http://www.worldbank.orgWtransitionnewsletter )N ominate d f or s 2002 aT H E NEW S LETT ER A B 0 U T R E F O R M I N G E C O N O M I E S TIHFANSITIN NEWSLETTER Vol. 13, No. 3 THE WORLD BANK in collaboration with: May-June 2002 STOCKHOLM SCHOOL OF ECONOMICS and THE WILLIAM DAVIDSON INSTITUTE Transition-With Chinese C'haracteristics China needs to learn from the experience of various transition economies. That was the main consideration of the China Institute for Reform and Development (CIRD), the Haikou (Hainan)-based think tank, when in mid-June it hosted an international symposium on this topic. Prominent economists from across China attended, together with foreign experts, including Stanford professor and international trade guru Masahiko Aoki; Poland's former fi- nance minister and leading transitologist Grzegorz Kolodko; as well as Professor Richard Rose, expert in mass behavior in new democracies and inventor of the New Russia, Barometer. During the three-day meeting the hosts, led by Executive Director Chi Fulin, elicited lively discussion on the topic. The following two articles are based on presentations during this conference. Progress in Ownership Changes and Hidden Risks in China's Transition By Fan Gang An important aspect of the reform process is how the growth of the nonstate sector has changed the conditions for reform of state-owned enterprises (SOEs) in particular, and of the state sector (SOEs, the state banking system, and the government) in general, and why the SOEs must be reformed if the nonstate sector and the economy as a whole are to continue growing. Clarifying these issues is crucial to understanding China's current situation and the future of its economic transition and development. OtherF questions can also be raised: Can China's gradual reform succeed? Will the SOEs' difficulties drag the whole economy down? Will China's economic growth be- come unsustainable because of the state sector's problem? The key characteristic of China's gradual approach to transi- lence of private ownership, compared with the domination of tion is not that it is slow, but that it develops elements of the the state-owned sector as under the old system. This in turn new system, such as the private sector and market pricing, means that no matter how big the state sector was at the start while keeping the old system, such as SOEs and state banks, of transition, as long as the nonstate sector can grow, the tran- in place for a while. -In comparison, radical reform of the type sition will eventually succeed. Thus the foremost issue of the undertaken in Russia, for example, started with reform of the entire process is to allow the nonstate sector to expand. old system, with the new elements growing on the ruins of the old structures. This comparison is not intended as a value Theoretically transition could take place without any reform of judgment, but simply to point out that approaches to transi- the state sector. A gradual approach could launch the transi- tion differ under different circumstances. tion without reforming the state sector, at least for a while. SOEs could operate and state employees could continue to Nevertheless, one way or another both approaches require struc- receive their wages as before until they all retired. Thus during tural changes in the economy. The fundamental structure of an the course of one generation the state sector could disappear economy is its ownership structure, and the transition from a andi the transition might be complete. This seems like the planned economy to a market economy requires the preva- least painful process and an ideal approach. WB Development Economics RA SITE WDI LGI M) BOFIT Urban Institute i Naturally such a course of action is unrealistic, but it ' IWhat's Inslde underscores the key elements of economic transition: v Progress in Ownership Changes and Hidden Risks in developing the private sector and limiting expansion of China'Progress in Ownership Changes and Hidden Risks in the state sector. No matter how large the state sector is .0 X China's Experience with Transition: What Is Behind Its and how significant its difficulties, the focus should al- . X 6 Stunning Economic Success? 5 ways be the growth of the private sector, with relatively t' little attention and resources devoted to reform of the 2 r ~ Stiglitz-Rogoff Debate on uGlobalization and Its state sector. - ._ X Discontents" 10 Stiglitz, the IMF, and Globalization 12 . . . /1 Excerpts from Globalization and Its Discontents 14 Chia's transiton started with the growth of the nonstate sector, the most important outcome of China's economic How Free from Fear are Citizens in Transition transition during the past 20 years. Reform of the state _- - : Societies? 18 sector, however, did not commence until recently. Dur- ing the 20 years of transition the state sector's prob- Undertaking a Difficult Transition in Yugoslavia 21 lems became severe, such as the low profitability, the International Training Program for Entrepreneurs increase in the number of loss-making enterprises, and in Mekong Countries 24 the accumulation of huge nonperforming loans owed to Vietnam Focuses on Education 26 the state banks. While the difficulties in the economy are related to the state sector's problems, the economy continues to grow and financial and social stability are LGIUOSI present because the state sector's role is diminishing. * Education, Ethnicity, and Single Motherhood 28 Currently it accounts for only about 30 percent of na- * Corruption and Poverty in Postcommunist Europe 30 tional income. * Education to Facilitate the Way Out of Poverty 31 SI~ssian Indstr WT Acesson:Deah Kellor However, influential interest groups in the state sector * Russian Industry and WTO Accession: Death Knell or are not eager to succumb. They are doing their best to New Beginning? 33 protect themselves and are using their political and monopolistic powers to acquire more resources and roll The William Davidson Institute back the advances of the private sector. Thus the * Transition Economies: Performances and nonreform approach is feasible only in theory, not in a Challenges 36 * The Political Economy of Transition 37 real-life political economy. * Institutional Determinants of Labor Reallocation in Tran- sition 38 Despite the apparent contradiction, the conditions for * Competition and Corporate Governance in reforming SOEs are improving in line with the growth of Transition Countries 40 *~~~~~~~ ~ Reeac Daafo.rniinEoois4 the nonstate sector. The reasons for this are as follows: * Research Data from Transition Economies 42 The Urban Institute * Increased competition from the nonstate-sectors elimi- * Poor Decentralization Policy Burdens Poland's nates the monopoly position of SOEs and reduces their Social Services 43 monopolistic profits. Their worsening financial situation * Measuring and Evaluating Transition: The Blessing and is the ultimate driving force for undertaking their reform. Curse of Indicators 44 * Expansion of the nonstate provides more job opportuni- BOFIT ties for laid-off state employees. In addition, given the pri- * The Importance of Nominal Convergence for EU vate sector's contribution to the overall growth of the Candidate Countries 47 economy, the govemment will have more resources to pro- * Finnish Firms See More Business in Russia-and vide increased unemployment benefits to laid-off workers. Reform Needs 48 * Growth of private financial assets enables the capital Conference Diary 51 restructuring and privatization of SOEs through market New Books and Working Papers 54 mechanisms. Bibliography of Selected Articles 59 * Increased entrepreneurial capability on the part of the private sector can allow private enterprises to take over _____________________________________________ sound assets of SOEs for more productive and efficient uses. TRANSITION, May-June 2002 C 2002 The World Bank As nonstate businesses are still generally small, they tem and increased unemployment benefits, plus getting compete mainly against small SOEs, which explains why a job in the nonstate sector has became more attrac- small SOEs have been the first to reform tive. and to be taken over by private entrepre- neurs. Some preliminary data from the prov- So far we have painted a relatively rosy inces indicate that in some regions more picture of the economic transition: as long than 70 percent of small SOEs have already as the nonstate sector continues to grow, been privatized or restructured. Thus once * the conditions for reforming the state sec- the nonstate sector has grown and private , tor will improve and institutional change counterparts to the larger SOEs have --4 will be achieved gradually, no matter how emerged, the conditions will be ripe for re- large the state sector was and how long forming the bigger SOEs. ' the transition process lasts. In reality, "' I, -S; r'~lS ~ however, reforms face tremendous diffi- In many cases the progress of reform de- I culties, and the possibility is always pends on the government's political will, but -;.' present that reforms are discontinued, the one could argue that such will is determined i transition process is reversed, and as a by economic conditions. Much depends on Mr. Fan Gang result economic growth halts. The main the perceived gains or losses accruing as problem is that the state sector may use a consequence of reform. All the major breakthroughs in its power to control income redistribution and resource policies toward SOE reform were adopted following a ma- allocation, and consequently delay the necessary struc- jor development in the economy or change in the perfor- tural changes. mance of different sectors. For example, the year after output (value added) in the nonstate sector surpassed Growth may be lower in the state sector, but it can still that of the SOEs for the first time in 1992, the Commu- rely on the government's power to control distribution nist Party's Central Committee decided to restructure prop- and resource allocation in order to subsidize the SOEs. erty rights. Similarly, following developments in 1996-97, In China the government not only has taxation power, when SOEs registered an accumulated net loss, the 15th but it has also maintained the monopoly of state banks Party Congress declared that the legal status of the and state financial institutions. Resource redistribution nonstate sector would henceforth be equivalent to that of and subsidies take various forms as follows: SOEs, and also decided that small SOEs should be fully exposed to market competition, even if that meant priva- * Budgetary subsidies, which became less important in tizing them. In many coastal regions the government's the mid-1980s, but have been on the rise recently, be- reform policy changed sharply when the private sector cause the government has been encouraging state banks surpassed the state sector as the main source of local to engage in debt-for-equity swaps with indebted SOEs. fiscal revenues. Nothing occurs by chance. * Nonperforming loans extended to SOEs by state banks, which can be viewed as quasi-government debts. The more than 100 million state employees used to ben- * Nonperforming foreign debts owed by the SOEs di- efit from lifetime employment and various privileges ex- rectly, by state financial institutions, or by government tended by. the government. Even though the SOEs were agencies that borrowed on the international capital 20 to 30 percent overstaffed, even according to official market on behalf of the state sector. government estimates, layoffs, particularly mass layoffs * Funds raised on the stock markets by SOEs whose of millions of workers each year, would have been un- performance has not improved is a form of subsidy to SOEs thinkable even five years ago; however, since 1995 more received from the public via the securities markets. than 15 million state employees have been laid off at an accelerating rate. The practice has become so widespread These subsidies must come from somewhere, and they that almost every SOE has laid off employees. come from the nonstate sector. If the nonstate sector had equal access to bank loans- or foreign loans and The question here is why state employees-perhaps could have an equally high nonperforming loan ratio, or if the most powerful interest group in China-refused to the nonstate sector could equally go to the stock mar- accept layoffs for a long time, but now accept the sever- ket tb raise funds pr6portional to its contribution to GDP, ance packages. The answer is simple. In recent years there would be no real subsidy. But "equally" is nonex- the government has shored up the social security sys- istent, at least in China. The most serious distortion in 3 2002 The World Bank TRANSITION, May-June 2002 II, : X-.:- , Th banks are too large to work with small The Private Sector Catches On In Transition Countries private enterprises. In sum, the private I Percentage of GDP generated by the private sector in t 90s, including sector is deprived of proper financing privatized businesses and startups channels. This serious distortion of re- COUNTRY 1 1 source allocation is risking a reversal ..: cw Cze.hRepublic 12% 8 _____________________-- of the transition process. r=o ti ,11 |Czech Republic 12% 50SS_ *.aB t ' t Estonia 10%> 55% Hungary 18% 55% Given the extent of taxes levied on the Rol anla, 17% 40% nonstate sector and the subsidies pro- vided to the state sector, the state sec- -' AL//11 CentralSoutheast. 11% 50% _ Europe/ Ba1ftcs tor must be reformed to prevent such jRussia 5% 50% resource transfers from becoming exces- Armenia 12% 40% sive. If the old sector could pass away Belarus 5% 15% naturally because of its lesser efficiency, ComrnonweaIth ot 10% 20% _ transition would be much less painful, Independent Stales and only patience would be required. How- 'Albania, Bulgauia, Croala. Czech Repubic. Estonia, Hungaryr LaMa, Lilhuanta, ever, those who have a vested interest in mnt irw 4eimi0i, SIWak HouldF ZWi SouI : EBR0AVDrN Bank the old system may use their political Scumbe@ EOROIWedd B3ank influence to resist such a process by . drawing resources away from the nonstate sector and delaying, or even relation to resource allocation is that the nonstate sec- reversing, the transition process. Therefore the "old tor, which contributes more than 70 percent of output, sector" has to be reformed. accounts for less than 30 percent of bank credits. And the most serious policy mistake in the past 20 years of The crucial issue is the extent of resource transfers reform has been the lack of development of nonstate from the state sector to the nonstate sector. If this financial institutions that could adequately provide for transfer or "tax" is excessively high, it risks a crisis the growth of the nonstate sector. The private sector is and the reversal of the transition process. Expansion barred from the securities markets, while the state-owned of the private sector could be halted if its accumulated Percent Political Economy of China's Transfonnation, 1980-97 40 30 s 0v* ------ -- -- -- 1! 10 1985 1988 1989 1990 1991 1992 1993 1994 1995 1996 1 -lo ---- Profit rate of SOEs -0- - Industrial output of SOEs -3 Industrial output of nonstate sector - - Contribution to fiscal revenue by SOEs - Contribution to fiscal revenue by nonstate sector Source: Author. TRANSITION, May-June 2002 C 2002 The World Bank resources are drained too vehemently, and the aim of ing their early stage of growth. A similar argument may the reform policy should be to prevent this from hap- also be applicable to some Eastern European econo- pening. The magnitude of this resource transfer is de- mies termined by two factors. The first is the size of the state sector in relation to the nonstate sector through- How can we measure the extent of the transfer in China? out the transition. The bigger the state sector, the Nonperforming loans represented roughly 25 percent of to bigger the resource transfer is likely to be. Second, total bank lending at the end of 1998, equivalent to about the less efficient and less profitable the state sector 27 percent of GDP. If we add government debt (about 9 . 6 - as a whole is, the bigger the likely resource transfer. percent of GDP) and foreign debt (about 14 percent), the Experience shows that the longer the state sector comprehensive public sector liability, as the resource trans- exists, the worse its financial situation and the lower fer may be referred to, equaled about 50 percent of GDP its profitability. Compared with similar indicators for other economies, China's overall financial situation does not seem to be as In Russia the state sector's virtually complete domi- bad as the volume of nonperforming loans indicates. Re- nation of the economy and 70 years of a planned cent trends in structural change are also encouraging: economy left no other choice but to undertake mass the role of the nonstate sector as a major contributor to privatization at the beginning of the transition, other- national output is increasing steadily. This indicates that wise the private sector would not have been able to the process of transformation is continuing and, at least grow, because any extra resources it might have been for now, is not threatened with a reversal. Nevertheless, able to accumulate would have been immediately the financial sector urgently needs reform. taxed away, at the very least by inflation. In, China, however, the relatively small size of state industries This article is based on the author's presentation at the (in terms of employment) at the initial stage of transi- recent Intemational Symposium on Transition hosted by tion made it possible to postpone the reform of SOEs the CIRD, Haiku/Hainan, China. Fan Gang is a professor for some time. In addition, the SOEs' relatively better of economics at Peking University and director of the financial situation because of their shorter history made National Economic Research Institute of the China Re- the resource transfer relatively small, and even enabled form Foundation in Beijing. His email address is the government to reduce nonstate companies' taxes dur- fangang@neri.org.cn. China's Experience with Transition: What Is Behind Its Stunning Economic Success? By Richard Hirschler China's great Prime Minister Chou En-Lai was once asked what he thought about the French revolution. "It is too early to tell," he responded. One could say the same about the transition process, the long, arduous road from central planning to a market economy that is still ongoing. However, it is never too early to make some assessments. Countries can learn from the mistakes of others and adopt best practices from elsewhere. Explaining China's Success the fonmer Soviet Union, primarily Russia? Three comple- mentary schools of thought attempt to do so. Despite all the odds, since Deng Xiaoping launched his reform policy 25 years ago China has made huge strides. * Initial conditions matter. The leading proponent of During this period its GDP increased from $300 billion this explanation is Jeffrey Sachs, who points out that to more than $1 trillion. A steady growth rate of 9 per- China started its reforms in the late 1970s as a develop- cent, during much of this time, elevated this country of ing, agricultural country, while the Soviet Union was .1.3 billion people out of poverty. China is heading toward overindustrialized, overcentralized, and overbureaucratized, becoming one of the world's most powerful economies and was dominated by obsolete heavy industry. Reflecting (see table 1). How can one explain these developments Chairman Mao's belief in community-based self-reliance, in China compared with the situation in the countries of even before the reform period China was much more C 2002 The World Bank TRANSITION, May-June 2002 decentralized than countries in the Soviet economic special economic zones, which are islands of foreign private sphere. China's dense network of horizontally linked, enterprises. Russia took the advice of neoliberal economists, smaller economic units at the local level provided much who suggested macroeconomic stabilization, liberalization, more flexibility than the Soviet Union's huge, special- and privatization, too seriously, hoping that such mea- ized industrial complexes, the favorite "pets" of Moscow's sures would create the proper conditions for a market central planners. Thus in China development and transi- economy. However, price liberalization-again under- Table 1. China's Key Economic Indicators, 2001-03 taken without assuring proper competi- Table 1. China's Key Economic Indicators, 2001-03 tion-drove prices up and pushed half the Indicator 200111 2002b 2003b country into poverty. Similarly, liberaliz- Real GDP growth (percent) 7.3 7.4 7.7 ing foreign exchange without creating a Private consumption (percent) 5.6 5.7 6.5 business-friendly atmosphere resulted in Gross fixed investment (percent) 11.4 13.5 12.5 capital flight. Meanwhile China went Consumer price inflation (percent)c 0.7 0.6 2.0 ahead by experimenting with new ideas Commercial bank prime rate (percent)c 5.9 5.3 6.5 in local areas, only expanding them once GDP ($ billions) 1,180.0 1,286.0 1,412.0 they had proven successful. Russia be- GDP per capita ($) 930.0 1,000.0 1,100.0 lieved, mistakenly, that a few masterful Trade balance ($ billions) 31.4 24.0 14.0 restructuring programs could create Current account balance ($ billions) 20.3 8.3 2.7 miracles. Exchange rate RMB:$1l 8.3 8.3 8.3 Exchange rate RMB:Y100c 6.8 6.2 6.4 * Institutions matter. Early on China's a. Estimated. decisionmakers were ready to create b. Forecast. "semi-perfect" institutions that conformed c. Annual average. to the "semi-perfect" market conditions- Source: Economic Intelligence Unit data. or maybe they just pragmatically adapted to changing circumstances. The house- tion went hand in hand. The space for maneuvering was hold responsibility system was already the result of such wide, and with the household responsibility system in a compromise: peasants can only lease the land long place in agriculture, the economy expanded in leaps term but cannot sell it. Twenty-five years ago though, it and bounds. Meanwhile in the "new" countries of the created a completely new situation in agriculture. collapsed Soviet Union, their old political, economic, and social structures had been dismantled (including the The dual-track approach enabled gradual price liberal- trade organization of the socialist countries), without the ization, the two-tier currency rate provided a grace pe- emergence of efficient new institutions. riod until the country could afford a single yuan rate. The relationship between the central government and local * Reform strategies matter. A prominent representa- governments gradually developed from the prereform "eat- tive of this other school of thought is Nobel laureate Jo- ing from one bowl" principle to the concept of "cooking seph Stiglitz, who focuses on the significance of different in separate kitchens." This in turn motivated local gov- reform strategies. Russia considered privatization more ernments to generate more revenues so they could re- important than competition. Its government rushed ahead tain more funds and spend more locally. Later, in the with mass privatizations that-given the lack of appro- 1990s, fiscal federalism was the guiding principle shap- priate institutions-propelled most "privatized" firms into ing the general rules of revenue sharing between the the hands of insiders, primarily nomenklatura manag- federal and local governments. ers. Later, through the loans for shares scams, the rich- est state enterprises were sold at bargain basement The backbone of economic expansion in the 1980s and prices to the chosen few, the infamous oligarchs. The early 1990s was the township and village enterprises, authorities blocked the entry of new enterprises in many which were owned by local governments. These unique ways, especially local governments that did not want to nonstate businesses created new jobs, provided valu- endanger existing businesses under their protection. able products for consumers, and contributed to regional development. By the late 1990s they had accomplished China, by contrast, succeeded in creating a favorable their objectives, and thus most are now being privatized. atmosphere for establishing "nonstate" businesses, In the financial sector the authorities encouraged cash namely, township and village enterprises, and in creating transfers (tolerating the anonymity of bank deposits), TRANsITION, May-June 2002 C) 2002 The World Bank j and thus the money-printing business (seigniorage) committee, the employee representative committee, and brought extra revenues to the state. The state was also the workers union) have been challenged by the "three benefiting from keeping deposit interest rates at an arti- new :meetings" (the meeting of shareholders, the meet- ficially low level, underpinned by the monopoly of the ing of the board of directors, and the meeting of the o state banks, and prohibiting capital transfers. In 2000 supervisory committee). Chinese economists therefore al 3 the authorities eliminated anonymity for new deposits, propose putting the state, institutional investors, and ': o but retained it for earlier ones. individual investors on an equal footing and letting boards select the most capable chief executive officers without i Further Challenges any 'political intervention. Eventually, except for a few enterprises in which the state intends to retain 100 per- These successes notwithstanding, some serious unre- cent ownership, all other enterprises should become joint U solved issues can stymie further development in China. stock companies with multiple owners, including domes- tic and foreign investors. Challenge 1: Dealing with Loss-Making State-Owned Enterprises The:National Bureau of Statistics has estimated that as a result of drastic retrenchment by SOEs, urban unem- The importance of state-owned enterprises (SOEs) to ployment, which has reached about 10 percent, is likely the economy is clearly diminishing as the private sec- to rise to 15 percent, or 30 million people. Meanwhile tor is becoming the driving engine of progress. Indus- unemployment in rural areas now amounts to 35 per- trial SOEs produced $0.81 in profit for every dollar they cent of the total rural work force, or 170 million people. invested in 1985. By 1997 this profit had fallen to $0.09, China will have to create between 100 million (World despite two decades of incremental reform. In 2000 Bank estimate) and 300 million (Chinese Academy of SOEs accounted for less than a quarter of industrial Social Sciences estimate) new jobs over the coming output and just over a third of urban formal employ- decade to maintain the status quo in the labor mar- ment (see table 2). Yet according to conservative esti- ket. Economists predict that WTO accession will not mates three-quarters of all bank lending ended up in have a long-term impact on the overall level of em- the SOEs' coffers. In comparison, private enterprises ployment, but will result in sectoral shifts as workers received just under 1 percent of all bank loans in 2000. move between industries. The silver lining of China's The SOEs' poor financial performance is responsible unemployment cloud is that it has significant room for the problems in the banking sector. The rating agency for job creation in the service sector. Standard & Poor's believes that fully half of all loans on the books-an amount equal to two-thirds of GDP- The unemployment situation could accelerate the imple- are nonperforming. In the late 1990s more than a third mentation of the government's long-stalled project to fund of SOEs were in the red. a basic social security and public welfare scheme by selling off government-held shares in listed state-owned Services (wholesale commerce, transportation, commu- companies. These account for almost 70 percent of cur- nications, and banking) are still dominated by state firms, rently issued "A" shares, or about $350 billion at current and their privatization could lead to major increases in efficiency. The consolidation of state-owned commer- Table 2. The State Sector's Diminishing Role: cial banks has started, and their bad loans are being SOEs' Share in Selected Indexes (percent) transferred to asset management companies in ex- change for government bonds. Recently, however, these Industrial Urban formal Government Bank banks have again been extending questionable loans to Year output employment revenue lending SOEs, so their portfolios have not improved much. Time is short. By 2006 foreign banks will be able to collect 1978 78.0 78.3 87.0 96.8 renminbi savings and compete with China's banks on 1988 57.0 70.3 71.6 90.0 an equal footing. 