stronger contri somewhat higher in the service sector (especially in trade) and bution to overall productivity growth. lower in manufacturing, with the exception of the high-tech industries, which had relatively high entry rates in the 1990s. Our firm-level data cover countries with different economic Market selection is fairly harsh. Between 20% and 40% of structures, institutions and growth performances: ten industrial start-ups fail within their first two years. Failure rates decline countries, five Central and Eastern European countries (Estonia, with duration, but only 40% to 50% of firms entering in any Hungary, Latvia, Romania, Slovenia), and nine economies in given year survive beyond their seventh year. Latin America and East Asia. The data are harmonized across Successful entrants, on the other hand, expand rapidly, but countries to enable meaningful international comparisons. their growth rates vary across industries and countries. U.S. The analysis of firm size is an important building block of firms tend to start small and, if successful, expand quickly to our analysis of creative destruction. Small firms are dominant in approach the minimum efficient scale. Firms in Western the creative destruction process, but successful small entrants Europe have less scope for expansion than in the U.S. also have great potential to expand, create more jobs and con- Transition economies show higher survival rates and greater tribute to technological adoption. We find that, in all countries, growth for successful firms, compared to industrial and other micro units (with fewer than 20 employees) dominate, account- emerging economies, as new firms enter new, relatively less ing for at least 80% of the total number of firms. Their share of populated markets and have enjoyed in the early phases of the total employment is much lower, ranging from less than 15% in transition a relatively lower level of competition. Romania to 20% in the United States and around 30% in some small European economies. Creative destruction important for productivity growth High degree of turbulence in all countries Our analysis reveals that the continuous process of retooling and innovation within existing firms accounts for the bulk of The other interesting finding of our analysis is the magni- overall labor productivity growth. But, especially in manufac- tude of firm turnover: if we focus on the population of firms turing, productivity enhancement is often associated with down- with at least 20 employees, we observe that firm turnover sizing rather than expansion. (entry plus exit rates) accounts for 3% to 8% of the total num- The overall contribution of firm entry and exit accounts for ber of firms in industrial countries and more than 10% in some between 20% and 50% of total productivity growth. In all transition economies. If we then also consider micro units (i.e., countries, the exit of the least productive firms boosts aggre- adding all firms with at least one employee), we observe firm gate productivity. As for entry, its effect on productivity is dif- turnover rates on the order of 20% to 25%. It is also interest- ferent across countries: new firms tend to be relatively less pro- ing to note that entry and exit rates tend to be highly correlat- ductive than incumbents in their early years, but those that sur- ed in most countries; in other words, entries and exits seem to vive tend to experience rapid productivity growth. And in tran- be part of a process in which a large number of new firms dis- sition economies, entrants are more productive than the place a similar number of obsolete firms, without affecting sig- incumbents even in their first years. It is also noteworthy that nificantly the total number of firms in the market at any given the new entrants' contribution to productivity varies a lot time. But in transition economies, where new firms are popu- across industries; new firms make a strong contribution to lating new sectors and activities while obsolete firms exit other aggregate industrial productivity in high-tech industries, where markets, the correlation between entry and exit across sectors stronger technological opportunities are often better harnessed is weak. by new firms. The World Bank · 13 Productivity improvements within incumbent firms and · Creative destruction assumes an even stronger role in new entrants' efforts at productivity also tend to be closely the transition countries studied. The magnitude of firm cre- related. Strong firm turnover, with newcomers replacing less ation and destruction is larger than in industrial countries: productive units, tends to promote competitive pressures and many new smaller firms have been replacing obsolete larger push existing firms to enhance their performance in order to units inherited from the central-planning period. Moreover, preserve their market shares. Indeed, higher firm turnover is new firms have filled in new market niches, enjoying, especial- associated with stronger productivity growth among incum- ly in the early years of transition, relatively low competition bents. The more creative destruction increases productivity, the and thus higher survival rates. As markets develop and become more it stimulates incumbents' growth. more populated, competition increases and new firms face a tougher market selection. The process of resource reallocation Conclusions has become increasingly effective over the course of transition, shifting resources to new, but also more productive, firms. Our analysis shows significant differences across countries There are also interesting differences across countries. in terms of firm size, firm turnover, survival rates and produc- Hungary, Estonia, Latvia and Slovenia have all experienced a tivity growth: strong creative destruction process, with strong growth after · All industrial countries show a marked process of cre- the entry and a significant contribution by new entry (and exit) ative destruction, though there are significant country differ- to productivity growth. Romania is still dominated by some ences. New U.S. firms tend to be smaller in size than incum- large firms; the entry of new firms has increased rapidly in bents and have lower relative productivity levels than new recent years as market reforms have progressed. Nevertheless, firms in Europe. But market selection and learning effects even successful new firms seem to have difficulty expanding. imply that successfully surviving entrants quickly expand, while low-productivity entrants exit rapidly, freeing resources Eric Bartelsman is professor of economics at the Free for new ventures. This indicates a higher degree of market University of Amsterdam and at Tinbergen Institute. John experimentation in the United States than in Europe. Also, the Haltiwanger is professor of economics at University of European countries exhibit a weaker ability to direct resources Maryland. Stefano Scarpetta is a labor market advisor and lead towards the most productive uses than in the U.S. economist at the World Bank. Lobbying on Entry In our model of a basic political conflict between two with approximately a one-half-point increase in effective classes of entrepreneurs -- established wealthier entrepre- investor protection (out of a possible six). The democracy neurs and potential entrants -- the former lobby politicians score measures the general openness of political institutions to maintain a low level of investor protection in order to and ranges from 0 to 10. A decrease in wealth inequality by prevent potential entry. A low level of protection prevents 10 points -- from that of Brazil to that of Turkey -- is asso- entering firms from raising capital. Incumbents can earn ciated with an increase in effective investor protection of higher rents in a less competitive environment and can one third of a point. Wealth inequality is measured by the promise larger political contributions than the entrants. average Gini coefficient over 1964-1983 interval, taking Thus, they win the conflict. The main implication of the values from 0 to 100, with a higher number indicating model is that entry should be higher in more democratic and greater inequality. less unequal societies. While financial development promotes entry in our Lobbying can create various sorts of formal and infor- model, we cannot offer a generic recommendation in favor mal entry barriers. Undermining financial development is a of financial development as an engine of entry, ignoring the natural channel for blocking entry. Informal barriers, creat- institutional context in which it would take place. ed by the selective enforcement of contracts or property Privatization and liberalization of the banking system may rights, are probably more dangerous than explicit barriers, fail to deliver growth if they are undermined by connected as they escape public scrutiny and may coexist with ade- lending and outright plundering by bank owners. While quate formal legislation. good legislation and policy play a role, ultimately financial An empirical test of the model's predictions on a sample development, entry and growth require the effective and fair of 38 developed and developing countries for 1983--1992 enforcement of rules. shows that, in more accountable countries, entry is signifi- cantly higher in industries that require more external capi- Enrico Perotti is chaired professor of international finance tal. This appears to be true independently of the country's at the University of Amsterdam. Paolo Volpin is an assistant level of economic development and legal framework. professor of finance at London Business School. The full text An increase in the democracy score from zero to 5.6, i.e. of the paper can be viewed at http://www1.worldbank.org/ from the level in Indonesia to the Philippines, is associated finance/assets/images/perotti-volpin.pdf. 14 · Beyond Transition -- The Newsletter About Reforming Economies What makes small firms grow? Evidence from Romania David Brown, John Earle and Dana Lup T he contributions of new start up firms to innovation problem reportedly greater for slow-growing, micro and small and economic growth are well recognized, as is the firms. The availability of buildings and land appears to be less crucial role played by this de novo sector in the transi serious. tion of formerly socialist economies. Our study focuses on · Malfunctioning of the business environment: only policy relevant factors that may determine whether newly 17.7% of entrepreneurs consider that at least one type of con- founded enterprises in transition economies develop into tract enforcement (with either customers or suppliers) is a very larger firms, creating jobs for workers and producing goods binding or serious constraint. Only a trivial number of firms for consumers, or instead languish as tiny "mom and pop" considered protection payments to the police and private par- operations with relatively few externalities for economic ties (mafias), which threaten property rights, as serious prob- development. Considering the effect of finance, human cap lems. Constraints associated with bureaucratic interference are ital, technical assistance, and the business environment on somewhat higher, with about one third of firms reporting seri- the development of Romanian firms, we find that finance is very important in stimulating the growth of small firms, as ous problems. About 47% of firms consider unfair competi- are tax credits provided by the state. tion a constraining factor. Whether competition is evaluated as "unfair" could certainly involve some subjectivity, but in the The study is based on a survey of 297 Romanian enter- Romanian context it may reflect the presence of subsidies or prises that at some point before March 2000 had received a regulations favoring larger, state-owned firms or jealousy over loan from an international micro-credit agency. This sampling special preferences granted to foreign investors, which have procedure has the advantage of a very high response rate been quite controversial in the country. Still more substantial (90%) of owner-managers and accountants to a long ques- is the view that the administrative burden of taxation is an tionnaire requesting very detailed and sensitive information. important constraint, as reported by 90% of managers. The firm-level survey data is then linked to longitudinal infor- · Macroeconomic climate: inflation was viewed by mation from several sources on employment and sales. most firms as a severe constraint, and about 30% cited it as More than two-thirds of the sample are micro firms (fewer the single most constraining factor. Low demand for the firm's than 10 employees), which have successfully started up, but products was cited as a constraint by 37%, but it was among whose further growth is far from assured. Micro firms repre- the most important factors for only very few firms. sent the overwhelming majority of small firms in Romania, accounting for 92.8% of all SMEs in 1999. An additional 23% Objective assessment finds that financing stimulates of firms in our sample have between 10 and 19 employees, and growth only 9.1% percent of the firms are "medium", according to the standard definition of 50--249 