http://www.worldbank.org/html/prddr/trans/WEB/trans.htm                               20274
r    a THE NEWSLETTER ABOUT REFORMING ECONOMIES
RANSITION
Volume 11, Number I       The World Bank in collaboration with The William Davidson Institute    Februaty 2000
The Bank Adapts to Changing Circumstances in
Transition Countries
Interview with Vice President Johannes Linn
How would World Bank operations adapt to changing circumstances in the transition countries? How long will the Bank continue
lending to the "graduating" countries of central Europe? What are the plans in the Balkans, Russia, and central Asia? Johannes
Linn, Vice President for Europe and Central Asia (ECA), spoke to Transition editor Richard Hirschler.
Q. In your assessment, will World  The Bank also provides support to several  ings on accession issues. We are coop-
Bank support to Europe and Central  EU candidates to modernize their agricul-  erating with private foundations-for ex-
Asia increase or decrease in the next  ture and mining industries, to spend more  ample, with the Bertelsmann Foundation
couple of years? What is the World  on the environment, and to carry out re-  in Germany-in this enterprise.
Bank's strategy toward the transition  forms in their education, health care, and
economies?                           pension systems. Let's not forget our ana-  So there will be a decline of our activities
lytical work, and our initiatives to build in-  in central Europe over time, but this is
A. Europe and Central Asia was the only  ternational networks among research and  hopefully going to be a gradual. Hungary
region in the last five to seven years that  policy institutions to exchange their find-  is in a way "self-graduating" since it does
consistently grew in importance, becom-
ing a major center of World Bank activi-      SITE
ties. In terms of the total number of projects  Stockholm Institute of Transition Economics
and exposure, it is now the third largest     STOCKHOLM SCHOOL OF ECONOMICS
region. Looking forward, a lot will depend
on what happens in key countries and sub-   SITE: Transition's New Partner
regions in our area. In the countries of cen-   We are pleased to announce that ourpartnership network has been strengthened by
tral Europe, Including the Baltics, the Bank
daEo,ntelini    the addition of the Stockholm Institute of Transition Economics (SITE). We will co-
still has an important-albeit declining   operate in publishing and distributing Transition and enriching its editorial content
over time-role to play in the next three to   with research findings, publications, meetings, and other materials from SITE and
five years to help their accession to the Eu-   other academic institutions in SITE's network. Transition already reaches a wide
ropean Union (EU). We are supporting the   audience, including academics, policy makers, business professionals, and research
capacity building of public institutions,  institutions, in three languages, English, Russian, and Chinese. This is possible
strengthening of sub-national institutions   with the help of ourpartners, primarily the William Davidson Institute at Ann Arbor,
including provincial and local govern-   Michigan, the Bank of Finland Institute for Economies in Transition (BOFIT), in
ments. These are important vehicles for   Helsinki, the International Centre for Policy Studies in Kyiv, Ukraine and the China
receiving and making effective use of  Institute for Reform and Development, Haikou, Hainan. The Director of SITE, Erik
funds from the EU and they need to be re-   Berglof, willjoin the editorial board of Transition (also see page 19).
inforced to be able to absorb those funds.
Development Research Group                      The World Bank               The William Davidson Institute
mm                            MEE~~~U.



not want to borrow much from the Bank. The  posed to bring stabilization, democratiza-  reform program that we endorse. We hope
Czech Republic has not borrowed for quite  tion, good-neighbor relations to, and foster  to move forward together with the govern-
a while. Slovenia, while still having borrowed  reconstruction and develop-        ment in such areas as reforming
a little bit, has reached such a high income  ment of, Albania, Bosnia and         the public sector and agriculture,
level that it is actually beyond the gradua-  Herzegovina, Bulgaria, Croatia,      creating a more investment-
tion threshold. In the nexttwo orthree years  the FormerYugoslavRepublicof         friendly environment for domes-
it will graduate. But in other countries, like  Macedonia, Romania, and (in        tic and foreign private investors,
Poland, we have a very active program.  the long term) the Federal Re-             and dealing with corruption is-
Whether we will be able to continue our  public of Yugoslavia. Together            sues. It is noteworthy that despite
advisory and analytical work-there is high  with the EU, the Bank will coor-       its huge economic potential,
demand for both in these countries-will  dinate donor activities and loan          Ukraine is the only country in the
depend on our overall budget priorities. This  funding, not only forcountry-spe-   former Soviet bloc that didn't ex-
is under review.                     cific development and reconstruction pro-  perience GDP growth in any of the years
grams, but also for regional and even wider,  since independence in 1991. That was the
In south east Europe and the Balkans-  global integration. Reform and intra-regional  cost of delaying reforms. In Russia we have
where the per capita income, at $2,200,  cooperation are necessary to overcome the  to see the outcome of the presidential elec-
is roughly half that in Poland, Hungary, the  legacy of conflict and poor economic per-  tion and the composition of the new gov-
Czech Republic, Slovakia or Slovenia-  formance, and to reduce poverty and  ernment and its economic plans.
the Bank has been given a new mandate  achieve prosperity in this region. In addi-
to promote the stability pact that is sup-  tion, these countries will have to be  Q. Putin will presumably be the next
effecitvely integrated also with the rest of  president, and according to Oxford
Europe and especially the EU if peace and  Analytica his "soft authoritarianism
LA..                prosperity are to return for good in south  could be compatible with a more or-
C  ontents                   east Europe. We expectto co-chairwith the  derly, statist capitalism."
EU the first regional, ministerial-level fund-
Interview with ECA VP Johannes Linn 1    ing conference on March 29, in Brussels.  A. Let's notget into this guessing game. Ob-
Gains and Losses in Russia 4         There is little doubt that in this-region, we  viously, the new president's economic pro-
will maintain our present activities.  gram will be crucial; also of importance is
Privatization in the Baltics and Russia 9                                 how effective he will be in convincing the
ProposalsoftheMeltzerCommission 11    Q. What does the Bank expect in Rus-  Duma to support particular legislation that
President Wolfensohn's Response 12    sia and Ukraine?                    may be required in key areas. That includes
legislation affecting private sector invest-
Challenges Facing China 13          A. Both countries have been large borrow-  ment, especiallytheforeign investmentcode;
Dept-Equity Swaps in China 15        ersfrom the Bank. In bothcountrieswepro-  bankruptcy legislation; banking sector re-
Milestones of Transition 16          vide support in building market institutions,  form legislation; and so on. Thus there is a
in going forward with key social sector re-  fair amount of legislation that has to be ap-
Letter to the Editor-The Merits of Com-   forms, and in restructuring some industries. proved by the Duma.
mon Law 17                           I can mention downsizing and restructuring
Interview with Slovakia's Deputy Prime   the coal sector in both countries-the re-  Q. Assuming that the new Russian gov-
Minister 18                          cent mining accident in Ukraine is a sad  ernment will engage in a bold reform
reminder that any delay can cost human life. program, how much World Bank money
Closeup: SITE 19                     We also have to make sure that the social  can Russia receive in the future?
William Davidson Institute          impact of this restructuring, the unavoidable
* Equity Market Developments 22     labor-shedding, is being addressed, and  A. We outlined a number of scenarios in
* Possibility of Ponzi Schemes 24   thatthe unemployed minersreceive proper  ourcountry assistance strategy. It starts at
* Corporate Governance in the Asian    assistance and retraining.         a very low level of about $150 million annu-
Crisis 26                                                                 ally to fund two new projects. If the situation
Much depends of course on the ability of  improves, if the implementation of our ex-
World Bank/MF Agenda 29              the new governments in both countries to  isting portfolio accelerates-among com-
Conference Diary 32
New Books and Working Papers 34      pursuethe reforms effectively. In Ukrainethe  mitted projects are our three outstanding
NBiblioksraphy  Wof rkingcd Parcers 434  1new government under Prime Minister  adjustment loans with more than $1 billion
Bibliography of Selected Articles 43  tViktorYushchenko has laid outan ambitious  undisbursed balances that can be dis-
W  TRANSITION, February 2000                                       © 2000 The World Bank/The William Davidson Institute



bursed quickly when conditions have been  maintain fiscal stability, to maintain the  A. A lot depends on how much the budget
met-and if steps are taken toward re-  former momentum of economic growth.  will actually have to be cut, which we do not
forms, wewould beableto raise ourinvolve-  As they struggle with fiscal deficits, they  knowyet. In anycase, firstwe are lookingfor
ment gradually to $300 million annually as  can hardly find the domestic matching  savings without cutting programs. Recently
a first step, possibly up to $500-$600 mil- funds for investments that would have  we have unified and consolidated some of
lion as the next step. The key issue for the  been financed with outside help. In a num-  ourcountry units. Their number has been re-
government and for us is not so much to  ber of countries in this region our project duced from 11 to 9. We have also consoli-
take on newfinancial commitments, but how  pipelines slow down because the govern-  dated our country coordination units in
quicklywe both can moveforward and dis-  ment doesn't have the necessary coun-  Washington forcountrieswhereourcountry
burse already committed loans.       terpart resources.                    directors are in the field. We are also hop-
ing for savings of real estate costs in some
Q. Do these disbursements depend  Also, a combination of political, eco-  countrieswheretherealestatepriceshave
on the Duma's actions?               nomic, and financial factors has pushed  dropped. In addition, we will look for in-
several countries, particularly Georgia  creased efficiency in the way we do our busi-
A. Implementation of the third Structural  and the Kyrgyz Republic, into significant  ness. Second, wewill have to consider-and
Adjustment Loan requires legislative ac-  difficulties. We are making efforts to as-  thisdependsontheoutcomeofbudgetallo-
tion. That is not the case with the second  sist them in keeping reform on course. To-  cation by the Bank-cutting back our pro-
Coal SectorAdjustment Loan-simply the  gether with the IMF we want to make sure  grams-in central Europe-for example,
envisaged program should be imple-  that fiscal resources are sufficient to sup-  possibly more rapidly than originally planned.
mented. The Social Protection Adjustment  port an appropriate investment program   We mayhavetoslowdown our rapid expan-
Loan requires legislation, at least its pen-  without endangering macro-stability. In  sion of support for south-east Europe, and
sion reform-component.               these, in majority low-income countries  we may be constrained in building up oursup-
that are eligibie for IDA credits, I expect  port in Russia and Ukraine, if and when these
Q. Could you also briefly comment on  we will hold the line and even strengthen  countries move forward consistently on re-
Central Asia and the Caucasus?       our presence.                        forms. Sothe budget isaconstraint. It isjusta
fact of life that we have to live with. But we will
A. These countries were hit very hard by  Q. How will you cope with the neces-  certainlydoourbestto maintain ourprograms
the Russian crisis in 1998. They are still sary budget cuts in the Bank over the  inthoseareaswhere Banksupportisthemost
feeling the pain. The downturn in their  next couple of years? Do you have to  effective in reducing poverty and helping re-
economies has made it much harder to  sacrifice projects?                  store economic growth and living standards.
World Bank/IDA Commitments to Borrowers in Europe and Central Asia, by Country, Fiscal 1990-99 (in US$ million)
12000 C
10000 ____
8000-_____
49 69.5
|~~~~~~~~~~~~ 393 1 .
4000                                                                     011.5                     2 821.8
2000
2000-~~~~~~              ~     ~     ~~~~~~ 12 10.1   |17.                     ._      l_ 
0-481 .8     35.4369.2   1 S.  73  1275 T   09.6    | 5   3 315 2 2B3.3 49.   44  .58  135 8, 15  Z   0.4  4 9     341
0 4e
Source: World Bank.
9 2000 The World Bank/The William Davidson Institute                                 TRANSITION, February 2000 



Dividing Transition Gains and Losses:
Pensions, Privatization, and Reform in Russia
by Ethan B. Kapstein and Branko Milanovic
"People cannot live on 234 rubles ($9. 75) per month," said Yevgeni Primakov, then Russian Prime Minister, in March 1999. He
was speaking of the 4 million Russians who must try to survive on the minimum pension. However, those who receive even this
pittance with any regularity must count themselves among the fortunate: pension arrears, compounded by systemioproblems in
the postal and banking systems, mean that millions of Russians receive no official transfers at all for months. The failure ofthe
social safety net is among the most visible and tragic outcomes of Russia's struggle with economic transition. Ten years after
transition began, it is clear that social policy reform should not be treated apart from other economic policy measures such as
macroeconomic stabilization, price liberalization, and privatization.
To simplify distributive issues, we look at sell these assets in exchange for votes and  tively. Poor, often living in rural isolation,
social policy formulation in terms of three  campaign contributions.     and lacking information about how to in-
groups of actors:                                                        fluence the electoral system, Russian pen-
Failure of the Social Safety Net    sioners have yet to create a "gray power"
Rent-recipients are workers and manag-                                   lobbying group, as their counterparts have
ers of state-owned enterprises and entre-  In Russia, a large, diverse, and politically  done in many other countries.
preneurs not working for state enterprises. fragmented country, winning popularvotes
(Rent-seeking can be defined as any activ-  iscostly. The funds have come largelyfrom  Joel Hellman, in his article on Russian
ity designed to exploit a monopoly or gain  the entrepreneurial class, as a reward for  political economy during the transition era
access to government subsidies, as op-  "gifts" received from the administration-  ("Winners TakeAll: The Politics of Partial
posed to profit seeking in a market with  subsidized credits, deferred tax payments,  Reform in Postcommunist Transitions,"
competitive firms). We consider workers  and other rents, including the gains from   World Politics 50, January 1998), made
and managers jointly because, once the  privatization. The concentrated interests of the case that "surprisingly, the politics of
government decides on mass privatization, the winners, especially the managers and  postcom mu n ist economic reforms has
theircommon interestattheoutsetistore-  workers in privatized enterprises, have  not been dominated by the traditional
ceive state enterprises and other state  overwhelmed those of the politically unor-  short-term losers of economic transi-
property at the lowest price, and to obtain  ganized pensioners, who despite their  tion-striking workers, resentful former
tax breaks and subsidies, all with the ob-  large numbers find it difficult to act collec-  state bureaucrats, impoverished pension-
jective of maximizing income. Over the
longer term, the interests of workers and
lonagers t, tdiverge.               Table 1. Percentage of Pro-Yeltsin Vote in 1996 and Household per Capita
managers can diverge.               Income, By Socio-Economic Group
Transfer-recipients include pensioners,                                                Household per capita
recipients of other social transfers (such                                              income at the time
as the unemployed and destitute), and                                                    of election (1000
public sector employees. Their common  Socio economic group          Proeltsin of          1993 pricesh
feature is that their incomes depend en-
p     ~~Entrepreneurs/businesspeople         93.2                 26.6
tirely, or largely, on government transfers,   nep bnemplee93.2                                26.6
'  '                 ' ~~~~~Self-employed                     81.6                 19.8
which in turn depend on tax collection.    Part-time workers               77.0                12.3
Housekeepers                          74.5                 5.9
Elected officials in government have three  Full-time workers             70.6                 10.6
assets that they "sell" to voters: state prop-  Unemployed                68.9                  5.4
erty, rents (including tax exemptions and  Students                       57.0                  7'.1
subsidies), and transfers. They "sell" state  Pensioners                  51.5                  6.7
property and rents to workers, and trans-  Average                        67.7                 12.8
fers to pensioners. To get funds for trans-  a. Dollar exchange rate in 1993: $1 = 664 rubles.
fers they need to tax workers. Politicians  Source: author's compilation.
* TRANSITION, February 2000                                       © 2000 The World Bank/The William Davidson Institute



ers, or armies of the unemployed. Instead,  Along with unskilled and public-sector  what their electoral weight. Of those priori-
the most common obstacles to the progress  workers, pensioners have been the rela-  ties, few were higher than the privatization
of economic reform have come from very  tive losers in the transition. In 1993-94,  of Russian state enterprises.
different sources: from enterprise insiders  although only 19 percent of the population,
who have become new owners only to strip  pensioners were 26 percent of those liv-  Soviet-Era Directors as New Owners
theirfirms' assets, from commercial bank-  ing in poverty. Their potential electoral
ers, from local officials, and from so-called  weight is considerable-they are about 40  Russia began its privatization program in
mafiosi." These winners, Hellman argues,  percent of the electorate.       1992. As Michael McFaul recounts (Agency
"have frequently attempted to block specific                               Problems in the Privatization of Large
advances in the reform process that threat-  Russian pensioners have never been rela-  Enterprises in Russia, 1994,) "Empow-
ens to eliminate the special advantages  tive beneficiaries of state largesse. But at ered with increasing control over their en-
and market distortions upon which their own  least during the Soviet era they regularly  terprises, directors could also supplement
early reform gains were based." We argue  received the meager sum that they were  their individual wealth by hiding profits or
that these groups have siphoned off the  due. The transition has been even less kind  skimming extra production. An extensive
gains from transition thatwere up forgrabs  to them (see box). Apparently, the govern-  gray economy provided tremendous incen-
and that could have gone instead to trans-  ment has had higher priorities than meet-  tives for opportunistic behavior. Moreover,
fer recipients, including pensioners.  ing its obligations to the aged, no matter  the forces inhibiting corruption did not ex-
Russia Badly Needs Pension Reform
In Russia pension transfers accounted for about 5.5 percent of  0 Serious inequalities between and within generations.
GDP in 1999 (compared to 6.9 percent of a larger GDP in 1992)  The Russian government has been preparing a reform of its
and supported 37 million pensioners. The pension system has  pension system, which would rest on a multipillar approach com-
the following defects:                                 bining pay-as-you-go and fully funded systems through direct
worker contributions to a retirement account. With World Bank
* High contribution rates and weak compliance. The pen-  assistance, Russia is making the plans itself, but the scheme
sion system, like its Soviet predecessor, is funded by a 29  is not well advanced.
percent payroll tax and is replenished from the budget if it falls
short. Employees' direct contributions are eitherzero or mini- A$800 million Social ProtectionAdjustment Loanfrom the Bank,
mal, placing the burden almost entirely on the employer, for-  approved in 1997, is intended to assist the reform by:
merly state-owned but now commonly private. This encourages
managers to evade tax by under-reporting their payroll. The  * Strengthening the Pension Fund's revenue base by encour-
gap between official and actual contribution rates, coupled  aging better collection practices and enforcing compliance by
with other budgetary problems, explains the current shortfall  larger companies.
in pensions.
0 Introducing a minimum pension floor of not less than 80 per-
. Unfa.orable demoraphctendsTheshaecent of the minimum subsistence level and adjusting it accord-
*Unfavorable demographic trends. The share of pension-  igt  nlto.TeWrdBn   xet  ht1   ilo
ers in the overall population is 19 percent and rising. Between  igt  nlto.TeWrdBn   xet  ht1   ilo
1959 and 1990 ther  population  ov19percent 6 ndo d. Thesytwemn  pensioners would receive minimum pensions and about 4 mil-
lion would experience an improvement in living standards.
dependency ratio is high, with just under two workers to every
pensioner.                                             Russia's transition has been politically contested, if in an unorga-
nized way. Between 1992 and 1995 the percentage of Russians
* Growing fiscal imbalances. Falling output, tax evasion, and  polledwho had a negativeviewofthemarketeconomyrosefrom
tax offsets at the enterprise level have repeatedly forced the  7 percent to 44 percent. In a poll taken in December 1996, five
centrally managed Pension Fund to cut or even suspend pen-  years after transition began, 43 percent of Russians said they
sion payments. The fund has been in deepening financial crisis  'Would likethe Communiststo govern ourcountry." InApril 1999, a
since 1995. In late 1998 pension arrears were 30.5 billion rubles.  poll found that Yeltsin's popularity was falling rapidly. Only 6 per-
cent of those questioned approved of his work, while 92 percent
* Low retirement age. The retirement age is 55 for women  did not approve of it. It can be inferred thatthese views are highly
and 60 for men.                                        correlated with the country's economic performance.
