http://www.worldbank.org/html/prddr/trans/WEB/trans.htm http://www.wdi.bus.umich.edu
r ^ THE NEWSLETTER ABOUT REFORMING ECONOMIES
RANSITION
Volume 10, Number 6 The World Bank in collaboration with The William Davidson Institute December 1999
Nonpayments Cycle in Russia Suffocates Economic
Growth-Proposal of World Bank Economists
One question preoccupies many scholars and practitioners: How can economic growth in the Russian Federation be reinvigorated? A
recent report by three economists in the World Bank's Moscow office, Brian Pinto, Vladimir Drebentsov, andAlexander Morozov,
contributes to the current debate. The authors in their paper, "Dismantling Russia's Nonpayments System: Creating Conditions
for Growth", explain that the cycle of nonpayments is too ingrained in the economic structure to go away spontaneously. They
propose introducing policy measures that can turn the tide and launch Russia on a new path of growth. It is a timely proposal;
Prime Minister and acting President Vladimir Putin just recently called "the elimination of barter and other nonpayments" as one
of the country's most urgent tasks.
n early 1996 expectations ran high that that the recession would deepen in 1999, and all forms of noncash settlement. Over-
growth would resume at a sustainable with GDP falling 7-10 percent. But the col- due payments (arrears) are growing rap-
annual rate of 5-7 percent, starting in lapse of large Russian banks affected en- idly. Atthe end of 1998 they reached almost
1997. Indeed, by mid-1997 foreign ex- terprises relatively little because of the limited 40 percent of GDP, up from 15 percent at
change reserves rose to unprecedented links between the financial and real sectors. the end of 1994. All forms of noncash settle-
levels, real interest rates fell, and output As the devaluation of the ruble cut imports ment increased, including barter, the use
registered its first increase since the start and encouraged domestic production, Rus- of veksels (or promissory notes), and tax
of transition. But as a result of persistent sia achieved 1.5 percent growth in 1999. offsets in which government spending ar-
shortfalls in the government's cash rev- This did not mean, however, that Russia rears and overdue tax payments are mutu-
enue collection, public debt-from the sale steered its economy to a steady growth path. ally canceled. Cash collections during the
of short-term treasury bills-increased summer of 1998, before the meltdown,
substantially during the 1995-mid-1998 A common phenomenon characterized both were as low as 12-13 percent of domestic
stabilization period. So did the country's the pre-meltdown phase (during which sus- sales for both Gazprom and RAO UES (the
vulnerability to market sentiment. tainable growth failed to materialize) and the gas and electric power monopolies), and
post-meltdown period (during which the de- about 30 percent of sales for the railways.
Near the end of 1997, as Southeast Asia's clines were more modest than expected): a By 1998 the share of noncash settlements
financial crisis flared up, the international large number of enterprises refrained from in enterprise sales had increased to 50-70
finance institutions toughened their stance cash payment-even from payment itself. percent. From 1995 until mid-I 998 as much
in the face of the government's inability to While nonpayments ensured their subsis- as 50 percent of spending by subnational
meet its cash revenue targets. Investors tence, it impeded theirefficient restructuring. governments was in the form of noncash
became wary of the lack of fiscal adjust- As the authors point out in their report, this settlement, with the federal government's
ment and the slow progress in structural was a sure recipe for protracted stagnation. share averaging 20 percent.
reforms. It led eventually to the economic
meltdown in August 1998. The Deformed Structure Nonpayments mushroomed as a result of
inconsistencies in the government's policy:
After the sharp drop in output in the third The authors see two layers to the while it pursued the macroeconomic goal
quarter of 1998, many observers thought nonpayments structure: overdue payments of getting rid of inflation rapidly, it offered
Development Research Group The World Bank 1 The William Davidson Institute E
soft treatment, even subsidization, of non railways accumulated especially huge The Problem that Will Not Go Away
paying companies. The authors recall claims within the enterprise sector. Rather
events of recent years. than receive nothing at all, and avoid the The report tries to explain why this burning
write-off of these debts, they began ac- issue was not dealt with during the three
Real interest rates abruptly changed from cepting payments in kind. Noncash settle- years preceding the meltdown. Why did
negative to highly positive toward the end ments became a way of settling arrears. most policymakers fail to take the sys-
of 1994, and they remained positive until temic nature of the problem seriously?
early 1997. The high interest rates of trea- Cheap energy supplies were regarded by According to the authors, there was wide-
sury bills (GKOs) moved banks to invest the government as a crucial part of the life- spread belief that nonpayments would
in GKOs; result was a working capital saving mechanism that keeps companies spontaneously disappear as mnarket re-
shortage for the majority of firms. Anec- afloat and prevents increases in unemploy- forms and stabilization took hold. Tough tax
dotal evidence suggests that enterprise ment and aggravation of social tensions. enforcement would solve the problem. This
managers diverted liquid funds to GKOs, Therefore the govemment curtailed gas and view came from the mistaken belief that
exacerbating the liquidity problem. oil exports-major foreign currency earn- tax evasion was the main driving force
ers-in order to free supplies for domestic behind nonpayments.
Firms responded to high real interest rates sales on a price that was only a fraction of
and tightened liquidity by delaying pay- the world market price. Attempts of the en- Today this perception has radically changed.
ments and running up arrears to suppliers, ergy suppliers to raise domestic fuel prices Dismantling the system would require a dean
workers, and the government. Gazprom, were refuted. Disconnecting clients who do break with the past by hardening enterprise-
RAO UES, several oil companies, and the not paytheir gas and electricity bills isdiffi- level budgetconstraints, eliminating hidden
cult and could even be illegal under the cur- subsidies, and enforcing tax collection. If,
rent civil code, which is ambiguous on this. however, energy companies and other rich
Coiitents Some companies, identified on various firms are required to bail out the rest of the
strategic lists, may not be cut off under any economy, they will continue to be the major
State-Enterprise Dangerous Liaison- circumstances. Regional governors often tax delinquents, perpetuating nonpayments
EBRD World Bank Survey 6 interfere to save nonpayers from being cut and impeding the completion ol fiscal re-
* Interview with EBRD Policy Director 7 off the energy lifeline. form, and thereby the attainment of low infla-
tion and growth.
The Tale of Croatia's Economic Decline 10 Teprpisotatevrm '
The report poi nts out that the government's
Russian Crisis Hits Baltics 12 permissiveness-explained by its social Experience between 1995 and 1998 shows
Milestones of Transition 14 concem and by the collusion of state offi- that although inflation can be controlled
cials and enterprise managers-enabled through nonpayments, the economic costs
Howto Develop China's Infrastructure 15 enterprises to accumulate arrears with of such a policy are staggering in terms of
China-Russia Compared impunity and to pay tax and energy bills misallocation of resources and postponed
* Agricultural Reform in China 17 with overpriced, noncompetitive goods. enterprise restructuring, facilitation of cor-
* Russia's Resilient Collectives 19 Implicit subsidies of the energy monopo- ruption, bad investment climate, and stifled
* Economic Slowdown? 21 lies to various companies (though unequal growth prospects. Furthermore, under
* Transition Process in Asia 22 barter and unpaid energy bills) amounted
to an estimated $60 billion between 1993 .
William Davidson Institute and 1997. The energy monopolies in turn The tedm "hard budget constraints" was
Corporate Governance (CG) became delinquent on their own tax and coined by the Hungarian economist
* Lessons from Reforms 23 social security payments, which aggra- Janos komai.pEssentially itsmeans einan-
* Fiascos in Russian CG 24 vated the deficit of the enlarged govern- al discln fims o uday the bils
* CG and Securities Market Failure 26 ment (including deficits of the federal, local ances out or that the gove-
* Common Law and Growth 28 governments and the extra budgetary quences, without hope that the goverm-
* What Went Wrong in Russia? 29 funds). Thus, in effect, these subsidies were ment will balil them out. The resumption
* WDI Working Papers 32 financed in part by the energy sector and in ofdgrt istrints.entepends hr
Agenda 33 part by public borrowing from domestic and et con stint Growth d nd on
Conference Diary 37 international capital markets. In addition, efficient use of existing assets and effi-
New Books and Working Papers 38 enterprises received from the government dent reallocation of resources through
Bibliography of Selected Articles 47 both direct and hidden subsidies (the latter the exit of bankrupt companies and the
Bibliography_of_Selected_Articles 47 1 through tax offsets and arrears). entry of start-ups.
* TRANSITION, December 1999 © 1999 The World Bank/The William Davidson Institute
these circumstances, low inflation, which The report warns that the revival of eco- ture. The process will not reverse itself au-
places public debt on an unsustainable nomic growth in Russia will demand a hard- tomatically, even if real interest rates fall and
course, is not likely to last, so it indicates ening of budget constraints-in otherwords, more credit becomes available. Broad po-
neither success nor credibility. the dismantling of the nonpayments struc- litical measures are required.
Russia's Fragile Economic Growth
According to government figures, Russia's GDP grew 1.5 per- Despite these favorable indicators, confidence in the Russian
cent in 1999-only the second such rate of growth in the post- economy remains low for a number of reasons:
Soviet era. Industrial output was also up by 8.1 percent. The
figures followed declines in 1998, however, when GDP fell 4.6 0 Economists say the government did little in 1999 to create
percent and industrial output dropped 5.2 percent. Relative to the foundations for further growth. Russia remains plagued by
1997, industrial production increased only 3 percent in 1999. corruption, lack of infrastructure, and lack of a firm legal frame-
Industrial production fell more than 50 percent over the past work.
decade. In 1999 the ruble sank 31 percent. The decline repre-
sented an improvement over 1998, when the ruble fell 75 per- 0 The situation of private households drastically deteriorated.
cent, and was a more modest decline than forecasters had Deutsche Bank estimates show that private consumption fell
predicted. 10 percent in 1999, while government consumption declined 7
percent.
There was also good news on the fiscal front, where the budget
was executed in full "for the first time in the past eight to nine 0 The IMF continues to withhold the second tranche of its $4.5
years," according to Finance Minister Mikhail Kasyanov, now billion credit, citing Russia's failure to meet institutional reform
First Deputy Prime Minister. Budget revenues will be about 598 requirements.
billion rubles, or 13.3 percent of GDP; spending will be 666
billion rubles, or 14.8 percent of GDP. Russia will collect about 0 Neither banks nor stock markets are channeling significant
380 billion rubles in taxes in 1999, 41 percent above the tar- funds to producers. Bank loans outstanding to the private sec-
geted 269 billion rubles, according to Sergei Ignatiyev, a First tor at the end ofAugustwere only about 10 percent of expected
Deputy Finance Minister. 1999 GDP. The market capitalization of the 33 large compa-
nies that constitute the Russian Trading System index in early
The driving forces behind the Russian economy in 1999 were December was about 16 percent of GDP. Turnover in shares
booming oil prices and the effects of the 1998 devaluation, averaged about 2 percent of GDP.
which gave formerly noncompetitive domestic industries a shot
in the arm. Oil prices recently reached almost $26 a barrel, their * The Russian business community continues to place large
highest level in nine years. Russian producers are benefiting sums offshore and to undertake little investment in the domes-
from both higher prices and lower production costs as a result tic economy. A recent study by the Finance Ministry estimated
of the decline in the ruble. On average, more than four-fifths of capital flight in the third quarter at $2.9 billion a month. Imports
Russian oil companies' costs are in rubles, as they use do- of machinery and equipment in the first three quarters of 1999
mestic equipment and services. were two-fifths that of the same period last year.
The consumer price index rose about 35 percent in 1999. The These concerns notwithstanding, there are some signs of
annualized rate of inflation in Novemberwas only 15 percent. The hope. Yegor Gaidar's Institute of the Economy in Transition
balance of payments situation also has positive aspects: the Min- detected some increase in bank lending to the corporate sec-
istry of the Economy forecasts a merchandise trade surplus of tor in December 1999 and some increase in investment in
$30 billion for the year, and Russian authorities have managed to food processing, construction materials, engineering, and
honor debt-service payments on post-Soviet debt. Foreign direct chemicals.
investment has made a partial recovery from last year's decline,
increasing more than 150 percent to $12.1 billion. The largest This material was based on articles by Floriana Fossato, Igor
contributor is the United States ($4.2 billion), followed by Cyprus Semenenko, andAndrew McChesney of Moscow Times and
($2.7 billion). Money originating from Russian companies is com- Oxford Analytica, the Oxford (U.K)-based international re-
ing back through Cyprus as Cypriot money. search group.
( 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999 C
How to Break the Cycle and itself. Once net creditors realize that tion of the fiscal deficit. Above all, a further
the government will no longer provide buildup of arrears in the pursuit of artificial
What measures would help the Russian hidden subsidies through tax breaks and reduction of inflation should be avoided.
economy break out of the vicious cycle other concessions, the practice of Moving to a cash-basis for the budget
of nonpayments? According to the au- nonpayments will end spontaneously. might result in a temporary increase in in-
thors, nonpayments would decline if the The change in the rules would also re- flation, but it is preferable to a quick but
government signaled that the rules of the store needed integrity to the tax system. unsustainable return to single-digit inflation.
game have changed, that it has cor- At the same time, the much-strengthened
rected its course, and that it will impose Slashing inflation should be based on federal treasury must be used to control
hard budget constraints on enterprises genuine fiscal reform, and genuine reduc- spending commitments, and the govern-
Putin Wants to Combine Strong State with Market Economy
In his first major policy statement, at the end of 1999, Prime sector, noting that energy and metals account for 15 percent of
Minister and acting President Vladimir Putin said there is no GDP and more than 70 percent of export revenues. But, he
altemative to a market economy, but the state is obliged to sup- said, a new direction is needed that places more emphasis on
port such sectors as science, education, culture, and health. consumer goods and services and high technology.
Rejecting both blind adherence to Western market ideas and a
return to the Soviet past, he noted that the biggest mistake re- Russia would need to grow by at least 8 percent a year for the
formers had made was to try to impose Western patterns on next 15 years to reach the level of Spain or Portugal, 10 per-
Russian soil. "We can count on a worthy future only if we man- cent a year to equal Britain or France. In the 1990s Russia's
age to naturally combine the principles of a market economy GDP declined to half of its value the previous decade. "Accord-
and democracy with Russia's realities," he said. "The need for ing to the overall size of GDP," Putin said, "we are 10 times
a comprehensive system of state regulation of the economy smaller than the United States and five times less than China."
and social sphere is an important lesson of the 1990s." The
time, he said, was not ripe for classical liberalism. "Sometime Putin noted that productivity in the real sector is extremely low,
later we will probably take this recipe, but now the situation adding that industry was noncompetitive and most Russian ma-
demands stronger state influence." chinery and equipment was more than 10 years old. Investment
has dwindled: only 4.5 percent of the nation's industrial equip-
The state, its institutions, and its structures have always played ment was less than five years old in 1998, down from nealrly 30
important roles in the life of Russia and its people. For Rus- percent in 1990. Individual productivity is one quarter that in the
sians a strong state is the source and guarantor of order, the United States.
initiator and main driving force of all change. A strong state can
be developed by rationalizing the power structure, raising the Putin added, "Investments in the real economy sector fell by five
professionalism and discipline of officials, intensifying anticor- times in the 1990s, including 3.5 times into fixed assets. The
ruption efforts, changing personnel policies, increasing the material foundations of the Russian economy are being under-
power of the judicial branch, improving federal relations, and mined. We call for pursuing an investment policy thatwoulcl com-
effectively combating crime. The public wants greater control bine pure market mechanisms with measures of state guidance."
over executive power to avoid arbitrariness and abuses. There-
fore, attention should be paid to the establishment of a partner- Russia's economic recovery will be long and difficult without
ship between executive power and civil society. foreign capital. Everything should be done to attract foreign
capital and expand the country's participation in international
Putin argued that individualism is far less important for Rus- economic organizations. Membership in the World Trade Or-
sians than communal ties. "The collective form of lifestyle has ganization should be a priority, pointed out Putin.
always dominated over individualism. Russian society wants
the restoration of a guiding and regulatory role of the state to This material was based on news agency reports from
the extent dictated by national traditions and the state of the Reuters and the Associated Press. The full text of Flutin's
country," he added. Putin also ruled out any reforms that would statement in Russian can be found on the Internet at:
reduce living standards, as poverty is already widespread. He www.pra vitelstvo. gov. ru/government/minister/article-
also acknowledged the importance of Russia's raw materials vvpl_txt.html and at www.pravitelstvo.gov.ru.
a TRANSITION, December 1999 C) 1999 The World Bank/The William Davidson Institute
ment at all levels must insist on cash tax Increasing attention should be paid to the lation of the energy monopolies to a trans-
payments. deficit of the consolidated (federal and parent and efficient basis: the government
subnational) budget. Budgetary arrears must pay its bills on time and in cash, and
A smooth switch to a transparent, cash- need to be eliminated by improving the the energy monopolies must be empow-
based taxation system means abolishing general fiscal management. Realistic bud- ered to disconnect nonpayers. Only then
tax offsets, which are implicit subsidies geting must be introduced, in which the will the government's insistence-thaten-
transmitted through the tax system. Ad hoc Ministry of Finance plays a strong and pri- ergy monopolies themselves pay their
tax exemptions and individualized bargain- mary role. Budget procedures need to be taxes in cash, and strive for higher cash
ing over tax bills must be removed to pro- streamlined, and the federal treasury collections in their sales- be credible and
vide uniform tax treatment of all companies should be empowered with the right to reg- enforceable.
and sectors. This measure would prepare ister and control spending commitments.
the ground for a gradual decrease in the The likely social impact of hard budgets
statutory tax burden in tandem with in- Two conditions need to be fulfilled in or- should be softened. Temporary disrup-
creased tax compliance. derto move the pricing, taxation, and regu- tions are bound to arise, especially with
the supply of social services now chan-
neled through enterprises. Such disrup-
tions should be addressed. Given the
14 ~~~~~~~~~~~~~~~~~large size of the hidden subsidies, it is
possible that a more effective but less
43vCe in)REE j ARS were J costly targeted social safety net can be
designed.
U i sUN aUr OF 10M[ f` Tackling Social Issues
> s 9iN WSlAT7 tw "- t The standard view is that policymakers in
A ~ ~ ~ ~~$ Russia tolerate nonpayments because the
- ; social consequences of hard budgets
'A would be difficult to accept. Enterprises are
1 T . saved because of fears of rising unemploy-
ment and disruption in the flow of social
services they provide. Data show, however,
that delayed transfers to the population
and unpaid wages account for a signifi-
cant part of government arrears at the
subnational level.
This is difficult to reconcile with the no-
tion that social concerns are driving the
no-exit policy for enterprises. Indeed, so-
cial spending was one major casualty of
the chronic tax shortfalls between 1995
and 1998. We agree with the authors' fi-
nal conclusion: sustainable growth, with-
out which gaps in the social safety net will
further widen, cannot be resumed under
current conditions of nonpayments.
The authors can be reached by email.
bpinto2@worldbank.org, drebentsov@
worldbank.org, and amorozov@ world
bank.org
Source: The Internet.
© 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999 U
EBRD and World Bank Survey Reveals Intimate
State-Enterprise Relationship
The recently published Transition Report 1999-Ten Years of Transition presents the results of a major new survey, con-
ducted by the European Bank for Reconstruction and Development (EBRD) in collaboration with the World Bank, of more than
3,000 firms in 20 transition economies. The Business Environment and Enterprise Performance Survey asked entrepreneurs
and managers about the extent and nature of their dealings with the state and the associated obstacles to doing business. The
survey included questions on corruption, organized crime, state intervention, and the influence of firms on governments-or
"capture of governments."
Four key findings of the survey: Countries normally considered among the Kyrgyz Republic and Moldova, businesses
most advanced transition economies, such have given low ratings on both governance
* Governance is the exercise of eco- as Estonia, Hungary, and Slovenia, are andthesecurityofpropertyrights.
nomic, political, and administrative author- ranked alongside some of the least ad-
ity to manage a country's affairs at all levels. vanced, such asAzerbaijan and Uzbekistan, One explanation for this relationship is that
in terms of quality of governance (tables 1 it reflects how the capacity of the state to
* Government comprises the mecha- and 2). In other countries that have been
nisms, processes, and institutions through praised for early reform efforts, such as the Continued on page 8
which citizens and groups articulate their
interests, exercise their legal rights, meet
their obligations, and mediate their differ- Table 1. The quality of governance
ences. Micro- Macro-
economic economic Physical Law Governance
3 Whether governance is "good" or "bad" Country governance governance infrastructure and order index
depends on the degree of legitimacy, rep- Hungary 0.92 1 .72 2.42 2.34 1.98
resentation, popular accountability, and ef- Slovenia 1.17 1.73 2.26 2.23 1.95
ficiency with which public affairs are Estonia 1.25 1.74 2.38 2.17 1.95
conducted. Uzbekistan 1.4 1.44 2.11 2.16 1.83
Armenia 0.55 1.15 2.21 2.32 1.72
* In the corporate world, good corporate Poland 0.96 1.53 2.37 1.82 1.69
governanceismeanttoprovideincentives SlovakRep. 0.88 1.68 2.11 1.7 1.65
to the board of directors and management Czech Rep. 0.8 1.35 1.57 1.97 1.59
to act in the interest of the company and Belarus 0.67 0.77 2.18 2.25 1.57
itsshareholders. Lithuania 0.69 31.7 2.19 1.48 1.54
Azerbaijan 1.02 1.59 1.73 1.56 1.53
n Gc iCroatia 0.67 1.18 2.13 1.62 1.43
Grading Governance In Transition Bulgaria 0.9 1.25 1.77 1.49 1.38
Economies Kazakhstan 0.75 0.72 1.85 1.68 1.27
Georgia 0.67 0.93 1.78 1.47 1.24
The following results and interpretations Ukraine 0.34 0.77 1.76 1.68 1.24
have been excerpted from the report. Russia 0.47 0.65 1.91 1.54 1.16
Romania 0.45 0.6 1.49 1.48 1.07
0 Quality of governance. The relation- Kyrgyz Rep. 0.46 0.48 1.85 0.98 0.85
ship between governance and economic Moldova 0.52 0.35 1.42 1.1 0.82
reform (in terms of liberalization and Note: Firms were asked how problematic nine factors were for the operation and growth
privatization) is not uniform. Firms in the of their business. Answers were on a scale ranging from: 0 (major obstacle) to 3 (no
most advanced and least advanced tran- obstacle). The factors are grouped into four broad subcategories: microeconomic gover-
sition economies have more favorable as- nance-including taxes and regulations; macroeconomic governance-inclh.ding policy
instability, inflation, exchange rate; physical infrastructure-no subcategories; and law and
sessments of governance than those in order-including judiciary, corruption, street crime, organized crime. The governance in-
countries that have adopted partial re- dex is constructed as the average of the country scores across all nine factors.
forms. Source: Business Environment and Enterprise Performance Survey.