employees. Nearly half the Studies of managerial opinions are useful and suggestive, firms surveyed operate in wholesale or retail trade, but there is but there is a clear need for careful quantitative assessment of also significant representation from several manufacturing sec- the relationship between firm growth and objective measures tors, transportation, and a variety of services. Growth rates in of policy-related factors. These objective measures include average annual employment and sales are our measures of firm finance, human capital, technical assistance, and the business growth in this study. environment. By "objective", we mean quantities that may be independently verified and that are defined according to gen- Lack of finance is a severe constraint, managers report erally accepted and interpersonally comparable metrics. The results of our panel analysis provide evidence that In detailed interviews, we asked each respondent to rate on loans stimulate the growth of small startup firms in Romania. a scale from 1 (not constraining at all) to 5 (extremely con- This finding, which is highly robust to alternative specifica- straining) the degree to which he/she believed that a given fac- tions and methods of estimation, runs counter to the claims by tor constrained his/her firm's growth. We asked about four some recent studies that external finance is not an important main sets of factors: constraint for small-firm growth in Eastern Europe. · Financial constraints: about 78% of firms considered As for other factors, such as human capital, technical assis- the lack of capital as a very constraining factor, and the per- tance and business climate variables, there is little or no evi- centage was higher in slow-growing and smaller firms.The high dence that they constrain growth. This is consistent with the level of taxation, which may reduce the possibility of internal evaluations of managers that hiring difficulties, corruption, finance as an alternative to costly external sources, was consid- permits, inspections, and problems with contract enforcement ered an important constraint by nearly all firms (91.1%), with and property rights are not important constraints for their comparatively little variation by growth rate or size. businesses. · Labor and material inputs: about one third of entre- Because of the chosen sampling method, the results may be preneurs mentioned hiring as a severe constraint, with the generalized only with regard to firms that are similar to those The World Bank· 15 in our sample. The relevant policy question, however, is not firm a larger loan or extending finance to more firms, should whether loans should be extended to the universe of all firms further promote the growth of the Romanian small firm sector. in Romania, but rather whether the loan program should, for In contrast, we found little or no evidence that focusing aid on example, be doubled in size, either by doubling the loans that the provision of technical assistance, investing in human capi- the sample firms receive or by doubling the number of firms tal, or improving the business climate would enhance growth. that receive loans. If small firms in Romania are indeed capi- tal-constrained, as our evidence strongly suggests, then we David Brown is a lecturer in finance at Heriot-Watt doubt that the next 300 or so firms in the queue for finance University in Edinburgh. John Earle is a senior economist at would differ materially from the 300 who did receive a micro- the Upjohn Institute for Employment Research and professor finance loan. of economics at Central European University (CEU) in The study suggests that international aid in the form of Budapest. Dana Lup is a research associate at CEU and a microfinance programs has been well spent, as the programs Ph.D. student at the University of Chicago. The full text of the have played an important role in the growth of participating paper can be viewed at http://papers.ssrn.com/sol3/papers. firms. An expansion of these programs, either by giving each cfm?abstract_id=425421. Financing conditions for small and medium enterprises in the new EU member states Foreign bank penetration in the eight new Central and firms' working capital comes from internal funds, compared East European and Baltic EU member countries plus to 56% for large firms. Bank credit generally plays a rela- Bulgaria and Romania has occurred at an impressive speed tively small role in the overall financing of both working over the past decade. But while the entrance of foreign capital and new investment. Borrowing from banks, howev- banks has significantly increased the efficiency of these er, plays a far more important role for large firms, who on countries' banking systems, the degree of financial deepen- average finance around 17% of their working capital and ing remains low. new investment through bank credit. This is compared with With the exception of Slovenia, the banking sectors of the around 13% for medium firms and 7% for small firms. In new member states are largely dominated by foreign-owned short, the analysis shows a strong positive relationship institutions. The assets held by foreign-owned banks, relative between firm size and bank financing. to the assets of all banks, have increased significantly over While foreign bank penetration has spurred the efficien- the past decade, from an unweighted average of 22% in cy of the financial markets of the new EU member states, 1996 to 71% in 2002. In Estonia the share of banking assets empirical evidence from other regions suggests that the high in foreign holding is as high as 98%. Financial markets have concentration of financial services and the dominance of become more competitive, but also more concentrated. The foreign-owned institutions could have serious effects for the market shares of the five largest banks in seven out of the ten financing of small local businesses in these countries. The countries studied varied from 65% to 99%, which is signifi- so-called large-bank barriers hypothesis and the foreign- cantly higher than the unweighted average of 55% for "old" owned-bank barriers hypothesis suppose that large and for- EU countries. Over the recent years, the number of banks eign institutions experience difficulties in lending to smaller decreased markedly in all countries. entities with more opaque structures. In the new member While there is no data available to control directly for countries, it is specifically these banks that dominate the possible effects of foreign bank ownership and the high con- market, suggesting that SMEs might not see an improve- centration on SME lending in the new member states, the ment in their financing conditions on the same scale as larg- Business Environment and Enterprise Performance Survey er enterprises. While the results of the BEEPS cannot be (BEEPS) carried out by the EBRD and the World Bank pro- taken as sufficient empirical proof of the large-bank and vides insights into the financing conditions of enterprises of foreign-owned-bank barriers hypotheses, they do support different sizes in these countries. Using data on 2,427 firms, these hypotheses. the analysis reveals that financing conditions for all types of businesses in the ten countries have improved since 1999. Ulrich Volz is a research fellow at the Hamburg Institute However, access to finance remains a major problem for of International Economics and the Free University of business development, and financing conditions are consid- Berlin. The article is based on the author's paper "European erably more difficult for SMEs than for larger entities. Financial Integration and the Financing of Local Businesses While the proportion of external finance as a part of in the New EU Member States". The full text is available as total financing is rather small for firms of all sizes, it is sig- EBRD Working Paper No. 89 at http://www.ebrd.com/ nificantly lower for small enterprises. Some 68% of small pubs/econ/workingp/89.pdf 16 · Beyond Transition -- The Newsletter About Reforming Economies Doing Business -- 2005: removing obstacles to growth Simeon Djankov 2004 was a good year for doing business in most transition Businesses in poor countries face much larger regulatory economies, the World Bank Group concludes in its Doing burdens Business in 2005 survey. Slovakia was the leading reformer, together with Lithuania breaking into the list of the 20 It takes 123 days to start a business in Azerbaijan, but 9 economies with the best business conditions. However, the days in Turkey. It costs $711, or 46% of per capita income, to survey finds that conditions for starting and running a busi start a business in Bosnia and Herzegovina, and $166 in ness in poorer countries are consistently more burdensome Lithuania, or just 3.7% of per capita income. Enforcing a con- than in richer countries. Meanwhile, the benefits of better tract in the Kyrgyz Republic costs 48% of the debt value, but regulation and property rights protection include higher only 8.1% in Hungary. economic growth and improved human development indica These differences persist across the world: the countries tors, while the costs for many of the reforms are modest. that most need entrepreneurs to create jobs and boost growth The major impetus for reform in 2003 was competition in -- poor countries -- put the most obstacles in their way. The the enlarged European Union. Accession countries reformed in average difference between poor and rich industrial countries anticipation of the competitive pressures their businesses on the Doing Business cost indicators is threefold. Rich coun- would face in the larger European market. Incumbent mem- tries score twice as high poor ones on indicators relating to bers reformed to maintain their advantage in the presence of property rights-enforcing contracts, protecting investors, and the many low-wage producers from accession countries that the legal rights of borrowers and lenders. would now compete with them on equal terms. When entry regulations are burdensome, few businesses Slovakia was the leading reformer: it introduced flexible bother to register. Instead, they choose to operate in the infor- working hours, eased the hiring of first-time workers, opened mal economy. Facing high transaction costs to get formal prop- a private credit registry, cut the time to start a business in half erty title, many would-be entrepreneurs own informal assets and, thanks to a new collateral law, reduced the time to recov- that cannot be used as collateral to obtain loans. In "The er debt by three-quarters. Two other European Union entrants Mystery of Capital", Hernando de Soto calls this "dead capi- -- Lithuania and Poland -- significantly lightened the burden tal". The solution is obvious: simplify business entry and get on businesses. titles to property. Being in the top 20 on the ease of doing business does not mean zero regulation. Indeed, for protecting property rights, Payoffs from reform: higher growth, greater savings more regulation is needed to make the top 20 list (Table 1). All of the top countries regulate, but they do so in less costly and A hypothetical improvement on all aspects of the Doing burdensome ways. And, more than governments in other coun- Business indicators, reaching the top quartile, is associated tries, they focus their efforts on protecting property rights. If with an estimated 1.4 to 2.2 percentage points in annual eco- Australia requires only two procedures to start a business, why nomic growth. This is after controlling for other factors, such have 15 in Ukraine and 16 in Belarus? If it takes 15 procedures as income, government expenditure, investment, education, to enforce a contract in Denmark, why have 43 in Romania? If inflation, conflict and geography. In contrast, reaching the top it takes three days to register property in Lithuania, why take quartile in terms of macroeconomic and education indicators 956 in Croatia? And if laws require all seven main types of dis- is associated with only 0.4 to 1.0 additional percentage points closure to protect equity investors in Canada, why do those in in growth. Belarus require only one? Economic growth is only one benefit of better business reg- ulation and property protection. Human development indica- tors are higher as well. Governments can use revenues to Table 1. Top 20 economies on the ease of doing business improve their health and education systems, rather than sup- port an overblown bureaucracy. 