©D 2000 The World Bank/The William Davidson Institute                                TRANSITION, February 2000   C



ist." Nor did workers offset the malign be-  Tax arrears are one of the most important The Russian state was easily captured by
havior of their managers. Russian enter-  ways in which budget constraints are soft-  well-organized industrial interests. They al-
prises provided their employees with  ened, but this has consequences for pen-  lied themselves with the government elite,
medical care, apartments, leisure facilities,  sioners. The state's failure to collect taxes  bankrolled it, and helped Yeltsin win the
and schools.Workerswerethuscompletely  and itswillingness to turn a blind eyeto tax  1996 presidential election, in return for
dependent on enterprise directors not only  evasion have led to a fiscal crisis, which in  promises that government largesse would
fortheiremployment, but also forthe subsi-  turn has been met bythe governments fail- continue to flow. Figures from the Russian
dies that kept these services at nominal cost.  ure to meet its obligations to transfer re-  Center for Public Opinion and Market Re-
cipients. Joseph Stiglitz pointed out  search, analyzing the voting patterns of so-
A majority of enterprises were transferred  (Corporate Govemance Failures in the  cial groups during the second round of the
from the state to their managers and em-  Transition, presentation in Paris, 1999),  1996 election, show that 93 percent of
ployees, who were able to acquire 51 per-  that reneging on social payments-for in-  entrepreneurs and 82 percent of the self-
cent of the ordinary shares at 1.7 times  stance, by not paying theelderlypensions  employed voted forYeltsin (seetable 1).An
their book value. This prevented outside  what they believe they have earned-was  analysis by employment shows that 91 per-
investors from gaining majority ownership.  not only tantamount to breaking an implicit cent of top managers, 82 percent of division
The authorities lost their tax base, but con-  social contract, but also helped to destroy  heads, and 78 percent of professionals voted
tinued to subsidize the firms and social  social capital that is crucial for economic  for Yeltsin (table 2). All these groups were
assets. In 1992 these subsidies amounted  development, especially if it became obvi-  among the winners of the transition.
to $55 billion, falling to $20 billion in 1993.  ousthatthegovemmentwassimuitaneously
As subsidies fell, however, tax arrears  transferring vastamounts of wealth to a few  Pensioners and unskilled workers did not
mounted.                             individuals.                         turn en masse against the government that
How Tight Was Russia's Safety Net in the Face of the Crisis?
by Michael Lokshin and Martin Ravallion
The financial crisis that hit Russia in Aug ust 1998 combined a  after the crisis. The data suggest that the crisis affected urban
devaluation of the ruble, default on domestic and foreign debts,  households more than rural ones. The fall in mean expenditure
and a collapse of the stock market and major commercial banks. was about 27 percent in urban area and 21 percent in rural
It effectively deprived most Russians of their savings and un-  areas.
dermined their trust in financial institutions.
How did the social safety net respond to such a shock? There
A nationally representative sample of Russians, interviewed  was less money available-on average, government transfers
shortly after the 1998 crisis, had suffered a widespread dete-  fell by 18 percent between 1996 and 1998. Allocation improved,
rioration in welfare compared with their position two years ear-  however. Transfers increased by almost 100 percent for house-
lier. Current expenditures had generally contracted more than  holds with expenditures of less than half the poverty line, even
incomes. Even poor households had cut spending relative to  though the number of households in this group doubled. Pay-
income, probably because they not only had less money, but ments to other poor households also grew appreciably. The main
also feared worse times ahead.                         increase was in pensions. The average monthly pension re-
ceived by households from the poorest group rose from 28 to
Average household income was 20 percent lower in real terms.  142 rubles, up more than a fivefold in real terms. Family allow-
The share of wages in total income fell from 41 percent to 36  ances and social aid to poor households declined, though not
percent and the share of income from government transfers  enough to outweigh the gains in pensions. The safety net's re-
rose. However, the average amount of government transfers  sponse reduced the impact of the crisis by helping some previ-
decreased by 18 percent in real terms. The share of home pro-  ously poor families escape poverty, but it fell far short of what
duction in income increased from 15 percent to 21 percent,  was needed to protect living standards.
and the real value of income from this source also rose. This
was evidently part of a private coping mechanism. Help from   Based on the authors'paper: "Welfare Impacts of Russia's 1998
relatives was 40 percent lower in absolute terms.      Financial Crisis and the Response of the Public Safety Net."
Martin Ravallion's email address is mravallion@worldbankorg
Total household expenditure fell by 25 percent, while the pov-  and his postal address until 7/2000 is ARQADE, Manufacture,
erty rate increased sharply, from 22 percent to 33 percent just 21 Allee de Brienne, 31 000 Toulouse.
*  TRANSITION, February 2000                                       (C 2000 The World Bank/The William Davidson Institute



Table 2. Percentage of Pro-Yeltsin Vote in 1996 and Household per Capita In- To sum up, policy reform must always be
come, by Job Type                                                        considered in a political-economic con-
text. The Russian government's electoral
ncomeatthetimeofvote   strategy paid off-the winners from a
Percentagemof(1000  bes atim  of flawed privatization were more vocal and
Percentage of           (1000 rubles at       better organized than the losers-but it
Job position                Yeltsin vote            1993 prices)a        better organized than the loser-uti
*                                                     ~~~~~~~~~~~~~~~~~~~~~~is hardly sustainable, given the large num-
Top managers                    90.9                    27.3             ber of losers, and it cannot be repeated
Heads of divisions             82.3                     16.3            indefinitely. Nor is it any way to construct
Professionals                  77.6                     12.3             a stable democracy. That requires insti-
Clerical employees             73.3                      9.5            tution building, and that is the greatest
Skilled workers                66.5                     10.0            theoretical and practical challenge for the
Unskilled workers              67.7                      8.4             next stage of the reform process in Rus-
Agricultural skilled workers    47.0                     7.0             sia and many other transition countries.
Peasants                       42.9                      5.0
Average                         73.1                    11.8             Ethan B. Kapstein is Stassen Professor
a. Dollar exchange rate in 1993: $1 = 664 rubles.                        of Intemational Peace at the University
Source: authors compliation.                                             of Minnesota and Branko Milanovic is
Principal Economist with the Policy Re-
presided over their impoverishment: 51  Moscow were 9 percent more pro-Yeltsin  search Division, the World Bank.
percent of pensioners (although that was  than those who lived in small cities (although
the lowest percentage of any social group),  residents of large cities other than Moscow  This article is based on the authors' pa-
66 percent of unskilled workers, and 42  were no likelier to support him). Finally, per: 'Dividing the Spoils: Pensions,
percent of peasants still voted for Yeltsin. women were 7 percent more likely (all else  Privatization, and Reform in Russia's
In Russia, with its lack of civil society and  being equal) to vote for Yeltsin.  Transition," No. 292, March 2000. To or-
organized contestation, no effective
counter-balance to rent-seeking by the  These results are hardly unexpected-but  der: Patric3a Sade, room M23-556, tel.
managerial class emerged. Russian labor they indicate that the losers in transition (the  202-473-3902,'fax:0521, ne
and small business interests remained  aged and those who lacked education, in-  mail:psader@worldbank.org, Internet:
weak, disorganized, and depoliticized.    come, and hope) were less likely than the  http:/Amwww.worldbankorglresearch/working
winners to support the government. Pen-  papers. The authors may be contacted
Winners Take All?                   sioners shared most of these "negative"  at ekapstein@hhh.umn.edu and bmil
characteristics and voted accordingly.  anovic@worldbank.org.
Further analysis of the figures shows that
voters' social groups or jobs were not the   Polluted Rivers in Hungary
most important factors in deciding whether .___
they supported Yeltsin. Other variables  7                     t
such as income, education, location, ex-
pected change in status, and gender took
precedence. For example, young people
with high incomes who lived in Moscow, 
had some university education, and were
optimistic (that is, expected their status to    -.  ,. .      j-                                    -
improve in the next two years) tended to       .. :  -          ;
voteforYeltsin.Avoterwhomovedfromthe
median income to an income higher than                  . . *            e
90 percent of the population (with all other  x                >            _                         _
factors held constant), was 9 percent more   -                    . S>
likely to vote for Yeltsin. People with some  "Since the river was poisoned no one eats the fish, but Lochness is
university education were 12 to 15 percent            interested in buying these creatures."
more likely to vote for Yeltsin than those who
had attended technical college. People in From the Hungarian daily N6pszabdsag.
C 2000 The World Bank/The William Davidson Institute                               TRANSITION, February 2000   C



Mirror, Mirror on the Wall ... Russia's Public Opinion Polls Track Changes in Reform Sentiment
by Larissa Kosova
Russians'views of economic transition depends on their pro-  berswho feltthattheir social status had worsened peaked again
fession, political views, and social position. The Russian Cen-  after the 1998 crisis, but there was some recovery in 1999.
ter for Public Opinion and Market Research has been surveying
Russian public opinion for 10 years, providing researchers and  Russian society is split into separate social universes, and the
politicians with data for analyzing the response to transition.   division is growing wider. In one universe are people who feel
their social status is improving. They are younger, better edu-
Reform attracts about the same support and opposition now  cated, earn relatively well, want a high level of consumption,
as when it began in 1992, with one-third of the adult population  and are always ready to adapt to changes. They are confident
approving and one-third disapproving. Those proportions have  that if they lose one job they will find another. They have cre-
not been constant, however. During Gaidar's premiership, sup-  ated a new fabric of social relationships, forming independent
porters outnumbered opponents two to one. Support for reform  social organizations without a political agenda. This is how 15
was also high during the presidential election campaign in 1996.  to 20 percent of Russian think and live.
It fell after the crisis in 1998, but has risen again by fall 1999.
In the other social universe, people's social status is declining.
The pro-reformers are generally younger, more urban, with a  They have low salaries, increasingly isolated status, poor social
higher level of education. They are more apt to take initiative,  connections, a shrinking social space, and falling living standards.
more competitive, and better prepared to take responsibility  They are in insecure jobs or are unemployed, and they have lost
for their decisions. Opponents of reform tend to be those whose  hope of improving their circumstances in the near future. About
careers or sociai status have suffered during the transition years.  40 percent of the population lives in this universe. Another 40 per-
Their quality of life and self-respect have deteriorated. Quite a  cent believe their social status has not change much in the past 5
few recall with nostalgia a stable and more comfortable life un-  years-they, however, live in unstable stability.
der Communism.
Figure 2. How Would You Evaluate the Living Standard
In January 2000,43 percent of respondents felt that their social  of Your Family?
status was worse than it had been five years before, and 43
percent felt that it remained the same. Only about 14 percent  100l                                 Very bad
felt that it had improved. This group grew between 1994 and   75
1997, but was reduced by the crisis of 1998. After one year                                         Bad
their share fluctuated again around 14 percent.         50
Figure 1. Perception of Social Status Changes           25                                          Acceptable
0                                          Very good
60  .        .a
c~~~~~~~~~ E                                 L     t            Ž    ,  '. ff
50~ ~~~~~~~~~~~~~~. ;c~                               ~ _~~ ~ '        c, C§ -; u    @  
40   .... .Sed .........---                                         W
40 .-. .Steady./-                            I      Larissa Kosova is a senior researcher at the Russian Center
30              -............... ............... ..... for Public Opinion and Market Research (VCIOM), 16,
Worsening                          Kazakova Str., Moscow, 103064. tel.: 7 095-265-5026, fax.:
20  -------- ------- ------- ------- ------- ------- -------
7-095-261- 8870, email:lkos@wciom.ru. VCIOM's Web site:
1 0-. .                    ..- ..                   http://wwwwciom.ru/HOME_EHTM
O        I        I         I    Improvincl
1994.9 1995.9 1996.9 1997.9 1998.7 1999.1 2000.1    VCIOM is the largest independent research company in Rus-
sia. Its research network comprises 28 regional offices. Field-
work is done by 3,000 specially trained interviewers. Their
In September 1996, following the presidential elections, the  standard national sample comprises 2,100 respondents.
number of respondents who felt that their social status was un-
changed was one-third lower than in 1995, and the number of  We appreciate Irina Klytchnikova's valuable help with the
those who felt that it was worse was 1.5 times higher. The num-  translation.
* TRANSITION, February 2000                                        (C 2000 The World Bank/The William Davidson Institute



The Baltics and Russia: Privatization Dilemmas on
Different Levels
It is instructive to compare privatization dilemmas in the Baltics and Russia. The discussions below are based on recent publica-
tions by the Bank of Finland Institute for Economies in Transition (BOFIT).
Baltic Privatization Compared-Most Industrial Enterprises Privatized
by Seija Lainela
Estonia's privatization process was virtually complete by 1996, All these factors have contributed to Estonia's success. It has
so only a few industrial enterprises remain for divestiture. Latvia's  the lowest unemployment rate in the Baltics and has weathered
large-scale privatization did not start until the mid-1 990s, but is  the effects of the Russian crisis well. Lithuania still has much to
now largely complete. In both countries open tenders and direct do to enhance the functioning of its markets.
sales to strategic investors both at home and abroad have been
the preferred approaches to privatizing medium-size and large  As Baltic privatization has entered its last phase-sell-off of large
enterprises, because they aim at securing long-run viability. For  infrastructure enterprises-the process has again become more
large enterprises, once a strategic owner has been found, public  contested and time-consuming. The most important sectors up
auctions and offerings are used to divest the remaining state  for divestiture are energy and transportation. The Baltic econo-
ownership.                                             mies are heavily involved in cargo transit to and from Russia.
Lithuania chose a different strategy, launching a voucher-  In Estonia the biggest enterprises slated for privatization include the
based mass privatization program as early as 1991 and re-  Estonian Railways, theoil-shale-buming powerstationsin Narva, and
stricting foreign ownership. This tended to favor enterprise  the portof Tallinn.Although theirprvatization has been putoff forsome
insiders-the employees and managers. Mass privatization was  time, it is hoped that the railways at leastwill be sold this year.
abandoned after the 1996 parliamentary elections in favor of di-
rect sales and tenders. Since then medium- and large-scale  Latvia made little progress last year in privatization because
privatization has gathered speed and foreign ownership has  of disagreement on methods and friction between politically pow-
become increasingly significant. Even so, several hundred com-  erful industrial groups. The sell-off of the two largest remaining
panies remain to be privatized.                        infrastructure enterprises-the shipping company LASCO and
parts of energy producer Latvenergo-should go ahead this year.
Open tenders and direct sales tend to instil better corporate gov-
ernance and stronger financial position in enterprises than mass  In Lithuania privatization of one of the two state-owned banks is
privatization or insider deals. The presence of foreign investors  foreseen this year, and the sell-off of the other is under prepara-
with greater management experience and access to financing  tion. Restructuring of Lithuania's heavily subsidized energy sec-
(factors typically in short supply in transition economies) also  tor is long overdue. The government has approved plans for the
enhances development of the enterprise sector.         splitting and partial sell-off of the national gas and power com-
panies. Political resistance to privatization of state-owned as-
The creation of new private enterprises is also important in  sets is rather strong, and the opposition has demanded a halt to
the process until after the parliamentary elections in autumn 2000.
building a well-functioning market economy. New enterprises                 pr
absorb workers made redundant by privatization and restruc-  To sum up, privatization in the Baltics has now reached utilities
turing of state enterprises, hence smoothing the transition so-  production and other monopolized sectors, making the creation
cially. The emergence of new enterprises has been especially  of an efficient regulatory framework for securing competition and
notable in Estonia, where the institutional setting is considered  fair pricing necessary. Guided by relevant EU regulations, this
favorable for entrepreneurs. In Lithuania red tape and frequently  work is under way in all countries.
changing business regulations are identified as major hin-
drances. Functioning bankruptcy legislation is also essential  Seia Lainela is an economist at the Bank of Finland Institute for
in imposing financial discipline on the enterprise sector and  Economies in Transition (BOFIT). This article was published by
enhancing the operation of markets. Again, Estonia is at the  the institute in Baltic Economies-The Quarter in Review No 1/
forefront among transition economies in establishing stringent  2000, February 2000. It is on the institute's Web site: http://
and effective bankruptcy procedures.                   www.boffil/bofitl
© 2000 The World Bank/The William Davidson Institute                                TRANSITION, February 2000



New Wave of Privatization in Russia? The Policy Choices
By Juha Honkkila
The means and policy priorities of privatization and enterprise reform in former socialist economies have been debated for a
decade. In most transitional economies the process has been relatively successful. Ownership and control rights structures have
evolved very much in line with privatization theories.
One popular argument says that there is a policy trade-off be-  rent rates of nonpayment of taxes it is impossible for local or
tween finding efficient owners and maintaining social justice. On  central governments to improve their budgets. Moreover, the
the one hand, comprehensive restructuring of enterprises requires  public will turn against reform if the expected losers cannot be
vast amounts of physical and human capital, and the easiest  compensated by social security.
solution is to sell firms to their core owners. On the other hand,
selling all state assets to insiders creates an inequitable distri-  The Russian government needs to be considerably stronger and
bution of wealth, which, together with a large increase in unem-  wealthier before it can attempt any shock-therapy type changes
ployment, makes most of the population losers in the reform  in the ownership structure of firms. There also needs to be an
process. Gross inequity hurts the aggregate welfare of the  appropriate legal and institutional background that encourages
economy, delays further reforms, and possibly leads to a decline  enterprises to start behaving in a more market-oriented fashion.
in future growth prospects.
Juha Honkkila is an economist at the University of Helsinki.
Most privatization plans have included a mix of voucher schemes  This article is excerpted from "What are the Policy Choices for
and insider privatization as ways to compensate probable los-  Enterprise Reform in Russia?" published by the Bank of Fin-
ers and preserve the popularity of enterprise reform policies. In  land Institute for Economies in Transition in Russian
principle, vouchers provide everyone with an equal chance to  Economy-The Month in Review, No. 2 March 2000.
get part of the economy's assets and gain from transition. In fact,
evidence from the former socialist economies shows that the  Bank of Finland Institute for Economies in Transition, P 0. Box
objectives of voucher privatization have often not been achieved.  160 FIN-00101 Helsinki. Tel. 3589-183-2268, email: bofit@bof.fi
Russia is probably the worst example. Income inequality is ap-  Intemet: wwwbof.fi/bofit
proximately at the level of Latin American countries and higher
than in other transition economy. Mass privatization has in few
cases led to meaningful changes in the control rights structure
and behavior of firms.
Enterprise reform needs to be far more broadly based.
* First, the Russian economy needs large-scale institutional
changes to make the enterprise sector work more efficiently.
Changing ownership rights from public to private did not lead to
the required improvements in enterprise management, and hope-
fully the Russian government has learned this lesson. Simply
changing legal ownership rights does not necessarily improve
anything.
* Second, eliminating demonetization of the economy needs to
be a top priority. A market economy cannot function as long as
enterprises prefer barter trade to money. Without the proper leg-
islation, straightforward settlement of inter-firm contracts remains
problematic.
"I bought a nice car to be able to properly represent
* Third, the government faces an equally critical problem with           our poor province."
tax payments. The Russian public sector cannot support very
much more unemployment, even in the short term. With the cur- Cartoon of Kong Ding (Beijing)
i  TPANSITION, February 2000                                       C 2000 The World Bank/The William Davidson Institute



A Blueprint for Dismembering the World Bank Group?
The Recommendations of the Meltzer Commission, and a Response from World Bank President
James D. WVolfensohn
On March 8, 2000, the bipartisan International Financial Institution Advisory Commission, chaired by Allan Meltzer, political
economy professor at Carnegie Mellon University published a report, commissioned by Congress, recommending drastic
changes in the organization and function of the World Bank and other intemational financial institutions including the IMF In the
following, we present some contentions and proposals of the report that relate directly to the World Bank. President Wolfensohrls
response was published a few days later on the Washington Post's op-ed page.
From the Meltzer Commission's Report
In keeping with a mission to alleviate pov-  of last resort. This recommendation would  velopment agency concurs with the merit
ertyinthedevelopingworld, the World Bank  ensure that development aid added to  oftheproposal,thecountrywould receive
claims to focus its lending on the countries  available resources.        a loan with a subsidized interest rate. The
most in need of official assistance because                               extent of the interest rate subsidy would
of poverty and lack of access to private  Performance-Based Grants. Grants  rangefrom 10percentto90 percent, as in
sector resources. Not so. Seventy percent should replace the traditional World Bank  grant financing of user fees.
of World Bank nonaid resources flow to 11  tools of loans and guarantees for physical
countries that enjoy substantial access to  infrastructure and social service projects.  To underscore the shift in emphasis from
private resource flows. (The share of this  In poor countries without capital market lending to development, the name of the
group grew from 63 percent to 74 percent  access, poverty alleviation grants to subsi-  World Bank should be changed to World
between 1993 and 1999: China received  dize userfees should be paid directlytothe  Development Agency. Similar changes
12 percent,ArgentinalO percent, Russia 9  supplierupon independentlyverified deliv-  should be made at the regional develop-
percent, Mexico 7 percent, Indonesia 7  eryofservice. Fromvaccinationsto roads,  mentbanks. Developmentagenciesshould
percent, Brazil 7 percent, Korea 6 percent,  from literacy to water supply, services  be precluded from financial crisis lending.