* TRANSITION, December 1999 © 1999 The World Bank/The William Davidson Institute
EBRD: After the Russian Shock, Sound Again
Policy Director Steven M. Fries on New Priorities
What are the latest business results and what are the future plans of the London-based European Bank for Reconstruction and Develop-
ment (EBRDJ ? Steven M. Fries, Director of Policy Studies at the EBRD Office of the Chief Economist, sees a bright future for the institute,
which wi/l celebrate its 10th birthday in 2001 and will hold its next annual gathering in May 2000 in Riga, the capital of Latvia.
Q: In 1998 the EBRD closed its books with an operating Georgia's electricity sector, $52 million
loss of more than $200 million-the first loss in the past to build a gas-compressor station in
sixyears. Will the result be better in calendaryear 1999? Ukraine, $10 million in cofinancing to
privatize Macedonia's leading commercial
A: Our bank, at the end of 1998, had to significantly increase its bank, a credit line to support small busi-
level of loan and investment loss provisioning, dictated by the ruble ness in Romania, and the largest equity
crisis and its chain reaction across the CIS region. [Banks have to investment that the EBRD has under-
put aside loss provisions, or reserves, to guard their liquidity in case taken: El 25 million to purchase a 7.47 per-
of nonpayment; consequently, the provisioning level depends on the cent stake in Ceskoslovenska Obchodni Banka from the
risk factor of the loan or equity investment.-The editor] This re- National Bank of Slovakia. Is there any new pattern?
sulted in a substantial net loss for the year. The lesson we learned
was that even sound investment projects can go down if the legal A: The basic criteria has not changed; that is, the bank's core
and regulatory framework is not supporting the private sector and, business remains the financing of projects that are financially sound,
on the macro front, if financial discipline is lacking. primarily in the private sector, that advance the transition, and
complement rather than substitute for the private sector's financ-
In 1999 the tide has tumed. The equity portfolio brought high retums, ing. The strategy, though, has been strengthened in a number of
and we succeeded in keeping our administrative expenses under ways, drawing on the Bank's experience as an investor in the re-
strict control. As a result, during the first nine months the EBRD re- gion and our understanding of the transition-the forces which ad-
corded an operating profit of Euro (E)130.2 million before provi- vance it and those which hold it back. As our recent enterprise
sions. Even after deducting provisions, we registered a net profit of survey on the business environment-conducted jointly with the
E9.7 million. Ourtotal provisionsforthe banking portfolioamounted World Bank and reported in the latest Transition Report-has re-
to El .1 billion, or 16.7 percent of disbursed outstanding loans and vealed, the environment for businesses varies widely across both
equity investments. At the end of September 1999 the EBRD's au- countries and different types of firms. New private businesses also
thorized capital was E20 billion and paid-in capital and reserves face a more challenging business environment than do privatized
equaled E5 billion. You have to compare these figures with the fact and state-owned enterprises. At the same time, new private busi-
thatsince 1991 we have committed E12 billion forthe financing of nesses have registered much strongergrowth performance than
projects throughout the 26 countries of the region, representing an have other types of firms. Recognizing both the importance of the
aggregate value of E42.9 billion. Of these commitments, two-thirds new businesses and the major obstacles they face, the EBRD's
have been in the private sector, one-fifth in equity investments, and new strategy places strong emphasis on the promotion of start-
about one-third were in the financial sector. ups and the growth of small and medium-size enterprises (SMEs)
through credit lines, microlending, equity and venture funds and
The Bank also made commitments to 102 new investment through initiatives to improve the investment climate. The newstrat-
projects in 1999 worth E2.2 billion. This level of activity was egy also maintains a strong emphasis on development of the fi-
achieved despite challenging economic conditions in Russia, nancial sector and on expanding access to financial services,
where new commitments amounted to El 50 million, down from particularly by SMEs. Infrastructure operations will continue, and
E541 million in 1998. However, if economic and governance we will undertake-through a coordinated approach with the World
conditions continue to improve as anticipated, EBRD investments Bank and other institutions-restructuring of potentiallyviable large
commitments in Russia could increase to between E300 - 400 enterprises. We take the social dimensions of our activity seri-
million in the current year. ously, primarily by supporting SMEs, which are a major source of
job creation, and-as in Bulgaria's case-helping to establish pen-
Q: The EBRD recently published its new medium-term sion funds. To sum up, our portfolio became more diversified, our
operational strategy. How much will it change the bank's activities are more balanced, our operations more efficient-I look
loan and investment policy? The latest operations of the optimisticly toward the next 10 years of our operations and to the
EBRD are quite impressive: $30 million to develop seconddecadeoftransition.
©D 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999 U
govern the economy has changed in dif- jectto capture. The differences across the countries where the state has been less
ferent ways within each country. The least transition economies as well as the sheer subject to undue influence through capture
advanced transition economies have extent of the problem in particular cases are by vested interests. However, privatization
made the slowest progress in dismantling striking. In Moldova, Russia, and Ukraine in high-capture states is associated with
key aspects of the state's control over the more than 40 percent of the firms surveyed a lower quality of governance.
economy and therefore continue to pre- feel a significant impact from the sale of
serve much of the state control inherited govemment legislation. This share is nearly In countries where the state is prone to
from the previous system. Firms in these 60 percent inAzerbaijan. By contrast, fewer undue influence by powerful vested inter-
countries do not see the state as a major than 10 percent of firms in Slovenia and ests, the effectiveness of reforms in im-
obstacle, since it continues to perform Uzbekistan report a similar impact. proving governance and securing property
many of the functions that it carried out rights has been diluted. Alternatively, such
under the old regime in an economy that In countries such asAzerbaijan, Bulgaria, reforms could be blocked by vested inter-
still bears a strong resemblance to the pre- Moldova, Russia, and Ukraine there ap- ests-those who profit from the market
vious system. pears a greater concentration of power distortions associated with partial eco-
over the state among key vested interests. nomic reforms-with the capacity to influ-
In contrast, countries that have introduced In other countries, such as Estonia, a large ence government policymaking.
partial reforms have begun the process of proportion of firms report that they are able
dismantling thestate'scapacitytogovern the to influence government decisions, while 0 The relationship between the state
economy according to the requirements of a relatively small proportion claim that state and the firm. Progress in economic re-
the command system-this without develop- capture significantly affects their business. form has not been synonymous with the
ing the new institutions on which market- elimination of state intervention in enter-
based governance could be established. In The reliance by certain firms on direct ties prise decisionmaking. States and firms
this setting, firms might see the state as un- to individual government officials is likely continue to be tied together in a web of
able to provide the services it once did and to encourage bribery and corruption. interactions in which the state prcvides a
incapable of meeting the demands of the These ties are less transparent and harder wide range of direct and indirect sLibsidies
emerging market economy. to monitor than institutional ties. They al- to firms, while firms provide public officials
low the focus to shift from the interests of with some combination of control over
S Governance and state capture. An broad sectors, regions, or groups to indi- company decisions and bribes.
important factor in explaining differences vidual firms. In high-capture states, it is less
across countries in the quality of gover- likely that businesses will engage in col- State intervention is most common in pric-
nance istheextenttowhich powerful vested lective action to urge the government to ing, with 36 percent of firms reporting
interests in the economy "capture" or un- provide public services that could improve some degree of intervention. Ir some
duly influence the state by providing private overall economic governance. Instead, lob- countries, the level of reported price inter-
benefits to politicians. High-capture states bying is undertaken to address the particu- vention is extremely high: Belarus (88 per-
tend to focus on providing specific advan- lar interests of specific firms. cent), the Slovak Republic (64 percent),
tages to influential firms and lobbies. Moldova (54 percent), and Ukraine (44
According to the enterprises in transition percent). On investment, sales, and
Russia's governance problems, for example, economies, high-capture states tend to tax wages, about 25 percent of all firms re-
are often blamed on the so-called oligarchs, and regulate more heavily, extract more port some state intervention.
who urge the state to grant them a range of bribes, mismanage the macroeconomic
special privileges and exemptions that un- environment, and prove less effective at The small share of firms reporting state
dermine market-oriented institutions at a preserving law and order. The survey intervention in employment-just 16 per-
high cost to the rest of the economy. shows that greater capture of the state by cent-is rather surprising given the state's
vested interests has a powerfully negative commitment to full employment under com-
Firms were asked to assess the impact impact on the quality of governance in tran- munism. Although much reduced, state in-
on their business of the sale of parliamen- sition economies. tervention in company decisions is still a
tary legislation and presidential decrees prominent feature of transition economies.
to private interests. The capacity of private * Governance and privatization. The In Hungary, the Slovak Republic, and
individuals orfirmstopayforgovernment effects of privatization on the quality of Slovenia, for example, there are higher
legislation or presidential decrees to suit governance differ sharply according to the reported levels of intervention in employ-
their own interests is a very strong indica- degree of state capture. Privatization is ment and wages than in some of the less
tion of the degree to which a state is sub- associated with improved governance in advanced economies. States in less ad-
* TRANSI-ION, December 1999 (C 1999 The WN`orld Bank/The William Davidson Institute
Table 2. The frequency and extent Time Tax and Bribe Tax the frequency of bribe payments differs
of the bribe tax quite substantially.
The level of state intervention in company
Percentage Average decisions, although vastly reduced from In Central and Eastern Europe the bribe tax
of firms bribe tax as the era of central planning, still places sub- represents less than 3 percent of annual
brbing apercentage stantial demands on the time of senior revenuesinanumberofcountries,suchas
Country frequreal ofeanue, f managers. In Kazakhstan, Moldova, and Croatia, Estonia, and Poland. Fewer than
Country or more8 revenuesP Ukraine more than 14 percent of man- 20 percent of the firms in these countries
Azerbaijan 59.3 6.6 agement time is spent with officials, while report paying bribes frequently. Firms in
Romania 50.9 4.0 this figure drops to under 6 percent in Bulgaria, the Czech Republic, Lithuania,
Uzbekistan 46.6 5.7 Azerbaijan, Bulgaria, Croatia, the Czech and Romania report a similar rate of bribe
Armenia 40.3 6.8 Republic, and Slovenia. tax, but there are sharp differences in the
Georgia 36.8 8.1 frequency of bribe payments.
Ukraine 35.3 6.5 In addition to time spent with officials and
Slovakia 34.6 3.7 state intervention in company decisions, Bribery in the transition economies consti-
Moldova 33.3 6.1 firms also pay direct private benefits to tutes an extremely regressive tax. While
Poland 32.7 2.5 public officials in the form of bribes. These large firms report an average bribe tax of
Hungary 31.3 3.5 may be paid for a variety of purposes, such 2.8 percent of annual revenues, the aver-
Russia 29.2 4.1 as to obtain public services, avoid or alter age bribes for small firms are nearly double
Kyrgyz Rep. 26.9 5.5 existing regulations and taxes, gain gov- at 5.4 percent. There is also a major differ-
Czech Rep. 26.3 4.5 ernment contracts, obtain subsidies or ence in the frequency of bribe payments.
Bulgaria 23.9 3.5 other state financing, win influence, and While 16 percent of large firms report pay-
Kazakhstan 23.7 4.7 appease "predatory" officials. Firms can ing bribes frequently, the proportion for
Lithuania 23.2 4.2 consider bribes as a cost to be paid for small firms rises to 37 percent.
Croatia 17.7 2.1 obtaining advantages or preferences from
Belarus 14.2 3.1 govemment oras an unofficialtaxontheir The regressive nature of the bribe tax is
Estonia 12.9 2.8 business due to weaknesses in the sys- especially pronounced in a number of CIS
Slovenia 7.7 3.4 tem of governance. countries. In Moldova, for example, small
Source: Business Environment and Enter- firms report paying an average bribe tax
prise Performancy Survey. Firms in the region pay an average bribe of nearly 9 percent of annual revenues,
a. Firms were asked to what extent the fol- tax that ranges from a low of 2 percent of which is more than four times the level for
lowing statement is true: "It is common for annual revenues in Croatia to a high of 8 large firms. Similarly, small firms in Arme-
firms in my line of business to pay some ir- percent in Georgia. When added to what nia, Ukraine, and Uzbekistan report bribe
regular 'unofficial payments' to get things is already considered by firms to be an ex- levels nearing or exceeding 8 percent. In
done." Response categories comprised: Al- tremely high level of official taxation, the addition, the high frequency of bribe pay-
ways, Mostly, Frequently, Sometimes, Sel- bribe tax imposes a severe burden on en- ments for small firms in these countries
dom, and Never. terprises in the region. contributes to the extremely high level of
b. Firms were asked what percentage of an- senior management time spent dealing
nual revenues "firms like yours" make in ir- The average bribe tax in the CIS coun- with government officials. In Ukrainian
regular 'unofficial payments' to public officials. tries-5.7 percent of revenues-is almost small firms, for example, this reaches up
twice the level reported in Central and to 18 percent of management time. For
Eastern Europe-3.3 percent of revenues. small firms, in particular, the combination
vanced countries tend to focus on interven- Within the CIS, firms in the Caucasus of the bribe tax and the time tax has had a
tion in prices and rsales, with minimal in- countries consistently report the highest severe impact on the development of new
tervention in employment. While the rate of bribe tax, followed by Moldova private sector companies, targeting the
advanced economies appear to intervene and Ukraine. In Central Asia the level of most dynamic sector in the economy.
to support the workforce, the less ad- bribe tax is somewhat lower, but the pro-
vanced countries are more likely to inter- portion of firms reporting that they pay Private sector firms pay a larger share of
vene in enterprises'decisions as a tool for bribes frequently is considerably higher their revenues in bribes than state com-
in Uzbekistan than in other countries. panies yet this result is due primarily to
macroeconomic management, as they did
Firms in Belarus and Russia report the the higher bribe tax for new entrants-5.1
under central planning. lowest level of bribe tax in the CIS, but percent.
C 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999
Benefits to the Firm longer uses plans and commands to di- utility arrears, and influence over regula-
rect firms, but the links between the state tion and policymaking.
Do firms receive any specific benefits- and firms remain close. The survey data
that is, beyond the provision of standard show that firms both incur costs and re- Excerpted from Transition Report
public goods? Such benefits could take a ceive benefits from this relationship. On 1999-Ten Years of Transition, pub-
number of forms, including direct subsi- the cost side, government officials inter- lished by the EBRD. To order: EBRD
dies, implicit subsidies (for example, tol- vene in a variety of company decisions, Publications Desk, One Exchjange
erance of tax arrears and arrears to extract bribes from firms, and impose sig- Square, London EC2A 2JN, UK, tel.:
state-owned utilities), special exemptions nificant demands on the time of senior 44171-338-7553; fax: 44171-338'-6102;
from state regulations, and preferences in managers. At the same time, firms remain email: pubsdesk@ebrd.com, Internet:
the award of state contracts. As many of dependent on the state for a range of ben- http://www. ebrd. com/english/Publicl
these benefits are nontransparent by na- efits, including direct investment, tax and index.htm.
ture, they cannot be easily measured and
compared across countries and firms.
However, the survey provides an opportu-
nity to examine two types of benefits, Croatia Confronts Vicious Circle of
namely direct subsidies and implicit sub-
sidies from the state in the form of arrears. Economic Decline
In the large majority of transition econo- by Marinko Skare
mies, fewer than 15 percent of firms re-
port receiving state subsidies. InArmenia, oon a new center-left government In October 1993 Croatia launched a sta-
Bulgaria, Georgia, Kazakhstan, the Kyrgyz _ will take the helm in Croatia, fol- bilization program with the primary goal of
Republic, and Ukraine firms are primarily lowing national elections that defeating inflation. This program was
supported by means of implicit, ratherthan brought victory to the opposition parties. based on applying a nominal exchange
direct, subsidies. In Belarus, the Czech Barring any last minute surprises, Croatia's rate anchor-Croatia's currency, the kuna,
Republic, Hungary, and Uzbekistan firms new premierwill be Ivica Racan. Racan was was linked to the deutschemark-and
are primarily supported through direct sub- leader of the Social Democratic Party (the wage, price, and interest rate anchors. By
sidies, while the level of arrears has been old Communist Party) that lost the elections January 1994 Croatia's annual inflation
contained. in 1990, and then embraced social demo- rate dropped while the kuna appreciated.
cratic values. Togetherwith the Social Lib- In 1995 GDP growth reached 6.8 percent,
State-owned firms continue to allow the erals the new leadership plans to lead a rate that continued until 1998. During this
state substantial control over company Croatia in a new direction-embracing the period, the annual inflation rate stabilized
decisions and pay moderate levels of marketeconomy,bringingthecountrycloser around3percent.
bribes to state officials, while receiving to the European Union, boosting employ-
benefits from the state mainly in the form ment, and improving living standards. But Adverse consequences of the stalbilization
of direct subsidies. In privatized firms state first the burdensome legacy of the last de- program soon surfaced, however. Unem-
intervention has been substantially re- cade will need to be cast off. ployment rose gradually until it reached the
duced, but the level of bribes remains at present level of 20 percent. Output decline
least as high as-if not higher than-the The Wrong Choice since 1990 has been only partially respon-
level in state-owned firms. The flow of ben- sible for this high jobless rate. A more im-
efits from the state to privatized firms has At the start of the transition some 10 portant factor has been the privatization of
not ceased, but has changed forms, with years ago, socialist countries had a state enterprises. Notthatthese enterprises
a greater reliance on implicit, as opposed choice among several macroeconomic became streamlined and laid off excess
to direct, subsidies. policies, including shock therapy and workers; rather, the new owners were gen-
gradual stabilization. Croatia chose erally more interested in stripping assets
Survey Shows ... shock therapy. As it turns out, this was and making quick profits than in engaging
the wrong choice. Shock therapy for in long-term business developrnent. The
A decade of transition has transformed the Croatia did not mean "recession today result has been massive layoffs.
interaction between the state and enter- for the sake of growth tomorrow"; it
prises in the countries of Central and East- meant "recession today for the sake of The balance of payments deteriorated, in
ern Europe and the CIS. The state no recession tomorrow." partasaresultoftheworseningtradebal-
1 TRANStTION, December 1999 (C 1999 The World BanklThe William Davidson Institute
ance. Croatian enterprises could not make property rights were uncertain, payments expenditures, which have reached 75 to
up for huge export losses suffered in the for sales or services were often denied, 80 percent of GDP, could aggravate al-
early 1 990s. Appreciation of the kuna un- theft and crime were pervasive, and the ready serious social conditions, and the
dermined the competitive position of judicial system was unreliable. 25 percent poverty rate-mainly among
Croatian exporters. Foreign sales have pensioners-is likely to rise further.
been on the decline since 1994, with ex- Economists expect the slowdown of the
ports dropping 10 percent in 1999, despite Croatian economy to continue in 2000, The expectation that a stabilization pro-
the weakening of the kuna since the end of with growth rate estimates ranging from gram without consistent structural reforms
1998. The Kosovo war also set back tour- 0.9 percent to a decline of 2.5 percent, could lead to economic revival and suc-
ism-a major currency earnerfor Croatia. similar to the trend in 1999. The $9.2 bil- cessful transition to a market economy
lion foreign debt will likely increase. Pay- proved wrong. As long as Croatia post-
National savings gradually shrank, and net ments of the loans' principal due in 2000 poned consistent structural reforms it also
investments declined. Introduction of the will consume 5 percent of GDP. The ex- postponed economic growth. In a macro-
value-added tax in 1998 brought tempo- change rate, now at 7.5 kuna to the dollar, economic environment that neglected the
rary respite, but the tax burden remained may depreciate further in 2000. Many growth-driven sectors and discouraged
excessively high. The heavy tax burden on economists predict that the balance of investments and savings, recession was
enterprises leaves no room for private or payments will worsen, foreign exchange all but inevitable. With the new course be-
public investment. The outcome has been reserves may decrease, and, as a result ing set for Croatia's economic policy, this
declining output and increasing indebted- of contraction in the money supply, inter- chain seems at last to be broken.
ness. To maintain the value of the kuna, est rates may increase in the coming year.
the National Bank stuck to its restrictive Marinko Skare is professor at the Faculty
monetary policy, keeping real interest rates Entering a New Course of Economics and Tourism, University Dr.
high. Domestic and foreign debt reached Mio Mirkovic, Pula, Croatia. He can be
51 percent of GDP. More bank failures and higher unemploy- reached at P Preradovica 1, 52100 Pula,
ment, at least in short term, are predicted Croatia, tel: 38-552-218-211, fax: 38-552-
Burden of Bad Loans for the Croatian economy. Cuts in state 216-416, email: ms kare@efpu.hr.