1995 34.0 64.9 71.1 81.0 2000 23.5 38.1 n.a. 77.5 Corporate governance in SOEs is complicated because n.a. Not available. the party controls the selection and dismissal of man- Sources: China Statistical Yearbook, Edward Steinfeld, Forg- agers. According to the Chinese press, at some large, ing Reform in China (Cambridge, U.K. Cambridge Univer- corporatized SOEs the "three old committees" (the party sityX Press, 1998). C 2002 The World Bank TRANSITION, May-June 2002 Table 3. Household Consumption, 1994 and 2000 ments had risen from 20 per- 1994 2000 1994-2000 cent of national medical spend- CCi a _ ;, (percentage (percentage (percentage change ing in 1978 to around 50 percent Item of total) of total) in value) in 2000. ; 1 66*, .Medicines and health care 2.4 5.0 +174.7 Local insurance schemes cover Housing 5.6 9.7 +130.2 50 million people, and insur- i1 Education and entertainment 7.5 10.9 +110.5 ance provided through the work Transport and communication 4.2 6.1 +91.0 placecoversanother50million. Household durables 6.9 7.8 +50.6 Some 600 million workers, or wg 'n'> Services 4.1 4.6 +48.6 85 percent of the labor force, F '<-y ' Food 53.1 43.9 +9.6 have no insurance at all. The v_--__ - @3 Clothing and footwear 16.1 11.1 -8.3 aim is for basic medical ex- ~~~~~~~~~~~~~~~~~~ai Tota for bascpitaalex Total per capita penses to be covered by indi- consumer expenditure 100.0 100.0 +32.7 vidual insurance accounts Source: Urban and Rural Socioeconomic Survey Organization, National Bureau of funded by employer and em- Statistics. ployee contributions. "Major," as yet undefined, expenses market prices. Additional cash could be raised as new will be covered by a social fund financed by employ- state companies are listed or by issuing government ers and municipal governments, and individuals' en- bonds. titlements from this fund will be capped. Catastrophic illnesses, such as cancer or AIDS, are supposed to Challenge 2: Reforming Pensions, Health Care, and be covered by commercial health insurers, but cur- Housing rently China does not have any commercial health insurers. Chinese policymakers have recognized the need to cre- ate a social safety net funded by workers and employ- The availability and quality of housing have increased, ers to replace the socialist cradle-to-grave welfare but the cost is often beyond the average person's system that was sucking SOEs dry. Two decades of reach and adequate mortgage lending to fill the gap reform have seen a massive transfer of risk from SOEs has not yet developed. Per capita urban living space to individual workers, and health care and housing are increased from 5.2 square meters in 1985 to 9.6 square by far the fastest-growing segments of household bud- meters in 2000, and on average, Chinese city dwell- gets. These costs continue to rise rapidly, even as the ers now enjoy more living space than their counter- cost of food, clothing and many other household goods parts in Hong Kong. declines (table 3). State enterprises have been selling off houses to work- In absolute terms, Chinese consumers pay nearly three ers at low insider prices. By 1995, seven years after times as much for health care as they did in 1994 and state units began selling housing to its occupants, more than double for housing and education. According 29 percent of urbanites lived in apartments they had to the National Bureau of Statistics, in 1994 $0.70 of purchased by means of this mechanism and another every dollar Chinese households spent went for food or 11 percent owned housing they had built themselves clothing. By 2000 that figure had slipped to $0.55. Dur- or had inherited. However, homeowners who bought ing the same period expenditure on housing and health housing from their work units do not own their apart- care leapt from $0.08 per dollar to nearly $0.15. ments outright, as they are not entirely free to sell them. Work places must still approve any sale and Five years ago the government started pilot health care often have the right to buy the apartment back. If the programs in 59 cities to experiment with locally ad- unit is sold to a third party, the work place claims the ministered health insurance schemes funded by con- lion's share of the profit on the sale. tributions from employers and deductions from employees' wages. The intent was to relieve SOEs of In addition, the apartment sales have not ended the the burden of running their own hospitals and give a system of allocated housing. While workers who have break to individuals, whose out-of-pocket medical pay- been employed for a number of years have been busy TRANSITION, May-June 2002 C 2002 The World Bank buying subsidized apartments from their employers, purposes, often to pay the pensions of current retir- newly hired workers still line up for assigned housing. ees By the end of 2001 more than RMB 200 billion The result is that people who can buy at low insider ($24 billion) had been looted from pension funds, and prices have no incentive to sell, and those who are the fiqure is growing. not allowed to buy at such prices simply can not af- ford the purchase. The private rental market for ordi- Challenge 3: Keeping Government and Business nary housing is virtually nonexistent, and the purchase at Arms' Length price of an apartment on the open market ranges from 10 to 20 times the average annual income. In the late A market economy can be endangered by crony capi- 1990s SOEs still owned about two-thirds of all urban talism. If state bureaucrats favor special groups or housing. individuals or state capture by business enterprises is prevalent, this could thwart the development of a As concerns the pension system, retirees used to level playing field, prevent fair competition, and feed D receive payments from their work units based on the corruption. In addition, China must strengthen the rule number of years of service and their final wages. The of law and nurture a free press that is ready and able funds came from the work unit's coffers, rather than to report unlawful abuses. Communication channels from any sort of fund or savings account, making it a between the government and the public have to be pay as you go system. Workers who retired before kept open business deals must be transparent. In ad- the mid-1 990s continue to be paid under this system, dition, the public at large should be able to express with payments indexed to the one-year bank' deposit its views. As World Bank President James Wolfensohn rate, now 1.98 percent. Currently China has about eight noted during his recent visit to China: "That comes workers for every retiree, but by 2050 this figure will with maturity in the market, but it certainly requires fall to three. leadership at the top. If there is not that sort of leader- ship and integrity at the top, you will not get rid of Worried by this trend, since the mid-1990s China has crony capitalism. If you have it at the top, then you tried to switch to a fully funded system, whereby em- can. have a really good shot at keeping it to a mini- ployers and employees contribute to funds that the murm." As many reformers within the Chinese Com- same employees will draw on when they retire. In 1997 munist Party have stated, the Communist Party the State Council introduced the following framework: should be able to manage the difficult transformation a mandatory amount of 11 percent of payroll goes to from central planing to a market economy without di- individual retirement accounts, of which employees rectly interfering in the process contribute 8 percent and enterprises contribute 3 per- cent. Local governments impose a further "social re- By joining the WTO China is becoming more integrated sponsibility" tax on enterprises, often around 17 into the global economy. Flows of foreign direct invest- percent of payroll. Thus under this framework indi- ment to China in 2002-06 are estimated to average more viduals contribute 8 percent and enterprises contrib- than $60 billion per year, and are likely to reach $72 ute a total of 20 percent of payroll. billion by 2006. By the end of 2002 China will already have more than $440 billion in foreign direct investment In theory, there would be three separate funds: a so- stock. The circumstances are right for surging ahead cial fund to provide retirees with a basic pension of 24 with economic, social, and political reforms, remem- percent of the average local wage, a mandatory indi- bering that history never lacks surprises. Twenty years vidual retirement account to bring the benefit close to ago few had predicted the huge success of China's 50 percent of the average local wage, and an extra economic transformation in the subsequent two de- individual account for workers at profitable enterprises. cades, and China is continuing full tilt on its remaining This would bring retirement benefits to levels equiva- journey toward a modern market economy. lent to current pension levels, but represents a huge relative decrease from past pensions: a person who This article is based on the author's presentation at retired in 1978 received a pension worth 97 percent of the recent international conference on Transition his or her final wage. The new system has several hosted by the CIRD in Haikou/Hainan, China. Reports other problems, of which the most significant is that and, analyses.by The Economist Intelligence Unit and contributions to the first two funds are collected by Oxford Analytica were valuable resources for drafting local governments, which then use the cash for other this, article. © 2002 The World Bank TRANSnI'ION, May-June 2002 - II Stiglitz-Rogoff Debate on "Globalization and Its Discontents" Joseph Stiglitz, winner of the 2001 Nobel Prize in Economics and former World Bank chief economist, and Kenneth Rogoff, economic counselor and director of the Research Department at the IMF, held an exciting debate on development issues at the end of June, hosted by the World Bank. We highlight I parts of the discussion that focused on Stiglitz's recently published book Globalization and Its Discon- tents. As background we also provide a slightly shortened version of a recent speech on the same topic byj I by Thomas C. Dawson, director of the IMF's External Relations Department. Finally, we also quote some excerpts from this book that generated so much emotion. -Stiglitz: IMF Imposed Excessive Restrictions "The book deals with important aspects of globalization * Western advisers, especially those of interna- of which the World Bank and IMF are only parts, but tional financial institutions, failed to adopt an ap- important parts. I will outline the general perspective of propriate posture toward the transition countries. the book and highlight six important and re- The role of their economists should be to lated issues. present the available economic policy alter- 2 L i natives and let the political process choose The general perspective is based on the fol- from among these. This is particularly true lowing: i . if the consequences of different policies are uncertain. In the book I detailed the crisis in *Globalization has benefited several transition economies and argued that the countries, especially those in Southeast Asia. - failures were enormous. One of the hardest Those that have benefited the most were taking question for an economist is what would have control of globalization for their own purposes. happened in the absence of a certain ac- The development success of China and some tion. We cannot be sure, but we have some other East Asian nations was based on their Mr. Joseph Stiglitz evidence about what other countries have exports growth, which would not have been pos- tried, and I suggest in the book that had sible had they not participated in globalization; however, they these alternatives been followed, the outcomes would were unwilling to go along with other recommended actions, have been better. such as capital market liberalization, and have still not opened up their markets with respect to capital flows. Their And now for the six related issues: case has shown very vividly that countries can get large amount of foreign direct investment without opening up their * Capital market liberalization. This was a risk with- capital markets. Thus those countries that have been the out rewards. Malaysia, for example, was widely criti- most successful did not succumb to market fundamental- cized for introducing capital control. In retrospect, ism. however, this control resulted in a shorter downturn and * Globalization has been run by rules more or less a lesser legacy of debt than in the other countries af- set by the advanced industrial countries, especially fected by the 1997 Asian crisis. During the East Asian by special interest groups within these countries, to their crisis the IMF argued that contagion needed an appro- own benefit. To the extent the rules were not dominated priate response and rapid intervention to halt the spread by special interest groups, they were heavily influenced of the crisis from one country to another, but it did not by free market ideology. address the underlying problem. Contagion is an exter- * The industrial countries were enormously hypo- nality, while capital liberalization is a cause of volatility critical, demanding trade liberalization and the elimina- of the exchange rate and of the current account. Thus tion of subsidies while maintaining trade barriers and we ought to do something about the underlying disease. subsidies for their own products. As a result, the terms Recently the IMF has changed its position, realizing that of trade worked to the disadvantage of the developing capital liberalization is not as advantageous as it had countries. previously thought. TRANSITION, May-June 2002 C 2002 The World Bank * Transparency, accountability, and conditionality. monetary, fiscal, and other economic conditions] were In the past the IMF's conditionality requirements were extensively criticized. My view was th6i they were inef- . K excessive, but the Fund is moving in the right direction. fective, leaving countries. in debt, with their workers and Nevertheless, a number of conditions are still extremely domestic businesses suffering the most and the ben- s ; inappropriate. As to transparency, freedom of informa- efits going largely,to the creditors. The IMF is now mov- tion should be the guiding principle, and I would like to ing away from bailouts toward bankruptcy procedures. , < see the IMF move in that direction. Conditionality tied * Monetary policy. The IMF has not yet made any to a loan should not be used as a means of concessions in relation to monetary policy. I argue in A micromanagement, but should be regarded as a broad the book that raising interest rates durin;g the East Asian framework. In East Asia, and particularly in South Ko- crisis exacerbated that crisis, leading to more bank- rea, most conditions that the IMF imposed had noth- ruptcies that in turn led to weaker economies. Capital ing to do with the crisis. Conditionality clearly went left the countries rather than flowing into the countries. overboard. The Fund is now recognizing that it was The IMF argued that if interest rates were not higher, the using conditionality excessively. exchange rate would fall and that would cause bank- * Excessive fiscal contraction policies. The IMF rec- ruptcies. I argued that there was no tradeoff, that high ognized that it had pushed for excessively restrictive interest rates did not support the exchange rate, but fiscal policy in East Asia, but in Latin America and some that even if they did, there was a moral hazard issue: other countries it still seems to be continuing its exces- should we bail out those who were speculating against sively contractionary policies. a currency at the expense of domestic businesses? * Bankruptcy and bailouts. During the East Asian cri- * Political and social context of intervention by the sis bailouts [Editor's Note: rescue packages offering bil- international financial institutions. Insufficient atten- lions of dollars to countries that accepted certain tion has been paid to this issue." Rogoff: Your Medicine is Dubious "Let me make the following three substantive points: issue more debt and to print more money. You seem to * First, there are many ideas and lessons in your book believe that if a distressed government issues more cur- with which we at the Fund would generally agree. For rency, its citizens will suddenly think it more valuable. example, we completely agree that a dra- You seem to believe that when investors are matic change is needed in how we handle - . no longerwilling to hold a government's debt, situations where countries go bankrupt. > all that needs to be done is to increase the * Second, in the book you set out a blue- , :..: supply and it will sell like hot cakes. We at print for how you believe the IMF can radi- . -. the IMF have considerable experience sug- cally improve its advice on macroeconomic gesting otherwise. We have found that when policy. Your ideas are at best highly contro- . a country in fiscal distress tries to escape versial, at worst snake oil. , r. by printing more money, inflation rises, of- * Third, and most important, in your role as , ten uncontrollably. Uncontrolled inflation chief economist at the World Bank you de- strangles growth, hurting the entire popu- cided to become what you see as a heroic lace, but especially the indigent. When an whistle-blower, speaking out against macro- Mr. Kenneth Rogoff almost bankrupt government fails to cred- economic policies adopted during the 1990s ibly constrain its fiscal deficits, things gen- Asian crisis that you believed to be misguided. You were erally get worse instead of better. 100 percent sure that your policies were absolutely the right ones. I would cloak your theories in the mantle of Arthur Laffer and other extreme expositors of 1980s Reagan-style Let's look at Stiglitzian prescriptions for helping a dis- supply-side economics. Laffer believed that if the gov- tressed emerging market debtor, the ideas you put forth ernment would only cut tax rates, people would work as superior to existing practice. Governments typically harder, and total government revenues would rise. The come to the IMF for financial assistance when they are Stiglitz-Laffer theory of crisis management holds that having trouble finding buyers for their debt and when the countries need not worry about expanding deficits, as in value of their money is falling. The Stiglitzian prescrip- so doing they will increase their debt service capacity tion is to raise the profile of fiscal deficits, that is, to more than proportionately. c 2002 The World Bank TRANSITION, May-June 2002 I do not have time here to do justice to some of your Throughout your book you betray an unrelenting belief in the other offbeat policy prescriptions, but let me say this pervasiveness of market failures and a staunch conviction c _ , about the transition countries. You accuse the IMF of that governments can and will make things better. You call i ' Ihaving "lost Russia." Your analysis of the transition in us "market fundamentalists." We do not believe that mar- Russia reads like a paper in which a theorist abstracts kets are always perfect, as you accuse us of doing, but we t C iilfrom all the major problems and focuses only on the do believe there are many instances of govemment failure w 8 couple he or she can handle. You entirely neglect the as well and that, on the whole, govemment failure is a far fact that when the IMF entered Russia the country was bigger problem than market failure in the developing world. not only in the middle of an economic crisis, it was in Your altemative medicines, involving ever more govemment the middle of a social and political crisis as well. intervention, are highly dubious in many real-world settings." : Stiglitz, the IMF, and Globalization By Thomas C. Dawson Stiglitz accuses the IMF of being driven by a belief in the perfection of markets and the imperfection of governments. The accusation is simply wrong. IMF staff are well aware that they owe their jobs to the imperfections of markets. What is probably true is that the staff of the IMF (and the mid-1990s. The critics say that the entry, and often the World Bank) have, over time, become more confi- the subsequent hasty exodus, of foreign capital into dent about the ability to use markets to serve the public economies that are too small or whose financial sectors interest. What caused this shift? Quite simply, the evi- are ill-equipped to regulate and absorb the capital can dence. Through the 1980s central planning represented be devastating. There is no denying that the vision of the an important alternative to markets as a way of organiz- world the IMF was promoting in the mid-1990s was dif- ing economies. The collapse of the Soviet Union and ferent: at the 1997 IMF-World Bank meetings the pro- the fall of the Berlin Wall suggested to many that mar- posal on the table was to make eventual deregulation of kets, whatever their faults, were a more durable way of international capital flows obligatory for IMF members. organizing a country's economy. This feeling was rein- forced by the good economic performance of the United Nevertheless, while Stiglitz's characterization of a Kingdom and the United States, both of which had moved greater push toward capital account liberalization is to more market-oriented systems during the 1980s. broadly correct, it is inaccurate in many important de- tails. The IMF and the U.S. Treasury did not encour- I take strong exception to the portrayal of IMF staff as age countries to liberalize short-term flows through the uncaring bureaucrats serving the narrow interests of the banking sector, which is what turned out to be the Achil- Western financial community. Stiglitz implies that IMF les heel during the Asian crisis. In addition, many coun- staff see the unemployed "as just a statistic ... the unin- tries liberalize for their own reasons rather than as a tended casualties in the fight against inflation or to en- consequence of external prodding-Thailand, for in- sure that Western banks get repaid." He suggests that stance, was keen to have Bangkok emerge as an in- IMF staffers, like the pilots of "modern high-tech war- ternational financial sector like Singapore. However, as fare" who drop "bombs from 50,000 feet" have no feel- a result of the criticism by Stiglitz and others, the IMF ings for the people whose lives are affected by their is more vocal in pointing out the risks of rapid capital policies. The IMF's staff is drawn from nearly 150 coun- account liberalization. tries. Many are acutely aware of the pain and suffering of the people of developing countries and want the situ- Other aspects of our handling of the financial crisis in ation in these countries to get better. Stiglitz has not Asia have also come in for criticism from Stiglitz and cornered the market on morality and caring. others. We have acknowledged that we made mistakes in our initial response to the crisis. We were surprised Let me acknowledge the validity of some of Stiglitz's by the speed and virulence with which the crisis spread criticisms of the IMF. One criticism is that the U.S. Trea- to many countries in the region. The experience revealed sury and the IMF showed excessive zeal in encourag- that the IMF had not kept up with the rapid develop- ing countries to open up to short-term foreign capital in ments in international capital markets, a deficiency it TRANSITION, May-June 2002 C) 2002 The World Bank has tried to rectify through a number of steps taken over cure a more orderly and timely restructuring of unsus- the last couple of years. tainable sovereign debts. For those of you who may have 1 been following this issue, the mechanism being proposed , Our most glaring error, according to many observers, is to empower a super-majority of creditors to take key 1 e r was to recommend excessive belt-tightening to Thai- decisions in the restructuring process in negotiation with -:XMw 3: land at the start of the crisis. Recall that in July 1997 the debtor. Stiglitz has been quite supportive of the gen- 0 Thailand was still growing rapidly, had a huge and grow- eral idea of having a sovereign debt restructuring mecha- w ing current account deficit (more than 8 percent of GDP), nism. and faced large, though as yet unrecognized, fiscal li- abilities to recapitalize the financial system. It was With t respect to our other main task, poverty alleviation, v against this background that the IMF recommended a Stiglitz notes that the IMF and the World Bank have roughly unchanged fiscal position. However, once the recently launched a new approach. This is a more par- scope of the crisis became evident, we quickly changed ticipatory approach, one that involves a country's gov- course. Indeed, MF-supported programs in Thailand and ernment and its civil society at an early stage in other crisis countries were soon marked by large bud- measuring the size of the poverty problem and in devis- get deficits, in part because of increases in spending on ing development strategies to reduce poverty. We get a social safety net programs. This is exactly the kind of rare compliment when Stiglitz says that even though easing of fiscal policy Stiglitz advocates. participatory assessments are not yet being perfectly implemented "they are a step in the right direction." He There is another, more technical, debate about which also notes correctly that if the gap between the rhetoric there is still no meeting of the minds between Stiglitz and the reality of the new poverty strategy "persists for and others. This debate concerns the appropriateness too long or remains too great, there will be a sense of of the IMF's advice on monetary policy during the Asian disillusionment." crisis. The IMF and many others continue to disagree with Stiglitz's assertion that it is obvious that monetary Thomas Dawson's talk was presented to the MIT Club policy must also be eased at the onset of a financial of Washington on July 2, 2002. crisis. As Larry Summers noted recently, "When a country's exchange rate is declining rapidly because capital is trying to leave the country, and the country's $i n financial institutions are in real trouble, there is a funda- mental conflict between restoring external confidence ar,_ c> by raising interest rates and providing for financial repair 4p l I through increased liquidity. It's a classic problem of a F J I_ single instrument and multiple targets. Confidence is ? AU widely recognized as essential in combating financial cr ises." Others have taken similar positions. MIT Pro- fessor Rudiger Dornbusch, for instance, says that "in- - vestors will take confidence and bring money back when - they see fiscal conservatism and high interest rates. Do that for a few months and you are on the right track." So the point is that professional consensus on this topic is lacking. What is needed is honest debate and a closer -- ,t F ' look at the evidence, not polemics. The experience of more recent financial crises, such as the one in Argentina, suggest that our existing mecha- d1 nisms to resolve crises in a rapid and orderly fashion do not work smoothly. One problem is that governments do , ' not deal with their sovereign debt problems promptly; they often allow the situation to fester until a crisis is precipitated. Our current deputy head, Anne Krueger, ./ has suggested creating a statutory mechanism to se- C 2002 The World Bank TRANSITION, May-June 2002 jExcerpts from Globalization and Its Discontents g1 By Joseph Stiglitz 1 On Russia's 1998 Crisis The country was deeply in debt, and the higher interest rates that the East Asia crisis had provoked created an enormous additional strain. This rickety tower collapsed when oil prices fell. Oil is both a major export commodity ' and a source of government tax revenue for Russia, and the drop in prices had a predictably devastating effect. Given the exchange rate at the time, Russia's oil industry could cease being profitable. A devaluation would then l be inevitable. It was clear that the ruble was overvalued. Russia was flooded with imports, and domestic producers were having a hard time competing. The switch to a market economy and away from the military was supposed to * allow a redeployment of resources to produce more consumer goods, or more machines to produce consumer goods. But investment had halted, and the country was not producing consumer goods. The overvalued exchange rate, combined with the other macroeconomic policies foisted on the country by the IMF, had crushed the economy, and while the official unemployment rate remained subdued, there was massive disguised unemployment. The managers of many firms were reluctant to fire workers, given the absence of an adequate safety net. Though unemployment was disguised, it was no less traumatic: while the workers only pretended to work, the firms only pretended to pay. Wage payments fell into massive arrears, and when workers were paid, it was often with bartered goods rather than rubles. If for these people, and for the country as a whole, the overvalued exchange rate was a disaster, for the new class of businessmen the overvalued exchange rate was a boon. They needed fewer rubles to buy their Mercedes, their Chanel handbags, and imported Italian gourmet foods. For the oligarchs trying to get their money out of the country, too, the overvalued exchange rate was a boon-it meant that they could get more dollars for their rubles, as they squirreled away their profits in foreign bank accounts. Despite this suffering on the part of the majority of Russians, the reformers and their advisers in the IMF feared a devaluation, believing that it would set off another round of hyperinflation. They strongly resisted any change in the exchange rate and were willing to pour billions of dollars into the country to avoid it. By May, and certainly by June of 1998, it was clear Russia would need outside assistance to maintain its exchange rate. Confidence in the currency had eroded. In the belief that a devaluation was inevitable, domestic interest rates soared and more money left the country as people converted their rubles for dollars. Because of this fear of holding rubles, and the lack of confidence in the government's ability to repay its debt, by June 1998 the government had to pay almost 60 percent interest rates on its ruble loans (GKOs, the Russian equivalent of U.S. Treasury bills). That figure soared to 150 percent in a matter of weeks. Even when the govern- ment promised to pay back in dollars, it faced high interest rates. (Yields on dollar-denominated debt issued by the Russian government rose from slightly over 10% to almost 50%, 45 percentage points higher than the interest rate the U.S. government had to pay on its Treasury bills at the time.) The market thought there was a high probability of default, and the market was right. The IMF came to the rescue with $4.8 billion in July 1998. When the crisis hit, the IMF led the rescue efforts, but it wanted the World Bank to provide $6 billion of the rescue package. The total rescue package was for $22.6 billion. The IMF would provide $11.2 billion of this total, the World Bank would lend $6 billion, and the rest would be provided by the Japanese government. This was hotly debated inside the World Bank. There were many of us who had been questioning lending to Russia all along. We ques- tioned whether the benefits to possible future growth were large enough to justify loans that would leave a legacy of debt. Many thought that the IMF was making it easier for the government to put off meaningful reforms, such as collecting taxes from the oil companies. The evidence of corruption in Russia was clear. Apart from these moral issues, there were straightforward economic issues. The IMF's bailout money was sup- posed to be used to support the exchange rate. However, ... [o]ur calculations showed that Russia's exchange rate was overvalued, so providing money to maintain that exchange rate was simply bad economic policy. Moreover, calculations at the World Bank before the loan was made, based on estimates of government revenues and TRANSITION, May-June 2002 C 2002 The World Bank expenditures over time, strongly suggested that the July 1998 loan would, not work. Unless a miracle brought interest rates down drastically, by the time autumn rolled around, Russia would be back in crisis. U-- There was another route by which I reached the conclusion that a further loan to Russia would be a great mistake. Russia was a naturally resource-rich country. If it got its act together, it didn't need money from the outside; and if it didn't get its act together, it wasn't clear that any money from the outside would make much difference. Under either scenario, the case against giving money seemed compelling. In spite of strong opposition from its own staff, the Bank was under enormous political pressure from the Clinton administration to lend money to Russia. The Bank managed a compromise, publicly announcing a very large loan, but providing the loan in tranches install- ments. A decision was taken to make $300 million available immediately, with the rest available only later, as we saw how Russia's reforms progressed. Most of us thought that the program would fail long before the additional money had to be forthcoming. Our predictions proved correct. Three weeks after the loan was made, Russia announced a unilateral suspension of payments and a devaluation of the ruble. The ruble crashed. By January 1999, the ruble had declined in real effective terms by more than 45 percent from its July 1998 level. The August 17 announcement precipitated a global financial crisis. Interest rates to emerging markets soared higher than they had been at the peak of the East Asian crisis. The surprise about the collapse was not the collapse itself, but the fact that it really did take some of the IMF officials-including some of the most senior ones-by surprise. They had genuinely believed that their program would work. Our own forecast proved only partially correct: we thought that the money might sustain the exchange rate for three months; it lasted three weeks. We felt that it would take days or even weeks for the oligarchs to bleed the money out of the country; it took merely hours and days. By lending Russia money for a doomed cause, IMF policies led Russia into deeper debt, with nothing to show for it. The cost of the mistake was not borne by the IMF officials who gave the loan, or America who had pushed for it, or the Western bankers and the oligarchs who benefited from the loan, but by the Russian taxpayer. There was one positive aspect of the crisis: The devaluation spurred Russia's import competing sectors-goods actually pro- duced in Russia finally took a growing share of the home market. This "unintended consequence" ultimately led to the long-awaited growth in Russia's real (as opposed to black) economy. On the Bolshevik Approach to Market Reform Had the radical reformers looked beyond their narrow focus on economics, they would have found that history shows that most of the experiments in radical reform were beset by problems. This is true from the French Revolution in 1789, to the Paris Commune of 1871, to the Bolshevik Revolution in Russia in 1917, and to China's Cultural Revolu- tion of the 1960s and 1970s. It is easy to understand the forces giving rise to each of these revolutions, but each produced its own Robespierre, its own political leaders who were either corrupted by the revolution or took it to extremes. By contrast, the successful American "Revolution" was not a true revolution in society; it was a revolution- ary change in political structures, but it represented an evolutionary change in the structure of society. The radical reformers in Russia were trying simultaneously for a revolution in the economic regime and in the structure of society. The saddest commentary is that, in the end, they failed in both: a market economy in which many old party apparatchiks had simply been vested with enhanced powers to run and profit from the enterprises they formerly managed, in which former KGB officials still held the levers of power. There was one new dimension: a few new oligarchs, able and willing to exert immense political and economic power. In effect, the radical reformers employed Bolshevik strategies though they were reading from different texts. The Bolsheviks tried to impose communism on a reluctant country in the years following 1917. They argued that the way to build socialism was for an elite cadre to "lead" (often a euphemism for "force" ) the masses into the correct path, which was not necessarily the path the masses wanted or thought best. In the "new" post-Communist 0 2002 The World Bank TRANSITION, May-June 2002 revolution in Russia, an elite, spearheaded by international bureaucrats, similarly attempted to force rapid change on a reluctant population. £ 0 Those who advocated the Bolshevik approach not only seemed to ignore the history of such radical reforms but also postulated that political processes would work in ways for which history provided no evidence. For instance, economists such as Andrei Shleifer, who recognized the importance of the institutional infrastructure for a market U w economy, believed that privatization, no matter how implemented, would lead to a political demand for the institu- tions that govern private property. Shleifer's argument can be thought of as an (unwarranted) extension of Coase's theorem. The economist Ronald H. E qi, Coase, who was awarded a Nobel Prize for his work, argued