India 4 percent, Thailand 3 percent, Turkey  should be performed by outside private  All country and regional programs in Latin
3 percent, and Philippines 2 percent of  sector providers (including NGOs and  America and Asia should be the primary
nonaid resources).                   charitable organizations) as well as by pub-  responsibility of the area's regional banks.
lic agencies. Service contracts should be  The World Bank should become the princi-
The development banks [the World Bank  awarded on competitive bid. Payments  pal source of aid forAfrica until the African
and the regional development banks] must should be made directly to suppliers. Costs  Development Bank is ready to take full re-
be transformed from capital-intensive  should be divided between recipient coun-  sponsibility. The World Bank would also be
lenders to sources of technical assistance,  tries and the development agency. The sub-  the development agency responsible for the
providers of regional and global public  sidy would vary between 10 percent and  fewremainingpoorcountriesinEuropeand
goods, and facilitators of an increased flow  90 percent, depending on capital market the Middle East.
of private sector resources to the emerg-  access and per capita income.
ing countries. The focus of their individual                              The World DevelopmentAgency should con-
financial efforts should be on the 80 to 90  Institutional Reform Loans. Institutional  centrate on the production of global public
poorest countries of the world that lack  reforms lay the groundwork for productive  goods and serve as a center for technical
capital market access.               investmentand economicgrowth. They pro-  assistance to the regional development
vide the true long-term path to end poverty. agencies. Global public goods include treat-
All resource transfers to countries with ac-  Reforms are more likely to succeed if they  ment of tropical diseases and AIDS, ratio-
cess to capital market access or a per  arise from decisions made by the devel-  nal protection of environmental resources,
capita income of more than $4,000 should  oping country. Lending frameworks, with in- tropical climate agricultural programs, devel-
be phased out over the next five years.  centives for implementation, should be  opmentofmanagementand regulatoryprac-
Starting at $2,500 per capita income, offi-  redesigned to fit the needs of the poorest tices, and inter-country infrastructure.
cial assistance should be limited. Emer-  countries that do not have capital market
gency lending should be the responsibility  access. Each developing economy should  In its reduced role, the World Development
of the IMF in its capacity as quasi lender  present its own reform program. If the de-  Agency would have less need for its cur-
(D 2000 The World Bank/The William Davidson Institute                               TRANSITION, February 2000  m



rent callable capital. Some of it should be  creased provision of global public goods.  International Finance Corporation should
reallocated to regional development agen-  Independent evaluations of the agency's  become an integral part of the redefined
cies, and some should be reduced in line  effectiveness should be published annually. World Development Agency. Its capital
with a declining loan portfolio. The income                              base would be returned to shareholders
from paid-in capital and retained earnings  Investment, guarantees, and lending to  as existing portfolios are redeemed. MIGA
should be reallocated to finance the in- the private sector should be halted. The  should be eliminated.
Limiting the Scope of the World Bank
by James D. Wolfensohn
During the past few days a good deal of coverage has been  The loss of the Bank's cross-regional perspective and the syner-
focused on the Meltzer Commission Report on the international gies it generates would hurt everyone-especially the poor of
financial institutions, and what it might mean for the World Bank.  the developing world. But the burden would fall heaviest on the
Let me take this opportunity to lay out some real concerns that 2.2 billion people living on less than $2 a day in Asia and Latin
we at the Bank have, and also to set the record straight.  America, since the Bank would no longer be involved in country
programs there.
We are, of course, pleased that the issue of poverty reduction
should be headline news. We share the commission's concern  Reflecting other commission recommendations, we also
that more must be done by all the players in the fight against would need to withdraw from important country programs in
poverty, and we applaud all who broach this difficult subject. We  Europe, such as Poland, where we have supported the cre-
also welcome the commission's call for debt relief, and we hope  ation of market-friendly legal and regulatory frameworks and fi-
that funding support from Congress will follow it. This is crucial.  nancial sector and health care reforms.
Weneverthelessbelievethatanumberofthecommission'spro-  Nor do the commission's recommendations seem to be sup-
posals are based on a fundamental misreading of the develop-  ported by sound analysis and careful use of statistics. The report
ment challenges we face today. Poor people in developing  states that 70 percent of the World Bank's nonconcessional lend-
countries will be the losers if these proposals are implemented.  ing goes to 11 countries that have substantial access to capital
If the World Bank were to withdraw entirely from Asia and from   markets, but it ignores the fact that these countries are home to
Latin America; if it were to stop lending to countries with a per  more than 60 percent of the poor people in the developing world.
capita income above $4,000 a year, it would cut out the  The report's authors also fault the bank for neglecting its own
marginalized, the poorest, the excluded who live in these coun-  insight that aid can be effective only in countries with good poli-
tries.                                                 cies. But in 1997-99, the best-performing countries annually re-
ceived almost five times more International Development
Private sector investors will not fund the improvements in health, Association resources per capita than poor performers.
education and other essential public services that people need
to pull themselves out of poverty. Moreover, if the World Bank  We have changed, and we are changing. By the late 1990s, the
were to stop lending for anti-corruption work, good governance,  financial sector and the social sectors, such as education and
regulatory reform, and institution building it would cease to cre-  health, absorbed about a quarter each of total annual World
ate the kind of enabling environment that can attract private funds  Bank lending, up from around 5 percent each during the early
to countries and areas that currently receive little. No other orga- 1 980s. None of this is reflected in the commission's report. Nor
nization is doing this work on a global scale.        is the fact that our operational performance has improved mark-
edly over the past few years. Instead, the report bases much of
A critical strength of the World Bank is its ability to learn from  its argument on a distorted use of statistics on Bank effective-
developing countries in all regions of the world and to reflect those ness.
lessons in its policy advice and operations and in its global re-
search programs. Under the commission's proposal to devolve  We welcome debate. But we need to test the commission's rec-
country programs to regional development banks, our clients  ommendationsagainstthechallengesthatwefaceontheground
would be limited to countries in Africa, the Middle East, Europe,  every day. Unfortunately, against this measure I believe that many
and the former Soviet Union. This would undermine the World  of them significantly miss the mark.
Bank's global character at the very time that the demands of glo-
balization are pointing in the opposite direction.     Published in the Washington Post, March 13, 2000, Page A17.
*  TRANSITION, February 2000                                     (D 2000 The World Bank/The William Davidson Institute



Challenges Facing China at the Turn of the Century
by Chi Fulin
Reforms propelled China to sustained and rapid economic growth in the past 20 years. Now, however, the country-just like other
nations-faces new challenges presented by globalization and the rapid advance of new technologies. In this constantly chang-
ing international and domestic environment, further reform is crucial. Economic reform, by strengthening markets and removing
institutional barriers, will foster China's integration into the world economy and its ability to compete intemationally.
F     or the past 20 years China's aver- velopment. The government must also  A major ingredient of this restructuring
age annual economic growth has  end state monopolies, introduce deregu-  must be the transformation of state-owned
been 9 percent, but GDP per-  lation, and encourage competition. Be-  enterprises into stockholding companies.
capita is only about $800. By international  cause of overindustrialization under the  The joint stockholding structure mobilizes
standards, China would be defined as a  planned economy, traditional industries  capital in a way ideal to the needs of so-
low-income developing country. Thus there  occupy too great a share of the national  cialized mass production. Rapid transfor-
is great potential for further economic  economy at the expense of services.  mation of state-owned enterprises will not
growth. In the past two years, China has  Market constraints are retarding industrial  only help to overcome the present capital
been plagued by deflation. Although the  growth, but the service sector has been  shortage, but will also contribute to a
expansionary monetary and fiscal policies  unable to replace industry as the major  healthier economic structure.
adopted by the government halted the eco-  driving force of the economy. For ex-
nomic slide, they could not restart growth.  ample, red tape and lack of real compe-  The stockholding company structure is
This demonstrates that institutional barri-  tition have hindered the performance of  based on clear ownership rights that le-
ers need to be removed to allow success-  China's aviation industry and communi-  gally separate the enterprise from state
ful macroeconomic policies.          cations sector. The underdeveloped ser-  administration and will encourage inves-
vice sector is also failing to satisfy public  tors to buy state assets. Improving the
Removing Institutional Barriers      demand.                              growth potential of these companies by
diversifying their equity structures should
These barriers obstruct China's enormous  Transferring Ownership          also increase the value of the remaining
potential for private investment, given to-                               state-owned shares. The system is flex-
tal savings by enterprises and the public  The fall in demand after the Asian finan-  ible enough to allow the most profitable
of more than 6,000 billion yuan. Although  cial crises affected China's economic  enterprises to increase capital at rela-
investments by the state have an impor-  performance. The Chinese economy si-  tively low cost, so capital will flow to the
tant role in stimulating the economy to  multaneously produces relative sur-  most competitive industries. The stock-
eliminate deflationary trends, their major  pluses and relative shortages. While  holding system also improves corporate
function should be to support private invest-  some manufactured goods and com-  governance, with the responsibilities of
ment. From 1980 to 1997, nonstate invest-  modities are oversupplied, financial ser-  owners, managers, and workers clearly
ment increased by 27.3 percent annually,  vices, housing, education, and medical defined.
9 percent more than state investment. But care are scarce. In the past two years,
in 1998, the nonstate economy invested  as prices in the service sector crept up,  The restructuring should begin with the con-
11.6 percent less then the state, primarily  many industrial products were marked  version of 10 or 20 large flagship state en-
because investment in manufacturing in-  down. From 1995 to July 1999, the av-  terprises into stockholding companies. To
dustries had reached saturation, while bar-  erage price of services increased by 42  encourage private capital to invest, the gov-
riers deterred badly needed nonstate  percent, an average annual increase of  ernment should issue convertible bonds
investment in the service sector. Further  12.4 percent                   with a value of 15-20 billion yuan ($2-2.5
reform is needed to open up new invest-                                   billion) to support the transformation.
ment channels and mobilize savings.  Restructuring the state sector is urgent, as
the 4th Plenum of the 15th Communist  Next, there should be vigorous yet prudent
Increased investment in services such as  Party National Congress agreed. The qual-  corporatization of enterprises in the infra-
transport, communications, finance, insur-  ity and speed of this strategic restructur-  structure sector, drawing domestic and
ance, education, and technology is not,  ingwilldirectlyinfluenceChina'slong-term  foreign capital into telecommunications,
however, enough to ensure vigorous de-  economic development.             civil aviation, power generation and dis-
©D 2000 The World Bank/The William Davidson Institute                               TRANSITION, February 2000   i



tribution, and transport. At present,  is the leading issue. How can the costs of to shares. This capitalization of land-use
China's infrastructure is dominated by  reform be shared among different social  rights would stimulate investment in, and
state enterprises, which is not condu-  groupswithoutcausingtoomuchdistress?  developmentof,theruraleconomy.
cive to competition, the mobili-           How can people be provided with
zation of private savings, or the          the necessary public goods with-  Two other important issues should also be
provision of good services.                out increasing the costs of social considered in the context of China's stra-
Transformation of state-owned              reform? People will have a better  tegic transformation: opening China's mar-
companies in this key sector               idea of what to expect if they un-  ket, and reforming the government and the
would also significantly improve           derstand the general intentions of  political system.
the macroeconomic situation.               economic reform.
Opening China's market will accelerate
The transformation of state-owned          More people will share the ben-  China's economic growth and stimulate
commercial banks must also be started-     efits of reform if we encourage  domestic enterprises to compete interna-
even if gradually-to strengthen their capi-  stock ownership by employees, and stimu-  tionally and domestically. Globalization
tal reserves and improve competitiveness.  late private ownership of housing and the  makes the opening of the market inevi-
The huge pool of bad debts is an undesir-  enhancement of farmer's rights.  table, so reform should concentrate on up-
able legacy of the planned economy. As a                                 grading industries and attracting foreign
solution, many banks are swapping debt  Employee stock ownership plans should  investment. Deep-seated market-oriented
forequity, butthe state-owned commercial  be adopted through a combination of pur-  reform and an open market are the keys
banks are still heavily burdened with low-  chase and free allocation of shares, rec-  to integrating China into international so-
quality assets. Through restructuring and  ognizing the property-rights of labor. In the  ciety.
private investment, the banks' shortcom-  past two decades, various kinds of part-
ings can be overcome and the quality of nership and employee stock ownership  During China's economic transition, the
their assets improved. The opening of plans have been widely adopted in West-  government has a crucial role in macro-
China's financial sector to the global  ern market economies to coordinate the  economic regulation, maintenance of
economy is inevitable. State-owned com-  relationship between employers and em-  market order, improvement of the mar-
mercial banks should be able to sell part  ployees and improve the benefits man-  ket environment, and strategic restruc-
of their shares to private investors (or in- agement of companies. An effective  turing of state enterprises. It is therefore
vestmentfunds mobilizing the population's  incentive system can optimize the combi-  imperative to reform the government,
savings), and private investors' plans to  nation of human and material resources,  streamline public administration, and re-
create new financial institutions should be  giving a long-term impetus to company de-  adjust the relationship between govern-
encouraged. The earlier reform begins, the  velopment. I believe that the essence of a  ment and enterprises according to the
better.                             socialist market economy is the people's  requirements of the market. The govern-
market economy, recognizing labor's  ment should no longer be the owner of
Getting Rich Together               property rights. Reform can proceed with  enterprises but should instead carry out
vigor and dynamism only if the interests of its public administrative role more effec-
Deng Xiaoping made it clear that the aim  employees are identical with the interests  tively.
of reform should be "getting rich to-  of the company.
gether." Economic reform must therefore                                  Reform of the political system has become
benefit the majority of the people. The  Housing construction should be stimulated  a basic condition for deepening economic
essence of reform is to readjust benefits  by state-subsidized loans at low or even  reform. Economic reform is linked with all
and gradually reassess property owner-  no interest, the provision of tax benefits, aspects of social and political life, for it
ship. Clear and regulated property rights  and the elimination of various fees. This  brings about wide reallocation of benefits.
are an important stimulus to economic  would contribute to economic growth and  It should be placed at the top of the reform
growth.                             social stability, given the current situation  agenda. Reform of the political system and
of the macro economy and state banks.   changes in the government's role should
As people begin to worry about job secu-                                 go hand-in-hand with the economic reform
rity, the initial enthusiasm for economic re-  Farmers should be entitled to long-term  process.
form has dissipated. We must ask whether  and guaranteed land-use rights. They
there is any realistic possibility of constant should be able to use land rights as collat-  Chi Fulin is executive director of the
improvement in workers' long-term income  eral for bank loans, or as their contribution  China Institute for Reform and Develop-
in a period when reallocation of benefits  to an investment project that entitles them   ment (CIRD) in Haikou, Hainan Province.
*  TRANSITION, February 2000                                      C) 2000 The World Bank/The William Davidson Institute



China Gets Ready for Debt-Equity Swaps
In the first half of 1999, about one-third of China's large and medium-sized state enterprises were making losses. The financia'
position of the state sector has since improved, because demand has risen and costs have fallen. There has also been pressure cn
state enterprise managers to improve performance. Nonetheless, state enterprises still face a serious shortage of funds for cuirent
liabilities and investment in technical upgrading. Aside from the closure of firms without a commercial future, there is a need for
financial restructuring and organizational overhaul. The same holds true for banks.
Over the last few years banks have become more discriminating in  additional funds for investment in technological upgrading, and
extending credit, and the major commercial banks have all reported  pave the way for stock market listing. The purchase of the debt is
a sharp rise in profits for 1999. However, banks' balance sheets  equivalent to writing off the banks' nonperforming debt and pro-
remain burdened by nonperforming loans resulting from poor lend-  viding them with additional capital. Both processes have been
ing policies. (By Chinese standards, a nonperforming loan is one  going on for some time, piecemeal and on a small scale.
that has not been serviced for a year or more; the international stan-
dard is six months). About 20 percent of outstanding loans are offi- The institutional vehicles of the swap are financial intermediar-
cially considered nonperforming, most of them owed by large state  ies created for the purpose. There are now four such asset man-
enterprises. Byinternationalstandards,someofChina'scommer-  agement corporations, each paired with one of the main
cial banks are insolvent.                               commercial banks: Cinda (Construction Bank of China), Great
Wall (Agricultural Bank of China), Oriental (Bank of China), and
Inadequate capital and heavy nonperforming loan burdens are just  Huarong (Industrial and Commercial Bank of China). Cinda was
two of the major problems faced by commercial banks. Another is  the first to be established, in April 1999, and the others were set
their organizational weakness. China's commercial banking sec-  up in the last quarter of 1999, Huarong being the last.
tor is highly centralized, and while hugely overstaffed is short of
personnel familiarwith international financial practices. The bank-  Although paired with commercial banks, asset management
ing system needs reorganization as well as recapitalization.  corporations are meant to be independent financial institutions
under the regulatory oversight of the People's Bank of China (the
The financial restructuring of state enterprises and cleansing of central bank). However, their institutional links with the four com-
the balance sheets of commercial banks have become more  mercial banks remain ambiguous and will need to be clarified
urgent as negotiations for China's entry into the World Trade  as the debt-equity swap proceeds and the asset management
Organization (WTO) have gained momentum. WTO membership  corporations begin disposing of their equity stakes. Their initial
will commit China to a timetable for the lowering of barriers  capital of 10 billion yuan ($1.2 billion) each comes entirely from
against imports and the entry of foreign firms into a wide range  the finance ministry. They are expected to raise additional capi-
of industries. It will also involve the opening of domestic financial  tal by selling bonds and, in time, by listing on stock exchanges.
markets to foreign institutions. To prepare for increased compe-  They are created for only 10 years, with the possibility of an ex-
tition, the Communist Party leadership has directed that the trans-  tension by the central bank.
formation of medium-sized and large state enterprises into
modern, market-oriented firms be completed by the end of this  The asset management corporations' terms of reference give them
year. The four main commercial banks are also to be transformed,  a wide field of operation, including debt-equity swaps, securitized
into share-holding corporations with equity listed on domestic  lending, preparation of enterprises forstock market listing, project
and foreign markets. This transformation is built on a reduction  evaluation, bond issues, and financial and legal consulting. At
in banks' nonperforming loans and their recapitalization.  present they are concentrating on debt-equity swaps, which are
restricted in various ways by their terms of reference:
The centerpiece of the financial restructuring of state enterprises  * The swaps are confined to debts contracted before 1996, to
and the four main commercial banks is the government's plan  prevent banks and enterprises from engaging in reckless lend-
for a massive debt-equity swap. The debt to be swapped is about  ing and borrowing in response to the program.
half the outstanding loans of the banking sector. Broadly there  * The debt must be owed to the four main commercial banks or
will be two linked transactions, the swap of selected enterprise  to the State Development Bank. The State Development Bank
debt for equity, and the purchase of the swapped debt from banks. was established in 1994, partially with the aim of taking over the
nonperforming loans of the four commercial banks. The swap
The swap of debt for equity is intended to reduce the leverage  explicitly excludes the debts of the country's scores of invest-
(debt-to-equity ratio) of state enterprises-estimated to be  ment trust companies and credit cooperatives, many of which
around 70 percent of assets on average-provide them with  are also laden with nonperforminq loans and some of which have
© 2000 The World Bank/The William Davidson Institute                                 TRA\NSmON, February 2000  I



defaulted on their obligations.                        would be the case in a market economy, at a knock-down price.
0 State enterprises are selected for the swap not by asset man- They will also acquire an equivalent equity stake in debtor enter-
agement corporations alone, but jointly with the State Economic  prises, which may be sold to a third party or bought back by the
and Trade Commission (SETC), the super-ministry responsible  enterprise. Enterprise managers and existing owners want to
for industrial restructuring and regulatory oversight of the state  have the option of purchasing back their equity, but asset man-
sector. The volume and composition of debt to be swapped is  agement corporations are opposed to any restrictions on the
decided by the SETC in consultation with the finance ministry.   disposal of their equity stakes.
Given the massive financial benefits they promise, the swaps  It is accepted that the proceeds from the sale of the equity will fall
are keenly sought by state enterprises. By the end of 1999,  shortoftheoutlaysonthepurchaseofthedebt. Unlikedebt-equity
2,000 large and medium-size state enterprises had applied  swaps in market economies, China's is loss-making by design
to participate in the scheme. Of these, 601 firms have been  and has no immediate costsforthe enterprises orbanks involved.
selected. To qualify, they must be loss-making large enter-  Thefinanceministryiscommittedtocoveringthedeficitofasset
prises in industries designated by the government as "key" or  management corporations. Although this guarantee is not open-
"pillar;" they should have undertaken key state projects, the  ended, itmayproveverycostlyforthegovernment.
implication being that their debts result partly from obligations
imposed on them by the government; and they should be po-  The debt-equity swap program should, overthe next few years,
tentially viable, with marketable products, a high level of tech-  lead to a huge expansion of China's equity market and overseas
nology, and good operational and managerial structures. The  listings. It will also facilitate an organizational restructuring of en-
plan is to swap debt worth 459.6 billion yuan ($5.4 billion), terprise groups. It is, however, highly unlikely to solve all the ma-
53.1 percent of the total outstanding loans of the banking sec- jor problems of the state industrial and financial sectors. After
tor at the end of 1997.                                the swap, the government will still have to deal with many poorly
performing state enterprises.
