32568 The Newsletter About Reforming Economies Beyond Transition October/November/December 2004 · Volume 15, No. 1 http://www.worldbank.org/transitionnewsletter Russian Oligarchs: a Quantitative Assessment Theme of the Issue: Corporate Governance Russian industrial tycoons, or "oligarchs", are notorious for their wealth, derived from the control over vast natural resources. They are also said to Please see pages 4--17 have exerted significant influence on Russia's national politics. Although the oligarchs' role in the Russian economy and politics is debatable, quanti tative assessments can already be made. Sergei Guriev and Andrei Rachinsky, from the New Economic School/CEFIR in Moscow, explore how Infrastructure in Transition: many oligarchs there are, what assets they control, and how well they man Regulation and Private age them, allowing cross country and historical comparisons. The article draws on the study of ownership concentration conducted for the World Sector Participation Bank's 2004 Country Economic Memorandum for Russia. Efficient and accessible infrastructure Page 4 services help to promote economic growth and to alleviate poverty. There is general support for this argument but less evidence on how this should be Does Good Corporate Governance Shelter achieved in practice. Transition countries Investors from Contagion? face significant infrastructure challenges, such as tariffs that do not reflect costs, Russian 1998 financial crisis had adverse effects on countries far extensive cross subsidization, poor rev beyond the borders of the Russian Federation. Due to geographic enue collection, and time worn service proximity and close trade and financial links, the transition networks. Progress in infrastructure economies were among those most severely hit by the Russian virus. reform in the region has been hindered Proceeding from the assumption that there is a link between the by a lack of efficient regulatory institu severity of a crisis and the corporate governance systems in each tions, and by vested interests seeking to affected country, Anete Pajuste of Riga Business School and SITE protect their positions of strength. What examines which firms were most affected by the Russian crisis and has the region learned from reforms so what mattered more, firm or country characteristics. far, and how successful has private sector involvement been? Alan Rousso of the Page 10 EBRD reports on the main findings of the EBRD's 2004 Transition Report. Page 24 Challenges for Transition Economies, Challenges for the World Bank The Europe and Central Asia region has experienced unprecedented challenges since the dissolution of the Soviet Union in December 1991. This vast region of 28 countries and 500 million people moved from centrally planned to market economies, and from communism to democracy. Johannes Linn, a former vice president of the World Bank for the Europe and Central Asia region, writes that four distinct sub regions have emerged -- the Central European countries and the Baltics, South East Europe, Turkey, and the CIS countries -- each facing unique economic and political problems and challenges. Page 20 2 · Transition-- The Newsletter About Reforming Economies From the Managing Editor: Dear reader, The Newsletter is going through a transition of its own. From its original focus on tran- sition news, the Newsletter has evolved -- with the accumulation of experience, improved data, more rigorous thinking on transition and the increasingly different circumstances in which the transition countries find themselves -- into a digest of new policy-oriented research and a calendar of important activities. As Richard Hirschler, the founder and editor for many years, is retiring, the time has come to move forward in the publication's development. A new editorial board has been appointed, consisting of Alan Gelb, Pradeep Mitra, and Boris Pleskovic, and I have agreed to serve as managing editor, overseeing the Newsletter's transformation. The new editorial board wants to make the Newsletter one of the leading publications for policy circles concerned with transition, fostering debate among policy-oriented researchers and policy makers, par- ticularly in the transition countries. The publication should cover the key policy issues and local/regional policy process- es, offer analysis and lessons across countries, and present interdisciplinary work in fields such as economics, law, and politics. We want to cultivate the "newsletter" image in terms of design, but model its content on leading policy publi- cations, with features and more debate-oriented contributions. Articles will be shorter, and the whole publication less voluminous. There will be four issues per year. We aim to emphasize research from think tanks in transition countries and involve these institutions in the pro- duction of the Newsletter. Olga Mosina, of the Centre for Economic and Financial Research (CEFIR) at the New Economic School in Moscow, will serve as editor-in-chief, drawing on local editors from newly emerging centers of excellence in policy research. The Newsletter will be published in both English and Russian, with the Russian edition adjusted to improve impact among Russian-speaking policymakers. Some new features have already been introduced in this issue. From now on, each issue will have a theme. This time the focus is on corporate governance, one of the most important topics in the region at the moment. The subject is scru- tinized from several angles. The issue reports on recent research findings, including articles by Anete Pajuste, Chong-En Bai, and Sergei Guriev and Andrei Rachinsky. The articles by Mihir Desai and Alberto Moel, Krzysztof Obloj, and Andrew Weiss and Georgiy Nikitin provide specific country examples. The article by Stijn Claessens and myself briefly surveys one strand of the literature and suggests policy implications. In a special debate section, policymakers and others are invited to discuss the featured topic. In this issue William Browder, one of the leading shareholder activists in Russia through his Hermitage Fund, criticizes the development of minority "squeeze outs", while Viktor Pleskachevsky of the Russian State Duma argues in favor of the amendments to the Russian corporate legislation. To underscore our evolution, we are changing the title for the publication to Beyond Transition. Other changes will be implemented gradually and in close interaction with our readers, so please let us now what you think as we proceed with our own transition. Erik Berglof, Managing Editor The World Bank· 3 What's Inside Theme of the Issue: Corporate Governance "I Want to Create a Mechanism for Transforming a Public Enterprise into a Private One" Russian Oligarchs: a Quantitative Assessment Viktor Pleskachevsky 19 Sergei Guriev, Andrei Rachinsky 4 From Research to Policy What Do Firms Disclose and Why? Enforcing Corporate Governance and Challenges for Transition Economies, Transparency in Central and Eastern Europe Challenges for the World Bank Anete Pajuste 6 Johannes Linn 20 Corporate Governance in Poland: a Progress in Transition and the Link to Growth History of Experimenting and Learning Alan Rousso 22 Krzysztof Obloj 7 Infrastructure in Transition: Regulation and Corporate Governance and Market Private Sector Participation Valuation in China Alan Rousso 24 Chong-En Bai, Qiao Liu, Joe Lu, Frank M. Song, and Junxi Zhang 8 Russian Rail Restructuring: Some Steps Taken, Some Remaining Do Good Governance Provisions Shelter Russell Pittman 26 Investors from Contagion? Evidence from the Russian Crisis World Development Report 2005: Anete Pajuste 10 Findings and Implications for the Europe and Central Asia Region Corporate Law and the Governance Pradeep Mitra 27 Mechanism in Russia Ichiro Iwasaki 11 How Slovakia Transformed Itself from a "Black Hole" to an Investor's Paradise Enforcing Corporate Governance Olga Gyarfasova 29 Erik Berglof and Stijn Claessens 12 Czech Bankruptcy Reform: a Light "The Outcome of Russian Public Capital at the End of the Tunnel? Markets is Not Assured" Ondrej Knot, Ondrej Vychodil 30 Interview with William Goetzman 15 Minimum Wage Increase in Ownership Composition, Corporate Hungary -- a Radical Measure with Governance, and Performance: Evidence Mixed Results from the Czech Transition Miklos Koren 31 Andrew Weiss and Georgiy Nikitin 16 World Bank \ IMF Agenda 32 Czech Mate: a Case of Insider Expropriation Mihir Desai, Alberto Moel 17 New Books and Working Papers 34 Discussion Conference Diary 37 The Threat of Minority "Squeeze Outs" Bibliography of Selected Articles 39 in Russia William Browder 18 4 · Transition-- The Newsletter About Reforming Economies Theme of the Issue: Corporate Governance Russian Oligarchs: a Quantitative Assessment Sergei Guriev, Andrei Rachinsky A study of ownership concentration in Russia under World Bank's 2004 Country Economic Memorandum for taken by World Bank in 2003 broadly confirmed Russia attempted to answer these and other questions. stereotypes about the so called "oligarchs". The con The World Bank study identified the structure of control in centration of ownership in contemporary Russia is higher 45 Russian industrial sectors, including natural resources, than in other countries. The 22 largest business groups con manufacturing, construction, and market services. In the trol about 40% of Russian industry. Micro level data suggest resource and manufacturing industries, 32 sectors were select- that oligarchs run their assets better than other Russian pri ed, representing 77% of total sales. We plied through lists of vate owners. While the relative weight of oligarchs' firms in hundreds of intermediate owners in order to determine the ulti- the Russian economy is tremendous, the firms themselves do mate owners, including foreign firms, individuals, and federal not appear excessively large by the standards of the global government and regional governments. markets in which most of them operate. Historical experi ence from other countries, meanwhile, suggests that such a high level of ownership concentration can create consider Are the Stereotypes True? able problems in building sustainable democracy in Russia. This ambitious project has confirmed common stereotypes. Russian industrial tycoons, or "oligarchs", are the quintes- Indeed, ownership of Russian industry is highly concentrated: sence of Russia's transition to capitalism. An oligarchy, as dis- 22 large business groups control about 40% of industrial out- cussed in Plato's Republic and Aristotle's Politics, is a form of put, more than all other private owners put together. The assets government by a small group. In contemporary Russia, the of the largest private owners are concentrated in the natural term denotes a large-scale businessman who controls resources resources industries. sufficiently vast to influence national politics. The first mention Many of the differences observed between oligarch-con- of oligarchs was probably made by Boris Berezovsky (by all trolled firms and other firms are determined by industry accounts, an oligarch himself) who, in a 1996 interview with specifics. For example, oligarchs' control over large enterprises the Financial Times, named seven bankers who controlled can be explained by the fact that they operate in industries about 50% of Russia's productive assets. Berezovsky said that where the average enterprise is large. Similarly, oligarchs' firms these people exerted significant influence on Russia's state are on average more productive, but if we compare productiv- policy. ity levels of firms controlled by oligarchs and by other private Are these oligarchs likely to be agents of economic and owners within the same industries, the difference in productiv- political change, or opponents of such change? On the one ity turns out to be insignificant. hand, oligarchs are the only feasible counterweight to the Still, if we look at productivity growth, the oligarchs' enter- predatory and corrupt Russian bureaucracy; and they are a prises have fared well, controlling for size, industry and loca- unique constituency that is both willing and able to lobby for tion. In 2002, the oligarchs outperformed other private the development of market institutions. They are also the only Russian owners by 8% in terms of total factor productivity Russian owners who can afford to invest and restructure growth. Their companies are inferior only to foreign-owned Russian businesses in a very hostile business climate. On the firms (which beat other Russian firms by 12%). It should be other hand, the oligarchs have weakened Russia's economy noted that fast productivity growth is associated with greater directly, by stripping assets from Russian firms and sending output growth rather than a dramatic decrease in employment. money abroad, and indirectly, by discrediting the ideas of Do oligarchs hold excessive market power in the sectors private property and the corporation among the public at that they control? The sectors controlled by oligarchs are those large. They have also weakened Russia's democratic institu- that are highly concentrated. However, these are also the trad- tions, by capturing federal and state agencies. able goods sectors that are most subject to global competition. The debate about the role of the oligarchs will probably go Except for ore and automotive manufacturing, all of these sec- on for decades. Several quantitative assessments, however, can tors sell to global markets. Ore production is mostly owned by already be made. How many oligarchs are there in Russia? the oligarchs' steel-making conglomerates, which use the ore as What assets do they control, and how well do they manage an input, so the problem of concentration is somewhat miti- them? Should the oligarchs' empires be broken? How high is gated by vertical integration. The automotive sector, however, the concentration of wealth in Russia compared to other coun- is a classic example of interest-group politics. Russian-made tries? The study of ownership concentration conducted for the cars are not internationally competitive and the industry has The World Bank· 5 always relied on protectionism, which has increased along with political power; many acquired wealth with substantial sup- growing oligarchic control over the industry. Thus, except for port from the state (through direct subsidies, tax breaks, land the automotive sector, there seems to be little reason for con- grants, subsidized credits, etc). Not surprisingly, many of these cern over the oligarchs' excessive market power. Some oli- dominant owners were at some point considered illegitimate garchs are important global players in their industries (espe- by public opinion. cially in oil and metals), but none is a dominant market leader. These countries have achieved high levels of economic Russia therefore does not need antitrust policies aimed at growth, although the high concentration of ownership has in breaking up oligarchs' holdings. all cases slowed down the development of an effective demo- cratic system. The most serious problem created by Russia's oligarchic capitalism is that privatization has not led to secure Who owns Russia? Shares in sales and employment controlled property rights. Russian voters still do not fully recognize the by each category of owners in the sample legitimacy of privatization. This has created a conflict between the core free market values (private property rights), on the one Owner category Employment Sales hand, and crucial democratic values (majority rule), on the other. However, the problem of the illegitimacy of concentrat- ed ownership can not be resolved by a simple redistribution of Largest private owners 42% 39% wealth. Historical experience suggests that the size and com- (22 groups) position of conglomerates depends on the institutional envi- ronment and market conditions. Hence, if oligarchs' empires Other private domestic 22% 13% are broken up and sold piece by piece, they are likely to reemerge as unified groups, albeit controlled by new owners. Foreign 3% 8% Nationalization will not work, either. The assets currently con- trolled by oligarchs can and should be run by private owners; Regional governments 6% 6% there are no externalities or public good arguments involved, and the inefficiency of Russia's state-owned companies is noto- Federal government 15% 26% rious. It is not surprising that in our dataset privately owned firms consistently outperform public companies, controlling No data 12% 8% for industry, location, and size. The only way out for Russia lies in further financial development, the enforcement of com- petition policies, openness, lower entry barriers, and a more Russian oligarchs in an international perspective effective legal system Cross-country comparisons of wealth concentration are Sergei Guriev is the Human Capital Foundation Associate usually based on the share of stock market capitalization con- Professor of Corporate Finance at the New Economic School, trolled by a certain number of families (e.g. ten). By this meas- e-mail sguriev@nes.ru.Andrei Rachinsky is an economist at the ure, ownership concentration in modern Russia is higher than Centre for Economic and Financial Research (CEFIR) in in any other country for which data are available. However, in Moscow, e-mail arachinsky@cefir.ru. This article draws on the historical perspective Russia does not seem to be unique. Quite authors' background paper "Ownership concentration in a few countries have gone through a period of high ownership Russian industry" for the World Bank's Country Economic concentration, but they have eventually moved on. Korean Memorandum and the paper "The Role of Oligarchs in chaebols, Japanese zaibatsu, Swedish and Italian family firms, Russian Capitalism", forthcoming in the winter 2005 issue of and US "robber barons" all enjoyed similar economic and the Journal of Economic Perspectives. OECD Corporate Governance Principles The OECD Principles of Corporate Governance endorsed including minority and foreign shareholders; by OECD Ministers in 1999 and thoroughly reviewed in 2004 · Encourage active cooperation between corporations offer non-binding standards, good practices, and guidance on and stakeholders in creating wealth, jobs, and the sustainabi- implementation, which can be adapted to the specific circum- lity of financially sound enterprises; stances of individual countries and regions. According to the · Ensure timely and accurate disclosure on all materi- Principles, a good corporate governance framework should: al matters regarding the corporation; · Be consistent with the rule of law and clearly articu- · Ensure the effective monitoring of management by late the division of responsibilities among different superviso- the board, and the board's accountability to the company and ry, regulatory and enforcement authorities; the shareholders. · Protect shareholders' rights; · Ensure the equitable treatment of all shareholders, Source: OECD, www.oecd.org 6 · Transition-- The Newsletter About Reforming Economies What Do Firms Disclose and Why? Enforcing Corporate Governance and Transparency in Central and Eastern Europe Anete Pajuste T he countries of Central and Eastern Europe began their · The disclosure index is lowest in Romania, Slovakia transition from different starting points and have pur and Poland, and highest in the Czech Republic and Estonia; sued remarkably different policies. Yet today, their · What is disclosed depends on the legal framework and economic systems are rapidly converging. The contours of a corporate practice in a given country, and it does not correlate new European capitalism are emerging, combining features with a firm's financial performance; of continental European capitalism with large controlling · Financial performance is strongly related with how shareholders and elements of entrepreneurial, or founder, easily information is available to the public, such that infor- capitalism most associated with the United States. The core mation is more available in larger firms, firms with lower lever- corporate governance challenge, however, remains the age and higher market-to-book ratios. same: balancing the incentives of controlling owners to exercise governance with the protection of minority Despite existing regulation, non-disclosure of the most investors. basic elements of corporate governance arrangements is wide- The emerging capitalist systems in Central and Eastern spread. How could different forms of enforcement improve Europe share many features. Ownership and control of indi- the situation? In answering this question, we differentiate vidual firms are becoming more concentrated, and corporate between private ordering, private enforcement and public groupings are extending their influence. Policies aimed at enforcement. severely restricting or eliminating controlling shareholders, the Private ordering can take the form of voluntary corporate most potent governance mechanism in these countries, risk governance codes, standards and company ratings developed seriously undermining corporate restructuring and the ability by financial institutions, industry associations, the media or of companies to raise external funds. Instead, efforts should be others. While these may be less credible than formal laws, this directed at ensuring that holders of large blocks of shares act mechanism has significant potential in Central and Eastern in the interest of the company, enforcing extensive transparen- Europe. Private enforcement of public law, i.e. actions by pri- cy regulation. vate agents to punish contract violations by using courts and While other aspects of corporate governance rules often are state enforcement, is still underdeveloped and should be stim- highly controversial, there is broad unanimity regarding rules ulated and improved. Public enforcement entails enforcement for providing information on who owns the firm and what and prosecution by the state. Both have a role in influencing governance arrangements are in place. Most of the Central and the overall effectiveness of the corporate governance system; Eastern European (CEE) countries have already introduced the they may overlap and can substitute and reinforce each other. minimum disclosure standards stipulated by the Transparency An important precondition for successful reform is the Directive of the European Union. Several countries, however, political will to support enforcement. Unfortunately, capacity- have taken on additional commitments. building for enforcement mechanisms is a long-term effort that Our study explores the transparency rules in individual is neither very visible nor politically rewarding. As a result, countries and the nature of information released by compa- improvements in enforcing the rule of law should be expected nies, with particular attention to the enforcement of disclosure to take longer than one might hope. When political will is lack- requirements in different countries. Using a sample of 245 ing, increased transparency could facilitate more private initia- companies listed on CEE stock exchanges over the last six tives. For example, by forcing firms to declare transactions years, we construct an availability index based on the avail- with related and affiliated parties, other investors are given the ability of annual reports on the company's website. To evalu- opportunity to scrutinize such deals and, possibly, challenge ate enforcement of disclosure rules, we then analyze 117 them in court. Over time, increased information should allow annual reports in terms of information on remuneration and investors to better evaluate the costs and benefits of different shareholdings by management and the board, as well as control arrangements in Central and Eastern Europe. related and affiliated party transactions. We construct an aggregate disclosure index based on the degree of detail the Anete Pajuste is an assistant professor at Riga Business company provides. School and a research affiliate at the Stockholm Institute of The study shows