Because many laws and regulations were
not implemented or enforced, a culture of The New Elite
nonpayment prevailed in Croatia. Insol-
vency of the state spread to enterprises. By I X
1999 total arrears reached $3 billion. With . .
many borrowers unable to repay debts in _ - 3 ; - I .
time, the volume of bad loans increased. [
Fiscal discipline was abandoned. Banks, , AJK iUL
already struggling with bad debt, were
forced to aid enterprises. Bad debts A. L
reached 1 1. 1 percent of banks' total assets I_
in 1997. In 1999 nine banks, with 8 percent_
of Croatia's total bank assets, declared
bankruptcy. Public investments, after drop- I -r
ping 7.5 percent between 1995 and 1997,
were cut another 25 percent in 1999.
Enterprises complained that policies / 'ii -;
changed frequently, unexpectedly, and '
sometimes even retroactively. They also IAIK .4-
complained that uncertainty surrounded
official announcements, information was "May I introduce one of the most talented entrepreneurs of our
scarce, the business community was ex- country, he declares a monthly income of three cents!"
cluded from the drafting of rules and regu- .-
lations affecting business decisions, From the Hungarian daily N6pszabdsag.
(C 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999 C
Russian Crisis Hits the Baltics Harder than Expected
by Iikka Korhonen
T he Baltic countries-Estonia,1 990s. Indeed, in 1997, experts started to markets fairly quickly. It has since become
Latvia, and Lithuania-have been worry about economic overheating-es- clear that sidestepping the effects of the
the most successful among coun- pecially in Estonia, where GDP growth Russian crisis was impossible.
tries of the former Soviet Union in manag- reached 10.6 percent. The Baltic countries
ing their economies. Although the economic chose fixed exchange rates, so the nec- The crisis intruded on the Baltics through
slump at the beginning of transition was essary tightening of economic policy was financial markets and the banking system.
profound, the Baltic countries swiftly accomplished solely through fiscal means. While banks in Estonia and Lithuania in-
achieved positive growth. They were also As a result, in Estonia growth slowed even vested relatively little in Russia and other
fastest in stabilizing their economies. They before the Russian crisis. Commonwealth of Independent States
brought inflation under control following (CIS) markets (with only about 1 percent
currency reform, and did not allow budget Exposed Banks Suffer of their total assets invested in Russia
deficits to balloon out of control. They also before the crisis), Latvian banks with tra-
tackled structural reforms early on. In many When the Russian crisis erupted in August ditionally close ties to Russian cornpanies
respects, the Baltics have already caught 1998, many commentators hoped that the became heavily exposed (having invested
up with the more advanced transition effects would be short-lived-at least in the about 8 percent oftheirtotal assets in Rus-
economies in Central Europe. neighboring countries. Although the Baltic sia). Many Latvian banks couldn't resist the
countries had extensive trade ties with high interest rate offered to buyers of
All three Baltic countries have posted im- Russia (see table), there was hope that Russia's short-term treasury bills (GKOs).
pressive growth figures since the mid- some exports could be reoriented to other Russia's decision to halt debt servicing
BOFIT-Finland's Research Institute Monitors Transition Issues
The Bank of Finland's Institute for Economies in Transition range of data sources, and the support of considerable eco-
(BOFIT), based in Helsinki, is involved in academic research nomic expertise.
and the monitoring and analysis of developments in transition
economies. Its activities focus on countries geographically BOFIT has a range of print and online publications, mostly in En-
close to Finland-Russia and the Baltic states of Estonia, glish. Russian and Baltic Economies-The Week in Review is
Latvia, and Lithuania. However, given the growing significance an online review of recent events. Russian Economy-The
of China in the world economy, it recently began monitoring Month in Review contains monthly analysis of macroeccnomic
China as well. developments, fiscal policy, and financial markets in Russia. Bal-
tic Economies-The Quarter in Review analyzes recent eco-
During its eight years of operation, BOFIT has established it- nomic developments in Estonia, Latvia, and Lithuania.
self as Finland's leading institute of transition studies. Because
of its focus on the Russian and Baltic economies, BOFIT has BOFIT Discussion Papers are academic studies by B3OFIT
also found a valuable niche in the international research com- economists and visiting researchers directed toward more spe-
munity. The institute has created a wide network of contacts cialized audiences such as policymakers. BOFIT Online is an
with academic institutions and government bodies in transition electronic publications series with a focus on more descrip-
economies and in developed countries. Every year specialists tive work on transition economies. All publications can be down-
from abroad are invited to work at BOFIT under BOFIT's Visit- loaded free of charge from BOFIT's Web site, or received
ing Researcher Program. Contracts typically cover a fixed pe- through email subscriptions. Most publications are also avail-
riod, usually several months to a year. able in hard copy. Series subscriptions are free, including de-
livery by surface mail.
BOFIT has a permanent staff of 15-10 of whom are econo-
mists-and operates under the auspices of the Bank of Fin- More information on BOFIT can be found on its Web site at
land (Finland's central bank). Functioning as a department of www.bof filbofitl. Mailing address: BOFIT Bank of Finland, P 0.
the central bank confers many benefits. Researchers have ac- Box 160, FIN-00101 Helsinki, Finland, tel: 3589-183-2268,
cess to the bank's extensive international connections, a wide fax: 3589-183-2294.
* TRANSITION. December 1999 (© 1999 The World Bank/The William Davidson Institute
Exports of Baltic Countries in the First Seven Months of 1998 and Sales to CIS Countries Down
1999
Significant depreciation of the ruble had
January-July 1998 January-July 1999 % change Severely dedtecompetie position
in te vlueseverely damaged the competitive position
nluethefavalue oof the Baltic companies selling on the Rus-
Vailueon% of aexports(mlliValue %f ofal exports (localcurrency)sian market. Exports to Russia and other
(millions of $) exports (millions of $) exports (local currency) CIS countries, also affected by the crisis,
Estonia plummeted drastically in the first seven
Exports to Russia 288 15.0 142 9.0 -45.4 months of 1999 compared with the first
Exports to entire CIS 447 23.2 217 13.8 -46.1 seven months of 1998, before the crisis
Exports to EU 1,000 52.0 973 61.8 8.0 (see table). True, the Baltics have reori-
Total exports 1,927 100.0 1,575 100.0 -9.2 ented some of their exports to other mar-
Latvia kets, especially the European Union.
Exports to Russia 168 15.3 67 7.0 -60.0 However, reorienting trade has been quite
Exports to entire CIS 249 22.6 110 11.3 -55.8 difficult, especially in the food industry, where
Exports to EU 578 52.7 616 63.6 6.6 most major bankruptcy cases associated
Total exports 1,097 100.0 968 100.0 -11.8 with the Russian crisis have occurred.
Lithuania
ExportstoRussia 419 21.4 121 6.9 -71.1 AsBalticexportstoCISmarketsslumped
Exports to entire CIS 850 43.4 324 18.5 -61.9 and interest rates rose, domestic produc-
Exports to EU 661 33.7 873 49.9 32.1 tion also suffered. In all three Baltic coun-
Total exports 1,957 100.0 1,750 100.0 -23.8 tries, GDP declined in the last quarter of
Source: BOFIT. 1998, and this trend continued in the first
half of 1999. Falling production also led to
delivered a heavy blow. The Bank of Latvia In Baltic interbank markets, interest rates higher unemployment. The registered un-
was forced to close a relatively small com- rose after the crisis, but returned fairly employment rate rose several percentage
mercial bank. Rigas Komercbanka, quickly to lower levels. In equity markets, points in the yearfollowing the crisis, and it
Latvia's fourth largest bank, experienced the effects were more subdued. The Bal- now stands at about 5 percent in Estonia,
a run on its deposits, but managed to keep tic markets had been on a downward trend 10 percent in Latvia, and 8 percent in
its doors open; eventually, however, it was for some time-a trend that continued af- Lithuania. These figures, however, tend to
shutdown, recapitalized, and reopened. ter the crisis. underreport actual unemployment.
GDP ups and downs in the Baltics from 1996 to mid-1999 Recent production statistics suggest that
the worst is over in Estonia and Latvia. Both
14 .>>4½T\.stna economies appear to have bottomed out
12 ( Q1/97 and growth returned in the second half of
10 1999. Inthe face of widening public sector
deficits, both countries successfully cut bud-
a 8NK~;4. .. get expenditures, seem to have stabilized
6 their economies, and are meeting the ex-
uan 19TeWlBn/hWlaDvdopectations of private investors. Interest
o-O 4 ~~~~~~~~~~~~~~~~~~~rates have come down. Public sector defi-
2, ti~> 4N>~4 ~Mcits, high in 1999, are forecast to fall in 2000.
0 <~...~>~These prospects haveGcalmed the financial
-2 .~ ~4 ~ I-0c, December 1999 © 1999 The 'World Bank/The William Davidson rstitutc
The (Not So) Mysterious Resilience of Russia's
Agricultural Collectives
by Maria Amelina
A nyone who examines Russian ag- ticularly appropriate for a post-Soviet set- the regional government has pursued a
ricultural reform has to wonder at ting. In Soviet times institutions were cre- more interventionist agricultural policy,
the institutional resil- ated to serve political and while in the Leningrad oblast the adminis-
ience of collective farms. In- , economic goals simulta- tration has shifted to a more laissez-faire
deed, kolkhozi (collectives) , neously: the role of collec- regulatory stance.
and sovkhozi (state farms) of tive farms was not only to
Soviet times-awkwardly produce agricultural output, What made these two administrations act
renamed joint stock compa- ) but also to serve as an differently? More interesting, what allowed
nies-continue to be the ideological showcase for the interventionist governmentto succeed
dominant agricultural pro- the superiority of large- in the environment of liberalized prices and
ducers. Now that they are scale collective agriculture. curtailed federal support?
owned largely by their em- Local governments notonly
ployees, their profitability provided the environment The Saratov oblast is following the post-
and efficiency are decreas- for the operation of eco- Soviet path. Politically, the oblast govern-
ing. Yet the number of collective farms still nomic entities and coordinated the distri- ment depends heavily on rural votes and on
stood at 27,000 in 1997, the same as in bution of agricultural inputs and outputs, personal and professional rural ties. All the
1994. They produce half the country's ag- they also oversaw the timely fulfillment of key positions in the oblast administration,
ricultural output, own more than 80 percent plans. including the mayor of the city of Saratov, are
of agricultural land, and refuse to disap- held by former Soviet agricultural managers
pear (see table 1 and 2). A close alliance between local govern- and administrators. The local administration,
ments and collective farm managers despite nationally liberalized prices, adheres
At the same time, the number of individual evolved because of their shared respon- to the earlier practice of central distribution
farms has remained surprisingly low. Eight sibilities. The goal of this informal asso- of resources with the help of the commodity
years afterthe enactment of the first presi- ciation was to guarantee that collective creditssystem. Forexample, the oblastgov-
dential decrees legalizing individual farm- farms within the jurisdiction of a particular ernment instructs oil refineries to deliverfuel
ing, the number of individual farms had administrator gained preferential access to collective farms during the sowing period,
actually decreased-from a peak of to scarce inputs-such as fuel, fertilizers, in return for tax forgiveness. The collective
280,000 in 1996 to 274,000 at the end of and seeds. The timely acquisition of these enterprises are required to repay commod-
1997. Individual farms produce just 2 per- inputs from centralized sources and the ity credits to budgetary organizations after
cent of recorded agricultural output on 6 fulfillment of output plans shaped the rules harvesting, either with food deliveries or in
percent of agricultural land. The remaining in the "battles for harvest," a term for har- cash.
48 percent is produced on tiny private vesting and sowing under socialism.
plots-averaging one-third of a hectare- The oblast government is able to define
by rural and urban workers for whom this is Islands of the Command Economy the conditions of commodity credit repay-
a part-time occupation or by pensioners for ment, besides deciding at what price the
whom it supplements retirement benefits. In the post-Soviet era, during which fed- commodities shoLIld be delivered by the
eral agricultural policies have been weakly farms. The firmness of the repayment con-
Ideological Remnants implemented, the role of regional (oblast- ditions depends on the priorities of the
level) government in fostering-or block- oblast administration for a particular year.
To explain the puzzle of the longevity of ing-agricultural reform has become If political imperatives of courting the vil-
collective farms, it is important to evaluate critical. Research in two Russian provinces lage vote dominate the agenda, the repay-
both the political and the economic ben- reveals fundamental differences in the way ments are not enforced. If, however, the
efits that different groups of stakeholders oblast governments have influenced agri- government needs to generate more rev-
derive from the preservation of this institu- cultural producers and, consequently, en- enue, it forbids all other sales before the
tional structure. The structure seems par- terprise restructuring. In the Saratov oblast commodity credits are repaid.
C) 1999 The World Bank/The William Davidson tnstitute TRANSrRON, December 1999
Table 1. Collective enterprises: Main indicators The local administrative elites of this
1991 1994 1997 oblast also come primarily from urban
Number of collective producers backgrounds, and consequently do not
(thousands) 26.9 26.9 27.0 have the skills required for Soviet-style
Number of unprofitable collective enterprises distribution of resources.
(percentage of the total number of farms) 5 5 82
Share of agricultural production Further in this oblast the budget constraint
(percentage of national agricultural production) 68.8 54.5 49.9 futhe inthis ast th be conctraint
Agricultural land use of the enterprises appears to be harciening
(percentage of total agricultural land) 91.2 82.8 80.4 much fasterthan in the Saratov oblast. Em-
Average size of land holdings per collective producer ployees of collective farms derive their in-
(hectares) 4,200 3,300 2,900 comes primarily from cash wages paid in
Source: Goskomstat, Statistical Bulletin, 8 (37), October 1997; Moscow. Sel'skoe Hoziaistvo a direct and transparent manner. To be able
v Rossii 1998, Moscow. to compensate their employees in cash
rather than in kind, the collective enterprises
This elasticity of budget constraint is noth- lesser extent, from direct wage payments sell their output in the market and generate
ing new for collective farm managers. Fa- by the collective farm. Inputs for private ag- the necessary revenue. This is in sharp con-
miliar with the economic mood swings of ricultural production, however, as well as trast to the continuous operation of the bar-
their Soviet superiors, post-Soviet collec- agricultural services, come predominantly ter circle observed in the Saratov oblast.
tive farm managers know how to adjust in the form of official and unofficial pay-
their behavior to these fluctuations. They ments derived from the collective farm. The These divergent developments in oblast-
do not have to adjust their skill in distribu- low cost of inputs compared with their mar- level policies and their effect on the insti-
tion to the new market realities, where suc- ket price makes the employees prefer the tutional evolution of collective farms have
cess depends on generating profits. In limited and egalitarian access to re- far-reaching implications:
other words, most collective farm manag- sources from the ex-kolkhoz to the risk of
ers can only perform their traditional so- independent farming. * Post-Soviet hierarchical structures
cial, political, and economic roles in an crowd out other potential players from the
interventionist setting. The other side of the coin is that growth of agricultural market. In the Saratov oblast,
private farming-facilitated by the supply of for example, the number of individual farm-
Interviews with collective farm managers inputs from the collective farm-is severely ers is decreasing despite the favorable
in the Saratov oblast indicated that these constrained bythe egalitarian natureof input natural endowments (such as rich black
farms serve as "guarantors of stability" in distribution and low-close to subsistence- soil) and a good legal framework 'or land
the countryside, as a safety net of last re- levels of inputs available from the system. transactions, while in the agriculturally
sort, and as input providers for the small poorly endowed Leningrad oblast the num-
private household plots of their employ- There is a different dynamic in the ber of individual farmers is growing.
ees. Collective farm managers also have Leningrad oblast. This oblast is more in- 0 Shedding light on economic and politi-
to make sure that the farms produce dustrial, with a larger share of GDP com- cal motivations within this hierarchical
enough to exchange for the inputs that will ing from nonagricultural production and a structure helps clear up some misunder-
be needed to resume the production cycle larger population living in urban areas. standing. For example, to explain the en-
the next season. Obviously, these goals are
very different from the market imperative Table 2: Individual farms and private plots: Main indicators
of profit maximization. 1991 1994 1996 1997
Share of agricultural production
Shedding Light on Motivations (percentage of total) - 1.7 1.9 2.2
Agricultural land use
The employees of collective farms are also (percentage of total) 0.6 4.8 5.2 5.7
interested in the preservation of this as- Average size of land plots
(hectares) - 42 43 44
sociation for a number of reasons. A Number of producers
household-level survey of the employee- (thousands) 4.4 270 280 274
shareholders of the collec-tive farms in the Source: Goskomstat, Statistical Bulletin, (37), October 1997; Sel'skoe Hoziaistvo v
Saratov oblast showed that their income Rossii 1998, Moscow.
is derived primarily from household plots Note: In 1993 some privately held plots were reclassified as plots for individual con-
and livestock production and, to a much struction, which led to the decrease in the total number of plots in this category.
* TRANSITION, December 1999 (C 1999 The World Bank/The William Davidson Institute
durance of the kolkhoz system and the agricultural reform in those regions that are benefits that secures the longevity of the
slow change in the Russian countryside, agriculturally better endowed. However, it kolkhoz system.
some students of Russian agricultural re- appears to be more effective to concen-
form argue that the rural population is old trate the restructuring effort on those re- Maria Amelina is an economist in the De-
and aging, unable to embrace reform. This gions where the reform process has taken velopment Economics Research Group at
sort of interpretation seems to liberate better root-where local governments the World Bank. Her findings are based
policymakers from the burden of seeking have disengaged themselves from agricul- on a survey conducted between January
new approaches to reform: even in the tural production and where agricultural pro- and March of 1999, in 181 Households
medium term there is very little one can ducers operate under uniform rules. of the Leningrad and Saratov Oblasts.
do about demographic trends. Foreign assistance to agricultural reform This article is based on her paper "Why Is
in Russia has to take into account the di- the Russian Peasant a Kolkhoznik Still?"
The intuitive approach-and the one likely verse patterns of restructuring as well as The author can be reached by email: Ma
to yield the largest return-is to support the intricate and, in part, hidden web of melina@WorldBank.org.
0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Oxford Analytica: Economic Slowdown Expected in
Cambodia, Laos, and Vietnam
In the aftermath of the East Asian crisis and in the absence of bold structural reforms, economic growth in Cambodia, Lao PDR
(Laos), and Vietnam is likely to remain below the levels achieved in the first half of the 1990s. With population growth still rapid,
overcoming poverty will be a slow process, predicts Oxford Analytica, an intemational research group based in Oxford.
S ince embarking on market-ori- Laos and Vietnam have conducted their With key urban centers saturated with
ented economic reforms some experiment with market reforms in a cli- quality consumer durables, the most
15 years ago, Cambodia, Laos, mate of relative political stability. In both successful companies in this environ-
and Vietnam have undergone substantial countries the Communist Party has main- ment are those that have targeted the
change. In the mid-1 980s the political in- tained its monopoly on power. By contrast, low-cost, nonluxury market.
fluence of the former Soviet Union in the Cambodia has experienced a transition
region was still strong, and the region's from one-party rule to a multiparty, consti- 0 Agricultural drag. While the contribu-
three economies were firmly oriented to- tutional democracy. tion of agriculture to GDP is lower in Viet-
ward the eastern bloc. All three countries nam than in Cambodia and Laos, all three
are now members of the Association of Despite these changes, major questions countries remain essentially agricultural
Southeast Asian Nations (ASEAN), and hang over the future of the three countries, economies. The process of industrializa-
their trade and investment ties are pre- for the following reasons: tion is just beginning. Devising and imple-
dominately with other parts of Asia and the menting viable industrialization strategies
European Union. 0 Low incomes. All three countries are remains a continuing challenge, as does
very poor. Average annual per capita in- managing the social problems inherent in
Overseas, investments from China play comes stand at around $300. Even thelargemovementoflaborfromruralto
an important role in the economies of Vietnam, which is more attractive to in- urban areas now underway.
Cambodia and Vietnam; in Laos, Thai- ternational investors owing to its large
land has emerged as the leading trade population of 76 million, is a small mar- 0 Difficult business environment. Low
and investment partner, supporting far- ket in terms of consumer purchasing labor costs alone do not compensate for
reaching economic and social change. power. As economic expansion has adifficultbusinessenvironment. Nonlabor
Until the advent of the East Asian crisis slowed in the wake of the East Asian costs are high, reflecting excessive bu-
in 1997, Cambodia, Laos, and Vietnam crisis against a backdrop of still rapid reaucracyandcorruption.Thepost-crisis
were experiencing unprecedented eco- population growth (albeit at a slower decline in costs in the more developed
nomic growth, which offered the prospect rate in Vietnam), the prospect of a swift Asian economies has reinforced the rela-
of sustained rises in average per capita improvement in average income levels tive unattractiveness of SoutheastAsia to
incomes. in any of the three countries is remote. investors.
©D 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999
in 2000-01. GDP growth in Cambodia, the resumption of international donor lend- lowerfood prices. Inflation is unlikely to be
Laos, and Vietnam is unlikely to return to ing kicks in. Laos and Vietnam can expect a major problem in Vietnam and Cambo-
the levels recorded in the first half of the average GDP growth of around 5.5 percent dia this year.
1 990s. This reflects a ioss of international in 2000-01. This compares with 4.0 per-
business confidence, exacerbated by the cent for Cambodia in 1999, 4.6 percent for The outlook for all three countries depends
East Asian crisis and the fact that earlier Vietnam, and and 4.0 percent for Laos. on the ability of their governments to push
growth was achieved on the back of one- through difficult structural changes to shift
off gains that cannot be repeated. Assum- The challenge for Laos is to bring inflation from a planned to a market economy. De-
ing political stability and a reasonable below the current triple-digit levels. In the spite the frustrations voiced by multilateral
harvest, Cambodia is likely to record the third quarter of 1999, there were some signs institutions and investors, the international
fastest economic growth of the three thatinflation mayhavepeaked. Laos'ssat- donor community is likely to remain en-
countries, averaging around 6 percent, as isfactory late-1 999 harvest should lead to gaged in all three countries in 20()0.