The swap will consist of two transactions. The asset manage-
ment corporations will purchase the designated debt of the com-  This article is based on a report by Oxford Analytica, the inter-
mercial banks with which they are paired at face value, not, as  national research group based in Oxford, United Kingdom.
Milestones of Transition
How green is your country? A new in-  the "second wave" entrants, the others be- According to preliminary information from
dex to measure countries'compliance with  ing Malta, Bulgaria, Romania, and Slovakia.  Estonia's national statistics office, the
environmental standards was announced  For the purposes of entry talks, EU legisla-  country produced 12 percent less milk and
by the World Economic Forum in Davos.  tion and rules are divided into 31 topics or  11 percent fewer eggs last year than in
TheEnvironmentalSustainabilityIndexis  "chapters." Latvia has announced readi-  1998. The number of cattle also fell.
designed to track and rank 56 countries.  ness to start discussion on 15 chapters that  Latvia's grain harvest was 19 percent.
According to the initial findings, Norway is  pose no major hurdles. It needs time to pre-  smaller than in 1998 and beef production
theworld'smostenvironmentallyfriendly  pare the remaining 16 chapters, which in- fell 14 percent. Grain production in
country, while Vietnam is the least so. Swit-  clude agricultural policy and environmental  Lithuania fell 25 percent last year, while
zerland had the best institutions for enforc-  regulations. Lithuania is prepared to start  milk and egg production fell about 10 per-
ing environmental compliance. The index  talks on seven chapters. Among the new  cent.
project was financed by a $200,000 grant  hopefuls, Latvia is seen as the second most
from a nonprofit Canadian foundation. It advanced candidate after Malta. Both Latvia  Croatia
uses data from local governments, the  and Lithuania hope to complete their mem-
OECD, and the World Bank.           bership negotiations during 2002.    New economic program. This year's
budget will be 5 percent smaller than last
Central Eastern Europe              Baltic agricultural output down last year's in nominal terms, Finance Minister
year. All Baltic countries recorded signifi-  Mate Crkvenac announced. Inheriting a
EU Negotiations start with Latvia,  cant drops in agricultural output last year.  depressed and chronically mismanaged
Lithuania. The Baltic states have begun  The devaluation of the ruble in fall 1998
talks on joining the European Union with  halted their agricultural exports to Russia.  Continued on page 31
m  TRANSITION, February 2000                                     (C 2000 The World Bank/The William Davidson Institute



Letter to the Editor
Common Law as the Economic Locomotive-Really ?
"Laws are a dead letter without courts to expound and define their true meaning and operation"(Alexander Hamilton).
I have no problem with Paul G Mahoney's  the Continent, and crucial distinctions exist  not advisable: bereft of tradition and inti-
opinion thatcommon-lawcountrhesmight  between Britain and the United States, as  mate understanding of what the rules are
have experienced a stronger economic  Rainer Grote persuasively and clearly ex-  meant to achieve and how they are sup-
growth cyclefrom 1980to 1997thancivillaw   ploresinhisarticle"RuleofLaw, Rechtsstaat  posed to be applied, itwill create adverse
countries ("The Common Law and Eco-  and Etat de Droit" in Constitutionalism,  results in the host country. Interpretation
nomic Growth: Hayek Might Be Right," Tran-  Universalism and Democracy: A Com-  of statutory regulations will breed more
sition, December 1999, 10(6): 28). It might  parative Analysis, (Christian Stark, ed.)  predictable results. Also the countries of
also be a fair conclusion that the more pri-  Nomos Ed., Baden-Baden, 1999, page 269  the former Soviet Union do have a "code
vate sector friendly approach in the former  sequitur. This legal tradition has led England  tradition," however faint. Therefore it
("property and contract") might have some-  to have no constitution but still one of the  seems to be bad advice to persuade
thing to do with it. I disagree, however, that  most powerful judicial checks on the legality  them to change course onto a more risky
currently the civil law countries (of Europe)  of laws and administrative acts.  path.
have weaker administrative controls by the
judiciary than common law countries, and  This is precisely the reason, however, why  Hans-Werner Wabnitz, counsel, World
that implanting a very new and alien legal  "implanting" the common-law system is  Bank, LEGAF, hwabnitz@worldbankorg.
philosophy and its consequences into de-
veloping "transition countries"-notably the
former Soviet Union-would strengthen eco-         .                        'e4 _
nomic development there.       _
Germany, for instance, which has influenced
to some degree legal history and legal devel-
opment in eastem countries, has a very strong                                          ___________-__
administrative law review system. Indeed,     ' 
there is an entire judicial branch solely con-
cerned with the legality of administrative
acts-structures similarto the civil courts, with    -        d     E
a Federal Administrative Supreme Court          -                        ! _ i
(Bundesverwaltungsgericht) at its head. The
constitutional court (Bundesverfassungs-
gerichf) has the constitutional right to check
the constitutionality of laws, and hear com-  _       -                        pLw, '
plaints that a law is unconstitutional and there-                                   NO..' ^             _
fore administrative action based on it that
damages the plaintiffs interests should be
voided.                                                                                 ___ _,
France has a different history, but its
Conseil d'Etat (infamous recently because
of its President, Roland Dumas) has its
own, different rulesforthe control of admin-                    '   '-
istrative acts, which are also, to a certain           _
extent, reviewed by ordinary courts.
TheAnglo-Saxon legal history and system
is indeed peculiar and quite different from From the World Press Review/BaslerZeitung
(C 2000 The World Bank/The William Davidson Institute                                  TRANSImION, February 2000



Targeting EU Accession in the First Wave
Interview with Pavol Hamzik, Slovakia's Deputy Prime Minister
Slovakia would like to conclude accession negotiations with the European Union by 2004 andjoin the EU with the first wave of
new entrants, according to Deputy Prime Minister Pavol Hamzik, the chief Slovakian negotiator. Hamzik is also responsible for
Slovakia's relations with other intemational organizations, including the OECD and NATO.
Q.Afterex-PremierMeciar's call foraref-  lists other qualifications for entry, in-  A. We would prefer to have more inflow of
erendum that would force early elec-  cluding promoting competitiveness  foreign capital and foreign direct investments,
tions and bring him back to                    through enterprise restruc-  but the boom that started in the early 1990s
power, the European Commis-                    turing, financial sector re-  is over. Slovakia's regulations and taxes are
sionerfor Enlargement, Gunter                  form, an investment-friendly  comparable to other central European coun-
Verheugen, described the do-                   environment, and sound  tries, andwewillfurtherimprovethem. The
mestic political situation in                  bankruptcy law.             same applies to the bankruptcy framework-
Slovakia as "rickety and com-                                              parliament will debate amendments to the
plex." What are the chances of         .       A. We opened the country after  bankruptcy law to provide greater protection
early elections?                               the 1998 elections, not only po-  to creditors. It is linked to EU accession, but
litically, but also economically, to  also to our forthcoming OECD entry.
A. Vladimir Meciar's initiative                foreign investors and enter-
has no support within the coalition, nor ma-  prises. Hopefully we will join the OECD this  Q. How is the World Bank helping the
jority backing in Parliament. And most citi-  year. And, of course, we have to be com-  accession process?
zens- according to opinion polls-will not  petitive once we get inside the Union. That
go to the ballot boxes. And without the ap-  applies to all frontrunners, notjust Slovakia.  A. Ourgovernment and the World Bank are
proval of at least 51 percent of voting-age                                putting together a country assistance strat-
citizens, no earlyelectionswill be held! This  Q. Is then Slovakia a frontrunner?  egy, a framework that prioritizes economic
initiative is part of Meciar's political game,                             and social policy measures that the World
but I don't think he will be successful. De-  A.Absolutely. We lost a couple of years, we  Bank is willing to support. Discussions with
spite the painful restrictive measures the  were not invited to the 1997 opening of the  the Bank are ongoing, to extend assis-
government had to introduce last year in  accession negotiations, but we can catch  tance in a broad range of sectors to help
order to stabilize the economy, we avoided  up, and are convinced that by 2004-this a. us to pursue the necessary reform agenda.
sliding into recession, and that also  realistic date-togetherwith Hungary, Po-  One major issue is restructuring of banks
helped keep the political situation stable.  land, and other countries of the so-called  and enterprises. We are negotiating about
Visegrad Group, we will be officially ac-  an Enterprise and Financial SectorAdjust-
Our current account deficit that stubbornly  cepted into the Union. Slovakia is not too  ment Loan. Financing public sector re-
remained in the 10percentrangeofGDP   much behind. We went through the indi-  form, including anticorruption, public
between 1996 and 1998, dropped to 5.6  vidual screening of chapters [the various  management reform, and fiscal decentrali-
percent in 1999. The budget deficit also  sectorsthatarereviewed accordingtotheir  zation, is also a high priority on the
declined, from 5 percent of GDP in 1997  readiness for accession] and the Commis-  government's agenda. The social sector
and 1998, to less than 4 percent in 1999.  sioner recommended to open eight chap-  reform includes pension and social ben-
Interest rates fell from about 30 percent at  ters with us in the course of negotiations  efits, health, and education. We expect the
the fall of 1998 to 10 percent now. We also  during the Portuguese presidency. The  Bank to provide loans that help finance
lowered corporate income tax from 40  Czechs and Hungarians both started with  these fiscal expenditures in the next three
percent to 29 percent. Economic growth  seven chapters, so it is a good signal for  years. As Slovakia enters the ELI, the coun-
was a modest 1.9 percent last year, but  us.According to the Commission's report,  try "graduates," and will not take further
still much betterthan zero growth, as pre-  Slovakia's preparedness is good, espe-  loans from the Bank. But until then, we
dicted by most international institutions.   cially where legislation is concerned.  count on its support. It augurs well that co-
operation with the Bank's tearn is excel-
Q. Besides meeting the stabilization  Q. What about the other criteria: creat-  lent, they are doing an outstancling job, as
targets, how will Slovakia assure a  ing an investment-friendly atmosphere,  has been proved with the preparation of
quick accession to the European  supporting small and medium-sized en-  the enterprise and financial sector adjust-
Union? The Accession Agreement  terprises, reforming the administration?  ment project.
*  TRANSITION, February 2000                                       © 2000 The World Bank/The William Davidson Institute



Closeup: The Stockholm Institute of Transition
Economics (SITE)
SITE is a private, nonprofit foundation located at the Stockholm School of Economics. Its founders include the Swedish
government and private companies. Its Director is Erik Berglof.
Research: Theoretical and Policy Ori-  in London, and the Departement et  International Networks
ented                               Laboratoire d'Etudes Theoriques et
Appliqu6es (DELTA) in Paris. RECEP of-  SITE collaborates closely with CEPR, of
Research at SITE tackles the institutional  fers an academic environmentfor high-qual-  which most SITE researchers are fellows
challenges of economic transition. SITE  ity, policy-relevant research on the Russian  or affiliates. In July 2000 SITE/RECEP
researchers work on issues such as the  economy. The project is integrating RECEP  will co-organize, with the World Bank and
development of financial systems and  into the international research community  the William Davidson Institute, CEPR's
corporate governance institutions, the role  and increasing the Centre's contribution to  large annual conference on transition to
of the government in promoting or under-  the policy process and public debate in Rus-  be held in Moscow. In its activities, SITE
mining market institutions, and the evolu-  sia. (See www.recep.org for information on  also works with the European Centre for
tion of public sector institutions and  faculty research-including papers pre- Advanced Research in Economics and
regulatory frameworks. Understanding  sented at RECEP's annual conference in  Statistics (ECARES) in Brussels, the
the role of institutions-functioning banks,  December 1999-and activities.)  Brookings Institution, the Eurasia Foun-
reliable civic institutions, and the enforce-                            dation, the Institute of Economic Transi-
ment of laws and contracts-requires not SITE is now spearheading a similar ini-  tion at the Bank of Finland, the University
only theoretical tools but also empirical  tiative, the Baltic International Centre for of Amsterdam, and others.
study. SITE leads a number of interna-  Policy Studies (BICEPS) in Riga, to at-
tional projects to improve the quality of tract back students from the West to an  SITE disseminates research on transition
data in transition countries. SITE re-  exciting research environment and involve  through its Working Paper series and
searchers have collected extensive data  them in the policy process in the Baltic  through the Transition EconomicsAbstract
at the microeconomic level (firms and  countries. In addition, SITE is supporting  Series (TEASE). The Stockholm Report
households), both from official sources  capacity-building projects at the New  on Transition shares policy implications
and through surveys in transition coun-  Economic School and Economics Edu-  of research findings with government and
tries. For example, SITE has built up the  cation research Consortium (EERC) in  business audiences. The widely known
largest and most reliable databank avail-  Moscow, the European University in St. Russian Economic Trends, written at
able on Russian enterprises.        Petersburg, the Kiyv-MohylyAcademy in  RECEP, is the top publication on the Rus-
Kiev, CERGE-EI in Prague, and Central  sian economy. SITE will also launch, in
Building Local Capacity              European University in Budapest.    spring 2000, Baltic Economic Trends.
An important part of SITE's mission is to
assist transition countries in developing
their own centers of research and knowl-       E    r     ;
edge and building local capacity in teach-
ing and applying modern economics. SITE
has recruited the first Russian graduates
of top Western Ph.D. programs to return
to work in Russia, at the Russian European
Centre for Economic Policy (RECEP), a
Tacis (European Union) funded, Moscow-
based research and policy think tank.
Since 1997 SITE has managed and devel-
oped RECEP, with two partners; the Cen-
tre for Economic Policy Research (CEPR) From the World Press Review
C 2000 The World Bank/The William Davidson Institute                               TRANSITION, February 2000  *



SITE Working Papers
We review two recent SITE papers. The first is a result of the ongoing research on Russia's industry. Most SITE and RECEP
Working Papers are downloadable at: www.hhs.se/site and wwwrecep.org.
Annette N. Brown, Barents Group, and J. David Brown, SITE, The Transition of Market Structure in Russia: Economic Les-
sons and Implications for Competition.
Using a wide variety of indicators, the authors analyze how the  dustrial structure is experiencing dramatic changes. The size
industrial structure of Russia is changing during transition, and  distribution of firms is generally converging to that found in the
whether these changes are promoting competition. They then  United States. Manufacturing concentration is increasing on av-
investigate the economic processes that direct these changes  erage, but these averages mask huge structural changes. Prod-
and econometrically test several hypotheses concerning the de-  uct concentration is decreasing. The various structural changes
terminants of market structure. They find that the Russian in- suggest that the potential for competition is improving.
Ekatherina Zhuravskaya, SITE/RECEP, Incentives to Provide Local Public Goods: Fiscal Federalism, Russian Style, SITE
Working Paper 153, 2000.
Over the past decade the fiscal power of the regional govern-  bargaining between the regions and the federation-that is, be-
ments increased enormously. Economic models of federalism  tween the localities and the regions.
generally emphasize beneficial effects of decentralization and
especially the importance of competition between regions to at-  The author (RECEP Academic Director; Ph.D. Harvard Uni-
tract mobile voters or capital. In Russia, however, regions com-  versity 1998) is the first holder of a Hans Rausing Assistant
pete not only to provide public goods efficiently but mostly in other  Professorship in a joint appointment between SITE and RECEP
ways. The Russian system of inter-governmental relations en- A 10-yeargrantto SITEfrom the Fannyand Leo KoernerChari-
courages government officials at all levels to neglect tax collec-  table Trust funds these academic positions for Russian gradu-
tion, disregard requests of the federal center, overspend, and  ates returning to work in their home country. She is also the
subsidize inefficiently. The lack of clear division of responsibility  winnerof the Young Economists Competition of the Nobel Sym-
with regard to revenues and expenditures results in constant posium.
Conference for the Record: The Economics of Transition-Nobel Symposium in Economics
September 10-12,1999, Stockholm, Sweden
International Program Committee: Olivier Blanchard (MIT), G6rard Roland (ECARE).
Local organizers: Erik Berglof (SITE), John Earle (SITE, Central European University).
In September 1999 SITE organized the fifth Nobel Symposium on economics, which brought some 50 leading economists from 14
countries to Stockholm. The symposium, devoted to the economics of transition, took stock of the accumulated research in the aea
and identified the remaining open questions. Theoretical and policy-oriented work was presented in six academic sessions (see
below). Janos Kornai (Harvard University and Collegium Budapest) presented the keynote address. Afinal, open session featured
a summary by Olivier Blanchard and G6rard Roland with comments by Joseph Stiglitz and five policymakers from transition coun-
tries, including former Russian prime minister Yegor Gaidar.
The following papers were presented at the symposium (downloadable at wwwhhs.se/site):
Andrew Berg, Eduardo Borensztein, Ratna Sahay, and Jeromin  Grabbing Hand: The Determinants of Unofficial Activity in
Zettelmeyer (IMF), The Evolution of Output in Transition  69 Countries.
Economies: Explaining the Differences.
Roman Frydman (NewYork University), Cheryl Gray (World Bank),
Tito Boeri (IGIER-Bocconi), Transition with Labor Supply.    Marek Hessel (Fordham University), and Andrzej Rapaczynski
(Columbia University School of Law), When Does Privatization
Eric Friedman (Rutgers University), Simon Johnson (MIT), Daniel Work? The Impact of Private Ownership on Corporate Per-
Kaufmann, and Pablo Zoido-Lobaton (World Bank), Dodging the  formance in the Transition Economies.
M   TRANSITION, February 2000                                     C) 2000 The World Bank/The William Davidson Institute



Hehui Jin (Stanford University), Yingyi Qian (Stanford University),  Eric Maskin (Harvard University) and Chenggang Xu (London
and Barry R. Weingast (Hoover Institution, Stanford University),  School of Economics), Soft Budget Constraint Theories:
Regional Decentralization and Fiscal Incentives: Federal-  From Centralization to the Market.
ism, Chinese Style.
Yingyi Qian (Stanford University), G6rard Roland (Universite Libre
Simon Johnson (MIT), Daniel Kaufmann (World Bank), John  de Bruxelles), and Chenggang Xu (London School of Econom-
McMillan (UC San Diego), and Christopher Woodruff (UC San  ics), Coordinating Changes in M-Form and U-Form Orga-
Diego), Why Do Firms Hide?: Bribes and Unofficial Activity  nizations.
after Communism.
Daniel Treisman (UC Los Angeles and Hoover Institution), The
Simon Johnson (MIT), John McMillan (UC San Diego), and Chris- Causes of Corruption: A Cross-National Study.
topher Woodruff (UC San Diego), Contract Enforcement in
Transition.                                            Alwyn Young (University of Chicago), The Razor's Edge: Dis-
tortions and Incremental Reform in the People's Republic
Dalia Marin (University of Munich) and Monika Schnitzer (Uni- of China.
versity of Munich), Disorganization and Financial Collapse.
TEASE: Transition Economics Abstract Series
One of SITE's most far-reaching dissemination initiatives is  the transition economies may obtain free subscriptions by con-
TEASE, an electronic journal of abstracts of new and signifi-  tacting the publisher (subscribe@ssm.com).
cant theoretical and empirical work (edited by Erik Bergl6f).
The emphasis is on economic approaches to transition, but TEASE Advisory Board:
contributions in the border area of political science and eco-
nomics, as well as law are considered. The journal, with both  PhikopAhin, Univrsit egse,r
i-Masahiko Aoki, Stanford University
Working Paper and Accepted Paper components, also in- Kenneth Arrow, Stanford University
cludes listings of professional announcements and job open-  Olivier Blanchard, Massachusetts Institute of Technology
ings in the field. TEASE is disseminated via the Economics  Irena Grosfeld, DELTA, Paris
Research Network (ERN), published under the auspices of Bengt Holmstrom, Massachusetts Institute of Technology
Social Sciences Electronic Publishing. See the TEASE Web  Janos Kornai, Harvard University and Collegium Budapest
site for downloadable papers and information about ERN's  Gur Ofer, New Economics School, Moscow
extensive range of electronic abstract journals: www.ssrn.com/ Richard Portes, London Business School
ern/index.html.                                        Yingji Qian, Stanford University
G6rard Roland, ECARE, Free University of Brussels
Jeffrey Sachs, Harvard University
For a trial subscription to TEASE, email: trial@ssrn.com. To  Andrei Shleifer, Harvard University
submit an abstract for consideration, send the abstract and the  Hans-Werner Sinn, University of Munich
full paper by email to Minea.Hedlund@hhs.se. Readers from  Jan Svejnar, University of Michigan and CERGE-EI, Prague
Russian Economic Trends (RET)
Russian Economic Trends (co-editors Niina Pautola and Pe-  economic indicators, and are available free of charge at
terWestin, RECEP, Moscow) is the leading publication of analy-  www.hhs.se/site.
sis and statistics on the Russian economy. Written by a team of
top Western and Russian research economists, RET brings to-  For RET subscription information, see www.blackwell
gether research results, monitoring of macroeconomic devel-  publishers.co.uk/ruet. Mailing address: SITE, Stockholm
opments, special reports on topics of current interest, and  School of Economics, Box 6501, SE-113 83 Stockholm, Swe-
extensive data in graph and table form. The quarterly edition,  den, Sveavagen 65, 9th floor tel.: 468-736-9670, fax.: 468-
with special reports based on RECEP and SITE research on  316-422  Email: SITE@hhs.se, Erik Berglof, Director:
the Russian economy, offers unique analytical depth. Monthly  Erik.Berglof@hhs.se; Jody Lanfrey, Executive Officer:
issues comment on current economic events and update key  Jody.Lanfrey@hhs.se.