1. New Zealand 11. Switzerland The gains come from two sources. First, businesses spend 2. United States 12. Denmark less time and money on dealing with regulations and chasing 3. Singapore 13. Netherlands after scarce sources of finance. Instead, they spend their ener- 4. Hong Kong, China 14. Finland gies on producing and marketing their goods. Second, govern- 5. Australia 15. Ireland ments spend fewer resources regulating and more providing 6. Norway 16. Belgium basic social services. Sweden, a top 10 country on the ease of 7. United Kingdom 17. Lithuania doing business, spends $7 billion a year, or 8% of the govern- 8. Canada 18. Slovakia ment budget, and employs an estimated 100,000 government 9. Sweden 19. Botswana officials to deal with business regulations. The Netherlands 10. Japan 20. Thailand spend $22 billion, or 11% of its budget. The World Bank · 17 What would happen if these countries were to reduce red Simple solutions for starting a business that have already tape by a moderate 15%? The savings would amount to worked in some countries include: between 1.2% and 1.8% of total government expenditures, or · Registration as an administrative process in Canada, approximately half of the public health budget. Some govern- Chile, Italy, and Serbia and Montenegro; ments are more ambitious. In 2002, the Dutch government set · Use of a single identification number in Belgium, a goal of cutting expenditures on administrative burdens by Estonia, Morocco, and Turkey; 25% by 2006. It is estimated that $2 billion has already been · No minimum capital requirement in Botswana, saved by doing impact assessments before new regulations Ireland, Tanzania, and Thailand; reach the parliament. · Electronic application in Latvia, Moldova, Sweden, The benefits of regulatory reform are likely to be even and Vietnam. greater in developing countries, which tend to regulate more. Yet few governments are eager to reform, arguing that they Modest reform costs have limited capacity, that it takes a long time, and that it costs a lot. In 2003, countries that scored lowest on the ease of doing The costs are modest for many reforms. Setting up a private business measure reformed at one third the rate of countries in credit bureau cost less than $1.5 million in Bosnia and the top quartile. Herzegovina. Setting up an administrative agency for business registration cost less than $2 million in Serbia and What to reform? Montenegro. Integrating the business start-up process into a single access point cost $10 million in Turkey. Simple calcula- Reform involves simplification. Governments would have tions from growth analysis suggest that the benefit-to-cost more capacity and more money if they reformed. To prioritize ratios of such reforms are on the order of 25:1. Easing start-up reforms, governments can start by measuring regulatory costs was recently listed by a panel packed with Nobel laureates as and identifying the biggest opportunities for improvement. one of the most cost-effective ways to spur development -- Belgium did so by introducing an annual survey of enterprises ahead of investing in infrastructure, developing the financial on the main regulatory obstacles they face. A total of 2,600 sector, and scaling up health services. businesses participate in the survey, and the results are report- ed to the parliament. The process identified problems in com- pany registration -- a main reason for the 2003 reform -- and "Doing Business in 2005" was prepared by a team led by in business licensing, where reform is ongoing. The govern- Simeon Djankov and Caralee McLiesh. More information ments of Mozambique and Vietnam regularly seek advice from about the report is available on the Doing Business website: the business community on reform priorities. http://www.doingbusiness.org. Table 2. Starting a business, selected countries in Eastern and Central Europe and the CIS The survey studied commercial or industrial firms with up to 50 employees and start-up capital of 10 times the economy's per-capita Gross National Income. Country Number of Time (days) Cost (% of income Min. capital (% of GNI per Capita procedures per capita) income per capita) (US$) Azerbaijan 14 123 14.7 0 810 Belarus 16 79 25.3 44.3 1 590 Bosnia and Herzegovina 12 54 46.2 65.0 1 540 Croatia 12 49 14.4 24.4 5 350 Czech Republic 10 40 10.8 44.5 6 740 Estonia 6 72 7.5 49.7 4 960 Hungary 6 52 22.9 86.4 6 330 Kazakhstan 9 25 10.5 32.7 1 780 Lithuania 8 26 3.7 62.8 4 490 Poland 10 31 20.6 237.9 5 270 Russian Federation 9 36 6.7 5.6 2 610 Slovak Republic 9 52 5.7 46.1 4 920 Slovenia 10 61 12.3 19.0 11 830 Turkey 8 9 26.4 0 2 790 Ukraine 15 34 17.6 113.9 970 18 · Beyond Transition -- The Newsletter About Reforming Economies Russia's small business climate continues to improve Oleg Zamulin S ince 2001, a team of CEFIR researchers has been regu businesses. Many firms chose to switch to the simplified system larly monitoring the administrative barriers to small that year and reported paying fewer types of different taxes (by business development in Russia, having completed to two or three) than other firms. This, in turn, reflected on entre- date four rounds of extensive surveys of small business preneurs' subjective perceptions of the tax administration: owners, the most recent conducted in the spring of 2004. The firms using the simplified system viewed taxation as a signifi- surveys revealed a notable improvement in the business cli cantly less severe problem than did other firms. mate for small firms between 2001 and 2003. A lot more work ahead An improvement in the business climate for small firms between 2001 and 2003 is visible both in the subjective per- All of the above suggests that the business climate has con- ceptions of business owners and in the figures they report. Our siderably improved, and government policies have played a results are based on detailed interviews of some 2,000 small role. At the same time, a great deal more needs to be done firms, i.e. firms with a median size of 10 employees, in 20 before the government can claim victory over corruption and Russian regions. Improvements can probably be attributed in excessive regulation. The positive impact of the new laws part to the country's rapid economic growth in recent years. described above is apparent, however their implementation However, we find that the de-bureaucratization reform leaves something to be desired. Some 40% of licenses issued launched by the government in 2001, which aimed to simplify still have a period of validity shorter than the five years registration, licensing, and other such procedures, has had a required by law; and many "permits" demanded by local positive effect as well. authorities in particular have dubious legitimacy. Registering a The fourth round demonstrates that small businesses per- new firm takes more than a week for half of Russian business- ceive such vital issues as the tax level, tax administration, the es, exceeding the five working days mandated by the registra- economic environment, and government regulations as less tion law, and a far cry from the one-stop procedure in many severe than two years earlier. Interestingly, the only problem other countries. Certain government agencies are reported to that provoked more complaints than before is increased com- harass businesses with frequent repeated inspections: for exam- petition. In fact, in 10 out of 20 regions surveyed competition ple, 70% of respondents who were inspected by the police dur- ranked as firms' No. 1 problem. Given an overall increase in ing a six-month period, had several such inspections. As for the number of small firms and their share of GDP in 2001-- fines by the police, 62% of them are not based on any official 2003, stronger competition is likely due to the emergence of scale and are simply bribes. So, the improvements documented new firms and the expansion of existing ones. in our survey are only one step forward towards lifting the bureaucratic burden on business. Cheaper start-ups Clearly, the ultimate victory over the predatory nature of regulation requires more than just new laws. Indeed, the study The survey also shows that the costs of starting a business continues to record that such things as civil society, political have diminished, due to streamlined regulatory procedures. competition, fiscal incentives of local governments, and state Thus, a year after the registration law was adopted (in 2002), capture do matter. De-bureaucratization is found to be faster in the number of state agencies a median entrepreneur had to visit those regions and municipalities, in which: to register a new business fell from five to three. Almost half of · small businesses are better represented, in terms of all firms registering in 2003 completed the procedure within a their share in the local economy; week, as prescribed by the new law, while previously only a · governors had been elected by a small margin; fifth of all firms managed to register that fast. · local governments depend more on the local tax base Firms now spend less time obtaining licenses, partly and less on transfers from higher-level governments; and because the list of licensed activities has been shortened, and · the structure of industry is more diverse, such that big the period of license validity has, on average, increased. In the companies are prevented from capturing governments and second half of 2003, only 15% of respondents had applied for blocking the entry of smaller competitors. licenses and permits, down from 30% in the corresponding period two years earlier. Oleg Zamulin is assistant professor at the New Economic The number of inspections by state agencies has been School (NES) in Moscow and a senior economist at CEFIR at falling as well, as has the amount of time managers spent deal- NES. The monitoring project has been conducted by CEFIR ing with inspectors. Almost half of the firms said their top since 2001, in collaboration with the World Bank and with the managers spent no time on inspections in the second half of financial support of the U.S. Agency for International 2003, while only about 25% could say so two years earlier. Development and the Foreign Investment Advisory Service, a Tax administration also improved significantly, thanks to joint facility of the International Finance Corporation and the the 2003 law simplifying the tax accounting system for small World Bank. The World Bank · 19 Russian customs: a barrier to foreign trade, investments and entry? Ksenia Yudaeva and Konstantin Kozlov V arious surveys of local and foreign businessmen in not infrequently give insistent advice to use the services of cer- Russia suggest that corruption in customs and the tain firms, and customs is not an exception. Instead of unpredictability of the customs clearance process demanding bribes, government officials create private firms on are important barriers to increased flows of international the side, which collect "official" fees for services rendered, trade and FDI. To address these problems and bring Russian thereby "institutionalizing" corruption. legislation in line with the WTO standards, a new Customs Another potential source of corruption is the official Code was introduced on January 1, 2004. Has the new law requirement that customs inspect almost 100% of all ship- addressed the all too common ills? Six months after the law ments, a very time-consuming process and a source of massive was adopted, a new study by CEFIR finds little or no delays in customs clearance. In developed countries, customs improvement in Russian customs. officials rely on special techniques to assess the probability of cheating and inspect only those shipments, which have a high To get a better understanding of the problems faced by risk. Russian regulations create grounds for corruption, in that Russian import/export firms and to see whether the new a bribe may be paid to avoid an inspection. More than 80% of Customs Code has led to any improvements, CEFIR surveyed respondents reported that they faced custom inspections 510 firms in seven central and north-western regions. Of these, "always" or "often". 