that in order to achieve efficiency, well-defined property rights are essential. Even if one distributed assets to someone who did not know how to manage them well, in a society with well-defined property rights that person would have an incentive to sell to someone who could manage the assets efficiently. That is why, advocates of rapid privatization argued, one didn't really need to pay close attention to how privatization was accomplished. It is now recognized that the conditions under which Coase's conjecture is valid are highly restrictive-and certainly weren't satisfied in Russia as it embarked on its transition. Shleifer and company, however, took Coase's ideas further than Coase himself would have done. They believed that political processes were governed in the same way as economic processes. If a group with vested interests in property could be created, it would demand the establishment of an institutional infrastructure necessary to make a market economy work, and its demands would be reflected in the political process. Unfortunately, the long history of political reforms suggests that the distribution of income does matter. It has been the middle class that has demanded the reforms that are often referred to as "the rule of law." Today, in Russia, we do not see demands for strong competition policy forthcoming from the oligarchs, the new monopolists. Demands for the rule of law have come from these oligarchs, who obtained their wealth through behind-the-scenes special deals within the Kremlin, only as they have seen their special influence on Russia's rulers wane. On Changing the Global Financial Architecture The reforms of the international financial system have only just begun. In my mind, among the key reforms required are the following: * Acceptance of the dangers of capital market liberalization, and that short-term capital flows ("hot money") impose huge externalities, costs borne by those not directly party to the transaction (the lenders and borrowers). Whenever there are such large externalities, interventions-including those done through the banking and tax systems-are desirable. Rather than resisting these interventions, the international financial institutions should be directing their efforts to making them work better. * Bankruptcy reforms and standstills [Editor's Note: suspension of payment by the government]. The appro- priate way of addressing problems when private borrowers cannot repay creditors, whether domestic or foreign, is through bankruptcy, not through an IMF-financed bailout of creditors. What is required is bankruptcy reform that recognizes the special nature of bankruptcies that arise out of macroeconomic disturbances; what is needed is a super-Chapter 11, a bankruptcy provision that expedites restructuring and gives greater presumption for the contin- uation of existing management. Such a reform will have the further advantage of inducing more due diligence on the part of creditors, rather than encouraging the kind of reckless lending that has been so common in the past. * Less reliance on bailouts. With increased use of bankruptcies and standstills, there will be less need for the big bailouts, which failed so frequently, with the money either going to ensure that Western creditors got paid back more than they otherwise would, or that exchange rates were maintained at overvalued levels longer than they otherwise would have been (allowing the rich inside the country to get more of their money out at more favorable terms, but leaving the country more indebted). * Improved banking regulation-both design and implementation-in the developed and the less developed countries alike. Weak bank regulation in developed countries can lead to bad lending practices, an export of instabil- ity. While there may be some debate whether the design of the risk-based capital adequacy standards adds to the TRANSITION, May-June 2002 C© 2002 TlIe World Bank stability of the financial systems in the developed countries, there is little doubt that it has contributed to global instability, by encouraging short-term lending. [Editor's Note: An international standard which recommends minimum - capital adequacy ratios has been developed to ensure that banks can absorb a reasonable level of losses before becoming insolvent. Thus banks have to lock up certain percentage of their total capital, depending on their risk- weighted credit exposure.] Financial sector deregulation and the excessive reliance on capital adequacy standards l , has been misguided and destabilizing; what is required is a broader, less ideological approach to regulation, adapted to the capacities and circumstances of each country. Thailand was right to have restricted speculative real estate lending in the 1 980s. It was wrong to encourage the Thais to eliminate these restrictions. There are a number of other | restrictions such as speed limits (restrictions on the rate of increase of banks' assets) which are likely to enhance stability. Yet the reforms cannot, at the same time, lose sight of the broader goals: a safe and sound banking system is important, but it must also be one that supplies capital to finance enterprises and job creation. LI * Improved risk management. Today, countries around the world face enormous risk from the volatility of exchange rates. While the problem is clear, the solution is not. Experts-including those at the IMF-have vacil- L____ lated in the kinds of exchange-rate systems, that they have advocated. They encouraged Argentina to peg its currency to the dollar. After the East Asia crisis, they argued that countries should either have a freely floating exchange rate or a fixed peg. With the disaster in Argentina, this advice is likely to change again. No matter what reforms occur to the exchange rate mechanism, countries will still face enormous risks. Fixing their exchange rate to one currency will not resolve the problems; it can actually exacerbate fluctuations with respect to other curren- cies. But there are other dimensions to risk. The Latin American debt crisis in the 1980s was brought about by the huge increase in interest rates, a result of Federal Reserve Chairman Paul Volcker's tight money policy in the United States. Developing countries have to learn to manage these risks, probably by buying insurance against these fluctuations in the international capital markets. * Improved safety nets. Most developing countries have weak safety nets, including a lack of unemployment insurance programs. Even in more developed countries, safety nets are weak and inadequate in the two sectors that predominate in developing countries, agriculture and small businesses, so international assistance will be essential if the developing countries are to make substantial strides in improving their safety nets. * Improved response to crises. We have seen the failure of the crisis responses in the 1997-98 crisis. The assistance given was badly designed and poorly implemented. The programs did not take sufficiently into account the lack of safety nets, that maintaining credit flows was of vital importance, and that collapse in trade between countries would spread the crisis. The policies were based not only on bad forecasts but on a failure to recognize that it is easier to destroy firms than to recreate them, that the damage caused by high interest rates will not be reversed when they are lowered. There needs to be a restoration of balance: the concerns of workers and small businesses have to be balanced with the concerns of creditors; the impacts of policies on domestic capital flight have to balance the seemingly excessive attention currently paid to outside investors. Responses to future financial crises will have to be placed within a social and political context. Apart from the devastation of the riots that happen when crises are mismanaged, capital will not be attracted to countries facing social and political turmoil, and no government, except the most repressive, can control such turmoil, especially when policies are perceived to have been imposed from the outside. Most important, there needs to be a return to basic economic principles; rather than focusing on ephemeral investor psychology, on the unpredictability of confidence, the IMF needs to return to its original mandate of providing funds to restore aggregate demand in countries facing an economic recession. As the United States went into a recession in 2001, the debate was not whether there should be a stimulus package, but its design. By now, the lessons of Argentina and East Asia should be clear: confidence will never be restored to economies that remain mired in deep recessions. Part of the reason I remain hopeful about the possibility of reforming the international economic institutions is that I have seen change occur at the World Bank. It has not been easy. Nor has it gone as far as I would have liked. But the changes have been significant. By the time I arrived, the new president, James Wolfensohn, was well on his way to trying to make the Bank responsive to the concerns of the developing countries. Though the new direction was not always clear, the intellectual foundations not always firm, support within the Bank far from universal, the Bank had begun seriously to address the fundamental criticisms levied at it. Reforms involved changes in three areas: development, aid in general and the Bank's aid in particular; and-the relationship between the Bank and the developing countries. C 2002 The World Bank TRANSITION, May-June 2002 How Free from Fear Are Citizens in Transition 1 Societies? By Richard Rose 1 Freedom from fear is the first freedom. If people live in fear of their lives, any advantage gained through education or a higher income can be wiped out by a single violent act. If the state cannot ensure - 1 individual security, it is failing in its primary obligation to maintain order. The collapse of the old re- gimes in transition countries has not only brought greater freedom for ordinary people, but also for I criminals. While the collective security figures represent anxieties about what might happen, the indi- vidual security index reflects what has actually happened to individuals, their families, or their friends. When the All-Russian Center on Research of Public Lithuania, where 39 percent of survey respondents have Opinion asks whether Russians value order or democ- been victimized or know someone whose house has racy more, most people consistently put order first. been broken into, and Russia, where more than a third Russians do not-want a return to Soviet-style repres- of survey respondents live in unsafe areas. Poles and sion, but-they do want freedom from fear. Security and Slovenes have the least to fear, as fewer than one-sixth fe-ar are states of mind. For that reason, we need data have been affected by burglaries. about individual attitudes rather than official statistics that notoriously under-report crimes. For the past de- Altogether, 40 percent of citizens have immediate grounds cade, the Centre for the Study of Public Policy has been for insecurity because they, a family member, or a friend collecting evidence of individual and collective insecu- have been mugged on the street or had their house bro- rity in its nationally representative barometer surveys of ken into (see the figure). In Lithuania 57 percent of citi- the public in postcommunist countries in transition (see zens have been touched by crime, and in Slovakia, 53 http://www.cspp.strath.ac.uk). percent have been affected. Even in the safest country in the region, Slovenia, 24 percent have been too close for Measuring Individual Insecurity comfort to street crime or having their house burgled. Paradoxically, security can be defined by its opposite, Even among people who have not been victimized or a sense of insecurity. In the past year in 11 Central and known a victim of crime, high crime rates encourage a Eastern European countries 7 Table 1. Experience of Violent Crime, Selected Transition Countries percent of adults have been robbed while on the street, 9 percent have had a family mem- Survey questions: In the past year have you or anyone in your family or your ber attacked, and 12 percent friends been attacked or had something stolen when on the street? In the past have had a friend attacked. year have you or any friends had their house broken into and something stolen? Safety on the streets is highest The total number of respondents was 13,010. in Slovenia, where only 14 per- Attacked on the street Theft from house cent of survey respondents have Country Self Family Friend None Own Friend None been close to street crime, and Slovenia 3 6 5 86 4 11 85 is lowest in Slovakia, where 44 Latvia 7 6 7 79 7 11 82 percent of survey respondents Hungary 7 8 6 78 8 14 77 have good grounds to feel inse- Poland 5 9 9 77 4 9 87 cure (table 1). Estonia 3 8 14 75 6 22 71 Romania 9 5 13 73 6 11 83 Bulgaria 10 8 14 69 14 16 69 House break-ins are wide- Czech Republic 8 9 14 68 6 20 73 spread. One in 12 households Russia 7 8 20 67 8 29 64 has been robbed and 1 in 6 Lithuania 11 14 15 61 19 19 61 adults have had a friend whose Slovakia 11 14 19 56 9 22 68 house has been burgled. The Source: Centre for the Study of Public Policy, New Europe Barometer I (Glasgow, 2001) extent of burglary is highest in and New Russia Barometer X (Glasgow, 2001). TRANSITION, May-June 2002 © 2002 The World Bank feeling of insecurity. For example, among Russians who In all three Baltic states the majority feels much more have not been affected by crime in the past year, more insecure than the Russian minority. Among Estonian than half feel unsafe on the streets and two-fifths feel nationals, 96 percent see the Russian minority as a unsafe at home. Altogether, 70 percent of Russians feel potential threat to peace; among Latvians, 80 percent vulnerable to attack on the streets. see Russian residents as a potential threat, and this is also true of 60 percent of Lithuanians. By contrast, 67 Measuring Collective Insecurity percent of Russians in Estonia see ethnic problems as a potential cause of trouble and only 27 percent see Individual and collective security differ in the directness them as more than a little threat. Among the Russian of their impact. Collective insecurity is a sense of vul- minority in Latvia, 56 percent see ethnic problems as nerability to what might happen. Whereas street crime threatening, and in Lithuania the figure is 48 percent. A and burglary are everyday occurrences, collective measure of fear of the Russian state affects almost all threats to security are contingent risks. In the 11 coun- Estonians and Latvians and five-sixths of Lithuanians. tries surveyed here, the great majority of citizens have In the minority population, few see the Russian state as not lived in a war zone or been caught up in domestic posing a big or some threat, but less than half dismiss it ethnic conflict. The extent to which people see such as giving no cause for concern. The largest Russian ethnic group sees the Russian state as Figure 1. Grounds for Insecurity, Selected Transition Countries having at least a little potential to Robbed on street and/or had house broken into threaten the security of the Baltic states. Friend In countries where ethnic minorities are only a small percentage of the popula- s df8thSelt y Iiita tion, from two-thirds to nine-tenths of the 21% population do not see them as a big or some threat to peace. By contrast, in Russia, where an internal war is raging in Chechnya, more than two-thirds of the population see minority ethnic groups as posing at least a small threat to do- mestic security, and in Slovakia, where nationalists have sought to make political capital by propagating anti-Hungarian sen- timents, concern about ethnic problems is even higher. Even countries that are ethnically ho- mogeneous today, such as Poland, have Noonow neighbors with whom they have been at 60% war in the past. While substantial fears Source: Combined answers to questions reported in table 1. of their neighbors are only evident in the Baltic states, in 9 of the 11 countries conflicts as threatening their own security will vary with surveyed the median citizen expresses at least a little national circumstances (table 2). Peoples from the anxiety about nearby threats to peace and security. Baltic countries are doubly insecure. In Estonia, Latvia, and Lithuania more than two-thirds see some threat Two Indexes Not One from the Russian Federation and more than two-thirds see ethnic conflict within Estonia and Latvia as a pos- Simple indexes are popular in policy debate, because they sibility. While the small percentage of Russians in can be condensed into a headline based on league tables Lithuania substantially reduces anxieties about ethnic that! show which country is doing best and which worst. In conflict there, Lithuanians are almost as insecure as policy analysis, however, adding up incommensurables their Baltic neighbors in worrying about the Russian hides information rather than highlighting it. Individual and state. collective security differ fundarnentally in their cause and © 2002 The World Bank TRANSITION, May-June 2002 i; in the problems they present to governments. Crime waves popular fears of being a victim of crime substantially in- Ii require honest and effective policing and social policies to creases individual insecurity. Whereas two-thirds of Rus- I reduce the causes of crime. By contrast, threats from neigh- sians report that they do not know people who have been i: bonng states require military force and threats from ethnic directly affected by crime in the street, only 15 percent minorities require patient negotiation, and even exceptional say they definitely feel safe when they go out on the street. legislation, to reduce friction with the majority. Collective security issues addressed in arguments While individual and collective security differ, a country could about expanding NATO to include more transition coun- be doing well on both counts. This is the case in Poland tries reflect real military concerns, but discussions and Slovenia, where crime against individuals is relatively about ballistic missiles are, literally and figuratively, low and threats from ethnic minorities and neighboring over the heads of the great majority of people in the it.. ~ states are also low. Hungarians are also relatively secure. region. Insecurity is chiefly the fear of being hit on the Bulgaria, the Czech Republic, and Romania are close to head while out on the street or having one's home the regional average for both experience of crime and a burgled while out or while in it. If transition states are sense of collective security. However, crimes take many to demonstrate their effectiveness, they must do more forms. Whereas only a sixth of Romanians report being to reduce the violent crime that generates widespread affected by crimes of violence, the New Europe Barometer insecurity here and now. shows that 88 percent think that corruption is rife in gov- ernment. Richard Rose is director of the Centre for the Study of Public Policy, University of Strathclyde, Glasgow, and By contrast, in Lithuania and Slovakia individual insecu- convenor of the Global Barometer Survey Network, which rity is high because of violent crimes, and collective inse- covers Africa, East Asia, and Latin America as well as curity is relatively high too. Estonia and Russia are doing postcommunist countries. His latest book is Elections relatively badly, because while individual insecurity is about without Order: Russia's Challenge to Vladimir Putin (Cam- average for the region, collective insecurity is worse than bridge, U.K.: Cambridge University Press, 2002), with Neil average. In Latvia, the above average perception of free- Munro. For more details see http.//wwwcspp.strath.ac.uk. dom from violent crime is off- set by above average anxiety Table 2. Ethnic Minorities and Perceptions of Neighboring Countries as Threats, about collective security. Selected Transition Countries (percentage of respondents) In percentage terms, the dif- ference between quantitative Survey questions: Do you think ethnic relations pose a threat to peace and security ierendicabeto idvuatitati an in this society? Do you think neighboring countries pose a threat to the peace and indicators of Individual and collective security is limited, security of this country? The total number of respondents was 12,718. An average of 40 percent- of Threats from Threats from survey respondents have been ethnic groups neighboring countries affected by crime, 29 percent Country Some Little None Some Little None see some ora big threat from Slovenia 10 28 62 11 37 51 ethnic conflict within their so- Hungary 19 31 50 23 42 35 ciety and 26 percent see a Poland 18 36 46 20 37 43 cieaty Bulgaria 29 30 41 19 31 50 threat from neighboring coun- Lithuania 22 37 41 33 40 27 tries. However, there is a fun- Romania 32 29 38 27 26 46 damental difference between Czech Republic 24 42 33 8 50 41 the measures. While the col- Russia 44 25 30 34 30 36 lective security figures repre- Latvia 37 33 30 49 27 23 sent anxieties about what Slovakia 43 32 24 30 38 33 might happen, the individual Estonia 43 42 15 51 29 20 security index reflects what Note: "Some threat" includes a small percentage of respondents who see the issue as a has actually happened to in- big threat. dividuals, their families, or Sources: Centre for the Study of Public Policy, New Russia Barometer X (Glasgow: their friends. Adjusting crime 2001), New Baltic Barometer IV (Glasgow: 2000), New Democracies Barometer V figures to take into account (Glasgow: 1998). TRANSITION, May-June 2002 C 2002 The World Bank Undertaking a Difficult Transition in Yugoslavia ByAleksandra Brankovic and Aleksa Nenadovic Transition in the Federal Republic (FR) of Yugoslavia various products and services. By October 2000 the av- J - 2 had initially begun in the 1990s, alongside similar en- erage monthly wage equaled about $40, and the middle II 0 w deavors in other formerly communist countries. Soon class had virtually disappeared . 3 FR Yugoslavia split into five independent countries. Ex- cept in Slovenia war, the suspension of business and Changes after October 2000 trade relationships among the new states, and the move- ment of large number of refugees made the transition In October 2000 dramatic changes began: extremely painful. In Serbia and Montenegro these trends were further aggravated by their international economic * Prices were liberalized, and so most price distortions ..-. and political isolation (with UN sanctions lasting from disappeared. As a result, year-on-year inflation increased, 1992 to 1995), by their extremely high inflation, by NATO but in 2001 cumulative inflation was reduced to 40.7 per- bombardment in 1999, and by economic mismanage- cent from 112 percent in 2000. Inflation did not fall more ment and disinvestment.:Economic and political changes because of higher electricity tariffs and fees for public were initially delayed, and later completely halted. utility services, which alone contributed two-thirds of the 40.7 percent inflation rate (see the table on the next page). Expectations and Disappointments * Once the new democratic government took power, this was soon followed by the renewal of Serbia's mem- The political changes in 2000 raised expectations that bership in various international economic institutions, the country would step away from its recent past and including the IMF, the World Bank, and the European move toward economic and social recovery and growth, Bank for Reconstruction and Development. Serbia signed even though the situation at the end of 2000, when the an agreement with the Paris Club that enables Serbia to new leadership took over, was not encouraging. As in undertake a phased, 66 percent write-off of debt totaling other transition economies, output has fallen significantly $4.5 billion, which represents about 40 percent of the since 1989, the beginning of transition, but in Yugosla- country's total external debt. About half of the debt write- via it has not yet recovered. At the end of the 1990s off will come into effect as soon as a three-year agree- GDP shrank to less than half of its 1989 level, and monthly ment with the IMF has been signed, and the rest will be industrial production was less than one-third of that in written off following successful completion of the IMF 1989. During the period of international isolation the agreement. This write-off is critically important if Serbia shadow economy accounted for a large proportion of wants to go ahead with economic reconstruction and GDP, and unemployment also rose significantly. reforms. * Major progress was also achieved in liberalizing the Before the recent political changes the fiscal system foreign trade regime. Bureaucratic obstacles were abol- was complex and was characterized by a lack of trans- ished, customs duties were lowered, and customs tar- parency. Approximately 40 percent of public expendi- iffs and procedures were simplified. tures were financed outside the budget and special tax * In December 2000 the country adopted a managed concessions were granted to "privileged" taxpayers. float exchange rate. The exchange rate has been stable ever since, which in turn has significantly lowered infla- Even though FR Yugoslavia had already had serious prob- tionary expectations and strengthened confidence in the lems with unemployment before, in the 1990s the,situation domestic currency. Last year the value of foreign ex- deteriorated further and the number of unemployed reached change reserves doubled. a quarter of the labor force (this figure does not take the * The National Bank of Yugoslavia has become a largely agriculturallaborforceintoaccount). Largenumbersofthose independent institution, and has pursued a monetary who were officially employed were in reality on forced leave policy based on fully covering the money supply with and received only the minimum wage. At one point in 1993 foreign currency reserves. It stopped its earlier practice their number was estimated as at least 800,000. of directly lending to enterprises, and also reduced its loans to the government. The steady increase in the Inflation was generally high throughout the 1990s even monthly growth rate of the money supply through 2001 though the state controlled the prices of and fees for reflected the gradual remonetization of the Serbian © 2002 The World Bank TRANSITION, May-June 2002 III Basic Economic Indicators, Serbia, 1998-2002 Ii Indicator 1998 1999 2000 2001 2002 I Real GDP growth ($) 2.3 -18.3 5.7 6.2 4.0 Growth in industrial production (%) 4 -26 12 0 3 Growth in the real net wage index (%) 2 -16 6 17 4 il Open unemployment rate (%) 22.8 25.5 25.6 26.8 27.9 Trade balance ($ millions) -1,673 -1,512 -1,773 -2,493 -2,624 Exports of commodities ($ millions) 2,685 1,369 1,557 1,708 1,947 Percentage change in commodities' exports 8.8 -49.0 13.7 9.7 14.0 Imports of commodities ($ millions) 4,358 2,881 3,330 4,201 4,571 Percentage change in commodities' imports 0.7 -33.9 -15.6 26.2 8.8 * Real Ml, end of period (DM millions) 1,280 744 988 2,161 2,874 Foreign currency reserves of the National Bank of Yugoslavia, year end ($ millions) n.a. 297 524 1,169 1,319 Discount rate, average of monthly rates (%) n.a. 2.13 2.00 1.47 n.a. Market interest rate, average of monthly rates (%) 7.0 4.3 5.8 4.8 n.a. Consumer price inflation, year-on-year (%) 29.9 43.5 112 40.7 n.a. Exchange rate, yearly average (YUN/$) 11.2 23.2 54.9 66.4 n.a. n.a. Not available. Source: Based on projections by the G17 Institute, the Serbian and Yugoslav governments, and the IMF. economy and did not risk acceleration of the inflation cent will be distributed for free to adult citizens. Three rate. cement plants have already been sold for about $150 * Restructuring the banking sector proved to be more million through public tenders. State-owned enterprises difficult than had been foreseen. Four major banks rep- still control 80 percent of the capital stock and employ resenting 15 percent of the country's banking sector almost 75 percent of the labor force, but generate not were shut down because they had incurred losses of more than 50 percent of total profits. about $35 million in the first 11 months of 2001. How- ever, some other banks that had been shut down be- Future Challenges cause of illegal operations are now back in operation following a decision by the Supreme Court, which is The prices of electricity and public utilities should be still under the influence of Slobodan Milosevic's cro- liberalized in the coming years. This must be done nies. gradually so as not to further jeopardize people's live- * A new fiscal system was introduced, affirming the lihoods and to induce individual savings. [Editor's note: integration of the budget and pooling all fiscal revenues According to a recent article from the Washington and fiscal expenses. In 2001 the fiscal deficit was lower Post, official estimates put unemployment at 35 per- than expected, namely (1.2 percent of GDP instead of cent. Laid-off workers receive a year and a half of ben- 6 percent as projected, because of efficient collection efits and are then on their own. One-third of Serbs of fiscal revenues and lower public expenditure. subsist on the equivalent of a dollar a day; another * The number of people employed in state-owned en- third live on twice that. The country is experiencing a terprises has gradually shrunk, while the number of typical post-Berlin Wall hangover of unfulfilled expec- those employed by the private sector has been rising. tations.] In December 2001 the new Labor Law was passed that made it easier for employers to hire and fire employ- Even though public debt was lower in 2001 than ex- ees. pected, it could increase in the coming years for several * With the enactment of the Privatization Law in 2001 reasons: increasing public investment; restructuring of Serbia adopted the necessary legal and institutional the economy, which is likely to cost more than fore- framework to start privatization, which will be carried seen; and servicing external debt. Options to help im- out through public tenders and public auctions. Em- prove fiscal performance include adopting a public ployees may acquire shares free of charge up to 15 procurement law, establishing a treasury system, and percent of an enterprise's capital, and another 15 per- introducing a value added tax. TRANsITiON,;May-June 2002 C 2002 The World Bank The deep-seated industrial decline could be turned around and as soon as improvements are visible in other fields, with a large amount of foreign direct investment that the level of foreign investment should gradually increase. brought new equipment and new technology into the coun- try. As for energy, the security of the energy supply could Auctions and sales of small and medium enterprises be an issue in the future. Serbia has already borrowed (SMEs) began in 2002, and 150 large state-owned en- several loans to rebuild its energy production and distri- terprises are to be privatized over the next four years. r bution network, but until private investment starts to flow The restructuring of large, insolvent enterprises-which in, the situation will remain problematic. employ more than 200,000 people, or 9.5 percent of the labor force-will also start in 2002 with the objective of Unfortunately, high interest rates discourage investment. preparing them for privatization in the future. Public en- Rates are high not because money is unavailable, but as terprises will be restructured in the short and medium a leftover from 2001, when investing was extremely risky. term. In the short term restructuring will be based on - Inflows of foreign direct investment have not been signifi- decentralizing, or even separating, various units of en- cant so far. Foreign investors are waiting for macroeco- terprises. Eventually business activities will be exposed nomic stabilization and for a more favorable institutional to market forces and hard budget constraints will be environment. They are still deterred by the risks of social imposed, while protecting public interests. Speeding up unrest and political conflicts, the federation's uncertain the development of SMEs is important, because the future, the complicated bureaucratic procedures, the in- expectation- is that SMEs will absorb much of the labor efficient judicial system, and the still undeveloped finan- made redundant as a result of the restructuring of large cial markets. Some of these issues have been addressed, state-owned enterprises. The G17 Institute: Belgrade's Catalyst for Reform The G17 Institute was established in response to the radical economic and political changes that took place in Serbia and Montenegro following the victory of opposition candidate Vojislav Kostunica in the September 24, 2000, presidential elections. The institute grew out of the original Group 17 (G17), an organization that brought together economists and experts in other social sciences with the aim of promoting and implementing the ideas of a modern market economy, an open and democratic society, and the rule of law through its programs, projects, and