Are Asian Economies Different?
Sanjay Kalra and Torsten Slok
China avoided the large output de-clines 0 The choices on the speed and scope of late 1 980s and price and exchange rate in-
suffered by the transition economies of Cen- the transition were heavily influenced by ini- stability in Lao PDR in late 1994.
tral and Eastern Europe and Central Asia. tial conditions, political acceptance of the
The country's economic performance over market mechanism, and the availability of Has gradualism succeeded in Chirna? The
the past two decades has been impressive. external financial assistance and foreign di- fastest growth took place in the sectors
In China, the Lao People's Democratic Re- rect investment. The initial conditions were with the most comprehensive reforms.
public, and Vietnam the relatively large ag- characterized by low per capita income, ex- China's initial conditions-including a
ricultural sectors and the availability of large treme poverty, rudimentary infrastructure, large rural labor surplus and a large agri-
rural labor surpluses helped accelerate weak administrative capacity, and, in cultural sector-permitted rapid growth
growth without the large-scale dismantling China, a large state industrial sector. without requiring politically difficult reforms
of the "overindustrialized" state-owned sec- * The responses to impending instability of the state enterprises. Starting from a
tor that happened in Eastern Europe and have been unpredictable. At times, mac- position of near autarky, China also de-
the former Soviet Union. roeconomic instability spurred liberaliza- rived significant gains from trade.
tion and reform (as in Vietnam in the
In broad terms, the reform process in China mid-1 980s); at other times (most recently China's and Vietnam's selective and
can be characterized by the following: in Lao PDR and Vietnam in the wake of gradualist strategy appears to have pro-
* The "easy-to-hard" reform sequence the Asian crisis) there has been some vided rich dividends, but cannot be seen
started with those sectors with the easiest backtracking and recourse to old methods as unambiguously validating gradualism.
and greatest gains. of command and control. Indeed, high growth occurred in agriculture
o The reform process took a "dual track" * Partial reforms inevitably generated ten- and other sectors in which reforms were
approach with the aim of having the old sions and macroeconomic imbalances, fastest. Reform is slow in state-owned en-
gradually give way to the new. suggesting the need for continuation of- terprises, and the financial sector is still
* The cyclical pattern of implementation and often providing spurs for-the reform weak. Recurring losses have accurnulated
assured that periods of advance would be process. The dual track pricing and ex- in large portfolios of nonperforming loans.
followed by periods of consolidation. change rate systems provided market sig- It is becoming evident that vigorous reform
* Reforms have been carried outwith con- nals on the margin, but also produced in the industrial and financial sectors is the
siderable pragmatism and flexibility, en- macroeconomic imbalances and gener- key to future sustained growth.
abling different norms to coexist and ated considerable scope for corruption and
compete. rent seeking. Similarly, continuing weak- Sanjay Kalra and Torsten Slok are
nesses in the financial system, governance economists at the International Monetary
The transition process in China, Cam- problems, and the absence of controls over Fund. This article is based on their recent
bodia. Lao PDR, and Vietnam has enterpriseaccesstobankcreditgenerated paper, "Inflation and Growth in Transition:
been marked by a number of common inflationary pressures. Such factors pro- Are theAsian EconomiesDifferert?"IMF
factors: voked crisis conditions in Vietnam in the Working Paper Series, No. WP/99/118.
j Tl< \\sic uc\ Decenmber 1999 © 1999 The World Bank/The Wihliam Davidson 'nstitutC
THE WILLIAM DAVIDSON INSTITUTE
AT THE UNIVERSITY OF MICHIGAN BUSINESS SCHOOL
Corporate Governance: Lessons from Transition
Economy Reforms
by Merritt Fox and Michael Heller, William Davidson Institute and University of Michigan Law School
To date, most theoretical work on corporate governance has fo- for transition economies. Should policymakers in transition strive
cused on advanced market economies. In post-socialist coun- to develop a corporate governance structure sufficient to sup-
tries, corporate finance and institutional economics scholars have port viable public markets for equity finance? Or should they fo-
often done little more than convey the received theory to transi- cus instead on factors that promote bank-centered finance and
tion policymakers. A recent conference on "Corporate Gover- mediate among inside stakeholders? Developing these issues,
nance Lessons from Transition Economy Reforms" focused, for Jack Coffee (Columbia Law School) presented "The Lessons of
the first time, on the reverse concern: what, if anything, do the Securities Market Failure: Privatization, Minority Protection, and
reform experiences of transition countries teach about corpo- Investor Confidence."
rate governance theory more generally?
Measuring Good Corporate Governance
Sponsored by the William Davidson Institute and the University
of Michigan Law School, the September 1999 conference Implementing well-functioning corporate governance regimes
brought together leading corporate governance theorists to requires developing and testing policy-sensitive indicators, im-
present the principal papers. The conference highlighted four proving the amount and quality of national corporate sector data,
areas for policy-oriented research in corporate governance: (1) and collecting and disseminating best practices. A coherent set
definitions, (2) measurement, (3) linkages to the real economy, of policy-sensitive indicators for the corporate sector needs to
and (4) linkages between research and practice. be developed, one thatwould include financial, institutional, and
performance indicators.
Defining Good Corporate Governance
To give one example, a financial indicator could be developed
Scholars have not, to date, given sufficient attention to providing from the average premium paid for a control block of shares in a
a precise and policy-oriented definition of what constitutes "good country's companies. If the premium is relatively small, then the
corporate governance." The existing literature focuses on devel- corporate law system is performing well in terms of promoting
oped market economies, with debate breaking down between residual maximization and pro rata distributions. (The residual is
"Anglo-American" and "Continental" perspectives. But this de- defined as the difference between what a firm pays at contractu-
bate misses insights that can be gained from transition coun- ally pre-determined prices to obtain its inputs, and what it re-
tries undergoing fundamental structural reform. ceives for its output.) In such a system, portfolio investors would
be willing to pay enough for noncontrol shares to make public
Three of the conference papers focused on basic definition ques- equity finance commonly practical.
tions: Henry Hansmann (Yale Law School) and Reinier Kraakman
(Harvard Law School), "An Asset Partitioning Theory of Organiza- Several papers presented empirical work exploring these difficult
tional Law", Lucian Bebchuk (Harvard Law School), "A Rent Pro- measurement issues, including Mark Ramseyer (Harvard Law
tection Theory of Corporate Ownership and Control," and Merritt School), "Lessons from Japanese Transition, 1870-191 0,"Andrzej
Fox (Michigan Law School) and Michael Heller (Michigan Law Rapaczynski (Columbia Law School), "Why Ownership Matters:
School), "Lessons from Fiascos in Russian Corporate Govemance." Entrepreneurship and Restructuring in Central Europe" and Randall
Morck (University of Alberta) and Bernard Yeung (New York Uni-
The conference also addressed the issue of whether "good cor- versity), "The Information Content of Stock Markets: Why Do
porate governance" for developed economies is identical to that Emerging Markets Have Synchronous Stock Price Movement?"
(D 1999 The World Bank/The William Davidson Institute T\I .ks!oN. December Q99 Q
Proving the Link between Good Corporate Governance cide with, and would be subsumed under, "rule of law" work that
and Wealth Creation countries are already pursuing. Also, efforts to improve sectoral
data collection will both lay the groundwork for necessary em-
The link between improved corporate governance and wealth pirical research and be immediately useful to current market par-
creation must be better established, not just on an empirical level, ticipants and governmental regulators.
but also in terms of corporate governance theory. On this topic,
Paul Mahoney (University of Virginia Law School) presented "The In a sobering account of early efforts to link theoretical work with
Common Law and Economic Growth: Hayek Might be Right" and practical reforms, Bernard Black (Stanford Law School), Reinier
Katharina Pistor (Harvard Kennedy School of Government) pre- Kraakman (Harvard Law School), and Anna Tarasova (Univer-
sented results from "Economic Development, Legality, and the sity of Maryland-IRIS) presented "Russian Privatization and Cor-
Transplant Effect." porate Governance: What Went Wrong?"
Practical Steps to Improve Corporate Governance Professors Merrit Fox and Michael Heller are preparing the
proceedings of this conference for publication in an edited vol-
There are immediate practical steps that transition countries can ume. Excerpts from four of the papers are printed belovv. All the
undertake to promote improved corporate governance. For ex- conference papers are available by contacting Sharon
ample, many of the needed corporate governance reforms coin- Nakpairat at sharonch@umich.edu.
Lessons from Fiascos in Russian Corporate
Governance
by Merritt B. Fox and Michael A. Heller, William Davidson Institute and the University of Michigan Law School
Russian industry has performed poorly since privatization. The To answer the first question, we define corporate governance in
voluminous literature on transition economies explains this poor a way that looks to the economic functions of the firm rather than
performance primarily in terms of continued bureaucratic med- to any particular set of national corporate laws. Firms exhioit good
dling, poor macroeconomic and tax policy, and low human capi- corporate governance when they both maximize residuals and,
tal. Problems in corporate governance are often mentioned as in the case of investor-owned firms, make pro rata distributions
well, but little analyzed. The goal of this paper is to open the black to shareholders. Whether managers operate their firms in ways
box of "poor corporate governance" by detailing its conse- that meet these ideals depends on the structure of constraints
quences for the Russian economy and by tracing its causes to and incentives in which they operate, a structure that depends in
the initial structure of Russian privatization. Understanding what part, but only in part, on the prevailing legal system. Defective
wentwrong in Russia teaches lessons not onlyfortransition policy, corporate governance means that a firm does not meet one or
but also for corporate governance theory generally. both elements of our definition.
After the fall of Russian communism, state enterprises were rap- Most attention in reports on transition economies has focused
idly privatized, stock markets created, and a corporate legal code on problems relating to non-pro rata distributions: for example,
adopted. However, even at its peak before the 1998 collapse, when insiders dilute shares of outsiders, loot companies, fail to
the total stock market capitalization of all Russian industry only pay dividends, and engage in many other tactics that deprive
reached about $130 billion-less than Intel Corporation. These outside shareholders of their pro rata share of the wealth gener-
numbers represent a trivial fraction of the apparent value of the ated by the firm. Non-pro rata distributions do indeed help ex-
underlying corporate assets controlled by Russian corporations. plain low stock prices and the poor performance of the corporate
The low prices reflect severe corporate governance problems, sector. But failure to maximize residuals has the same effect,
including the high probability that the firms' underlying assets will indeed even more directly. The vast transition literature never
be grossly mismanaged and that whatever cash flow is produced makes clear which failure dominates in any particular enterprise
will be diverted to benefit insiders or reinvested in unproductive fiasco. Instead, bad corporate governance becomes a catch-all
projects. In this paper, we focus on two questions: What are the for problems that should be understood as being quite distinct.
consequences of these corporate governance problems for the
real economy in Russia? Why are these problems so widespread In this paper, we give more precision to the idea of "bad" corpo-
and persistent? rate governance by developing a typology of the kinds cf dam-
m TRANSmuOŽ, December 1999 ( 1999 The World BanklThe William Davidson lnsu\nae
age to the real economy that loosely constrained, poorly cation of corporate law violations, weak enforcement of judg-
incentivized managers can inflict. We identify, with examples, why ments, and the absence of a network of trust among Russian
this damage has been particularly severe in Russia. This typol- businesspeople-factors that are common to all post-socialist
ogy is summarized in the following table. corporate economies. We expand this inquiry by focusing on the
role of initial conditions at the time of privatization-specifically,
Nonmaximization of Profit the initial boundaries of privatized firms and the initial allocation
of firm shares primarily to insiders-and the bargaining dynam-
Pathology 1: Unreformable value-destroying firms fail to ics that have followed. Our focus helps explain why Russian cor-
close. Arises when an unreformable, value-destroying firm can porate performance remains so much worse than in other
dissipate cash reserves or salvageable assets. Corporate gov- transition countries. These initial conditions are unique to Rus-
ernance is not the key issue when the firm has no reserves or sia (and the other republics of the former Soviet Union). They
salvageable assets, or when subsidies or unsuitable credits are result from a privatization program that followed the course of
present. least resistance. The domestic Russian architects of privatization
Pathology 2: Viable firms fail to use existing capacity effi- and theirforeign advisers believed it politically necessary to move
ciently. Arises when continued firm operation, if undertaken as quickly. As with real estate privatization, the initial path in corpo-
efficiently as possible and without new investment, would be a rate privatization represents not only political expediency, but also
positive net present value (NPV) decision; but costs are not mini- the primacy of pure economists over those more sensitive to the
mized, the best price is not obtained for given output, or a non bargaining implications of packaging rights. The reformers hoped,
profit-maximizing output level is chosen naively as it turned out, that resources would naturally flow to their
Pathology 3: Firms misinvest internally generated cash highestvalue users after marketswereestablished. Buttheyun-
flows. Arises when a firm uses internally generated cash flow to derestimated the roadblocks that the initial conditions would con-
invest in new negative NPV projects instead of paying out this tinue to impose for resource reallocation.
cash flow to shareholders who could invest the funds better else-
where in the economy. Conclusion
Pathology 4: Firms fail to implement positive NPV projects.
Arises when a firm identifies but then fails to act on positive NPV A typology of Russian corporate governance can offer useful les-
projects. Managers tend to be risk averse because they cannot sons for corporate governance theory. The rich array of deviant
diversify away unsystematic risk of a firm's project. If others do behavior we canvass in Russia helps flesh out a framework of
not pick up the opportunity, the firm's failure also reduces social pathologies that, in a comprehensive way, links corporate gov-
welfare. ernance failures to real economy effects. How is this analytic tool
Pathology 5: Firms fail to identify positive NPV projects. useful? It helps give more precision to the often vague notion of
Arises when a firm's managers fail to identify positive NPV corporategovernancefailures. Scholarswriteaboutthecostsof
projects that the firm is particularly well positioned to find. The poor corporate governance without telling us the mechanisms
possibility of venture financing and spinoffs can reduce the preva- by which loosely constrained and poorly incentivized managers
lence and social costs of this pathology. are causing social welfare losses. We suggest that in every
economy, those losses may be inflicted in differing degrees
Non-Pro Rata Distributions through five distinct pathologies of nonmaximization of profit and
two versions of non-pro rata distributions. Identifying which pa-
Pathology 6: Firms fail to prevent diversion of claims. Arises thology predominates may help point to more appropriate cor-
when some residual owners of a firm manipulate corporate, bank- porate governance reforms.
ruptcy, and other laws to shift ownership away from other residual
owners-often by diluting shares held by outside minority share- The second focus of the paper-explaining what has caused the
holders. flowering of Russian corporate pathologies-may also prove
Pathology 7: Firms fail to prevent diversion of assets. Arises useful for corporate governance theory. Not surprisingly, the ex-
when some residual owners privately appropriate assets and op- isting scholarly literature on comparative corporate governance
portunities belonging to the firm, but leave the firm's formal own- mostly reflects the experience of the United States, Western Eu-
ership structure intact. rope, and Japan. In the United States it is unusual for a corpora-
tion to maintain a share ownership pattern over the long term
As for the second question-why corporate governance prob- that involves a majority of shares owned by insiders and a minor-
lems are so widespread in Russia-we go beyond standard ityowned byoutsiderswhotradetheirsharespublicly. Ourunder-
causal explanations of poor corporate governance, which include standing of the mechanisms that constrain management to act in
the low level of corporate transparency, lack of effective adjudi- relatively share-value-maximizing ways-one share, one vote, the
© 1999 The W7orld Bank/The William Davidson Institute TRAN\SmON4, December 1999
hostile takeover threat, share price-based management compen- More generally, the Russian experience suggests we rethink
sation schemes, board elections, shareholderapproval of certain how close corporations operate. While there is a well-devel-
interested and extraordinary transactions, ex post court review, oped jurisprudence of close corporations in the United States,
the managerial labor market and other reputational incentives-is there is only a modest literature on the economics of such legal
built primarily against the U.S. backdrop because the typicalAmeri- relations. Governance of the close corporation has traditionally
can corporation forms the paradigm fortheorizing. been viewed by lawyer-economists as a contracting prDblem
among well-informed, well-represented, motivated individiuals,
We suggest that looking at Russia introduces an analytic focus where the best policy advice that can be given is to have tle law
not immediately obvious from studying such long-established not obstruct the deals these individuals might reach.
systems. Among other things, we see concretely that initial con-
ditions matter for subsequent corporate governance develop- The bargaining failures that followed privatization in Russia could
ment. The Russian experience suggests two salient initial shed light on our own system by focusing attention on the under-
conditions-uneconomic firm boundaries and competing groups studied area of losses from fragmented ownership in close cor-
of insider owners-that offer avenues for further research. At a porations and other special corporate governance arrangements
minimum, the bargaining failures that followed privatization pro- such as those associated with start-up companies backed by
vide evidence that counsels skepticism toward the periodic claims venture capital. When insiders exercise their rights so that each
of some scholars and activists for including "stakeholders"-such blocks the others, corporate assets may be wasted in a "tragedy
as labor, the local community, and the local government itself-in of the anticommons." If competing blocks of insiders have incen-
corporate governance. The Russian experience reminds us, also tives each to veto share-value-maximizing decisions, or if the
quite starkly, of the tradeoff between the agency costs of man- costs of aggregating and negotiating insider interests to reach
agement in a publicly held corporation and the disadvantages of such decisions are sufficiently high, then corporate assei:s may
lack of access to public equity finance. This tradeoff appears in be wasted in low value uses. In short, the Russian experience
the leveraged buyouts of the late 1980s and the "going private" counters recent theoretical and empirical research, which argues
trend of the early 1 970s: firms involved in both movements have that control by multiple large shareholders actually improves firm
tended to go public again at some later point. performance.
Privatization and Corporate Governance: Lessons
from Securities Market Failure
by John C. Coffee, Jr., Columbia University Law School
Recent research on corporate governance has found system- by controlling shareholders, but justifies this cost as necessary
atic differences among nations in ownership concentration, capital to realize and expedite the efficiency gains incident to
market development, the value of voting rights, and the use of privatization? Or should privatization proceed more cautiously
external finance. In particular, the size, depth, and liquidity of se- because of the risks of market failure and political corruption
curities markets has clearly been found to correlate directly with that may result when control seekers are tempted to bribe and
the quality of the legal protections given shareholders, and in turn, seduce the judicial and regulatory systems to achieve lhe pri-
encourages capital market growth and ownership dispersion. Be- vate benefit of control? These tempting private benefits arise,
cause the nature and quality of these legal protections differs of course, precisely to the extent that privatization preceded
widely across nations, the corporate world today subdivides into the creation of an adequate legal foundation. The cases exam-
rival systems of dispersed ownership and concentrated owner- ined in this article illustrate this tension and favor a prudential
ship, with different structures of corporate governance charac- course of phased privatization.
terizing each.
What Really Distinguishes the Czech and Polish Experi-
This point has important implications for a policy debate that ences?
has begun among scholars who have studied the transitional
process: should privatization be "fast" or "slow"? Should To this point, the Czech and Polish experiences have been dif-
policymakers adopt a "damn-the-torpedoes, full-speed-ahead" ferentiated in terms of the highly spontaneous character of Czech
approach that accepts the inevitability of some overreaching privatization versus the carefully planned-indeed, constrained-
* TRA,\SFN, December 1999 (C 1999 The World Bank/The William Davidson Institute
character of Polish privatization. But both nations share one com- sibly unintended, role of the N IFs was to provide an assurance to
mon fact that is troubling for the new scholarship that empha- smaller shareholders that they need not fear the potential expro-
sizes the importance of differences in substantive corporate law: priation of their investment in a privatized company, at least be-
they each had a corporation law heavily based on the German cause of its vulnerability to a predatory control seeker. Indeed,
civil law structure. Put simply, their experiences were very differ- much of the scramble for control in the Czech Republic seems to
ent, but their corporate laws were largely the same. As a result, have been defensively motivated: each large shareholder essen-
because the corporate laws of Poland and the Czech Republic tially realized that if they did not acquire control, someone else
each provide only weak protection for minority shareholders, their would, with resulting injury to them. In short, the fear of loss may
different experiences cannot be used to corroborate the claim have provided a greater incentive to compete for control than the
that differences in substantive corporate law are the key causal expectation of any synergistic or opportunistic gain.
factors that determine the success or failure of privatization.
In this light, the inefficient exposure to loss that the Czech system
Yet, if Poland and the Czech Republic had similar corporate laws, imposed on minority shareholders may also explain the earlier
their approaches to securities regulation were entirely different. noted absence of equity offerings for cash in the Czech Repub-
Not only did Poland impose high disclosure standards from the lic, in contrast to theirfrequency in Poland. Because an offering
outset (including quarterly reporting), it also created an SEC-like of equity securities inherently dilutes large shareholders, it ex-
agency to enforce its laws from the beginning of its privatization poses them to an increased risk of exploitation; correspondingly,
experience. In addition, Poland adopted provisions requiring it also disturbs and potentially upsets any equilibrium that may
ownership transparency that are similar to parallel provisions in have been achieved among large shareholders. Having acquired
the United States. These provisions require disclosure by a po- a majority position, a controlling shareholder might prefer to rely
tential acquirer of ownership of specified thresholds of a on high-cost bank financings than to utilize equity financing where
company's shares. Finally, Poland (but not the Czech Republic) use of the latter could interfere with its ability to realize the pri-
followed the British model of takeover regulation by requiring any vate benefits of control. But this fear was not a danger in Poland,
shareholder who acquired more than a specified level of stock where the NIFs gave greater assurance of continuity at least for
to make a mandatory bid for the remaining shares. In sum, as an interim period. Thus one implication of the Czech experience
Katharina Pistor has shown, Poland had "weak" corporate law, may be that unregulated control contests and the rapid transition
but "strong" securities law. from dispersed to concentrated ownership can give rise to ex-
ternalities-both political and economic.