that the level of disclosure varies substan- Transition Economics (SITE), the Stockholm School of tially across firms, and there is a strong country effect on what Economics and the Baltic International Centre for Economic companies disclose: Policy Studies. The World Bank· 7 Corporate Governance in Poland: a History of Experimenting and Learning Krzysztof Obloj T he modern history of Polish corporate governance dates tributed in a controlled manner to party members and other back to 1989, when the 1926 Commercial Code was political cronies. The second factor was the growing sophisti- brought back into use. With thousands of state owned cation of international funds, local investors, and powerful companies set to be privatized, a major challenge in the 1990s state-owned companies (especially banks and insurance firms) was finding and training supervisory board members. In about how they could use the system to manipulate capital recent years, numerous corporate governance conflicts have markets. Seats on boards needed to be secured and controlled highlighted the need for new measures and initiatives. by people who would perform in accordance with the wishes of particular shareholders. These two factors led in the late Corporate governance in Poland is regulated by a 1990s to a growing number of corporate governance problems Commercial Code established in 1926, reactivated in 1989, in Poland. and modernized in January 2002. The new code strengthened Between 1999 and 2004 shareholder conflicts, aggressive and clarified the powers of shareholders and supervisory investment tactics, unexpected breaches of trust by former boards, spelling out their competencies, responsibilities, and allies, and the mistreatment of minority investors all combined procedures. Changes in company bylaws, the approval of to employ hordes of lawyers, whose imaginative ideas and financial statements, and the election of supervisory and man- interpretations yielded hundreds of ways to bend corporate agement board members, for example, must be decided at governance law. Some of the biggest corporate governance shareholder meetings. Most of these decisions can be adopted conflicts arose from inherent tensions between foreign by a simple majority of all voting shares; only major decisions, investors looking to fit their Polish subsidiaries into a multina- such as those changing a company's capital structure, require a tional network, and local investors seeking to maximize their qualified majority of at least 75%. Like Germany, Poland vest- in-country returns. ed the primary responsibility for the ongoing monitoring of After the 2002 commercial code did little to improve this company performance, operations, and managers in a separate situation, a special initiative was launched to develop codes of supervisory board. good corporate governance practice, with the support of the At the beginning of the 1990s, discussions about corporate Securities and Exchange Commission and the Warsaw Stock governance were dominated by the daunting issue of who Exchange. The resulting Code of Good Governance Practices should serve on supervisory boards. With more than 7,000 stipulates that dominant investors have special rights as they state-owned firms slated to be privatized in the 1990s, demand take larger risks, while minority rights should be protected for board members was enormous, and supply constrained. without prejudice to the interests of the dominant investors. It The state agency responsible for privatization set out to create promotes the idea of independent directors in the supervisory future management board members through a four-week edu- board and recommends that crucial decisions about the fate of cation program, capped by a complex series of exams. An the company be made only with their consent. The code also international cadre of expert teachers was recruited for the calls on supervisory board members to treat the interests of all program, including university professors of economics, law shareholders and the company as equally important. Other and business. issues treated in detail by the code are the preparation and exe- Those who passed the exams entered a pool, from which cution of shareholder meetings, and the procedures for and the State Treasury Ministry selected board members. From organization of supervisory and executive boards. 1991--1993, when the capital market was still nascent, the In short, the market is learning, experimenting and trying process of appointing board members was not very political. to develop good principles and mechanisms for resolving The norms of professionalism and independence for board investors' conflicting interests. There remains, however, a long members were widely accepted and respected, even by politi- way to go. cians, as indispensable elements of the development of a mar- ket economy. Over time, however, the norms of professionalism and inde- Krzysztof Obloj is a professor at the School of Manage- pendence were diluted by two major factors. The first was the ment, Warsaw University. He has been a member or a chair- return to power in 1993 and later in 2001 of the former com- man of more than 15 boards of public and private companies, munist party, renamed as Social Democrats. The former com- including a chairman of Agora-Gazeta SA, the largest Polish munists were used to the nomenklatura system, the common media group; PZU SA, the largest financial and insurance practice of requiring the approval of national, regional, and group in Central and Eastern Europe; and DWORY SA, one of local communist party committees before allocating posts. the largest chemical companies in Poland. He contributed this Posts on supervisory boards became valuable assets, to be dis- comment to the Newsletter. 8 · Transition-- The Newsletter About Reforming Economies Corporate Governance and Market Valuation in China Chong En Bai, Qiao Liu, Joe Lu, Frank M. Song, and Junxi Zhang M ore than three hundred years ago, Adam Smith siderable capital from the public through banks and the capital raised the issue of the separation of ownership and market, they remain extremely inefficient. Recent official statis- stewardship in joint stock corporations. Centuries tics suggest that about one-third of all SOEs are loss-makers, later, in 1932, the seminal work of Berle and Means argued another third either break even or are plagued with impli-cit that, in practice, firm managers pursue their own interests losses, and the remaining third are marginally profitable. rather than those of shareholders. How can the conflict of Ineffective governance is widely believed to be the root cause of interests between a firm's owners and its managers, and the lackluster performance. Thus, improving corporate gover- between controlling and minority shareholders, be resolved? nance should be a crucial objective of China's further econom- A set of effective mechanisms is needed to ensure that the ic reform. suppliers of finance get an adequate return on their invest To improve corporate governance, the government must ment, that the firm's value to its owners is maximized, and strengthen laws protecting shareholder interests and improve that the rights of shareholders are observed. In other words, good corporate governance is necessary. the enforcement of such laws and regulations. It is equally important that firms act to improve the situation. The question, Corporate Governance after the Asian Financial Crisis however, is whether firms have incentives to improve corporate governance. For a firm's corporate governance practices to The emerging markets crisis in 1997 and 1998 rekindled have a positive effect on its market value, two conditions must worldwide interest in the issue of corporate governance. In be satisfied. First, good governance must increase the returns to recent years, advocating higher governance standards has firm's shareholders; second, the stock market must be suffi- become a constant campaign, in which an increasing number of ciently efficient that share prices reflect fundamental values. parties -- academics, the media, regulators, corporations, insti- These conditions are more likely to be satisfied in mature mar- tutional investors, international organizations, and shareholder kets than in emerging markets. Share prices in China are often rights watchdogs -- have been participating. McKinsey & considered to be driven by pure speculation and to bear no rela- Company found in 2002 that the number of articles mentioning tionship to fundamentals. However, a series of surveys of insti- the term 'corporate governance' in major international econom- tutional and private equity investors focusing on emerging mar- ics and finance media had increased ten-fold from the pre-crisis kets conducted by McKinsey (The McKinsey Quarterly, various period 1996--1997 to the period 2000--2001. In the academic issues from 1999 to 2002) indicates that 80% of them are will- literature, the crisis has spawned a voluminous body of research ing to pay a premium for well-governed firms. on governance related issues, especially in emerging markets. Corporate Governance Mechanisms Corporate Governance in China In essence, good corporate governance consists of a set of The Chinese government opened stock exchanges in the mechanisms to ensure that the suppliers of finance get an ade- early 1990s to raise capital and improve the operating per- quate return on their investment. There are two competing formance of state-owned enterprises (SOEs). In less than twelve views on the appropriate type of corporate governance: the years, China's stock markets have grown to become the eighth market-based approach used in the US and the UK, and the largest in the world, with an aggregate market capitalization of control-based model commonly found in emerging economies more than $500 billion. Chinese companies, especially SOEs, and in continental Europe. The market-based model involves have benefited substantially from the rapid growth in issuance an independent board, dispersed ownership, transparent disclo- and the general public's enthusiasm for the equity market. sure, active takeover markets, and well-developed legal infra- Meanwhile, stock market regulations have been evolving to structure. In contrast, the control model emphasizes an insider address the tradeoff between growth and control. Even though board, a concentrated ownership structure, limited disclosure, issuance approval, pricing, and placement systems have been and reliance on family finance or the banking system. liberalized significantly, they are still tightly controlled, com- Broadly speaking, there are two classes of mechanisms to pared to other Asian markets. Nonetheless, poor governance resolve the conflict between owners and managers and between practices are rampant among listed Chinese companies. In controlling shareholders and minority shareholders. Internal 2001, the largest shareholder of Meierya, which had been a mechanisms include the ownership structure, the board of profitable company, colluded with other parties and embezzled directors, managerial compensation, financial transparency, $44.6 million, or 41% of the company's total equity. In the and adequate information disclosure. External same year, the largest shareholder of Sanjiu Pharmacy extract- mechanisms include an active market for corporate control, the ed $301.9 million, or 96% of the company's total equity. proper legal framework, and, finally, competition on the Although Chinese companies, especially SOEs, obtain con- product market. The World Bank· 9 Quantifying Corporate Governance Mechanisms and Market Valuation In our research we attempt to quantify several measures of corporate governance. Our analysis is based on a panel data set collected from firms' annual reports for the period between 1999 and 2001. We pay particular attention to an important characteristic of Chinese firms, namely the dominance of state- owned shares. Our analysis shows that: · The largest shareholder in each firm holds a signifi- cantly large stake, with the average at 44.8% and the highest at 88.6%; · A large majority (79%) of the publicly listed firms in China have a parent company; · More than one third of CEOs are also either chairman or vice chairman of the board of directors; · The proportion of outsider directors on the board is surprisingly high, with a mean of 70.6%; · As for the measure of top managers' economic inter- "-- And these are the main shareholders of our company" est in a company, it is insignificant: typically they own very lit- tle of their companies' shares, on average only 0.1%; · Neither dual listing nor multiple listing is common for market valuation, indicating that smaller firms have higher Chinese firms: the average proportion of companies issuing H valuation. or B shares does not exceed 10%. Companies that issue shares Our findings have implications both for securities regula- traded on the Hong Kong Stock Exchange (H shares) or shares tors and listed companies in China. Securities regulators in that are open mainly to foreign investors on domestic stock much of the world recognize the importance of corporate gov- exchanges (B shares) are subject to stricter legal rules, so a dual ernance in enhancing firms' investment values. Various codes or a multiple listing serves as a proxy for a better legal envi- of best practice are imposed to improve a firm's overall stan- ronment and financial transparency; dard of governance. Given the Chinese institutional back- · More than 50% of companies are controlled by the ground and the current level of capital market development in government. China, our study suggests that the government should unload the shares it holds and relax the transfer of corporately held Conclusions shares. In so doing, the government should encourage share- holding by strategic investors, who have only an arm's length After controlling for industry-specific effects, we find that relationship with the controlling shareholder, so that they can the results of our analysis are consistent with our theoretical become effective competitors for control of the firm. predictions: Regulators should improve the enforcement of regulations, · Large holdings by the largest shareholder, the place- especially disclosure rules, such that domestically listed firms ment of the CEO as chairman or vice chairman of the board of fall under similarly effective regulation as firms listed abroad. directors, and ownership by the government of the largest The government should also encourage the emergence of stake all have statistically significant, negative effects on mar- accounting and auditing firms with good reputations, to facil- ket valuation; itate more accurate disclosure. Chinese firms, meanwhile, · The higher the degree of concentration among other should increase the independence of the board of directors large shareholders, the higher the firm's market valuation. from management, to improve the board's monitoring role. Hence, potential competition for corporate control and the They should also employ reputable accounting and auditing constraints imposed by other large shareholders on the largest firms, to enhance the credibility of their accounting reports. In shareholder's aspiration to tunnel are important determinants so doing, they can increase the market value of their firm and of valuation; thereby reduce the future cost of capital. · Issuing shares to foreign investors has a statistically significant, positive effect on market valuation; Chong-En Bai is Mansfield Freeman Chair Professor of · The proportion of outside directors on the board has Economics in the Department of Economics, School of no significant effect on a firm's market valuation. This suggests Economics and Management at Tsinghua University, Beijing, that outside board members may not really be independent of and professor of the Faculty of Business and Economics at The management in China's listed companies; University of Hong Kong. Qiao Liu, Joe Lu, Frank M. Song, · Increasing the shareholdings of top managers may not and Junxi Zhang are all professors with the Faculty of Business be value enhancing in China, perhaps because these sharehold- and Economics at The University of Hong Kong. The article is ing are relatively small in the listed companies; based on the authors' paper forthcoming in the Journal of · The size of the firm is negatively correlated with Comparative Economics. 10 · Transition-- The Newsletter About Reforming Economies Do Good Governance Provisions Shelter Investors from Contagion? Evidence from the Russian Crisis Anete Pajuste O n Monday, August 17, 1998 the Russian government returns, as it represents an external shock to other countries in announced the devaluation of the ruble and a three the region. This study proceeds from the assumption that there month moratorium on the payment of external is a link between the severity of the Russian contagion for debts by commercial banks. Within days, the ruble exchange Central and Eastern European companies on the one hand, and rate plummeted, sending numerous commercial banks into the corporate governance systems and the level of financial bankruptcy depriving millions of Russians of their savings development achieved in each country on the other hand. and jobs. This "black Monday" had adverse effects on coun Using company data from 417 firms in 10 transition coun- tries far beyond the borders of the Russian Federation. Due tries (Croatia, the Czech Republic, Estonia, Hungary, Latvia, to geographic proximity and close trade and financial links, Lithuania, Poland, Romania, Slovakia and Slovenia), the the transition economies were among those most severely study evaluated the effect of firm, industry, and country hit by the Russian virus. Which firms were most affected by characteristics on short-term (one month surrounding "black the crisis? And what mattered more, firm or country characteristics? Monday") and long-term (one year after the crisis) stock returns. Contagion Channels A preliminary look at the data reveals a substantial varia- tion in stock returns across countries. Thus, average cumula- A crisis in one country may be transmitted to firms in other tive returns (buy-and-hold returns) fell by 32% in Latvia and countries through the following five channels: product com- increased by 4% in Slovakia one month after August 17. petitiveness, an income effect, a credit crunch, a forced-portfo- Returns fell further in Latvia a year after the crisis (by 76%), lio recomposition, and a wake-up call effect. while they increased by 22% in Poland. The product competitiveness theory holds that if one coun- try devalues its currency, exports from this country will Which Effects Dominate? become relatively less expensive in other countries. As a result, the competitiveness of domestic products against these imports Which effects -- firm-level or country-level -- dominated decreases. If the product competitiveness effect is important, in transmitting the Russian crisis? To answer this question, the we would expect lower stock returns for firms that compete countries were divided into two groups, one with "good" cor- with imports from Russia. porate governance, i.e. with above median rule of law scores, The income effect suggests that as aggregate demand in and the other with "bad" corporate governance, i.e. with Russia declines during the crisis, firms that export to Russia scores equal to or below the median. The rule of law scores should face reduced demand, and thus lower stock returns. (from Pistor et al., 2000) measure the tradition of law and The credit crunch effect occurs when a crisis in one coun- order in a country and range from 0 to 10. This classification try reduces international financial liquidity and makes bor- puts the Czech Republic, Estonia, Hungary, Poland and rowing for firms in other countries more costly. As a result, Slovenia into the "good country" group, while Croatia, Latvia, highly leveraged companies should be more negatively affected Lithuania, Romania and Slovakia are in the "bad country" by the crisis and therefore experience lower stock returns. group. The analysis shows that short-term returns were signif- The forced-portfolio recomposition effect implies that a cri- icantly lower in good governance countries, while long-term sis in one market can reduce the liquidity of individual and total returns were significantly lower in bad governance investors, forcing them to sell assets in other countries in order countries. to satisfy margin calls or meet regulatory requirements. The firms in the sample were divided into four groups, Finally, the wake-up call effect suggests that a crisis in one according to firm-specific characteristics: country can force investors to reassess the sustainability of macroeconomic fundamentals and corporate governance sys- 1. Non-exposed firm in a "good" country, tems in countries with similar characteristics. Investors can 2. Non-exposed firm in a "bad" country, react by pulling out from countries and firms that they believe 3. Exposed firm in a "good" country, to be the next crisis suspect. 