public activities. Over the last 10 years economic issues have been completely marginalized by politicians who favored irrational and populist policies and failed to recognize that without adequate solutions to economic problems there would be no progress in other areas. In June 2001 G17 became the G17 Institute, a research institute devoted to the study of economic processes and the application of contemporary achievements in economics, with the objective of promoting economic and social advances in Serbia. Research activities include both macroeconomic and microeconomic policy issues, as well as more specialized areas, such as business economics, current economic trends and policies, meth- ods of economic analysis, human resources development, spatial and regional economics, international eco- nomics and technological development, and investment project planning. Another important part of the institute's work involves education and dissemination. Since 1998 G17 has conducted highly successful three- to four- week economic policy summer schools. A number of talented young researchers excelled during the schools and some of them are currently working as researchers in the institute. The institute has continued this activity and plans to increase the number and frequency of such courses. The ultimate objective is to create a small graduate school for economics. The institute's goal is to increase academic understanding of the transition to a market economy in the country, but also to provide expertise and economic advice to domestic and foreign policymakers and international organizations. The institute places great emphasis on promoting cooperation with similar institutes abroad through regular exchanges of visitors and through research;scholarships. The institute currently employs 15 full- and part-time researchers, and is divided into four departments that deal with social policy, macroeconomics, institutional reforms, and European integration. Its research findings are disseminated by means of monthly publications, press conferences, special publications, public debates, roundtables, and frequent appearances in the media by its staff. In September 2001 the institute initiated a series of working papers. © 2002 The World Bank TRANSITION, May-June 2002 Strengthening bilateral and multilateral economic relations Uncertainty surrounding Serbia's and Montenegro's with other countries and intemational institutions is also a future relations could also slow down the reform pro- - priority. FR Yugoslavia has applied for WTO membership cess and postpone the inflow of foreign investment. and is negotiating a stabilization and association agree- A three-year "probation" period as agreed to by the m g r lil ment with the EU. FR Yugoslavia might become a WTO two republics is not a stable framework for a long- I -I a 11 member in the next four or five years, but probably would term strategy. Kosovo's provisional status is another w not be able to join the EU before the next decade. By the source of uncertainty. Finally, Serbia is still a fragile c £- | end of 2002 it will have signed agreements on free trade democracy, with complicated relationships within the with all-the Southeast European countries, and a free trade ruling coalition, and nationalistic sentiments are still ') 1 area will be subsequently formed. This might help the coun- strong. These factors make foreign investors cau- try improve its extemal position by reducing its high trade tious. Thus the policymakers in Belgrade face a ;ii deficit. Lagging export performance to date has mainly been daunting task in sustaining the reforms needed for X! an outcome of neglecting to improve product quality and economic recovery. maintaining inefficient production systems and manage- ment at the enterprise level. For years enterprises were The authors are junior researchers at the G17 Insti- oriented towards rent-seeking and tax evasion, and little tute, Belgrade, Knez Mihailova 10, 11000 Belgrade, investment took place. Thus export recovery requires radi- Yugoslavia, email: office@gl 7institute.com, URL: cal restructuring and technological upgrading. http://www.g17institute.coml. International Training Program for Entrepreneurs in Mekong Countries By John McKenzie Vietnamese entrepreneurs, emerging from the economic shadow of the state sector, eagerly responded to the recent publication of a "Teach Yourself Business Management" series. Demand has been so strong that it has generated impetus for the creation of a new, multifaceted, flexible training program in business to reach out to small and medium enterprises throughout Cambodia, Laos, and Vietnam. A major effort of the Mekong Project Development Facil- were offered were expensive, and course content was ity (MPDF)-an international program managed by the largely taken from Western business schools. International Finance Corporation that supports private, domestic small and medium enterprises (SMEs) in Cam- MPDF thus engaged in curriculum development; brought bodia, Laos, and Vietnam (see the box)-is to boost in overseas subject specialists; and, in partnership with the market for management training services. A special three local business schools, developed 36-hour courses project team has been set up in Ho Chi Minh City dedi- in accounting, marketing, human resource management, cated to producing international standard learning ma- and operations management. The management training terial adapted to the local market. Partners of capacity program was well adapted to local conditions both in building delivery include publishers, training centers and terms of quality and price. As a result, it has snowballed management consultants; and branding and marketing having now been adopted by 21 new partner schools its learning products. and business colleges, all of which were provided with the full curriculum and training of trainers course mate- In 1997, the first year of the MDPF's operations, it be- rial and adult teaching methodology. 71 such courses came clear that there was a chronic lack not only of conducted last year were delivered on a commercial appropriate learning materials, but also of instructors basis and more than 1,600 SME managers participated. who could train SME owners and managers. At that time business management training courses in Vietnam were Yet the impact of the training programs are still lim- inappropriate for domestic firms, as they were aimed at ited in meeting the specific market needs of SMEs in the executives of joint ventures and large state-owned the Mekong region. Vietnam has more than 70,000 corporations. Few courses were available, those that registered private companies plus 2 million household TRANSITION, May-June 2002 © 2002 The World Bank enterprises, thus to date the training program has only and translated this year, moving beyond human re- so far scratched the surface. In addition, many SME sources and marketing to such topics as finance and owners and managers simply do not have the time for accounting, general and operations management, and scheduled seminars or classroom attendance. Thus the personal productivity skills. j . challenge is to move beyond the classroom, and the aim of the Flexible Learning Unit-launched on April 1, The new publications will feature improvements, particu- 2002, grown out of the MPDF's original larly in the choice of words and structure, to make them business management program-is to get - - even more locally relevant and easy to use. the training content into people's hands Few training materials address the needs by other means. - - of SMEs employing 10 to 300 people that ) may have started out as family businesses. The "Teach Yourself' series was launched - Many such companies have grown and in May 2001 and soon after the books be- suddenly find themselves needing a struc- came bestsellers. By December the en- I ture rather than operating on an informal tire first print run of 24,000 titles in basis. The idea is for the individual train- Vietnamese and 5,000 in Khmer had been ->' A ing programs to be provided in any way sold. Sales of the English language ver- the client or client group wishes. This can sion in Cambodia and Vietnam were less range from in-house workshops, industry brisk, but still impressive. The series is association seminars, home study, and in- published through a partnership with the teractive media links to more conventional Youth Publishing House in Vietnam and classroom situations. For classroom and the Angkor Book Store in Cambodia. Both Mr. John McKenzie other facilitated training, the Flexible Learn- publishers print and distribute the books throughout ing Unit will work with a number of local partners includ- Cambodia and Vietnam on a commercial basis. The ing publishers, training centers, television producers, current cover price is $1.80 per title (slightly more ex- CD-Rom publishers and internet sites to establish a vari- pensive than a photocopy). ety:of channels through which to distribute content. The series focuses on the practical needs of SME own- The idea is to design modules to meet such market ers and managers. Examples of existing "Teach Your- demand, starting from the bottom up. The first step is to self" titles include: Recruiting, Job Search, and develop a content library, and the Flexible Learning Unit Selection; Wage and Salary Systems; About Custom- has already begun to procure suitable content from a ers: Gathering Information; Promotion and Advertising; variety of global outlets. The unit is recruiting local staff and Pricing and Pricing Strategy. The Canadian Open with formal training as instructional designers and con- Learning Agency of British Colombia designed the se- tent specialists, mainly from universities or from foreign ries and Mark Nielsen, director of the agency's product companies with direct experience of on-the-job training. development and research group, is now heading the Once the unit has developed the learning modules and Flexible Learning Unit on a 12-month assignment. An- adapted them to various media forms, its next task will other 20 titles are being adapted for the local market be to customize and market them. Mekong Project Development Facility The Mekong Project Development Facility (MPDF) was established in 1997 to support the development of private, domestically-owned small and medium enterprises in Cambodia, Laos, and Vietnam. Its headquarters are in Hanoi, with regional offices in Hanoi, Ho Chi Minh City, Vientiane, and Phnom Penh. The MPDF is managed by the International Finance Corporation and is financed by a number of donor countries and institutions, including the Asian Development Bank, the Intemational Finance Corporation, Australia, Canada, Finland, Japan, Norway, Sweden, Switzerland, and the United Kingdom. It provides specialized assistance to two main target groups, namely: * To private sector managers with plans for business expansion via the Company Advisory Assistance Program * To organizations providing business services to private companies, such as joint stock banks and training institutions, via the Business Support Services Development Program. C) 2002 The World Bank TRANSITION, May-June 2002 The goal of the Flexible Learning Unit is to become a MPDF is confident that, step by step, it can build up its self-sustaining, independent entity"in designing a vari- business training program in the three Mekong countries. ety of business management training programs for cli- Through the Flexible Leaming Unit MPDF is now building ents throughout Cambodia, Laos, and Vietnam, in the capacity to generate training content. Ultimately it seeks accordance with the MPDF's guideline that all activities to deliver leaming to anyone, anytime, anywhere on any must be self-sustaining i.e. "marketable" and paid for by business training subject by developing the product and its the customer. distribution channels. After that, the market will take over. Accordingly, once learning material have been transferred The author is the manager of the MPDF's Business Sup- to partner training centers and others, they are then of- port Services branch, which has been responsible for fered to SME users for a fee on a for-profit basis. seffing up the Flexible Leaming Unit. a Vietnam Focuses on Education In downtown Ho Chi Minh City stands a colonial-era villa Both Hanoi and Ho Chi Minh City are already flush with with Moorish windows and a turret where a multinational private language schools that offer evening and week- oil company's executives, and later a senior Commu- end classes of varying quality and costs to such learn- nist Party official, once lodged. As Ami Kazmin of the ers as small shopkeepers, police officers, taxi drivers, Financial Times reported, today the mansion houses and the children of well-placed government officials. Vietnam's hope for the future: an independent campus of Australia's Royal Melbourne Institute of Technology On the technical end, Indian software companies NIIT (RMIT), Vietnam's first wholly foreign-owned university, and APTECH, which specialize in training computer pro- where around 400 students are studying language and grammers, have set up centers to generate manpower technical skills to help them thrive in the global market- for the country's fledgling programming industry. Saigon place. Tech, an institute started by a local economics profes- sor and an overseas Vietnamese software developer with Knowledge at this small but idyllic satellite of Australia's the backing of the Houston Community College, opened "working man's college" does not come cheap. Tuition its doors last year and now has 180 students studying fees range from $1,200 for a 10-week, 200-hour English its five-semester course at a cost of $4,000 each. course to $8,460 for a software engineering degree course, not an insignificant amount in a city where an- To woo more foreigners to set up universities, the gov- nual per capital GDP is estimated at just $1,400 a year. ernment offers generous incentives, taxing foreign edu- Yet the hefty tuition is not expected to constrain the cation ventures at just 10 percent, compared with rates institution's growth. Within two years RMIT Vietnam- of 30to40 percentforothersectors. Now, however, Hanoi with the backing of the Asian Development Bank and faces a new challenge: upgrading its ability to regulate the World Bank's International Finance Corporation- the growing private education sector to ensure that stu- plans to open a brand new university campus with initial dents get a decent education in exchange for their hefty capacity for 5,000 full-time students and room for further fees. growth. Since 1995 Vietnam has received the equivalent of $483.8 Currently an estimated 1.5 million high school gradu- million in total official development assistance for the ates compete in grueling national entrance exams for education sector. Of this amount, loans account for 52 fewer than 250,000 places at state-run universities. Those percent or $252.2 million and grants total $231.6 mil- selected for admission are rewarded with dilapidated, lion. The foreign loans are included in total state budget overcrowded facilities; poorly paid professors; and out- spending on the education sector, which stands at 15.6 dated curricula that bear little relevance to modern work- percent of total budget spending this year, while grants place skills. While Hanoi-which aspires to a are not included. Vietnam has to pay interest rates of "knowledge-based economy"-is boosting its education 0.45 to 1 percent per year for the foreign loans. spending, the funds are largely directed toward primary and lower secondary education in rural areas rather than Ongoing education projects using foreign loans in Viet- to higher education. nam include the following: TRANSITION, May-June 2002 C 2002 The World Bank * The Primary Education Project (1995-2002), with o The Primary Teacher Training Project (2002-05) total capital of.$70 million provided by the World Bank, has received a World Bank loan of $20 million. aims to improve the capacity of the state-run Education Publishing House, the country's sole textbook publisher; * The Tertiary Education Project (1998-2006) obtained update textbooks; upgrade schools; and train local man- a 'Norld Bank loan of $80 million. agement cadres. o The Combustible Engine Laboratory Upgrade * The Junior Secondary Education Project (1998- Project for the Hanoi University of Technology (1999- 2004) uses a $50 million Asian Development Bank loan 2004) uses a $9 million loan provided by the Austrian to reform curricula and textbooks, retrain teachers, up- government. grade teacher training colleges, and upgrade classrooms in 234 schools in 10 provinces. According to the Deputy Education Minister Le Vu Hung, altogether Vietnam will receive loans of $550 million from * * The Junior Secondary Teacher Training Project the World Bank and the Asian Development Bank for (from August 2000) is funded by a $25 million Asian five major education and training development projects Development Bank loan. between 2003 and 2007. The World Bank/IMF Agenda World Bank Lends to Russia's Treasury System and ... poverty, with children particularly at risk. Access to high- quality education and health care is restricted, and the On June 6 the World Bank approved a $231 million loan risks of an HIV epidemic are growing. Growth has been to Russia to support its Treasury Development Project. uneven, with poor regions and segments of the popula- The Treasury system will help Russia use more effec- tion falling further behind. Exports are largely based on tive tools for budget execution and financial manage- commodities and investment remains overconcentrated ment, thereby improving the efficiency and transparency in the same sectors. Small and medium enterprise of resource allocation. Strengthening public administra- growth has been anemic. Institutional capacity remains tion management is a top priority. The project will also weak, and governance and corruption are still serious help the government translate its anticorruption strat- issues. s egy into specific programs. The Treasury Development Project will be repayable in 17 years, including a 5-year Despite Russia's current strong fiscal position, this CAS grace period. The Russian Federation joined the World argues for a continued strong World Bank Group pres- Bank in 1992. Since then commitments to the country ence during fiscal years 2003-05 to help the government have totaled $12.5 billion for 52 operations. consolidate and implement its formidable development agenda. A strong World Bank presence is also the wish ... Decides on Lending $600 Million Annually of the government. The CAS is organized around three central themes as follows: On June 6 the World Bank's Board of Executive Direc- tors discussed the World Bank Group's Country Assis- * Improving the business environment by tance Strategy (CAS) for the Russian Federation for fiscal -Creating the conditions for diversification of the years 2003-05. The CAS envisages an IBRD program of economy to reduce over-reliance on the natural resource lending and guarantees of up to $600 million, per fiscal sectors. year over the CAS period, supported by an extensive -Promoting a level playing field among busi- program of analytical work in support of the reform nesses. 1 agenda. At the same time the directors voiced concern -Increasing effective financial intermediation and that despite Russia's strong economic performance opportunities for entry. since 1999, which has been accompanied by consider- -Developing and delivering modern and flexible able progress in the legislative agenda, formidable chal- education and training services. lenges remain. At least 40 million Russians still live in Continued on page 49 C 2002 The World Bank TRANSITION, May-June 2002 L Articles provided by: - Il gQ Local Government and Public Service Open So Institute Reform Initiative o Education, Ethnicity, and Single Motherhood: The Determinants of Poverty in Postcommunist Countries ! By Ivan Szelenyi Our recent survey on poverty was conducted in six postcommunist European countries: Bulgaria, Hun- gary, Poland, Romania, Russia, and Slovakia. The survey used random samples of the adult population (in three of the countries the Roma population was oversampled). The survey asked people to recall how they had lived in 1988 compared with 2000 and to assess whether their situation had improved or deteriorated as a result of transition. In every country people see the transition as a period of In Bulgaria this figure was 36 percent. We tried to as- sacrifice. Between 55 and 85 percent of those surveyed sess poverty by asking people whether they had suf- believed that they lived 'worse" or "much worse" in 2000 fered from hunger in 2000. When asked, "Did you go to than in 1988. The respondents also reported a higher level bed hungry last week because you could not afford to of extreme poverty in 2000 than 12 years earlier. Five to buy food?", 6 percent of Hungarians and 16 percent of 15 percent said they had experienced extreme poverty in Bulgarians responded in the affirmative. 2000, while only 1 to 5 percent said the same for 1988. Thus a reasonable conclusion is that the proportion of Thus the extent of poverty has increased substantially the population that lives below the poverty line has in- compared with late state socialism, where extreme pov- creased from two to five times during the 12 years of the erty was relatively rare, mainly because of full employ- postcommunist era (depending, of course, on how one ment. But did the character of poverty also change? Did defines the poverty line). Moreover, dramatic differences postcommunism create a "new poverty"? Many commen- in poverty levels exist across the countries surveyed. tators suggest that it did. Earlier research indicates that poverty under state socialism was mainly a life cycle and A similar survey in 1993 compared 1988 with 1993 and demographic phenomenon. The single most important asked similar questions in some of the same countries, predictor of poverty was the number of children in a fam- but the results were different. Then the proportion of those ily. Families with many children tended to be relatively who reported a worsening living standard was almost poor, but as children entered the labor market they moved identical in all the countries surveyed. The 2000 survey out of poverty. By contrast, the important predictors of tells a different story: some countries exhibit signs of the new povGrty appear to be education and labor market consolidation and even modest improvement in living performance. Achievement rather than ascription (ascribed standards and less poverty. For example, in Hungary in status is a person's social position that is given at birth) 1993, 62 percent of the population reported a deteriora- indicates who falls below the poverty line. tion in their living standards, while only 57 percent did so in 2000. By contrast, in Bulgaria in 1993, 69 percent Thus poverty is a structural phenomenon that will not of the respondents claimed that their living standards necessarily disappear with changes in the life cycle. had deteriorated, but 84 percent did so in 2000. People who are inadequately educated, and thus per- form poorly in the labor market, are likely to continue to The 2000 survey indicated that the level of poverty is do so throughout their lives. Our data offer qualified sup- strikingly different from country to country. In Hungary 8 port to the hypothesis that with the transition to a mar- percent of the population lived below the poverty line set ket economy, the determination of poverty may have by the World Bank ($4.30 per day per "equivalent adult"). shifted from ascription to achievement, because the TRANSrnON, May-June 2002 © 2002 LGI/OSI © 2002 The World Bank quality of education is now the most important indicator surveyed rely on self-support when it comes to food. of poverty. Households with low levels of education are Roma, however, are much more likely to receive transfer four to five times more likely to be below the World Bank payments than non-Roma: almost twice as many Roma , poverty line than households with higher levels of edu- families receive child allowances compared with non- cation. Labor market performance in itself is not that Roma households, and Roma receive two to three important. Those households where the head of house- times more transfers in the forms of social assistance V hold is unemployed or is out of the labor force are more and unemployment benefits than non-Roma families. likely to be poor than other households; however, this In self-support the opposite is true: Roma are half as effect is not nearly as strong as the education effect. likely to be able to provide for themselves compared withi non-Roma. ___ Nevertheless, even though education is the strongest factor determining poverty, ethnicity and gender also Postcommunism led to a massive increase in poverty, play important determining roles in postcommunist but the extent and persistence of this poverty varies a Europe. Even after accounting for education, Roma are great deal across regimes. Neoliberal regimes show twice as likely to be poor than non-Roma. Similarly, lower levels of poverty than neopatrimonial systems. households headed by single mothers are also about While poverty has moderated somewhat during the last twice as likely to be poor than other households. Clearly five years in the neoliberal countries, poverty increased improving educational opportunities for Roma would be in th:e neopatrimonial countries. an important vehicle for reducing poverty among Roma, though education alone will be insufficient, because The most important finding of our study was that there substantial inequalities between Roma and non-Roma are three determinants of poverty under postcommunist will persist in other spheres, in particular, unequal em- capitalism. The effects of ethnicity and single mother- ployment opportunities. hood complement the effects of education. Education is twice as important as ethnicity and single motherhood, When considering the three determinants of poverty- but after controlling for education, both Roma and single education, ethnicity, and single motherhood-an addi- mothers are still about twice as likely to be poor than tional unique feature of postcommunist societies is other groups. Thus while market transition criteria based relevant. While a link between ethnicity and single on achievement may have gained ground, ethnicity and motherhood can be expected in the United States, this gender remained strong predictors of poverty. is not the case in Central and Eastern Europe given the strength of extended Roma families. Unwed Roma The author is professor and chair of sociology at mothers are much more likely to live with the fathers of Yale University, and can be reached by email at their children, and if their partners abandon them they ivan: szelenyi@yale.edu. This article is a shorter ver- are likely to live with other kin. Hence the Roma are sion of "Poverty Strikes Back, " published in the sum- not as exposed to the risks of poverty attributable only mer 2002 edition of LGI's Local Government Brief. to single motherhood. M[arket Economy Another important question the survey asked was: "How do people cope with poverty? To what extent can they rely on welfare institutions, and to what extent do they survive by self-support?" Thus our study looked both at - / = access to transfer payments and self-support, two complementary coping mechanisms. Surprisingly, the structure of both was similar across countries. The major 1___--- transfer payment, excluding pensions, is a child allow- ance, which 25 to 40 percent of the households surveyed receive. Social assistance and unemployment benefits are available to approximately another 10 percent. The welfare system is rather uniform across countries, "Earlier, only a change in the weather gave me and typically is selective and targeted. The structure of a headache, now it is the stock exchange." self-support is also similar, roughly half the households From the Hungarian magazine H6cipo C 2002 The World Bank © 2002 LGI/OSI TRANSITION, May-June 2002 flICorruption and Poverty in Postcommunist Europe By William L. Miller 1i Moral crusaders condemn the use of contacts, gifts, Republic, Slovakia, and Ukraine) that we studied, though i and bribes as intrinsically immoral or illegal, a sin or a it is nonetheless a significant source of annoyance in crime. Lawyers condemn it as being illegal. But econo- some of them. Even an incorruptible bureaucracy can f ei mists and political scientists have been more ambiva- be inefficient, insensitive, unresponsive, arbitrary, capri- H lent. As long as corruption had a positive effect on cious, or unfair, and these are the things that ultimately 6?$ D)f V ]economic efficiency and political stability, economists affect citizens. However, a corrupt bureaucracy is likely -__)I: l and political scientists did not rush to condemn it. In to be more inefficient, more arbitrary, and more capri- -i,!particular, many observers of the Soviet Union felt that cious than an incorruptible one. While a corrupt bureau- the system was unworkable unless fraud and deception cracy may be more sensitive, responsive, and fair to were allowed on a vast scale. Even in postcommunist those citizens who pay bribes for the privilege, it can be Russia commentators have argued that bribery is an so only at the cost of being less sensitive, less respon- indispensable part of life, that it softens the edges of an sive, and less fair to the poor, who cannot pay, or pay authoritarian society and enables citizens to circum- enough, to buy privilege. vent a ponderous state bureaucracy. We measured poverty not by low income itself, but by its However, the weight of opinion among economists and inadequacy. We asked respondents whether, after "taking political scientists has changed, with the most recent into account the number of people in your family," they studies suggesting that corruption is both economically rated their family income as "not really enough to survive inefficient and politically destabilizing. Economists now on "(33 percent overall), "only just enough to survive on" (43 argue that corruption distorts economic activity. It is not percent), "enough for a fair standard of living" (20 percent), merely a tax, but an arbitrary tax that damages eco- or "enough for a good standard of living" (4 percent). Those nomic development more than its sister activity, taxa- whose incomes are "not enough to survive on" are certainly tion. It is a cause of poverty, but worse than that it "poor,"andthosewithenoughfora"fair"or"good"standard increases inequality and hits the poorest hardest. of living can be described as "well-off." Inequalities of wealth provide the means to pay bribes, Poverty correlates with low education, with being a pen- while inequalities of power provide the means to extort sioner, and with being unemployed. The poor were less them. Far from softening the hard edges of society, econo- likely to have to deal with customs, passport, or court mists now argue that a state with endemic corruption officials; with the police; or with officials that handled can be especially brutal to the very poor, who have no contracts or regulatory documents. Conversely, the poor resources to compete with those willing to pay bribes. were more likely to deal with pension, unemployment, Hence bribery is a sell-out to the rich and makes political and health service officials. Thus the poor might avoid systems less democratic. State contracts for unneces- the notoriously corrupt traffic police or customs officials, sary projects go to inefficient and uncompetitive firms, but they were forced into relatively frequent contact with and state benefits and services go to citizens who are health service staff whose corruption is equally notori- neither those most entitled to them nor the most needy. ous, and their lack of education meant that they could The state is cheated out of revenue by those who bribe not easily use information or negotiate the use of gifts officials, and consequently has to impose greater (even- and bribes that they could ill-afford. tually unbearable) tax burdens on those who cannot avoid payment by bribing officials and/or let public services, on The poor ranged from 12 percent in the Czech Republic which the poor in particular depend, collapse. and 14 percent in Slovakia to 45 percent in Bulgaria and 53 percent in Ukraine. This complicated the analysis enor- Corruption is only one aspect of the relationship between mously, because it confused the impact of poverty with citizens and officials in postcommunist Europe. Our find- the impact of Bulgarian and Ukrainian circumstances or ings show that corruption in itself is neither the most culture. The poor are disproportionately located in Ukraine, frequently annoying nor the most intensely annoying andthewell-offaredisproportionatelylocatedintheCzech aspect of encounters between citizens and street-level Republic. It may not be entirely a coincidence that bureaucrats in any of the countries (Bulgaria, the Czech Ukraine is both the poorest and the most corrupt of the TRANSITION, May-June 2002 © 2002 LGI/OSI © 2002 The World Bank four countries, but the poor in other countries do not think wrong people seem to get the favors, especially in Bul- and behave exactly like those who live in Ukraine. garia and Ukraine. | When we asked about the actual strategies they had Our research produced at least some evidence that pay- 3t. used recently in their own dealings with officials, the ingl bribes in Bulgaria and Ukraine helped the poor more X .