194 were importers, 115 were exporters, and 201 were engaged When asked to rank the various obstacles created by cus- in both import and export, with an average size of 350 employ- toms, more than half of the firms ranked controversial and ees. Partially or fully foreign-owned firms made up 13% of the unpredictably changing legislation as a serious or very serious sample. Firms were asked to make qualitative assessments of problem (see the figure). This result is surprising, given the any changes they encountered in their dealings with customs recent improvements in the customs legislation. The problem authorities shortly after the adoption of the law. of arbitrary interpretation and implementation of the law by The survey found two major changes in the customs clear- customs officials was ranked a close second. ance procedures brought about by the new Code. On the posi- The results of the survey also reveal remarkable differences tive side, the amount of time spent on customs clearance in the quality of customs operations in various regions. The decreased for at least 35% of importers. However, for 33% of Leningrad oblast seems to be the fastest in terms of clearance importers and 42% of exporters the costs of customs interme- time and the most predictable as concerns documentary require- diaries' services increased; only 5% of the firms surveyed saw ments, however more than 50% of firms -- by far the highest these costs decrease. Customs intermediaries are routinely share of all the regions -- stressed increased payments to inter- employed by firms to speed up customs clearance. Small firms mediaries. In all regions, one third of firms reported an increase explain that they rely on intermediaries because they lack the in intermediaries' fees, and only a fraction of firms, mostly in needed qualifications themselves. Large firms say that using the Moscow oblast, said that fees had decreased. The fact that intermediaries is "more convenient", as the latter have the nec- intermediary services have become more costly could be purely essary licenses and certificates, which would otherwise be diffi- a result of inflation. However, anecdotal evidence suggests that cult or costly to obtain. Thus, the system of licenses and certifi- an increase in demands for bribes by customs officials played an cates does not serve as a filter, i.e. to block the import of low- important role. quality goods, serving instead mainly as a source of corruption. Six months is a very short period of time for a new piece of Small firms also report that customs officials sometimes legislation to have an effect on customs operations. Indeed, insist that they hire intermediaries. Various government offices most of the firms surveyed said that they had seen little differ- 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% ence in the customs procedures in the first half of 2004 com- pared to the second half of 2003. The government's effort to Controversial and unpredictable customs law simplify customs procedures has had some success, mainly in Arbitrary implementation of the law by officials reducing clearance times. But there is plenty of room for Delays on border and in customs improvement, particularly if a probability assessment technique Charges by intermediaries were to be introduced. Progress varies substantially across regions. The growing importance of intermediaries indicates Tariffs and quotas that significant entry barriers for new trade firms still exist. Licensing and certification Preparation of necessary documents Ksenia Yudaeva is director of policy programs at CEFIR at Delays because of other state bodies (not customs) NES in Moscow and scholar-in-residence at the Carnegie No problem Minor Serious Very serious Threatening to business Moscow Center. Konstantin Kozlov is an economist at CEFIR. 20 · Beyond Transition The Newsletter About Reforming Economies Discussion Several representatives and members of SME organiza- Consultancy and Management; tions in Lithuania, Slovakia, Romania and Russia provid- Ludovit Balco, Director of National Agency for ed their opinions on entrepreneurs and entrepreneurship Development of Small and Medium Enterprises at our request: (NADSME), Slovakia; Arvydas Darulis, Director of the Lithuanian Small and Oana Irina Coanta, owner of Inside Communication, Medium Enterprise Development Agency; member of the Association of Business Women and Top Camelia Bulat, program director, Centre for Managers in Brasov, Romania; International Private Enterprise, Romania; Stamate Lamaita, Economic and Marketing Director Dina Krylova, member of the board of directors, of S.C. Sistem S.R.L., member of the Association of OPORA, Russia; Business Women and Top Managers in Brasov, Romania. Ispas Adriana, vice-president of the Chamber of The views expressed below are those of the authors Commerce and Industry, and director of SME's Center of and not necessarily of the organizations they represent. 1. Who is a typical entrepreneur (or member of your asso- structure, closeness to authorities, etc. Transylvania is the sec- ciation) in your country? Why do people become entrepreneurs? ond region in Romania where entrepreneurship is well devel- oped. This area is perceived as populated by serious, hard- Dina Krylova, Russia: These are people who cannot sell working people, determined to do things well. The Eastern part themselves as employees for a high price, but who have good of Romania, Moldova, is struggling. With the exception of larg- business qualities and are ready to take on risks. Their start-up er cities, the Moldova's area is behind the rest of the country. capital is either their own savings or what they can borrow Oana Irina Coanta, Romania: The different regional devel- from relatives and friends. Their sector is usually trading and opment is a consequence of the influence of the surrounding services. countries. Transylvania and Northern Moldavia are areas Stamate Lamaita, Romania: In Romania, I don't think where entrepreneurship has, since the first years after the revo- there is a typical entrepreneur. Generally, people become entre- lution, received more material and logistics support than the preneurs because they have a spirit of "adventure", something rest of the country. Better infrastructure, people' s mentality, like "I should try this...". Of course, theoretically, there are a and their ability to communicate are factors that have led to a lot of steps in management that one has to make before becom- more rapid development of certain areas. ing an entrepreneur, but the impulse comes from the inside. Arvydas Darulis, Lithuania: The level of SME development Arvydas Darulis, Lithuania: Entrepreneurs are usually peo- follows the economic development of a region. For instance, ple who are energetic, self-confident. They set long-term goals Vilnius, Kaunas and Klaipeda are economically the most devel- and consider money to be a measure of accomplishment. They oped counties in Lithuania, they have the main industrial, intel- persist in problem solving, take moderate risks, learn from fail- lectual and cultural assets and the lowest unemployment levels ures, seek and use feedback, take initiative, accept personal (Vilnius is also the capital city and Klaipeda is the seaport). responsibility and use all available resources. They compete And these are the ones that have the largest number of SMEs with themselves and believe that success or failure lies within compared to other counties. Nevertheless, it is expected that their personal control or influence. Their main reason for start- regional differences will gradually diminish. The successful ing a business is a great desire to work independently, as they absorption of EU structural funds and national regional devel- are tired of working for others; they also wish to improve opment programs will help to minimize regional disparities. something for themselves and for others. Ludovit Balco, Slovakia: Our survey of 2000 people con- 3. Some studies show that there is a certain fixed share ducted in 2003 showed that the two most frequent reasons for of the population who become entrepreneurs (7-10%). Do you starting a business for current entrepreneurs were the desire to think that entrepreneurship can be fostered, and, if yes, why? increase one's income (35%) and lack of other job opportuni- ties (33%). Striving for independence, becoming "one's own Stamate Lamaita, Romania: I associate entrepreneurship boss" motivated 18%, and the opportunity to follow one's with people who write poetry -- not everybody can be a poet, interests motivated 16% of current entrepreneurs. so not everybody can be an entrepreneur. Usually, this attitude of responsibility, of taking life in your own hands, is not spe- 2. Can you trace any regional differences in SME devel- cific to every individual, but only to some. Entrepreneurship opment? To what do you attribute these? may be fostered, but not successfully. I think the effort is huge and the results are only average. Camelia Bulat, Romania: Bucharest, the capital of Romania, Ispas Adriana, Romania: Entrepreneurship can be fostered attracted most of the investments, because of the power, infra- because there are a lot of unexploited abilities among employ- The World Bank · 21 ees and the unemployed. This process should begin in early its problems. Intolerance is sometimes aroused by the ethnic school years and college years. dominance of certain spheres (such as fruit and vegetable trad- Arvydas Darulis, Lithuania: I highly approve of the opin- ing, for example), connections with criminal elements, and the ion that it is very important to foster entrepreneurship. The at times low level of general entrepreneurial culture. The experience of developed countries all over the world points out younger people are, the more positive their attitude tends to be that small and medium-sized businesses promote greater com- toward small business, as well as their desire to run their own petitiveness and economic growth and are the main condition business. for the successful formation of the middle-class. This sector of the economy has the ability to react quickly to supply-demand 5. What are the biggest problems and constraints small changes in the market, to deliver the products and services that business owners face in your country? are in the greatest demand in a specific period of time, and to create new jobs. That's why a favorable environment for busi- Oana Irina Coanta, Romania: Probably the most uncom- ness development has to be created. fortable are the political and ethnical ones. Dina Krylova, Russia: The readiness to go into business is Arvydas Darulis, Lithuania: According to different surveys, linked to the level of entrepreneurial risks and the opportuni- the most frequent complaints concern constantly changing ties for alternative employment or social support. Russia has a laws, high tax rates, lack of capital, complicated access to cred- traditionally low level of social support and limited number of it, lack of working capital, high competition, and bureaucracy. well-paid jobs, is used to high risks and unpredictable results, Dina Krylova, Russia: The basic problem is the huge and has a population that learned to be creative under socialism constantly growing amount of administrative costs, the extrac- but is not prepared to perfect themselves professionally as a tion of extra-legal fees for permissions and approvals, and the hired employee. As a result, there is a relatively high percent- high pressure of corruption. The state's participation in busi- age of people prepared to go into business. The problem is ness, its interference in competition and its violation of the with the viability of those businesses and with entrepreneurs' rights of entrepreneurs are serious barriers. willingness to take on the necessary knowledge. Camelia Bulat, Romania: Currently, the pressure on leu, Camelia Bulat, Romania: Maybe it might be fostered, but Romanian national currency. After 15 years of constant depre- not too much, not above the "normal" level. Friendly legisla- ciation of the leu, since last autumn we have been witnessing tion, easiness in starting a company, access to capital, little the opposite situation. Entrepreneurs are having a hard time to bureaucracy are just some of the conditions that help to foster adapt, especially the ones who export in Europe.Access to cap- entrepreneurship. Still, if this "normal" level is pushed too far, ital, a labor code that is very much in favor of the employees, just to increase entrepreneurship, then the market may become and competition from China and other Asian countries are distorted. Legislation and fiscal stimuli must be fair and con- other constraints to developing entrepreneurship. sistent. Otherwise, they would lead to worsened efficiency, incompetence, and decreased competitiveness. 6. Do you believe that the government should support Ludovit Balco, Slovakia: Entrepreneurship can be fostered small business owners? Why? If yes, can you name specific by eliminating barriers in business environment. This is the measures it should take? most effective way, because it creates the same favorable con- ditions for all and does not damage competition. Camelia Bulat, Romania: No. Romania's new government has already introduced a major change: the 16% flat tax rate. 4. Is the public attitude towards entrepreneurs impor- Ludovit Balco, Slovakia: The best support for enterprises is tant for small business development? How would you describe the improvement of the business environment. It means the the attitude in your country? elimination of administrative and financial barriers, a fair competitive environment, easy access to financing, transparent Ispas Adriana, Romania: I consider the public attitude to and stable legal system and effective law enforcement. The be very important. Unfortunately, in Romania, this attitude is government can intervene only in cases of market failure, such rather hostile. Such hostility may be explained by two things: as the unavailability of some types of financing, inadequate media that mostly focus on the negative side, such as cases of innovative activities, etc. entrepreneurs breaking the law, and by the typical Romanian Dina Krylova, Russia: The state must even the playing mentality of envying others' achievements, without being field, supporting small start-ups that don't have sufficient aware of the risks that every business is exposed to, and with- resources, helping them get onto the market. The most impor- out trying to follow a good example. tant thing is to create economic stimuli for business activities, Ludovit Balco, Slovakia: The public attitude towards entre- without interfering in the activities of enterprises, limiting reg- preneurship is slowly changing in a positive direction. ulators' purview and keeping oversight to the necessary mini- Negative attitude stems from the untransparent privatization mum. process and insufficient legal framework that has given room Ispas Adriana, Romania: The government should replace to instances of tax fraud, unfair competition, and corruption. the incoherent legislation, adopt measures to protect exporters Dina Krylova, Russia: A large portion of society has some from fluctuations of the currency and maintain the income tax sort of relationship with small business and is sympathetic to for SMEs at 3%. 