4. Exposed firm in a "bad" country. The Effect of Firm, Industry and Country Characteristics Non-exposed firms are those that do not compete with on Stock Returns imports from Russia, do not export to Russia, have higher sales growth, have lower leverage, are smaller in size, have less A crisis situation offers a good opportunity to study the liquid stocks, and have a foreign blockholder among the effects of firm, industry, and country characteristics on stock owners. The World Bank · 11 Country Factors are Important Conclusions The analysis of cumulative short-term returns shows that Stock performance varied substantially across firms and firms exporting to Russia, as well as larger and more liquid countries during and after the Russian crisis. Firms operating firms, experienced significantly sharper declines in stock prices in industries that compete with major imports from Russia during the one-month period around the crisis. These results (product competitiveness effect) and in industries with major provide evidence that investors believe the income effect can exports to Russia (income effect), firms with greater liquidity affect firms with direct sales to the crisis region. Moreover, (forced portfolio recomposition effect), higher leverage (credit there is evidence of the forced portfolio recomposition effect in crunch effect), without a foreign blockholder, as well as firms larger and more liquid firms that experience capital outflow operating in countries with a poor record of investor protec- due to investors' short-term liquidity constraints. tion had significantly lower stock returns one year after the cri- The analysis of cumulative long-term returns shows that sis. There is also a strong short-term forced portfolio recom- firms that did not compete with imports from Russia, firms position effect: firms with a presumably higher institutional- with a foreign blockholder, and faster growing, larger, more investor presence, i.e., bigger and more liquid firms, exhibited liquid and less leveraged firms overcame the negative effects of sharp short-term decreases in stock prices. the crisis faster (i.e. the stock returns one year from the crisis The study provides additional evidence on the relationship were higher). Non-exposed firms had significantly higher total between corporate governance and market efficiency. Stock returns. prices in countries with higher rule-of-law scores absorbed the As for total returns, the study finds that, with two excep- negative news about the Russian crisis much faster than stock tions, exposed firms in "good" countries were hit less severely prices in countries with lower rule-of-law scores. Stock prices by the crisis than non-exposed firms in "bad" countries, sug- in good countries reached bottom around one month after gesting that the country's legal environment played an impor- "black Monday", while stock prices in bad countries tant role in overcoming the effects of the Russian crisis. Only continued to deteriorate for an additional five to six months. firms not competing with imports from Russia, and firms with Finally, both firm- and country-level characteristics do mat- higher sales growth in "bad" countries, experienced better ter in overcoming a crisis; however, firm-specific characteristics stock performance than 'good country' firms competing with play a bigger role for firms operating in countries with weak imports from Russia and with lower sales growth. investor protection laws. A "good" country label carries clear Thus, countries do matter, i.e. the legal protection of advantages. Maybe that is why it took so long to realize that investors is an important determinant of stock returns, which there are also Enrons in "good" countries. can outweigh the importance of firm-specific characteristics. A "good country" label reduced the severity of the Russian virus Anete Pajuste is an assistant professor at Riga Business across all firms in these countries, while firm-specific charac- School and a research affiliate at SITE, the Stockholm School teristics played a more significant role in countries with weak- of Economics and the Baltic International Centre for er corporate governance. Economic Policy Studies. Corporate Law and Governance System in Russia Russia's 1996 law on joint-stock companies envisions the delegated to executives. However, the law does not specify the creation of a 'self-regulating organization, in which managers executives' prerogatives in daily management, leaving the mat- and large stockholders will voluntarily observe the legal code. ter to the discretion of the company. Such a distribution of Given a weak law enforcement environment in Russia, the power is likely to result in a conflict between the board of idea seems quite reasonable. However, our analysis suggests directors and executives. In some companies, the board has that some provisions in the Russian corporate legislation may been unable to obtain sufficient and reliable information on create problems for companies' governance systems. Below management's actions and is thus unable to make proper judg- are just two examples, by way of illustration. ments on the company's activities. To secure the independence of supervisory bodies from the We conclude that no law can set out a complete legal executive, the law imposes relatively tight restrictions on the framework for a 'self-enforcing' organization. An effective concurrent holding of several posts. However, the restriction governance system can only emerge with the development of against executive officers assuming directorship, for example, the judicial system and further improvements in the Russian can be easily ignored by eliminating a collective executive business environment organ (one of five supervisory bodies), which exists at the dis- cretion of the company. This legal loophole, along with the Ichiro Iwasaki, an associate professor at Hitotsubashi dominant insider ownership structure, does not effectively dis- University, Japan, email: iiwasaki@ier.hit-u.ac.jp. Please see courage opportunistic behavior among executive officers. the author's full paper 'The Governance Mechanism of The board of directors is empowered to make a large num- Russian Firms: Its Self-enforcing Nature and Limitations' in ber of important managerial decisions, which may not be Post-Communist Economies, Vol. 15, No. 4, 2003. 12 · Transition-- The Newsletter About Reforming Economies Enforcing Corporate Governance Erik Berglof and Stijn Claessens G overnments, private companies and international tutional development of the country, especially its contracting bodies have devoted much effort in recent years to environment. A potentially important corporate governance the formulation of ever more elaborate rules of cor mechanism may be hard to influence through policy, and porate governance. Whatever their source, these sets of mechanisms susceptible to policy intervention may not be very rules are all remarkably similar. Yet practices differ substan important. Policy recommendations should take both of these tially across countries and companies (OECD 2003). Many problems into account. For example, in environments where concerns remain regarding the effectiveness of corporate the court system functions satisfactorily, private litigation to governance rules, as written rules are not adhered to and protect minority shareholders is an option for improving large firms' pronouncements are not followed up by actions. shareholder monitoring. In weaker enforcement environments, Policymakers have come to realize that, at least in transition policy may have to focus on promoting private mechanisms economies and developing countries, the key problem is the and empowering shareholders by disseminating information lack of enforcement, more than regulations and paper laws. (see the table). While problems of enforcement are common to develop- In industrialized countries, many firms are closely held, yet ment in general, they particularly affect firms seeking external minority investors have some means to challenge insiders and financing. Financial contracts, after all, commit a firm to ensure a reasonable rate of return on their investment. They adhere to certain obligations, in particular to pay appropriate are consequently willing to provide external financing. In tran- rates of return to the providers of external financing. A weak sition and developing economies, these means may not be enforcement environment makes it harder for firms to commit available, and enforcement is generally weaker. to honor financial contracts and, thus, to attract external financing. This, in turn, slows financial development. Empirical Private vs. Public Enforcement evidence on insider trading, for example, shows that it is not the presence of laws but rather actions taken against insider Although enforcement is generally agreed to be critically trading that help to explain the development of securities mar- important to economic performance and is the subject of a vast kets. Another international study finds that the level of literature, there is no simple analytical framework. Issues relat- enforcement is much more important than the quality of laws ed to enforcement can be classified in several ways. One dis- on the books in explaining the turnover of chief executive offi- tinction may be drawn between private and public mecha- cers (Defond and Hung 2003). This is not to say that laws are nisms. Private initiatives to enforce contracts are critical to the not important. Rather, laws alone do not suffice. functioning of any economy and can operate outside the legal Below, we develop a rudimentary framework to help under- system. Such initiatives may be undertaken by individual firms stand when corporate governance rules are enforced and sug- (e.g., reputation-building), between two firms (e.g., various gest what can be done to improve corporate governance forms of integration), or among several firms (e.g., industry mechanisms in a weak enforcement environment. The analysis associations with private conflict resolution and enforcement). of various options should help understand which reforms most Such private arrangements can later be standardized and improve corporate governance practices and mitigate social encoded in public law. Laws, in turn, may be enforced private- costs. ly through litigation, or publicly by the government. Under pri- vate law enforcement, private agents act within a legal or reg- Defining a Problem ulatory framework to punish contractual violations, using the courts to adjudicate and the state to enforce the final judge- Any recommendations on national policies relating to cor- ment. With public enforcement, the government provides the porate governance must start by defining the corporate gover- final enforcement system and acts as prosecutor. In the extreme nance problem facing a particular country, as these problems case, the government has full control over all activities, there vary considerably. are no property rights or contracts to enforce, and laws are Corporate governance, in large part, aims to mitigate the irrelevant. following problem of commitment: how can investors be An enforcement system thus consists of a continuum of ensured that management will choose the right projects, exert overlapping mechanisms ranging from private ordering sufficient effort, adequately disclose relevant information, and through private enforcement of laws and government-enforced ultimately repay investors? Investors can reduce the likelihood regulation to full government control (Djankov et al., 2003). of being defrauded or deceived by monitoring and, potentially, All mechanisms have costs, and there are tradeoffs between punishing management. Firms, in turn, may employ a variety costs and benefits. Private and public initiatives often comple- of commitment mechanisms to overcome investors' concerns ment rather than substitute each other. The effectiveness of (see the table). private enforcement mechanisms often depends on the Which mechanisms are preferred will depend on the insti- effectiveness of public enforcement mechanisms. Public The World Bank · 13 Corporate Governance Mechanisms in Developing Countries and Transition Economies Corporate governance mechanism Relative importance in developing Scope for policy intervention countries and transition economies Large blockholders Likely to be most important governance Ensure that rules protecting minority mechanism. investors do not go too far in removing incentives to hold controlling blocks. Market for corporate control Unlikely to be important when owner- Remove some managerial defenses; ship is strongly concentrated; can still require disclosure of ownership and con- take place through debt contracts, but trol; develop the rest of the financial sys- requires bankruptcy system. tem to allow competing bids to be financed. Proxy fights Unlikely to be effective when ownership Promote technological improvements is strongly concentrated. for communicating with and among shareholders; improve disclosure of ownership and control. Board activity Unlikely to be influential when control- Introduce elements of independence for ling owner can hire and fire board mem- directors; train directors; require disclo- bers. sure of voting; allow cumulative voting Executive compensation Less important when controlling owner Require disclosure of compensation can hire and fire. schemes, and conflicts-of-interest rules. Bank monitoring Important, but depends on health of Strengthen banking regulation and insti- banking system and the regulatory envi- tutions; promote credit bureaus and ronment. other intermediaries. Shareholder activism Potentially important, particularly in Encourage interaction among share- large firms with dispersed shareholders. holders; strengthen minority protection; enhance governance of institutional investors. Employee monitoring Potentially important, particularly in Require disclosure of information to smaller companies with highly skilled employees; possibly require board repre- human capital that can easily leave the sentation; ensure flexible labor markets. firm. Litigation Depends critically on quality of laws, Facilitate communication among share- bias of courts, and general enforcement holders; encourage class action suits (but environment, but can sometimes work. include safeguards against excessive liti- gation). Media and social control Potentially important, but depends on Encourage competition in and diverse media competition and independence. control of media industry; inform and empower the public. 14 · Transition-- The Newsletter About Reforming Economies and enforcement are complementary, and both can improve as countries develop. Laws and regulations, meanwhile, may be adopted not only to correct market failures, reduce trans- actions costs, and achieve social objectives, but also to extract bribes. Djankov, La Porta et al. (2003) find some support for this so-called tollbooth view, especially in developing countries, suggesting that policymakers should err on the side of more lax laws in weaker enforcement environments. Conclusions Ultimately, the effectiveness of many enforcement mecha- nisms hinges on the political sphere's commitment to enforce laws and regulations. Given the enormous potential gains from improvements in public enforcement, building support for reforming these institutions should be easy. Indeed, reforming enforcement institutions should be easier than changing basic investor rights, which often involves clear winners and losers. enforcement reduces the costs of private enforcement. But Many attempts to reform investor rights have been blocked by while more public intervention may mitigate market failure, it powerful opposition. Nonetheless, changes to investor rights is more vulnerable to government failure and may not be the do occur, often following financial and other crises. most efficient means of enforcement when private agents have A review of the literature highlights some general lessons on better information, resources, and incentives. Private agents are improving enforcement, not necessarily limited to corporate particularly important when the general institutional environ- governance: ment is weak. A system of social control is necessary where · Private-sector efforts to enhance enforcement are both markets and government fail or cannot be expected to often more effective than government-led efforts, but the two operate. More generally, social control is necessary to support forms of enforcement often complement one another. Securities the functioning of markets. regulation experience in the United States suggests that private Each country will choose a different mix of mechanisms, ordering can precede and serve as a basis for public laws and and the optimal mix for many developing countries will differ for private and public enforcement of those laws. from that observed in industrialized countries. Public enforce- · The balance between private ordering and private ment can play only a limited role in weak institutional envi- enforcement of public law depends on the quality of public ronments, as powerful controlling owners and managers will laws and the strength of enforcing institutions. When the gen- most likely find a way around the system. Private enforcement eral enforcement environment is weak, private ordering may be of public laws and the power of litigation and court interven- the only hope. tion vary greatly across countries, depending on how well pub- · Improvements in enforcement more often result from lic enforcement institutions function. Russian investors, for bottom-up rather than top-down initiatives. Capacity building example, almost never turn to courts, because the likelihood of is often important to support private initiatives, and it helps success is miniscule and even if they win the judgement is often build constituencies for reform. not enforced (Zhuravskaya et al., 2003). · Top-down efforts to improve the legal and enforce- When courts are weak, other enforcement mechanisms may ment environment are difficult and rarely successful. be used to enforce good corporate governance. Policies pro- Transplanting elements of foreign legal systems has generally moting bank lending and financial development may help not worked well, but the experience of accession to the enforce corporate governance. Yet even here relative costs are European Union suggests that outside anchors can play a important. In China, although court decisions are not always positive role in encouraging the implementation of reforms. predictable or enforced, investors increasingly take their griev- · In designing strategies for improving the enforcement ances to court. They do so because other mechanisms are either of corporate governance, both the likely impact of a particular unavailable or even more costly. governance mechanism and the scope for improving the The choice of mechanisms depends largely on the overall mechanism should be considered. A particular corporate gov- environment. Political institutions, as part of the general ernance mechanism may play a very important role in reducing enforcement environment, may function poorly, be dominated agency costs but leave little room for improving enforcement. by an absolute ruler, or be captured by special interests. Legal standards and the level of enforcement can also interact. A Erik Berglof is the director of the Stockholm Institute of benevolent government can trade off the benefits of stricter Transition Economics (SITE). Stijn Claessens is professor of legal standards with the costs of their enforcement. A benevo- international finance policy at the University of Amsterdam. lent government should set standards lower, because the costs The full report can be viewed at http://econ.worldbank.org/, of enforcing them are higher. In other words, legal standards Policy Research Working Paper No. 3404. The World Bank· 15 William Goetzmann: "The Outcome of Russian Public Capital Markets is Not Assured" Q. You have studied corporate governance issues in histor- despite a good national corproate code, why would you invest ical and comparative perspective extensively and recently pub- your money? lished "The history of corporate ownership in China". Based on your research, can you see any similarities between China, Q. In your view, what will the Russian corporate gover- Russia, and other transition economies? Is there anything nance landscape look like in the coming years? Russia can learn from other countries' experi- ence regarding corporate governance? A. I believe that progress will not always be easy and that public sentiment will range from A. Yes. The basic experience of all countries positive to negative as the inevitable growing seeking to develop capital markets after not pains continue for the Russian market. I do not having had them for a long time is the problem regard the outcome of public capital markets as of a complete legal framework for property assured. The public capital markets could disap- rights. It is not enough to have a structure of pear if public confidence cannot be sustained. I laws, but apparently a tradition of practice and think this would be unfortunate, given the great enforcement is important to establish norms of entrepreneurial energy in Russian society. The behavior. public capital markets work best as a means to The biggest challenge faced by Russia and finance innovation and new technological devel- China currently is not the lack of laws, but opments. They are democratizing elements William Goetzmann "loop-holes" in the legal system that allow the themselves, because they allow legitimate entre- seizure of property and supression of informa- preneurs to get capital to create new companies. tion about companies. An important example of this is the cur- I believe that the will exists in Russia to make progress. The rent ambiguous environment for the financial press in China. governance landscape at the top levels is clarifying, and I think Companies can sue reporters for slander even when the fraud the real work to be done now is in the legal system of enforce- they uncover in the press is true. Why? Because the right of ment and combatting fraud. legal appeal extends only to the provincial government level and companies have subtantial provincial government owner- Q. In your 1998 interview with Businessweek, you said that ship interests. This is an example where the legal right to sue you would only invest your own money in countries with well- for slander is being used to support a conflict of interest protected investors' rights. Six years after, have you invested between the local provincial government and the minority your own money in any emerging markets? shareholders. A. I am still a pessimist with regard to emerging markets. I Q. What, in your view, are the worst "sins" of Russia's should qualify this a little bit, however. I regard the real estate existing corporate governance system and what are the most market in the United States as an emerging market -- very sim- pressing issues in this respect facing Russia? ilar to the current Russian equity market, dominated by a few large players, low liquidity and subject to public swings in sen- A. I regard the recent examples in Russia of sudden corpo- timent. I have some of my investment in real estate stocks and rate takeovers as a prime example of the exploitation of loop- the rest in a mixture of US and international equities. I wish the holes in the law. There is enough legal structure to justify the market had done better since the year 2000, however. filing of complaints against a firm, enough to provide cover for the seizure of assets by a competitor at the expense of other William N. Goetzmann is the Edwin J. Beinecke Professor minority shareholders. Like the China case I mentioned above, of Finance and Management Studies and Director of this may be a case of competing legal jurisdictions in a system International Center for Finance at the Yale School of in which all the problems have not been worked out, but it rep- Management. He is a member of the European Finance resents a real risk to the public capital markets. If there is a risk Association. The interview first appeared in the Russian-lan- that your rights as shareholders can be suddenly taken away, guage version of the Transition Newsletter. The 32nd annual meeting of the European Finance jointly sponsored by HSE, Yale School of Management Association will be held from August 24 to 27, 2005 in and Humboldt University of Berlin. More information Moscow. The conference will be hosted by State University about the conference is available at: -- Higher School of Economics (HSE). The conference is http://www.efa2005.org/ 16 · Transition -- The Newsletter About Reforming Economies Ownership Composition, Corporate Governance, and Performance: Evidence from the Czech transition Andrew Weiss and Georgiy A. Nikitin P oor corporate governance is often associated with dif the manager of the largest family of funds "The Pirate of fuse ownership, poor regulatory control, and a legal Prague". Due to these activities and the adverse publicity the system that is not able or willing to protect sharehold sector received, the funds traded at large discounts to their net er rights. If ownership is diffuse, individual owners either asset value. There was no realistic possibility of raising new can't or won't pressure management to improve the compa money, thus removing the last meaningful incentive for fund ny's performance. However, concentrated ownership is managers to improve the performance of their investments. unlikely to solve these problems if the major shareholder The other large shareholder with poor incentives was the also suffers from poor governance, or if its managers are not Czech government. The political appointees who managed the motivated to improve the performance of the companies in government's investment portfolio had no incentive to maxi- which the institution invests. mize shareholder value: the government never replaced the Using data on performance and share ownership in the management of any company in which it was the largest Czech Republic from 1993 to 1997, we investigated how cor- investor. If poor corporate governance of a company's shares porate governance problems at the shareholder level affect the by institutional owners adversely affects the performance of performance of operating companies. After the Czech Republic the firm, then a firm whose largest shareholder was either an privatized its previously state-run economy in the early 1990s, investment fund group or the national government would have almost all companies became publicly traded, and the largest poor performance, as we found in our study. shareholders were either the national government or closed- In contrast to the national government, when a municipali- end funds -- publicly traded companies that