- poor in the Czech Republic and Slovakia were as likely than the well-off to get special favors. In these countries as the well-off to admit to using "contacts," "small gifts," the oor who paid bribes received favorable treatment as 3 and "bribes" (money or an expensive gift), while in Bul- often as the well-off who paid bribes, but the poor who did i I ' garia and Ukraine the poor were somewhat less likely not pay bribes got favors less often than the well-off who than average to admit to using contacts, gifts, or bribes. didl not pay bribes. If this is indeed the case, it would! Perhaps the poor were especially poor and unable to underline the reality that the poor generally lack other KQ)LJ pay in these countries. However, the poor were scarcely resources of education, information, and negotiating any more willing than average to condemn the practice skills-even prestige and influence-that the well-off can of using contacts, gifts, and bribes to influence officials, use as substitutes for crude bribes. This finding echoes and "if asked, and if they could afford to pay it" the poor the old, and now largely discredited, argument that cor- were just as willing as others to give a bribe "to solve an ruption gives the poor access that they would not other- important problem." Indeed, if we neglect to consider wise have. But that is perhaps the wrong way to look at cross-national differences, the poor appear significantly the situation. Rather, it is particularly in those places where more willing to pay bribes because the poor tend to be the' poor receive favors far less frequently than the well-off Ukrainians, who generally would pay, while the well-off that the poor who do not or cannot pay bribes are the tend to be Czechs, who generally do not. ones who suffer the most. Instead of emphasizing the ability of poor bribe-payers to buy what they should get What distinguished the poor, however, was that in every for free, we need to emphasize that the burden of corrup- country they were about 20 percent less likely than the tion falls hardest on those of the poor who are so hon- well-off to feel that they "knew their rights" when dealing est-or more likely so very poor-that they do not pay. with officials. In every country the poor were more dis- satisfied in their dealings with officials, less likely to The author is a professor of politics at the University of report that they had been treated with respect "as equals," Glasgow. Together with Ase Grodeland, and Tatyana less likely to report that they had been treated "fairly," Koshechkina, he conducted several surveys on corruption and less likely to report that they had enjoyed "espe- involving thousands of respondents in postcommunist cially favorable" treatment. Good government requires countries. His email address is w.l.miller@socsci.gla.ac.uk. especially favorable treatment for those with the great- This article was originally published in the summer 2002 est needs, but in the countries surveyed exactly the edition of LGI's Local Govemment Brief Education to Facilitate the Way Out of Poverty By Lucinia Bal Before the fall of the Iron Curtain, the communist states the Czech Republic, Hungary, Latvia, Poland, and Rus- had some of the highest literacy rates in the world. The sia-ranked average in scientific literacy, but scored well 1994-95 international adult literacy survey defined lit- below the OECD mean in reading literacy. These and eracy as the information-processing skills that adults other studies suggest that the postcommunist educa- need to perform tasks encountered at work, at home, tion systems have failed to develop the skills and dispo- and in the community, and included Poland in the re- sitions needed to meet today 's challenges. search. Although the percentage of young Polish adults who completed secondary education was higher than in The traditional teacher-centered approach to educa- some OECD countries, the overall literacy rate was sig- tion does not encourage the development of problem nificantly lower. The more recent OECD Program for In- solving techniques or of independent decisionmaking. ternational Student Assessment study assessed the Yet it is precisely this method that dominates most ability of 15-year-olds to use their knowledge and skills postcommunist school systems. New teaching meth- in real-life situations. The surveyed transition countries- ods spread slowly, especially because of inadequate C 2002 The World Bank C 2002 LGI/OSI TRANSITION, May-June 2002 li' preservice and in-service teacher training programs. urban accommodation remains unaffordable. The high il, 1~ Curricula are often outdated. Teaching materials are in percentage of rural inhabitants in these countries, some- - most cases inadequate, and sometimes prohibitively times more than 40 percent, aggravates this problem. 0 ' 3: ,:1expensive. With few exceptions vocational education has X ,,not yet started to create the practical skills and profes- The current education systems are extremely limited in o 0 E 1, sional flexibility the new economies need. National ex- including children with special needs in mainstream B ° Lu lilamination systems reward old methods of teaching and education. Worse, the special needs groups often in- C penalize new ones. Assessment systems rarely encour- clude children without such needs who have been diag- age critical thinking and initiative, but rather reward the nosed as such for social, and even political, reasons, 19 ) , reproduction of previously delivered content. In many for instance, the Roma. "Special" schools are often in- countries secondary and higher education is infected adequate because of a lack of funding, marginalization, il by corruption. Hasty decentralization to create demo- and antiquated teaching methods and materials. Obso- - ! cratic education systems did not au- lete vocational training compounds tomatically empower schools. the problem. Communities and local governments 1 have not been assisted to identify and 9 . Education budgets in many transi- adapt to their new roles with respect tion countries are low. Teachers' sala- to schools. Perhaps above all, qual- ,i ries are often derisory, many times ity assurance mechanisms to help _ below the subsistence rate. Expect- democratic education systems are ing good results from unmotivated and not yet in place. tired teachers is unrealistic. Access to quality education becomes avail- Life-long learning is currently a ma- - able only through private tuition and jor feature of the EU's social and eco- private schools, which are, of course, nomic policy, yet most transition F inaccessible to the poor. countries lack systemwide forms of - adult education and have almost no Capacity building is necessary in the concept of the meaning or impor- following two areas if countries want tance of life-long learning at the policy to develop their education systems level. The economic sector and the successfully: education system fail to interact to support adults in need of profes- * Develop technical and profes- sional retraining and skills to cope with the new situa- sional competence. This includes teacher training in tions they encounter. If children leave school with low contemporary teaching methodologies, curriculum de- attainment, they have few opportunities to go back to velopment, and assessment and evaluation methodolo- school or to retrain as adults. gies. * Enable governments to formulate and implement Is there equal access for all to quality education? The effective education policies. Evaluation mechanisms postcommunist countries have legislation that calls for must be deeply integrated into reform strategies. At the at least eight years of obligatory education and their national level new management approaches should in- governments have committed themselves to equity of volve local governments and schools in supporting qual- educational access. Yet records indicate that not all ity education. At the local level school management children 7 to 10 years old are enrolled in school, and training is recommended. The creation of a favorable that a significant percentage of students drop out before environment for participation and dialogue is likely to the end of the obligatory cycle. support and sustain educational change. Children from rural areas are greatly disadvantaged. De- The author has worked for the Open Society Institute creasing numbers of qualified teachers work in villages, for nine years, specializing in educational development. where the living conditions are worse than elsewhere Her email address is lbal@osi.hu. This article is a and the possibility of supplementary earnings is reduced. shorter version of "Education: The Way Out?", pub- Commuting is becoming difficult, because parents are lished in the summer 2002 edition of LGI's Local Gov- impoverished and roads are often in bad condition, and emient Brief. TRANSITION, May-June 2002 C 2002 LGI/OSI C 2002 The World Bank Articles provided by: SITE Stockholm Institute of Transition Economics STOCKHOLM SCHOOL OF ECONOMICS Russian Industry and WTO Accession: Death Knell or New Beginning? C By Ksenia Yudaeva, Evgenia Bessonova, and Konstantin Kozlov ) While WTO accession is anticipated to improve the position of the exporting sectors in international trade, more specifically, to reduce the number of antidumping cases initiated against Russian compa- nies, it is also expected to increase the exposure of Russian manufacturing firms to foreign competition. The government and the public worry that WTO accession might lead to a further decline in industrial C)" production, especially in manufacturing. Currently fuel and metal production industries account and 20 percent, respectively. Major exemptions are spirits for 34 percent of Russian industrial production and em- (100 percent), cigarettes (30 percent), sugar (30 per- ploy some 15 percent of those working in industry. Given cent), and automobiles (25 percent). However, collec- the relatively low geographical mobility of labor in Rus- tion has been poor, and in 1999 the amount actually sia, a continued decline in the manufacturing sector may collected was about half of what should have been result in substantial social costs. The government is amassed. Note, however, that the customs service has interested in evaluating such costs, both in the short made substantial efforts to improve tariff collection rates run and in the long run, and under different accession in recent years. scenarios. The government is particularly interested in * Nontariff barriers: licensing and certification, cus- assessments that take cross-industry effects into ac- toms valuation procedures. Measures aimed at im- count as follows: proving tariff collection rates include not only the unification of tariff rates, but also certification and licens- * International trade. Russia is an open economy. ing requirements for imports of goods with low tariff rates Exports constitute about 46 percent of GDP (1999 data), and regulation of minimal customs values of imported and 40 percent of budget revenues are revenues from goods; however, because of corruption among customs international trade (tariffs, excise duties, and customs officials such measures have not proven effective and fees). Officially reported imports are equal to about 28 only add to the bureaucracy and create more opportuni- percent of GDP, but these might be under-reported by ties for corruption. Survey evidence shows that the com- about 20 percent. Even when official statistics are used, plexity of customis procedures has become one of the import penetration appears to be quite high in some in- most serious barriers to foreign direct investment. We dustries, for example, 56 percent in heavy industry. plan to study the differences between Russian customs Therefore even before accession to the WTO, Russian regulations and WTO rules to assess the effects of + firms confront significant competition from imported changing customs procedures on the volume and struc- goods. ture of foreign trade. * Tariffs. Since the mid-1 990s Russia has not had quan- titative barriers to trade in place and tariffs are the only Wh'at level of protection will be maintained after WTO trade barriers. Tariffs are imposed on both imports and accession is as yet unclear. Russia's previous tariff exports. The level of import tariffs throughout the sec- offer envisaged an increase in tariff levels at the time F ond half of the 1990s was less than 30 percent for most of accession and a decrease to the current level dur- goods. The tariff rates structure was extremely compli- ing a grace period of five to seven years; however, cated until early 2002, when Russia undertook a major thinking that the other negotiating parties will accept effort to unify tariffs. Currently commodities are divided such an offer is unrealistic. The government recently into four subgroups with marginal tariff rates of 5, 10, 15, decided to change its tariff offer and make it more © 2002 The World Bank © 2002 SITE TRANSITION, May-June 2002 . liberal. We predict that accession will be followed by a * Monopolies fared much better than other firms. slight decrease in tariff protection in most sectors with * Firms that received subsidies from the federal budget .. the exception of those that have strong lobbying groups, experienced smaller output declines than firms that did such as automobile production or agriculture. However, not, while subsidies from regional governments had posi- if WTO accession improves the efficiency of the cus- tive effects only on firms in the food industry. __, toms authorities, a decrease in nominal tariffs may ac- * Surprisingly, the effect of small-scale privatization was . tually mean an increase in tariff protection in practice. In negative and significant in some branches of machine build- .any case, simplifying customs procedures and enhanc- ing, as well as in construction, light industry, and chemical ing transparency may have positive effects on imports industries. Possibly in some cases enterprise managers *!5i A organized directly by foreign companies. found that it was more profitable to rent out offices in their L a buildings instead of continuing with production. Output and Employment Trends Some of our results contradict the theory that reform The government is keen to ascertain the likely short- progress is beneficial for growth, and even provide evi- and long-run effects of WTO accession on production dence for the counterargument that reforms initially have and employment. Long-run effects can be estimated by a destructive effect on growth. The literature on growth constructing a model as done by David Tarr of the World in transition economies has not yet provided an answer Bank, and we plan to use some of his predictions in our as to which of these two effects is dominant. Our re- future work. However, adjustments to the long-run equi- sults suggest that at the initial stages of transition re- librium in Russia can take a fairly long time, thus partial forms could have had a destructive effect on large and equilibrium results can be useful for deriving estimates medium firms; however, reforms can lead to faster re- of the short-run effects. By estimating Tarr's equation, structuring of those firms more eager to introduce re- which directly connects imports and production or em- forms during the early stages of transition. ployment for 1993-96, we can report some preliminary results. (Note that we must use the equation because Our results have a number of implications for the WTO the available information on the prices of imports and accession debate. While the trade liberalization of the domestic counterparts is inadequate.) 1990s seems to have had a negative effect across sec- tors, disorganization was a more important factor in Many Russian economists and business people are some of the machine building industries and in light in- convinced that trade openness was the major factor dustry, so the overall decline cannot be attributed to the behind the output decline of the mid-1 990s. Consequently opening up of the economy. The important issue is the they fear that accession will result in another serious extent to which Russian industry has restructured since output decline and increase in unemployment (see Centre that time, and therefore how big the WTO accession for Financial and Economic Research and Club 2015, shock is likely to be. "Russia in the WTO: Myths and Reality," Transition, September 2001, p. 39). Testing the hypothesis that Our results demonstrate that employment in firms that output declined in 1993-96 as a result.of trade liberaliza- competed with imports in 1996 experienced the smallest tion and limiting our attention to the effect of increased decline among all industries during 1996-2000. Thus the imports on manufacturing, our results are as follows: completely uncompetitive industries had apparently al- ready disappeared following the 1990s trade liberaliza- * Trade liberalization was an important reason for the out- tion, and thus WTO accession will not have a detrimental put decline. Those industries whose share of imports in effect on the remaining industries. On the contrary, as consumption was high in 1994 experienced the largest WTO accession makes lobbying for protection a less decline in the early transition years. This result can be rewarding activity than restructuring, we also expect WTO attributed to these industries' low level of competitiveness. accession to have a substantive positive effect on restruc- * The decline in complex industries could have taken turing. As mentioned earlier, we leave the evaluation of place because of their poor ability to withstand foreign differences in short-run effects for future work. competition and not because of their disorganization. Another possibility is the reversed causality explana- Mixed Effects on Productivity tion, that is, the share of imports in complex industries was high because supply fell short of demand because One of the most important effects that WTO accession of their disorganization. can have will be its effects on the productivity of domestic TRANSITION, May-June 2002 © 2002 SITE c 2002 The World Bank firms in the medium term, but economic theory does TFP of domestic firms. We concluded that increased not allow us to give clear prediction.s about the direction import penetration either has no,,immediate significant and size of the effects. Advocates of the infant, industry effect on productivity, or if it does, then it is negative in argument claim that competition with imported goods lineiwith the effect on output. Trade liberalization initially can prevent a country from developing an industry where resulted in a decline in TFP, but perhaps the positive learning by doing and economy of scale effects are im- effects of import penetration on productivity occur only portant. This argument is often used by various lobbying with a delay. Firms need time to adjust their production groups in Russia, whose members claim that for do- methods and to introduce new, more competitive prod- mestic industry to develop, it must be protected for a ucts. We also concluded that the larger a company's sufficiently long period of time. However, trade openness market share, the less productivity increases as a re- is likely to have a positive influence on the total factor sult! of trade liberalization. This result was expected, productivity (TFP) of Russian firms, admittedly with some because it confirms the hypothesis that monopolistic time lag, for a number of reasons, namely: firms have weaker incentives to restructure. * Increasing trade flows imply an increase in competition, As far as WTO accession is concerned, our results sug- which in turn can force Russian firms to restructure faster. gest that it could boost restructurng by Russian firms. With * Increasing imports involves increasing information about increased intemational competition and better access to foreign goods and technologies, which can have posi- imported components and foreign consumer markets, Rus- tive spillover effects on domestic firms, as predicted by sian firms will become more productive and efficient. modern economic growth theory and confirmed by em- pirical papers on developing countries. Ksenia Yudaeva is the Acting Academic Director at the * Increasing imports of foreign inputs can have an indi- Centre for Financial and Economic Research (CEFIR) and rect effect on the TFP of domestic firms. The experi- is a Centre for Economic Policy Research affiliate. Evgenia ence of some other countries has shown that the positive Bessonova and Konstantin Kozlov are researchers at effects of trade policy reforms often dominate in the CEFIR. This article presents some results of the authors' medium and long run. study of the effects of the trade reform of the 1990s on domestic firms, along with some implications of WTO ac- Our estimates show that TFP started to grow in almost all cession for Russian industry. This project, funded by the industries in the late 1990s. Moreover, the growth was more Swedish Intemational Development Cooperation Agency, pronounced in large and medium firms than in small enter- started in late 2001. It has two main goals: to take stock prises. The percentage of firms with positive TFP growth of current research and policy advice work in relation to increased from around 20 percent to more than 50 percent Russia's accession to the WTO and to analyze the poten- in the last two years of the sample. We conducted a rough tial effects of accession on Russian industry. test of the effects of import competition on the productivity, output, labor, and capital of Russian firms in 1996-2000, Ripe for Retirement and some of the results are as follows: . .. .-L|. (B * Firms in industries with high levels of imports showed the highest TFP increase during the period under con- sideration, and this is the only group of firms for which _ overall TFP growth was positive. |t * Export industries experienced a pronounced decline in TFP during this period despite the substantial increase ---------- in output in the previous couple of years. This was a surprising finding. * TFP stagnated in nontraded goods industries and in -~y,0 industries with lower shares of imports in total demand. * In 1999-2000 all industries experienced increases in "It seems to me that you are unable to adapt to output, employment, and investment.I output, employment, and investment. tlhie modern age, your precise and impeccable For the years prior to 1997 we were able to conduct a bookkeeping is disgusting." more rigorous test of the effects of foreign trade on the From the Hungarian magazine Hocipo © 2002 The World Bank (©) 2002 SITE TRANSITION, May-June 2002 - I -~ fi I ¢ 1THE WILLIAM DAVIDSON INSTITUTE 4 lii 1 l AT THE UNIVERSrrY OF MICFHGAN BUSINESS SCHOOL A Symposium on Outstanding Issues of Transition Economics The winter 2002 issue of the Joumal of Economic Perspectives (vol. 16, no. 1) featured five articles by research fellows of the William Davidson Institute (WDI) that summarized their evaluation of the main outstanding issues in the economic transformation that is now more than 10 years old. The papers are summarized below and are all available in the WDI working paper series. Transition Economies: Performances and Challenges By Jan Svejnar * * * This paper assesses the strategies and outcomes of the first 12 years of the transition from plan to market , and outlines the principle challenges the transition economies face. It compares the performance of 'five Central European countries-the Czech Republic, Hungary, Poland, Slovakia, and Slovenia-with that of Russia during the same period. For comparison it also refers to three other groups: the Baltic countries of Estonia, Latvia, and Lithuania; the Balkan or Southeast European countries of Albania, Bulgaria, and Romania; and Ukraine as the second largest economy of the former Soviet Union. The overall assessment is that the countries' performance during the first 12 years of the transition has been poor. While important structural transformations have taken place, the relative gap in per capita in- ; O come between these countries and the advanced economies has widened. A major problem was clearly the initial recession that set these countries back relative to the advanced economies. Transition countries further east have, on average, per- mid-1990s indicates that geography does not provide a formed worse than their more western counterparts, complete explanation and that policies do matter. which suggests that geography-related initial conditions ^ have been important in the transition process. The Cen- Policymakers in the former Soviet bloc formulated tran- ww tral European countries, the most western of the transi- sition strategies that focused on macroeconomic stabi- tion economies, have historically shared the same lization and microeconomic restructuring, along with alphabet and religions, had similar educational and bu- institutional and political reforms. The implementation reaucratic systems, and intensively traded and other- of these strategies varied across countries in terms of wise interacted with countries in Western Europe. speed and specifics. A major debate took place about t Together with the Balkan countries they were under the the merits of fast or "big bang" reform versus gradual 'Soviet system for only four decades, compared with five reform, but as it turned out, almost all the transition i decades for the Baltic countries and seven decades for governments plunged ahead in rapid big bang style with l_=-_ j the CIS countries. Finally, the countries of Central Eu- what the paper defines as Type I reforms. However, sig- rope were the first to aspire to and be encouraged to nificant policy differences ensued in what the paper re- - - prepare for entry to the EU. Their physical proximity to fers to as Type II reforms, which only some governments 'and historical association with Europe seems to have carried out. given the western transition economies an important advantage in moving from the Soviet-style system to a Type I reforms include undertaking macroeconomic sta- democratic and market-oriented system. However, given bilization; liberalizing prices; reducing direct subsidies; that the western-most transition economy, the Czech breaking up trusts, state-owned enterprises, and the 'Republic, has performed worse than others since the monobank system; removing barriers to the creation of TRANSITION, May-June 2002 C 2002 WDI © 2002 The World Bank new firms; carrying out small-scale privatization; and in- because most have been implicitly equating the transi- troducing social safety nets. All these reforms were, for tion with a process that will make them partners with the most part, carried out quickly by all the transition the' relatively advanced countries in general, and with - countries. Type 11 reforms, by contrast, were implemented Western Europe in particular. Taking this into account, i o c differently by the various transition countries. These re- the end of transition is defined as a state when these forms include engaging in large-scale privatization; purs- economies replace central planning with a functioning - c ing further, in-depth development of a commercial banking market system, and when they generate rapid and sus- a 8 , sector and an effective tax system; putting in place labor taimable rates of economic growth that enable them to * market regulations and institutions related to the social interact with the more advanced market economies with- safety net; and establishing and enforcing a market- out major forms of protection. The Czech Republic, Es- oriented legal system and accompanying institutions. tonia, Hungary, Poland, Slovenia, and possibly Slovakia will probably reach this stage in a few years when they A natural question to ask is when transition is likely to be enter the EU. Others have a much longer way to go. completed. The answer depends on how one defines the terminal point. A number of analysts are on record on this Jan Svejnar is WDI's executive director and Everett E. issue and their definitions differ considerably. The per- Berg is a professor of business administration and of spective of this paper suggests that most citizens of the economics at the University of Michigan. The article transition countries do not feel that they have accom- on which this summary is based first appeared as WDI plished the transition. The paper suggests that this is Working Paper no. 415. The Political Economy of Transition By Gerard Roland The theory of the political economy of transition is part of a recent trend in economic research that attempts to integrate the political process into the analysis of economic problems. Political economy issues are being introduced and analyzed in all areas of economics: trade, macroeconomic policy, regulation, public finances, financial economics, labor, and others. The tools of game theory developed in recent decades now allow research to integrate the analysis of economic and political processes using unified tools of analysis. The overriding importance of political constraints in the transition pro- cess has led to developments in the theory of the political economy of reform. What are the main insights from that theory? How does it reflect the transition reality? What have we learned and what do we still need to learn? This article attempts to answer these questions. Political economy arguments have been at the heart of creating constituencies for further reforms. In China the debates and controversies about strategies of transition success of decollectivization built support for later re- from socialism to capitalism. For example, advocates forms. Similarly, the thinking in Central and Eastern of a big bang approach to transition argued for a fast and Europe was that successful entry of small and medium comprehensive implementation of all major reforms. enterprises could build support for later reforms in the Speed was of the essence, they argued, because there state sector. was a "window of opportunity" (or a "honeymoon period" or a "period of exceptional politics") created by the es- Political economy arguments, in addition to shedding tablishment of democracy. During this period, they main- light on the pace and sequencing of reforms, have also tained, governments should adopt reforms as fast as been extensively used to explain or justify many as- possible and attempt to make them irreversible. pects of the transition process. For example, mass privatization involving the giveaway of state assets to On the other side, those who opposed the big bang ap- citizens (as in the Czech Republic) or to workers (as in proach often advocated a gradualist strategy that em- Russia) was designed to overcome political constraints phasized the need for a precise sequencing of reforms. tol transition. To take another example, China imple- The political economy argument in favor of gradualism mented so-called dual-track liberalization, under which was that an appropriate sequencing of reforms would plan contracts between enterprises are maintained, but provide demonstrated successes to build upon, thereby frozen at a pre-existing level, and price liberalization is C) 2002 The World Bank © 2002 WDI TrANSI ]'ION, May-June 2002 t' ; !