In overview, these restrictions may have been responsible for
some of the differences in the Czech and Polish experiences. At Correspondingly, the sharp decline in the stock prices of Polish
the least, these restrictions helped to stop (or at least slow) the NIFs once shareholders were permitted to take control of them
frantic scramble for control that occurred in the Czech Republic. from the government also reinforces the interpretation that un-
Accordingly, the Polish experience may suggest the need for re- regulated control contests expose minority investors to the risk
finements in the model developed by those scholars of corpo- of expropriation and result in reduced share prices. Had the Pol-
rate governancewho havefocused, somewhat single-mindedly, ish government instead placed some maximum ceiling on the
on differences in substantive corporate law. In comparing sys- percentage that any investor (or group of investors) could own in
tems of corporate governance, many of the most important dif- an NIF, this decline might have been reduced.
ferences may lie at the level of securities regulation. Here, rules
prohibiting insider trading, requiring ownership transparency, and
restricting coercive takeover bids may do more to protect minor-
ity shareholders from expropriation than do corporate law rules.
Indeed, as earlier suggested, the most important common de-
nominator between the "protective" legal regimes in the United
States and the United Kingdom may be their highly similar secu-
rities laws, not their common law origins.
Another hypothesis, however, must also be noted: more impor-
tant than these legal differences may have been the creation of
the Polish National Investment Funds (NIFs). By holding control-
ling stakes, these state-created financial intermediaries blocked
the path of entrepreneurs who otherwise might have competed
to seize control of newly privatized companies. A critical, if pos-
©D 1999 The World Bank/The William Davidson Institute TPANSITION, December 1999
The Common Law and Economic Growth: Hayek
Might be Right
by Paul G Mahoney, University of Virginia School of Law
"The ideal of individual liberty seems to have flourished chiefly noted that the differences between the common law and civil law
among people where, at least for long periods, judge-made law loom larger in theory than in reality. In the United States, for ex-
predominated" (Hayek 1973, 94). ample, much of commercial law has become fairly code-like over
the course of this century because of the adoption of the Uniform
Recently, financial economists have produced evidence that fi- Commercial Code and the federal bankruptcy code. In civil law
nancial markets contribute to economic growth and legal institu- countries judges and scholars have come to appreciate that no
tions contribute to the growth of financial markets. King and Levine civil code can be sufficiently complete and unambiguous as to
(1993) demonstrate that countries with more developed finan- remove all discretion from the judges who apply it. Thus, while in
cial markets experience faster per capita GDP growth. La Porta theory civil law judges follow only the code and not the prece-
and othersl. (1998; 1997) find evidence that the extent to which a dent, in practice they pay attention to prior decisions of appel-
country's corporate laws protect the interests of minority inves- late tribunals (Merryman 1985).
tors is an important determinant of the cost of external capital.
They also, interestingly, find that countries whose legal systems This paper therefore attempts a preliminary analysis of whether
are derived from the common law tradition provide superior in- the differences between the common law and civil law traditions
vestor protections on average. Levine (1999) finds that better are sufficient to produce differential economic outcomes.' I first
investor protections are associated both with more developed provide cross-country evidence that the common law is associ-
financial markets and faster economic growth. ated with higher per capita economic growth compared to the
civil law. I then survey possible explanations and suggest that the
While the causal link between investor protection and financial most promising one lies in the common law's stronger protec-
market development seems obvious enough, the apparent link tions of property and contract rights against administrative ac-
between the common law tradition and investor protection is more tion. The common law has a strong tradition of judicial review of
surprising. Corporate law seems an unlikely place to find a sys- administrative decisions and the civil law has an equally strong
tematic difference between common and civil law countries. tradition of keeping ordinaryjudges out of the way of administra-
Compared to other areas of commercial law, such as contracts tors. The comparative freedom of common-law courts tc over-
or commercial paper, corporate law has been largely code-like turn administrative decisions makes rent-seeking more costly
in the common law countries from a very early date. This raises (because its outcome is more uncertain) in a common-law sys-
the question ofwhetherthe tendency toward more efficient rules tem, leading to a reduction in rent-seeking. I present evidence
of corporate law in common law countries is a coincidence that that governments in common law countries, on average inter-
might disappear or reverse in other areas of commercial law. fere less than their civil law counterparts with private economic
activity.
On the other hand, it may be that the common law provides su-
perior property rights protections across the board, leading to Conclusion
faster economic growth not merely through its impact on finan-
cial markets but on all commercial activities. There is, after all, a During 1980-97-an era when it seems plausible that govern-
substantial difference in the ideas motivating the common and ment policies had an especially large effect on economic growth
civil law traditions. The judges who played a leading role in shap- by influencing the extent of participation in the expanding inter-
ing English common law were deeply concerned with protecting national economy-common law countries experienced dramati-
property and contract rights. By contrast, the scholars who shaped cally larger real per capita GDP growth, on average, than did
the civil law, especially the Code Napol6on, were concerned civil law countries. The difference remains when we control for
principally with creating a strong, centralized executive to pursue initial GDP and secondary school enrollment, for foreign trade or
collective goals. Thus Hayek (1960; 1973) argued forcefully for proxies for trade, or for geographical region.
the superiority of the English to the French legal tradition.
A plausible explanation is that the common law countries were
It is not obvious that this difference in intellectual history trans- more apt to structure their economic systems around property
lates into practical differences today. Many legal scholars have and contract, and less around government economic activity and
TR.-ANTIOoN. December 1999 (C 1999 The World Bank/The William Davidson Institute
redistribution, than the civil law countries. A concrete mechanism countries, in which legal systems are deeply rooted, market-oriented
through which that effect may occur is the two traditions' different policies will not arise from changes in legal tradition, but from chang-
treatment of administrative action. Common law countries give ing political leadership and public attitudes. The results reported
judges more authorityto overturn administrative decisions alleged in this paper, however, may be of more interest for transition
to violate individual rights than do civil law countries. This may countries still in the process of creating legal institutions. The
reduce the amount of rent-seeking and increase the relative im- common law and its associated attitudes toward property and
portance of markets. contract may be more attractive than the civil law tradition that
has dominated legal development in the post-communist world
That is not to say, however, that differences in administrative law to date.
fully explain the more market-oriented policies in the common
law countries. Differences in the intellectual and ideological back- *Transition editor's footnote: Common law has been referred
ground of the common law and civil law systems may also make to as the "common sense of the community, crystallized and for-
a difference. Merryman (1985) defines a legal tradition as in- mulated by our ancestors." It exists and applies to a group on the
cluding "a set of deeply rooted, historically conditioned attitudes basis of historical legal precedents developed over hundreds of
about the nature of law, [and] about the role of law in the society years. Because it is not written by elected politicians, but rather
and the polity." In many, if not most, countries, lawyers are impor- by judges, it is also referred to as "unwritten" law. Judges seek
tant participants in government. Differences in the way common these principles outwhen trying a case and apply the precedents
and civilian lawyers think about law-particularly differences in to the facts to come up with a judgment. Common law is often
the way they think about individual economic freedoms versus contrasted with civil law systems, which require all laws to be
collective political freedoms-may influence their approaches to written in a code or written collection. Civil law deals with rights
government policy. Hayek, in otherwords, may have been right. and duties between individuals. It is inspired by Roman law, the
primary feature of which was that laws were written into a collec-
It is also important to recognize that legal systems are endow- tion; codified, and not determined, as is common law, by judges.
ments but not straightjackets. Over the past decade, governments The principle of civil law is to provide all citizens with an acces-
in Latin America-uniformly civil law countries-have made a sible and written collection of the laws that apply to them and that
dramatic shift to more market-oriented policies. For developed judges must follow.
Russian Privatization and Corporate Governance:
What Went Wrong?
by Bernard Black, Stanford Law School, Reinier Kraakman, Harvard Law School, and Anna Tarassova,
University of Maryland-IRIS
Rapid mass privatization of state-owned enterprises in formerly "auctions" were a massive giveaway of Russia's most important
centrally planned economies has not turned out nearly as well as companies at bargain prices to a handful of well-connected
its creators hoped, in Russia or elsewhere. When Russian mass "kleptocrats," who continued to behave in the ways that earned
privatization began in 1992-93, its proponents (including our- them this nickname. Medium-term prospects are grim; the Rus-
selves) hoped that the Russian economy would soon bottom out sian ruble has plunged-the Russian government has defaulted
and then turn upward, as the efficiency incentives unleashed by on both its dollar-denominated and ruble-denominated debt, most
privatization took hold. That did not happen. Instead, the Rus- banks are bankrupt, corruption is rampant, tax revenues have
sian economy stumbled along through mid-1 998, continuing to collapsed, capital flight is pervasive, and the government seems
shrink slowly by official indicators, then collapsed again, as it clueless aboutwhatto do next.
had in 1991-92 prior to privatization. Russia's mass privatization
"voucher auctions" were moderately honest, but gave control to The Russian disappointment with mass privatization is mirrored
managers. This permitted insiders (managers and controlling by similar problems in other former Soviet Union countries and
shareholders) to engage in extensive "self' or "inside" dealing also, though less severely, by problems with Czech mass
(transactions by the company, not on arms-length terms, in which privatization, which in its early stages seemed to be a model of
the insiders profit directly or indirectly at the company's expense), the transition from central planning to a market economy. This
which the government did nothing to control. Later privatization suggests that the failure of mass privatization to jumpstart the
©) 1999 The World Bank/The William Davidson Institute TRANS1TON, December 1999 U
Russian economy may reflect structural flaws in mass The Russian government accelerated the process of bad own-
privatization as a transitional mechanism, not just Russia's spe- ers driving out good ones by selling control of major enterprises
cific circumstances. (cheaply) to crooks, who got the funds to buy them by skimming
from the government. In most cases, these new owners trans-
This paper joins an emerging literature that criticizes the prevail- ferred their skimming talents to the enterprises they had acquired,
ing wisdom that rapid privatization of large firms is an important without improving the businesses and sometimes by starving
element of the transition from central planning to a market them forfunds.
economy. We develop below a case study of what went wrong
with large-firm privatization in Russia, using the Czech Republic In a mythical thick market for corporate control, honest entrepre-
as a comparison case study to assess the extent to which neurs could buy companies from crooks if the companywas worth
Russia's problems can be generalized. We bring to this task a more if run honestly than if run to maximize short-run ski nming.
reasonable mix of insiders' knowledge and outsiders' skepticism, But in fact, such entrepreneurs do not exist in Russia in signifi-
gained through experience with privatization and capital markets cant numbers orwith significant capital. If they existed, they would
reform in Russia and other countries. not pay anything close to fair value when buying a company from
a crook because they could not verify what shape the en:erprise
We leave to others the analysis of the macroeconomic steps that was in. Moreover, the business might be worth more to the crook,
Russia might have taken and focus here on microeconomic steps who has a comparative advantage in the important tasks of self-
related to privatization and capital markets development. But the dealing, evading taxes, obtaining favors from the government,
two are related-Russia's macro effort to balance the budget, not paying workers, enforcing contracts in effective albeit unoffi-
control inflation, and attract new investment was defeated, in large cial ways (instead of ineffective enforcement through the courts),
measure, by micro failures to rationalize the tax system, control and using these same unofficial means to enforce price-fixing or
corruption and organized crime, control insider self-dealing at market division agreements or scare off competitors. In contrast,
privatized enterprises, and establish a tolerably friendly business an honest owner risks having long-term investments expropri-
climate. ated by the government.
We see three main failures in the Russian privatization effort. First, Second, the profit incentives to restructure privatized enterprises
rapid, mass privatization of large enterprises is likely to lead to and create new ones can be swamped by a generally hostile
massive insider self-dealing unless (implausible in the initial tran- business environment created by (among other factors) a puni-
sition from central planning to markets) a country has a good infra- tive tax system, official corruption, organized crime, an unfriendly
structure for controlling self-dealing. If control is given to the current bureaucracy, failure to privatize the urban land that businesses
managers (which was the political deal that underlay Russian mass need to grow, and a business culture in which skirting the law
privatization), they often will not know how to run a company in a was seen as normal, even necessary, behavior.
market economy. Unless stopped (Russia made no effort to stop
them). some managers will steal whatever assets the company A hostile business environment makes asset-stripping more at-
still has, perhaps killing an otherwise viable company. If outsiders tractive to insiders, compared to the alternative of improving the
can acquire control in the stock market (as in the Czech Republic), business. And fewer new businesses meant weaker market com-
they will often be worse owners than the managers that they re- petition, which can create pressure on firms to restructure wholly
place. Indeed, bad owners will tend to drive out good ones. Acon- apart from profit motives.
trolling stake is worth more to a dishonest owner who will extract
all of a firm's value than to an honest owner who will share the Third, too-rapid privatization of large firms can comprornise fu-
firm's value with minority shareholders. ture reform efforts. Inside dealing would occur to some degree
even if large enterprises were not privatized. but the reduced
To prevent this outcome, a decent legal and enforcement infra- state control that accompanies privatization can make inside deal-
structure capacity must precede or at least accompany ing easier. In a vicious circle, dirty privatization also reinforces
privatization of large firms. If privatization comes first, massive corruption and organized crime, as the new owners (some al-
theft is likely to occur before the infrastructure to control it can ready with Mafia ties) turn their new wealth to the task ol bribing
develop. Moreover, as a practical matter, important parts of this judges and government officials. Corruption and organized crime
infrastructure can be built only on a base of existing private firms. then reinforce a culture in which inside dealing is the norm. Cor-
For example, to develop skill in prosecuting fraud and self- rupt officials and company insiders then join forces to rDsist fu-
dealing, regulators need some fraud and self-dealing to prac- ture reforms, while the public comes to see privatization land. by
tice on. Thus privatization must to some extent be staged, lest inference, other market reforms) as connected with inside deal-
the crooks simply outrun the regulators. ing, corruption, and the growth of organized crime.
T TR.AsmTION, December 1999 (C 1999 The World Bankl/The William Daviison Ins .tute
Our concerns here are with privatization of large enterprises, not cial statements showed a revenue of $8.60 per barrel of oil-about
with the other elements of the "shock therapy" prescription dis- $4 per barrel less than it should have been. One surmises that most
pensed by Western advisors. There is much to be said, in the of the missing revenue ended up in offshore bank accounts con-
transition to a market economy, for the government rapidly sell- trolled by the controlling investor and accomplices. This one power-
ing or giving away small shops and businesses to the people ful director skimmed over 30 cents per dollar of revenue, while stiffing
who work there, and apartments and land to the people who live workers on wages, defaulting on tax payments by claiming that the
there. These steps do not entail the separation of ownership and oil company could not afford them, destroying the value of minority
control that makes self-dealing attractive for those who control shares in both the oil company and its majority-owned production
large enterprises. But the Russian and Czech experience leads subsidiaries, and not reinvesting in the company's oil fields, which
us to believe that a concerted effort to develop the infrastructure badly needed new investment.
needed to control inside dealing is central to successful
privatization of large firms-as important, and in the early stages, It is doubtful that running the oil company honestly could have earned
perhaps more important than privatization itself. the bank director a fraction of what he earned by skimming rev-
enue, let alone offshore and tax-free. He made a rational, privately
To be sure, Russia's problems could have arisen without value-maximizing choice. Even if running the oil company hon-
privatization. Ukraine offers a sobering example: it has not priva- estly was the best long-run strategy, the bank director might have
tized large firms, is as corrupt as Russia, and has done even preferred a quickly skimmed bird in the hand to two long-run birds
worse economically. But the Ukrainian example only tells us that in the bush. Besides, skimming was a business that the director
doing nothing is not a viable strategy for the transition from Marx knew and was good at, while running an oil company was a tough
to markets either. A piece of the overall puzzle that seem impor- business that the director did not know and might fail in.
tant to us: The largest Russian companies were privatized in
massively corrupt fashion, and ended up controlled by none-too- This example illustrates a general point: Privatization is not
clean entrepreneurs, soon dubbed "kleptocrats" by the Russian enough. It matters who the owners are. If it is not politically fea-
press-a handful of well-connected men who made their first sible to import foreign owners, who are more likely to run priva-
millions-and sometimes billions-through sweetheart deals with tized businesses honestly (though hardly certain, as the Czechs
or outright theft from the government, and then leveraged that learned), and to reinvest if profit opportunities exist, the second-
initial wealth by buying major companies from the government best choice for large-firm privatization may be for the govern-
for astonishingly low prices. The "reformers" who promoted ment to begin with case-by-case privatization of selected firms
privatization regretted the corrupt sales of major companies, but with strong profits and reputations for honest management, watch
claimed that any private owner was better than continued state these firms carefully once they are privatized, and work hard to
ownership. Even if the new owners got their ownership in regret- develop the legal and institutional infrastructure needed to limit
table ways, they would thereafter have incentives to increase com- insiders' ability to self-deal.
pany value. The extent to which the reformers believed this story
themselves, or had been given financial inducements to put a Even without immediate privatization, the promise of running a
good spin on a dirty process, remains unknown. But many for- to-be-privatized company (with privatization conditioned on fu-
eign advisors bought this story. The "Washington consensus" ture performance), plus the need to compete in a world market,
supported dirty privatization as better than no privatization, and can motivate its managers to undertake some restructuring. If
supported Russia's privatization czar, Anatoli Chubais, as he the company generates cash, the governmentwill have a better
pursued privatization by any available means. chance of retaining enough revenues to maintain basic services.
The government's ability to detect and control theft will be higher
Left unnoticed was that the new owners had two ways to make if the enterprise is still state-owned. And the enterprise's long-
money-increase the company's value, or steal what value already run sale price will be far higher if it is sold in a stronger legal
existed. The first was difficult, perhaps beyond their ability, and environment, in a fairer auction, and perhaps with more foreign
uncertain in outcome. The second was easy, they were expert at participation than was politically acceptable in the near term. Ironi-
it, and it was sure to produce a handsome profit that could be cally, Russia and otherformerSoviet Union countries had such a
tucked away overseas, beyond the reach of a future Russian gov- "staged privatization" program in place in the early 1 990s, through
ernment. Most of the kleptocrats chose the second, easy approach. a program called "enterprise leasing." The privatizers killed en-
terprise leasing because they thought it was not fast enough and
As an example, a major Russian oil holding company was ac- gave too much power to enterprise managers.
quired in 1995 by a major Russian bank (itself controlled by a
powerful director) as part of the corrupt "loans-for-shares" Proponents of fast privatization of large firms may respond that
privatization process. For 1996 the oil company's published finan- there is no assurance that the infrastructure to control self-dealing
C 1999 The World Bank/The William Davidson Institute TPANSITION, December 1999 A
will develop on any relevant timeframe. This is indeed a risk. But Hungary, Latvia, Poland, and the Czech Republic (which, in hind-
the right response may be staged privatization plus working hard sight, may have succeeded despite, rather than because of, rapid
to improve the business climate and develop the infrastructure privatization of its major firms). Poland offers a nice contrast to
to control self-dealing, rather than privatizing large firms anyway Russia. It was slow to privatize either major businesses or the
and hoping that the outcome will somehow be acceptable. banks that were needed to finance new investment. It succeeded
economically nonetheless because it quickly privatizecl small
Several countries on the fringes of the former Soviet Union cre- businesses and land, and it created a climate in which newv busi-
ated a reasonably friendly climate for new businesses, and nesses could thrive and employ the workers that large enterprises
achieved corresponding economic success-including Estonia, needed to shed.
Recent working papers of the William Davidson Institute: www.wdi.bus.umich.edu
Levinsohn, James, Steven Berry, and Bartel,Ann P., and Ann E. Harrison. Own- Experience to Forecasting Education
Jed Friedman. Impacts of the Indone- ership Versus Environment: Why Are and Training in Transition Economies.
sian Economic Crisis: Price Changes Public Sector Firms Inefficient? No. No. 265.
and the Poor. No. 249, September 257.
1999. Boot, Arnoud W.A., and Jonatian R.
Puhani, Patrick A. Public Training and Mecey. Objectivity, Proximity, and
Turner, MatthewA, Loren Brandt, and Scott Oufflows from Unemployment. No. 258. Adaptability in Corporate Governance.
Rozelle. Property Rights Formation and No. 266.
the Organization of Exchange and Pro- Dowell, Glen, Stuart Hart, and Bernard
duction in Rural China . No. 250, Sep- Yeung. Do Corporate Global Environ- Filer, Randall K., Jan Hanousek, and
tember 1999. mental Standards in Emerging Mar- Nauro F. Campos . Do Stock A1arkets
kets Create or Destroy Market Value? Promote Economic Growth? No. 267.
Jan-Benedict, Jan, E.M. Steenkamp, and No. 259.
Steven M. Burgess. Consumer Behav- Linz, Susan. Are Russians Really Ready
ior Research in Emerging Consumer Jefferson, Gary H. Missing Market in for Capitalism? No. 268.
Markets: The Case of the Optimum Labor Quality: The Role of Quality
Stimuiation Level in South Africa. No. Markets in Transition. No. 260. Black, Bernard, Reinier Kraakman, and
251, September 1999. Anna Tarassova. Russian Privatization
Che, Jiahua. Decentralized Financing, and Corporate Governance, What
Fey, Carl F., and Daniel R. Denison. Or- Centralized Financing and the Dual Went Wrong? No. 269.
ganizational Culture and Effective- Track System: Toward a New Theory
ness: The Case of Foreign Firms in of Soft Budget Constraints. No. 261. Park, Albert, and Kaja Sehrt Tests for
Russia. No. 252, September 1999. Efficient Financial Intermediation with
Roland, Gerard, and Thierry Verdier . Law Application to China. No. 270.
Sachs, Jeffrey D., and Wing Thye Woo. Enforcement and Transition. No. 262.