© 2000 The World Bank/The William Davidson Institute                                TRANSITION, February 2000   C



THE WILLAAM DAVIDSON INSTITUTE
AT THE UNIVERSITY OF MICHIGAN BUSINESS SCHOOL
Equity Market Development in Emerging and
Transition Economies
Summary of papers from an international conference held in Amsterdam in December 1999
byAnna Meyendorff
F  inancial sector development remains an important com- veloping Economies: The Case of WestAfrican Banks," discuss
ponent of reform for even the most advanced of the tran-  the restructuring of the WestAfrican banking sector following a
sition economies. The development of effective banks  severe crisis in 1987 and 1988. Using stylized facts from the
and equity markets that provide capital for domestic firms is a  West African case, they argue thatforeign ownership of the bank-
prerequisite for long-term and sustainable economic growth.   ing sector may be destabilizing in the absence of a strong regu-
latory commission. This analysis is based on the assumption that
While the globalization of financial markets provides access to  foreign investors will choose a high-risk high-return strategy as
capital for some small segment of firms in emerging market long as Western African risks are idiosyncratic and not corre-
economies, either through listing abroad or through foreign di-  lated with global risk.
rect investment in the local banking sector, this access cannot
replace domestic financial institutions for the majority of firms.   The Creation of Equity Markets
A recent conference, co-sponsored by the William Davidson In- The second issue is the design and performance of fledgling
stitute, Amsterdam Center for International Finance Research,  equity markets in transition and emerging economies. The first
the Tinbergen Institute, and the International Review of Finance  two papers relate to the challenge of creating equity markets in
highlighted several aspects of development of the financial sec-  economies where market reforms are only beginning to take hold.
tor in transition and emerging markets.                The second two papers extend this discussion by providing evi-
dence that emerging equity markets have a long way to go be-
Banking Crises                                         fore they can catch up with developed equity markets.
The first issue, discussed in two papers, is the optimal policy for  Utpal Bhattacharya (Indiana University) is concerned with pre-
avoiding bank crises in the context of a troubled banking sector.  conditions for the proper functioning of equity markets, in his
Both papers challenge commonly held views of how to deal with  paper titled "On the Possibility of Ponzi Schemes in Transition
banking crises in transition economies. Jenny Corbett (Oxford  Economies." He argues that transition economies are the ideal
University and Centre for Economic Policy Research) and Janet  breeding grounds for Ponzi, or pyramid, schemes, in which a
Mitchell (Facultes universitaires Saint-Louis, European Center  self-interested promoter persuades people to invest their funds
forAdvanced Research in Economics and Statistics, Centre for  in a pseudo investment company with the promise of high re-
Economic Policy Research, and William Davidson Institute), in a  turns. Returns to early investors are paid from deposits by later
paper titled "Banking Crises and Bank Rescues: The Effect of  investors, rather than from actual earnings. The conditions that
Reputation," present a theoretical model that analyzes bank res-  allow Ponzi schemes to arise, and the resulting loss of faith in
cue packages and bank responses to offers of rescue made  "investment companies" and other financial institutions, make the
during a banking crisis. By taking into account bank managers' subsequent creation of equity markets extremelydifficult. (Ex-
reputational concerns, they show that banks may reject recapi-  cerpts from this paper are included below).
talization even when associated conditions are not very strict.
Wolfgang Aussenegg (Vienna University of Technology), in a
Jean PaulAzam, Bruno Biais, and Magueye Dia (Toulouse Uni-  paper titled "Going Public in Poland," links the privatization of
versity), in a paper titled "Privatization versus Regulation in De- Polish firms with the development of the stock market. Looking
*  TPANSITION, February 2000                                      (C 2000 The World Bank/The William Daviclson Institute



at the performance of three types of listings on the Warsaw Stock  those with no controlling shareholder, while foreign controlled firms
Exchange (including private sector initial public offers, or IPOs,  perform better than either. Stijn Claessens (World Bank), Simeon
individual privatizations, and listings through the mass  Djankov (World Bank and Centre for Economic Policy Research),
privatization program), he argues that the Polish government used  Joseph Fan (Hong Kong University of Science and Technology),
the stock market to build up a reputation for its privatization policy  and Larry Lang (Chinese University of Hong Kong) examine a
by underpricing IPOs. (The government sets a starting price for similar issue for nine East Asian economies in "The Rationale
an enterprise it is privatizing, and if the price is low, it generates  for Groups: Evidence from East Asia." Taking into account both
a lot of activity in the stock market.)                the benefits of diversification and the costs of expropriation by
controlling shareholders, they find that, on balance, group affilia-
Bernardo Bortolotti, Marcella Fantini, and Carlo Scarpa  tion is associated with lower firm valuation.
(Fondazione Eni Enrico Mattei, Milan), in "Why Do Governments
List Privatized Companies Abroad?", examine factors that lead  Simon Johnson (Massachusetts Institute of Technology and Wil-
governments to let privatizing companies list on international as  liam Davidson Institute), Peter Boone (Brunswick Warburg),
well as domestic capital markets. They find that in emerging  Alasdair Breach (Russian European Centre for Economic Policy),
markets, lower stock market liquidity is correlated with listing  and Eric Friedman (Rutgers University) link weak legal institu-
abroad, while in advanced market economies the reverse is true.  tions for corporate governance to the extent of stock market de-
clines in the Asian crisis of 1997-98, with a particular emphasis
Ian Domowitz (Pennsylvania State University), Jack Glen (Inter-  on the legal mechanisms that prevent managers from expropri-
national Finance Corporation), and Ananth Madhavan (Univer-  ating minority shareholders. (Excerpts from this paper are included
sity of Southern California) also compare equity markets in  below).
emerging and developed market economies, analyzing differ-
ences in trading costs. In their paper, titled "Liquidity, Volatility, Anna Meyendotff is a FacultyAssociate at the William Davidson
and Equity Trading Costs Across Countries and Over Time," they  Institute.
find that there is a wide variation in one-way equity trading costs
across countries, and the transactions costs are higher in emerg-  All of these papers will be made available as Davidson Institute
ing markets. The implication is that firms in emerging markets  Working Papers on the WDI Web site at www.wdi.bus.umich.edu,
can reduce their cost of capital by listing on developed country  or can be obtained by contacting Sharon Nakpairat at
markets.                                                shronch@umich.edu.
Ownership and Governance
Recent working papers of the
The third issue relates equity markets to firm ownership and cor-  R  .  .  .                    t
porate governance. The first three papers evaluate ownership  William  Davidson Institute:
forms that are more common in emerging than in developed mar-  www.wdi.bus.umich.edu
kets, namely business groups and family-controlled firms. The last
paper steps back to analyze the effect of these alternate gover-  Boeri, Tito. Transition with Labour Supply. No. 274, Decem-
nance structures on vulnerability to global financial instability.  ber 1999.
Raja Kali (University of Arkansas), in "Business Groups, the Fi-  B  C      .                            . i
Bai, Chong-En, David D. Li, Yingyi Qian, and Yijiang Wang. Lim-
nancial Market and Economic Development," argues that diver-  .  .
iting Government Predation Through Anonymous Bank-
sified business groups may facilitate economic development by  ing: A Theory with Evidence from China. No. 275, December
allowing for some risk sharing among owners in the absence of  1999.
well-functioning stock markets.
Gaddy, Clifford, and Barry W. Ickes. Stability and Disorder:
Two papers test the relationship between ownership structure  A   vltoaynlsso  usasVrulEooy  o
and stock market valuation of the firm. Yupana Wiwattanakantang  276 DEcm  ber 1999.
(Hitotsubashi University, Japan), in "The Effects of Ownership  2
Structure and Corporate Governance on the Performance of Thai  King, Lawrence Peter. The Developmental Consequences of
Firms," investigates whether, in Thai firms, of which 80 percent  Foreign Direct Investment in the Transition from Socialism
are family controlled, controlling shareholders expropriate cor-
porate benefits in a way that has a negative effect on the firms'
value. Family controlled firms are shown to perform similarly to                          Continued on page 29
(D 2000 The World Bank/The William Davidson InstiLute                                TRANSITION, February 2000  m



On the Possibility of Ponzi Schemes in Transition
Economies
by Utpal Bhattacharya (Indiana University)
At the height of his success in Boston in 1920, Charles A. Ponzi was hailed by those he was cheating as the greatest Italian win
ever lived. "You're wrong, "he said modestly "there's Columbus, who discovered America, and Marconi, who discovered radio."
"But, Charlie, you discovered money" they told him.
T       he money-making machine that CharlesA. Ponzi invented  In this paper we argue that a Ponzi scheme is an ingenious
in Boston in June 1919 was elegant in its simplicity. It had  method to expropriate state assets by a politically well-connected
three critical components. First, he convinced a group of promoter in a transition economy. How? The promoter lures citi-
people about an investment idea (coupons issued by the Inter- zens with promises of incredible returns. The promoter exploits
national Postal Union seemingly violated the law of one price  their rational belief that, if enough of them take part, the assets of
and, therefore, offered an arbitrage opportunity); two, he prom- the state may be used for a bailout if the scheme fails. So the
ised them a high return on their investment (a 50 percent interest Ponzi scheme in a transition economy is really a cynical exploi-
every 90 days); and, three, he built credibility by initially deliver-  tation of the "too big to fail doctrine" by a private citizen. The
ing on his promises ( "interest plus principal" of the earlier "in- contribution of this paper is to detail how this can happen, and
vestments" was paid by money "invested" by those who were  then link our hypothesis and its implications to some spectacular
recruited into the scheme later).As his reputation spread byword  Ponzi schemes that have occurred in transition economies.
of mouth, people flocked from all over New England to invest.
Ponzi took in about $200,000 a day. The scheme finally crashed  A classic Ponzi scheme is an inverted truncated pyramid. The
when the Boston Globe exposed him in August 1920.      bottom is the mass of citizens participating in the first round, the
height is the total number of rounds, and the top is the mass of
Such types of schemes have existed before Ponzi and continue  citizens participating in the last round. A promoter sells certifi-
to exist after him. The first extensively recorded scheme, cov-  cates to the citizens in each round, promising them an attractive
ered by Mackay (1841), was conceived by a Scotsman, John  return per round on their investment. Since the money raised in a
Law, in France in 1719. It was immediately followed by the South  round is used to pay off the obligation of investors from a previ-
Sea Bubble in Britain in 1720. Today, thanks to the Internet, Ponzi ous round, the revenue of the promoter comes mostly from the
schemes are making a dramatic comeback.                sales in the initial round and sales in the last round, when the
promoter runs away with the money collected. Also, as a record
Financial economists have long been puzzled by Ponzi schemes  of successful payment develops and information about the fan-
because they seemingly violate the laws of rationality. An exten-  tastic scheme spreads by word of mouth (or click cf mouse),
sive literature has developed to analyze the conditions under  most of the costs of the promoter are the marketing costs of
which Ponzi schemes and other types of bubbles can arise in  reaching the initial group of citizens. The risk-neutral promoter
economies that go on forever. The existence of these conditions  designs the scheme to maximize expected profits. The promoter
ensures that it is rational for agents to participate in any round  has one constraint: citizens should participate in each round.
because they expect to close their position in a later round at a
gain. So the Ponzi scheme goes on forever.             The economic forces at work in the initial rounds are as follows.
As the Ponzi scheme is against the public interest, it is in the
To explain Ponzi schemes in economies that do not go on for-  interest of the state to intervene immediately. However, there is
ever, additional assumptions have been introduced. This litera-  no representative government in a transition economy that will
ture can be broadly classified into two strands. The first strand is  do this. Neither are the citizens pivotal enough to coordinate a
behavioral, and it assumes that some agents are irrational. The  stoppage. The only entity that can intervene is a regulator, who
second strand, maintaining neoclassical assumptions, has as-  trades off the public interest against the private interest of a po-
sumed something specific about the economy (agency problem, litical class to which this promoter is linked. So intervention is not
asymmetric information, and so on.) that drives the results. Our certain. The stronger the political connections of the promoter,
paper belongs to this second strand. Its purpose is to demon-  the lower the probability of intervention. In the initial rounds, then,
strate how an unscrupulous promoter can devise a Ponzi scheme  the promoter offers a return that is high enough to ensure that the
in a specific type of finite economy-a transition economy.  risk-neutral citizen's expected loss if the regulator intervenes is
*  TRANSITION, February 2000                                      ©) 2000 The World Bank/The William Davidson Institute



not greater than the expected gain if the regulator does not inter- scheme where the state may give only partial compensation.
vene. So the citizen takes part in these initial rounds.  This is possible because, unlike in the case of symmetric infor-
mation where there are two types of citizen participatory con-
The economic forces atwork in the last two rounds are different.  straints (the constraint for the initial rounds and the constraint for
The promoter plans to terminate the scheme after collecting  the last two rounds), there is nowjust one participatory constraint
money in the last round, if the scheme has not already been ter-  (a probability weighted sum of the two types of constraints, where
minated by the regulator. As money raised in any round is used  the probability is the rational expectations belief of the citizens
to pay off the obligation of investors from a previous round, the  that they are not playing the last two rounds). This allows the pro-
citizens who are affected are not only the participants in the last moter an additional degree of freedom in designing his Ponzi
round, but also the participants in the second-to-last round. They  scheme. In particular, he can compensate the citizen's increased
become very upset. Anger spurs coordination. They organize to  expected loss in the last two rounds (caused by a partial bailout)
use the state's assets for a bailout, and as the protesters are  with an increased expected gain in previous rounds.
many, and the size of the state assets is large, the probability of
this bailout is not zero. As our subsequent discussion will reveal, We characterize the sufficient conditions under which this con-
bailouts of Ponzi schemes from state assets have occurred. As  strained maximization problem of the promoter has a solution.
every citizen has an equal claim on the public assets, the bailout We find that the conditions that breed Ponzi schemes are:
amounts to a redistribution of wealth from nonparticipants to par-
ticipants. The parameters of the Ponzi scheme are set such that 0 A large public sector (the proportion of national wealth owned
the expected loss incurred by participating (the price of the cer-  by the state is above a lower bound).
tificate minus the expected net redistribution gain from the bail-
out) is not greaterthan the loss incurred by not participating (the  * Ambiguous laws governing the transferof property rights from
expected redistribution loss from the bailout). So the citizens take  the state to the citizen (victims of a failed Ponzi scheme may
part in these last two rounds.                        organize to use the state's assets for a bailout, the probability of
which occurring is above a lower bound).
The final participatory constraint is the one faced by the promoter.
We need to address why the promoter has to wait till the last * Political connections (the probability of early termination of the
round to run away with the revenues collected. The answer is that Ponzi scheme by a regulator is below an upper bound).
at every round, the promoter has to trade off the sure revenue
from terminating and running away now against the expected rev-  0 An inexpensive access to citizens through mass media (ad-
enue from terminating and running away a round later. The pa- vertising effectiveness is above a lower bound).
rameters of the Ponzi scheme are set to ensure that the expected
revenue from termination a round later is greater than or equal to  The above conditions may exist in transition economies. So it
the sure revenue from premature termination now in all rounds  may not be mere coincidence that some of the biggest Ponzi
except the last. In other words, the Ponzi scheme is subgame  schemes in history have occurred in these economies. A careful
perfect.                                              examination of four Ponzi schemes-two past and two recent-
suggests that one or more of the four factors described above
An important result of this paper is that under symmetric infor- may have existed in these countries when the Poonzi schemes
mation, where all citizens know which round they are playing, they  occurred. A reading of Mackay's (1841) account of the Missis-
would be willing to enter a Ponzi scheme whether the bailout is  sippi Scheme indicates that John Law's scam had the blessings
certain or only probable, as long as citizens believe that the bail- of the French state, whose finances were in a mess after the
out will compensate them for more than what they lost. Since  death of Louis XIV. According to Mackay, "He proposed to the
compensation has never been known to exceed loss, this is an  regent (who could refuse him nothing) to establish a company
unreasonable belief. So we can conclude that, since the condi- that should have the exclusive privilege of trading to the great
tions under which Ponzi schemes will germinate in finite econo-  river Mississippi and the province of Louisiana." In 1719, Law's
mies with symmetric information are unlikely to exist, Ponzi company, the Compagnie des Indes, was further granted the
schemes would be rare in such economies.               exclusive privilege of trading with the East Indies, China, and the
South Seas. John Law started his scheme that year. His scam
To obtain a Ponzi scheme under a more realistic regime of a  had the three critical ingredients of a classic Ponzi scheme: an
partial and uncertain bailout, we need asymmetric information. investment idea (a share in the profits that were to be made by
Under asymmetric information, where citizens do not know for trade with exotic lands), a promised attractive return (a 40 per-
certain which round they are playing but have a belief that holds  cent annual return on the shares of the Mississippi Company)
under rational expectations, we give an example of a Ponzi and an initial meeting of obligations (he delivered an annual re-
(D 2000 The World Bank/The William Davidson Institute                              TRANSITION, February 2000  m



turn of 120 percent initially). It also had one feature that Charles  after the collapse. Bailouts, however, were not promised to par-
Ponzi's scheme did not-intimate involvement of the ruling class. ticipants in the myriad smaller Ponzi schemes (like Tibet, Ruski
It should be also be noted that when the scheme collapsed, the  Dom Selenga, and Khopor) that had also sprouted.
holders of useless Mississippi stock were given 2.5 percent in-
terest-bearing notes thatwere securedby the municipal revenues  These themes were replayed on a smaller scale in other transition
of the city of Paris.                                  economies in the 1990s. Ponzi schemes were reported in Roma-
nia (600 schemes, the biggest of which was Caritas, which involved
The South Sea Bubble in Britain in 1720 was, as Garber (1990)  20 percent of the population, and promised 800 percent return in
aptly describes, a shadow of the Mississippi Scheme. The Whig  100 days), Bulgaria, the Slovakia Republic, Serbia, and the Czech
ministry had been dismissed, and public debt was at an astound-  Republic.
ing 10 millions sterling. In 1720 Parliament granted the South
Sea Company monopoly rights over trade with the South Seas  In 1997 there was a Ponzi scheme in Albania. Maksude Kademi,
and, in exchange, obtained attractive refinancing terms for the  Bakshim Driza, and Rapush Xhaferi had promised returns as high
state debt. The South Sea Company then acted like Law's com-  as 100 percent in six months and had sold their certificates to
pany: it issued successive rounds of stock that promised a share  about half the population. They attracted a sum thatwas aboutfour
of trading profits, delivered attractive initial returns (100 percent timesAlbania's state budget, twice its bank deposits, and roughly
return from February to April 1720), and then disintegrated. Par-  equal to its GDP. When their "foundations" collapsed, about a sixth
liament partially bailed out investors bywritingoff7.1 million ster-  of the population lost all their savings, and violent civil unrest
ling of the company's debt.                            erupted. A salient feature of the three Albanian schemes was the
role of the ruling class. State television actively promoted these
In Russia in 1994 the MMM scheme promoted by Sergei Mavrodi funds, giving the impression of official approval. Political parties
collapsed. He had promised annual returns of 2,000 percent, re-  endorsed them. Election posters often included the logos of the
cruited 5 million Russians, and become the sixth richest man in  funds. Finally, when the schemes collapsed, the government ac-
Russia. Notable features of this scheme were that the regulators  cepted "moral responsibility" to pay back at least some of the $370
did not initially discourage it and that there was a partial bailout  million lost (the annual state budget is $500 million).