invest in the ty is the major shareholder, the local population may be better shares of other publicly traded companies. Unlike open-end able to monitor management and would have both the incen- mutual funds, shares in a closed-end fund cannot be redeemed tive and means to improve corporate performance. The local at their asset value, nor could new investments be made at the electorate directly benefit from improved performance of proportionate value of assets. Thus, the fund's price can fall municipal investments. Because the Czech political process was below the value of its assets. relatively open and honest, elected officials would be motivat- In the early 1990s, Czech citizens could buy a fixed num- ed to improve the performance of local companies. The evi- ber of vouchers at minimal cost. The vouchers were used to dence from China suggests that even if the political process is buy shares in operating companies or exchanged for shares in seriously flawed, village-owned enterprises can exhibit high these funds, which in turn used the vouchers to buy shares of levels of productivity (e.g. Wang and Jin, 2002). Unfortunately, companies. we have only seven cases of companies where the major share- Fund managers' fees were a function of the fund's assets, holder was a municipality. The statistical significance of our not its performance. Since the fund could not attract new results therefore varied with the estimation procedure; howev- money, management could only benefit materially from the er our point estimates consistently showed strong positive performance of the companies in which the fund invested if effects -- often the largest for any ownership type. they planned to raise additional capital or market a new fund. Our best example of the effects of large shareholders with The funds' shareholder base was diffuse and unsophisticated, good corporate governance was foreign portfolio investors -- regulatory control was lacking (the securities commission was generally western European firms.These owners were subject to not established until 1997), and the legal system was ineffectu- regulatory controls and were likely to hold large controlling al. The term "tunneling" was invented to describe the process stakes. During the 1990s, the percentage of companies in which by which fund managers extracted all the value of the funds the largest shareholder was either an investment company or they managed, leaving only a shell. Fortune magazine called the central government steadily declined, while the percentage of companies whose largest shareholder was a Effect of replacing the largest shareholder with a foreign company on performance foreign firm steadily of Czech firms in 1993 -- 1997 increased. Controlling for the Replaced shareholder Change in operating profit Change in operating profit Change in investment type of owner, owner- per worker, 000' CZK per unit of capital, 000' CZK rate, % ship concentration did Investment Fund 84.01* 135.16* 74.47* not affect performance, National Government 100.85* 171.02* 110.82* but the type of owner Municipality 15.61 -26.44 -189.36 had a large and statisti- cally significant effect on * Result statistically significant at 1% level performance. Firms with The World Bank· 17 foreigners or municipalities as their major shareholders were firms tend to perform better than publicly owned firms proba- more profitable and had higher investment rates than firms bly does not always hold. where the main owner was either an investment fund or the Countries with bad corporate governance are exacerbating national government. their problems by discouraging foreign portfolio investors The results reported in the table used a dummy variable for from taking large stakes in domestic companies. The domestic the identity of the largest shareholder. We obtained similar economy loses the benefit of the regulatory discipline of the results when we interacted ownership type with the percentage country in which the investor is domiciled. Within countries of shares owned by the largest shareholder, as a measure of the regulatory authorities should police the corporate governance ownership effect (see other results in Weiss and Nikitin, 2004). not just of operating companies, but also of large institutional investors such as pension funds and mutual funds. Legislation Conclusions and Policy Implications making it easier for the beneficiaries of pension funds to replace the trustees, or for the investors in closed-end funds to It is widely believed that state ownership hurts productivi- replace management or convert the fund to an open-end mutu- ty. However, there is nothing about state ownership in particu- al fund, may have significant positive effects on overall eco- lar that causes these ill effects. When the major shareholder is nomic performance. a private company, such as a Czech closed-end fund, the adverse effects on performance were as bad as for a state con- Andrew Weiss is a professor of economics at Boston trolled enterprise. Conversely, when the controlling sharehold- University and president and chief investment officer of Weiss er is a public body, such as the local municipality, which has the Asset Management. Georgiy A. Nikitin is a research analyst at motivation and ability to improve economic performance, per- Weiss Asset Management. formance was good. So the observation that privately owned Czech Mate: a Case of Insider Expropriation In 1991, Ronald Lauder, one of the heirs of the Estee London, and Stockholm. CME sought damages from Zelezny Lauder cosmetics fortune, created a holding company, Central personally, and in separate actions, claimed that the Czech European Media Enterprises (CME), to invest in media prop- Republic and the Media Council violated international treaties erties throughout Eastern Europe. In a bid for the first Czech by failing to protect CME's investment. Lauder managed a his- commercial TV station, CME worked together with a local toric verdict against both Zelezny and the Czech Republic company, CET 21, controlled by Vladimir Zelezny, a promi- when, in 2001, the Stockholm Tribunal ruled in favor of CME nent Czech journalist, producer, and a former press official for and the Czech government paid CME more than $350 million, the Czech government. The joint venture won the tender, and an amount equal to the annual budget of the Ministry of Health. Zelezny became director of the new TV channel, TV Nova. Our study demonstrates, first, that the power of insiders While foreign ownership of media companies was not illegal, need not be defined by their ownership shares. Prominent negotiations with the state Media Council left CET21 holding insiders -- such as leading employees and local representatives the license, awarding its exclusive use to an operating compa- of multinational firms -- can manipulate policy-makers, con- ny majority-owned by CME. TV Nova prospered under duct public relations, and violate contracts in a manner that Zelezny, gaining a 70% audience share within a year. Zelezny expropriates value from owners regardless of actual owner- himself was a host of a weekly program, which became the ship. Zelezny's ability to divert the firm's value arose from his most-watched program in the country. access to critical resources, his public image locally, and his By 1999, CME had bought out the other shareholders, ability to bend the rules of the game at will. including Zelezny, and held 99% of the operating company. Second, the geographical and cultural distance between Zelezny, however, set up a content production company of his Lauder and Zelezny distributed decision rights in a way that own and the Media Council ruled that the license delegated to allowed Zelezny to structure the joint venture opportunistical- CME could no longer be exclusive. These developments ly, to force monetization of his ownership in the company, and, undermined the proposed sale of CME. CME accused Zelezny ultimately, to expropriate the value of the asset. of violating the operating company's exclusive right to acquire Finally, local laws may be irrelevant to investor protections programming for TV Nova and dismissed him as a company for many investments. Although Lauder appealed to the local director. He continued, however, as director of TV Nova and courts, he also sought the protection of bilateral investment still controlled CET 21. A few months later, Zelezny retaliated treaties. These treaties are increasingly used in response to by terminating TV Nova's service agreement with the operat- expropriation, not just by governments, but also by managers ing company. Without a broadcast license, CME could not and investors. operate the TV channel. It was effectively put out of business and lost its entire market value. Mihir Desai is associate professor at Harvard University. Alberto Lauder sought to pressure the Czech government through Moel is a principal with The Monitor Group. The full text of their political influence, a public relations campaign and, finally, sued paper is available at the SSRN Electronic Library. A case study the government in international tribunals in Amsterdam, based on the events is available through www.hbsp.harvard.edu. 18 · Transition-- The Newsletter About Reforming Economies Discussion William Browder: The Threat of Minority "Squeeze Outs" in Russia D espite the inevitable hand wringing over the ongoing valued it at $67 million -- a 75% discount to TNK's 1999 net Yukos affair, President Putin's first term witnessed income and a 95% discount to contemporary peers. remarkable advances in the protection of minority Such chicanery aside, the Squeeze-Out Law amounts to a shareholders in Russia. The establishment of preemptive rights blanket amnesty on a decade of corporate looting, mismanage- gave minority shareholders the ability to stop dilutive and ment and shareholder harm by many Russian majority share- preferential stock issuances. The Duma legalized ownership of holders. Dilutive share issuances, rampant cronyism among partial shares, eliminating a common tactic by which control- management, abusive reverse stock splits, transfer pricing and ling shareholders conducted abusive reverse stock splits and other widespread abuses have together imposed a significant dis- forcibly divested minorities left with less than a single share. count on Russian equities. The Russian market trades at a price- The introduction of cumulative voting for board elections to-earnings ratio of approximately 7, compared to 24 in expanded minority participation in corporate affairs. Hungary and 30 in Venezuela, another oil-rich emerging market. Regardless of these advances, however, minority sharehold- Enabling controlling shareholders in Russian companies to ers in Russia continue to suffer regular attacks by majority conduct forced liquidations of minorities would do violence interests. On June 27, 2004, the first major assault of Putin's not only to the development of shareholder rights in Russia, second term materialized when four committee heads in the but would endanger the remarkable record of recent economic Duma introduced legislation that profoundly threatens the growth in Russia by further concentrating economic power in future development of minority shareholder rights in Russia the hands of a few market actors. Minorities, like the govern- and, more fundamentally, the credibility of Putin's economic ment, have a strong interest in the equitable and transparent agenda. In a sign of highly motivated support, the legislation accounting of profits. With minorities purged, some of the passed the first reading in the Duma in just six days, a sched- largest Russian companies will naturally evolve into closed, uling triumph virtually unheard of in the Russian legislative opaque and ambiguous entities, a development at odds with process. Technically introduced as a set of amendments to the the Kremlin's much-publicized goal of doubling GDP in ten Joint Stock Company Law, the so-called "Squeeze-Out Law" years. would permit a holder (or a collection of holders acting in con- Proponents of the Squeeze-Out Law predictably defend it cert) representing 90% of the equity in a Russian joint stock by citing similar laws in western jurisdictions, specifically the company to select and hire an appraiser to value the minority United States and Western Europe. While such minority buy- stake and to use this valuation as the basis of a compulsory out laws do exist, the similarities with the Russian proposal are buy-out offer to the minority shareholders. The divestiture of precious few. Among developed economies, only the United minorities is a fait accompli as soon as the buy-out offer is States (Delaware) matches a threshold to initiate a squeeze out made, regardless of the price offered or the fairness or inde- as low as 90%, with Germany at 95% and Italy and pendence of the underlying appraisal. The only recourse grant- Switzerland both at 98%. More importantly, every western ed to minorities in the draft legislation is to dispute the price in jurisdiction also incorporates legal, regulatory and other insti- a Russian court, but not the sale itself. Minority divestiture at tutional safeguards to prevent minority shareholder abuse. whatever price is inevitable. These safeguards include: mandatory court or government If enacted, the impact of the Squeeze-Out Law would be review of the appraised value of the minorities' stake; "Fair devastating. More than 188,000 individual shareholders hold- Price" and other legal doctrines supporting minorities' rights ing more than $3 billion in capital would be vulnerable to to a fair buyout price; case law permitting minorities to sue to squeeze-outs in the largest Russian companies alone. Many of stop the squeeze-out from occurring at any point; and signifi- the minority shareholders in these companies are employee cant liability for the appraisers, officers and directors in the shareholders, pension funds and foreign investors. Indeed, event the squeeze-out violates the fiduciary duty owed to every foreign public equity investor in Russia is by definition a shareholders or is otherwise fraudulent. Neither the Squeeze- minority shareholder. Out Law nor the embryonic Russian judicial system incorpo- Among the many structural failings of the Squeeze-Out rates any of these shareholder protections, which are essential Law, perhaps the most egregious is the enormous role and to ensuring that a law permitting minority buyouts doesn't responsibility it creates for appraisers. While the inherent con- become a license for below-market shareholder purges. flict with the majority shareholder overseeing the appraisal of the minorities' stake is obvious, the unique history of William Browder is the CEO of Hermitage Capital appraisals in Russia makes this all the more outrageous. Just Management, an investment advisory firm which manages the one example: the appraisal issued in the 1999 privatization of Hermitage Fund, the largest Russia-dedicated investment fund. the Russian government's 49% stake in the oil company TNK He contributed this comment to the Transition Newsletter. The World Bank · 19 Victor Pleskachevsky: "I want to create a mechanism for transforming a public enterprise into a private one." T he State Duma Property Committee has spent four years public companies. And at that point they become the targets of looking into the problem of corporate relations in blackmail by "professional minority stockholders", who say Russia, studying corporate conflicts and enterprise "Buy my shares at above-market prices, or else I won't agree to seizures. On November 15, 2004, parliamentary hearings were the transformation of the company." If this is not blackmail, held on "The Main Guidelines for Improving Corporate what is? Not infrequently, these companies haven't been pay- Legislation", which elaborated a concept for improving corpo- ing dividends for years, and now the "professional minority rate law. Some related bills may be introduced in the Duma stockholders" want to have them at their mercy. That is why before the end of the autumn session. Those bills already pend- we are committed to creating a mechanism for transforming a ing in parliament will be either adjusted to fit the concept, or public enterprise into a private one. rejected. As for the problem of determining the fair market value of The concept encompasses legislation in five areas of cor- the block of shares being bought out, we introduce a mecha- porate law: first, a package of laws to prevent corporate con- nism for independent appraisal, the results of which may be flicts, the seizure of enterprises and corporate blackmail (green- challenged in a court. Under our bill, the majority shareholder mail); second, a package of laws to prevent the violation and hires an independent appraiser at his own cost and the minor- abuse of shareholder rights, establishing a balance between ity shareholder cannot simply reject the appraisal. He has to majority and minority shareholders; third, a package of laws come up with his own appraisal of the price, file a lawsuit and setting higher standards for open joint stock companies and prove that the buyer has understated the price. If the majority creating mechanisms for transforming public companies into shareholder has offered 100 rubles and you think your holding private enterprises; fourth, a package of laws on integrated costs a million dollars, it is up to the court to decide, proceed- structures (holding companies and concerns) and mechanisms ing from independent expert assessments. And if, in the end, for reorganizing and liquidating enterprises; and finally, a the judge rules that the market price is 150 rubles, you can package of laws aimed at liquidating the legal surrogates that challenge the ruling in the second, third instance, and so on. have emerged during the ten formative years of corporate law Most shares are not traded on the market. Of the 157,000 joint (authorized capital, partial shares, nominal share price, closed stock companies, only seven or eight are traded, accounting for joint stock companies, "people's enterprises" in the form of 80 percent of market capitalization. During the past five years, joint stock companies, etc.). no more than 100 companies out of 157,000 have traded their The most controversial piece of legislation, allowing the shares more than once. owner of 90% of equity plus one share to buy out minorities, Of course, there is room for abuse and corruption. But the passed its first reading as early as spring. The bill sparked off court may come under pressure not only from majority share- quite a storm. Its opponents advance two main arguments: holders, but from minorities as well. Our minority sharehold- first, they claim that it is unconstitutional, and second, they ers are not humble grannies or granddads, they are investment focus on the problems that may arise in the process of apprais- funds with huge potential and highly skilled lawyers who will ing the block of shares owned by minority shareholders. As uphold the maximum price in any court and fight to the last. regards the former point, our main argument in favor of the The bill seeks to restore the balance in the relations bill's constitutionality is precisely the article in the Constitution between minority and majority shareholders. We elevate to a which says that no one can be divested of a property right or new level not only their rights, but also their responsibilities. At the right to dispose of one's property except under a court rul- present, both groups tend to abuse their rights. On the whole, ing or on the basis of the law. As it is, in the absence of the pro- this is not conducive to economic stability, so the current situ- posed compulsory minority buy-out mechanism, majority ation cannot be recognized as being optimal. shareholders often become victims of blackmail. How does it It is impossible to pass all the necessary measures as one happen? package of laws, as we are dealing with a huge number of laws. We demand higher standards of transparency and corpo- This will keep us busy for two or three years. We won't solve rate governance from joint stock companies, which increases all the existing problems, but we will take our corporate law to their costs. Major companies such as LUKOIL, Gazprom, RAO a higher level, as a coherent system of relations. The amend- UES, of course, can sustain the extra load, because their shares ment discussed here can be instrumental in getting rid of just are traded on the exchange. But the burden may turn out to be one problem: the problem of blackmail. But that is only the crippling for small companies, former state-owned factories first step. producing candles, or small restaurants which became joint stock companies in the process of privatization. For them, Viktor Pleskachevsky is chairman of the Russian State being a joint stock company is unnatural: they have a score of Duma's property committee and one of the authors of the shareholders and they are not going to offer their shares on the "Squeeze-out" law. He contributed this comment to the markets. So, they will have to reorganize themselves as non- Transition Newsletter. 20 · Transition The Newsletter About Reforming Economies From Research to Policy Challenges for Transition Economies, Challenges for the World Bank Johannes Linn T he Europe and Central Asia region has experienced Disintegration in South-East Europe was more violent and unprecedented challenges since the dissolution of the catastrophic than in the Soviet Union. Peace agreements and Soviet Union in December 1991. This vast region of 28 reconstruction in Bosnia and Herzegovina, Kosovo, and countries and 500 million people faced a triple transition: Serbia-Montenegro, as well as progressive, albeit still incom- moving from centrally planned to market economies, from plete economic reforms, have opened prospects for European integrated to fragmented economic space, and from com Union accession. Albania has been the greatest miracle of the munism to democracy. region: its per capita income is now three times what it was in 1992. This could only occur due to the country's openness and The economic development of all countries in the region integration with rest of Europe. The biggest challenges for the has followed the same trend since 1990: economic collapse, region are a peaceful resolution of the Kosovo conflict, nor- followed by a rapid recovery, as a result of which the transition malization of national and regional politics, and continued economies of Europe and Central Asia have now become one progress towards EU integration, with a particular emphasis of the most dynamic regions of the world. However, there are on governance and the investment climate. important differences among countries. In Central Europe and Although not a post-communist state, Turkey has had its the Baltics the recession was relatively shallow and short: GDP own transition path of a kind: its uneven economic develop- fell to 85% of the 1990 level and the recovery had begun by ment in the 1990s led to the financial crises of 2000-2002. 