| implemented "at the margin" for any production beyond contracting and to the legal, social, and political envi- the planned contract. The political economy argument ronment of contracting. Moreover, transition has also - for dual-track liberalization is that it was a way to liberal- forced us to think about institutions not in a static way, - at ize prices without eliminating the pre-existing rents of but in a dynamic way: how momentum for reform is cre- & s s jil economic agents. ated and how institutions can evolve, but also how mo- i. * - - | ES , l . mentum can be lost and how one can get stuck with * Political economy arguments have also been used to inefficient institutions. These questions, addressed by explain the striking difference in economic performance the political economy perspective, have become central across transition countries. While all transition econo- in understanding how successful capitalism can emerge. )j kO lmies experienced a fall in output at the start of the pro- The transition countries started this process of change ' Q \2y tcess, most countries in Central and Eastern Europe from specific initial conditions, but the questions ad- recovered after a few years, while Russia and most former dressed by transition go far beyond the transition pro-. iz 3 Soviet Union countries (apart from the Baltic states of cess itself. Estonia, Latvia, and Lithuania) saw little or no recovery of growth through most of the 1990s. One political G6rard Roland is a professor of economics at the Uni- economy argument often made is that the extent of state versity of Califomia at Berkeley, codirector of the Tran- capture and rent-seeking was much more important in sition Economies Program of the Center for Economic the former Soviet Union countries than in Central Eu- Policy Research, and a WDI research fellow. This ar- rope and that this difference goes a long way in explain- ticle is a summary of the author's study first published ing differences in output performance. Another political as WDI Working Paper no. 413. economy argument suggests that Central European countries expected to access the EU, which enhanced Institutional their incentives to change the systems of law enforce- ment, law compliance, and protection of property rights, Determ inants of Labor while in former Soviet Union countries, where prospects of accession to the EU were virtually nil, no such incen- Reallocation in tives existed. Policymakers often refer to the transition economies of Transition Countries the former Soviet Union and Central and Eastern Eu- By Tito Boeri and Katherine Terrell rope, but for these countries far more than the economy is involved in transition. They are also creating institu- The transition process from planned economies to tions of democracy and governance, including the ex- market-oriented economies involves a substantial ecutive, legislative,andjudiciarybranchesofgovernment; reallocation of labor. In the planned economies a free press; new social norms and values; an open- employment was typically concentrated in heavy ness to private organizations and to entrepreneurship; a industry, away from consumers' preferences. A network of regulators; and a new network of contractual strong small business sector was lacking, and pri- relationships, both domestically and abroad. The eco- vate initiative had been tolerated almost exclu- nomic transition is intimately related with these institu- sively in agriculture. Patterns of foreign trade were tional transformations. determined by economic planners within the frame- work of the Council for Mutual Economic Assistance. In this setting economists have often gone astray in their In the process of transition, employment had to flow analysis of transition economies by examining only eco- out of such sectors as state-owned heavy industry nomic factors and ignoring these deep institutional trans- into the new private, mostly small-scale, business formations. Successful institutions of capitalism are sector. The success of transition in a given country already present in advanced economies and we tend to can be assessed in part by how well it has addressed take them for granted when analyzing economies in tran- the problem of reallocating labor. sition or developing economies where such institutions are absent. The transition experience has therefore re- One of the reasons why studying the experience of tran- inforced the institutionalist perspective in economics and sition economies is so interesting is their wide range of engendered a shift in emphasis in economic thinking, experience with the reallocation of labor. Comparing ad- from the analysis of markets and price theory to that of iustment traiectories across countries and time provides TRANSII1ON, May-June 2002 © 2002 WDI © 2002 The World Bank several useful insights, from which two key patterns can Soviet Union and employment quantities adjusted more in be discemed. On the one hand, the countries created from Central and Eastern Europe. Given the need to have labor former republics of the Soviet Union typically display L- move to a new sector, the wage adjustment strategy was shaped patterns of GDP since the beginning of transition- less successful that the adjustment in employment levels. C: that is, a sharp decline and then a leveling out at the lower While we do not rule out the possibility that other institu- . level-although some recent signs of a possible uptum are tions may also have played an important role in the wage- apparent. They have also seen relatively little decline in employment tradeoff-information and research on employment, marked declines in labor productivity and real iristitutional effects is sketchy at this time-cross-country V . ' wages, relatively large tumover of the unemployment pool, differences in the design and generosity of nonemploy- and relatively small reallocations of jobs between the old rmient benefits are consistent with this explanation of the Q and the new sectors. On the other hand, most economies different adjustment trajectories. of Central and Eastern Europe saw more U-shaped pat- terns of GDP, with employment falling substantially at the Why was the model of social policy and labor market t., initial stages of the transition process, with consequently adjustment used in Central and Eastem Europe more lower declines in labor productivity. conducive to structural change than the model used in the countries of the former Soviet Union? The wage The recovery started earlier in the Central and Eastern Eu- floor imposed by nonemployment benefits in the countries ropean countries and was more pronounced than in the of Central and Eastem Europe meant that old and ineffi- former Soviet Union. However, along with a fairiy rapid de- cient firms were forced to shed their least productive labor gree of structural change, these countries have also expe- rather than being allowed to adjust wages downwards, or rienced desperately stagnant unemployment. Between e'ven to accumulate wage arrears, as occurred in Russia. these two polar adjustment trajectories, there are some Nonemployment benefits also imposed a wage floor in the intermediate cases, such as the Czech Republic and Es- private sector, which made jobs in the new gap-filling, retail tonia. The former, unique among the Central and Eastem service sector more attractive, but at the same time more European countries, experienced a long period of low un- difficult for the least skilled workers to obtain, and hence employment. The latter, unlike other former Soviet Repub- created more unemployment among this group. However, lics, displayed significant labor reallocation from the nonemployment benefits also operated as a subsidy to beginning of the transition process. job creation in the new sector, as the self-employed and the new small business sector were allowed to combine How can such differences in adjustment trajectories be benefits and earnings from work, thereby obtaining explicit explained? Can they be attributed to different macroeco- or hidden seed capital for the start-up of new entrepreneur- nomic policies or are they a by product of institutional asym- ial activities. Overall, nonemployment benefits contributed metries between the countries of Central and Eastern to more quantity adjustment, as opposed to price adjust- Europe and of the former Soviet Union? Unlike previous rment, in the countries of Central and Eastern Europe. This literature, which focused mainly on the timing of liberaliza- quantity adjustment implied faster structural change, which tion and privatization, along with the so-called "optimal speed in turn allowed for stronger growth sooner than in the coun- of transition literature," this paper primarily explores insti- tries of the former Soviet Union. tutional determinants of these asymmetric pattems of GDP, employment, and labor reallocation. From this perspective Why were these two different social policy models the paper offers tentative answers to four questions. adopted by countries starting from similar initial con- ditions and having the opportunity to introduce non- Why was labor market adjustment so different in the employment benefits from scratch? Further work taking countries of Central and Eastern Europe and of the a political economy perspective will have to address this former Soviet Union? One main explanation involves the issue. At least at first sight, it is difficult to attribute the different models of social policy that these two groups of cross-country variation in the size and composition of countries adopted. [Editor's Note: The replacement model social spending to differences in the degree of aversion the countries of Central and Eastern Europe followed as- to inequality, because the countries' historical and cul- signed a much greater role to unemployment benefits than tural roots were similar, as were their past records of in- the model the former Soviet Union countries followed.] The come inequality. Differences in the degree of economic higher level of nonemployment benefits implied floors to development or access to international capital markets that wage distributions and prevented a further decline of wages. 'made it more difficult for the former Soviet Union to sustain Thus wages adjusted more in the countries of the former large social policy outlays cannot, entirely explain the c 2002 The World Bank © 2002 WDI TRANSI'ION, May-June 2002 .C 1differences in the policy mix. The budget of the Russian employment-and more long-term unemployment-in the 3 Federal Employment Service, which was responsible countries of Central and Eastern Europe than in the coun- , g _ l I for paying unemployment benefits, was in surplus until tries of the former Soviet Union. The overall balance would c - l ,the mid-1990s. Rather than accumulating surpluses, seem to be in favor of the labor market adjustment ap- m such funds could have been used to improve the level of proach used in Central and Eastern Europe. In countries oL o >benefits or the number of people covered. that have weak wage bargaining institutions and little ability o ow ¢ Q uF ! to enforce minimum wage laws, unemployment benefits C s People who quit their jobs voluntarily, as opposed to being put a floor under wage setting. Contrary to conventional ,/ X , laid-off, were the dominant component of separations from wisdom, constraining from below wage flexibility may fos- state enterprises both in the former Soviet Union and in ter, rather than hinder, structural change. But a warning is ii Central and Eastern Europe. Hence the greater impor- in order here: this does not mean that in the transition to t tance attributed to unemployment benefits in countries a market economy it is always advisable to have institu- : - - ~ like the former Czechoslovakia, Hungary, and Poland than tions containing the growth of wage inequality. The former in Russia cannot be attributed to political pressures coming East Germany, for example, imported centralized wage from workers laid off at the outset of transition. The most bargaining institutions from West Germany that raised convincing explanation for these differences in policy and compressed the whole earning structure, which hin- models may be that the countries of Central and Eastern dered restructuring and employment gains. Europe were more culturally and politically drawn to the EU social policy model than were the countries of the TitoBoeriisaprofessorofeconomicsatlnnocenzo Gaspanni former Soviet Union. Central and Eastern European coun- Institute for Economic Research-Bocconi, a research fel- tries were also faster than the former Soviet Union in de- low of the Center for Economic Policy Research, and a WDI veloping broadly based electoral systems. This is likely research fellow He is also directorof the Rodolfo Debenedetti to have reduced the degree of freedom of governments in Foundation. Katherine Terrell is a professor of economics allowing for huge and persistent wage declines. at the University of Michigan, with a joint appointment at the Business School and the Ford School of Public Policy, and Which of the two main models of labor market ad- a WDI director for labor and human resources. She is also justment is preferable? A higher level of nonemployment an associate fellow at the Center for Economic Policy Re- benefits helped to encourage structural change and to search. This article is a summary of the authors' study first reduce income inequality, but it also generated more un- published as WDI Working Paper no. 384. Competition and Corporate Governance in Transition Countries By Saul Estrin Improved enterprise performance must be at the heart of This paper explores the elements of institutional devel- any successful transition from a command to a market- opment critical to the enhancement of company per- oriented economy. The standard pattern in the transi- formance in transition economies. These include the tion economies has been to seek to improve companies initial conditions; the forms of privatization; the institu- by heightening competition and enhancing corporate tional and legal framework, especially the corporate governance in various ways: by privatizing state-owned governance structure; the relationship between the pri- firms; by allowing and encouraging new firms and com- vate sector and the state; and the competitiveness of petition between existing firms; and by withdrawing gov- product markets, including the impact of international ernment subsidies so that firms must face their own trade. profits and losses, or what the literature refers to as a hard budget constraint. However, this pattern has had Policies and Enterprise Reform: Empirical mixed success. The ability of these reforms to improve Findings corporate performance appears highly sensitive to the institutional environment and initial conditions in which A substantial literature is now available on the determi- the policies were introduced, along with the specific na- nants of enterprise restructuring in transition economies. ture of the policies enacted. The main results outlined in this literature are as follows: TRANSITION, May-June 2002 © 2002 WDI C 2002 The World Bank * The impact of privatization on the performance of firms liberalization, competition, and enterprise support. A few l in transition economies has, for the most part, been posi- conclusions emerge from this survey of the determinants tive; however, the privatization effect is significantly stron- of enterprise performance. ger in Central Europe than in Russia and the CIS countries. 5.. In most cases,the impact is around twice the size. Initial conditions, in the sense of the degree of central plan- * The empirical evidence confirms the expectation that ning or the extent of structural macroeconomic imbalances, , the identity of the eventual owner affects the outcome of do not appear to have been a fundamental determinant of, privatization. Privatization to investment funds is five times either the reform path chosen or of subsequent economic as productive as privatization to insiders, and privatization performance. Those economies that were relatively more to foreigners or blockholders is three times as produc- reformed before the transition-ike Hungary, Poland, and l A tive as privatization to insiders. On average, banks and Slovenia-along with relatively less reformed ones-ike the blockholders improve company performance about as Czech Republic and some countries that were formerly part much as foreign owners. One interpretation of these find- of the Soviet Union like Estonia, and Latvia-are all current ings is that the concentration of ownership is crucial, leaders among the transition economies. However, none of because blockholders, funds, foreigners, and banks all the initially advanced countries have fallen seriously behind. have concentrated holdings. * The impact of differences in corporate governance on There does appear to be a sharp distinction in terms of enterprise performance is hard to test; however, studies the policies followed and their impact between Central that have focused on managerial turnover suggest that Europe on the one hand, and Russia and the CIS coun- new managers lead to higher productivity: by 6.2 percent tries on the other. The reasons for these divergences in the Czech Republic and 7.3 percent in Central Europe. are complex, and may stem from fundamentally differ- Similarly, managerial bonus schemes appear to raise to- ent political attitudes toward reform. The economies of tal factor productivity: doubling managers' bonuses in- Central Europe were led by legitimate governments creases total factor productivity growth by 7.4 percent. elected on platforms of reform, while the reformers in * The studies suggest that both domestic and import Russia and many of the CIS countries represented a competition play a significant role in improving company small but powerful political group that was advising the performance, thus product market competition has president, but was opposed by much of the parliamen- proved to be another important factor in raising compa- tary and civil service structure. Moreover, governments nies' productivity. .However, once again the, effects are in Russia and other CIS countries had to make compro- more robust for Central Europe. mises in introducing policies to build internal political * The hardness of budget constraints is also an important support for reform, perhaps because they faced more factor in stimulating enterprise restructuring. Early studies deeply entrenched managerial interests. This pattern of Poland found that restructuring occurred in state-owned resulted in reforms that were less conducive to improved firms prior to privatization if budget constraints were hard. enterprise performance and restructuring, notably with Ten papers have explored the issue econometrically, and respect to privatization methods, corporate governance, they confirm the positive impact of hard budget constraints competition, and subsidies. Moreover, many Central on total factor productivity, productivity, or sales growth. European countries wanted to join the EU, which pro- Again, the effect is highly significant in the studies of the vided their governments with additional legitimacy when non-CIS countries, but less consistent for Russia and the adopting Western European laws and institutions. Taken CIS states. It is harder to measure the impact of indirect together, these factors imply inferior performance in eco- soft budget constraints; however, policies that sever the nomic restructuring in Russia and the CIS. links between important economic institutions and the state, like privatizing utilities or the banking sector, probably en- Finally, transition policies underlying enterprise restruc- hance enterprise performance. Hence the private sector's turing must be regarded as complements to each other, share of GDP may itself be an important influence on the not substitutes. Privatization alone will be insufficient. impact of privatization. Enterprise reform will also require effective corporate gov- ernance and hard budget constraints. Conclusions 1Saul Estrin is deputy dean and professor of economics The transition countries began with very different ini- at the London Business School and a WDI research tial conditions and have since employed a variety of fellow This article is a summary of the author's study policies with respect to privatization, price and trade first published as WDI Working Paper no. 431. C 2002 The World Bank © 2002 WDI TRANSITION, May-June 2002 - Research Data from Transition Economies " By Randall K. Filer and Jan Hanousek More than 10 years into the transition from communism in the countries of the former Soviet Union and Central and Eastern Europe, a cursory search of the EconLit database turns up hundreds of empirical W studies published in refereed journals that deal with various issues in transition economies. Even so, we suspect that many economists are prevented from making full use of the possibilities offered by the transition because of the difficulties of obtaining and interpreting data from the region. The purpose of this brief essay is to suggest possible sources for data that can be used for economic analysis, as well as some general cautions regarding the use of these data. Many transition countries of the former Soviet Union and best meaningless, and at worst totally inaccurate. The pa- Central and Eastern Europe have been rapidly reforming per provides a sample of some common problems research- and increasing the capabilities of their statistical offices, ers might encounter while using data from these sources. and there are now few difficulties involved in obtaining mac- The bottom line is that when working with data from the roeconomic data from throughout the region. Problems with transition countries, paying careful attention to the details of respect to macroeconomic data occur not in obtaining these how the data were collected and the exact wording of ques- data, but in using them intelligently. The sources, coverage, tions and sample design is even more important than usual. and quality of macroeconomic data in the transition econo- mies have varied dramatically over the past decade. Many These cautions are intended to flag the need to pay special researchers have used data from the region as if their cover- attention to the idiosyncrasies and anomalies of data from age and quality were consistent .over the past decade, de- the transition economies. They are not meant to deny the spite the massive evidence to the contrary. These differences fact that the wealth of data available in the region presents and changes over time in the data call into question almost innumerable new opportunities for empirical economics. all cross-country comparisons based on official aggregate data. Given the wide availability and questionable nature of Randall K. Filer is a professor of economics at Hunter aggregate macroeconomic data, this essay focuses prima- College; the Graduate Center, City University of New York; rily on the microeconomic datasets that are increasingly and The Center for Economic Research and Graduate becoming available across the region. Education (CERGE-EI), Prague, and a WDI associate fellow. Jan Hanousek is an associate professor of eco- Access to microeconomic data on individuals and firms nomics, CERGE-EI, Prague, and a WDI research fellow from the transition economies is difficult. The concept of This article is a summary of the authors' study published free-or marginal cost-access for scholars to publicly as WDI Working Paper no. 416. collected 'data is only slowly penetrating the region. Many government statistical offices, constantly strapped for cash, Selection Criteria see presumably rich Westem academics as a source of e = = budget enhancement. Rather than establishing price lists for access to various datasets, offices appear to be acting as sophisticated price discriminators, negotiating widely variable prices based on presumed willingness to pay. None- theless, researchers willing to make the effort can obtain a wealth of data. Furthermore, conventional market research survey firms have been established throughout the region. a . i || These firms provide another opportunity for scholars, who often find it highly cost-effective to add study-specific ques- tions to ongoing random population surveys. Similarly, origi- nal surveys are feasible with modest support in even the * . . least developed transition economies. 9I need intelligent, independently thinking colleagues who know when I need applause, enthusiasiam, or Scholars who ignore the unique problems of data in the cheers and praise during my speech." transition countries run a serious risk of findings that are at From the Hungarian Daily Nepszabadsag TRANSITION, May-June 2002 - © 2002 WDI C 2002 The World Bank Articles provided by- i T} te Ud b}arir Irl s t i tLte . t_ - A Poor Decentralization Policy Burdens Poland's Social'Services By Janelle Kerlin Poland's mid-level decentralization reformn in 1999 was; an immense undertaking that included admin- I..LI istrative, political, and fiscal decentralization, as well as territorial re-division of the state. The goals of I the reform were to bring government closer to the people, improve public services, and further "de- r communize" the public bureaucracy. However, a closer look at the level of social services provision reveals many unfulfilled promises and unintended consequences of decentralization. New family assistance centers set up in the counties including policy that did not address the goals of the were assigned many tasks without sufficient funds for reform; policy that addressed reform goals in one area, full implementation. Funding for services varied depend- but worked at cross-purposes with goals in other areas; ing on whether they were provided in urban or more rural and policy that was written without sufficient foresight or areas. Given their limited fiscal autonomy, county and knowledge. About three-quarters of decentralization provincial governments were unable to direct services policy that affected social services was found to have according to the preferences of their respective regions. these shortcomings. Many of these outcomes can be traced to the politics of decentralization that created poor decentralization policy. The study turned to the development of the reform to learn why decentralization policy was so off base. Poor In mid-2000 the impact of decentralization on social decentralization policy that did not address goals of the * service delivery was examined using a nationwide rep- reform was found mainly in the area of reform finance. resentative survey of managers in 200 public social ser- Regulations addressing the finances of the reform had vice offices. While the survey was also conducted in been written by a small group of officials in the Ministry of provincial and municipal social service offices, it focused Finance who had purposely excluded other stakeholders mainly on services administered by the newly estab- from participation, such as representatives of local gov- lished county family assistance centers. Their respon- ermnent organizations, members of Parliament, govern- sibilities included referral services to residential nursing ment officials, and even staff of other departments within U homes, crisis intervention (domestic violence), counsel- the Finance Ministry. The result was that no one would ing services, services for the disabled, foster care, and agree to the legislation when it came time for it to be community integration services for youth. passed, because their concerns had not been taken into consideration. With no time left, Parliament had to pass The purpose of the survey was to determine the degree to "temporary" legislation that, rather than decentralizing fi- - which the overall goals of decentralization had been nances to the authority of new subnational governments, achieved in the area of social services. Survey:questions kept finance authority at the central level as it had beenoni asked about the degree of implementation of reform; the previously. Thus policy on reform finance did not meet a level of funding, the influence of civil society and societal reform goal for fiscal decentralization and subsequent fis- oversight, and the influence of county elections. The sur- cal autonomy for new subnational governments. In addi- vey also asked about changes in accessibility, flow of ti9n, policymakers who had deliberately isolated information between levels of govemment, and professional themselves manipulated the substitute reform to their own versus political criteria used in the selection of new direc- ends, resulting in other deviant policy that underfunded tors of the county family assistance centers. central transfers for decentralized services. The results s., .- , ,L. unsatisfactory outcomes in many Poor decentralization policy was also found where of these areas were due to poor decentralization policy, policy addressed reform goals in one area, but worked C 2002 The World Bank , 2002 The Urbak Institute TRANSITION, May-June 2002 , at cross-purposes with goals in other areas. For ex- offices were, in effect, centralized in relation to munici- ample, two of the main goals of the reform were to bring pal social service offices. As a result, social service s | ~government closer to the people and improve the effi- workers at the municipal level had a much more difficult R ciency of public service administration. However, to time communicating with provincial offices when difficul- achieve support for decentralization that would bring ties arose with centrally-funded benefits and programs. government closer to the people, reformers felt that they D ii had to compromise with citizen groups that demanded This analysis shows that increasing citizen involvement U : an inefficiently large number of counties. The result was and improving public services at the subnational level - -- ~ - 'j, that even though the first goal of bringing government through national-level democracy can be elusive. While / LA 4 1 closer to the people was achieved, the second, improv- scholars of decentralization may prescribe the specific ! ing administrative efficiency, was not. factors needed to achieve expected outcomes, the poli- iii tics of reform can prevent these factors from coming r += =: Also at times policymakers did not foresee how broader together simultaneously, or even from materializing at reform could negatively affect policy for a given sector. all. For example, even though many programs and services were decentralized to newly-restored, self-governing Janelle Kerlin is a visiting dissertation fellow at the Ur- counties, central government field offices remained at ban Institute. This article is based on her dissertation, the provincial level. When the number of provinces was "The Political Means and Social Service Ends of De- reduced from 49 to 16 to harmonize Poland's provincial centralization in Poland." For more information contact structure with that in Western Europe, these provincial the author at jkerlin@ui.urban.org. Measuring and Evaluating Transition: The Blessing and Curse of Indicators By Ivin Tosics During the first half of the 1990s the countries of Central and Eastern Europe (CEE) took many funda- mental decisions influenced mainly by political considerations, including changing property owner- ship structures, price structures, and social subsidies. The speed and depth of changes was unprecedented. In some CEE countries, for example, the privatization of the entire stock of public rental housing happened as a result of a political decision from one day to the next. Under such circumstances ongoing, comprehensive analysis of the changes and their consequences was impos- sible. Moreover, domestic political forces, usually planning only for the short term, were not inter- ested in such analysis. In 1993 the World Bank contracted the Metropolitan Re- shortages of housing and required massive investment search Institute (among institutions in three different akin to wartime reconstruction to solve its problems, we countries) to work on developing a system of intensive found little evidence of the validity of this view. (Related housing indicators. As an outcome of the first promising research, that is, theoretical work was conducted to- results, at the end of 1994 the World Bank decided that gether with Jozsef Heqedus and Steve Mayo.) Notwith- CEE countries would apply the housing and urban indi- standing clear problems related to the maintenance and cators in their preparatory work for the Habitat II project. upkeep of the housing stock throughout much of the This project, sponsored by the U.S. Agency for Interna- region, the stock is generally of better quality and better tional Development with additional help from UNCHS/ served with infrastructure than the housing stock of most Habitat and the Economic Commission of Europe, was other countries with similar economic resources. Instead, carried out between 1994 and 1996 and covered 12 CEE if there was a crisis it was one of disequilibrium: be- countries. tween preferences, ability to pay, and outcomes; be- tween institutional structures, incentive systems, and In contrast to many observers' assessments that before the requirements of a well-functioning housing sector the transition the Eastern European housing sector was capable of meeting the needs of all citizens. During the in crisis because of severe quantitative and qualitative years of the transition the inadequacies of the Eastern TRANSITION, May-June 2002 © 2002 The Urban Institute © 2002 The World Bank European housing model have become clear, and a major stock, the affordability problem, and the financial sector's process of restructuring the sector has begun. inefficiency and unwillingness to participate in finding a X solution to the housing problems. In the framework of the intensive indicators project not e only were the 11 key housing indicators calculated for Although the conclusions drawn from the indicator analy- 250 cities worldwide, but also new indicators were de- sis were generally well accepted, critics noted that the . . veloped that described the special features of housing analysis of the achievements and problems of the hous- 0 0 systems in Central and Eastern Europe. One, of these, ing sector in the CEE countries was based on one-sided ic the indicator to measure the level of