22 · Beyond Transition -- The Newsletter About Reforming Economies New Findings Who bears the cost of Russia's military draft? Michael Lokshin and Ruslan Yemtsov E ach year approximately 400,000 young men between its. In compulsory service systems such as Russia's, soldiers the ages of 18 and 27 are drafted to serve two years receive negligible or zero monetary compensation, and the mil- in the Russian military. Although all young men in itary training obtained during service is hardly transferable to Russia have a duty under law to perform military service, civilian occupations. many manage to avoid it, and fewer than 10% of the eligible In studying the distributional and welfare implications of population is actually enlisted. Who bears the burden of mil the military draft, we rely on the 2003 Round of the National itary draft? Our analysis of the distributional and welfare Survey of Household Welfare and Program Participation implications of the military draft, based on the data from a (NOBUS) collected by the Federal State Statistics Service in col- large survey in Russia, finds that poor, low educated, rural laboration with the World Bank. The survey covers 45,000 households are much more likely to have their sons enlisted. households in 46 regions. In contrast to other surveys of living The poor also face disproportionately large economic losses, standards, it includes information on household members who which exceed the statutory rates of personal income taxes. have been absent from the household for more than six The Russian military currently have 1.2 million personnel, months. We are thus able to identify 466 households with indi- made up of conscripts and professional cadres (contractual viduals in military service. employment still remains at only 15,000 soldiers). The descriptive statistics shows that the lowest proportion Conscription is regulated by the Law on military service, which of conscripts is registered among the smaller households (see in principle obliges all fit males between the ages of 18 and 27 figure). Fewer then 2% of sons in the single-parent (usually to perform military service. However, it offers exemptions to mother-only) families are drafted. The probability of serving in certain groups and allows alternative civil service. The regula- the army reaches almost 8% for large households. The proba- tion leaves substantial room for discretion on the part of pub- bility of being drafted is larger for smaller-sized locations. For lic officials to decide who is going to serve in the army. example, young males living in capital cities -- Moscow and Service in the army remains a feared duty, to be avoided by St. Petersburg -- are almost 6 times less likely to be drafted the majority of Russian families. Serious abuses in the army are than those from rural areas. well known, and many young soldiers fear being dispatched to Chechnya, where ongoing conflict continues to claim lives. Which households attempt to avoid military service? Widespread aversion to military service encourages recruit- ment officers to rely on coercion in order to fill draft quotas. A simple theoretical model that we develop in our paper The selective enforcement in enlisting young draftees leads to examines parents' decisions about investments in the human discriminatory outcomes, to which the poor and unprotected capital of their children. We test the model's predictions on the fall victim. The well-off, on the other hand, can often avoid the sample of 6,126 households with male youth aged 18--27 and draft through influence, bribery and other means. in good health, i.e. those eligible to serve in the army. The main findings are in line with our theoretical model and can be sum- Significant economic implications for individuals and marized as follows: households · The higher the household's income, the lower the probability that a member of the household will serve. The The presence of a military draft affects economy-wide probability of enlistment ranges from almost 20% for the low- resource allocation. Compulsory military service inflicts direct est consumption percentiles to less then 3% for the richest short-term costs on households with male children: forgone households. Educational attainment of household members, market earnings of the conscripts and the loss of production of which is related to the potential to generate income, has an household-specific goods, which can be interpreted as an even larger impact: the larger the share of highly educated implicit tax on households. But in contrast with taxes, the mil- adults in the household, the less likely the household is to have itary draft is avoided by a majority of the eligible population, its sons in the army. producing an inequitable distribution of such losses. · Households with a single son are much less likely to The long-term negative implications of the service include have him enlisted. The probability declines with size for house- the impact of military service on human capital formation. holds with four or fewer members and increases for larger Some countries introduce incentives that would motivate households. young men to enlist, including offering monetary compensa- · There are strong regional differences in draft enforce- tions (stipends), training in marketable skills, and tuition cred- ment, even controlling for labor market conditions in the The World Bank· 23 region. This implies that different regions are characterized by tunity cost of military service as a tax, we see that for poor very different costs of draft avoidance. households the order of magnitude is similar to the rate of per- · The size of settlements strongly correlates with the sonal income tax in Russia. However, unlike the flat 13% incidence of military draft. Males residing in cities with more income tax, the "military service tax" is very regressive. than 100,000 population have a much lower probability of Although military draft is not regarded as redistribution poli- being drafted, compared to those living in smaller towns and cy, the way it is implemented in Russia has profound distribu- villages. Probability declines for the larger cities. tional consequences. · The presence of professional military personnel among family members has no significant influence on the Conclusions probability of service. This may suggest that having their chil- dren enlisted as rank-and-file soldiers is not an attractive The burden of military service is not negligible, amounting option even for the families of military officers. on average to 15% of household consumption for poor house- Thus, the effects of military service are not distributionally holds. Richer household have more resources to evade service neutral. Poor, poorly educated, rural households are more like- obligations and are at least three times less likely to have their ly to have their sons enlisted than are urban, wealthy and bet- sons enlisted than the poor. Therefore, losses associated with ter-educated households. military service disproportionately fall on the poor. The highly regressive features of discretionarily enforced Short-term welfare costs up to 50% conscription into the military imply that inadequately gov- erned regulations have a large impact on the poor, even though To quantify the differential burden of military service on at first glance they seem to have no connection to redistribu- household well being, we estimate wages that currently serving tion policies. The existing system of military personnel pro- household members would earn had they avoided the draft. curement in Russia opens the way for the rich easily to shift The wages of new entrants to the labor market are usually low, the burden of a costly obligation before the state (the obliga- but even these low wages can represent a substantial addition tion to serve) onto the poor. to the income of households in poverty. The loss of these wages One important area that we omitted in our paper is the could push a household into a poverty trap. At the same time, gender dimension of welfare losses due to military draft. By for wealthier households, this potential income source is trivial. distorting the human capital formation decisions of house- Since we lack critical information on education level and holds with sons, conscription has effects on the demand for the tenure of conscripts, we adopt a complex strategy using a human capital of female children and may lead to even wider group of households with 16--17-year-old males, under the welfare losses. assumption that their characteristics are similar to the charac- Our findings have significant implications for the ongoing teristics of households with sons in an older age cohort. military reform in Russia. One could argue that a better The relative importance of losses associated with conscrip- enforced, uniform military draft should be implemented in tion could be captured by the ratio of expected forgone wages Russia to shift the costs of the military draft from the poor to to total household consumption. The estimated ratios range other groups of society, and thus to restore justice. We are very from 50% for the poorest to almost zero for the wealthiest strongly against this position. If better educated young men households. The poor are disproportionately affected by such would have to serve in the army, the short- and long-term costs losses. On average, households below the poverty line experi- of conscription both for individuals and for society as a whole ence approximately a 15% drop in per capita consumption due would be even higher than at present. We interpret our find- to the forgone wages, as opposed to an average of 6% for ings as important evidence that the non-universal draft that households above the poverty line. Conceptualizing the oppor- exists in Russia is inferior to an all-volunteer approach to mil- itary personnel procurement, not only on efficiency grounds Figure 1: Proportion of males aged 18--27 in compulsory (as has been widely argued), but also, most importantly, on military service by household size and type of locality. Mean equity grounds. and 95% confidence interval. Although we rely on Russian data, systems of involuntari- ly military procurement exist in many developing and transi- 15 15 tion economies. We believe that households in these countries service 13 13 face similar choices, and the resulting misallocations could in 11 11 have important distributional and welfare implications. 1827 9 9 Michael Lokshin is a senior economist in the Development males of 7 7 Research Group of the World Bank. Ruslan Yemtsov is a senior 5 5 economist in the Eastern Europe and Central Asia Poverty Reduction and Economic Management unit of the World Bank. Percentage 3 3 The findings, interpretations, and conclusions of the paper are 1 1 those of the authors and should not be attributed to the World 2 3 4 5 6+ Capitals 1M+ 500K 250K 100K 50K 20K <20K Village Household size Size/type oflocality Bank, its Executive Directors, or the countries they represent. 