Corporate Governance in the Asian Financial Crisis
by Simon Johnson (Massachusetts Institute of Technology and William Davidson histitute),Peter Boone (Brunswick
Warburg), Alasdair Breach (Russian-European Centre for Economic Policy), and Eric Friedman (Rutgers University)
W         A  /hat caused the large exchange rate depreciations  by domestic and foreign investors in all emerging markets. This
and stock market declines in some Asian countries  led to a fall in capital inflows and an increase in capital outflows
during 1997-98? The three main explanations for the  that triggered, in some cases, a very large nominal depreciation
Asian crisis emphasize macroeconomic and banking issues. and a stock market crash. The explanations do not address ex-
The standard Washington view attributes the Asian Crisis to  actly why this loss of confidence had such large effects in some
inappropriate macroeconomic policy during the 1990s, made  emerging market countries but not others.
worse by inept management of the initial depreciation in 1997
(Greenspan, Corsetti, Pesenti, and Roubini). In contrast,  This paper presents evidence that the weakness of legal insti-
Radelet and Sachs and Wade and Veneroso argue that the cri- tutions for corporate governance had an important effect on the
sis began with a mild panic that had no real foundation and  extent of depreciations and stock market declines in the Asian
was made serious only by IMF pressure to increase interest crisis. By "corporate governance" we mean the effectiveness
rates and to close down banks. Krugman presents a third theory  of mechanisms that minimize agency conflicts involving man-
based on international bank behavior by arguing there was a  agers, with particular emphasis on the legal mechanisms that
"Pangloss equilibrium" that caused a bubble in asset prices. In  prevent managers from expropriating minority shareholders.
his view, the Asian panics had their origins in implicit (and im-
plausible) guarantees offered by governments and believed by  The theoretical explanation is simple and quite complementary
investors.                                             to the usual macroeconomic arguments. If stealing by manag-
ers increases when the expected rate of return on investment
These explanations agree that for some reason, perhaps unre- falls, then an adverse shock to investor confidence will lead to
lated to economic fundamentals, there was a loss of confidence  increased theft and to lower capital inflow and greater attempted
*  TRANSITION, February 2000                                      (D 2000 The World Bank/The William Davidson Institute



capital outflow for a country. These, in turn, will translate into. In most of these instances, management was able to transfer
lower stock prices and a depreciated exchange rate. In the case  cash and other assets out of a company with outside investors.
of theAsian crisis, we find that corporate governance provides
at least as convincing an explanation for the extent of exchange  These assets may have been used to pay the management's
rate depreciation and stock market decline as any or all of the  personal debts, or they may have been used to shore up another
usual macroeconomic arguments.                         company with different shareholders, or they may have become
straight capital flight into a foreign bank account. The fact that
The Bangkok Bank of Commerce provides a well-documented  management in most emerging markets is also the controlling
case of expropriation by managers that worsened as the  shareholder makes these transfers easier to achieve. The down-
bank's financial troubles deepened. The experience of credi-  turns in these countries have been associated with significantly
tors in Hong Kong who lent to firms doing business in main-  more expropriation of cash and tangible assets by managers.
land China is similar-Hong Kong-based company liquidators
were not able to recover assets of Chinese companies that Our results highlight the importance of the legal protection af-
defaulted on loans (Wall Street Journal, August 25, 1999, p.  forded creditors and minority shareholders and are closely linked
A14.)                                                  to the recent findings of La Porta, Lopez-de-Silanes, Shleifer,
and Vishny. These authors show that the extent to which creditor
More generally, very few debt defaults from the Asian crisis of and minority shareholder rights are protected explains a great
1997-98 have resulted in investors receiving any liquidation  deal of the variation in how firms are funded and owned across
value. During the crisis, Korean minority shareholders pro-  countries. In particular, La Porta, Lopez-de-Silanes, Shleifer, and
tested the transfer of resources out of large firms, including  Vishny provide evidence from a sample of 49 countries that weak
Samsung Electronics and SK Telecom. Most collapses of shareholder rights and poor enforcement leads to underdevel-
banks and firms in Russia after the devaluation of August 1998  oped stock markets. Weak enforcement of shareholder rights
were associated with complete expropriation; creditors and  had first-order importance in determining the extent of exchange
minority shareholders got nothing.                     rate depreciation and stock market collapse in 1997-98.
Upcoming Davidson Institute Research Conferences, Workshops and
Executive Programs
Economic Development in South Asia                     Research papers in several areas of accounting (financial, mana-
April 8, 2000, William Davidson Institute, Ann Arbor, Michigan   gerial, tax, and so on.) addressing issues associated with tran-
sition or emerging economies will be presented. Papers will be
This one-day workshop will focus on pertinent economic issues  added to the Davidson Institute Working Paper Series. This con-
facing South Asia in general and India specifically. Leading schol-  ference is sponsored by the William Davidson Institute and is
ars of economic development who are doing current research  led by Professor William Lanen, Davidson Institute Area Direc-
on the region will present. Papers will be added to the Davidson  torforAccounting and Performance Issues, and the University of
Institute Working Paper Series. This conference is jointly spon-  Michigan.
sored by the Center for South and Southeast Studies at the Uni-
versity of Michigan and the William Davidson Institute and is led  Labor Markets in Transition Countries
by Professors Pradeep Chibber and Rohini Somanathan of the  May 25-27, 2000, Institute for the Study of Labor, Bonn,
University of Michigan and the William Davidson Institute.  Germany
Accounting Issues in Transition and Emerging Markets   This research conference will bring together leading scholars
April 13-15, 2000, William Davidson Institute, Ann Arbor,  of labor and human resource issues and will address questions
Michigan                                               such as labor demand, women in the workforce, wage differen-
tials, distribution of earnings, and labor market policies in a
This conference will bring together accounting researchers from   variety of transition countries. Papers will be added to the
around the world who share an interest in accounting issues in  Davidson Institute Working Paper Series. This conference is
these economies. The conference is limited to five or six papers  jointly sponsored by the William Davidson Institute and the In-
to ensure sufficient time for presentation and discussion.  stitute for the Study of Labor and is led by Professor Hartmut
C 2000 The World Bank/The William Davidson Institute                                TRANSITION, February 2000   U



Lehmann, Heriot-Watt University, and Katherine Terrell,  Econometrics Program
Davidson Institute Area Director for Labor and Human Resources  August 21-September 15, 2000, Economics Institute,
and the University of Michigan.                        Zagreb, Croatia
Human Resource Network Conference                     The Davidson Institute is sponsoring a program intended for
April 10-12,2000, William Davidson Institute,AnnArbor, Michigan  economists who want to understand and use basic econometric
techniques as taught and practiced in the West. Since most of
The Davidson Institute is sponsoring a three-day conference in  the econometric applications are based on the regression model
AnnArborformembers ofthe newlyestablished Human Resource  and its various extensions, a major part of the course will be de-
Network consortium. Membership is open to senior-level human  voted to these topics. Participants will learn about the assump-
resource executives from multinational and local companies with  tions underlying basic econometric models and will improve their
responsibilities for Central and Eastern Europe operations. Each  understanding of existing standard computer program packages.
meeting will focus on a specific topic as identified by the Network  Upon completion of the course, participants will be able to read
membership (for example, retention tools, compensation prac-  critically the results of most empirical research appearing in the
tices, labor law, localization, performance standards, process im-  literature and to apply the techniques learned in the course with
provement, teamwork, ethical issues, restructuring, and so on).  a good awareness of the pit falls involved.
Following the inaugural April event, two 1 -1/2 day workshops will be
held each year in rotating central locations, with presentations and  The program fee is US$2,000 (+22 percent VAT for Croatian
facilitated dialog led by both Network members and Davidson In-  residents). Tuition includes instructional materials, lunches, and
stitute faculty. The next meeting is planned to take place this fall in  coffee breaks. Fee is payable upon registration.
Vienna.                                               Information: Ms. Ana Kovacic, Program Administrator,
Ekonomski Institut, Zagreb, tel. ++123-35700, fax ++123-
Information: Dr. Sonia Ferencikova, HRN Director, tel.: 734 763- 35165, Email: ana.kovacic@eizg.hr.
5020, fax.: 734 763-5850, email: ferencik@umich.edu.
General Management Program: A Course for Senior Man- Recent working papers continued:
agers from Transition Economies                        www.wdi.bus.umich.edu
June 26-July 7, 2000, Zagreb, Croatia
Continued from page 23
The General Management Program is an intensive two-week
programdesignedforseniormanagersfromcompaniesintran-  to Capitalism: The Performance of Foreign Owned Firms
sition economies. In its third year, the program is geared to-  in Hungary. No. 277, December 1999.
ward individuals with an interest in general management
concepts that apply to more than one functional area of their  Kornai, Janos. The System Paradigm. No. 278, December 1999.
company. The courses combine theory and practice with case
studies and examples based on the Davidson Institute's expe-  Miwa, Yoshiro and J. Mark Ramseyer. The Value of Prominent
rience with companies operating in Central and Eastern Eu-  Directors. No. 279. December 1999.
rope. The program is conducted by leading business faculty
who have experience teaching in top-rated executive educa-  Hallagan, William, and Zhang Jun. Starting Positions, Reform
tion programs around the world and have worked with compa-  Speed, and Economic Outcomes in Transitioning Econo-
nies operating under new market conditions. Adept at facilitating  mies. No. 280, January 2000.
discussion and creating a learning climate, faculty are skilled
at making each session flexible to meet the needs and expec-  Alexeev, Michael, and James Leitzel. Income Distribution and
tations of the participants.                           Price Controls: Targeting a Social Safety Net During Eco-
nomic Transition. No. 281, January 2000.
The program fee is US$4,600 (+22 percent VAT for Croatian
residents). Tuition includes instructional materials, lunches, and  Fox, Merritt B., and MichaelA. Heller. Lessons from Fiascoes
coffee breaks. Fee is payable upon registration.       in Russian Corporate Governance. No. 282, January 2000.
Information: Ms. Ana Kovacic, Program Administrator,  Friebel, Guido, and Sergei Guriev. Why Russian Workers Do
Ekonomski Institut, Zagreb, tel.: 123-35700, fax.: 123-35165,  Not Move: Attachment of Workers Through In-Kind Pay-
email: ana.kovacic@eizg.hr.                            ments. No. 283, January 2000.
*  TRANSITION, February 2000                                     (D 2000 The World Bankf/he William Davidson Institute



Qian, Yingyi, Gerard Roland, and Cheng-gang Xu. Coordinat-  Gora, Marek, and Michael Rutkowski. The Quest for Pension Re-
ing Changes in M-form and U-form Organizations. No. 284,  form: Poland's Security through Diversity. No. 286, January 2000.
January 2000.
Marin, Dalia, Daniel Kaufmann, and Bogdan Gorochowskij Bar-
Marin, Dalia, and Monika Schnitzer. Disorganization and Fi-  ter in Transition Economies: Competing Explanations Con-
nancial Collapse. No. 285, January 2000.               front UkrainianData. No. 287, January 2000.
World Bank/IMF Agenda
Horst Kohler's Scenario: A More Open  as public finance and enterprise reforms  potential tiger will require that the domes-
IMF                                  in China, the role of the state, and owner-  tic private sector be liberated and the con-
ship and taxation in transitional econo-  fidence of the foreign investors be rebuilt.
In his first press conference since receiv-  mies.                       It will require that access to market knowl-
ing international support as nominee man-                                 edge and technology be expanded," he
aging director of the IMF, Horst Kohler,  World Bank to Lend China $7 Billion  said. One way of moving forward, he sug-
president of the European Bank for Re-  in Next Three Years               gested, would be for the government to
construction and Development, said in                                     convene a coalition of partners -from the
Washington that he would work to make  New World Bank Vice President for East state and private sectors, academia, and
the Fund more open. "My intention is to  Asia and Pacific Region Jemal-ud-din  the international community-to help clarify
have an open dialogue with the public and  Kassum is visiting China from March 14 to  the prerequisites of rapid, poverty-reduc-
with private advocacy and aid groups," he  19, 2000. It is his first official visit to the re-  ing growth. With almost 30 million Vietnam-
said. The IMF should focus more on crisis  gion after taking up the post on March 1.  ese still below the poverty line, he said, the
prevention by monitoring conditions and  The Bank so far has supported 220 projects  preparation of a Comprehensive Develop-
advising countries, and should continue to  in most of the provinces for a total of more  ment Framework is urgent. The World
demand economic conditions in exchange  than $30 billion. One hundred ten of these  Bank President signed two aid projects
for loans. Earlier, Kohler conferred with  projects are still under implementation,  worth $135.7 million. Since resuming lend-
Stanley Fischer, the acting managing di-  making China's portfolio by far the largest  ing to Vietnam in November 1993, the
rector of the Fund, as well as with mem-  in the Bank. Given China's improved finan-  World Bank has made commitments of
bers of the Bank's board and US Treasury  cial situation and increased use of domes-  $2.4 billion in financial assistance and dis-
Secretary Lawrence H. Summers. Kohler tic resources, Kassum forecast that the  bursed $1 billion. Last year, it provided
said Fischer had agreed to remain as  World Bank's lending program overthe next $318 million in assistance.
deputy.                              three years might be in the range of $5 bil-
lion to $7 billion. Much of this financing  e-CAS Will Simplify Staff's Work
New Chief Economist at the Bank:  would involve supportfor infrastructure de-
Nicholas H. Stern                    velopment and water conservation pro-  An electronic tool to assist in preparing
grams, concentrated in the poorer innerand  CountryAssistance Strategies, dubbed "e-
The World Bank has appointed Nicholas  western provinces,aswellasforurbanand  CAS," has been proposed by Joanne
H. Stern as Senior Vice President, Devel-  environmental projects largely in the more  Salop, vice president of Operations Policy
opment Economics, and Chief Economist.  developed eastern areas.          and Strategy. e-CAS aims to lower costs
He will start at the Bank in late Spring. Stern                           and increase the benefits of preparing
replaces Joseph Stiglitz, who served as  Vietnam Asked to Prepare Compre-  country assistance strategies by stream-
the Bank's Chief Economist from 1996  hensive Development Framework       lining access to information. This would
until last month. Stern is leaving his pro-                               give countryteams more timefordialogue,
fessorship at the London School of Eco-  World Bank President James Wolfensohn,  professional analysis, and participation. e-
nomics. From 1994-99 he served as  during his visit in Vietnam, on February 23  CAS could have important corporate side-
Chief Economist and Special Counselor  addressed 350 senior representatives of effect benefits, too, such as more accurate
to the President at the European Bank for  the government, donors, private sector,  costing of the strategy program, better
Reconstruction and Development. Stern  NGOs, and the academic community in  tracking of implementation, and better ac-
has published extensively on such issues  Hanoi. "To restore Vietnam's role as a  cess to the strategies by Network, IFC,
(D 2000 The World Bank/The William Davidson Institute                               TRANSITION, February 2000  m



and MIGA colleagues who are not on the  credits of about $30 million. The United  Recent World Bank Loans to Estonia,
country team. e-CAS would give staff elec-  States will provide $9 million in grants. The  Latvia, Tajikistan, Bulgaria, Romania,
tronic access to Bank Group information,  beneficiary governments would contribute  and Slovenia
and Bank Group "offerings" in different sec-  about $18 million. The EU is expected to
tors and along various product lines. e-  provide grants of about $50 million.  A $25 million transport loan for Estonia
CAS also would include an electronic                                       will address road traffic safety problems.
partnershipsmenu,withlinkstowhatother  Czech Restructuring Needs Enabling  Estonia joined the World Bank in 1992
donors and partners are doing in a par-  Legal Environment                 and its commitments so far total $138 mil-
ticular country or sector, so that staff can                              lion for 8 projects (approved on March 16).
better determine programming options.  Despite encouraging changes to the
There would also be a module for calcu-  bankruptcy law, the Czech Republic has  A $40.41 million Programmatic Structural
lating the cost of a proposal. Once the  to do more to establish a legal environ-  Adjustment Loan will support Latvia's ef-
country assistance strategy document had  ment that can contribute to successful re-  forts to speed up the economy and improve
been completed, e-CAS would be "frozen"  structuring of the corporate sector, World  its public sector performance. Latvia joined
electronically and an implementation mod-  Bank economist Roberto Rocha told the  the World Bank in 1992 and commitments
ule would begin to track the program as it CTK news agency. "In addition to the im-  so far total about $355.41 million for 17
developed.                           provements in the bankruptcy and fore-  operations (approved on March 16).
closure laws, it is also necessary to
IMF to Decide on Loan Program for  amend some other laws, primarily in the  A $5.4 million credit to Tajikistan for a Pri-
Ukraine after Audit                  field of taxation, that would boost both  mary Health Care Project will help replace
court and out-of-court settlements," says  the current health care system. Tajikistan
Deputy Prime Minister Yuriy Yekhanurov  Rocha. The World Bank is also calling  joined the World Bank in 1993 and com-
said on February 21 that the IMF will de-  for a restructuring strategy for small and  mitments so far total about $190 million
cidewhetherto unfreezeits$2.6 billion loan  medium-sized firms which maximizes  for 11 projects (approved on March 7).
program for Ukraine after an audit of the  the involvement of the private sector, ei-
National Bank. The audit was ordered af-  ther through sales of loans or through  A $50.1 million equivalent (euro 49.5 mil-
ter the Financial Times alleged that in 1997  outsourcing arrangements. The Czech  lion) Environment and Privatization Support
and early 1998 the National Bank dressed  Parliament amended the BankruptcyAct Adjustment Loan will support Bulgaria's
up its reserves in order to qualify for contin-  in January, strengthening the position of  environmental policies, including the harmo-
ued credits from the Fund. It also secretly  creditors and cutting off bad managers  nization of environmental legislation with EU
invested its reserves in risky ventures  and owners from cash-flow.        requirements. Bulgaria joined the World
against the advice of IMF officials. Ukraine                               Bank in 1990 and commitments so far to-
needs additional funding to cope with $3.1  World Bank's On-Line Pension Primer  tal about $1.2 billion for 20 projects (ap-
billion in loan payments due this year.  http://www.worldbank.org/pensions  proved on February 24).
Six Balkan Countries Sign $145 Million  The World Bank published an online  A$11 million loan for an Agricultural Sup-
Deal                                 primeron pension reform on March 1, de-  port Services Project in Romania will
signed to help policymakers transform  support the transfer and exchange of ag-
To reduce trade and transport costs and  unwieldy and unsustainable pension sys-  ricultural knowledge and information to
combat smuggling, Albania, Bosnia and  tems into modern social safety nets that farmers and agro-businesses. Romania
Herzegovina, Bulgaria, Croatia, FYR  can protect the aged and contribute to  joined the World Bank in 1972 and com-
Macedonia, and Romania signed an agree-  economic productivity. "It's not just a dry  mitments since 1990 total about $3.5 bil-
ment on February 10 in the Macedonian  text book. It links worldwide experience in  lion for 27 projects (approvecl January
capital, Skopje. They are to set up a com-  a dynamic mannerwith implementation on  27).
mittee to deal with the World Bank's trade  the ground," said Robert Holzmann, direc-
andtransportationprograminSoutheastEu-  tor of Social Protection at the Bank. The  A $9.3 million (Euro 9 million) loan to
rope. "The program will represent the first primer addresses issues including financ-  Slovenia for a Health Sector Management
regionally linked project in support of the Sta-  ing the transition from pay-as-you-go to  Project is the first of two adaptable pro-
bility Pact," the Bank said, referring to the  multipillar pension systems, designing a  gram loans totaling $12.9 million. Commit-
EU-sponsored economic and political treaty  market and regulatory structure to facilitate  ments since Slovenia joined tlhe Bank in
forthe Balkans. The program will be financed  pension reform, and the rules and interna-  1993 have been about $160.5 million for
by IBRD loans of about $38 million and IDA  tional practice of pension provision.  5 projects (approved on January 20).