ongoing housing initial assumptions, and therefore that the results of the expenditures, was the rent to income ratio. This had a comparisons could not be regarded as the only starting traditionally low value in the socialist countries com- point for devising new policies in these countries. To ' pared with the Western world, and by the mid-1990s it understand the essence of this criticism and to assess was still at around 5 percent of incomes. However, con- its validity, let us look at the theoretical and method- cluding that transition did not result in any change re- ological aspects of indicators. garding people's expenditures on housing would have been a mistake. In reality it did, because payments for Indicators: Statistics with a Policy Aim utilities-energy, water, sewage-increased dramatically from 2 to 3 percent of incomes to around 20 percent. Indicators differ from raw data, and also from data pro- cessed into statistics, insofar as indicators are statis- As a result, the level of combined housing'expendi- tics directed specifically toward policy concerns that tures-rent plus utilities-in the postsocialist cities point toward successful policy outcomes. They are usu- reached that of Western cities, where rents were high, ally highly aggregated and have easily recognizable pur- but utility payments were low compared with incomes. poses. Indexes are found at an even higher level of the One of the important policy consequences was that the information pyramid, for example, the consumer price rapid increase in utility prices to world market levels in index or human development index. These combine dif- the postsocialist cities was crowding out the possibili- ferent indicators into a single number useful for com- ties for increasing rents and maintenance expenditures. parisons over time and space. This led to further deferrals of the maintenance of multi- family housing. Another consequence was a rapid in- According to this definition, the crucial difference be- crease in arrears. The mass privatization policy chosen tween data and indicators is that indicators are value- by many countries in the region did not solve the prob- led from the beginning. Experts who are given the lem, as low-income families could not deal with the prob- responsibility of developing indicators in a given country lems, whether as renters or as owners. at a given moment usually do so for a preselected policy aim, and the indicators they develop are tailored to mea- The analysis of housing indicators showed that during sure success in achieving this aim. Thus indicators go the transition period, the deterioration of the multifamily hand in hand with policies, and are usually developed housing stock and decreasing affordability were serious as part of the policy development cycle. problems. Hence the housing policy proposals of that period, which dealt almost exclusively with the problem Included in the World Bank's indicator set was the time of housing shortages and directed all subsidies to new needed to obtain a building permit. The assumption was construction, were questionable. that the shorter the time, the more efficient the housing/ urban planning system. The results clearly showed that In the years following the publication of the indicator this assumption was erroneous. While the waiting pe- results, many experts in the field accepted that- riod is 1 month in Thailand and 12 months in the Nether- contrary to common perceptions-the housing sector lands, one cannot conclude that the urban planning of the Central and Eastern European countries was not system is more efficient in Thailand. To make a correct in bad shape at the beginning of the transition when judgment about the efficiency of the urban planning sys- compared with the housing situation of countries with tem would only be possible on the basis of a more de- similar levels of economic development. The focus of tailed theory of efficiency, including the analysis of other the debates changed from housing shortages to the other circumstances, for example, what factors are examined problems discovered in the comparative analysis, for ex- and taken into consideration when making a decision ample, the future of the privatized multifamily housing on building permits (environmental factors, the density C) 2002 The World Bank © 2002 The Urban Institute TRANSITION, May-June 2002 of housing in the area, the level of urban sprawl and/or Because of the sharp contrast between these two ap- concentration, the potential external effects, and so on) proaches turning directly from one approach to the other and what procedures are followed. is impossible. This was one reason for the 1996 col- l lapse of the CEE housing indicators program. The prom- Leading housing analysts in the United Kingdom have ising collaborative work of the experts stopped suddenly HI raised this type of, criticism against the World Bank- after the Habitat II Conference, when the international initiated housing indicators system in more general terms. donors terminated their sponsorship. In this situation S^* ii In many Western European countries, especially in the the CEE countries themselves should have continued --l United Kingdom, the generally market-oriented housing this project; however, this did not happen. It did not oc- policy has a long tradition of rent control and a huge cur not because of the economic situation of these coun- lIi lsocial rental sector, and policies are increasingly con- tries, but because the project had been almost cerned with rehabilitation. These aspects of housing are exclusively organized in a top-down perspective based -- missing from the housing indicators system. on outside sponsorship. As a consequence, no local, or even national, entities were interested in continuing the In 1993 D. Maclennan and K. Gibb, in their study "Politi- program. cal Economy, Applied Welfare Economics and Housing in the UK" wrote: "The Bank's indicator set reflects both Before the Habitat II + 5 Conference, held in New York in an ethical view, namely what housing policies ought to June 2001, the indicators again appeared on Habitat's be, as well as a technical view of a housing market's agenda. A new approach to the indicators program had function. The Bank takes the standpoint that housing been elaborated that emphasized the indicators' policy policy should be concerned with measures to enable orientation, and that gave preference to a broadly based housing, land and finance markets to operate competi- consultative approach for selecting city indicators in- tively and to allow consumers to determine housing stead of highlighting the importance of universal key in- choices. The removal of regulatory and monopolistic dis- dicators. The approach also reflected the view that the tortions (and indices of their extent and consequences) system could be built using a bottom-up approach in- and the replacement of tied subsidies with income- stead of a top-down one. targeted housing allowances then come to the centre stage of policy analysis." The current new approach of UNCHS/Habitat to the indi- cators increases the chances that the CEE countries will According to this view, the World Bank's indicator sys- continue with this exercise. However, to achieve a new tem measures how a given country is performing from commitment from these countries the new methodologi- its own standpoint, for example, how open the land cal approach by itself will not be enough. A new policy market is, how efficiently the administration is working framework should also be developed. The indicators should to enable market actors in the development process, 'contribute to comparability, with the emphasis on mea- how clear competition procedures are. As a result, coun- suring the countries' progress with democratization, eco- tries with the best indicator results can proudly state nomic efficiency, poverty reduction, and other issues. A that they are the countries with the best enabling poli- new system of European urban indicators should also be cies helping the development of a free market in hous- developed, taking into account the current interest in Eu- ing and urban development. However, it does not follow ropean urban policy, the process of EU enlargement, and that these countries have the best housing or urban de- so on. Developing new urban indicators at subnational velopment policy in general. Other policies may exist in levels, linking indicators to regional and local issues, is relation to housing based on such principles as social also essential. justice or environmental considerations. To measure the effectiveness of such policies would require different in- Well-established and well-measured indicators could dicators. contribute a great deal to the development of economic and social analysis. Preventing misinterpretation of Why the Housing Indicator Program Collapsed these indicators is up to the researchers, scientists, and advisors. One can distinguish between more general, top-down developed indicators, usually devised for comparative The author is a researcher and the director of the Metro- purposes, and locally relevant, less general indicators politan Research Institute in Budapest. He can be developed using broadly based consultative processes. reached at tosics@mri.hu. TRANSITION, May-June 2002 C 2002 The Urban Institute © 2002 The World Bank Articles provided by: XBank of Finland Institute for Economies in Transition The Importance of Nominal Convergence for I ^ EU Candidate Countries By Marketta Jarvinen The conventional wisdom in EU circles is that candidate countries should focus on real convergence a rather than on nominal convergence criteria. While poiiticians and academics generally agree on this, i they differ on how real convergence is best achieved. In candidate countries, by contrast, the discussion tends to center on exchange rate strategies and nominal convergence during the run-up to the Euro- pean Monetary Union (EMU). Indeed, the discussions between the EU and the candidate countries on the EMU appear to suffer from a certain deafness orn both sides. The EU seems to be ignoring the candidate countries' intention to adopt the euro as soon as possible, while the candidate countries have failed to address real convergence issues. To their credit, the candidate countries have political real- ting the primary surplus at a fixed level. The Maastricht ity on their side. EU membership will be a political deci- criteria on deficit and debt force countries into a Ricardian | sion, while EMU entry demands the application of regime. A similar reasoning underlies the Stability and economic criteria that do not include real convergence. Growth Pact, whereby member states commit to re- To ensure that EMU decisions do not become political, spect the medium-term budgetary objective of positions as well as the smooth functioning of the enlarged euro close to balance or in surplus. area, the relevant EU authorities (finance ministries, the European Central Bank, and EU central banks) need to Fiscal Policy and Exchange Rate Regimes be prepared to discuss nominal criteria, that is, inflation, interest rates, exchange rates, and public finances, fo- Applying the fiscal theory of the price level in different cusing on their sustainable fulfillment. To date, exchange exchange rate regimes shows that no exchange rate I- rate regimes have generated the most discussion by far. regime in itself can impose fiscal responsibility. Irrespon- . Inflation has ceased to be a major macroeconomic prob- sible fiscal policy affects the price level in all exchange E lem in most Icountries, and the soundness and rate regimes. If fiscal policy is responsible, the price sustainability of public finances is gaining more attention level is determined in the traditional way by monetary through pre-accession economic programs submitted by policy and the fiscal variables have no effect. In a mon- candidate countries. etary union, irresponsible fiscal policy by one member country raises the price level of the entire union. In the The Fiscal Theory of the Price Level EU context, responsible fiscal policies are essential for . the functioning of the EMU, which is probably why the The fiscal theory of the price level appears appropriate EU has agreed on the Stability and Growth Pact. If the for providing a framework for analyzing the interaction exchange rate is to be credibly fixed within the new ex- between the variables of nominal convergence. It com- change rate mechanism (ERM II), the candidate coun- bines monetary and fiscal policies and provides a holis- try must conduct responsible fiscal policy or exit the tic approach to macroeconomic analysis. Fiscal policy peg. can be either Ricardian (monetary dominant), where pri- mary surpluses, that is, surplus before debt servicing [Editor's note: The countries not participating in the costs, adjust to guarantee fiscal solvency for any se- euro area will still be using their national currencies. To quence of prices, or non-Ricardian (fiscal dominant), prepare these currencies for later participation in the where a government's intertemporal budget constraint euro area while helping to ensure exchange rate disci- is satisfied for some, but not all, price paths. An ex- pline throughout the EU, the ERM II was introduced on ample of an "irresponsible" (non-Ricardian) policy is set- January 1, 1999. Its main feature is that the currencies C 2002 The World Bank © 2002 BOFIT TRANSITION, May-June 2002 of the participating countries will have a central rate against policies may be enhanced by a commitment to a fixed 3 the euro. The standard fluctuation margins will be of +/- exchange rate regime. Thus the dialogue between the 15 percent, although the determination of narrower mar- EU and the candidate countries on the topic of nominal ni w C I''gins is possible. Intervention support from the European convergence needs to deepen, and to do so soon. Such Central Bank to any currency of a participating country dialogue would support the conduct of responsible poli- is, in principle, automatic.] The accession countries will cies that extend beyond -the point of acceptance into w probably join the ERM II before adopting the euro. the monetary union. Rapid changes in fiscal stance are C s #> ;l possible as witnessed in the deterioration in Poland in 'The requirement for responsible policies is naturally 2001 and the amelioration in Lithuania in 2000, which, . strengthened by the Maastricht criteria (fiscal responsi- coincidentally, can be seen as confirming the foregoing I - + '.y bility and price and exchange rate stability). results: irresponsible fiscal policy is possible with a float- ing regime, while a currency board supports.the con- For the pre-ERM II period, countries with irresponsible duct of responsible policies. fiscal policies are probably better off sticking to flexible regimes that can absorb the effects of irresponsible poli- The author is an economist at Finland's Ministry of Fi- cies. A forced exit from the ERM II would certainly not nance. This article was published in the May issue of impress the EU and would likely prove costly in eco- the Baltic Economies-Bimonthly Review and is avail- nomic terms. By contrast, the credibility of responsible able at wwwbof.fi/bofit. Finnish Firms See More Business in Russia- and Reform Needs By Mirja Azeem To gain a better understanding of the Russian economic Russia increased almost 10 percent in 2001, domes- situation, earlier this year the Finnish-Russian Cham- tic production grew only 5 percent and imports expanded ber of Commerce commissioned the first of what will some 20 percent. Some long-term projections incor- be an ongoing series of semi-annual surveys of busi- porate the notion that rising incomes in Russia will ness leaders in the chamber's member companies. sustain growth in consumption and imports at a higher The results of the March survey represent the views of rate than production, and that this could be sustained more than 300 business managers working in industry for several years because of Russia's large external (over 40 percent), services (almost 30 percent), and surpluses. trade (20 percent). Some 75 percent of the companies represented operate in Russia, more than 40 percent The survey, which asked respondents to name and rank up export directly, and 8 percent have production facilities to five of their largest problems in their Russian operations, in Russia. Almost 45 percent of the exporting compa- revealed numerous issues faced by firms in the field. Rus- nies reported that their exports to Russia had increased sian legislation and regulations and the functioning of Rus- during the past six months, while the share of firms sianauthoritiestoppedthelistofbusinessmanagers'worries. with stagnant exports was the same. Well over 60 per- Customs was regarded as the foremost problem area, while cent of the companies with business in Russia noted legislation, bureaucracy, the authorities, and taxation also that their business had grown, and about 30 percent figured high. The outcome should encourage Russia to con- faced unchanged business volumes. Expectations for tinue to pursue reforms. It confirms that customs reform, the next six months were positive, with 70 percent of which has been designed, but not yet approved, is definitely both groups anticipating growth in exports or of busi- necessary and will bring clear gains to the economy. ness on the spot. Although few anticipated rapid growth of the Russian economy, three-quarters of all those Thesurveyresultsfurthersuggestthattheantibureaucracy surveyed expected "some growth" in the short term. laws, adopted last year to protect firms from the excesses These expectations are good indicators of possible of officials, should be implemented along with wider pub- trends in demand. Demand could feed imports rather lic sector reform. Notably, perceptions of Russia's taxa- than domestic production. While domestic demand in tion may have already improved, partly because of TRANSITION, May-June 2002 © 2002 BOFIT c 2002 The World Bank Russia's recently enacted profit.tax legislation. As sia to retain stable macroeconomic policy alongside another area in need of reform, the banking and pay- the reforms. ments system also appeared higher in the survey than more standard issues such as business culture, The author is chief executive officer of the Finnish-Russian prices, clients, and competition. Instability of the Chamber of Commerce (wwwfinruscc.fi). This article was economy and the currency appeared low on the list of published in the June issue of The Russian Economy- concerns. This should underscore the need for Rus- The Month in Review and is available at wwwbof.fi/boflt The World Bank/IMF Agenda (continued) Continued from page 27 particularly for small and medium enterprises. IFC helped set up several private equity funds and credit lines to * Strengthening public sector management by finance small and medium enterprises. -Enhancing accountability mechanisms and in- formation flows within and across different levels of gov- World Bank to Lend China More Than $1.3 Billion ernment Annually -Improving fiscal management at the national and subnational levels The World Bank's future lending to China will be in the -Improving the efficiency and quality of public range of $1.3 billion to $1.5 billion each year, said Presi- service delivery dent James Wolfensohn during his late May visit to * Mitigating social and environmental risks by China, as the Bank refocuses its poverty relief efforts in -Reducing poverty and mitigating the negative the world's most populous country. Wolfensohn said that consequences of income insecurity the Bank's projects in China will focus on aiding poor -Improving the quality of selected health and rural areas, assisting economic reforms, boosting the education services role of the private sector, and cleaning up the environ- -Improving the design, targeting, administrative ment. capacity, and financing of social protection programs -Addressing environmental hazards and improv- Since 1992 the Bank's lending to China has averaged ing environmental management. more than $2 billion annually, peaking at $3.1 billion in 1993. It has lent about $35 billion in total to China since Peter Woicke, Head of IFC, Visits Russia its first project in 1981. However, lending has fallen since 2b00, when China's growing wealth made it ineligible for To reaffirm the International Finance Corporation's (IFC's) the Bank's cheapest (International Development Asso- continued commitment to private sector development in ciation or IDA) financing, which is reserved for the poor- Russia, Peter Woicke, head of IFC and a managing di- est countries (IDA credits are interest free and usually rector of the World Bank Group, paid a two-day visit to have a maturity of 30 years with a 10-year grace period). Russia on May 30-31 and met with government and busi- Wolfensohn praised the country's economic policy ness leaders. IFC, the private sector development arm record, which, he said, had lifted 250 million people out of the World Bank Group, has worked actively to sup- of poverty over the past 20 years. Speaking at the end of port the development of a strong private sector in Rus- eight days in China, he suggested several areas where sia since it became a member in 1993. IFC has invested China could make further progress to consolidate its more than $136 million in equity and provided loans to- great achievements, namely: taling $448 million to the private sector in Russia, as well as mobilizing $110 million from other sources of * Focusing on poorer areas. Income disparities and financing. lack of opportunity are marginalizing millions of people, m, ainly in the remote western regions. More concerted Key IFC priorities in Russia include developing and efforts will mean not just greater investment in rural de- strengthening financial institutions, attracting foreign in- velopment, health, education, and basic infrastructure, vestment and technology, working with local partners to but also finding ways to provide financial assistance, improve transparency and corporate governance, and p'erhaps through microcredit schemes, to small busi- expanding efforts to improve the business environment, nesses and farmers. C) 2002 The World Bank TRANSInI ION, May-June 2002 .C i, * Continuing the transition to a more open, mar-' carbon dioxide over 10 years at the low cost of $0.67 ket-driven economy. The nonperforminig loans held by per metric ton. This amount is equivalent to the emis- state banks, the loss-making state-owned enterprises, sions of about 1.1 million U.S. citizens over one year, C 3 the unfunded pension systems, the inadequate prop- and the cost is well below prices being paid for car- , *1 X~ <|erty markets, and the relatively weak domestic financial bon reduction worldwide. Oc IL 1 |system are among the obstacles China must continue Q to deal with as it prepares for full compliance with WTO Another large regional GEF project involves 15 coun- i requirements in 2007. A better investment climate pre- tries at or near the Danube River, the GEF Strategic sumes progress in improving transparency and account- Partnership on the Danube/Black Sea Basin, whose ,/ Ii abilityinbusinesses, reducing corruption, and upgrading long-term objective is to reduce nutrient levels and -<> 7 the legal and judicial systems. A free press and a strong other hazardous substances until the Black Sea/ !I civil society could play an useful watchdog role in all Danube ecosystems return to the favorable condi- -- 11]this. tions of the 1960s. Now a second tranche can be * Stepping up efforts to restore and protect the drawn from the Nutrition Reduction Fund, managed natural environment. The environment has suffered jointly by the GEF and the World Bank. In addition badly through inadequate planning, protection, and en- Croatia will receive financing for a renewable energy forcement in both urban and rural areas. resources project, Poland for an energy efficiency automobile program, and Cuba for shoring up its pro- World Bank Credit to the Yugoslav Economy tected areas. On May 23 the World Bank approved a $85 million Pri- The GEF was established in 1991 to channel multilat- vate and Financial Sector Structural Adjustment Credit eral funds to projects that result in local and global for FR Yugoslavia. The credit will support the resolution environmental benefits. It aims to conserve biodiversity, of nonperforming loans held by banks and the reduce greenhouse gas emissions, protect the ozone privatization of indebted enterprises. "We are pleased to layer, clean up international waters, stop land degra- be able to support the privatization program adopted by dation, and eliminate persistent organic pollutants. the government of Serbia, which should be a good basis Since 1991 the GEF has allocated $4.2 billion in for restarting the growth of the real sector. The credit grants, supplemented by more than $11 billion in ad- equally supports government policy designed to remove ditional financing, for more than 1,000 projects in 160 regulatory barriers to the entry and growth of small and developing and transition countries. For more infor- medium enterprises," said Itzhak Goldberg, the World mation go to the GEF web site: www.gefweb.org. Bank's private sector team leader. The credit will be dis- bursed on International Development Association terms World Bank Credit to Assist Access to Safe Blood and will repayable in 20 years, including a 10-year grace in Vietnam period. It will be disbursed in one tranche. In late May the World Bank and Vietnam signed a $38.2 GEF Council Approves 20 Projects Worth $610.9 million credit for the Regional Blood Transfusion Cen- Million ters Project, which will support efforts to establish blood transfusion centers across the country. "The project will In mid-May the governing Council of the Global Environ- benefit a population of 30 million people in 21 provinces ment Facility (GEF) approved $113.7 million for 20 envi- served by 180 hospitals," pointed out Le Duc Thuy, gov- ronmental projects with a total value of-including ernor of the State Bank of Vietnam. As World Bank Vice cofinancing-$610.9 million. Many of the 20 new projects President and Chief Economist Nicholas Stern noted, provide opportunities for the private sector to participate several problems in the current blood supply system by supplying technology or making investments. need to be addressed, including estimates that only about 10 to 14 percent of blood needs are being met The 20 projects approved includes a regional project in- and that available supplies are of uncertain quality, mean- volving the Czech Republic, Slovakia, and the Baltic ing that transfusions tend to be risky. Compliance with countries, for which the GEF is providing $11.25 million existing national standards for testing, screening, and to help reduce greenhouse gas emissions and increase storing of blood by the many underfunded hospital blood energy efficiency. The expected reduction of the region's laboratories is highly uneven. The World Bank's support greenhouse gas emissions is 7.4 million metric tons of will change this situation, he added. TRANSITION, May-June 2002 © 2002 The World Bank Bulgaria: Country Assistance Strategy Offers, $750 Mil- In pursuing its assistance strategy the World Bank Group lion wili help Bulgaria to: In early May the World Bank's Board of Directors discussed * Promote private sector-led growth. The main goal the Country Assistance Strategy (CAS) for Bulgaria. Un- is to improve the business environment through acceler- der the most likely scenario, the World Bank's assistance ated privatization, better regulations for businesses, and program over the next three years is expected to entail a deyelopment of financial institutions. lending program of up to $750 million, and the CAS will l serve as the road map for this program. The World Bank I S p a a tion initiatives. The Bank will promote the development Group's program in Bulgaria over the coming three years of' will focus on reducing poverty, raising living standards, and an effective, transparent, and accountable public sec- ' ' ~~~~~~tor. In addition, programs for Improving the effciency of helping with the country's EU accession process. The Bank tol t t' pro Id imp t d l Group will support Bulgaria through a combination of re- search work, policy advice, and selected lending opera- * Mitigate the social impact of restructuring and tions. The International Finance Corporation will continue delivering social services more effectively. The to invest in the private sector by providing postprvatization Ba6nk's strategy will focus on alleviating poverty further, support and catalyzing business development, shifting the promoting human capital development, modernizing the focus to areas where Bulgaria has a comparative advan- education and health sectors, improving the targeting of tage, including such export-oriented sectors as wood, cloth- social safety net programs, and monitoring policy im- ing, pharmaceuticals, shipyards, tourism, and agribusiness. pa'cts on living standards and welfare. Conference Diary For the Record SITE Conference Announcements Building Competitive Advantage in Nations: Increas- Centre for Economic Policy Research/The Williamson ing Transparency, Combating Corruption, and Im- Davidson Institute (CEPRNWDI) Seventh Annual Inter- proving Corporate Governance national Conference on Transition Economics March 26-28, 2002, Budapest, Hungary June 20-22, 2002, Riga, Latvia "We see corruption and weak corporate governance as Hosts: The Stockholm Institute for Transition Econom- twin enemies of country competitiveness-these are two ics (SITE) and the Baltic International Centre for Eco- sides of the same coin of no accountability," said a high- nomic Policy Studies (BICEPS) at the Stockholm School ranking U.S.Agencyfor International Development (USAID) of; Economics (SSE) in Riga. official of the topic of a recent conference held in Budapest and organized by the USAID and the Center for Interna- Organizers: Erik Berglof of SITE, SSE, and CEPR; Gerard tional Private Enterprise (CIPE), together with J. E. Austin Roland of CEPR and the University of Califomia at Berkeley; Associates. The conference explored the links between and Jan Svejnar of WDI and the University of Michigan. building effective market-oriented policies andd'promoting better ethics in both the public and private sectors. About This conference will provide a forum for leading econo- 150 participants from 18 countries discussed how to im- mists and other social scientists working on transition prove the general investment climate through greater trans- anid development issues to meet, present new research, parency and accountability. Slovak Deputy Prime Minister develop collaborative relationships, and complete ongo- for the Economy Ivan Miklos discussed his govemment's ing research. The conference will also bring together key efforts to forge an effective public-private partnership to com- policymakers in the region with these researchers to fa- bat corruption. Speakers warned that corruption is imped- cilitate discussion and the exchange of ideas. A special ing investment and growth, increasing transaction costs, feature of this conference will be a panel that will explore i and wasting management time. similarities and differences between issues and methods in transition and development economics. A provisional i Information: CIPE's web site: http://wwwcipe.org/events/ program may be viewed on the BICEPS web site: http:l/ budaconf. A copy of the conference CD-ROM is also wrww.biceps.org. In parallel, economists originally from available. the Baltic states but now studvina or working around the © 2002 The World Bank TRANSITION, May-June 2002 world will meet to discuss issues of particular interest to Forthcoming their native countries. Centre for Financial,andIEconomic Research VIl North-Western Banking Conference ; Centre for Financial and Economic Research July 17-20, 2002, Saint Petersburg, Russia 5!'