1993. In the CIS countries the recession was deep and long, Since then it embarked on several vital economic and political bottoming out in 1996 at less than 60% of 1990 GDP. reforms, with privatization, banking and public sector reform, Fortunately, since 1999 these countries have experienced rapid and tight monetary and fiscal policies topping the agenda. and sustained growth. Improved political and macroeconomic stability have already The differences in economic performance, as well as the supported significant economic recovery over the last two problems and challenges they now face, have been increasing years and greatly enhanced economic prospects, including the over time. Four distinct sub-regions have emerged: the Central possibility of an imminent start to EU accession negotiations. European countries and the Baltics, South-East Europe, The country's biggest challenge in the near term is to maintain Turkey, and the CIS. macroeconomic stability, improve the institutional environ- ment and investment climate, and deal with regional imbal- Sub-regional Trends and Challenges ances. Over the longer term, Turkey risks being derailed on the way to EU membership or being negatively affected by politi- Central European countries and the Baltics had a quick cal instability in the Middle East. turn-around and an extraordinary progress of integration with The collapse of the Soviet Union, with the accompanying and into the EU. The Baltics present perhaps the biggest and breakdown of essential economic links, wrought tremendous the most astonishing success story. Despite having been part of economic and psychological costs of disintegration in all CIS the Soviet Union for decades, they were able to pursue deep countries. The reform process in this region has generally been and pervasive market reforms. As a result, they were able to slow, and the countries have had difficulties to reintegrate, integrate along with their Central European neighbors into the although on both fronts there have recently been positive signs. EU fewer than 15 years after the breakup of the Soviet Union. The three biggest countries, Kazakhstan, Russia and Ukraine, For all of the new EU members, the biggest challenge now is are recovering rapidly at this point. Ukraine in particular is an how to become the next Finland or Ireland rather than the next unusual economic success story, thanks to the cumulative Eastern Germany -- i.e., how to become flexible, dynamic and impact of reforms and the rapid growth of trade, both with the efficient knowledge societies. In order to do this, they need to CIS and the EU. The poorer CIS countries of Central Asia and deal with excessive labor market regulation, address corrup- the South Caucasus have not fared as well and are still facing tion and governance weaknesses, and further improve the some serious problems, such as a lack of access to the world investment climate. They need to tackle fiscal deficits and find economy, high debt burdens, and poverty. Belarus and solutions for their unsustainable social security and pension Turkmenistan are unique in having failed to implement mean- systems, as these countries face rapidly ageing populations. ingful market reforms and seem to be stuck in a time warp. The These problems very much resemble those that many Western CIS region's biggest challenge is to make progress in its politi- European countries now face. cal transition. The absence of democratic governance will The World Bank · 21 likely prevent institutional and governance reforms, inhibit the Challenges for the World Bank in the Region rebuilding of social infrastructure and the improvement of the investment climate, and limit regional cooperation and integra- The challenges the Bank faces in Europe and Central Asia tion with rest of the world. In the short and medium term the are a microcosm of the Bank's challenges worldwide: economic outlook for these countries is quite positive, although 1. In the middle-income countries the Bank needs to find longer-term prospects look less optimistic. constructive ways to stay engaged not only with advisory work, but also in lending, as this will be key to its survival as a global The World Bank's Ups and Downs in the Region development finance institution. The Bank needs to become more client-oriented, offer lower-cost financial opportunities, Apart from the fact that the Bank can be pleased with the and be more flexible and willing to work at a sector-wide level economic recovery and overall progress that can now be through broad-gauged programmatic loans (as distinct from observed in the transition economies of Europe and Central narrowly focused loans for specific investment projects). Asia, there are quite a few specific success stories: For example, 2. In the low-income countries, the Bank has a broadly the Bank was deeply engaged in supporting the successful eco- good approach, with its support for Poverty Reduction nomic reforms Central Europe undertook on its way to EU Strategies aimed at meeting the Millennium Development accession. In the Balkans, especially in Bosnia and Goals. But the key challenge will be to work more closely with Herzegovina, the Bank supported a lasting peace and post-con- governments, civil society and other donors for maximum flict reconstruction process in a productive partnership with effectiveness, broad-gauged ownership of aid-financed pro- the European Union. We supported intensively the recovery of grams in the country, and harmonized donor assistance as a Albania, including some very successful community participa- way to minimize the procedural burdens on recipient countries. tion projects. The Bank was also instrumental with post-con- 3. For countries that fail to carry out basic market-oriented flict support programs in Tajikistan, helping that country move reforms, the big challenge is to find the right intervention point. from civil war destruction to sustained recovery. Intense nego- The Bank should focus on working with NGOs, local commu- tiations and the implementation of a large structural loan for nities, mid-level government units, and young people, as it has Russia helped prevent backsliding on market-oriented reforms done in Belarus. It should not push lending, but maintain a lim- under a communist-leaning government following the financial ited relationship and dialogue with government where possible. crisis of 1998. In Turkey, adjustment and investment lending This commitment requires patience, realistic thinking and and analytical work helped the country out of its financial cri- planning for the long haul. sis just a few years ago. However, there were also cases where we made mistakes. In Johannes Linn is currently a visiting fellow in economic the poorer CIS countries the Bank was overly optimistic and studies at the Brookings Institution. From 1996 to 2003, he did not recognize the depth of the economic impact of disinte- was vice president of the World Bank's Europe and Central gration. In some countries, such as Belarus, Turkmenistan, Asia Region. The article is based on the author's presentation Uzbekistan, Bulgaria and Romania, the Bank has not been as of his recently published collection of addresses and speeches influential as it would like to have been. The loans-for-shares "Transition Years: Reflections on Economic Reform and Social privatization program in Russia during 1995-1996 was a seri- Change in Europe and Central Asia" at the World Bank. ous mistake, which the Bank should have opposed, although it clearly didn't have enough leverage at the time to change the outcome. In the case of Albania, we were late in recognizing the dangers posed by the Albania pyramid scheme, which led to a severe crisis in 1997. More generally, the Bank was not very well prepared for the financial crises that occurred in Bulgaria, Russia and Turkey. Again, the point isn't that the Bank could have prevented the crises from occurring, but a more explicit con- sideration of the difficult balance between trying to prevent a crisis versus allowing it to happen should be part of the deci- sion process in the Bank at an early stage as financial stress appears. Finally, we have learned three important lessons over the years: First, the Bank must address corruption as a serious development issue everywhere, especially in the transition countries. Second, there is frequently a need for a broader regional perspective, rather than a narrow country focus. Third, the Bank should do more to analyze the political context and identify the winners and losers from the reforms that it rec- Each region has its own path ommends to its clients. 22 · Transition-- The Newsletter About Reforming Economies Progress in Transition and the Link to Growth Alan Rousso T he EBRD's 2004 Transition Report records a surge in There is broad agreement in the literature that initial con- reform in a handful of countries (mainly those in the ditions, especially in the first years of transition, are important, waiting room of the European Union), a slowdown in and that the early adoption of sound macroeconomic policies the pace of reform in the advanced transition countries, and is good for growth. The area that has generated the most modest progress in a handful of CIS countries. debate so far is the influence of reforms on growth. Most of the early studies argued that reforms are beneficial for growth. A This geographic pattern of reform has been consistent over common finding was that an increase in a reform indicator has the past several years: a negative effect on growth at first but after a year has a posi- · Starting from a relatively low base, the transition tive influence that outweighs the initial decline (de Melo et al., process in south-eastern Europe (SEE) is continuing to gather 2001; Merlevede, 2003). Several papers concluded that the ini- pace, and the region is catching up with its neighbours in tial-phase "liberalizing" measures have a larger impact on Central-Eastern Europe and the Baltic states (CEB). The growth than measures to improve the institutional environ- prospect of accession to the European Union, which has ment (Fischer and Sahay, 2000; Havrylyshyn and van Rooden, already accelerated transition in CEB, is now speeding up 2003). One reason for this result is that institutional reforms progress in the accession candidates of Bulgaria, Croatia and are harder to carry out. They also bring long-term benefits that Romania. Progress in the western Balkans has been more may not have been visible in the short time-span available for modest, and Bosnia and Herzegovina and Serbia and analysis. Montenegro continue to lag behind. However, a number of recent papers cast doubt on the · In the CEB countries there remains considerable room benefits of reform. Although the positive effect of reforms can for improvement in institutional reform. There have been some be detected in the early period of transition, it tends to disap- developments in this area, but the formal accession of CEB pear in later stages (Fidrmuc, 2003; Lawson and Wang, 2004; countries to the EU in May 2004 may have reduced the incen- Lysenko, 2002). This reflects the fact that there has been a tive for reform and contributed to a second year of limited marked acceleration in growth in some of the less-reform progress, as measured by the EBRD's transition indicators. minded countries in the last four or five years, in parallel with · As a group, the CIS countries had another moderate a slowdown in the most advanced part of the region. year, with only the Kyrgyz Republic making noticeable It is possible, however, that previous studies failed to take progress. The reform process in this region has for a number of sufficient account of other relevant factors leading to growth. years shown signs of stalling. A particularly active -- and in Once they are included in the equation, the benefits of reforms some cases turbulent -- year of political transition may have may become apparent again. Three additional variables can be contributed to this. considered: Reforms and Growth During Transition -- What is the · The potential for countries that suffered the deepest Link? recessions to rebound more quickly; · Changes in terms of trade, particularly in relation to This modest progress in reform in the CIS countries comes oil prices, and dependence on oil imports or exports; and against the background of strong growth in the region since · The impact of external growth, by weighting the real 1999. At the other end of the reform spectrum, several new EU GDP growth rate in their main trading partner countries by members have seen a significant slowdown in growth in recent export shares. years. It has become increasingly clear that the link between reforms and growth in transition economies is more complex Additional Relevant Factors than many policy-makers and analysts had originally thought. Does reform lead to growth? If so, to what extent and at what Many transition countries have experienced severe falls in speed? Pro-reform governments may need reassurance that the output over the past decade. In general, the further the decline, long-term benefits of transition are sufficient to make any the greater has been the potential for a period of rapid growth short-term pain worthwhile. once recovery has started. For most countries that had long, Three broad factors may explain improvements in macro- deep recessions, average annual growth rates in the recovery economic performance and the fact that some countries are phase were in the range of 6--8% and even higher. For those growing faster than others. These are: initial conditions, countries that had relatively mild recessions, subsequent including the extent of inherited structural and macroeconom- growth was generally more modest. ic distortions; the implementation of appropriate monetary A second factor affecting growth in some countries, espe- and fiscal stabilization policies, resulting in lower inflation and cially in recent years, has been the surge in commodity prices, sustainable fiscal deficits; and progress in market-oriented and in particular the price of oil. This factor is especially reforms. important in the CIS, where several countries are oil-rich and The World Bank· 23 others can benefit directly and indirectly through trade and effect, especially when cumulated over several years. Thus, a other linkages. sustained commitment to reforms brings substantial benefits The third factor likely to influence growth in transition over the long term. countries, which have become increasingly integrated into the The results also throw some light on the causes of reform. world economy, is the economic performance of their main Two points are worth noting. First, civil liberties and reforms trading partners. If the main trading partners have buoyant are strongly linked. Countries that enjoy more freedom -- that economies, this can bring large benefits. However, if external is, those with a lower index of civil liberties -- have recorded demand is temporarily weak, this can lead to a short-term higher average growth. Secondly, growth has a positive effect slow-down in transition economies and a worsening in their on the level of reforms in the same period. This suggests that terms of trade. The prolonged period of modest growth in the countries may become locked into a "virtuous circle" -- an EU--15 (the 15 member countries before the latest accessions increase in growth has an immediate positive effect on reforms, in May 2004) in recent years has probably had an adverse which in turn benefit growth in the following period, with fur- effect on some of the new EU members, many of which con- ther knock-on effects on reform and so on. However, countries duct more than half of their trade with the EU--15. In con- should not take it for granted that once they enter this positive trast, the recent boom in Russia has had positive spillover spiral they will remain there. effects for a number of other CIS countries. If these three factors are incorporated in an econometric This article is based on the EBRD's 2004 Transition Report, analysis (Falcetti et al., 2004), the results show that reforms published in November, 2004. The assessments of progress in have a strong, positive effect on growth rates, with a one-year transition are made by the economists in the Bank's Office of time lag. Ceteris paribus, an increase in the EBRD reform index the Chief Economist. The section on reforms and growth was by 0.1 would raise the growth rate the following year (and written by Peter Sanfey, Elisabetta Falcetti and Tatiana Lysenko. each subsequent year if the new level of the reform index is Alan Rousso is a senior political counselor with the EBRD. maintained) by between 0.3% and 0.7%. This is not a trivial Economic Prospects 2005: Eastern Europe & Central Asia Regional trade arrangements helped Eastern Europe enues, while the accession of several of the region's coun- grow. With EU assistance, and with the aspiration of both tries to the EU provided a further boost to investment EU and WTO membership, Eastern European countries demand and FDI. have moved swiftly toward integration. The CIS has been Real GDP in Europe and Central Asia is expected to burdened with incomplete reforms and a poor investment increase by 7% in 2004, up from 5.9% in 2003, and out- climate that have weighed down the region's performance. stripping the 2000 peak of 6.7%. Regional growth is fore- The plethora of trading arrangements have been imple- cast to moderate over the near-term, with output rising by mented only partially and fallen short of realizing trade 5.6% and 5% in 2005 and 2006, respectively. In the next potential. Under the CIS--7 initiative, trade regimes have ten years, Eastern European and Central Asian growth is been generally liberalized, but have been limited by forecasted to average 3.5%. regional trade and transit barriers. Domestic consumption and investment in Russia and Source: WDR 2005, Global Economic Prospects 2005 at other CIS oil exporters were boosted by a surge in oil rev- http://siteresources.worldbank.org/INTGEP2005/Resources/ ECAHighlightsENG.pdf. 24 · Transition-- The Newsletter About Reforming Economies Infrastructure in Transition: Regulation and Private Sector Participation Alan Rousso E fficient and accessible infrastructure services help to regulatory functions mostly still lie with the relevant govern- promote economic growth and to alleviate poverty. ment ministry, with the exception of only a few countries, such There is general support for this argument but less evi as Estonia and Poland. Water and sewerage tend to be regulat- dence on how this should be achieved in practice. Policy ed by municipalities. Romania is the only transition country makers around the world continue to debate the best means that has established a national water regulator so far. of promoting infrastructure restructuring and investment. How new regulatory institutions actually function relative Nevertheless, there is broad agreement that creating and to established benchmarks can be assessed using the results of a implementing an effective regulatory regime is an important new EBRD survey of regulators in the electricity, railways and first step, essential to commercializing infrastructure and telecommunications sectors implemented in summer 2004. attracting private investment. There are six key characteristics of an effective regulatory system: coherence, predictability, capacity, independence, The transition countries face, to varying degrees, significant accountability and transparency (Noll, 2001; Stern et al., 1999). infrastructure challenges, including: tariffs that do not reflect The first three criteria depend on each country's wider legal and costs, with extensive cross-subsidization between different types institutional framework and are general prerequisites for an of services and different consumer groups; poor revenue collec- effective regulatory system. The other three criteria are more tion; as well as insufficient separation between operating and sector-specific.The EBRD survey provides an indicative ranking regulatory functions and between natural monopoly elements of these attributes, allowing for cross-country comparison. and areas that may be opened to competition. The main issue Chart 1 summarizes the findings for the electricity sector. for transition countries is to maintain and upgrade service net- Regulatory independence concerns the relationship between works -- which are often too extensive for current needs and in regulatory agencies and the government. The results of the sur- a poor state of repair -- rather than extend networks, as is the vey suggest that government interference continues to under- case in developing countries. Transition countries also need to mine regulatory independence in many transition countries. develop rules and regulations to encourage efficient, cost-effec- Accountability ensures that regulators enforce rules fairly tive, environmentally sustainable and affordable services. while protecting the legal rights and economic interests of the state, operators and users. It is facilitated by requirements such Regulation is in Its infancy as the publication of annual reports by the regulatory agency. The survey provided information on which regulatory agencies In most countries, new laws and regulators have been intro- must publish an annual report and how many annual reports duced for telecommunications and electricity. For railways, the have been published to date. Transparency involves the right of stakehold- ers to be informed about decisions affecting them Chart 1. Regulatory Quality in Selected Transition Countries, and also relates to the scope for corruption and Electricity Sector secretive decision-making. One way of judging the extent of transparency is the frequency with which existing regulatory decisions, rules and policies are published (also electronically). Regulatory quality tends to be higher in coun- tries where the rule of law is observed, bureau- cratic corruption is brought under control, property rights are protected and the media are relatively free (Levy and Spiller, 1994). Recent studies also show that investment in the telecom- munications and electricity sectors tends to be greater in countries with political institutions that constrain arbitrary behaviour by political actors (Henisz, 2002; Henisz and Zellner, 2001). Given the high costs and long-term commitment involved, investors in infrastructure utilities want assurances against administrative expropriation and legal recourse in case it occurs. The World Bank · 25 Throughout the region, progress in infrastruc- ture reform has been hindered by a lack of effi- Chart 2. Private Sector Participation by Sector cient regulatory institutions, and by vested inter- ests seeking to protect their positions of strength. This is particularly evident in the area of tariff reform, where well-connected interest groups have often succeeded in blocking tariff adjust- ments. There are justifiable concerns about the impact of tariff reform on poor consumers, who may not be able to afford steep price rises. However, there are a number of ways to address these concerns, such as "lifeline" tariffs that allow a certain level of services to be provided free of charge. Infrastructure reform may be difficult, but it is not impossible. Private Sector Participation is Not a Panacea Transition countries have sought private sec- tor assistance both in financing the upgrade and maintenance of infrastructure services and in improving the management of networks. Notable successes have been achieved, particularly in reducing losses and improv- What Has PSP Achieved? ing the collection of payments. There have also been some high- profile failures. With hindsight, we know that expectations Systematic evidence on the relative performance of private- about the potential impact of private sector participation (PSP) ly controlled utilities in transition countries is limited, due to a were probably unrealistically high. lack of data. However, there is some anecdotal evidence of util- Why do governments seek private sector participation in ities increasing productivity substantially, after being trans- infrastructure? The most obvious financial motive for privatiz- ferred to a private operator. A distinctive feature of PSP in ing infrastructure services is that it enables governments to raise telecommunications has been the effective implementation of funds from the sale of utilities' assets or from payments for con- new technologies, such as digital switching and mobile phones, cessions or leases. The total proceeds from infrastructure priva- which offer the prospect of improvements in productivity and tizations from 1992 to 2003 amounted to about $40 billion, at quality of service. Additional evidence from the electricity sec- 2000 prices. Although infrastructure privatization has raised tor suggests that the entry of private