The Asian Financial Crisis: What Hap- Brana, Sophie, and Mathilde Maurel.
pened, and What is to be Done? No. Berglof, Erik, and Ernst-Ludwig von Barter in Russia: Liquidity Slrlortage
253, September 1999. Thadden. The Changing Corporate Versus Lack of Restructuring. No.
Governance Paradigm: Implications 271.
Whitman, Marina. FDI in Emerging Mar- for Transition and Developing Coun-
kets: A Home-Country View. No. 254, tries. No. 263. Munich, Daniel, Jan Svejnar, and Katherine
October 1999. Terrell. Returns to Human Capital under
Huang, Yasheng. The Institutional Foun- the Communist Wage Grid and during
Bonin, John P., and Mark E. Schaffer. Re- dation of Foreign-Invested Enter- the Transition to a Market Economy. No.
visiting Hungary's Bankruptcy Epi- prises (FIEs) in China. No. 264. 272.
sode. No. 255.
Campos, Nauro F., Gerard Hughes, Sorm,Vit, and KatherineTerrell. Sectoral
Berkowitz, Daniel, and David N. DeJong. Stepan Jurajda, and Daniel Munich. When Restructuring and Labor Mobility: A
Accounting for Growth in Post-Soviet the Future Is not What It Used to Be: Comparative Look at the Czech Re-
Russia. No. 256. Lessons from the Western European public. No. 273.
M TRAN\STICN, December 1999 (D 1999 The World Bank/The William Davidson Institute
World Bank/IMF Agenda
Wolfensohn Visits Russia 0 Three new joint World Bank-lFC indus- ps294.htm) Summers urged the IMF to
try groups will be set up, for industries recognize the dominance and preferabil-
World Bank President James Wolfensohn where there is a strong interface between ity of private sector capital flows over
will visit Moscow at the beginning of Feb- public policy and private sector transac- government lending. Nearly $1.3 trillion
ruary, at the invitation of Prime Minister and tions. The newly appointed director of the in private capital flowed to emerging
acting President Vladimir Putin, the Itar- telecommunications and informatics markets in the 1990s, compared with
Tass news agency reported, quoting groupisMohsenKhalil,thatoftheoil,gas, about $170 billion in the 1980s. Twenty
Deputy Prime Minister Viktor Khristenko. and petrochemicals group is Rashad emerging market economies issued sov-
In another development, the World Bank Kaldany, and the director of the mining ereign Eurobonds in 1998, compared
on December 22, 1999, approved a $30 group is James Bond. with one in 1990.
million loan to support the fiscal perfor-
mance of local governments in Russia. 0 The Private Sector Advisory Services "Going forward the IMF needs to be more
Since Russia joined the Bank in 1992, will coordinate the principal advisory ser- limited in its financial involvement with
commitments to the country have totaled vices focused on the private sector in both countries, lending selectively and on short
$11 billion for 44 operations. the World Bank and the IFC. The director maturities," he said. "The IMF must be a
is Michael Klein. The advisory services in- last, and not first, resort." The IMF must do
World Bank-IFC Reorganize for Bet- cludesupportforprivatization, infrastruc- more to provide the private sectorwith in-
ter Coordination ture, corporate restructuring, corporate formation from emerging-market econo-
governance, and advice on policies and mies: promoting standard accounting
The World Bank Group will restructure to regulations to encourage foreign invest- methods and encouraging data reporting
better align and expand its work related to ment. on reserves, external debt, and indicators
the private sector, Peter Woicke, execu- of financial soundness.
tive vice president of the International Fi- Larry Summers Urges IMF to Restruc-
nance Corporation (IFC) and managing ture The IMF should rely on three core instru-
director of the World Bank, announced on ments for its short-term lending: a new
December 21. The announcement fol- The IMF should limit itself to short-term contingent credit line to help countries
lowed Board approval of the reforms, lending for financial emergencies and the ward off financial contagion; short-term
which will take effect January 1, 2000. World Bank should take more of a lead in stand-by arrangements for countries with
long-term development and poverty reduc- nonsystemic balance of payments prob-
Thereorganizationwilltightenthelinkbe- tion, remarked U.S. Treasury Secretary lems; and the Supplementary Reserve
tween the World Bank Group's public sec- Lawrence Summers on December 14 in Facility for countries suffering systemic
tor work and its private sector transactions a London speech timed to the Berlin capital account crises, for very short-term
in the developing world, which are made meetings of the Group of 20. The new G- loans at prices to encourage rapid repay-
through the IFC. The World Bank helps 20 includes the G-7 industrial countries- ment.
governments to formulate policy frame- Canada, France, Germany, Italy, Japan,
works that encourage a favorable busi- the United Kingdom, and the United The IMF should deepen the commitment
ness environment. The IFC, the private States-plusArgentina, Australia, Brazil, to transparency that is built into its own op-
sector arm of the Group, provides advice China, India, Indonesia, the Republic of erations, making its financial workings
and makes loans and equity investments Korea, Mexico, Russia, Saudi Arabia, clearer and more comprehensible to the
in companies. South Africa, and Turkey. The represen- public. "There is no reason why there
tatives of the European Union, including should not be a regular publication of the
* A new combined Small and Medium En- the European Central Bank, bring the tally IMF's operational budget." The IMF should
terprise Unit, under Director Ira Lieberman, to 20. The G-20 finance ministers and become more attuned, not just to markets
has a mandate to coordinate Bank Group central bankers are to meet again next but to the broad range of interests and in-
activities in support of small and medium- autumn in Canada. stitutions with a stake in the IMF's work,
size businesses. It includes dissemination maintaining a vigorous ongoing dialogue
of knowledge thatwill encourage creation In his remarks ("The Right Kind of IMF with civil society groups and others, Sum-
of local financial institutions for financing for a Stable Global Financial System," mers pointed out. He remarked, "It will be
of small and medium-size enterprises. http://www.ustreas.gov/press/releases/ important for its shareholders to consider
0 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999 m
not just the role of the IMF, but the World Bank. Creating a forum of researchers, Donors Pledge $2.8 Billion to Vietnam
Bank and other development institutions decisionmakers, and donors, the network
and also how these institutions relate to will link policy thinktanks in developing and Under the chairmanship of Andrew Steer,
each other." transition economies with their counter- the World Bank's director for Vietnam, for-
parts in the industrial world. The global eign donors at their annual meeting in mid-
World Bank's New Country Director network will help raise the quality of policy December pledged a total of $2.8 billion in
Hails Ukraine's New Government research and increase its impact on policy fresh aid to Vietnam, but said $700 million
design and implementation. of that amount was linked to accelerated
The World Bank weicomed Ukraine's new reform of the country's economy. Major do-
government, expressing hope for a fresh IMF: Capital Flow Controls Can Be nors include theAsian Development Bank,
start on reforms and promising a new strat- Useful-Sometimes the IMF, the United Nations Development
egy for lending to the former Soviet repub- Programme, the World Bank, and Austra-
lic. The World Bank's newly appointed Capital controls have helped some countries lia, France, Japan, and Sweden. Donors
director for Ukraine and Belarus, Luca insulatethemselves-atleasttemporarily- commended Vietnam for reduciig pov-
Barbone, said the Bank will work out a from financial crises. Rapid capital mar- erty in the 1 990s-a World Bank report
three-year plan for Ukraine. Barbone ket liberalization, when badly handled, said that the proportion of Vietnamese
praised the first reform steps of the newly can increase vulnerability to financial cri- living in poverty dropped from 58 percent
appointed government. "Everyone consid- ses. These are some remarkable ele- in 1993 to 37 percent in 1998 thanks to
ers that the present governmental team is ments in a new IMF report published on strong economic growth and agricultural
the best since Ukraine's independence. January 11. The report-Country Expe- reforms launched in 1986. But they ex-
The only problem for Ukraine is that it lost riences with the Use and Liberaliza- pressed concern about the slow pace of
its masterful central banker," said Barbone, tion of Capital Controls, by Akira economic reform.
commenting on the fact that former Na- Ariyoshi, Karl Habermeier, Bernard
tional Bankchief ViktorYushchenko, a re- Laurens, Inci Otker-Robe, Jorge Ivan Participants urged Vietnam to open its
former, was promoted to prime minister in Canales-Kriljenko, and Andrei Kirilenko- economy, embrace competition, and im-
the new government. warns, however, that none of the coun- prove the business climate. Deputy Prime
tries applying controls succeeded in MinisterNguyen Manh Cam told doiorsthat
In January IMF Managing Director Michel maintaining separation between domes- Vietnam was committed to speeding eco-
Camdessus is expected in Kiev to con- tic and foreign interest rates and reduc- nomic reforms and advancing its integra-
sult about releasing frozen loans to ing the appreciation of real exchange tion into the global economy. Cam, who is
Ukraine. The IMF has delivered some rates. Such controls may lose their ef- also foreign minister, said the doi rnoi pro-
$965 million from its $2.6 billion loan fectiveness as markets exploit potential cess of economic liberalization launiched in
package to Ukraine since 1998 but froze loopholes and circumvent controls. the late 1980s would gather pace in the next
the aid program in September. Ukrainian millennium. In 1998 donors pledged $2.7
officials say that without IMF and related Stiglitz Says Vietnam Needs Liberal billion in aid to Vietnam. Of that, $500 mil-
World Bank help, the country will have dif- Trade Policy for Growth lion was conditional on accelerated reform,
ficulties meeting its 2000 foreign debt ob- although none of this money has been dis-
ligations of more than $3 billion. Liberal international trade policies are es- bursed.
sential for growth in relatively small devel-
World Bank Launches Global Net- oping countries such as Vietnam, said the Andrew Steer noted that attempts by the
work: http:/Hwww.gdnet.org/ World Bank's outgoing Chief Economist government to improve the investment cli-
Joe Stiglitz in a Hanoi conference of local mate for the private sector, especially for-
The Global Development Network (GDN), and foreign business executives. Stiglitz eign businesses, were not yet sufficient to
a new worldwide institution devoted to said the financial damage suffered by reverse the trends of the past 30 months,
enhancing democratic governance at lo- Vietnam's neighbors duringAsia'sfinancial which saw investment levels plunge
cal, national, regional, and international crisis was the result of lax short-term capi- from 29 percent of GDP to 19 percent-
levels, was launched in Bonn, Germany, talflowcontrols, notopen trade policies. The although a number of recent measures,
during a conference in December. The transition from a socialist to a market such as the new Enterprise Law, were im-
launch was attended by more than 500 economy "poses challenges as well as op- portant positive steps towards creating a
acclaimed thinkers and policy leaders. portunities" for Vietnam's leaders, Stiglitz level paying field between private and
More than two dozen donor organizations said. Hanoi "must learn to manage the risks state enterprises (see page 37). In a
endorsed the GDN, initiated by the World associated with a more open economy." major report the World Bank said that if
E TRA\SMION, December 1999 © 1999 The World Bank/The William Davidson Institute
Vietnam was slow to reform-to liberal- liable local administration, making pro- you need fairly broad support, and that in-
ize the trade regime, boost the private vision for essential public services, sta- cludes not justthe large industrial custom-
sector, and restructure state-owned en- bilizing macroeconomic conditions, and ers, but also households."
terprises and the country's banks- setting the stage for private sectorled
growth could slip from 4 percent in 1999 recovery and long-term growth are the Selling off state utilities is a politically
to 3.5 percent in 2000 and to 3 percent priorities. In the next four to five years an- charged issue because customers-
thereafter, rates not seen since the late other $2.3 billion in donor assistance will accustomed to receiving power at state-
1 980s. Hanoi has targeted GDP growth be necessary. At the First Donors' Con- subsidized rates-are worried that private
of 5.5 to 6 percent in 2000. In the spirit ference on July 28, 1999, $2.1 billion had companies will raise prices and cut them
of the Comprehensive Development already been pledged. off. Privatization was inevitable because
Framework, donors agreed to assist the of the need to upgrade equipment and in-
authorities to draft policy strategies in For more information on the economic troduce more efficient and competitive dis-
fields such as education, health, forestry, reconstruction and development in tribution as countries in Central and
infrastructure, environment, governance Southeast Europe, visit the joint World Eastern Europe and Central Asia become
and enterprise reform. Bank-European Commission website at more closely allied with the European
http://vvww.seerecon.orgl Union. But regulators must adopt schemes
Donors Offer Another $1 Billion for to reassure poor users that they will not be
Kosovo Poor Need "Lifeline" Rates as Transi- left in the dark while not discouraging pay-
tion Economies Privatize Energy ment by those who can afford it. A World
During a November 17 meeting in Brus- Bank study has shown that schemes that
sels, representatives of 47 countries and Transition economies must develop plans guaranteed no disconnection of service
34 international organizations pledged tomaintainenergyserviceforpoorcustom- caused distortion of prices and a huge
about $1 billion of new financial assis- ers as state utilities are sold off, World Bank burden on the utility companies. By con-
tance in support of Kosovo's medium- lead energyspecialistforEuropeandCen- trast, Lovei pointed out, special electricity
term reconstruction program. Participants tral Asia Laszlo Lovei said at a conference tariff schedules that provide limited
in the meeting-cochaired by European on energy regulation in transition econo- amounts of power at low prices and
Commission Director Fabrizio Barbaso mies. "In most of these countries the bulk of greater amounts at higher cost-so-called
and World Bank Director Christiaan energyproductionanddistributionisstillin lifeline rates-seemed to have the best
Poortman-agreed that organizing a re- state hands. For privatization to succeed, cost-benefit results.
Feeling the presence of the new, classified anti-corruption squal.
From the Moscow Times.
© 1999 The World Bank/The William Davidson Institute T:RAV\NnTION, December 1999 *
Milestones of Transition continued
Continued from page 14 annual extemal financing need. Since 1996 Russia
consumption has fallen by one-quarter and
Czech laws and the judicial system do not business is suffering from a depressed At present, deaths exceed births by
protect the interests of creditors and mi- domestic market. Foreign direct invest- about 700,000 annually. Some experts
nority shareholders and allow loss-making ment in the first nine months of 1999 was say Russia's population could drop from
companies to survive. "There has not been only $145 million. Political instability, legal today's 150 million to 80 million in 50 years.
a single sentence for banking criminality uuncertainties relating to the status of prop- "If demography is said to be destiny, the
a single Tssentenceyfor banking criminalit erty, problems with the banking system, destiny of Russia for the next 50 years or
so far," Tosovsky said.Y
bureaucratic obstacles, and slow efforts to more is appalling," says Murray Feshbach,
adopt international accounting standards a research professor at Georgetown
have deterred investors. University's School of Foreign Service in
Is Hungary Central Europe's fastest Washington. Feshbach sees a rapid
growing economy? The Hungarian CIS spread of drug-resistant tuberculosis, AIDS,
economy expanded by 4.4 percent (on and sexually transmitted disease in Russia.
an annual basis) in the third quarter of Moldova One study predicts that some 13 million
Russians will be infected by HIV by 2005.
1999, up from 3.6 percent growth In the
first half. Analysts feel that the full-year Economic indicators for 1999 are Alcohol- and smoking-related illness in Rus-
GDP growth could top 4 percent. This worse than those for 1998. Moldova's sia is also a problem. The World Bank is
new prime minister, Dumitru Barghis, an considering a $150 million loan for a pro-
improvement was driven by a strong ex-
port performance-up 13.2 percent on engineer by training, told Parliament that gram to deal with AIDS and tuberculosis,
the same period in 1998-while import economic indicators slipped in 1999. Pre- while the World Health Organization, other
growth slowed from 10.2 percent in the liminary data show a 4 percent drop in UN organizations, the Soros Foundations,
second quarter to 9 percent. SG Securi- GDP and a budget deficit of more than 5 and the United States and other nations are
ties Limited, a London-based financial percent. Inflation is expected to be around trying to help in modestways.
advisory firm, reported that Hungary may 40 percent. Stressing that these are "the
advisoryth firm,areposteds tat Hingaomay iworst indicators over the last years," the What makes life harder? The FRussian
become the fastest growing economy In
Central and Eastern Europe in the next prime minister warned that the 2000 bud- National Public Opinion Center (VFSIOM)
two years, overtaking Poland. Its overall get, to be presented in February, will allow conducted a survey in the last twc weeks
economic growth is expected to accel- for no other expenditure than the servicing of December 1999. The 1,600 respon-
erate to 4.5 to 5 percent in 2000, after of the country's external and internal debt. dents, representing an adult urban popu-
an expected 4 percent GDP growth in
1999, and should remain at 5 percent in Quality of life issues cited by urban survey respondents in Russia,
2001. 1994, 1998, and 1999 (percentage of respondents)
Issue 1994 1998 1999
Romania
Low income 68 75 71
Priorities for 2000. Romania's priorities Health problems, poor availability
for 2000 are to meet an inflation target of of health care 27 31 29
25 to 30 percent, achieve GDP growth of Frustration, gloomy prospects 22 27 29
at least 1.3 percent, and reduce the 38 Everyday life problems 21 25 24
percent corporate tax to 25 percent. The Fear of losing job 24 19 22
government's program sees its main chal- Impossibility of ensuring good education
lenge as fighting unemployment, currently for children 9 12 19
around 11 percent. The current account Bad housing 15 13 14
deficit for 1999 has been halved to around Lack of spare time 11 9 10
$1.2 billion, or4 percent of estimated GDP. Lack of accord in the family 4 4 4
The country's international liquidity posi- A family member's drinking 6 4 3
tion, however, remains fragile: current re- Don't know 6 2 4
serves represent about one-third of the Source: VTSIOM.
0 TRANSITION, December 1999 C) 1999 The World Bank/The William Davidson Institute
lation, were allowed to list several issues
that represented for them the largest prob- °n erence D ary
lems of quality of life in Russia (see table).
Forthcoming Conferences Vice Presidency, Room MC4-385, World
The survey results for 1999 suggest that Bank, 1818 H Street, NW Washington, DC
no serious improvement has occurred in 2nd Kiel Workshop in Economics- 20433, tel.: 202-473-1062, fax: 202-522-
the lives of Russians over the past five Integration of Financial Markets in 0304, email: bpIeskovic@worldbankorg.
years. As in previous years, more than two- Europe
thirds of the population considered poor February 11-12, 2000, Kiel Institute of Twelfth Annual Bank Conference on De-
income to be the number-one problem. World Economics, Germany velopment Economics (ABCDE) 2000
Number two was health problems and poor April 18-20, 2000, Washington, DC
availability of medical services. Many low- Information: Claudia M. Buch, Stefan M.
income families cannot afford expensive Golder, Ralph P Heinrich, Kiel Institute The welcoming address will be given by
medication. The share of the population of World Economics, Duesternbrooker James D. Wolfensohn, president, World
experiencing frustration, and seeing no Weg 120, 24105 Kiel, Germany, tel.: 49 Bank, and keynote addresses by Joseph
prospects worth living for, has grown 431 88141, fax.: 49 431 85853, email: E. Stiglitz, World Bank; Jeffrey Sachs,
steadily, reaching 29 percent at the end of kiel-workshop@ifw.uni-kiel.de Harvard University; and Janos Kornai,
1999. Harvard University/Collegium Budapest.
The Institutional Foundations of a Mar- Sessions will include "New Development
Vietnam ket Economy, WDR 2001-2002 Thinking" (Paul Collier, Ravi Kanbur and
February 23-25, 2000, Villa Borsig, Berlin Nora Lustig, Jan W. Gunning, and Karla
The Vietnamese government enacts a Hoff), "Crises and Recovery" (William
new Enterprise Law. The new Enterprise Sponsors: Development Policy Forum/ Easterly, Roumeen Islam, and Joseph E.
Law in Vietnam facilitates more private DSE, World Bank, and German Ministry Stiglitz; Ricardo Caballero and Mohamad
business and ensures equal treatmentfor for Economic Cooperation and Develop- Hammour; Eisuke Sakakibara; and
state and privately owned companies. It will ment (BMZ) Guillermo Perry), "Corporate Governance
also loosen collateral requirements on and Restructuring" (Alexander Dyck, and
bank loans, which will help small compa- The welcoming address will be given by Gerard Roland), and "Social Security,
nies borrow money. Heinz Buehler, directorgeneral of the DSE, Public and Private Savings" (Peter
and opening addresses by Roumeen Islam, Orszag and Michael Orszag, and Orazio
Le Kha Phieu, general secretary of World Bank, and Gudrun Kochendoerfer- Attanasio and Miguel Szekely). The first
Vietnam's Communist Party, praised a Lucius, DPF/DSE. Sessions will include two afternoons will each have four paral-
gathering of young entrepreneurs from the "Defining Institutions and Moving toward lel workshop sessions. Participation by
state and private sectors for their efforts Institutional Change," Masaoki Aoki, non-Bank and non-IMF staff by invitation
in promoting business in Vietnam. "All en- Pranab Bardhan, and Kenneth Sokoloff; only.
terprises are equal in terms of rights and "Competition Policy and Regulation," Jean
duties underthe Vietnamese law,"he said. Jacques Laffont; "Governance and Politi- Information: Boris Pleskovic, Research
Private businesses often complain that cal Institutions," Robert Bates and Robert Advisory Staff, Development Economics
they aren't given the same access to capi- Wade; "Financial Institutions," Thomas F. Vice Presidency, Room MC4-385, World
tal as state-owned firms, and that they are Hellmann and Colin Mayer; "Enforcement Bank, 1818 H Street, NW Washington, DC
subject to complex registration, hiring, and of Contracts: The Judicial System," Avner 20433, tel.: 202-473-1062, fax: 202-522-
other requirements. Business executives Greif and Katharina Pistor; "Corporate Gov- 0304, email: bpleskovic@worldbankorg.
called for "a more favorable business en- ernance," Erik Berglof, Alexander Dyck,
vironment" for private businesses, the Viet- Simon Johnson, and Luigi Zingales; and International Experience: Developing
nam News Agency reported. Formal "Social Structure and Social Capital," the Civil Society in Russia
private businesses-not including family- Francois Bourguignon and Jean Philippe June 23-24, 2000, Omsk, Russia
run businesses-now employ around 1 Platteau. The closing remarks will be made
million of Vietnam's 40 million working by Roumeen Islam, World Bank. Participa- Organizers: Omsk State Pedagogical Uni-
people. tion is by invitation only. versity, in cooperation with the Russian-
American Academic Exchanges Alumni
We appreciate the contributions from Information: Boris Pleskovic, Research Association "Professionals for Coopera-
Radio Free Europe/Radio Liberty, Advisory Staff Development Economics tion."