(CEFIR) International Conference: Negotiating Russia's WTO Accession-Lessons from Multilateral Organizers: Association of Russian Banks, St. Peters- I Trade Liberalization and Club Enlargement burg Department of the Central Bank of Russia, June 24-25, 2002, Moscow Promsvyazbank, and the St. Petersburg Union of Manu- I! ~~~~~~~~~~~~~facturers and Owners (Employers). ! This intemational conference will bring together prominent I academics and policymakers to examine the theoretical A major topic, "Clients and Banks-from Cooperation to -, - and policy issues of Russia's accession into the WTO. Its Partnership," will include discussion of interaction be- , aims are to increase awareness among Russian econo- tween the banking and industrial sectors, banks' par- mists of intemational trade theory as an important area of ticipation in enterprise restructuring, completion of economics, to inform academic and policy circles in Russia regional projects, assisting industrial growth through trade on cutting-edge research in the areas of multilateral trade and project finance instruments, and attracting foreign liberalization and trade negotiations, and to give Western capital. A parallel session on "Legal Regulation of Bank- economists working on trade theory and policy an opportu- ing Activities" will deal with such issues as currency nity to discuss the policy-relevant implications of recent re- regulation, currency control, and loan security. search in the context of Russia's accession negotiations. Information: Conference@psbank. spb. ru. CEFIR is honored to welcome an eminent group of econo- mists to Moscow for the meeting, including Bill Ethier of Unofficial Activities in Transition Countries: 10 Years the University of Pennsylvania, Gene Grossman of of Experience Princeton University, James Markussen of the University October 18-19, 2002, Zagreb, Croatia of Colorado, Keith Maskus of the World Bank, Ray Riezman of the University of Iowa, Robert Stern of the This international conference will analyze the size, University of Michigan, and others. scope, causes, consequences, and policy implications of unofficial (illegal, unrecorded, unreported, informal, Some major themes that will be addressed are: underground, hidden, shadow, parallel) activities in tran- * Consequences of WTO accession for Russia's sition countries during the past decade. The confer- economy and for the world economy in general ence aims to answer such questions as: * Sector-specific aspects of Russia's accession nego- tiations (services, agriculture, investments, intellectual * Why have unofficial activities been so widespread in property) some transition countries and less important in oth- * Political economy of trade reforms and reciprocal trade ers? liberalization in the context of Russia's WTO accession * How did this develop? What have the consequences * Lessons and consequences of China's accession ne- been? gotiations for Russia's accession * Is some pattern or sequencing apparent in the devel- * The WTO legal system and the credibility of domestic opment of unofficial activities connected with transition reforms in Russia on the eve of accession and reforms? * Institutional design and the principles of the General * If so, can we derive any policy recommendations Agreement on Tariffs and Trade and the WTO from the experience of more advanced transition coun- * Reciprocity, nondiscrimination, and renegotiation in tries that could usefully be offered to those that have trade policy cooperation not gone as far along this road? * Gradualism in reciprocal trade liberalization. Prospective contributors are invited to submit an appli- Information: SITE, Stockholm Institute of Transition Eco- cation, abstract, and curriculum vitae before May 31 nomics and East European Economies, Box 6501, SE-113 and a final paper before September 30. Travel and ac- 83 Stockholm, Sweden, Sveavagen 65, 9th Fl.; tel: 468-736- commodation expenses will be paid for the authors of 9670, fax: 468-316-422, email: SITE@hhs.se, URL: http:// papers selected for presentation depending on avail- wwwhhs.se/site. able funds. TRANSITION, May-June 2002 © 2002 The World Bank Papers and abstracts should include key words, full essary or sufficient to enhance levels of general trust in name and affiliation, address, email, and fax and phone managerial behavior, and of whether or not these institu- numbers of the author. We strongly support email sub- tions can be successfully transplanted. missions. All papers must conform to standard journal * Is! a convergence of social institutions necessary to I g style formats. Please follow instructions provided on achievethelevelsoftrustin managerial behavior needed http://www.aeaweb.org/aer/styleguide.html. Selected to sustain economic functioning, or can different institu- papers will be published in a special issue of the jour- tional arrangements foster equally well the required Iev-, 3 w nal Financijska teorija i praksa and possibly in a con- els lof trust to encourage investor confidence in 1'1 U ference volume. governance and disclosure, labor confidence in fair treat- ment and business-to-business partners' confidence in Information: Katarina Ott, Institute of Public Finance, their contractual arrangements? In other words, are there Katanciceva 5, 10000 Zagreb, Croatia; tel..: 385-1- "functional equivalents" to the norms, laws, and regula -_l 4819363, fax: 385-1-4819365, email: kott@ijf.hr, URL: tions that are intended to sustain the necessary stan- http://www.if.hr. dard of managerial behavior in industrial countries? * In-depth studies categorizing how international busi- Call for Papers: Does Globalization Lead to Changes ness interactions influence social institutional develop- in Social Institutions That Enhance or Decrease mert (for better or for worse). "Trust" in Managerial Behavior? * Stiudies pertinent to developing, emerging, and transi- tion: economies are especially welcome. The conference will focus on identifiable trust exhibited in managerial behavior, including corporate governance, Submission instructions: Send an abstract (four pages employer-employee relationships, and firm-to-firm be- maximum) or completed paper that describes the research havior (with competitor firms, with suppliers, and with question, the theoretical argument, the empirical method, customer firms). We welcome theoretical and empirical and the anticipated results to Svetlana Corr, William Davidson research that focuses on the relationship between these Institute Program Coordinator, at corrs@umich.edu by Mon- target dependent variables and social institutions, and day,. July 22, 2002. For more information contact Bemard the relationship between global competition and eco- Yeung, New York University, Stern School of Business, at nomic integration and social institutions. In particular, Byeung@stem.nyu.edu or 212-998-0425. we are interested in how globalization changes the tar- get dependent variables via changing social institutions. The complete call for papers is available at http:// We are especially interested in research results that www.wdi.bus.umich.edu/research/call/Trust.doc. can influence practitioners in business and in public policies, and that can be integrated into classroom dis- The conference is sponsored by the Aspen Institute's cussions and business school curricula. Initiative for Social Innovation through Business and The William Davidson Institute at the University of Michigan Here is a set of possible research questions: Business School. * Descriptions of instances of international business dealings that have affected the historical development of Deadline for submission of a three- to four-page abstract: social institutions in different countries and cultures, and Monday, July 22, 2002. therefore led to changes in managerial behavior and the Notification of acceptance: September 6, 2002. trust it reflects. Preliminary conference: Ann Arbor, Michigan, Novem- * Explorations of how openness to the global economy ber 15-17, 2002. relates to contemporary institutional changes associ- Final conference: Aspen, Colorado, March 14-16, 2003 ated with change in trust in managerial behavior. Does the change have a positive or negative effect on eco- Marketing and Business Strategies for Central and nomic efficiency? On individual's welfare? Are the ef- Eastern Europe fects uniform or individual and firm specific? December 5-7, 2002, Arcotel Hotel Wimberger, Vienna, * Analysis of examples, either successful or unsuccess- Austria ful, of how economic openness has led to the transplant- ing from one country to another of the social institutions Thi's will be the 10th joint annual conference of the associated with fostering trust in managerial behavior. Kellstadt Center for Marketing Analysis and Planning; * Analysis of which sorts of social institutions are nec- DePaul University, Chicago; and the Department of © 2002 The World Bank TRANSITION, May-June 2002 International Business; University of Economics and 43-1-313 36/4371, fax: 43-1-313 36/751, email: Reiner. Business Administration, Vienna. Springer @wu-wien.ac.at, or Prof. Dr. Petr Chadraba, Kellstadt Center for Marketing Analysis and Planning, Empirical research, case studies, or discussion ses- DePaul University, 1 East Jackson Boulevard, Chicago, sions are sought that address such topics as com- Illinois 60604;tel.:312-362-6889, fax:312-362-5647, email: parative analysis of conditions of market entry in pchadrab@depaul.edu. - Central and Eastern European (CEE) countries, mar- , . ket entry through exports versus market entry via capi- International Health Summit on Public-Private _ tal investment, acquisitions as opposed to joint Partnerships * ventures in CEE, marketing strategies to reach CEE December 8-11, 2002, Sheraton Bal Harbour, Miami consumers, marketing mix decisions for markets in Beach, Florida, U.S.A. - CEE, financial strategies for opening CEE markets, and case studies of CEE experiences by Western Hosts expect eminent health sector leaders, including firms. policymakers; physicians; and executives of health plans, hospitals, and pharmaceutical and technology firms to Abstracts of the papers, in English, should be received attend. C-l by September 15, 2002. The final papers must be ready by November 1, 2002. For more information or Information: Registrar Office: Bay Area, California, .to send abstracts contact either of the conference United States; tel.: 925-680-1862, fax: 925-676-5785, -' 7L sponsors. email: eidetics@conferencemanagement. com; Euro- ( - pean Office: 24 Milson Road, London W140LJ, U.K.; Information: Prof. Dr. Reiner Springer, Wirtschaft- email: pgarside@ihsummit.com, URL http:// suniversitat Wien, Althanstr. 51, 1090 Vienna, Austria; tel.: www.ihsummit.comi. 7< -New Books and Working Papers The Macroeconomics and Growth Group regrets that it is unable to provide the publications listed. World Bank Publications economy more generally. The authors document how Q~W~ often bankruptcy is actually being used in 35 coun- To receive ordering and price information for World Bank tries, including the Czech Republic, Hungary, Poland, publications contact the World Bank, PO. Box 960, and Russia. They then investigate various insolvency Hemdon, VA 20172, United States; te/.: 703-661-1580, regimes in relation to the quality of the countries' over- fax.: 703-661-1501, email: books@worldbank.org, URL: all judicial systems. http://www. worldbank. org/publications, or visit the World Bank InfoShop at 701 18th Street, N.W., Washington, Bankruptcies are higher in common-law countries (where -D.C., te/.: 202-458-5454. the "unwritten" law is based on historical legal prece- v . -0 dents, shaped by judges, as opposed to civil law sys- C j Working Papers tems that require all laws to be codified) and in http://econ.worldbank.org/ market-oriented financial systems. Greater judicial effi- ciency is associated with more use of bankruptcy, but Stijn Claessens and Leora F. Klapper, Bankruptcy the combination of stronger creditor rights with greater around the World: Explanations of its Relative Use, judicial efficiency leads to less use. Countries with more WPS 2865, July 2002, 35 pp. efficient and speedy procedures for opening new busi- nesses have greater bankruptcy use. The presence of Recent financial crises have highlighted the impor- more small and medium firms is associated with less tance of insolvency systems for resolving corporate use of bankruptcy, which may reflect the costs of using sector financial distress. The literature and the crises formal bankruptcy procedures, deterring their use by have emphasized the complex role of creditors' rights, smaller firms. These findings suggest that proper insol- which affect not only the efficiency of resolution of vency systems combined with an effective judiciary sys- distressed corporations, but also influence risk-taking tem encourage less risky behavior and more out-of-court incentives and the degree of entrepreneurship in an settlements. TRANSITON, May-June 2002 ( 2002 The World Bank The authors may be contacted at stijn@fee.uva.nl or The!authorsmaybecontactedatgcaprio@worldbank.org Iklapper@worldbank. org. or phonohan@worldbank. org. Sunita Kikeri and John Nellis, Privatization in Com- Luc Laeven, Daniela Klingebiel, and Randy Kroszner, petitive Sectors: The Record to Date, WPS 2860, Financial Crises, Financial Dependence, and In- June 2002, 52 pp. dusrry Growth, WPS 2855, June 2002 Privatization improves firms'financial and operating per- Dorald Cox, Private Interhousehold Transfers in i Z formance, yields positive fiscal and macroeconomic Vietnam in the Early and Late 1990s, WPS 2853, benefits (proceeds are saved rather than spent, trans- June 2002 fers decline, and governments start collecting taxes from privatized firms), and improves overall welfare. The David A. Grigorian and Vlad Manole, Determinants of popular view that privatization always leads to layoffs Commercial Bank Performance in Transition: An is unfounded. While highly protected firms have seen Application of Data Envelopment Analysis, WPS significant declines in net employment, cormpetitive 2850, June 6, 2002 firms have generally experienced only slight declines, if any. The effects of privatization on wealth and in- Jacques Morisset and Olivier Lumenga Neso, Adminis- come distribution have only recently been receiving the trative Barriers to Foreign Investment in Develop- attention of analysts, and research is just getting un- ing Countries, WPS 2848, May 16, 2002 der way. International experience has shown that excessively Successful privatization requires strong political com- complex administrative procedures required to estab- mitment, combined with wider public understanding of lishi and operate a business discourage inflows of for- and support for the process; creation of competitive eigh direct investment. The authors present a new markets through the removal of entry and exit barriers, database on the administrative costs private inves- financial sector reforms that create commercially-oriented tors in 32 developing countries face. The database is banking systems, and effective regulatory frameworks more comprehensive than existing sources, as it con- that reinforce the benefits of private ownership; and trans- tains not only information about general entry proce- parency in the privatization process. dures, such as business and tax registration, but also captures regulations on land access, site develop- Theauthorsmaybecontactedatskikeri@worldbank.org ment, import procedures, and inspections. The data or jnellis@starpower.net. inc!ude measures on the number of procedures, di- rect monetary costs, and time. Olivier Fremond and Mierta Capaul, The State of Cor- porate Governance: Experience from Country As- The costs of administrative procedures vary signifi- sessments, WPS 2858, June 2002, 30 pp. cantly across countries. The most important barriers appear to be the delays associated with securing land Corporate governance deals with the ways in which the access and obtaining building permits, which in sev- rights of shareholders are protected and in which they re- eral countries take more than two years. Countries ceive a fair return. Good practices reduce the risk of expro- that impose excessive administrative costs on entry priation of outsiders by insiders, and thus reduce the costs tend to be equally intrusive in firm operations, thereby of the enterprise raising capital on the market. The authors weakening the argument that barriers to entry are a summarize experience with corporate governance in 15 substitute for the government's unwillingness or in- countries, including Bulgaria, Cambodia, China, Croatia, ability to regulate enterprise operations. The level of the Czech Republic, Laos, Ukraine, and Vietnam. administrative costs is positively correlated with the incidence of corruption and negatively correlated with The authors maybe contactedatofremond@worldbankorg the quality of governance, degree of openness, and or mcapaul@worldbank.org. public wages. These correlations suggest that admin- istrative reforms need to be incorporated into the Gerard Caprio, Jr., and Patrick Honohan, Banking broader agenda for reform, such as trade and finan- Policy and Macroeconomic Stability: An Explora- cial liberalization, anticorruption activities, and public tion, WPS 2856, June 2002 sector administration. ©3 2002 The World Bank TRANSITION, May-June 2002 1 Gregorio Impavido, Alberto R. Musalem, and Dimitri The Annual World Bank Conference on Development Vittas, Contractual Savings in Countries with a Economics is a global gathering of the world's leading .C £ _ 1Small Financial Sector, WPS 2841, May 7, 2002 scholars and development practitioners. Among the at- a v tendees were participants from developing countries, e Andrew Sunil Rajkumar and Vinaya Swaroop, Public universities, think tanks, nongovernmental organizations, E £ Spending and Outcomes: Does Governance Mat- and international financial institutions. The 13th annual ¢ 0 w ter? WPS 2840, May 7, 2002 conference, held in May 2001, concentrated on the cur- el- i rent thinking in development policy and the implications Other World Bank Publications for the global economy, with a particular focus on the l-> _ t!! two important and controversial themes of globalization ) William Battaile, 2001 Annual Review of Develop- and health. This book is a collection of conference pa- ment Effectiveness: Making Choices, Operations pers from this forum, published together with the Oxford Evaluation Studies, 2002, 108 pp University Press. The bottom line for the World Bank is its development The World Bank Atlas, 2002, June 2002, 64 pp. effectiveness. The independent Operations Evaluation Department tracks the Bank's development perfor- Special Package Set. World Bank Atlas 2002 and mance, analyzing the effectiveness of Bank projects, The Little Data Book 2002, June 2002 programs, and processes; draws lessons from its op- erational experience; and provides advice to the Board Institute of Public Finance, Zagreb/Croatia based on evaluations at the project, country, sector, Occasional Paper Series and thematic levels. The latest project evaluation data confirm a significant improvement in the outcomes of To order: Institute of Public Finance, Katanciceva 5, the Bank's lending performance, especially for projects 10000, Zagreb, Croatia; tel.: 385-1-481-9363, fax.: 385- that had been completed by June 2001. The upward 1-481-9365, URL: http://www.ijfhr, email: office@ijf.hr. trend continues into fiscal year 2001, with solid im- provements in sustainability and institutional develop- Vedran Sosic, Dollarization and the Underground ment impact. Lending is, however, only one dimension Economy: Accidental Partners? OP no. 15, April 2002, of the Bank's broader assistance tool kit, which in- 22 pp. cludes both financial and nonfinancial instruments. Selecting the right combination and proper sequenc- Aleksandar Stulhofer and Ivan Rimac, Opportunism, ing of activities can make the difference between suc- Institutions, and Moral Costs: The Socio-Cultural cess and failure. Dimension of the Underground Economy in Croatia 1995-1999, OP no. 14, April 2002, 13 pp. Csaba Csaki, John Nash, Vera Matusevich, and Holger Kray, Food and Agricultural Policy in Russia: How much, if at all, should Croatia be concerned about Progress to Date and the Road Forward, World Bank the underground economy? In the postcommunist tran- Technical Paper 523, 2002, 168 pp. sitional setting the underground economy reflects the failure of institutions. It is negatively correlated with eco- Russia's agriculture sector has considerable untapped nomic openness and the volume of investment; tax rev- productive potential. Given this potential, agriculture enue, the development of the banking system, and the could provide a solid foundation for growth and poverty capital market; the rule of law; the quality of the political alleviation, particularly in rural areas. The objectives of establishment; and civil society. It is positively corre- this book are to facilitate the debate of issues key to lated with corruption and the degree of economic regu- agricultural policy, to contribute to a greater understand- lation. The underground economy has a destructive effect ing of the Russian agriculture sector, and to identify a on social development and diminishes social trust. In framework for further collaboration between the Russian Croatia the underground economy reached about 25 government and the World Bank in the rural sector. percent of "official" GDP in the early 1990s. Since 1995, however, its role has been declining. Boris Pleskovic and Nicholas Stern, editors, Annual World Bank Conference on Development Econom- Sanja Madzarevic-Sujster, An Estimate of Tax Evasion in ics 2001/2002, April 2002, 274 pp. Croatia, OP no. 13, April 2002, 23 pp. TRANSITION, May-June 2002 © 2002 The World Bank In the midst of adjustment of the taxation system to the In sbme Central and Eastem European countres, unlike in' market economy, the broadening of the tax base, the intro- EU member states, regionalization has occurred via institu- duction of new and the abolition of old taxes, and the changes tional changes, even if the socioeconomic dimension is still in tax rates, making reliable calculations about the extent of in its infancy. These institutional changes anticipate poli- tax evasion is difficult. Through a separate analysis of the cies that are being contemplated with a view to gaining EU evasion of some direct and indirect taxes for 1994-2000 two membership and obtaining structural funds for regional de- estimates have been obtained: the lower estimate puts tax vel6pment. To date regionalization in Central and Eastern l. evasion at the equivalent of 5.5 percent of GDP and the European countries has been a regionalization of institu- upper estimate ranges from 7.5 to 11 percent of GDP tions. The five countries under review in this book-Hun- gary, Lithuania, Poland, and Slovakia-have introduced new ' BOFIT Discussion Papers regional levels of govemment. Axel Bruggemann and Thomas Linne, Are the Central Katalin Tausz, editor, Impact of Decentralization on and Eastern European Transition Countries Still Vul- Social Policy, Local Government and Public Reform nerable to a Financial Crisis? Results from the Sig- Initiative, Budapest, LGI Studies Series, 2002, 236 pp. nals Approach Decentralization is defined, interpreted, and made a The aim of the paper is to analyze the vulnerability of the political issue in several, sometimes contradictory, ways. Central and Eastern European accession countries to Sometimes it is considered a term, sometimes a con- the EU, as well as of Russia and Turkey, to a financial cept, a process, a theory, a methodology, a policy, or crisis. Our methodology is an extension of the signals even a trend. In the states of the former Soviet bloc sys- approach. We develop a composite indicator to measure temic changes provided the opportunity for breaking down the evolution of the risk potential in each country. Our the' heavily centralized structures. A combined team of findings show that crises in Central and Eastern Europe Hungarian, Latvian, and Ukrainian experts on social policy are caused by much the usual suspects as in other emerg- and public administration carried out this research project ing markets, in particular, an overvalued exchange rate. in their own countries. Weak exports and dwindling currency reserves have good predictive power for assessing crisis vulnerabilities. Gabor Peteri, editor, Mastering Decentralization and Public Administration Reforms in Central and East- Balazs Egert, Investigating the Balassa-Samuelson ern Europe, Local Government and Public Reform Ini- Hypothesis in Transition: Do We Understand What tiative, Budapest, LGI Studies Series, 2002, 119 pp. We See? BOFIT DP no. 6/2002 De'centralization and the formulation of democratic lo- This paper studies the Balassa-Samuelson effect in the cal government system are parts of broader reforms. Czech Republic, Hungary, Poland, Slovakia, and Slovenia. First, they essentially change the political setup by Time series and panel co-integration techniques are used shifting citizens' workplace and job-related dependency to show that the Balassa-Samuelson effect worked rea- toward territorial, residence-based political structures. sonably well in these transition economies from the first Local governments become critical elements of the new quarter of 1991 to the second quarter of 2001. However, poiitical system. Second, the establishment of local productivity growth did not fully translate into price increases governments also transforms the structure and proce- because of the structure of consumer price indexes. We dures of public administration. Traditional mechanisms thus argue that productivity growth will not hinder the abil- of 'dual subordination, when local administrations had ity of the. five EU accession candidates to meet the to report both to local councils and to sectoral minis- Maastricht criterion on inflation in the medium term. tries, is changing to a new relationship between cen- tral and local governments by separating functions, LGI/OSI Publications developing audit and control mechanisms, and increas- ing the influence of elected councils and mayors over Gerard Marcou, editor, Regionalization for Develop- local administrations. ment and Accession to the European Union: A Com- parative Perspective, Local Government and Public William Davidson Institute Working Papers Reform Initiative, Budapest, LGI Studies Series, 2002, Papers can be downloaded at no charge from 208. pp. www.wdi.bus.umich.edu C) 2002 The World Bank © 2002 The Urbak Institute TRANSI'lIION, May-June 2002 if l,|Evzen Kocenda and Jan Svejnar, The Effects of Owner- Josef C. Brada, Ali M. Kutan, and Su Zhou, Real and I' ship Forms and Concentration on Firm Performance Monetary Convergence within the European Union after Large-Scale Privatization, WP 471, May 2002 and between the European Union and Candidate Countries: A Rolling Co-integration Approach, WP i Nauro F. Campos and Fabrizio Coricelli, Growth in Tran- 458, April 2002 sition: What We Know, What We Don't, and What ¢ 0 w We Should, WP 470, February 2002 Arnoud W. A. Boot and Todd T. Milbourn, Credit Rat- C t o ings as Coordination Mechanisms, WP 457, March Susan J. Linz, Barriers to Investment by Russian 2002 .l_ A l Firms: Property Protection or Credit, Constraints? »,OqC) [l WP 469, May 2002 Josef C. Brada, and Ali M. Kutan, Balkan and Medi- terranean Candidates for European Union Member- --> !~ Susan J. Linz, Job Satisfaction among Russian Work- ship: The Convergence of Their Monetary Policy ers, WP 468, May 2002 with that of the European Central Bank, WP 456, April 2002 Viliam Druska, Byeong Ju Jeong, Michal Kejak, and Viatcheslav Vinogradov, Assessing the Problem of David M. Kemme, Russian Financial Transition: The Human Capital Mismatch in Transition Economies, Development of Institutions and Markets for Growth, WP 467, March 2002 WP 455, October 2002 Susan J. Linz, Motivating Russian Workers: Analysis Xiaogang Wu and Yu Xie, Does the Market Pay Off? of Age and Gender Differences, WP 466, February 2002 Earnings Inequality and Returns to Education in Urban China, WP 454, April 2002 Gary Krueger and Susan J. Linz, Virtual Reality: Bar- ter and Restructuring in Russian Industry, WP 465, Bat Batjargal and Mannie M. Liu, Entrepreneurs' Ac- April 2001 cess to Private Equity in China: The Role of Social Capital, WP 453, April 2002 Michael Berlemann, Kalin Hristov, and Nikolay Nenovsky, Lending of Last Resort, Moral Hazard and Twin Alan A. Bevan, Saul Estrin, Boris Kuznetsov, Mark E. Crises: Lessons from the Bulgarian Financial Crisis Schaffer, ManuelaAngelucci, Julian Fennema, and Giovanni 1996/1997, WP 464, May 2002 Mangiarotti, The Determinants of Privatized Enterprise Performance in Russia, WP 452, June 2001 Tomasz Mickiewicz and Anna Zalewska, Dein- dustrialization-Lessons from the Structural Out- Lubomir Lizal, Determinants of Financial Distress: comes of Post-Communist Transition, WP 463, Janu- What Drives Bankruptcy in a Transition Economy? ary 2002 The Czech Republic Case, WP 451, January 2002 Albert Park and Minggao Shen, Joint Liability Lend- Other Publications ing and the Rise and Fall of China's Township and Village Enterprises, WP 462, July 2001 Brigitte Granville and Peter Oppenheimer, editors, Russia's Post-Communist Economy, Oxford University Press, Ox- Albert Park and Minggao Shen, A Refinancing Model ford, United Kingdom, 2001, 551 pp. of Decentralization with Empirical Evidence from To order: Oxford University Press, Great Clarendon Street, China, WP 461, April 2002 Oxford OX2 6DP, United Kingdom, tel. 01-865-556-767. Margaret Maurer-Fazio and James Hughes, The Effects K. Malfliet and L. Verpoest, editors, Russia and Europe of Market Liberalization on the Relative Earnings in a Changing International Environment, Leuven Uni- of Chinese Women, WP 460, March 2002 versity Press, Leuven, Belgium, 2002, 180 pp. To order: Leuven University Press, Europahuis, Blijde- Margaret Maurer-Fazio, The Role of Education in De- Inkomststraat 5, 3000 Leuven, Belgium, tel.: 32-16-32- termining Labor Market Outcomes in Urban China's 5345, fax.: 32-16-32-5352, URL: http://vwww.lup.be, email: Transitional Labor Markets, WP 459, April 2002 university press@upers.kuleuven.ac.be. TRANSITION, May-June 2002 C 2002 The World Bank Bibliography of Selected Articles The web site addresses are for information only. Given the frequent changes in their content, we cannot take responsibility for their accuracy. Postsocialist Economies Jaxques Rupnik, New Nationalism in Central Europe, East European Constitutional Review, (United States/ g m t A. M. Al-Obaidan, Efficiency Effect of Privatization Hungary) 11(1/2): 68-70 Winter/Spring 2002. http://-< -- a in the Developing Countries, Applied Economics www.law.nyu.edu/eecr/volllnuml_2/index.html (United Kingdom) 34(1):111-17, January 10, 2002 cis S. P. Das, Foreign Direct Investment and the Rela- tive Wage in a Developing Economy, Journal of De- Simon Commander, Irina Dolinskaya, and Christian velopment Economics (Netherlands) 67(1): 55-77, Mumssen, Determinants of Barter in Russia: An February 2002. http://www.elsevier.com/homepage/sae/ Empirical Analysis, Joumal of Development Econom- 9 econworld/econbase/devec/frame.htm ics (Netherlands) 67(2): 275-307, April 2002. http:li www.elsevier.com/homepage/sae/econworld/econbase/ Y Eilat and C. Zinnes, The Shadow Economy in Tran- devec/frame.htm sition Countries: Friend or Foe? A Policy Perspec- tive, World Development (United Kingdom) 30(7): Financial Times (United Kingdom), Russia: Financial 1233-54, July 2002 Tim:es Survey Suppl.: I-X, April 15, 2002. http II news .ft.com/home/usl 0. N. Toulan, A Resource Perspective on Interna- - tionalization Responses to Market Liberalization, Mikhail Krasnov, Reforming Russia's Courts-Is the Emerging Markets Review (Netherlands) 3(1): 51-68, Coricept of Judicial Reform Timely? East European March 2002. http://www.elsevier.com/inca/publications/ Constitutional Review (United States/Hungary) 11(1/2): store/3/8/6/i ndex. htt 92-95, Winter/Spring 2002. http://www.law.nyu.edu/eecrl vol11 numl_2/index.html Central and Eastern Europe Asia G. Bakacsi and others, Eastern Europe Cluster: Tra- dition and Transition, Journal of World Business Ben Dolven, Shanghai's Capital Drought, Far East- (United States) 37(1): 69-80, Spring 2002 em Economic Review (Singapore) 165( 27): 30-34, July 11, 2002. http://www.feer.com/articles/2002/0207_11/ M. Bisogno and A. Chong, Poverty and Inequality in pO3bchina.html Bosnia and Herzegovina after the Civil War, World Development (United Kingdom) 30(1): 61-75, January, P. B Duong and Y. Izumida, Rural Development Finance 2002 in Vietnam: Microeconometric Analysis of Household Surveys, Wor/dDevelopment(United Kingdom) 30(2): 319- Investing in Central and Eastern Europe: Financial 35, February 2002. http://www.elsevier.comAinca/publica- Times Survey, Financial Times (United Kingdom), tions/store/3/8/6/index.http Suppl.: I-VI, May 17, 2002. http://news.ft.com/home/usl M. Godfrey, C. Sophal, T. Kato, L. Vou Piseth, P. Donna, Financial Times (United Kingdom), Poland: Financial T. Saravy, T. Savora, and S. Sovannarith, Technical As- Times Survey Suppl.: I-VI, June 17, 2002. http:// sistance and Capacity Development in an Aid-Depen- news.ft.com/home/us/ dent Economy: The Experience of Cambodia, World Development (United Kingdom) 30(3): 355-73, March 2002 C. Jensen, Foreign Direct Investment, Industrial Restructuring, and the Upgrading of Polish Exports. John Pomfret, For China's Local Bigwigs, New Money Applied Economics (United Kingdom) 34(2): 207-17, Means Power, Washington Post (United States), July January 20, 2002 7, 2002. http://www.washingtonpost.com/ i C 2002 The World Bank TRANSITION, May-June 2002 Subscribe to TRANSITION We appreciate the continuing (ENGLISH VERSION) support of: TRANSITION For a free subscription to the English Bank of Finland Managing Director: Boris Plescovic language version of TRANsmoN, write to: Institute for Economies in Transition Senior Editor: Richard Hirschler Room MC3-374 Jennifer Vito P.O. 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