24 · BeyondTransition -- The Newsletter About Reforming Economies How transition paths differ: enterprise performance in Russia and China Sumon Bhaumik, Saul Estrin C hina's GDP per capita has been increasing by an To summarize the main results, in China enterprises impressive 8% per annum for more than twenty appear to be responsive to market and supply phenomena -- years, while Russian GDP had fallen to 64% of its 1990 managerial effort, technology and investment. However, we level by 2000, with output declining in seven years of the ten. find little or no significant impact from institutional factors To throw light on the broader issues of divergence in transi at a sectoral or regional level, or from the extent of privati- tion paths, we analyze the determinants of company per zation. In contrast, Russian firms are unresponsive to almost formance in China's and Russia's very different economies. all the normal economic drivers -- long run factor supplies, We find that in China enterprise performance was associat outsider versus insider privatization, competition, manage- ed with rapid increases in factor inputs but was not signifi ment effort, or technological factors -- though we do identi- cantly affected by ownership or institutional factors. In con fy a positive relationship between changes in sales and trast, region specific factors were the most important deter employment. The determinants of enterprise performance in minants in Russia, while improvements in factor quantity (except for labor), quality and privatization to outsiders did Russia in fact prove to be mainly region-specific, and these not improve sales growth. we interpret to be largely institutional. We go on to explore more formally whether these findings may be explained by The study is based on two comparable random surveys differences in managerial quality between Russia and China conducted in 2000 of 274 Chinese firms from three provinces, and inter-regional variation in the quality of institutions. The and 437 Russian firms operating across 13 oblasts. regressions suggest that both factors are relevant in under- Quantitative measures, such as sales, labor and capital are standing the difference in enterprise performance in the two comparable across the samples, although some qualitative systems. variables differ. In conclusion, what inference can we draw from the fact In most firms in our Chinese sample collectively the state that economic factors like changes in labor and capital and, to had the controlling stake, while in Russia the majority of firms a limited extent, the level of technology, explain inter-firm vari- were controlled by insiders. Even though the real sales of the ation in sales growth in China, while in Russia most of the average Chinese firm in our sample grew between 1995 and variation is explained by region-specific factors? The first and 1999, while the real sales of the average Russian firm in our the most obvious implication is that, unlike in China, the sample declined, sales per laborer in Russian firms remained Russian market remains both geographically and institutional- higher that that in Chinese firms, even after the 1998 recession. ly fragmented, an observation that is consistent with our Further, there was real sales growth in a large minority of knowledge about the political economy of economic gover- Russian firms. The size of the labor force for both Russian and nance in Russia and China. Moreover, the effectiveness of Chinese firms declined over time, indicating some degree of reforms that liberalize markets while leaving ownership restructuring in both countries. While the real capital stock unchanged or only partially adjusted seems to be strongly sup- (valued at historic cost) of an average Chinese firm grew sub- ported by our Chinese findings. stantially over the 1995--99 period, an average Russian firm We therefore confirm that state-owned and corporatized experienced severe real decapitalization during 1997--99, firms in China are responding to market signals and improving rather more markedly than the decline in demand. This decap- performance along the same lines as privately owned firms in italization is probably the consequence of Russian firms selling market economies. This suggests that, in certain contexts, such assets and writing off unproductive capital in the aftermath of as the one of modern China, market incentives are sufficient to the 1998 crisis. Interestingly, however, despite the significant ensure some degree of efficiency in enterprise activity without capitalization of the Chinese firms, the average of the propor- immediate full privatization. This is not to say that perform- tion of new (i.e. less than five years old) capital stock in ance cannot be further improved by private ownership; indeed, Chinese firms remained less than 20%, suggesting that invest- the evidence that privatization improves enterprise perform- ment was concentrated in large firms. ance is strong. But it is consistent with the view that neither The empirical strategy involves the estimation of separate "big bang" reform policies nor early privatization are the sine augmented sales functions using the Chinese and the Russian qua non of successful transition. data. The results show that, in the late 1990s, economic factors had a much greater impact on enterprise performance in China Sumon Bhaumik is a lecturer at Queen's University Belfast, than in Russia, even though we have contrasted samples of Saul Estrin is a professor of economics and deputy dean at firms from more isolated inland regions in China with compa- London Business School. Their full paper can be viewed at nies from across Russia, including such leading centers as http://www.bus.umich.edu/KresgeLibrary/Collections/Working Moscow and St. Petersburg. papers/wdi/wp744.pdf. The World Bank· 25 India's reform attracts interest in Beijing Suman Bery I ndian analysts usually laud China's economic achieve Much of the discussion at the workshop revolved around ments: high rates of savings and investments, success in the links between the state-owned enterprise sector (SOEs), attracting large flows of foreign direct investments and social protection, and the financial sector. It was pointed out buoyant manufacturing. It turns out China has something to that the burden of social protection was moved from the state learn from India. Chinese experts are especially impressed by to the SOEs in 1979, as part of the decentralizing reforms. India's success in higher margin activities, such as informa Decentralization was instrumental in stimulating the local tion technology and pharmaceuticals. enterprises that have provided so much dynamism to the Chinese economy, but reform of the SOEs themselves was not In December 2004 I was part of a small group of Indian embarked upon till much later, in 1993. As in India, it remains economists invited to a workshop in Beijing, comparing the very much a work in progress. economies of India and China. The conference was organized A recent issue of the McKinsey Quarterly ("China Today", by the newly established Centre for China in the World the 2004 Special Edition) points out that in 2003, SOEs gen- Economy (CCWE) at Tsinghua University. The level of respect erated just 17% of China's GDP, although they employed 50% and attention paid to the Indian experience by the Chinese ana- of the work force and controlled 57% of industrial assets. lysts and academics -- and the degree of self-criticism on issues Over the years, the state banking system has propped up these that are often lauded by Indians -- came as something of a sur- failing businesses, to maintain employment and fulfill their prise. Indian commentators admire China's high rates of sav- social protection obligations, but at the cost of distress to the ing and investment, the buoyancy of its manufacturing, and its banking system. Similarly, the costs of non-income generating success in attracting foreign direct investment. Chinese partici- infrastructure projects also end up in the banking system. pants at the conference provided a somewhat more nuanced Efforts are underway to put in place a social security sys- view. tem less dependent on public enterprises. At the same time, a While acknowledging the dynamism of their manufacturing massive recapitalization and restructuring of the public banks sector, the Chinese played down their prowess in manufactur- is being initiated. In a move reminiscent of current proposals to ing. One Chinese observer referred to Chinese manufacturing use Indian reserves for infrastructure development, a sum of workers functioning as "coolies", brining relatively little added $45 billion (4% of GDP) from China's foreign exchange value. Indian expertise and success in higher margin activities, reserves was transferred to an investment vehicle for holding such as information technology and pharmaceuticals, was seen capital in two large state-owned banks. Following recapitaliza- as a more impressive indicator of indigenous capacity. tion and restructuring, these banks will prepare for a flotation As reported in a December 2004 Financial Times survey of on international equity markets and actively seek strategic China, China's over-reliance on foreign trade and foreign direct investors. This is in sharp contrast to India's ideological reser- investment are now being questioned. A senior fellow at vations on the same issue. The situation on the equity markets China's Academy of Social Sciences is quoted as saying that it is is distinctly less favorable in China than in India, with the insti- absurd that exports plus imports should be as high as 60% of tutional structure considerably less robust and sophisticated, GDP in such a large economy as China's. He also notes that the and the role of the equity markets in capital allocation corre- flood of foreign direct investment flowing to China is substan- spondingly less well developed. tially stimulated by the inefficient and distortionary incentives What conclusions for India should one draw from all this? offered by a myriad of local jurisdictions competing for modern As Tarun Khanna of Harvard Business School observes in the employment. These ought to be reduced or eliminated, but the McKinsey Quarterly, the Chinese government has continued to central government finds it difficult to exercise effective control. be more interventionist in resource allocation than the Indian Current Chinese concerns about the politics of economic government. On the other hand, it has had a greater commit- reform also came as somewhat of a surprise. Despite consid- ment to competition, as reflected in its trade and tariff policies erable political concern in India about widening income and its policies toward foreign direct investment. Neither coun- inequality, there is little conclusive evidence of changes in the try has yet been successful in setting up efficient and transpar- personal income distribution in India over the last two ent regulation in the infrastructure sectors. India's relative suc- decades. By contrast, the recent Chinese experience has cess in financial sector regulation gives some encouragement involved a clear widening in the distribution of personal that, in due course, such a culture will be established in other income. The different experiences of the two economies are sectors as well. reflected in their different patterns of urbanization. There has been relatively little change in India's rural-urban split, despite accelerating per capita income growth, reflecting relatively Suman Bery is Director-General of the National Council of equal wage growth in the two sectors. China's rapid urban- Applied Economic Research, New Delhi. This piece is excerpt- ization, on the other hand, is a sign of the widening income ed from his article, in "Business Standard", India's leading gap between the two sectors. financial newspaper, on December 14, 2004. 26 · BeyondTransition The Newsletter About Reforming Economies World Bank\IMF Agenda New Online Database Brings Investment Climate to Desktop with greater private involvement, the government must take the lead role. The World Bank Group will continue to support The database of the Bank's new Investment Climate this area, the report notes. Surveys (ICS) (http://iresearch.worldbank.org/ics/jsp/index.jsp) covers more than 27,000 companies in 51 countries, with data Thinking the Unthinkable: Fusion of the Bank and the IMF? from another 15 countries due on line in March. Covering all major aspects of the investment climate, the database comple- Fritz Fischer, a former German Executive Director at the ments the World Bank/IFC Doing Business database, which World Bank, wrote in the latest edition of the International focuses more narrowly on regulatory constraints to business. Economy Magazine that "changes in the two Bretton Woods ICS ask what happens to firms in practice, while Doing institutions in recent years have led to various calls for reforms Business data show what should happen to specific types of meant to reconfirm the basic mandates of the IMF and the entrepreneurs if they follow all of the laws and regulations as World Bank and to eliminate duplication of effort". He noted prescribed. The surveys allow for analysis of issues across com- that, "A number of arguments can be made in favor of a reor- pany characteristics such as size, ownership, or different geo- ganization that is less than a full-fledged merger and instead graphical locations within a country. combines the two administrations and Boards under one roof". Further, in a letter to the Financial Times (Jan. 31), he wrote Wolfensohn Discussed Competitiveness in Moscow that "The IMF and World Bank have been serving the same clients for the past 20 years; i.e. developing and transition During his two-day visit to Moscow in early February, countries only. It can thus be debated whether the founding World Bank President James Wolfensohn focused on Russia's fathers would have created two separate institutions 50 years investment climate and competitiveness. Wolfensohn met with ago had they foreseen this development and other dramatic President Putin and other key representatives of the Russian changes (for example the surge of private capital markets and federal and regional authorities. Putin said that Russia no investments). This then begs the question whether combining longer needs large-scale borrowing from the World Bank, but the two institutions and having one board of 24 executive remains interested in receiving support for some projects, such directors (instead of two) would not reduce costs, minimize as developing infrastructure and improving corporate gover- duplication and, above all, guarantee consistent advice to the nance. The World Bank loaned Russia some $10 billion in clients," he added. 