companies has tended to large sums in absolute terms, it financed just over 8% of the reduce overall distribution losses (by an average of 1.9 percent- region's cumulative fiscal deficit between 1990 and 2002. age points). Perhaps surprisingly, this is not a substantial contribution to the As lessons from past projects are absorbed, the shape of pri- total financing needs of governments in the region. vate sector participation is changing. Increasingly, the private Aside from financing, it has been argued that private man- sector is invited to provide management skills rather than to agers seeking to maximize profits (frequently backed by addi- finance capital investment. This makes the arrangements less tional equity resources) are generally better placed to improve risky for both partners but no less difficult to structure. Short- labor productivity, optimize asset management and provide bet- term and often speculative investors have gradually been ter services to the local population. replaced by companies interested in longer-term strategic involvement in the region. Another important trend is the emer- Where is the Private Sector Most Active? gence of local companies, ranging from "national champions" in sectors requiring high capital outlays to small, dynamic com- According to EBRD's assessments, PSP is most advanced in panies active in municipal and regional markets. the telecommunications sector (mobile telephony), followed by urban transport (mini buses) and, to a lesser extent, the elec- This article is based on from the EBRD's 2004 Transition tricity sector (see Chart 2). As far as regions are concerned, PSP Report. The authors of the section on regulation are Alex is most present in CEB countries and the EU candidate coun- Chirmiciu, Alan Rousso, Jon Stern and Maria Vagliasindi. The tries of south-eastern Europe (SEE). Among the CIS countries, authors of the section on private sector participation are only Armenia, Georgia, Kazakhstan and Russia have notewor- Gordon Hughes, Zbigniew Kominek,Andre Meier and Toshiaki thy levels of PSP. In other CIS countries, PSP remains largely Sakatsume. Alan Rousso is a senior political counselor with the confined to mobile telecommunications and urban transport. EBRD. 26 · Transition-- The Newsletter About Reforming Economies Russian Rail Restructuring: Some Steps Taken, Some Remaining Russell Pittman L ast year the Russian railways began implementing an integrated train companies to operate on the RZhD infrastruc- ambitious three part restructuring plan that is not ture under non-discriminatory access terms. scheduled to be completed before at least 2010. The Some reformers have argued for a complete "vertical sepa- three parts of the plan correspond roughly to the three ration", in which RZhD would continue to control the rail principal steps that liberal reformers typically urge for the infrastructure but would not be permitted to operate its own traditional infrastructure monopolies in developing coun trains. The advantage of this model over vertical access is that tries: separation of operations from regulatory functions, the infrastructure operator would have no incentive to dis- elimination of cross subsidization, and the introduction of criminate against the independent train companies in terms of competition where economically feasible. As always, the access price, service quality, and so on. Proponents of this alter- devil is in the details, and, despite significant achievements native frequently cite the fact that the job of insuring nondis- so far, many questions remain to be answered. criminatory behavior by the integrated RZhD will be the The first step has been taken: the old, monolithic Ministry responsibility of traditionally weak Russian antimonopoly of Railways has spun off the new operating entity, the Russian authorities. Railways Company (RZhD). RZhD remains state-owned. RZhD counters such reasoning with the equally persuasive Nonetheless, it has already entered bond markets in a big argument that vertical separation comes at a cost of lost way, aided by a BB+ rating from Standard & Poor's -- no economies of vertical operation, most conspicuously regarding other Russian enterprise enjoys a higher rating. In addition, train coordination and safety. Even if the problems experienced the investment-starved railway system has seen a large infu- following vertical separation of the rail sector in the UK are not sion of private capital, in the form of privately owned rolling demonstrative evidence -- some would argue that the problem stock. in the UK was the manner of separation, rather than separation This first step, however crucial, is still only a first step: the itself -- they still provide a cautionary tale for a country like result is a more transparent and better equipped monopoly, but Russia, whose economy depends so heavily on its freight rail- RZhD remains a monopoly. The next two stages may be more way sector. difficult, as each will face important opponents. The RZhD reform plan also refers to the possibility of a The principal goal of the second phase of the reforms is to completely different model for creating rail-on-rail competition end the subsidization of passenger services by freight services. in the third stage of reforms: by creating vertically integrated In part, this is a standard good-government measure: if the rail franchises that would compete with each other both over government (and especially regional and local governments) parallel routes and for shipping commodities to and from par- want their citizens to travel by rail at a price below cost, ticular locations. This rail reform model, which has been used arguably they should pay for that. But it is also a matter of successfully in Argentina, Mexico and, to a lesser extent, Brazil, financial health for RZhD: the experience of other countries, avoids the close day-to-day access regulation required by the including the US, demonstrates quite clearly that if a freight vertical access model and the complete vertical dismemberment railway is forced to subsidize passenger services, it is in dan- of the vertical separation model. ger of losing much of its profitable freight traffic to competi- One reason for the great uncertainty surrounding this third tors who do not have to pay such subsidies, especially motor stage of reforms is that it is not clear yet what agency or organ- carriers. ization will be pushing for it. It is not in RZhD's interest to cre- Whether the coalition of RZhD executives and economic ate effective competition for its monopoly. The Ministry of reformers is strong enough to move these subsidization costs Economic Development and Trade, the Federal Antimonopoly from freight traffic to government budgets is not clear yet, but Service, the new rail rate regulator -- each of these faces for- at least RZhD has incentives to try to make it happen. midable opponents as they seek to create a truly competitive The outcome of the third stage of reform, in which compe- railway sector in the Russia of tomorrow. tition is to be created on the railways, is much less certain. Indeed, even the concept of competition is not clear yet, and Russell Pittman is director of economic research and direc- RZhD has no incentive to hurry the process along. tor of international technical assistance in the Economic In principle, RZhD is committed to a "vertical access" Analysis Group, Antitrust Division, U.S. Department of model for the creation of competition: RZhD would remain Justice, as well as a visiting professor at the New Economic vertically integrated, controlling the infrastructure as well as School, Moscow. The views expressed are his own. operating trains, but it would allow independent, non- The World Bank· 27 World Development Report 2005: Findings and Implications for the Europe and Central Asia Region Pradeep Mitra I. Reducing policy-related risks and costs for businesses, addressing the most important constraints, and by sustaining a closing the gap between policy declarations and implementa- process of ongoing improvements. For example, much progress tion, and focusing on delivering the basics -- these are some of has been made since the start of transition in countries of the the measures that can help create a better investment climate World Bank's Europe and Central Asia (ECA) region, which for everyone. includes all the transition economies of Eastern Europe and the former Soviet Union, as well as Turkey, although progress is This World Development Report is about creating a cli- variable across and within countries. Slovakia headed the list mate in which firms and entrepreneurs of all types have oppor- of reformers in 2003 and Lithuania was in the top six. tunities and incentives to invest productively, create jobs, and Moreover, the ECA region as a whole matched the high- expand, thereby contributing to growth and poverty reduction. income OECD countries in investment climate reforms, with Drawing on new research, including surveys of more than two to five times the number of reforms in other regions. 26,000 firms in 53 developing and transition countries, and the Lithuania and Slovakia rank immediately after the high- Doing Business Project, which benchmarks regulatory regimes income OECD countries in the top 20 in terms of ease of doing in more than 130 developing and developed countries, the business in 2003. Latvia is among the fastest countries in Report looks at what governments can do to create better which to register a firm, and displayed among the largest con- investment climates for their societies. tributions to productivity from net entry, exceeding most First, an investment climate that is better not only for firms OECD countries on both scores. but for society as a whole requires taxation and well-designed regulation (including removing still pervasive barriers to com- II. The ECA region is ahead of most developing countries petition); good governance; secure property rights; the provi- but requires more reforms to rival high-income OECD coun- sion of infrastructure; and functioning financial and labor tries. markets. Business costs, including weak contract enforcement and onerous regulation, can amount to more than 25% of Reflecting reforms over the last decade, the investment cli- sales -- or more than three times what firms typically pay in mate in the ECA region has moved from the back of the pack taxes. Unreliable electricity supply and other infrastructure, to just behind the high-income OECD countries, with the crime, and corruption can impose costs that are more than notable exception of labor market regulations (see the table). double those of regulation. The costs of crime exceed 10% of However, various aspects of the business climate still require sales in Armenia and Azerbaijan. substantial reform across the region to catch up. For example, Second, governments need to reduce the policy-related and Slovenia and Poland are among the slowest to enforce a con- macroeconomic risks that are perceived as the top constraint tract, requiring an average of about 1,000 days, while costs as on business in 28% and 23%, respectively, of the countries sur- a percent of debt to be recovered are almost three times high- veyed. The report shows that stronger competitive pressure, er than in the high-income OECD countries, although admit- which can be promoted by trade liberalization, can boost the tedly less than half the cost in other developing regions probability of innovation by more than 50%. Yet, unjustified (excluding the Middle East and North Africa). and highly variable regulatory barriers that add to uncertainty Equally, in some dimensions various ECA countries com- are pervasive, and consistent and effective efforts to curb anti- pare unfavorably to developing countries from other regions. competitive behavior by firms remain weak in most developing For example, in Ukraine and Albania, 44% and 55% respec- countries. tively of firms report that senior management spends more Third, gaps between policies and their implementation can than 10% of their time dealing with government regulations, be huge according to close to 90% of the firms surveyed. As a worse than Brazil and Cambodia and close to the 49%--61% result, informal economies are often large, reaching 75% of of firms with similar complaints in Kenya, Tanzania, Ecuador GDP in Georgia and accounting for almost half of GDP in and India. Russia. Governments need to tackle corruption and other Reforms directly impact performance. As a percent of forms of rent-seeking, to build credibility with firms, to foster sales, business costs tend to be lower in those ECA countries public trust and legitimacy, and to ensure that their policy where reform is more advanced. For example, in Poland these interventions are crafted to fit local conditions. costs are well below 10% of sales, compared to almost 15% Finally, everything does not have to be done at once, nor is to more than 25% in China, Brazil, Algeria and Tanzania. perfection required. Impressive results can be achieved by Similarly, close to three quarters of firms in Poland, Hungary, 28 · Transition The Newsletter About Reforming Economies Rank of various regions according to selected business environment indicators Entry: Cost of Protecting Cost of Enforcing Legal Property Registration Rigidity of Exit: Recovery startup as percent Investors- Contracts: Rights Cost (% of property Employment Rate (cents on of GNI per capita Disclosure Index Percentage of debt Index per capita) Index the dollar) OECD: High income 1 1 1 1 3 2 1 Europe & Central Asia 2 2 2 2 1 4 2 East Asia & Pacific 4 4 7 2 2 1 3 Middle East & North Africa 5 4 3 5 6 3 4 South Asia 3 6 5 5 5 5 6 Latin America & Caribbean 6 3 4 7 4 6 5 Sub-Saharan Africa 7 7 6 4 7 7 7 Source: Staff calculations from data in Doing Business in 2005 database at http://rru.worldbank.org/DoingBusiness/ExploreTopics/HiringFiringWorkers/CompareAll.aspx?direction=asc&sort=4 Slovakia and Tajikistan report facing significant competitive other regions (half to three quarters of firms pay 3%--7% of pressures, while the proportion is about 40% in Georgia. At sales). Lithuania has been at the forefront of efforts to combat the same time, even in a new EU member state such as corruption, with the creation in 1997 of a Special Investigation Estonia, almost 50% of firms complain about regulatory pre- Service that reports to the president and parliament. dictability, while three quarters of Russian firms find the interpretation of regulations to be unpredictable -- a higher III.The way forward ... with continued international support. proportion than in Indonesia, Pakistan or even Zambia (60%--70% of firms). Most ECA countries are well positioned to build on the suc- Investment also responds directly to improvements in the cesses of transition and tackle the remaining policy and insti- business climate. Firms in Poland, Romania, Russia, Slovakia, tutional challenges. Slower reformers can accelerate their and Ukraine that believe their property rights are secure rein- efforts and gain ground by emulating best practices learned vest between 14% and 40% more of their profits in their busi- from their neighbors. Faster reformers can adopt best practices nesses than those that don't share that belief. At the same time, from high-income OECD countries. The Report calls on the firms in many countries lack confidence in the courts to uphold international community to assist this process by: property rights. For example, in Moldova close to three quar- · Removing trade restrictions, subsidies and other mar- ters of firms have doubts in this area, and even in the Czech ket distortions in developed countries that harm the investment Republic barely half have faith in the courts, a lower figure climate in developing countries. This can deliver benefits to than the 60% in Brazil or 80% in Malaysia. developing countries worth more than four times the value of For the ECA region as a whole, access to finance is not a investment-related aid they receive; major problem, with complaints from only 10% of firms (com- · Providing more, and more effective, assistance to help pared to 25%--65% of firms in other regions), reflecting the governments improve their investment climates. Technical opening of the financial market to foreign investment and inte- assistance on the design and implementation of policy improve- gration into the world economy. Infrastructure is more prob- ments can be especially potent, but currently receives fewer lematic, with close to a quarter of firms in the ECA region resources than direct support for individual firms and transac- reporting serious obstacles in this area. However, here again tions; ECA does better than all the other regions (30%--55% of · Helping to tackle the huge knowledge agenda on firms complain) except for East Asia and the Pacific, with less investment climate issues, to provide more guidance to policy- than 20% complaining. makers on the design and implementation of policy improve- Labor regulations remain a problem in many ECA countries, ments. with more firms concerned about this in Poland than in the Philippines, Kenya, Pakistan and Algeria. Similarly, although Pradeep Mitra is Chief Economist for the Europe & Central 43% of firms in Central and Eastern Europe report paying Asia Region at the World Bank, Washington, DC. He con- bribes that average 2.8% of sales, both figures are lower than in tributed this article to the Transition Newsletter. The World Bank· 29 How Slovakia Transformed Itself from a "Black Hole" to an Investor's Paradise Olga Gyarfasova S lovakia has done more than any other country to several important reforms, such as in civil service. Economic improve its business environment in the past year. The reforms came to the fore after the 2002 elections. The fact that World Bank "Doing Business 2005" report lists Slovakia coalition partners in the center-right government under Prime as one of the 20 most business friendly of the 53 developing Minister Mikulas Dzurinda had a common stance on key countries surveyed. Cumulatively, reforms conducted over social and economic issues certainly played a big role. In devel- the past two years could add 2.5 percentage points to the oping economic and social policies, the government could rely Slovak economy's annual growth. The Washington Times on intellectual capital amassed in think tanks, nongovernmen- called the new Slovak tax system "one of the best systems in tal organizations, and newspapers, all home to a reform-mind- the world", and many analysts, politicians, and businesspeo ed intellectual elite. The government also exploited a shift in ple compare Slovakia to Hong Kong and Ireland in terms of public opinion towards free-market principles and away from economic performance and the investment climate. socialist views. As a result, the reforms were all based on neo- A Model of Economic Reform liberal ideas and supply-side economics. Some of the major reforms implemented in the past two Reforms Unloved, but Largely Unchallenged years include: · Tax reform was guided by key objectives: simplicity, Although support for the coalition has been quite weak, the neutrality, and efficiency. Progressive income taxation and two reforms were helped by a certain degree of apathy among vot- different VAT rates were replaced by a single flat income tax of ers and the lack of serious political opponents. The left-wing 19% and a single VAT rate. Many loopholes were closed in opposition, along with some trade unions, tried to block the order to end de facto subsidies to certain sectors, and a whole reforms by initiating a referendum that would have led to early series of taxes were completely eradicated, such as the inheri- elections. They won the referendum, but because of the low tance tax, a tax on gifts, the real-estate transfer tax, and the div- turnout (36%, with at least 50% needed) the results were idend tax, a move particularly appreciated by foreign investors. annuled. · Labor laws were tightened to motivate the unem- The greatest threat to the reforms lies not with political ployed to seek work and adjusted to reduce the black econo- opposition or public disapproval, but with relations within the my. The unemployment rate is now slowly declining. coalition itself. So far, the coalition has been held together by · The pension system reform replaced the old system, in the ambitious reform program and, despite now being a which workers pay the pensions of retirees, with a new "three- minority government, looks likely to remain in office until pillar" system, which combined the pay-as-you-go model with 2006. Because no single party emerged a clear winner in the obligatory personal pension accounts administered by private recent elections, the need for coalitions will remain in the companies, as well as voluntary private accounts, in which future. Some of the present coalition members will necessarily people may put additional pension savings.The pension system feature in future governments, which will make it harder to is now rated among the most progressive in Europe. reverse the reforms. · Health-care reform, which was passed by parliament Thus, forecasters anticipate steady economic growth and very recently, requires that patients partly cover the costs of strict fiscal discipline as Slovakia prepares to adopt the euro. many medicines and non-essential medical services. Health- Tax reform should boost foreign direct investment, new labor insurance companies will compete on an open market, and laws should reduce unemployment, while political decentrali- state-owned insurers will be transformed into joint-stock com- zation should encourage regional growth and stabilize democ- panies, potentially opening the door to private investors. racy. Despite this optimistic scenario, Slovakia faces urgent These achievements are especially remarkable considering problems, such as deep regional disparities, widespread cor- that for years after Czechoslovakia split up in 1993, Slovakia ruption, and the need to better integrate the Roma minority. lagged far behind its Visegrad neighbors. It was ruled by a The American businessman Steve Forbes, owner of the coalition of nationalists, post-communists and other authori- influential Forbes magazine, believes Slovakia could be "the tarians under Prime Minister Meciar and lacked any signifi- domino that pushes the rest of the EU, particularly 'Old cant political debate. State assets were literally given away to Europe' nations Germany and France, toward a more free- Meciar's "domestic capital-producing class", and economic enterprise, entrepreneurial era." reform was not even discussed. How has the country managed this drastic change? The piece is based on the article "From Black Hole to While the focus of the coalition government formed after Leading Light" published in "Transitions Online" (TOL), the 1998 elections was largely on restoring democratic princi- http://www.tol.cz, on October 6, 2004. The author is an ana- ples rather than on structural transformation, it implemented lyst at the Institute for Public Affairs in Bratislava. 