E   TRANSITION, February 2000                                      (C 2000 The World Bank/The William Davidson Institute



Milestones of Transition (continued)
Continued from page 16               Poland                               to a memorandum the country has signed
economy, the new government of Prime                                      with the IMF, Prime Minister Dumitru
Minister Ivica Racan promises economic  Poland is urged to speed up EU entry  Braghis was reported as saying on March
growth, integration with the West, and  process. The European commissionerfor  16. If Moldova fulfills the memorandum,
higher employment. It has also pledged  enlargement, G(unter Verheugen, has  which calls for the privatization of key com-
to reduce state expenditure and taxes,  urged Poland to speed up its preparations  panies, it will be eligible to receive exter-
review the process of privatization, and  for accession. So far, Poland has provi-  nal financing. The prime minister said the
reform the pension and health care sys-  sionally completed 9 of 31 negotiation  cabinet is not sure it will be able to pay
tems. Prod uction and real wages last  chapters. Of the balance, 14 remain open,  some $81.3 million in debt payments due
year were on average 90 percent ofthe  and the restwill beopened inthe nextfew  this yearwithout external financial assis-
1989 level, and at present the country  months. Several of the most difficult chap-  tance. This year's budget is based on 2
is still suffering from a recession that  ters remain, including agriculture, regional  percent GDP growth and calls for a bud-
began in late 1998. The leading sec-  policy,immigration,andbudgetandfinan-  getdeficitequalto2.4percentofGDP.
tors-tourism, shipbuilding and agri-  cial control. Agriculture, which employs
culture-remain in difficulty.        more than one-quarter of Poland's popu-  Rewarding cybersuffix.md. John Harris,
lation of 39 million, is expected to prove  president of the Florida-based Domain
Hungary                              particularly troublesome.            Name Trust, noticed that US doctors are
keen to attach "md", meaning medical doc-
EU accession seen boosting eco-  Romania                                 tor, to their domain names. However the
nomy. Analysts at Salomon Smith Barney                                    suffix denotes Moldova. Under a 25-year
(SSB) believe that the gates of the Euro-  Five chapters ready for EU talks. Ro-  contract, signed with Moldova's Republi-
pean Union will open to Hungary in 2004,  mania will open membership negotiations  can Centre for Informatics, an arm of the
and that Hungarywill definitely be included  with the European Union on five chap-  transportation and communications min-
in the first round of new admissions, along  ters-research, education, foreign and  istry, Moldova so far has made $200,000
with Slovenia. The report predicts strong  common security policy, and small and me-  by permitting its use. The country is using
investor interest during the period lead-  dium-sized companies. The government the money to develop its Internet facilities.
ing up to accession, similar to that wit-  onMarch 16approvedakey medium-term
nessed in Italy, Spain, Scandinavia, and  economic strategy paperthat calls for non-  Russia
Greece during their periods of conver-  inflationary and sustainable economic
gence before the introduction of the euro.  growth. The document is considered es-  Ten-year growth strategy. German Gref,
The structural reforms being carried out sential for the country's talks with the EU.  president of the nongovernment think-tank
in preparation for integration will result in                             Centre for Strategic Research, charged by
a balancing of the economy, a reduction  Y2K austerity budget. The new budget is  Vladimir Putin to work out a 10-year devel-
in interest rates, and appreciation in real  based on 1.3 percent expected economic  opment program, announced that short-
terms of the currency, leading to better  growth2d percentinflation(halvedfromf ast term reforms would focus on taxes,
conditions for financial investment than  Ye) aD  eisges a deficit of 3 percent  customs, and property rights. Yevgeny
of GDP. Prime Minister Mugur Isarescu
ever before.                         said it was "unacceptable for taxpayers to  Yasin, one of the most liberal members of
contribute more money to the state budget  mid-1 990s governments and a member of
Even more shares in foreign hands.  than all companies put together." Tax eva  the board of the think-tank, told reporters
The proportion of Hungarian shares in for-  sion is widespread and is said to account that the initial measures that he expected
eign hands continued to grow in the last for at least one-third of the whole economy.  parliament to pass would include the sec-
quarter of 1999, according the National                                   ond part of a long-awaited tax code, a land
Bank of Hungary's quarterly report on se-  CIS                            code, bankruptcy law amendments, which
curities ownership. Foreigners now own                                    are key to selling off tottering factories,
four-fifths of all Budapest Stock Exchange  Moldova                       and shareholders' rights legislation. Yasin
shares, up from two-thirds two years ago.                                 said he supported some government in-
Foreign investors financed the Hungarian  Privatization is the key. Moldova may  terference in the economy in order to mod-
national debt with $1.8 billion in "hot money"  default on its debt payments for this year if ernize and restructure it, such as forming
by the end of the year.             the parliament does not pass laws related  state banks, financed by loans, to support
C) 2000 The World Bank/The William Davidson Institute                               TRANSITION, February 2000   C



exports and key industries like technology.  Oblast. With these acquisitions, the  restructuring, Chubais has said, is to mod-
Gref said Putin wanted a strong govern-  Berezovskii/Abramovich tandem will con-  ernize the outdated system by selling parts
ment to make a fair business environment  trol an estimated 60-70 percent of  of it to private investors. His critics accuse
and enforce it throughout the country.  Russia's aluminum industry-10-20 per-  him of attempting to transfer valuable
cent of the world aluminum market. Alu-  power assets to friends and financiers of
Gref in particular said the government  minum is one of Russia's most lucrative  the Union of Right Forces, his political
would seek to defend intellectual property.  industries and, like oil and gas, provides  party, which won seats in the new parlia-
The lack of federal funding for the courts  a steady flow of hard currency from ex-  ment.
had caused them to fall under the influence  ports.
of "business circles and regional authori-                                Salaries are too low. At 1,520 rubles a
ties." He said the government will regain  Critics of Russian utility overhaul take  month, about $62, average pay is intoler-
control of all its law-enforcement bodies  aim at Chubais. A high-voltage political  ably low in Russia, according to First
by restoring funding. "We clearly under-  battle is raging overhowtooverhaul Russia's  Deputy-Premier Mikhail Kasyanov. He
stand that such a situation is intolerable,"  electricitysystem. Criticsfrom all sides have  said that the government has made little
said Gref. "It must be changed."     been taking aim at Anatoly Chubais, the ar-  improvement since the August 1998 cri-
chitect of Russia's privatization program and  sis, with average pay now only 74 percent
Drink, disease, and depression eat  current head of electricity monopoly RAO  of what it was before the crisis.
away at Russian population. The popu-  Unified Energy Systems, as he prepares a
lation of Russia fell by almost 800,000 last  pilot restructuring of several of the 70 power  We appreciate the contributions from Ra-
year. There are now almost three million  stations under his control. The goal of the  dio Free Europe/Radio Liberty.
fewer Russians than there were when the
Soviet Union collapsed. Most experts ex-
pect the decline to continue because the  Conference  Diary
birth rate is low, with abortion common, and  o
the death rate is high, with formidable al-
cohol abuse, a failing public health system,  Theoretical and Practical Aspects of  Russia; money-laundering scandals;
a growing AIDS problem, and a shockingly  Public Finance                  shareholder rights; NATO expansion; de-
high suicide rate. The State Statistics  March 31-April 1,2000, Prague,   velopment of Russia's oil resources.
Committee reported that the population at  Czech Republic                 Information: Marshall I. Goldman, Davis
the end of 1999 was 145.5 million, 2.8 mil-                               Center for Russian Studies, Harvard
lion fewer than in 1992. Births fell to 1.215  Organizer: The Public Finance Depart-  University, 1737 Cambridge Street,
millionwhiledeathsincreasedto2.14mil-  ment, University of Economics, under  Cambridge, Massachusetts 02138,
lion. The Russian press reported earlier  the auspices of Professor Stepanka  United States, tel.: 617-495-8900 or
thismonththatforeverybirthinthecoun-  Novakova, Dean of the Faculty of Fi-  617-495-4485, fax.: 617-495-8319, e-
try there are two abortions. Georgetown  nance and Accounting.            mail: dgurvich@fas.harvard.edu.
University's Murray Feshback predicted  Information: Barbora Slintakova, De-
recently that with the birth rate falling  partment of Public Finance, University  Twelfth Annual Bank Conference on
sharply, and the death rate climbing,  of Economics, W. Churchill Sq. 4,  Development Economics (ABCDE)
Russia's population would dwindle to 80-  13067 Prague 3, the Czech Republic,  April 18-20, 2000, Washington, DC.
100 million by 2050.                 tel.: 4202-2409-5159, fax 4202-2422-  http://www.worldbank.org/research/abcde/
0820, Internet: http://nb.vse.cz/kvf/winl
Russian oligarchs' pre-election asset  confpf.htm                         OpeningaddresswillbegivenbyJames D.
grab. Two of Russia's best-known "oli-                                    Wolfensohn, the president of the VVorld Bank.
garchs," Boris Berezovskii, head of America-Russian Relations             keynote addresses by Joseph E. Stiglitz,
LogoVAZ, and Roman Abramovich, head  April 14-16, 2000, Arden House Confer-  World Bank; Jeffrey Sachs, Harvard Univer-
of Sibneft, revealed they are in the process  ence Center, Harriman, NewYork  sity; and Janos Kornai, Harvard University
of acquiring controlling interests in two of                              and Collegium Budapest. Session one: New
Russia's largest aluminum smelters,  Organizers: Davis Center for Russian  Development Thinking (Paul Collier;
Bratsk and Krasnoyarsk. It was also an-  Studies and W. Averell Harriman Institute.  Enrique Flores, Ravi Kanbur, Nora Lustig,
nounced that LogoVAZ has acquired a  Topics: what the new Russian President  Jan W. Gunning, Karla Hoff, Francois
controlling interest in the Novokuznetsk  will mean for the United States; what a new  Bourguignon, Nancy Birdsall, GustavRanis,
Metallurgical Combine in Kemerovo  administrationinWashingtonwillmeanfor  and Charles C. Soludo). Session two:
1  TRANSITION, February 2000                                      (D 2000 The World Bank/The William Davidson Institute



Crises and Recovery (William Easterly,  will give the luncheon speech: Develop-  economics ofAIDS vaccines for develop-
Roumeen Islam, Joseph E. Stiglitz,  ment Theory at a Crossroads. Eight pa-  ing countries.
Ricardo Caballero, Mohamad Hammour,  pers will be presented on four topics. Topic  Abstracts will be evaluated with respect to
Eisuke Sakakibara, Guillermo Perry;  one: 50 Years of Development Econom-  theoretical soundness, methodology, ana-
Abhjijit Banerjee, Alejandro Werner, and  ics: What Have We Leamed? (Nicholas  lytic rigor, and the significance of the re-
Steven Radelet). Session three: Corpo-  Stern, Irma Adelman). Topic two: Knowl-  search for public policy. Deadline: June 1,
rate Governance and Restructuring-  edge, Innovation, andDevelopment(Paul  2000.
Lessons from Transition and Crises  David, Philippe Aghion). Topic three: So-  Information: http.//wwwiaen.org/
(Alexander Dyck, Gerard Roland, John  cial Capital, Governance, and Institutions
Earle, and Rafael Laporta). Session four:  (Jozef Ritzen, Jean Philippe Platteau).  Participation in the Twenty First Cen-
Social Security Public and Private Sav-  Topic four: Global Govemance: In Search  tury: New Opportunities, New Per-
ings (Peter Orszag, Michael Orszag,  of a New Framework (Jean-Fran,ois  spectives
Orazio Attansio, Miguel Szekely, Robert  Rischard). There will be parallel workshop  July 6-8, 2000, Trento, Italy
Holzmann, and Christina Paxson). On  sessions on the first two days of the con-
each of the first two afternoons there will ference. The wrap-up and concluding re-  Organizer: International Association for the
be four parallel workshop sessions. Par-  marks will be given by Jean-Fran,ois  Economics of Participation.
ticipation by non-Bank and non-IMF staff  Rischard and Pierre-Alain Muet. Partici-  Topics: innovative forms of participa-
by invitation only.                  pation is by invitation only. The conference  tion; participation in the age of e-com-
Information: Boris Pleskovic (e-mail:  is sponsored by the World Bank and the  merce; employee participation and the
bpleskovic@worldbank.org), Research  Conseild'analyse6conomique, Ministryof  management of change; finance and
Advisory Staff, Development Economics  Finance, France.                   employee ownership; employee owner-
Vice Presidency, World Bank, 1818 H  Information: Jean-Christophe Bas (e-  ship and economic transition; participa-
Street, N. W, Room MC4-385, Washing-  mail: jbas@worldbank.org), ExtemalAf-  tion and reconstruction in south east
ton DC 20433, tel. 202-473-1062, fax 202-  fairs Counselor, The World Bank, 66  Europe; inter-firm  cooperation and
522-0304.                            avenue d'l6na, 75116 Paris, France tel business alliances; participation, trust,
33-1-40 69 30 35, fax 33-1-47 23 74 36  and social inclusion; mutuality, social
Second Annual Bank Conference on  or Boris Pleskovic (e-mail: bpleskovic  enterprise, and participation.
Development Economics in Europe-  @worldbank.org), Research Advisory  Submissions are invited from all rel-
DevelopmentThinking atthe Millennium   Staff, World Bank, 1818 H Street, N. W,  evant fields of study including: industrial
June 26-28, 2000                     Room MC4-385, Washington DC 20433,  economics; comparative economic sys-
http://www.worldbank.org/research/abcde/ tel 1-202-473-1062, fax 1-202-522-0304.  tems; organizational studies; manage-
ment studies; economic sociology;
Opening addresses by Lionel Jospin,  International Conference on AIDS     institutional economics; evolutionary
prime minister of France, and James D. July 2000, Durban, South Africa    economics; development economics;
Wolfensohn, president of the World Bank.                                  studies of economies in transition.
Welcoming addresses will be given by  Organizer: The International AIDS Eco-  Abstract submission deadline: abstracts
Christian Sautter, French minister of  nomic Network (IAEN).              should include full details of institutional af-
economy, finance and industry, Pierre-  Research welcome on the following top-  filiation, mailing address plus, possibly, a
Alain Muet, of the Conseil d'analyse  ics: the cost-effectiveness of alternative  short list of keywords. The deadline forthe
economique in the French finance minis-  prevention interventions (behavioral and  receipt of proposals for papers to be pre-
try, and Jean-Fran,ois Rischard, World  medical), and alternative treatments in the  sented at the conference in the form of an
Bank. Keynote addresses will be given by  settings of low-income countries; eco-  abstract of up to 300 words is February 15,
AmartyaSen, Nobel Economics Laureate  nomic analysis that helps governments  2000.Authorsweretobenotifiedoftheac-
1998; Robert Mundell, Nobel Economics  prioritize their scarce resources for pre-  ceptance of their paper by March 15,2000.
Laureate1999,andChristianSautter.There  vention and treatment; the macroeco-  Final papers plus extended abstracts
will be two roundtable discussions: one on  nomic and national welfare impacts of should be submitted to the organizers by
"Growth, Poverty Reduction, and Inequal-  AIDS in developing countries; the eco-  June 10, 2000.
ity: Lessons Learned" (T.N. Srinivasan,  nomic impact of HIV/AIDS on microeco-  Information: Alberto Zevi, Intemational
Fran,ois Bourguignon), and the other on  nomic actors-households and private  Association for the Economics of Partici-
"Openness and Development" (Dani  firms-and how they cope; the impact of pation (CFI), Via Vicenza 5A, 00185,
Rodrik and others). Joseph E. Stiglitz, chief  economic crises on the spread of HIV/ Rome, Italy fax.:39-06-4451766, e-mailto
economist of the World Bank 1996-2000,  AIDS and public policy toward AIDS; the  A.ZEVI@CFI.IT
© 2000 The World Bank/The William Davidson Institute                                TRANSITION, February 2000



New Boo ks and Working Papers
The Macroeconomics and Growth Group regrets that it is unable to provide the publications listed.
World Bank publications             Voices of the Poor, in three volumes, co-  pated in the most recent round of the Inter-
publication of the World Bank and Oxford  national Comparison Program. Economic
To receive ordering and price information  University Press.            data also include gross national products,
for World Bank publications, contact the                                and for gross domestic products the
World Bank, PO. Box 7247-8619, Phila-  Deepa Narayan, Raj Patel, Kai Schafft,  shares of exports, agriculture, and invest-
delphia, PA 19170, United States, tel.: Anne Rademacher, and Sarah Koch-  mentaregiven.Therearealsofigureson
202-473-1155, fax: 202-676-0581, email:  Schulte, Can Anyone Hear Us?, March  private investment, energy consumption,
books@worldbank.org, Internet: http:// 2000, 360 pp.                    and population growth.
www. world bank. org or http://www. world
bank. org/html/dec/Publications/Work  Deepa Narayan, Robert Chambers,  The Little Data Book 2000, forthcoming,
papers/tranecon.htm, or visit the World  Meera Shah, and Patti Petesch, Crying  April 2000.
Bank bookstore in the United States, at Out for Change, forthcoming, June 2000,
701 18th Street, NW, Washington, DC, or approximately 200 pp.           The Little Data Book 2000 is a quick ref-
France, at 66 avenue d'lena, 75116 Paris.                               erence for users of the World Develop-
Deepa Narayan and Patti Petesch (edi-  ment Indicators and others interested in
World DevelopmentIndicators2000Print  tors), From Many Lands, forthcoming,  development data. This book presents
Edition 420 pp. and CD-ROM, March 2000.  August 2000, approximately 300 pp.  data for 206 countries in an easy country-
by-country reference format. It provides the
Now in its 4th edition, World Development  Far more effectively than any previous sur-  latest information for World Bank members
Indicators, the World Bank's statistical ref- vey technique, Voices of the Poor provides  as well as other countries with populations
erence publication, provides a compre-  a detailed picture of the life of the poor and  of more than 30,000. The 13 summary
hensive view of 148 economies and 14  explains the constraints that trap people in  pages of the book cover regional and in-
country groups, with basic indicators for a  poverty. After listening to the destitute in many  come group aggregates.
further 58 countries. This edition retains  developing countries and transition econo-
the basic thematic presentation, with six  mies around theworld, theauthorsconclude  Global Development Finance 2000
sections covering World View, People, that conventional measures of poverty,  (Print edition and CD-ROM). Volume 1,
Environment, Economy, States and Mar-  based on income, education, and health, Analysis and Summary Tables, 232 pp.
kets, and Global Links. World Develop-  should also measure empowerment.  Volume 2, Country Tables. CD-ROM:
ment Indicators 2000 contains a wealth                                  Single-user version, Spring 2000.
of information including:           World Bank Atlas 2000, forthcoming,
* Development Assistance Committee's  April 2000.                       Growth in developing countries is starting
development goals.                                                      to recover from the 1997-99 global finan-
* Unemployment data.                The World Bank Atlas 2000 provides  cial crisis, but this time on the basis of
* Data on relative prices and purchasing  easy-to-read world maps, tables, and  stronger-than-anticipated and broadening
power parities.                     graphs highlighting key social, economic,  growth in industrial countries, exceptional
* Military expenditures.            and environmental data for 206 econo-  strength in the recovery of global trade, and
* Data on average tariffs.          mies. The 32nd edition has been updated  the firming of commodity prices. The re-
and improved with new material taken  covery is based on elements that permit
The CD-ROM edition contains 500 time- from the World Development Indicators  more "self-financing" and a more sustain-
series indicators for 206 countries and  2000. There are six sections, including  able path of recovery in developing coun-
regional and income groups. It provides  Global Links and World View, drawn from  tries than a selective and volatile recovery
definitions, source information, and all the  the corresponding sections in the World  in international capital flows. Given the
text from the print edition. Users can re-  Development Indicators 2000.  momentum of world recovery, growth fore-
trieve data into their own spreadsheet for-                             casts for 2000 are revised upward.
mat, export data into many popular  Theatlasprovidesthelatestmeasuresof
formats, save their queries, and create  purchasing power parities and data on  Faster growth of exports, firming export
their own maps and graphs.          relative prices for countries that partici-  prices, looserfinancial conditions, and the
*  TRANSITION, February 2000                                     © 2000 The World Bank/The William Davidson Institute



return of investor confidence should bol-  During Albania's economic transition, the  nies, financial institutions, and private in-
ster developing country growth over the  number of vulnerable people has been  vestors.
forecast period. Volume 1 reviews policy  swollen by deep social unrest, widespread
options to design and adopt safeguards  poverty, uncontrolled migration, and the  Working Papers
that may help protect a country from vola-  reemergence of clan-based loyalties.
tile private capital flows. It concludes with  These people are more likely to be  http.//www.worldbank.org/research/
a historical overview of the main lessons  marginalized by the economic cycle, mak-  workingpapers
of a century of booms and busts of private  ing it more difficult to ensure a successful
capital flows to emerging markets.  transition. A strategy for social policy  Nauro F. Campos, Institutional Change
should applyabottom-upapproachwhen  in Transition Context Is Everything:
Volume 2 provides statistical data for 137  dealing with the vulnerable.  Measuring Economies, WPS 2269,
countries reporting debt under the World                                January 2000, 38 pp.
Bank Debtor Reporting System and sum-  Zvi Lerman and Csaba Csaki, Ukraine:
mary data for the country groups. The  Review of Farm Restructuring Experi-  Campos examines institution building in
tables are designed to facilitate cross-  ences, TP 459, January 2000, 80 pp.    transition economies using five measures
country comparison of key statistics, in-                               of governance:
cluding statistical tables for income and  Discussion Papers            * Accountability of the executive.
external debt.                                                          0 Quality of the bureaucracy.
Marnia Lazreg (editor), Making the Tran-  0 Rule of law.
Higher Education in Developing Coun-  sition Work for Women in Europe and  0 Character of the policy-making process.
tries: Peril and Promise, February 2000,  Central Asia, DP 411, January 2000,120  * Strength of civil society.