1992--2002. Wolfensohn stressed the need for Russia to iden- tify and implement policies aimed at strengthening global com- Eight Nations Agree on Plan to Lift Status of Gypsies petitiveness. He also suggested that Russia should develop its high-tech industries and follow the example of India, Singapore Leaders from Central Europe met in Sofia early February and Ireland, countries that have successfully tapped into an and decided to launch the Decade of Roma Inclusion -- the educated and eager populace to nurture technology booms most sweeping effort to improve the status of Roma, Europe's over the past decade. most vulnerable minority. World Bank President James Wolfensohn and Open Society Institute Chairman George World Bank Report on Closing the Digital Divide Soros, who represented the two principal sponsoring organiza- tions of the initiative, also participated. Public-private partnerships would ensure that more people Roma are now one of the largest, poorest, and fastest grow- in the developing world get access to modern tools of commu- ing minorities in Europe. The total Roma population in all of nication, a new report from the World Bank suggests. The draft Europe is estimated at between 7 and 9 million, and approxi- report, entitled "Financing Information and Communication mately 6 million Roma live in the countries of Central and Infrastructure Needs in the Developing World: Public and Eastern Europe. Poverty rates for Roma range between four and Private Roles", says that one half of the world's households ten times that of non-Roma in Bulgaria, Hungary, Romania, have a fixed telephone line, while 77% of the world's popula- and Serbia and Montenegro. Some 70--80% of Roma have less tion is under the signal footprint of a mobile phone provider. than a primary school education. The Decade of Roma However, access to more advanced services, such as Internet Inclusion represents the first cooperative international effort to servers, broadband and international bandwidth, lags consid- change the lives of Roma. Progress should be achieved in four erably in the developing world. priority areas: education, employment, health, and housing. The private sector has invested more than $210 billion in telecommunications capacity in developing countries over the New EU Members: Slower Growth, Budget Concerns last ten years, and attracting further private investment remains one key part of the strategy to narrow the digital divide. Well Slower growth, easing inflation pressure and budget con- regulated private competition in telecommunications brings cerns will characterize future economic development in most higher investment and more rapid rollout of services. But even new European Union member states, according to a report The World Bank· 27 released by the World Bank in mid-February. The chief author receive the first loan awarded under the program, for $84.3 of the report, Thomas Blatt Laursen, said slowing growth million, with the guarantee of the Romanian government reflects the "waning effects of EU accession, less accommodat- ing fiscal and monetary policies, and a slight slowdown in Comparing Purchasing Power across Currencies growth among the EU's pre-enlargement 15 members". The World Bank estimates gross domestic product growth In late February Bank Chief Economist Francois for the eight will be 4.5% on average in 2005, compared with a Bourguignon, together with leading statisticians of the Bank, high of 5.5% in mid-2004. The slowdown will be felt in the and representatives of global partner organizations, launched Baltics more than elsewhere. Election-focused budgets may also the first round of the International Comparison Program slow reform momentum across the region already in 2005. (ICP), a global effort to collect comparable price data in 108 Although the World Bank doesn't expect budget deficits above countries. The new global data collection effort will generate an average of 4% in 2005, that is still above the 3% threshold Purchasing Power Parity (PPP) data to convert GDP and its prescribed for euro adoption. Most new members plan suffi- sub-aggregates-reported in different currencies-into a standard ciently tight 2005 budgets, though Hungary risks overshooting common currency that equalizes the real purchasing power of its deficit goal again. The World Bank said that with the excep- each of the currencies. "The world's largest-ever and most tion of Slovakia, whose minority government continued to complex statistical price collection program is underway", said implement its reform plan, weak popular support and upcoming Dennis Trewin, an Australian statistician and Chair of the ICP elections have slowed reform efforts in the accession countries. Executive Board. "Survey workers in over a hundred develop- ing countries have either started or will soon be collecting price Charging Non-Borrowers for Advice? data for over a thousand selected products, including various kinds of food, clothing, and housing, among others". The World Bank may soon need to charge advisory fees to countries seeking its advice, as growing numbers of middle- $45 Million Loan to Belarus? income developing countries no longer require loan programs, Peter Woicke, executive vice president of the Bank's The World Bank may lend Belarus some $45 million to help International Finance Corporation (IFC), said. Woicke, who tackle the aftermath of the Chernobyl nuclear disaster, despite since retired, said the World Bank needed to find new revenue the ex-Soviet state's reluctance to work with it on other loans, sources as Asian and Eastern European countries become Reuters reports, based on the Bank's information. Last year, increasingly wealthy and no longer need low-interest develop- Belarus rejected a $50 million World Bank loan to help fight ment loans. "There is still a demand from these countries for AIDS and tuberculosis, saying "it needed no loans from the advisory service, technical assistance, knowledge transfer. The West". Paul Bermingham, the World Bank's head for Ukraine, bank has to spend more time on figuring out how to get these Belarus and Moldova, said the funds would be channeled for advisory services right. I can't say that sort of service can be projects in energy and forestry to help development in regions delivered for free to increasingly richer countries", he said. affected by the 1986 explosion at the Chernobyl nuclear power Woicke said he believed the IFC needed to phase out its plant over the border in then-Soviet Ukraine. activities in economically successful, mid-income countries. In the next few years, Woicke said he hopes the IFC will be able Further Steps in Anticorruption Fight to end its involvement in the Baltic countries as well as in the EU accession countries."If you work in an investment bank or The World Bank on February 24 released its first annual a commercial bank, you are always there to make it bigger, to report on investigations into allegations of fraud and corrup- grow it, to be more successful. Our success actually is to make tion, both internally and in Bank-financed projects. In the five it smaller and to disappear at some point", he said. years since 1999, the Bank's institutional integrity department has investigated and closed more than 2,000 cases, both inter- $1 Billion Financing Facility for South East Europe Energy nal and external. Allegations received ranged from instances of Community fraud and corruption in Bank-financed projects or in relation to the Bank's own administrative budget, to other forms of The World Bank's Board in late January approved a $1 bil- workplace misconduct such as sexual harassment, violations of lion adaptable program loan (APL) facility to support the policies and procedures, and non-compliance with personal Energy Community of South East Europe program (ECSEE), a financial obligations. Since 1999 to date, the Bank has sanc- program aimed at integrating energy systems in South East tioned more than 300 firms and individuals for fraud and cor- European countries into the internal energy market of the ruption in Bank-financed projects. The number of serious alle- European Union. The ECSEE APL program will help the coun- gations involving Bank staff represents less than 1% of the tries in the region develop the energy community by imple- total staff. Nine staff members were found to have engaged in menting priority investments supporting electricity market and fraudulent or corrupt practices and were terminated and power system operations, technical assistance for system devel- barred from rehire. Three staff members found to have opment, and project preparation and implementation. engaged in other forms of misconduct received other discipli- Romanian hydropower generator Hidroelectrica S.A. will nary action consistent with Bank rules and procedures. 28 · Beyond Transition The Newsletter About Reforming Economies New Books and Working Papers World Bank Publications issues include pollution of the Warta and its main tributaries, and growing problems of water allocation and scarcity. The dispersion of water policy authority across several levels of Information and orders: the World Bank, P.O. Box 960, government, basin authorities' lack of power and funding, lit- Herndon, VA 20172, U.S.; tel.: +1-703-661-1580, fax.: 703- tle stakeholder participation, and delays in water law reform 661-1501, email: books@worldbank.org, www.worldbank.org/ have complicated the development and implementation of inte- publications, or visit the World Bank InfoShop at 701 18th grated management at the basin level. Street, N.W., Washington, D.C., tel.: +1-202-458-5454. David Dollar and Victoria Levin Agriculture Investment Sourcebook Sowing and Reaping: Institutional Quality and Project January 2005, 530 pp. Outcomes in Developing Countries WPS 3524, February 2005, 25 pp. Investing to promote agricultural growth and poverty reduction is a central pillar of the World Bank's current rural strategy. The This paper presents microeconomic evidence on factors con- book shares information on investment options and identifies ducive to the success of aid-funded projects in developing coun- innovative approaches that will aid the design of future lending tries. The authors find that the existence of high-quality institu- programs for agriculture. Drawing on a wide range of experi- tions in a recipient country raises the probability that aid will be ences from donor agencies, governments, institutions, and other used effectively. There is also some evidence that geography groups, the book provides generic good practices and many matters. examples to demonstrate that investment in agriculture can pro- vide rewarding and sustainable returns for development efforts. Lourdes Trujillo, Antonio Estache, and Sergio Perelman Infrastructure Performance and Reform in Developing and Uma Lele Transition Economies: Evidence from a Survey of Productivity Addressing the Challenges of Globalization: An Independent Measures Evaluation of the World Bank's Approach to Global Programs WPS 3514, February 2005, 28 pp. January 2005 Having reviewed some 80 studies on electricity and gas, water Addressing the challenges posed by globalization often requires and sanitation, and rail and ports in developing countries, the collective action at the global level. The World Bank is an authors conclude that there is a difference in the relevance of important participant in such programs and activities because ownership for efficiency between utilities and transport in of its global reach, its ability to mobilize resources, and its mul- developing countries. In transport, private operators have per- tisectoral expertise. The book derives crosscutting lessons for formed better than public operators. For utilities, ownership the Bank on program selectivity, design, implementation, gov- often does not matter as much. Across sectors, private opera- ernance, financing and evaluation. It also identifies areas where tors functioning in a competitive environment or regulated further Bank action on its global-level strategy and program- under price caps or hybrid regulatory regimes tend to catch up ming is needed to improve the global program effectiveness. to best practice faster than public operators. Francois Bourguignon, Boris Pleskovic, and Andre Sapir, eds. Mihails Hazans Annual World Bank Conference on Development Economics-- Unemployment and the Earnings Structure in Latvia Europe. Are We on Track to Achieve the Millennium WPS 3504, January 2005, 90 pp. Development Goals? Washington, DC: World Bank and Oxford University Press, Latvia has recorded sustained GDP and productivity growth 2005, 266 pp. since 1997. Yet unemployment rates have remained high. The author analyzes labor flows between employment, unemploy- World Bank Working Papers ment, and nonparticipation and finds that the type of education http://econ.worldbank.org/ and the region of residence are the most important determinants of success by the unemployed in finding jobs. The unemployed William Blomquist, Ariel Dinar, and Andrzej Tonderski from ethnic minorities have lower chances of finding a job with- Institutional and Policy Analysis of River Basin Management: in a year, while the difference between genders is not significant. The Warta River Basin, Poland WPS 3528, February 2005, 37 pp. Judith M. Dean, Mary E. Lovely, and Hua Wang Are Foreign Investors Attracted to Weak Environmental The authors describe and analyze the emergence of river-basin Regulations? Evaluating the Evidence from China