( 1999 The World BankJThe William Davidson Institute TRANSITION, December 1999 FM
Topics: Protecting human rights: Role of the
society and the state; economic factor in ew g ap
developing the civil society; interaction of The Macroeconomics and Growth Group regrets that it is unable to provide the pub-
mass media and the authorities; internation- lications listed.
alization ofuniversities and improvement of
the educational process; development of
international cooperation in the conditions World Bank Publications percent, underpinned by high inviestment
of civil society; training professionals for for- growth but boosted by strong inflovvs of for-
eign countries; civic education programs; To receive ordering and price information eign direct investment. The economic situ-
and teaching civic education. for World Bank publications, contact the ation in both Romania and Ukraine is
World Bank, P.O. Box 7247-8619, Phila- tenuous, reflecting high debt service pay-
Information: International Affairs Office, delphia, PA 19170, United States, tel: 202- ments. Output in most Commonwealth of
email: common@omsk.edu, tel./fax.: +7 473-1155, fax: 202-676-0581, email: Independent States countries is projected
3812 243795. books@worldbank.org, Internet: http:// to recover more gradually, owing to ex-
www.world bank.org or http.//vwww. world pected slow growth in Russia. The long-term
2000 International Conference- bank. org/html/dec/Publications/Work growth forecast for the ECA region has
Emerging Economies papers/tranecon.htm, or visit the World been reduced from 5 percent a year to 4
July 10-12, 2000, Prague, Czech Republic Bank bookstore in the United States, at percent over the period from 2002 to 2008.
701 18th Street, NW, Washington, DC, or
Organizer: Academy of Business and Ad- France, at 66 avenue d'lena, 75116 Paris. Susan Stout and Timothy A Johnston, In-
ministrative Sciences. vesting in Health: Development Effec-
Global Economic Prospects and the tiveness in the Health, Nutrition, and
Information: Dr. A. R. Korukonda, Pro- Developing Countries 2000, December Population Sectors, Operations Evalu-
gram Chair, 2000 ABAS Intemational 1999, http:/lwww.worldbank.org/pros- ation Studies, 1999,92 pp.
Conference in Prague, PO. Box 88, pects/.
Room 226 Murphy Professional Build- World Bank lending for health, nutrition,
ing, St. Bonaventure, University St. In 1999 developing countries were ex- and population activities is accelerating.
Bonaventure, New York 14778, tel.: 716- pected to grow by 2.7 percent, accelerat- The Bank is now the major source of ex-
375-2076; 716-375-2089; or 716-372- ing to 4.2 percent growth in 2000. For ternal finance for the sector in the devel-
8094, fax.: 716-373-2270 or 716-375- developing countries, excluding those in oping world. Its emphasis has evolved
7859. transition, growth is significantly less than from expanding service delivery capacity
the rate of the precrisis 1 990s. Despite a to encouraging systemic reform.
Sixth ICCEES World Congress Secre- faster than expected global recovery, the
tariat, Finnish Institute for Russian lingering effects of the global financial cri- Frank Sader, Attracting Foreign Direct
and East European Studies sis continue to depress output and ham- Investment into Infrastructure--Why Is
July 29 -August 3, 2000, Tampere, Finland per efforts to reduce poverty worldwide, It So Difficult? FIAS Occasional Papers
this report concludes. No. 12, 1999, 192 pp.
Information: Annankatu 44, Helsinki
00100 Finland. tel.: 358-9-2285 4434; fax: The appendix to the report shows regional During the early 1990s the Foreign Invest-
358-9-2285 4431; email: iccees@rusin.fi; prospects for the transition economies of ment Advisory Service (FIAS), a joint fa-
Intemet: http://vwww.rusin.fi/iccees. Europe and Central Asia (ECA). Acceler- cility of the World Bank and the IFC, found
ating world trade and stabilizing commod- that governments and foreign investors
Sixth EACES Conference: Globaliza- ity prices should contribute to a stronger alike were concerned about and frustrated
tion and European Integration recovery in the region in 2000, and real with difficulties in successfully implement-
September 7-9, 2000, University of GDP is expected to increase by 2.5 per- ing private infrastructure projects. So FIAS
Barcelona, Spain cent. Economic output decreased by 0.2 has been advising many governments in
percent in 1998 for the region, reflecting the developing world on the best way to
Information: Department Politica Econo- Russia's liquidity crisis and subsequent establish a policy framework attractive to
mica, Universidad. Avda. Diagonal, 640, regional contagion. For 1999 the growth foreign investors. This study synthesizes
08034 Barcelona, Spain, tel.: 3493-402- estimate is 0.3 percent. In 2000 average these experiences and derives lessons for
1949, fax: 3493-402-4573, email: gate growth for the Central and Eastern Euro- facilitating and encouraging foreign direct
2000@eco.ub.es. pean (CEE) countries is forecasted at 3.2 investment in infrastructure.
* TRANSITION, December 1999 (C 1999 The World Bank/The William Davidson Institute
Verdon S. Staines, A Health Sector Strat- both positive and normative issues in the ditions, health care, and the infrastructure.
egy for the Europe and Central Asia economics of health care and health insur- The EU accession process dominates the
Region, September 1999, 96 pp. ance. Drawing on agency theory, welfare sector analyses.
economics, econometrics, and develop-
The health systems inherited by the transi- ment economics, this book is a reference Technical Papers
tion economies of ECA are changing in and textbook for health policy profession-
response to fundamental and unprec- als, policymakers, researchers, and stu- Privatization of the Power and Natu-
edented challenges. The massive social dents of economics and international ral Gas Industries in Hungary and
and economictransformation unleashed by development. Kazakhstan, TP No. 451, 1999, 152 pp.
the Soviet system's collapse was highly dis-
ruptive and placed great pressure on the Country Studies Hungary and Kazakhstan have privatized
health sectors. Although the desired shape a large portion of their electric power and
of future health systems in many ECA coun- Moldova-Poverty Assessment, No- natural gas industries-but following dif-
tries is discernible, the process for getting vember 1999, 85 pp. ferent strategies. In contrast, the otherfor-
there must be invented along the way. This merly socialist countries in the CEE have
volume summarizes the World Bank's ex- Hungary: On the Road to the Euro- privatized almost none of these industries.
perience in this arena and the lessons it pean Union, November 1999, 249 pp. Hungary and Kazakhstan began their re-
suggests. It outlines both an external strat- forms from different starting points. The
egy that the Bank's ECA health staff could Hungary is one of the top economic per- Hungarian power and gas sectors had a
use in assisting countries to restructure their formers among CEE countries in transition, long history of being relatively well man-
health systems and an internal strategy that and one of the strongest candidates for aged. In contrast, Kazakhstan inherited
the staff could use to organize their activi- accession to the European Union. Its finan- pieces of the old systems that were de-
ties to achieve this result. cial sector is among the most robust and signed to serve the needs of the Soviet
efficient in Central Europe, with rapidly Union and had to develop new organiza-
Martin Ravallion, Poverty Comparisons: emerging capital markets. This study, which tions to manage the system.
A Guide to Concepts and Methods, analyzes economic developments in Hun-
Russian language edition, Living Stan- garyin recentyears, points outthatthe en- Lev Freinkman, Daniel Treisman, and
dards Measurement Study No. 88R, 1999, terprise sector is efficient and now mostly Stepan Titov, Subnational Budgeting in
144 pp. private, with substantially increasing labor Russia: Preempting a Potential Crisis,
productivityand expanding commercial ties TP No.452, November 1999,141 pp.
Timothy Heleniak, Migration from the with the EU and other international markets.
Russian North during the Transition Reforms of Russia's budgetary system at
Period, Social Protection Discussion Czech Republic: Toward EU Acces- the subnational level are vital to preserv-
Paper No. 9925, September 1999, 61 pp. sion, 1999, 344 pp. ing macroeconomic stability, improving the
efficiency and accountability of govern-
To order: SP Advisory Service, tel: 202- Until 1996 the Czech Republic was per- ment, and enhancing incentives for local
458-5267, fax: 202-614-0471, email: ceived as the most successful transition and regional governments to support eco-
socialprotection@worldbank.org, Internet: economy in the CEE region. However, the nomic growth.
http://vvww.wordbankorg/sp. Czech miracle came to a halt in May 1997.
The country's future economic develop- Julia Bucknall, Poland: Complying with
William Jack, Principles of Health Eco- ment and successful integration into the EU Environmental Legislation, TP No.
nomics for Developing Countries, EU depends on whether it can reach sus- 454, November 1999, 65 pp.
World Bank Institute Development Studies tainable growth again. This report ana-
Series, January 2000, 305 pp. lyzes economic developments in the The EU Commission acknowledges the
Czech Republic since 1997. The report severity of the environmental problems in
This book explains the allocation of health is composed of two volumes: a summary Poland, especially in areas of wastewater
care resources, broadly defined, and is report and the main report. The latter as- treatment and air pollution. Compliance
aimed at aiding the design and analysis sesses economic performance, fiscal with the EU standard in areas such as
of policies that affect health care out- problems, intergovernment and local fi- drinking waterand waste managementwill
comes. It provides a modern treatment of nance, foreign trade, finance and banking, require high levels of public and private
health economics for developing, transi- enterprise reform, agriculture, environ- investment and considerable administra-
tion, and industrial countries. It addresses ment, public administration, social con- tive effort.
C) 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999
Dale F. Gray, Assessment of Corporate market responsiveness of first-level voca- Maurice Schiff, Labor Market Integra-
Sector Value and Vulnerability: Links tional education, and especially to avoid tion in the Presence of Social Capital,
to Exchange Rate and Financial Cri- excessive and premature specialization. WPS 2222, November 1999, 26 pp.
ses, TP No. 455, November 1999, 53 pp.
Working Papers Social capital raises productivity and falls
Recent crises have demonstrated the im- with labor mobility. [The notion of "social
portance of improving our understanding of To order: Intemet: http:/vAvww.wotldbankorg/ capital" was first introduced by the soci-
the links between the corporate sector, the research/workingpapers ologist James Coleman in 198E. He de-
financial sector, and the macroeconomy in fined it as "the ability of people to work
a world of volatile capital flows. Assessing Wlodzimierz Okrasa, Who Avoids and together for common purposes in groups
thevulnerabilityofthe corporate sectorand Who Escapes from Poverty during the and organizations." It is argued that a
its links to financial and exchange rate cri- Transition? Evidence from Polish group with members who trust each other
sis is important for both improved surveil- Panel Data, 1993-96, WPS 2218, No- can accomplish more economic growth
lance and in the design of policies in crisis vember 1999, 52 pp., and The Dynam- than asimilargroupwithouttrust. Coleman
countries. ics of Poverty and the Effectiveness has suggested that social capital is a new
of Poland's Safety Net (1993-96), WPS production factor that must be added to
Mary Canning, Peter Moock, and Timothy 2221, November 1999. the conventional concepts of human and
Heleniak, Reforming Education in the physical capital.-The editor. Labor mar-
Regions of Russia, TP No. 457, Decem- There is a chronic, long-term poverty prob- ket integration generates a negative ex-
ber 1999, 112 pp. lem in Poland. Those from larger house- ternality: it results in "too much" mobility,
holds, farm households, and households too low a level of social capital, and an
Russia's education system, with broad dependent on social welfare are most at ambiguous effect on welfare. Trade liber-
access and high levels of scholarly risk. Okrasa uses four-year panel data alization is superior to labor market inte-
achievement, has long been a source of from Poland's household budgetsurveyto gration because it reduces mobility and the
strength. The Soviet system, however, was explore the distinction between transitory negative externality associated with it.
grossly overcentralized, inefficient, and and long-term poverty.
lacking in accountability. In the past decade To order: Lili Tabada, Room MC3-333, tel:
attempted rapid decentralization has not To order: Sheila Fallon,Room MC3-558, tel: 202-473-6896, fax: 202-522-1159, email:
been well designed: there has been no 202-473-8009, fax 202-522-1153, email: Itabada@worldbank.org. The author may
corresponding transfer of resources, and sfallon@woridbank.org. The authormay be be contacted at mschiff@worldbank.org.
levels of responsibility have remained un- contacted at wokrasa@woridbankorg.
clear. Unless these problems are corrected Michael Klein, Money, Politics, and a
soon, their harmful impact on the quality Emiko Fukase and Will Martin, The Effect Future for the International Financial
and equity of education could be serious. of the United States' Granting Most System, WPS 2226, November 1999,22
This report analyzes the nature of the cur- Favored Nation Status to Vietnam, pp.
rent problems and discusses policy op- WPS 2219, November 1999,26 pp., and
tions open to the Russian government in A Quantitative Evaluation of Vietnam's In developing the architecture fcr a finan-
its efforts to improve educational efficiency Accession to the ASEAN Free Trade cial system, the challenge is to combine
and preserve and even improve equitable Area, WPS 2220, November 1999,61 pp. deregulation and safety nets against sys-
access without sacrificing the traditions of temic failure with effective prudential regu-
academic excellence. The general tariff rates that the United lation and oversight. In the author's
States imposes on goods from Vietnam scenario the world moves toward a mon-
Among other proposals the authors offer, average 35 percent, compared with 4.9 etary system in which fixed exchange rate
efficiency could be increased by giving percentforthe mostfavored nation (MFN) systems, ordefacto currency cornpetition,
schools increased financial autonomy, us- rate. If the United States grants Vietnam limit the power of central banks. This lim-
ing a per capita financing formula, and MFN status, Vietnamese exports to the its options for discretionary and open-
beginning to rationalize the teaching force United States would more than double. ended liquidity support to help deal with
and improve its quality. A national system systemic financial crises. Mistrust in mon-
of student assessment might help to both To order: Lili Tabada,Room MC3-333, tel: etary authorities and the emergence of
raise quality and improve the equity of ac- 202-473-6896, fax:202-522-1159, email: private settlement systems lead to a re-
cess to highly selective institutions. Re- Itabada@worldbank org. The authors may turn of asset-backed money as the means
forms are required for improving the be contacted at efukase@worldbank.org. of payment.
TRANSITION, December 1999 C) 1999 The World Bank/The William Davidson Institute
To order: Mina Salehi, Room 19-240, tel: email: lbarbone@worldbankorg.Other tries (Bangladesh, China, and India) than
202-473-7157, fax: 202-522-2029, email: authors may be contacted at oldmonk87 in large, rich OECD countries. Income dif-
msalehi@worldbank.org. The authormay @yahoo.com, Idewulf@worldbankorg, or ferences widened within the countries-
be contacted at michael.u.klein@si. ahansson1@worldbankorg. for example, between the urban and rural
shell.com. populations of China. This is the first pa-
Dorsati Madani, A Review of the Role per that calculates world income distribu-
Hua Wang and Somik Lall, Valuing Wa- and Impact of Export Processing tion for individuals based entirely on data
ter for Chinese Industries: A Marginal Zones, WPS 2238, November 1999, 107 from household surveys.
Productivity Assessment, WPS 2236, pp.
November 1999, 23 pp. To order Patricia Sader, Room MC3-556,
As instruments for encouraging economic te/: 202-473-3902, fax: 202-522-1153, email:
The marginal productivity of water used for development, export processing zones psader@worldbankorg. The authormaybe
industry varies among sectors in China, but have only limited usefulness. A better policy contacted at bmilanovic@woddbankorg.
there is great potential for the Chinese choice is general liberalization of a
government to encourage water conser- country's economy. The World Bank should Daniel Kaufmann and Shang-Jin Wei,
vation by raising water prices to industry. be cautious about supporting export pro- Does "Grease Money" Speed Up the
cessing zone projects. Wheels of Commerce? WPS 2254,
To order: Roula Yazigi, Room MC2-533, tel: December 1999, 17 pp.
202-473-7176, fax: 202-522-3230, email: To order: Lili Tabada,Room MC3-333, tel:
ryazigi@wo4ldbankorg. Theauthorsmaybe 202-473-6896, fax: 202-522-1159, email: Can corruption improve economic effi-
contacted at hwangl@worldbankorg or Itabada@worldbank org. The author may ciency and can bribery be productive? Not
slalll@worldbankorg. be contacted at dmadani@worldbank.org. according to this study. According to the
"efficient grease" hypothesis, corruption
Luca Barbone, Arindam Das-Gupta, Luc Bartlomiej Kaminski, The EU Factor in can improve economic efficiency and fight-
De Wulf, and Anna Hansson, Reforming the Trade Policies of Central European ing bribery can be counterproductive.
Tax Systems: The World Bank Record Countries, WPS 2239, November 1999,
in the 1990s, WPS 2237, November 31 pp. This need not be the case. The authors
1999, 35 pp. examine the relationship between bribe
Despite strong protectionist sentiments, payments, management time wasted
The main constraint on World Bank opera- trade regimes have remained open in the with bureaucrats, and cost of capital.
tions in tax and customs administration is Central European countries that had been They find that firms that pay more in
the Bank's inadequate institutional frame- invited to negotiate their accession to the bribes are also likely to spend more
work for accumulating knowledge from European Union. Regional disciplines (the management time with bureaucrats, ne-
loan operations. The Bank's theoretical EU factor), combined with the legacy of low gotiating regulations, and face a higher
basis is still rudimentary. Too little atten- tariffs under GATT commitments, appear cost of capital.
tion has been paid to improving account- to have offset domestic protectionist im-
ability, administrative cost-effectiveness, pulses. To order: Hedy Sladovich, Room MC2-
and anticorruption institution-building. 609, tel: 202-473-7698, fax: 202-522-11,
Projects have made inadequate use of To order. Lili Tabada,Room MC3-333, tel: email: hsladovich@worldbank.org. The
various performance indicators. Institu- 202-473-6896, fax: 202-522-1159, email: authors may be contacted at dkauf
tional components of project design have ltabada@won'dbankorg. The authormaybe mann@worldbank.org or swei@world
been biased toward organization, man- contacted at bkaminski@worldbankorg. bank.org.
power upgrading, and procedures related
to information technology. Better and more Branko Milanovic, True World Income
uniform methods should be used to evalu- Distribution, 1988 and 1993: First Cal-
ate project outcomes. The Bank must sub- culations, Based on Household Sur- IMF Working Papers
stantially improve pre-project diagnosis, veys Alone, WPS 2244, November 1999,
project design, execution, and effective- 65 pp. To order IMF Publication Services, 700
ness. 19th Street, NW, Washington, DC 20431,
World inequality increased between 1988 United States, tel: 202-623-7430, fax: 202-
To order. Luca Barbone, Room J7-119, and 1993 as per capita income increased 623-7201, email: publications@imf.org,
tel: 202-473-2556, fax: 202-473-8466, more slowly in rural, populousAsian coun- Internet http://vvwwwimf.org.
C 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999 C
Luiz de Mello, Fiscal Federalism and Augmented Matching Function Ap- finance, trade, and tourism sectors, and
Government Size in Transition Econo- proach on Polish Regional Data, No. there were considerable outflows from the
mies-The Case of Moldova, WP/99/ 2244, September 1999, 47 pp. agricultural and industrial sectors. The
176, 1999. pool of unemployed is changing fast, and
Dalia Marin and Monika Schnitzer, Dis- job-to-job flows are relatively high.
Berthold U. Wigger and Robert K.von organization and Financial Collapse,
Weizsacker, Risk, Resources, and Edu- No. 2245, September 1999, 28 pp. Gerard J. van den Berg and Louise Grogan,
cation-Public Versus Private Financ- The Duration of Unemployment in Rus-
ing of Higher Education, WP/99/174, Charles Wyplosz, Ten Years of Transfor- sia, No. 2268, October 1999,39 pp.
1999. mation: Macroeconomic Lessons, No.
2254,1999. Daniel MOnich, Jan Svejnar, and Katherine
Rene Weber and Gunther Taube, On the Terrell, Returns to Human Capital un-
Fast Track to EU Accession-Macro- ManyoftheargumentsinfavorofBig Bang der the Communist Wage Grid and
economic Effects and Policy Chal- have now been proven right. Once more during the Transition to a Market
lenges for Estonia,WP/99/156, 1999. inflation has been found to be incompat- Economy, No. 2332, December 1999.
ible with growth, and the importance of a
Zuzana Brixiova, Wenli Li, and Tarik good microeconomic structure-espe- Under communism workers had their
Yousef, Skill Acquisition and Firm Cre- cially an effective banking system-is con- wages set according to a centrally-deter-
ation in Transition Economies, WP/99/ firmed. The choice of an exchange rate mined wage grid. For decades the com-
130, 1999. regime, another early controversy, ap- munist wage grid maintained an extremely
pears secondary to adherence to a strict low rate of return on education. During tran-
monetary policy. The decline of the state sition the retum increased dramatcally and
is both spectacular and puzzling, combin- equally in all ownership categories of firms.
Centre for Economic Policy Research ing desirable and dangerous features.
Discussion Papers Constantin Sonin, Inequality, F'roperty
Mathilde Maurel and Sophie Brana, Bar- Rights Protection, and Economic
To order: Centre for Economic Policy ter in Russia: Liquidity Shortage ver- Growth in Transition Economies:
Research, 90-98 Goswel/ Road, London sus Lack of Restructuring, No. 2258, Theory and Russian Evidence, No.