30 · Transition The Newsletter About Reforming Economies Czech Bankruptcy Reform: A Light at the End of the Tunnel? Ondrej Vychodil, Ondrej Knot O nly three countries of the 141 in the World Bank's would improve the situation, it does not address some other Closing Business 2004 database -- India, Brazil and problems, such as a bias towards liquidating a bankrupt firm Chad -- have bankruptcy procedures that take longer due to excessively strict conditions for the non-liquidation solu- than those in the Czech Republic. The average bankruptcy in tion, late initiation, and the duration of bankruptcy procedures. the Republic takes more than nine years to complete, The first draft of the law presented in the spring of 2004 compared to an average of 21 months for the 'old' EU. Such was heavily criticized from various sides. First, as in the current lengthy procedures, combined with weak protection for law, bankruptcy was again viewed mainly as a legal issue, and creditors, allow managers to tunnel out the value from not one of management of an insolvent company. Second, insolvent firms. drawing on U.S. legislation, the chapter on reorganization sig- The effects of inefficient legislation on the Czech capital nificantly increased the authority and discretion of judges, who market are such that banks -- already risk averse and facing were given the sole power to prevent the debtor from harming harder budget constraints after privatization -- are doubly creditors. The case of Union Banka has shown, however, that, reluctant to lend to firms. unlike in the U.S., the Czech system cannot rely on judges' In the summer of 2001, the government took a first step by integrity and competence in sophisticated commercial deci- proposing to draft new bankruptcy legislation, which would sions, such as whether an insolvent firm should continue replace the inefficient Bankruptcy and Composition Act of operation. 1991 (amended 20 times since). The core concepts of the The government reshuffle in July 2004 provided a strong reform include a more debtor-friendly approach thanks to a impulse for addressing the key problems in bankruptcy legisla- reorganization chapter, which allows the debtor to retain con- tion. The government invited a broader panel of legal and eco- trol over the firm, the re-introduction of the principle that nomic experts to re-write the law and make it compatible with secured debtors are entitled to the full proceeds of the security the existing institutional framework and the needs of the Czech sale, as well as better protection for creditors, by enabling them economy. The resulting draft strengthens the rights of creditors, to dismiss a court-appointed bankruptcy trustee and appoint a while giving them incentives to keep the firm operating when- new one. ever reasonable. The application of the bankruptcy chapter The urgent need to reform the bankruptcy legislation was does not have to lead to a liquidation of the insolvent firm, as highlighted by the corruption scandal surrounding the bank- has usually been the case under the current law. The reorgani- ruptcy of Union Banka, a medium-sized bank, in spring 2003. zation chapter is designed to minimize the risk that the debtor The bank's managers made a deal with a "bankruptcy mafia" will abuse the system. What's more, the law sets time limits for involving a bankruptcy judge, to keep full control over the some court decisions, gives managers incentives to initiate bank. To ensure that the case would be brought to the pre- timely bankruptcy proceedings, and contains specific provi- selected judge, the managers moved the headquarters to anoth- sions for the insolvency of financial institutions. The new draft er city, where they filed for bankruptcy. The judge immediately appears to have broad support across the political spectrum. declared the bankruptcy and appointed a trustee, who would Provided the parliament adopts the law in the beginning of act quickly in the interest of the incumbent management at the 2005, it can take force in 2006. expense of the bank's depositors. Serious accusations were raised regarding the bank's managers, the bankruptcy judge, Ondrej Vychodil and Ondrej Knot are PhD candidates at and the bankruptcy trustee, as well as highly positioned mem- CERGE--EI in Prague. bers of the state administration. The case proved to be the tip of an iceberg, as similar prac- tices were uncovered at large industrial enterprises. The events Bankruptcy proceedings in the Czech Republic, 2000 and 2002 intensified the pressure from the media and the public for faster Number of bankruptcy proceedings measures. However, the government's pace in preparing the 2000 2002 reform remained unsatisfactory, and progress was impeded by Total bankruptcy the fact that the legislative work was in the hands of the same proceedings, of which: 14604 14646 people who had been in charge of previous amendments. To circumvent the government's sluggishness, several large Unresolved from the Czech banks drafted an extensive amendment to the 1991 Act. previous period 9694 10387 The amendment, which significantly reduces space for corrup- Resolved cases, of which: 4067 4429 tion by increasing creditors' rights, limiting judges' discretion, Stopped proceedings 1955 1735 and enhancing debtors' and trustees' accountability, is current- ly under discussion in the parliament. While the amendment Source: www.ejustice.cz The World Bank· 31 Minimum Wage Increase in Hungary -- a Radical Measure with Mixed Results Miklos Koren P icture a Hungarian mechanic and an insurance broker weighed the positive supply effect: low-wage workers were 14 -- which is more likely to hold a minimum wage job? percentage points less likely to find a job after unemployment Wrong. It's the insurance broker. The minimum wage than low-skill workers. Overall, the minimum wage increase in Hungary defies economic intuition in other ways, as well. It significantly deteriorated the employment chances of people at was raised by 57% in 2001 and an additional 25% in 2002, an the lower end of the wage distribution. aggregate increase unprecedented among OECD countries. To examine the indirect macroeconomic effects of the min- imum wage rise on labor tax revenues, prices, GDP and the This unexpected shock allows for a "laboratory experi- budget deficit, the study by Halpern et al. builds a multisector ment" on microeconomic factors, such as labor demand and general equilibrium model of the Hungarian economy. To supply, job loss and gain, and efficient -- or "fair" -- wages. model firms' tax-avoiding behavior, the authors assume that a But the drastic measure also had repercussions for macroeco- fraction of firms only pay taxes and social security contribu- nomic aggregates, such as output and prices, government tions based on the minimum wage. Since they have no direct expenditures and tax revenues. measures or reliable estimates of the importance of this phe- This brings us back to the insurance broker. While the nomenon, they vary this fraction between 10% and 40%. majority of low-wage earners are unskilled workers at small The impact of the 2001 minimum wage rise is such that, as firms in depressed regions, many professionals are also paid the demand for low-skill workers falls, aggregate employment the minimum wage, because taxes and mandatory social secu- drops by 0.6%--1.1%. The more tax avoidance in the econo- rity contributions levied on wages are much higher than those my, the farther the fall, because the minimum wage increase levied on entrepreneurial income. Many firms complement a means an increase in effective labor taxes. low-wage contract, which carries social security benefits Even though companies are able to pass on some of their (healthcare, pension, etc.), with low-tax compensation labor cost increase to customers, corporate profitability and schemes. For an average experienced skilled worker, this can hence investment plummets. This has a negative impact on real cut total labor costs by a whopping 43%. The minimum wage GDP, which declines by 0.6%--2%. At the same time, because increase was hence an attempt by the government to counter of the increase in labor costs, consumer prices rise by 0.5%-- this tax avoidance. The government also aimed to compress 1.6%. wage distribution: by 2002, the fraction of workers paid the As for the government budget, revenues from labor taxes minimum wage rose to 17.3% from just 5% in 2000. and social security contributions rise by 0.6%--3% in real Such significant changes in relative wages tend, however, to terms, depending largely on how much of the economy is bring about turmoil in labor markets. In Hungary, the steady engaged in tax avoidance. This is a small sum compared to the upward trend in employment broke sharply in early 2001 (see magnitude of the rise and the government's hopes that it could figure), coinciding with the first minimum wage hike. substantially "whiten" the grey sector. The rise could only have Obviously, myriad factors other than the minimum wage, such had a bigger effect on tax revenues if one is willing to assume as the global recession, may have influenced employment. Two that more than 40% of firms were playing the minimum wage recent studies, one by Kertesi and Kollo (2004) and another by game, which is an unreasonably large proportion. Halpern et al. (2004), set out to separate these factors. Overall, because value added taxes comprise 57% of tax In analyzing labor market effects, Kertesi and Kollo find revenues and both corporate and value added tax receipts that the direct result of the minimum wage increase was the decline in real terms, total tax revenues are unchanged or drop in demand for unskilled workers by between 1% and decline slightly (by 0.4%). Since the structure of government 3%, especially among small enterprises in depressed regions. expenditure is assumed to remain fixed, the budget deficit is Lower labor demand, in turn, increased the probability that largely unchanged. This probably underestimates the budget- low-wage workers would be let go. Workers earning 90%-- ary costs of the minimum wage increase, as many social secu- 110% of the new minimum wage were twice as likely to lose rity benefits are indexed to the minimum wage. their jobs as workers in the control group, with just slightly Who benefited from this policy in the end? Even though higher wages (110%--125% of the minimum wage). low-wage workers face a mix of better wage prospects and The probability that the unemployed will find employment deteriorated job security, those lucky enough to keep their jobs may theoretically go either way after a minimum wage rise. On must surely have welcomed the sizeable rise in their real wages. the one hand, better wage prospects for the low-skilled unem- However, contrary to the hopes of the government and popu- ployed may increase the intensity of their job search or their lar belief, tax revenues and the budget deficit have not been sig- willingness to leave unemployment -- a supply-side effect nificantly affected. much emphasized by the government. On the other hand, the destruction of low-wage jobs lowers the demand for entry in Miklos Koren is PhD candidate at Harvard University and employment. Analyzing exit rates from unemployment, Kertesi junior research fellow at the Institute of Economics of the and Kollo conclude that the negative demand effect out- Hungarian Academy of Sciences. 32 · Transition The Newsletter About Reforming Economies World Bank\IMF Agenda AIDS Menacing Central -- Eastern Europe, articulate a common position on the need for supporting MICs New Report Warns and draft a framework for collaboration. A new IMF report, The Macroeconomics of HIV/AIDS, Economies in Transition: OED Assistance analyzes how HIV/AIDS adversely affects physical capital, Evaluation exacerbates poverty and inequality, debilitates welfare pro- grams, and impacts government finance and public services. An The Bank's initial strategy in the transition economies was economy severely affected by AIDS may contract to some one- relevant, but its effectiveness was limited by an underestima- third of its initial size in three generations, unless the govern- tion of the need to focus on poverty alleviation and good ment is willing to spend an extra 3--4% of GDP. governance, while rapid privatization was encouraged to pro- Last year, in Central -- Eastern Europe including the CIS mote private sector development without enough attention to countries, 1.3 million people were living with AIDS. the supporting legal and institutional framework. That was one Prevalence among the adult population (aged 15--49) was rel- conclusion highlighted in a new report by the Bank's atively low, at 0.6%. Even so, 49,000 people died of AIDS, and Operation Evaluation Department (OED), titled Evaluation of 360,000 people in the region became infected, according to Bank Assistance to the Transition Economies (available at UNAIDS, the Joint United Nations Program on HIV/AIDS. http://www.worldbank.org/oed/transitioneconomies/). In the There is evidence that the epidemic has recently begun grow- countries of the former Soviet Union, lending based on the ing through heterosexual transmission in the region. In 2002, expectation of a short, shallow transition recession led to sig- on average 41% of new infections were among intra-venous nificant indebtedness. The Bank has internalized these drug users, and 10% were through heterosexual transmission. lessons and shifted its emphasis to poverty monitoring and alle- The worst affected countries are Ukraine and the Baltic states, viation and good governance in both lending and analytical but HIV continues to spread in Belarus, Moldova, work. The approach to privatization and private sector de- Kazakhstan, the Kyrgyz Republic, and Uzbekistan. The five velopment has evolved considerably. Central Asian republics straddle major drug trafficking routes The evaluation examined five areas in depth: private sector into the Russian Federation and Europe. On the whole, more development, governance and public sector management, the than 80% of HIV-positive people in the region are not yet 30 financial sector, social protection, and energy. The evaluation years old. The report, released in mid-November, was written highlighted the importance of holding lending at prudent levels by Markus Haacker and Shanta Devarajan, the chief econo- while building a solid knowledge base. Analysis of governance mist of the World Bank's Human Development Network, and poverty monitoring should be early features of an assis- among others. tance program. A comprehensive, long-term approach is required to develop strategies for institutional change and pub- Management Action Plan Supports Middle lic sector reform. Active programs of stakeholder inclusion should be widely replicated. The evaluation was carried out in Income Countries partnership with the Swiss Agency for Development and Cooperation (SDC). The World Bank is seeking to increase support for middle- In its response, Bank management welcomed OED's evalu- income countries (MICs), where more than 70% of the de- ation and noted that it commended the Bank's performance as veloping world's poor people live. (About 2.6 billion people having been broadly successful. Transition in its political, eco- live in 76 middle-income countries, half of them in China). The nomic and social dimensions was an unprecedented event and Board recently discussed a Management Action Plan that while a lot more is now known about it with the benefit of per- should remove unnecessary obstacles to the Bank's analytical, fect hindsight, the longer depth and duration of the recession in financial, and risk management, as well as modernize and sim- the CIS compared to that in Central and Eastern Europe had plify its policies and procedures. The plan's specific targets not been foreseen by the Bank, its counterparts or anyone else include the reduction of transaction costs; pragmatic use of working on those countries. The emphasis on rapid privatiza- lending conditionality; increased flexibility in the Country tion was seen as appropriate both to create irreversibility in the Assistance Strategies of well-performing countries; expanded face of what was seen by country counterparts as the danger of use of output-based disbursements; alignment of the Bank's political reversal, especially in the CIS countries, and to stem analytical and advisory work with countries' priorities and cir- the extensive asset stripping in public enterprises. Nor during cumstances; and improved dissemination of the Bank's finan- the tumultuous period of the early transition could extensive cial and innovative products. A working party will be set up to analytical work on governance have been carried out in The World Bank· 33 advance of lending. However, the Bank has learned from expe- country in November. Wolfensohn outlined four areas -- oil rience, and poverty monitoring and good governance are now revenue management, health, education, and infrastructure -- key elements of its country programs. where Kazakhstan and the World Bank can work effectively together. "The World Bank is ready to partner with Bretton Woods Sisters Launch Debt Data Base Kazakhstan in its journey to a more competitive and diversi- fied economy," Wolfensohn said, adding that more invest- ments are needed in infrastructure, education, and health. The The World Bank and the International Monetary Fund new partnership between the country and the World Bank (IMF) in mid-November launched an online data base that Group offers an innovative approach to enhancing the com- offers access to external debt statistics for 41 countries, petitiveness of the Kazakh economy and helping the country updated every three months. The database brings together diversify away from its reliance on oil and gas. In this regard, external debt statistics published individually by countries that Kazakhstan is a pioneer in the development of new ways for subscribe to the IMF's Special Data Dissemination Standard the World Bank Group to work with middle-income countries. (SDDS). It provides policymakers and market participants with The keystone of the new partnership is the Joint Economic more timely data in a format that enables cross-country Research Program (JERP), co-financed by the World Bank and comparison, as well as better support for balance-sheet analy- the Government of Kazakhstan. An agreement to extend the sis and surveillance initiatives. The Quarterly External Debt JERP for an additional three years was signed in Astana on Database, maintained by the World Bank, is available on the November 16. World Bank web site: http://www.worldbank.org/data/work- ing/QEDS/sdds_main.html. The database initially covers SDDS countries, but the goal Scrutinizing Czech Investment Funds is to extend participation to all countries where external debt data are available according to the SDDS requirements. "We The World Bank recently disclosed the findings of a report expect that policymakers and analysts will find this online titled "Assessment of Governance in the Czech Collective database, updated on a quarterly basis, to be a valuable tool," Investment Fund Sector". It highlighted several key problems, said Francois Bourguignon, the World Bank's Chief Economist including the potential for conflicts of interest between invest- and Senior Vice President for Development Economics. ment management companies, depositaries and unit-holders, particularly if an investment manager and depositary are part of the same financial conglomerate. The report also noted that World Bank Loans Support Romania's EU the supervisory boards of investment management companies Accession are not practicing oversight over fund managers and urged the regulation of abusive practices.The assessment is part of a joint The World Bank Board of Directors approved two loans to World Bank -- Czech government initiative to support finan- Romania, totaling $275 million, to support infrastructure cial and private sector development in the Czech Republic. An development and agricultural information systems. The assessment of governance in the Czech banking system is to be Transport Restructuring Project ($225 million) -- to be imple- completed in January 2005. mented over the next five years -- has two major components: improving roads and the railway system. Bypass roads ("belt- Caspian Environment Forum Focused on ways") will be constructed around five major Romanian cities Sustainable Development -- Brasov, Bacau, Targu Mures, Reghin and Medias. Passenger and freight rail transport will be modernized through the implementation of an integrated computerized system. The International financial organizations, donor governments, MAKIS (Modernizing Agricultural Knowledge and firms, NGOs, and representatives from five Caspian states met Information Systems) Project, ($50 million) will help rural in Baku, Azerbaijan in mid-November, to discuss needed envi- farmers increase their incomes. Farmers will be trained in ronmental investment to support local entrepreneurs, ecolo- methods of fertilization, increasing productivity, and the provi- gists, and fishermen. The world's largest land-locked sea faces sion high-quality exports to EU markets. Major research insti- an array of environmental challenges: a stressed and eroded yet tutions will also receive technical assistance. Since 1990, the still unique biodiversity, with some species on the brink of World Bank has provided loans to Romania worth more than extinction, continued desertification and deforestation, declin- $4 billion. The 2004--2005 lending program is likely to be the ing fish stocks, and unsustainable development of coastal areas largest, amounting to almost $850 million. and communities. The fluctuations in the sea level are inundat- ing infrastructure, residential areas, farmlands and amenities, causing billions of dollars of damage while washing pollutants James Wolfensohn in Kazakhstan into the sea. During the conference, the five countries of the Caspian -- Azerbaijan, Iran, Kazakhstan, Russia, and World Bank President James D. Wolfensohn met with Turkmenistan -- updated donors on current environmental Kazakh President Nursultan Nazarbayev during a visit to the investments, research and institutional changes. The forum has 34 · Transition The Newsletter About Reforming Economies been organized through the Caspian Environment Program, a clearance in mid-January, 2005, and to the Board of Directors partnership between the five littoral states and their interna- for approval in late March, 2005. Since Poland rejoined the tional partners, including the World Bank. World Bank in 1986, the Bank's commitments to the country reached almost $6 billion, across 41 operations. The World Yes to Moldova's Three Pillar Strategy Bank is involved in such areas as infrastructure, competitive- ness, and regulatory and financial reform, as well as health financing reform and higher education The World Bank's Board of Executive Directors in November expressed support to Moldova's Poverty Reduction Strategy Paper, adopted by the government in May 2004 and Fraudulent British Health Care Firm Exposed submitted to the World Bank and IMF in June. The strategy focuses on sustaining economic growth through a program of The World Bank announced the exclusion for four years of structural reforms; strengthening human development by the Britain-based BIS Healthcare Group and its principal, improving education and health; and strengthening social pro- Bruno Gomes, for fraudulent practices during the selection tection and inclusion. The executive directors expressed con- process of the World Bank-financed Croatia Health System cern over the slow progress in implementing structural reforms, Project (CHSP). The Bank found numerous instances of fraud increased government intervention in economic activity, and in the contractor's proposal, concerning its claimed experience the unsustainable medium-term fiscal framework. They urged and qualifications. BIS Healthcare was contracted to provide Moldova's authorities to rectify their policies, especially in consulting in the integration of a pilot health services compo- areas such as state monopolies, licensing and regulation, land nent under the CHSP project. When the $2.42-million contract consolidation and agriculture subsidies, pension reform, and expired in 2002, due to delays in implementation only half of privatization. the original amount had been disbursed. BIS Healthcare will not receive any new World Bank-financed contracts during the New Country Partnership Strategy for Poland exclusion period. The CHSP is financed by a $29-million IBRD loan and is expected to close June 30, 2005. The World Bank has begun the consultation process for its new 2005--07 Country Partnership Strategy with Poland. Strengthening Credit Unions in Transition This document is intended to serve as the roadmap for the Economies World Bank's work in the country until the middle of 2007. The draft proposes three core priorities: promoting growth A two-day workshop on Strengthening Cooperative and reversing negative debt dynamics by reducing the budget Financial Institutions (Credit Unions) in Europe and Central deficit and restructuring expenditures; improving the invest- Asia took place in Baku on November 10. The workshop, ment climate and enhancing competitiveness; and reducing organized by the World Bank and co-hosted by the government poverty, encouraging social inclusion and raising employment. and National Bank of Azerbaijan, gathered some 70 partici- The strategy will be discussed with a broad spectrum of stake- pants from 20 countries and several international organiza- holders and social partners, including civil society groups, tions to discuss the role of credit unions in current development politicians, businesses, academics, youth groups and trade processes. As the host country's representatives pointed out, the unions. The strategy has been posted in the website of the development of the network of credit unions in Azerbaijan is World Bank's office in Poland: www.worldbank.org.pl. crucial for meeting the agricultural sector's financial needs. Following the consultations, the final version of the strategy will be presented to the World Bank's senior management for New Books and Working Papers World Bank Publications Cheryl Gray, Joel Hellman and Randi Ryterman Anticorruption in Transition 2: Corruption in Enterprise-State To order, contact the World Bank, P.O. Box 960, Herndon, VA Interactions in Europe and Central Asia 1999 -- 2002 20172, U.S.; tel.: 1 703-661-1580, fax.: 1 703-661-1501, 2004, 99 pp. http://www.worldbank.org/publications, email: books@world- bank.org, or visit the World Bank InfoShop at 701 18th Street, Controlling corruption is an essential part of good governance N.W., Washington, D.C., tel.: 1 202-458-5454. and poverty reduction, and it poses an enormous challenge for governments all around the world. Anticorruption in The World Bank· 35 Transition 2 analyzes patterns and trends in corruption in busi- tion. These problems include financial shocks, rapid shifts in ness-government interactions in the transition economies of the competitiveness of major exports, changes in international Central and Eastern Europe and the former Soviet Union. It production networking, and significant reconfiguration in the points to some encouraging signs that the magnitude and neg- geographical composition of production systems that had pro- ative impact that corruption exerts on businesses may be vided the foundation for growth. The book is a collection of declining in many countries in the region. It also shows how studies by leading experts in such fields as corporate and polit- some types of firms -- most notably small private ones -- ical governance, economic policy, globalization, higher educa- encounter more corruption than others, and it underscores the tion, legal reform, regional integration, and social protection. importance of policy and institutional reforms in achieving long-term success in the fight against corruption. The longer- Francois Bourguignon and Boris Pleskovic (eds.) term sustainability of recent improvements is not certain, how- Annual World Bank Conference on Development Economics ever, and the challenges ahead remain formidable. 