management in the Warta River Basin. Water management WPS 3505, February 2005, 49 pp. The World Bank· 29 One of the most contentious debates today is whether pollu- EU Needs Fiscal Watchdog to Replace Stability and Growth tion-intensive industries from rich countries relocate to poor Pact countries with weaker environmental standards. The authors 2005 estimate the strength of "pollution-haven" behavior by examin- ing the location choices of equity joint venture (EJV) projects in The European Union's Stability and Growth Pact has now been China. They find that EJVs from all source countries go into suspended. The authors of the new CEPR Report "Stability and provinces with relatively high concentrations of foreign invest- Growth in Europe: Towards a Better Pact" argue that the Pact ment, skilled workers, potential local suppliers, special incen- should be replaced with an independent panel of experts, who tives, and less state ownership. Low environmental levies are an would have the sole task of safeguarding the sustainability of attraction only for joint ventures in highly-polluting industries public finances in the euro area. with partners from Hong Kong, Macao, and Taiwan (China). Edward Elgar Publishing George Clarke To order: 136 West Street, Suite 202, Northampton, MA Do Government Policies that Promote Competition Encourage 01060-3711, U.S.A; URL: http://www.e-elgar.co.uk/. or Discourage New Product and Process Development in Low and Middle-Income Countries? Miroslav N. Jovanovic WPS 3471, January 2005, 42 pp. The Economics Of European Integration: Limits and Prospects 2005, 944 pp. The author assesses how competition and trade policy affect innovation. He finds that reducing tariffs and enacting and Richard E. Just, Darrell L. Hueth, Prof. Titular, Andrew enforcing competition laws modestly increase both the pres- Schmitz, Ben Hill Griffin sure on firms to innovate and the level of price competition in The Welfare Economics Of Public Policy: A Practical Approach the domestic economy. The net impact of lower tariffs on new to Project and Policy Evaluation product and process development is negative but small. In con- 2004, 712pp. trast, stricter competition laws and better enforcement increase the likelihood of new product and process development. Manfred Kets de Vries, Stanislav Shekshnya, Konstantin Korotov, and Elisabeth Florent-Treacy Jos Verbeek, Pierella Paci, and Marcin J. Sasin The New Russian Business Leaders Economic Growth, Income Distribution, and Poverty in Poland 2004, 368 pp. during Transition WPS 3467, December 2004, 18 pp. Xu Yi-chong Electricity Reform in China, India and Russia Poland has struggled in the past few years to reduce poverty 2004, 384 pp. while still experiencing positive economic growth. Analyzing linkages between macroeconomic policies and economic WIDER Publications growth variables, the authors show that in Poland, poverty- http://www.wider.unu.edu. reducing growth depends heavily on the ability of the economy to generate jobs. During the early years of transition, net job Anthony Shorrocks and Rolph van der Hoeven (eds.) growth was positive, while after the Russian crisis of 1998, Growth, Inequality, and Poverty: Prospects for Pro-Poor productivity gains were accomplished mostly by shedding Economic Development labor, leading to increased poverty in Poland. February 2005, UNU-WIDER Studies in Development Economics, Oxford University Press. CEPR Working Papers http://www.cepr.org. Ravi Kanbur and Anthony J. Venables, (eds.) Spatial Inequality and Development Euro Area Business Cycle: Stylized Facts and Measurement Issues January 2005, UNU-WIDER Studies in Development February 2005. Economics, Oxford University Press. The book covers a broad range of issues, including: dating the Stefan Dercon (ed.) business cycle, measuring the output gap, the role of interna- Insurance Against Poverty tional variables in predicting the cycle of European countries, November 2004, UNU-WIDER Studies in Development and the relation between the euro and US cycles. Some of the Economics, Oxford University Press. analysis is methodological and evaluates different econometric techniques for assessing turning points in economic activity, A.B. Atkinson, (ed.) measuring the cycle, and the timely assessment of the state of New Sources of Development Finance the economy. Some of the analysis is empirical, based on coun- November 2004, UNU-WIDER and UN-DESA, UNU-WIDER try-specific variables or aggregate euro-area data. Studies in Development Economics, Oxford University Press. 30 · Beyond Transition The Newsletter About Reforming Economies Conference Diary CASE International Conference"Europe after the Enlargement" 7th Annual Bank Conference on Development Economics April 8--9, 2005, Warsaw, Poland (ABCDE)--Europe May 23--24, 2005, Amsterdam, the Netherlands The conference will analyze and discuss opportunities and risks emerging from the 2004 EU enlargement. Topics include: Opening Address: Agnes Van Ardenne, Minister for the constitutional future of the EU; economic governance in the Development Cooperation, the Netherlands enlarged EU and EMU; perspectives on the Lisbon strategy; per- Keynote Addresses: Francois Bourguignon, Chief Economist spectives on future EU enlargements; and development challenges and Senior Vice-President, the World Bank; Ernesto Zedillo, for- in countries bordering the EU. Jean-Claude Trichet, President of mer President, Mexico, and Director, Yale Center for the Study the European Central Bank, will deliver the keynote address. of Globalization, USA Information: http://www.case.com.pl/strona--ID-seminar- Macroeconomic Vulnerability: Patrick Guillaumont, ia_miedzynarodowe,seminarium_id-3523703,nlang-710.html University of Clermont-Ferrand, France; Vulnerability: A Micro Perspective: Stefan Dercon, Oxford University, UK; BOFIT/CEFIR Workshop on Russian macroeconomic and Understanding the Links between Development and Security: financial issues Gregory F. Treverton, Rand Corporation, USA; Health Risks: April 8--9, 2005, Moscow, Russia Joep Lange, University of Amsterdam, the Netherlands Closing Session: James D. Wolfensohn, President, the World The workshop will discuss exchange rate policies, monetary Bank; Ngozi Okonjo-Iweala, Minister of Finance, Nigeria; policy, money demand, inflation, de-dollarization, bank super- Agnes van Ardenne, Minister of Development Cooperation, vision, stock markets, and the sustainability of growth. the Netherlands; Supachai Panitchpakdi, Director General, Please contact Mr Iikka Korhonen: BOFIT, tel: +358-10- WTO. 8312272, fax: +358-10-8312294, email: iikka.korhonen@bof.fi. Information and registration: www.worldbank.org/abcde- europe; Gaetano Vivo, email: gvivo@worldbank.org, tel.: +33-1- First Development Economics (DEC) Lectures 40 69 3000, or Leita Jones, email: jones2@worldbank.org, tele- April 21, 2005, Washington D.C., USA phone: +1(202)473-5030. For sessions contact: Jean-Christophe Bas, email: jbas@worldbank.org; or Boris Pleskovic, email: Opening Remarks: Francois Bourguignon, World Bank bpleskovic@worldbank.org. Lecture 1: Lawlessness and Economics: Evaluating Recipes for Development: Avinash Dixit, Princeton University. European Financial Services Conference Discussant: Philip Keefer, World Bank. Lecture 2: Globalization May 30--June 1, 2005, Varna, Bulgaria and Industrial Development: John Sutton, London School of Economics. Discussant: Michael Klein, World Bank. Lecture 3: The conference, organized by the "Economika 2000" Club, Growing Public: Is the Welfare State Mortal or Exportable? the Bulgarian Industrial Capital Association and "Razvitie Peter Lindert, University of California--Davis. Discussant: XXI" Foundation, will focus on the modernization of financial Francois Bourguignon, World Bank. services in compliance with the European Commission's The conference is open to World Bank and IMF staff. Financial Services Action Plan.Topics include: the challenges of General information: Boris Pleskovic, Research Manager, EU financial market integration in member and candidate Development Economics, tel: +1(202)473-1062; email: countries; banking sector development in light of EU enlarge- bpleskovic@worldbank.org. Logistics information: Theresa ment; the insurance sector and stock markets; and convergence Bampoe, tel: +1(202)473-1017, email: tbampoe@worldbank.org of regulation models in the EU. Information: http://www.bicabg.org/en/docs/EFSC_appl. 2005 EBRD Annual Meeting and Business Forum FormEN+Announce.doc, e-mail: bica@bica-bg.org. "Building bridges, promoting prosperity" May 22--23, 2005, Belgrade, Serbia and Montenegro The World Bank and Central European University (CEU) in Budapest Conference "Scaling Up the Success of Capacity The Meeting will discuss the latest investment information Building in Economic Education and Research" in the 27 countries from Central Europe to Central Asia: June 14--15, 2005, Budapest, Hungary · Key challenges in the new EU countries; · Current developments and reforms in Russia and the CIS; Opening Address: Yehuda Elkana, CEU · Assessment of south-eastern Europe's growth potential; Keynote Addresses: Francois Bourguignon, World Bank; · Key issues affecting the EBRD region -- opening bor- Janos Kornai, Harvard University and Collegium, Budapest; ders and expanding markets, tackling corruption, enhancing Arjun Appadurai, New School; George Soros, Open Society municipal development, securing future energy supplies. Institute. Topics to discuss: Lessons of Experience and Future Information: http://www.ebrd.org/new/calendar/index.htm Directions; Regional Perspectives; Developing a PhD Program; The World Bank· 31 Curriculum Development and Policy Research. Speakers present new research on institutions and development in com- include: William Newton-Smith, OSI and Oxford University; parative perspectve. Policy discussions will focus on institutional Gur Ofer, NES and Hebrew University; Justin Lin, CCER and change in Turkey and the challenges of future entry into the EU. Peking University; William Lyakurwa, AERC and Robert Information: http://www.cepr.org/meets/Diary/listyear.asp Campbell, EERC and Indiana University, and Jan Svejnar, ?year=2005 CERGE and Michigan University. Closing Remarks: George Soros, Yehuda Elkana, James D. Wolfensohn. UNU-WIDER Jubilee Conference "WIDER Thinking General information: Boris Pleskovic, email: Ahead: the Future of Development Economics" bpleskovic@worldbank.org, or Aehyung Kim, email: June 17--18, 2005, Helsinki, Finland akim3@worldbank.org. Logistics information: Theresa Bampoe, tel: +1(202) 473 1017, email: tbampoe@worldbank.org Marking the 20th anniversary of UNU-WIDER, the confer- ence will highlight new and emerging issues in development. Institutions, Development and Transition Topics include growth, trade and finance for development; pover- June 17, 2005, Istanbul, Turkey ty and inequality; strategies for poverty reduction; conflict; and economic policy-making for development.The conference is open Orgaized by the CEPR's "Institutions and Economic to younger researchers and established scholars, and nationals Performance" Program jointly with the Bureau for Research and from developing countries are encouraged to participate. Economic Analysis of Development, this 10th conference will Information: http://www.wider.unu.edu/welcome.htm Bibliography "Banking deregulation promotes "creative destruction" by Dean, Michael Harper and Charles Hulten, eds. New Developments in Marianne Bertrand, Antoinette Schoar, and David Thesmar Productivity Analysis, Chicago: University of Chicago Press. Black, Sandra and Philip Strahan, 2002. "Entrepreneurship and Bank Credit Availability", Journal of Finance 57 (6); 2807-2833. "How transition paths differ: enterprise performance in Russia King,Robert and Ross Levine,1993."Finance and Growth: Schumpeter and China" by Sumon Bhaumik and Saul Estrin Might Be Right", Quarterly Journal of Economics, 108: 717-738. Estrin, S., 2002. "Competition and Corporate Governance in Melitz, Jacques, 1990. "Financial Deregulation in France", Transition", Journal of Economic Perspectives, 16 (1), 101-124. European Economic Review 34: 394-402. Estrin, S., 2003. 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Meznar, J., 1992. "The Ranks of the Poor: Military Service and Caves, R.E., 1998. "Industrial Organization and New Findings on Social Differentiation in North-East Brazil, 1830-75," Hispanic the Turnover and Mobility of Firms". Journal of Economic Literature American Historical Review, Vol. 72(3): 335-51 36:4, pp. 1947-82. Mulligan, C., and A. Shleifer, 2004. "Conscription as Regulation," Foster, Lucia, Haltiwanger, John, and C.J. Krizan, 2001. "Aggregate Working paper #10558, National Bureau of Economic Research, Productivity Growth: Lessons from Microeconomic Evidence." in Edward Cambridge, MA 32 · BeyondTransition The Newsletter About Reforming Economies Order Form Transition The Beyond Transition Newsletter if FREE of charge. Please fill in the order form below if you would like to receive a complementary subscrip- tion to the English version. Please indicate if you would like to receive an electronic version (a .pdf file) or a printed copy. 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