EC1 V 7RR, United Kingdom, tel: 44171- October 1999, 22 pp. 2300, November 1999.
878-2900, fax: 44171-878-2999, email:
cepr@ cepr. org. Jozef Konings and Guilia Faggio, Gross Evzen Kocenda, Limited Macroeco-
Job Flows and Firm Growth in Transi- nomic Convergence in Transition
Koen Schoors, The Credit Squeeze dur- tion Countries: Evidence Using Firm Countries, No. 2285, Novembeir 1999.
ing Russia's Early Transition: A Bank- Level Data on Five Countries, No. 2261,
Based View, No. 2229, September 1999, October 1999. OECD Publications
45 pp.
Using comparable firm-level data forl 993- To order: OECD Washington Center,
The hypothesis thatthe 1994 credit crunch 97 showing job flows in five transition 2001 L Street, NW, Suite 650, VWashing-
in Russia was caused by the tightened economies-Bulgaria, Estonia, Poland, ton, DC 20036-4922, tel: (202) 785-6323
monetary policy turned out to be wrong. Romania, and Slovenia-the authors find or 1-800-456-6323, fax: (202) 785-0350,
Russian banks-taking advantage of ex- that early in transition job destruction domi- Intemet: http://wwwoecdwash.org.
cess liquidity in the banking system-ac- nates job creation, while job creation picks
cumulated huge excess reserves but upinthematurestageoftransition. Financing Newly Emerging Private
preferred to hold onto them rather than Enterprises in Transition Economies,
grant loans. This question is still relevant Katherine Terrell and Vit Sorm, ACompara- 1999, 286 pp.
because Russian commercial banks in the tive Look at Labour Mobility in the Czech
aftermath of the August 1998 crisis have Republic: Where Have All the Workers
again accumulated excess reserves and Gone? No. 2263, October 1999, 37 pp.
decreased their lending to the economy. University of Leicester Publications
The Czech labor market showed a great
Patrick A Puhani, Public Training and deal of flexibility during 1994-98. Many To order: Faculty of Social Sciences, De-
Outflows from Unemployment: An individuals moved into the newly created partment of Economics, University of
* TRsANSITION, December 1999 C) 1999 The World Bank/The William Davidson Institute
Leicester, LEI 7RH, tel: 0116-252-2892, pension had fallen to 45 percent of its 1990 tion to Financial Crisis, Studies &Analy-
fax: 0116-252-2908. level. In 1998 Romania launched its pen- ses No. 158, 1999, 71 pp.
sion reform, based on the three-pillar sys-
Anna Zalewska-Mitura and Stephen G. tem, which will introduce points to calculate Max Gillman, Evaluating Government
Hall, Do Market Participants Learn? benefits from the state pension fund, in- Policy in Transition Countries, Studies
The Case of the Budapest Stock Ex- crease the retirement age, and divert one- &Analyses No.156,1999,32 pp.
change, No. 99/4, March 1999, 20 pp. third of the mandatory social security tax
into new, private, fully funded universal Kyzysztof Rybinski and Thomas Linne,
Roberto Golinelli and Renzo Orsi, Testing pension funds. The third pillar comprises The Emerging Financial System of
for Structural Change in Cointegrated voluntary pension funds. Poland: Institutional Constraints and
Relationships: Analysis of Price- External Links, Studies & Analyses No.
Wages Models for Poland and Hun- Mateusz Walewski, A Short Play on the 154, 1999, 36 pp.
gary, No. 99/3, March 1999, 29 pp. Idea of the Laffer Curve in Transition
Economies, Studies &Analyses No. 175, Rafal Antczak and Malgorzata Antczak,
Thomas Linne, The Integration of the 1999, 28 pp. The Case of Gradual Approach to For-
Central and East European Equity eign Trade Liberalization in Transition
Markets into the International Capital Malgorzata Markiewicz, Marta Dekhtiarchuk, Economies, Studies &Analyses No. 150,
Markets:AKalman FilterApproach, No. and Urban Gorski, Monetary Policy in 1999, 62 pp.
99/2, March 1999, 13 pp. Ukraine in 1996-1999, Studies &Analyses
No. 171,1999,48 pp. Jaroslaw Neneman, The Reform of In-
Adriana Agapie, Stochastic Optimiza- direct Taxation in Hungary, the
tion in Econometric Models-A Com- Joanna Siwinska, The External Public Czech Republic, Poland and Roma-
parison of GA, SA, and RSG, No. 99/1, Debt of Baltic and Selected CIS Coun- nia, Studies &Analyses No. 149, 1999,
March 1999, 26 pp. tries in Years 1992-1997: Estonia, 26 pp.
Latvia, Lithuania, Kazakhstan, Kyrgyz
Barbara Roberts and Jeffrey Round, Im- Republic, Moldova, Russia Federation Emir Djugeli and lrakli Gvaramadze,
port Demand Specification in Comput- and Ukraine, Studies &Analyses No. 169, "Zero" Auctions: Purpose and Analy-
able General Equilibrium Models of 1999, 32 pp. sis of the Results, Studies & Analyses
Economies in Transition, No. 99/4, May No. 140,1999, 43 pp.
1999, 23 pp. Marek Styczen, Socio-demographic
Forecast of Poland, 1997-2050, for Malgorzata Markiewicz, Fiscal Policy
Modeling Incomes and Social Security and Disinflation in Transition Econo-
Retirement Pensions, Studies & Analy- mies, Studies &Analyses No. 127,1999,
CASE Publications ses No. 168, 1999, 56 pp. 44 pp.
To order. Center for Social and Economic Ondrej Schneider, Implicit Public Debt
Research, ul. Bagatela 14,00-585 Warsaw, of the Czech Social-Security System,
Poland, tel: 4822-628-0912, fax: 4822- Studies& Analyses No. 167, 1999,24 pp. CASE-CEU Publications
628-6581, email: case@case.com.pl.
Joanna Siwinska, Public Debt Structure To order: Center for Social and Eco-
Barbara Blaszczyk and Richard Wood- and Dynamics in the Czech Republic, nomic Research, ul. Bagatela 14, 00-
ward (eds.), Privatization and Company Hungary, Poland, and Romania, Stud- 585 Warsaw, Poland, tel: 4822-628-0912,
Restructuring in Poland, Case Reports ies &Analyses No. 162, 1999,47 pp. fax: 4822-628-6581, email: case@
No. 18,1999,48 pp. case.com.pl, and Open Society Institute-
Magdalena Tomczynska, Comparative Regional Publishing Center, 1051
Georges de Menil, Stephane Hamayon, Analyses of Direct Tax Systems in Se- Budapest, Oktober 6 u. 12, Hungary, tel:
and Mihai Seitan, Romania's Pension lected Central European Countries, 361-327-3014, fax: 361-327-3042.
System: The Weight of the Past, Stud- Studies &Analyses No. 161,1999,73 pp.
ies &Analyses No. 177,1999, 28 pp. Nicholas Stern, What Tax Reform Is
M. Dabrowski, M. Dekhtiarchuk, U. Gorski, Needed for Fast Economic Develop-
By 1997 Romania's pension system had P. Kovalev, Y. Kuz'min, and K. Sultan ment? CASE-CEU Working Papers Se-
registered a deficit, and the average real (eds.), Ukraine: From Fragile Stabiliza- ries No. 30, 1999,16 pp.
© 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999
Stanislaw Gomulka and Marek Styczen, IER Publications years of work for men and 35 for women.
Estimating the Impact of the 1999 Pen- The government would replace the work-
sion Reform in Poland, 2000-2050, To order: Institute for Economic Research, ing age with an old age limit: 65 years for
CASE-CEU Working Paper Series No. Kardeljevapl. 17, 1000 Ljubljana, Slovenia, men and 63 for women. The full wvorking
27, 1999, 52 pp. tel: 061-1328-151, fax: 061-342-760, email: age assured a pension equal to 85 per-
recnikm@ier.si, Intemet: http://vww.ier si/ cent of one's highest average wage for 10
Jacek Rostowski, The Approach to EU consecutive years. According to the reform
and EMU Membership: The Implica- Marjan Simoncic and Franc Kuzmin, Mac- proposal, this will change in the next 30
tions for Macroeconomic Policy in roeconomic Effects of the Pension years. The accrual rate will gradually de-
Applicant Countries, CASE-CEU Work- Reform in Slovenia, Working Paper No. crease: each year the pension basis will
ing Paper Series No. 26, 1999, 20 pp. 3,1999, 26 pp. be reduced by 0.5 percent, up to 70 per-
cent of net wage. So the pension basis for
Przemyslaw Wozniak, Various Measures In Slovenia the contribution rate on gross the new entrants to the pension system in
of Underlying Inflation in Poland 1995- wages was raised in 1991 to maintain 2000 will be 84.5 percent, in 2001, 84
1998, CASE-CEU Working Paper Series balance in the pension budget. But in percent, and soon.
No. 25,1999, 56 pp. 1996 the government reduced the contri- 0 The 10-year period will be gradually pro-
bution rate by 5 percent to reduce labor longed up to 25 years. Each year one ad-
Barbara Liberda and Tomasz Tokarski, costs. Itis unclearhowsuccessful the mea- ditional yearwill be added to the calculation
Determinants of Saving and Economic sure was in stimulating growth in industrial of the pension base. The overall effect is
Growth in Poland in Comparison to the production and exports. Eventually the the same as if the pension base were low-
OECD Countries, CASE-CEU Working government had to refund the pension bud- ered from 85 percent to 70 percent of net
Paper Series No. 24,1999, 28 pp. get for the lost revenue. The transfer pay- wages.
ment from the state budget increased in 0 The social partners still debate whether
Mariana Kotzeva, Targeting Social As- 1996 by 12 percent, just enough to cover pensions should be indexed to wage or
sistance under Hard Budget Con- the budget gap. Further reduction of the consumer price increases. Reformers
straints: Evidence from Bulgaria, contribution rate in the following two years would like to index pensions to prices, not
CASE-CEU Working Paper Series No. claimed additional transfers from the state gross wage growth.
23, 1999, 38 pp. budget.
Tine Stanovnik and Nada Stropriik, Eco-
Andrzej Baniak and Jacek Cukrowski, In- Planned reforms will radically change the nomic Well-Being of the Elderly and
formation Processing in Decision- pension system in the near future. Initially Pension Reform in Slovenia, Working
Making: Effects of Technological the pension system would have involved Paper No. 2,1999, 35 pp.
Change on Efficient Structures, CASE- setting up a three-pillar system. Two pil-
CEU Working Paper Series No. 20,1999, lars would have been mandatory-a Vladimir Lavrac, Exchange Rate of the
18 pp. slimmed down version of the present so- Slovenian Tolar in the Context of
cial security fund complemented by a pri- Slovenia's Inclusion in the Eli and in
Andras Simonovitis, A Comparison of vate capital (pension) fund. Both pillars the EMU, Working paper No. 1,1999,18
the Local Stability of Rational and would have been fed by splitting the pp.
Naive Expectations, CASE-CEU Work- present social security contributions-85
ing Paper Series No. 19, 1999, 31 pp. to 15 percent-paid on gross wages. The The costs and benefits for Slovenia of join-
capital fund-with government guaran- ing the European Monetary Union are in
Yuri Yegorov, Dacha Pricing in Russia: tee-would have offered a minimum 4 principle similar to those for the EU mem-
General Equilibrium Model of Loca- percent annual return. The third pillar-vol- ber countries. Slovenia has a small, open,
tion, CASE-CEU Working Paper Series untary pension funds at banks and insur- and diversified economy with a high pro-
No. 18, 1999, 27 pp. ance companies-is already functioning. portion of trade oriented to the EU. It is not
expected to be specifically exposed to the
Miklos Szanyi, Foreign Direct Invest- The three social partners-trade unions, so-called asymmetric shocks because its
ments in Small Business in Transition the government, and employers-recently trade structure is similar to that of the EU
Economies, CASE-CEU Working Paper agreed to abandon the second pillar, at and its economy is rather synchronized with
Series No. 15, 1999, 34 pp. least for a time. But some changes in the the cycles in the EU economies. Slovenia's
pension system seem to be unavoidable: loss of the exchange rate as an instrument
0 Full pension eligibility has required 40 of adjustment, which would resultfrom its
TRPANSITION, December 1999 ©) 1999 The World BankfThe William Davidson Institute
future inclusion in the monetary union, and Russia and Ukraine, No. 258, June Boris Majcen, Measurement of Costs
wouldn't affect Slovenia much, particularly 1999, 28 pp. and Benefits of Accession to the EU
if the emphasis of efforts to sustain the for Selected CEECs: Country Report
economy's international competitiveness The transformation of farming appears to Slovenia, No. 256, May 1999, 93 pp.
shifted from the exchange rate instrument have reached a mature stage in most Cen-
toward a more flexible labor market. tral and East European countries. By con- Johann Burgstaller and Michael Landes-
trast, in Russia and Ukraine, only formally mann, Trade Performance of East Eu-
restructured farms dominate and the sale ropean Producers on EU Markets: An
of land remains prohibited. The transition Assessment of Product Quality, No.
Institute of Public Finance Publica- economies reduced agricultural subsidies 255, April 1999, 15 pp.
tions during the 1990s and subsidies are much
lowerthanintheEUandOECDcountries. Josef Poschl and others, Transition
To order: Institute of Public Finance, There was a large decline in agricultural Countries in 1998/99: Widespread
Katanciceva 5, 10000 Zagreb, Croatia, output in several of the transition econo- Economic Slowdown with Escalating
tel: 385-1481-9363, fax: 385-1481-9365, mies-especially in Russia and Ukraine- Structural Problems, No. 253, February
email: ured@ijf.hr. mainly because of declining demand for 1999, 85 pp.
certain agricultural products and diminish-
Predrag Bejakovic and Alastair McAuley, ing competitiveness in sectors requiring Other Publications
Welfare Policy and Social Transfers in restructuring.
Croatia, Occasional Paper No. 8, July Jiri Vecernik and Petr Mateju (eds.), Ten
1999, 33 pp. After the collapse of agricultural trade be- Years of Rebuilding Capitalism: Czech
tween the transition economies, the agro- Society after 1989, Academia, Prague,
Katraina Ott and Anto Bajo, Public In- food trade of the CEE countries shifted 1999.
vestments in Croatia, Occasional Paper mainly to the EU countries. The financial
No. 7, March 1999,12 pp. collapse in Russia triggered a decline in The first "social report" on the Czech Re-
prices in 1998 as the supply of certain key public, this book describes demographic,
Financing of capital investment in commodities greatly exceeded demand. economic, social, and political changes
Croatia needs broad reform, including To relieve tension among the farmers- since the velvet revolution of 1989. In his
setting up a government treasury; better and to protect their markets-countries concluding remarks, Jiri Vecernik warns
dividing responsibilities between the used subsidies, tariffs, and import quotas. that in an institutionally insufficient and
payments clearing agency, other govern- The 1998 agro-food trade of the CEE morally corrupt environment, the demo-
ment agencies, and public enterprises; countries recorded a deficit of about $300 cratic mechanism often serves to legiti-
improving local government finance; and million, after a surplus of $600 million in mate pre-existing power, and without
increasing the effectiveness of funds al- 1997. Russia's agro-food deficit con- rules or enforced order, the market can
location through the Croat Bank for Re- tracted by $3 billion to $10 billion because be taken over by monopolies. "The pur-
construction and Development. Foreign of a sharp devaluation. The Ukrainian sur- pose of the subsequent flow of capital
financing should be mobilized. Cost-ben- plus dropped by $600 million, to $300 mil- between the state banks and companies
efit analyses are neglected because lion. was to maintain the status quo, rather than
pubic projects lack transparent bidding cut old ties and create a business sphere
and evaluation. The upcoming negotiations with the World governed independently from the state."
Trade Organization will putfurther pressure Illegal accumulation of property, and the
on the EU to reform its common agricul- rise of the "new rich" harmed the interests
tural policy before 2006. Inadequate re- of the middle class, the main pillar of the
WIIW Publications forms may postpone accession of the society.
candidate countries, or may require pro-
To order: The Vienna Institute for Intema- longation of the transitional arrangements. Information: Institute of Sociology, Czech
tional Economic Studies, Oppolzergasse 6, Academy of Sciences, Jilska 1, 110 00
A-1010, Vienna, tel:431-533-6610, fax: 431- Peter Havlik and others, The Transition Praha1, Czech Republic, fax: 4202-2222-
533-6610/50, Intemet:http:/Aww.wiiwac.at Countries in 1999: A Further Weaken- 1658. The authors can be reached at: Jiri
ing of Growth and Some Hopes for Vecernik, email: vecernik@mbox.ces
Zdenek Lukas, Agriculture in Transition: Later Recovery, No.257, June 1999, 94 net.cz, Petr Mateju, email: mateju@
Widening Gap between the CEECs pp. soc.cas.cz
© 1999 The World Bank/The William Davidson Institute TRANSITION, December 1999 3
M. Holt Russin and others (eds.), The B 00120 Helsinki, Finland, tel: 3589-609- necessity of an overall welfare measure in
Post-Soviet Handbook: A Guide to 900, fax: 3589-601-753, Intemet: http:// analyzing effects of regional integration.
Grassroots Organizations and Internet wwwelta.fi/
Resources, Revised Edition, University Cathal O'Donoghue and Holly Sutherland,
of Washington Press, October 1999,416 Daniel Piazolo, Welfare Effects versus AccouningfortheFamily:TheTreatment
pp. Income Effects of Poland's Integration of Marriage and Children in European
into the European Union, Kiel Working IncomeTaxSystems, Innocenti Occasional
To order: University of Washington Press, Paper No.940, Kiel Institute of World Eco- Paper No.65, Italy, 1998,54 pp.
PO. Box 50096, Seattle, Washington nomics, Germany, 1999.
98145-5096, United States, tel: 206-543- To order: UNICEF, Intemational Child
4050. fax: 206-543-3932. To order: email: dpiazolo@ifw.uni-kiel.de, Development Centre, Economic and
Internet: http.//www.uni-kiel.de:8080/lfW/ Social Policy Programme, Piazza SS.
Zoltan Csefalvay, Michael Landesmann, pub/kap/1999/kap940.htm. Annuziata 12, 50122, Florence, Italy, tel:
and Gyorgy Matolcsy, Hungary's Acces- 39-055-2345-258, fax: 39-055-2448-17,
sion to the EU: The Impact of Selected This paper presents a dynamic comput- email: ciusco@unicef-icdc.it, Internet:
Areas of Hungarian-Austrian Rela- able general equilibrium model for www.unicef-icdc.org.
tions, The Vienna Institute for International Poland's integration into the European
Economic Studies and Economic Growth Union that allows for quantification of the Poland International Economic Re-
Institute, Budapest, 1999,150 pp. incomeandwelfareeffectsstemmingfrom port: 1998/99, Warsaw School of Eco-
tariff reduction, border-cost reduction, re- nomics, Poland, 1999, 243 pp.
Istvan Janos Tith, Ownership Structure, duction of the technical barriers to trade,
Business Links and Performance of and increased net EU transfers from Brus- To order World Economy Research Insti-
Firms in a Transforming Economy, The sels. For all channels, steady-state national tute, World Economy Faculty, Warsaw
Case of Hungary, Discussion Paper No. income increases substantially compared School of Economics, 24 Rakowiecka Str.
1999/3, Institute of Economics, Hungarian with the reference scenario (status quo). 02-554 Warsaw, Poland, tel: 4822-489132,
Academy of Sciences, Hungary, June However, the welfare effects are surpris- fax:4822-489132, email: weri@sgh. wawpl.
1999, 82 pp. ingly small. The findings show the impor-
tance of renouncing consumption today in Review and Outlook for Eastern Eu-.
Hungary's enterprise structure can be order to build up the capital stock neces- rope, PlanEcon, United States, June
characterized by the following major fac- sary to achieve higher output and higher 1999, 285 pp.
tors: the company structure stabilized by consumption in the future. Large discrep-
1996; ownership is concentrated; holdings ancies between welfare and income ef- To order: PlanEcon, Inc., 1111 Fourteenth
do not have a dominant role; private Hun- fects illustrate the importance of the recent Street, NW, Suite 801, Washington, DC
garian and foreign ownership is dominant; discussion on welfare versus income gains 20005-5603, tel: 202-898-0471', fax: 202-
and foreign-owned companies are driving from trade liberalization, and stress the 898-0445.
the modernization process. Hungarian
enterprises have excellent production and Donors' WrongApproach
profit figures-and strong growth potential.
Financial discipline is still weak in the cor-
porate community, however. cs- i
To order: Library of Institute of Economics,
H-1502, Budapest P0. Box 262, fax: 361- e .
319-3136, email: bibio@econ.core.hu.
Jarmo Eronen, Cluster Analysis and ,r
Russian Forest Industry Complex, Dis-
cussion Paper No. 682, Elinkeinoelaman
Tutkiuslaitos, 1999.
To order ETLA, The Research Institute
of the Finnish Economy, Lonnrotinkatu 4 From the Hungarian daily N6pszabdsag.
M TRANSITION, December 1999 C) 1999 The World Bank/The William Davidson Institute
Bibliography of Selected Articles
Postsocialist Economies Wright, D. The Other Side of China's Central and Eastern Europe
Prosperity. China Business Review
Antal, L. On the Nature of International (United States) 26:22-29, September- Bara, H. Improving Citizen Access in
Financial Crises: High Waves Fol- October 1999. Romania. Public Management Forum
lowed by Low Tide. Central European (France) 5(3):11, May-June 1999.
Banker(Hungary) 5-11, June 1999. Zahang, Z. A Review of Research on
Economic Theory in China since the Bruggemann, A., and T. Linne. Various
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