2004: Accelerating Development (Bangalore conference pro- ceedings) Harry Broadman, James Anderson, Constantijn Claessens, Randi 2004, 388 pp. Ryterman, Stefka Slavova, Maria Vagliasindi, Gallina Vincelette Building Market Institutions in South Eastern Europe -- The Annual Bank Conference on Development Economics Comparative Prospects for Investment and Private Sector (ABCDE) is one of the world's best known series of confer- Development ences for the presentation and discussion of new knowledge June 2004, 410 pp. about development. First held at World Bank headquarters in Washington, D.C., in 1988, the ABCDE has become broader in This report is a collaborative effort between the World Bank scope as the world's economies have become more intercon- and the EBRD. It studies impediments to investment and pri- nected and challenges have become more complex. Presenting vate sector development in the countries of South Eastern the proceedings of the May 2003 conference, the volume dis- Europe -- Albania, Bosnia and Herzegovina, Bulgaria, Croatia, cusses such topics as fostering entrepreneurship, innovation the former Yugoslav Republic of Macedonia, Moldova, and growth; challenges of development in lagging regions; par- Romania, and Serbia and Montenegro. The report yields new ticipation, inclusion and results and scaling up and evaluation. insights for improving the region's business environment and Contributors to the volume include: Nicholas Stern, Senior makes concrete recommendations for reforms that would ease Vice President and Chief Economist of the World Bank; Azim the constraints on domestic and foreign investment, which are Hasham Premji, Chairman of Bangalore's Wipro Corporation; essential for economic growth in the region. Francois Bourguignon of the Ecole des Hautes Etudes en Sciences Sociales, France; Partha Dasgupta of Cambridge Shahid Yusuf, M. Anjum Altaf, and Kaoru Nabeshima (eds.) University; and Justin Lin of Hong Kong University. Global Production Networking and Technological Change in East Asia David Coady, Margaret Grosh, and John Hoddinott World Bank and Oxford University Press, 2004, 470 pp. Targeting of Transfers in Developing Countries: Review of In the coming decades, East Asian economies must face the Lessons and Experience challenges of an increasingly globalized marketplace. This Regional and Sectoral Study, 2004, 124 pp. book explores the changing parameters of competition in East Asia and argues that success ultimately will depend on the abil- Drawing on a database of more than 100 anti-poverty inter- ity of the region's firms to harness the potential of global pro- ventions in 47 countries, the book provides a general review of duction networks and to build their own innovative capability. experiences with methods used to target interventions in tran- Presenting the latest findings on global production networks sition and developing countries. It explores what targeting and the evolution of technological capabilities, it provides options are available and what results can be expected, while researchers, students, and policymakers with in-depth informa- delivering information that will assist in selecting and imple- tion and analysis on key issues related to growth and develop- menting strategies. There is no single preferred method for all ment in East Asia. types of programs or all country contexts. Successful targeting depends critically on how a method is implemented. The Shahid Yusuf, M. Anjum Altaf, and Kaoru Nabeshima (eds.) enclosed CD-ROM includes a database of interventions, an Global Change and East Asian Policy Initiatives annotated bibliography (PDF), and Spanish and Russian trans- World Bank and Oxford University Press, 2004, 468 pps. lations of the book (PDFs). Many East Asian economies have grown briskly in the past few Deepak Bhattasali, Shantong Li, and William Martin (eds.) years. However, future development will depend on the quality China and the WTO: Accession, Policy Reform, and Poverty and timeliness of regional and national policy actions. The Reduction Strategies policy agenda must address the problems that buffeted the region in the late 1990s -- associated with the weakness of World Bank Trade and Development Series. A Co-publication domestic institutions and policies in the context of globaliza- of the World Bank and Oxford University Press, 2004, 424 p 36 · Transition The Newsletter About Reforming Economies World Bank Working Papers WPS no. 3396, September 2004, 36 pp. http://econ.worldbank.org/ Jesper Jensen, Thomas F. Rutherford, and David G. Tarr Bernd Rechel, Laidon Shapo, and Martin McKee The Impact of Liberalizing Barriers to Foreign Direct Millennium Development Goals for Health in Europe and Investment in Services: The Case of Russian Accession to the Central Asia: Relevance and Policy Implications World Trade Organization World Bank Working Paper No. 33, 2004, 68 pp. WPS no. 3391, August 2004, 58 pp. Maria Amelina, Dan Chiribuca, and Stephen Knack Institut za Javne Financije Occasional Paper Mapped In or Mapped Out? The Romanian Poor in Inter- Series Household and Community Networks World Bank Working Paper No. 34, 2004, 96 pp. To order: Katanciceva 5, 10000 Zagreb, tel: 4886 448; fax.: Lev Freinkman, Evgeny Polyakov, and Carolina Revenco 4819 365, internet: http://www.ijf.hr/. Trade Performance and Regional Integration of the CIS Countries Predrag Bejakovic and Joseph Lowther World Bank Working Paper No. 38, 2004, 80 pp. Croatian Human Resource Competitiveness Study 2004 Kathleen Kuehnast and Nora Dudwick Better a Hundred Friends than a Hundred Rubles? Social Vjekoslav Bratic Networks in Transition -- The Kyrgyz Republic The Role of Parliament in the Budgetary Process -- The World Bank Working Paper No. 39, 2004, 80 pp. Example of Croatian Parliament (2000--2003) No. 19, 2004 Other World Bank Working Papers Anto Bajo Local Government Unit Borrowing In Croatia: Opportunities Natalia Agapitova and Alfred Watkins and Constraints Creating a 21st Century National Innovation System for a No. 20, 2004 21st Century Latvian Economy WPS no. 3457, November 2004, 95 pp. Mihaela Bronic The Costs of Customs Compliance in Croatia in 2001 Fan Zhai and Thomas W. Hertel No. 21, 2004 Labor Market Distortions, Rural-Urban Inequality, and the Opening of China's Economy Research Centre for East European Studies WPS no. 3455, November 2004, 41 pp. Working Papers Franck Lecocq and Zmarak Shalizi Will the Kyoto Protocol Affect Growth in Russia? To order: Forschungsstelle Osteuropa, Publikationsreferat WPS no. 3454, November 2004, 25 pp. (Publications Dept.), Klagenfurter Str. 3, D-28359 Bremen, German, E-mail: : publikationsreferat@osteuropa.uni-bre- Bartlomiej Kaminski and Francis Ng men.de Romania's Integration into European Markets: Implications for Sustainability of the Current Export Boom Hans-Hermann Hohmann and Friederike Welter (eds.) WPS no. 3451, November 2004, 40 pp. Entrepreneurial Strategies and Trust. Structure and Evolution of Entrepreneurial Behavioural Patterns in "Low Trust" and Antonio Estache "High Trust" Environments of East and West Europe. Emerging Infrastructure Policy Issues in Developing No. 54-57, 2004 Countries: A Survey of the Recent Economic Literature WPS no. 3442, November 2004, 43 pp. Katja Claus Die Entstehung der "Zweiten Kultur" in Leningrad Am Shaohua Chen and Martin Ravallion Beispiel der Zeitschrift "Casy" (1976--1990) China's (Uneven) Progress Against Poverty No. 58, 2004 WPS 3408, September 2004, 57 pp. Heiko Pleines und Hans-Henning Schroder (Hg.): Kym Anderson Putin auf dem Weg in die zweite Amtszeit Machtsicherung Agricultural Trade Reform and Poverty Reduction in und Politikgestaltung Developing Countries No. 59, 2004 The World Bank · 37 Neues Europa? Osteuropa 15 Jahre danach Anna Dorbec Beitrage fur die 12. Bruhler Tagung junger Osteuropa- Liquidity provision in transition economy: the lessons from Experten Russia No. 60, 2004 Discussion Paper No. 17/2004 WIDER Discussion Papers Greetje M.M. Everaert The Political Economy of Restructuring and Subsidisation: An International Perspective To order: Katajanokanlaituri 6 B, FIN-00160 Helsinki, Discussion Paper No. 12/2004 Finland, tel. 358-9-61599 228, fax.: 358-9-61599 333, con- tact Adam Swallow, email: swallow@wider.unu.edu Other Publications James B. Davies Micro-simulation, CGE and Macro Modeling for Transition Bryane Michael and Linacre College and Developing Economies Capacities to Govern Help Avoid A New Divide in Europe? Discussion Paper No. 8, 2004 To order: bryane.michael@linacre.ox.ac.uk Guanghua Wan, Ming Lu and Zhao Chen Leland Rhett Miller Globalization and Regional Income Inequality: Evidence from New Rules to the Old Great Game: An Assessment of the within China Shanghai Cooperation Organization's Proposed Free Trade Discussion Paper No. 10, 2004 Zone Maryland Series in Contemporary Asian Studies, No. 3, 2004 To order: Sidley Austin Brown & Wood LLP, 787 Seventh BOFIT Discussion Papers Avenue, New York, New York 10019, E-mail: lrmiller@sid- ley.com To order: Bank of Finland Institute for Economies in Transition (BOFIT), P.O. Box 160, FIN-00101 HELSINKI, Andrea Chandler e-mail: bofit@bof.fi, URL: Shocking Mother Russia: Democratization, Social Rights, http://www.bof.fi/bofit/fin/6dp/index.stm and Pension Reform in Russia 1990--2001 University of Toronto Press, November 2004, 246 pp. Steven Rosefielde To order: University of Toronto Press, Head office, 10 St. An abnormal country Mary Street, Suite 700, Toronto, ON, M4Y 2W8, fax.: 416- Discussion Paper No. 15/2004 978-4738 Conference Diary 17th Annual Bank Conference on Development Economics Financial Reforms: Perspectives on Financial Sector Reforms in (ABCDE) Africa, Lemma W. Senbet, University of Maryland January 27, 2005, Dakar, Senegal Economic Development: Convergence and Development Traps, Jean-Claude Berthelemy, University of Paris 1, Pantheon Inaugural Address: Abdoulaye Wade, President, Republic of Sorbonne Senegal Trade and Development: Risks and Rewards from Regional Opening Address: Francois Bourguignon, Senior Vice President Trading Arrangements in Africa-Economic Partnership and Chief Economist, The World Bank Agreements (EPAs) between the EU and SSA, Lawrence E. Keynote Address: Abdoulaye Diop, Minister of Finance and Hinkle, The World Bank Economy, Senegal Investment Climate: The Business Environment and Growth and Integration: Explaining African Economic Comparative Advantage in Africa: Evidence from Investment Growth: The Role of Policy Syndromes, Augustin K. Fosu, Climate Data, Benn P. Eifert, Alan H. Gelb, and Vijaya United Nations Economic Commission for Africa (UNECA) Ramachandran, The World Bank and Stephen O'Connell, Swarthmore College; The Mystery of Growth Accelerations, Ricardo Hausmann, Harvard University Attendance at the conference is by invitation only. ABCDE- 38 · Transition The Newsletter About Reforming Economies Dakar will be followed by the Africa Regional Workshop on CERGE-EI will host a global conference on educational Growth and Poverty Reduction in Dakar on January 28, 2005 research in developing or transition countries, sponsored by the Education Policy Research Network of the Global Information: For general information on ABCDE-Dakar see Development Network (GDN). Any researcher who is a per- www.econ.worldbank.org/abcde. For information on ABCDE manent resident of a developing or transition country may par- sessions, contact Boris Pleskovic, Research Manager, ticipate. The fundamental goal of the conference is to strength- Development Economics, World Bank, 1818 H Street, NW, en capacity in developing and transition countries to carry out MSN MC4-402, Washington, DC, 20433; tel.: 202 473 1062; policy-relevant empirical research on education. The confer- fax: 202 522 0304, email: bpleskovic@worldbank.org. For ence will discuss the following topics: improving the quality of logistics information, contact Leita Jones, Program Assistant, education, education and development, education and inequal- Development Economics,World Bank, tel.: 202 473 5030, fax: ity, cost of education, and education reform. 202 522 0304, email: Ljones2@worldbank.org. Information: http://www.cerge-ei.cz Financing for Development in the ECE Region: Promoting Growth in Low-income Transition Economies EU Enlargement from a Business Perspective February 21, 2005, Geneva, Switzerland 1st International Conference April 28, 2005 Keszthely, Hungary The seminar is organized by UNECE as a follow-up event to the International Conference on Financing for Development The conference will discuss the economics of the enlargement, held at Monterrey, Mexico, in 2002. The following sections are provide first-hand information on EU programs and funding planned: available for SMEs in New Member States, and give practical · Strategies for development and growth; advice on developing successful business strategies for entering · Economic integration and trade; new markets in Europe. · Financial management and sustainable growth in resource- rich economies. Information and registration: 1037 Budapest, Kunigunda 18, fax.: 361-436-9038, E-mail: eucenter@conference.org, Jose Antonio Ocampo, Under-Secretary General for Economic Internet: http://www.eucenter.org/training/training.php. and Social Affairs, will deliver a key note speech. The Ronald Coase Institute Workshop on Institutional Information and registration: United Nations Economic Analysis Commission for Europe, Economic Analysis Division, Palais September 17--22, 2005, Barcelona, Spain des Nations, CH-1211 Geneva 10, Switzerland, Jaromir Cekota, tel. 41 22 917 2445, or Ralph Heinrich, tel: 41 22 917 The workshop on institutional analysis is designed for social 1269, http://www.unece.org/ead/ead_sprin_sem_new.htm, scientists early in their careers. Established institutional schol- email: unece.seminar05@unece.org, ars will lecture on their own perspectives and strategies for work in this field. Participants will make two presentations of Modernization of Economy and Nurturing of Institutions their own ongoing research. The annual meeting of the 6-th International Research Conference International Society for New Institutional Economics (ISNIE) April 5 -- 7, 2005, Moscow, Russia will take place in Barcelona immediately after this workshop, on September 22 -- 24. The conference is organized by the State University -- Higher School of Economics (SU-HSE), with the participation of the To apply: e-mail an abstract (350 words maximum) of an World Bank and International Monetary Fund. Workshops ongoing research project plus a one-page curriculum vitae, to will be held in 4 sections: workshop2005@coase.org by April 1, 2005. Additional infor- · Macroeconomic Policy of Modernization; mation is available at: www.coase.org. · Institutional and Structural Reforms; · Social Policy; The Institutions of Market Exchange · State and Legal Modernization. 9th Annual Conference of the International Society for New Institutional Economics (ISNIE) Proposals for presentations at section meetings should be e- September 22-24, 2005, Barcelona, Spain mailed to SU-HSE at: interconf@hse.ru by December, 20, 2004. Other participants should register by e-mailing to inter- The conference program will include sessions on the applica- conf@hse.ru by March 10, 2005 or by filling out the registra- tion of institutional analysis to history, political science, law, tion form at http://www.hse.ru/ic6/english.html. and organizational behavior. Proposals to present a paper at the conference are due by March 1, 2005. Education Research in Developing Countries March 31 -- April 02, 2005, Prague, Czech Republic Information: http://www.isnie.org/ISNIE05.htm The World Bank· 39 Bibliography "Enforcing Corporate Governance" by Erik Berglof and Economic Studies, Vol. 45, pp. 2-24. Stijn Claessens C. Lawson and H. Wang (2004). "Economic transition in Defond, Mark L., and Mingyi Hung (2003). "Investor central and eastern Europe and the former Soviet Union: which Protection and Corporate Governance: Evidence from policies worked?", University of Bath, Department of Worldwide CEO Turnover", mimeo, University of Southern Economics and International Development, Working Paper. California -- Leventhal School of Accounting. T. Lysenko (2002). "Determinants of economic growth in Djankov, Simeon, Edward L. Glaeser, Rafael La Porta, transition economies", M.Phil dissertation, Cambridge Florencio Lopez-de-Silanes, and Andrei Shleifer (2003). "The University. New Comparative Economics". Journal of Comparative B. Merlevede (2003). "Reform reversals and output growth Economics. in transition", Economics of Transition, Vol. 11, No. 4, pp. Djankov, Simeon, Rafael La Porta, Florencio Lopez-de- 649-67. Silanes, and Andrei Shleifer (2003). "Courts". The Quarterly World Bank (2004). "Doing Business in 2005: Removing Journal of Economics, 118, 453-517. Obstacles to Growth", Oxford University Press. OECD (2003). "Experiences from the Regional Corporate Governance Roundtables", Paris. "Infrastructure in transition: regulation and private sector Zhuravskaya, Ekaterina and Oleg Zamulin (2003). participation" by Alan Rousso "Administrative Barriers to Small Business in Russia: Results W. J. Henisz (2002). "The Institutional Environment for from a New Survey", CEFIR working paper, at Infrastructure Investment", Industrial and Corporate Change, http://www.cefir.org/papers_academic.html. vol. 11(2), pp 352-389. W. J. Henisz and B.A. Zellner (2001). "Interest Groups, "Ownership Composition, Corporate Governance, and Political Institutions and Electricity Investment", mimeo. Performance: Evidence from the Czech transition" by Andrew P. Levy and B. Spiller (1994). "The Institutional Weiss and Georgiy A. Nikitin Foundations of Regulatory Commitment: A Comparative Wang, Hua and Yanhong Jin (2002). "Industrial Analysis of Telecommunications Regulation", Journal of Law, Ownership and Environmental Performance: Evidence from Economics and Organization, vol. 10, pp 201--246. China", World Bank Policy Research Working Paper 2936, R. Noll (2000). "Telecommunications Reform in December. Developing Countries", in A. O. Krueger, eds., Economic Policy Weiss, Andrew and Georgiy Nikitin (2004). "Foreign Reform: The Second Stage, University of Chicago Press. Portfolio Investment Improves Performance: Evidence from the J. Stern and S. Holder (1999). "Regulatory Governance: cri- Czech Republic", Topics in Economic Analysis & Policy: Vol. teria for assessing the performance of regulatoy systems. An 4: No. 1, Article 15. application to infrastructure industries in the developing coun- tries of Asia", Utilities Policy, vol. 8, pp 33--50. "Progress in transition and the link to growth" by Alan M. Vagliasindi and A. Chirmiciu (2004). "Assessment of Rousso the Effectiveness of Regulatory Regimes in Transition M. De Melo, C. Denizer, A. Gelb and S. Tenev (2001). Economies", EBRD mimeo. "Circumstances and choice: the role of initial conditions and policies in transition economies", World Bank Economic "Minimum wage increase in Hungary -- a radical measure Review, Vol. 15, No. 1, pp. 1-31. with mixed results" by Miklos Koren E. Falcetti, T. Lysenko and P. Sanfey (2004). "Reforms and Kertesi, Gabor and Janos Kollo (2004). "A 2001. evi min- growth in transition: re-examining the evidence" EBRD imalber-emeles foglalkoztatasi kovetkezmenyei," mimeo. Kozgazdasagi Szemle 51:293-324. previously circulated as J. Fidrmuc (2003). "Economic reform, democracy and "The Employment Effects of Nearly Doubling the Minimum growth during post-communist transition", European Journal Wage -- The Case of Hungary," Budapest Working Papers on of Political Economy, Vol. 19, pp. 583-604. the Labor Market 2003/6; S. Fischer and R. Sahay (2000). "The transition economies Halpern, Laszlo, Miklos Koren, Gabor Korosi and Janos after ten years", IMF Working Paper WP/00/30, Washington Vincze (2004). "A minimalber koltsegvetesi hatasai," D.C. Kozgazdasagi Szemle 51:325--345. Both studies were financed O. Havrylyshyn and R. van Rooden (2003). "Institutions by a joint grant of the Hungarian Academy of Sciences and the matter in transition but so do policies", Comparative Ministry of Employment and Labor. 40 · Transition The Newsletter About Reforming Economies Order Form Transition The Transition Newsletter if FREE of charge. Please fill in the order form below if you would like to receive a complementary subscription to the English version. Managing Editor: Erik Berglof (SITE) Please print out this form and fax to +1 (202) 522-1152 or mail to: Email: Erik.Berglof@hhs.se Jennifer Vito The World Bank Editorial Board: Mail Stop # MC3-302 Alan Gelb, Director, Development Policy 1818 H Street, N.W. 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