136 pp.                             PP.
Campos follows how institutions change
A decisive shift is needed in educational John R. Hansen and Diana Cook, Eco-  with time, and compares institutions in
priorities, reversing the assumption that nomic Growth with Equity: Ukrainian  central and eastern European with those
poor countries should focus predominantly  Perspectives, DP 407, February 2000.  in the former Soviet Union. The rule of law
on improving access to basic education.                                 emerges as the most important influence
Developing countries need growing num-  Since Ukraine declared its independence  on per capita income and school enroll-
bers of highly skilled people if they are to  from the Soviet Union in 1991, it has un-  ment. For life expectancy, however, the
thrive in the emerging knowledge economy.  dergone enormous changes on the road  quality of the bureaucracy is the most im-
The Task Force on Higher Education and  to reform. This report discusses the cur-  portant. An important conclusion is that in-
Society, convened by the World Bank and  rent policies, proposes a new framework  stitutions do change with time and are by
UNESCO, reports on six key issues:  for future policies, and makes recommen-  no means as immutable as the literature
* Rising demand for higher education and  dations for their implementation. It covers  has suggested. The range of policy
the implications of the knowledge revolu-  agriculture, education, energy, health care, choices for changing institutions may be
tion.                              fiscal policy, industry and trade, the shadow  much wider than is often assumed.
* Investment in highereducation in the pub- economy, and social protection.  To orier: Jason Victor; Room MC4-362, tel.:
lic interest.                                                           202-473-6549, fax: 202-522-1158, email:
* The importance of designing more co-  The Private Sector and Power Genera- jvictor@worldbank. org. The authormay be
herent systems of higher education.  tion in China, DP 406, February 2000,  contactedatnauro.campos@cerge.cuni.cz.
* Techniques for improving standards of 84 pp.
governance.                                                             Paul Glewwe, Michele Gragnolati,and
* The acute need for better science and  In the early 1980s the Chinese Govern-  Hassan Zaman, Who Gained from
technology education.               ment began to ease restrictions on the  Vietnam's Boom in the 1990s? An
* The relevance of general or liberal edu-  power industry and encourage private  Analysis of Poverty and Inequality
cation to modern societies.         participation in power sector develop-  Trends, WPS 2275, January 2000, 55 pp.
ment. This paper comprises the pro-
Technical Papers                    ceedings of a conference in Beijing in  Drawing on the Vietnam Living Standards
June 1999, sponsored by China's Min-  Surveys for 1992-93 and 1997-98, the
Gloria La Cava and Rafaella Y. Nanetti,  istry of Finance and the World Bank and  authors contend that Vietnam's gains in
Albania: Filling the Vulnerability Gap,  attended by government officials, repre-  poverty reduction were striking in the
TP 460, February 2000, 88 pp.       sentatives of provincial power compa-  1990s. Returns to education increased
© 2000 The World Bank/The William Davidson Institute                              TRANSITION, February 2000  m



significantly during this period. Urban  vestment in Transition Economies:  guaranteedobligations;anddevelopgov-
white-collar households were more suc-  The Case of Bulgaria, WPS 278, Janu-  ernment capacity to analyze and manage
cessful at getting out of poverty than rural ary 2000, 28 pp.          risks.
households. Nearly half of Vietnam's rural                             To order: Leila Zlaoui, Room H4-317, tel.:
population however, still lives below the  In Bulgaria and other transition econo-  202-473-3100, fax: 202-522-2754, email:
poverty line, and poverty rates among eth-  mies, liquidity constraints and hence ac-  lzlaoui@worldbankorg. Other authors
nic minorities remain very high.   cess to external funds must be seen in the  may be contacted at hpolackova@
To order: Patricia Sader, Room MC3-556,  context of soft budget constraints and the  worldbank. org or sshatalov@worldbank.
tel.: 202-473-3902, fax: 202-522-1153,  financial system's failure to enforce the  org.
email: psader@worldbankorg. The au-  efficient allocation of funds. Liquidity con-
thors may be contacted at pglewwe@   straints in Bulgaria may be seen as a sign  Daniela Klingebiel, The Use of Asset
dept.agecon. umn. edu, mgragnolati of financial weakness.              Management Companies in the Reso-
@worldbank.org orhzaman@worldbank.  To order: Nina Budina, Room MC3-353,  lution of Banking Crises: Cross-Coun-
org.                               tel.: 202-458-2045, fax: 202-522-3518,  try Experience, WPS 2284, February
email: nbudina@worldbankorg. The other 2000, 52 pp.
Arvind Panagariya, Evaluating the Case  authors may be contacted at h.garretsen
for Export Subsidies, WPS 2276, Janu-  @bwkun.nl ore.dejong@bw.kun.nl.  Asset management companies have
ary 2000, 30 pp.                                                       been used to address the overhang of
Hua Wang and Dale Whittington, Willing-  bad debt in a country's financial system-
Under perfect competition, a country try-  ness to Pay for Air Quality Improve-  by expediting corporate restructuring or
ing to retaliate against a trading partner's  ments in Sofia, Bulgaria, WPS 2280,  rapidly disposing of corporate assets.
export subsidies by instituting its own ex-  January 2000, 27 pp.      The paper suggests that such companies
port subsidies will only hurt itself. The ar-  To order: Roula Yazigi, Room MC2-533,  tend to be ineffective at corporate re-
gument that export subsidies may be  tel: 202-473-7176, fax: 202-522-3230,  structuring and are good at disposing of
useful for neutralizing import tariffs is spu-  email: ryazigi@worldbank. org. Hua Wang  assets only if there are liquid assets, pro-
rious. India's experience shows export may be contacted at hwang1@world  fessional management, political inde-
subsidies to have little impact on exports.  bank.org.                 pendence, adequate bankruptcy and
Brazil and Mexico's experience shows                                   foreclosure laws, appropriate funding,
export subsidies to be a costly instrument Hana Polackova Brixi, Sergei Shatalov, good information and management sys-
of export diversification. Those who argue  and Leila Zlaoui, Managing Fiscal Risk  tems, and transparent operations and
that pro-export interventions were impor-  in Bulgaria, WPS 2282, January 2000,  processes.
tant in East Asia have not provided con-  46 pp.                       To order: Rose Vo, room MC9-624, tel.:
vincing evidence of a causal relationship                              202-473-3722, fax.: 202-522-2031, email:
between the interventions and growth.    Bulgaria's Currency Board Arrangement hvol@worldbankorg. The authormaybe
To order: Lili Tabada, Room MC3-333,  has effectively imposed fiscal discipline,  contacted at dklingebiel@worldbank.org.
tel.: 202-473-6896, fax: 202-522-1159,  but leaves only limited room to accommo-
email: Itabada@worldbank.org. The au-  date fiscal shocks that could come from  Susmita Dasgupta, Benott Laplante,
thor may be contacted at panagari@  the collection ability of the social security  Nlandu Mamingi, and Hua Wang, Indus-
econ.umd.edu.                      agencies and the government's environ-  trial Environmental Performance in
mental liabilities, investment requirements,  China: The Impact of Inspections,
Nina Budina and Tzvetan Mantchev, De-  and possible further involvement in off-bud- WPS 2285, February 2000, 25 pp.
terminants of Bulgarian Brady Bond  get programs, such as government guar-
Prices: An Empirical Assessment,  antees.                              Inspections have a statistically significant
WPS 2277, January 2000, 30 pp.                                         impact on firms' environmental perfor-
To order: Nina Budina, Room MC3-353,  The following measures are recom-  mance in the Chinese city of Zhenjiang,
tel.: 202-458-2045, fax: 202-522-3518,  mended: minimize the currency and inter- and citizens' complaints have a significant
email: nbudina@worldbank.org. Tzvetan  est rate risks in the government liability  impact on inspections. So stronger infor-
Mantchevmaybe contacted at tmantchev  structures; reform the country's pension  mation and education campaigns may
@hotmail.com.                      and health care systems; build up ad-  improve social welfare in the city.
equate contingency reserves; introduce  To order: Yasmin D'Souza, Room MC2-
Nina Budina, Harry Garretsen, and Eelke  risk-sharing arrangements; prioritize and  622, tel.: 202-473-1449, fax: 202-522-
de Jong, Liquidity Constraints and In-  place strict limits on the amounts of new  3230, email: ydsouza@worldbank.org.
*  TRANSITION, February 2000                                    ©) 2000 The World Bank/The William Davidson Institute



The authors may be contacted at sdas  competitive auctions. The objective is to  and money growth must be severed.
gupta@worldbank.org, blaplante@world  show regional governments that a more  0 Structural reform is important, and
bank.org, orhwangl@worldbankorg.    sustainable way to protect employment is  microeconomic policies, often overlooked,
to give managers incentives to increase  should be started as soon as possible.
Gil Mehrez and Daniel Kaufmann, Trans-  enterprises' value by transferring effective  This means establishing property rights,
parency, Liberalization, and Banking  control to investors.              hardening budget constraints, building a
Crises, WPS 2286, February 2000,33 pp.                                   healthy banking system, and ensuring true
To order: Diane Bouvet, Room J3-273, tel.: The proposed mechanism would provide  domestic competition.
202-473-5818, fax: 202-334-8350, email:  cash benefits to insiders who agree to sell  * The choice of an exchange rate regime,
dbouvet@woridbankorg. The authors may  control to outside investors. The increased  another early controversy, is apparently
be contacted at gmehrez@worldbank org  cash revenue (ratherthan in-kind or money  less important than adherence to a strict
ordkaufmann@worldbankorg.           surrogates) would enable regional govern-  monetary policy. The floaters have tightly
ments to finance safety nets for the unem-  managed their exchange rates, while the
Raj M. Desai and ltzhak Goldberg, The  ployed and to promote other regional fixers have repeatedly devalued and have
Vicious Circles of Control: Regional  initiatives.                       often ended up floating. Some form of
Governments and Insiders in Priva-  To order: Sophia Cox, Room H6-033, tel.: monetary targeting is needed, but it mat-
tized Russian Enterprises, WPS 2287,  202-473-6633, fax: 202-522-0078, email ters little which target is chosen so long as
February 2000, 23 pp.               address scox@worldbank.org. The au-  it is adhered to.
thors may be contacted at desair@   * Creating irreversibilities early on allows
How can one account for the behavior of gunet.georgetown.edu or igoldberg@   governments to change without seriously
insider managers in Russia, who, in strip-  worldbankorg.                affecting the transition. The less stable the
ping assets from the very firms they own,                                economy, the more politics matter. A shaky
appear to be stealing from one pocket to  Charles Wyplosz, Ten Years of Transfor-  economy is fertile ground for policy rever-
fill the other? Desai and Goldberg suggest  mation: Macroeconomic Lessons,  sals that set the clock back several years,
that such asset stripping and failure to re- WPS 2288, February 2000, 56 pp.  as in Bulgaria, Romania, and Russia.
structure are the consequences of interac-                               To order: Mani Jandu, Room MC4-386, tel.:
tions between insiders (manager-owners)  With hindsight, the old debate-big bang  202-473-3103, fax: 202-522-0304, email.
and regional governments in a particular versus gradualism-was really a problem   mjandu@worldbank.org. The author may
property rights regime. In this regime, the  of feasibility, although many of the argu- be contacted at wyplosz@hei.unige.ch.
ability to realize value is limited by uncer-  ments in favor of the big bang have now
tainty and illiquidity, so managers have little  been proven right. Once more, inflation  Howard J. Shatz and David G. Tarr, Ex-
incentiveto increase value.         has been found to be incompatible with  change Rate Overvaluation and Trade
growth and the importance of a good  Protection: Lessons from Experience,
As Russia's central institutions ceded  microeconomic structure-especially an  WPS 2289, February 2000, 27 pp.
power to the regions, regional govern-  effective banking system-has been con-
ments imposed various distortions on en-  firmed. The decline of the state in transi-  More than half the world's countries main-
terprises to protect local employment.  tion economies is both spectacular and  tain fixed or managed exchange rates.
Prospective outside investors doubt they  puzzling-with both desirable and danger-  Exchange rate management in many coun-
can acquire the control they need to restruc-  ous features.             tries has resulted in overvaluation of the
ture firms and doubt they can avoid the                                  real exchange rate. About a quarter of the
distortions regional governments impose.  Among useful lessons learned:  countries forwhich data are available have
The result is little restructuring and little new  * It pays to start early and move fast. The  overvalued exchange rates, with black
investment. Regional governments, know-  big bang is highly desirable but impracti-  market premiums from 10 percentto more
ing the firms' taxable cash flows are re-  cal, and gradualism is unavoidable but than 100 percent. Defending an overval-
duced through cash flow diversion, collect ought to be compressed as much as pos-  ued exchange rate with protectionist trade
revenues in kind.                   sible. The countries that bit the bullet early  policies would significantly retard the
and hard have done better over the past country's growth and delay its integration
To disentangle these vicious circles of con-  decade.                    into the world trading community. Better to
trol, Desai and Goldberg propose a pilot  0 Stabilize first, grow next. Macroeco-  have devaluation occur without debilitat-
for transforming the ownership of insider-  nomic stabilization is a prerequisite for  ing losses in reserves and lost productiv-
dominated firms by simultaneous tax-debt-  growth. The budget deficit need not be  ity because of import controls.
for-equity conversion and resale through  eliminated, but the link between deficits  To order: Lili Tabada, Room MC3-333,
(D 2000 The World Bank/The William Davidson Institute                              TRANSITION, February 2000  M



teL.: 202-473-6896, fax: 202-522-1159,  rency. Macroeconomic policy should be  Terri Ziacik, An Assessment of the Es-
email: ltabada@worldbank.org. David  aimed at managing these movements. If tonian Investment Climate: Results of
Tarr may be contacted at dtarr@world  the exchange rate regime is fixed, flexibil-  a Survey of Foreign Investors and
bank.org.                           ity must be maintained elsewhere in the  Policy Implications, BOFIT DP 3/2000.
economy. Policymakers may need to make
Raymond Fisman and Roberta Gatti, De-  trade-offs between price and output sta-  Credible economic reform has played a
centralization and Corruption: Evi-  bility once market jitters have set in.  key role in Estonia's success in attract-
dence across Countries, WPS 2290,  * Risk management in the financial sector  ing significant amounts of foreign direct
February 2000, 18 pp.               The regulatory and supervisoryframeworks  investment. Analyzing two years of data
To order: Emily Khine, Room MC3-341,  in developing countries need to be adapted  from a survey of foreign investors in Es-
tel.: 202-473-7471, fax: 202-522-3518,  to special features of these markets. Many  tonia, the author concludes that the labor
email: kkhine@worldbank.org. The au-  developing countries, for example, still lack  force and market-related factors are the
thors may be contacted at rf250@col adequate insurance markets.          primary motivations for investors coming
umbia.edu orrgatti@worldbank.org.   * Information and transparency. More  to Estonia, while bureaucracy, corruption,
disclosure and better quality of informa-  and labor quality are the greatest prob-
Jer6me Foulon, Paul Lanoie, and Benoit tion could reduce the volatility that arises  lems.
Laplante, Incentives for Pollution Con-  from herding behavior. They might also
trol: Regulation and Public Disclo-  have a beneficial effect on the allocation  Rupinder Singh, Bank Regulation, Com-
sure, WPS 2291, February 2000, 31 pp.  of capital.                       pliance and Enforcement, BOFIT DP 2/
To order: Yasmin D'Souza, Room MC2-  To order: Roumeen Islam, Room MC4-  2000.
635, tel.: 202-473-1449, fax: 202-522-  327, tel.: 202-473-2628, fax: 202-522-
3230, email: ydsouza@worldbank.org.  1158, email: rislam@worldbank.org.  Victor Polterovich, Employment-Wage
Benoft Laplante may be contacted at                                      Decisions in the Insider-Owned Firm,
blaplante@worldbank.org.                                                 BOFIT DP 1/2000.
Roumeen Islam, Should Capital Flows  IMF Working Papers                  Ville Kaitila, Trade and Revealed Com-
Be Regulated? A Look at the Issues and                                   parative Advantage: Hungary, the
Policies, WPS 2293, March 2000, 35 pp.  To order: IMF Publication Services, 700  Czech Republic, and the European
19th Street, NW, Washington, DC 20431,  Union, BOFIT DP 8/1999.
How can emerging markets improve risk  United States, tel.: 202-623-7430, fax: 202-
management in their open, liberalized  623-7201, email: publications@imf.org,  This study analyzes the trade of Hungary
markets? Implicit and explicit guarantees  Intemet: http://wwv.imf.org.  and the Czech Republic with their most
on financial transactions, externalities, and                            important trading partner, the European
information asymmetries in financial mar-  Mark De Broeck and Vicent R. Koen, The  Union, in 1997. The EU accounted for 70
kets may exacerbate contagion. This jus-  "Soaring Eagle"-Anatomy of the Pol-  percent of exports and 60 percent of im-
tifies government to deal with the volatility  ish Take-Off in the 1990s, WP 00/6,  ports in Hungary, and for 60 percent of both
of capital flows, which complement private  2000.                        in the Czech Republic. Germany is their big-
sector risk management. The main instru-                                 gest EU partner, accounting for 45 percent
ments can be grouped in the following cat-  Torsten Slok, Monetary Policy in Tran-  of Hungary's EU trade and 56 percent of
egories:                            sition-The Case of Mongolia, WP 00/ the Czech Republic's. Austria and Italy are
* Debt management. High short-term  21, 2000.                            their nexttwo most important partners.
debt relative to liquid assets has been a
common feature of recent financial crises.  Thomas Wolf and Emine Gurgen, Improv-  The most important goods are machines,
Governments can affect the level, maturity  ing Governance and Fighting Corrup-  electrical equipment, vehicles, and vehicle
structure, and composition of debt (includ-  tion in the Baltic and CIS Countries-  parts, all traded in both directions. The
ing private debt), through prudential regu-  The Role of the IMF, WP 00/1, 2000.    Czech Republic and Hungary are both, for
lation in the financial sector, corporate                                example, deeply involved in the European
sector regulation, and restrictions on capi-                             car industry. Therefore much ol their busi-
tal movements.                                                           ness with the EU-57 percent and 45 per-
* Other macroeconomic policies. Large  Bank of Finland Institute for Econo-  cent respectively-consists of a Czech or
real exchange rate appreciation has been  mies in Transition (BOFIT) Discussion  Hungarian industry trading with its Euro-
among the main reasons for runs on cur-  Papers                          pean counterpart.
TRANSITION, February 2000                                     © 2000 The World Bank/rhe William Davidson Institute



Hungary's exports to the EU seem to be  workers receive no compensation fortheir  CASE-CEU Publications
based more on human-capital intensive  foregone option to move.
medium- to high-technology products                                      To order: Center for Social and Economic
while those of the Czech Republic are  Peter Bofinger and Timo Wollmershaeuser,  Research, ul. Bagatela 14, 00-585 Warsaw,
more labor intensive. The Czech car indus-  Options for the Exchange Rate Poli-  Poland, tel.: 4822-628-0912, fax: 4822-
try, however, is strong. The structure of both  cies of the EU Accession Countries  628-6581, email: case@case.com.pl, and
countries' revealed comparative advan-  (and Other Emerging Market Econo-  Open Society Institute-Regional Publish-
tage is wide, which protects them from   mies), DP 2379, February 2000.  ing Center, 1051 Budapest, Oktober 6 u.
shocks in any one sector.                                                12, Hungary tel.: 361-327-3014, fax: 361-
Tito Boeri, Optimal Speed of Transition  327-3042.
10 Years After, DP 2384, February 2000.
Lucjan T. Orlowski, The Development of
Centre for Economic Policy Research  Stefano Manzocchi and Gianmarco  Financial Markets in Poland, 1999, 32
(CEPR) Discussion Papers            Ottaviano, Outsiders in Economic In-  pp.
tegration: The Case of a Transition
Constantin Sonin, Inequality, Property  Economy, DP 2385, February 2000.    Andrzej Baniak, Unilateral Spillovers
Rights Protection, and Economic                                          Between East and West and Quality
Growth in Transition Economies:  JOrgen von Hagen and Rolf Strauch, East  Competition, 1999,27 pp.
Theory and Russian Evidence, DP  Germany: Transition With Unification-
2300, November 1999.                Experiments and Experiences, DP
2386, February 2000.
Daniel MOnich, Jan Svejnar, and Katherine                                Centre for the Study of Public Policy
Terrell, Returns to Human Capital Un-  German Union meant the extension of (CSPP)
der the Communist Wage Grid and  West Germany's legal, administrative, and
During the Transition to a Market  economic infrastructure to the five new  To order: CSPP, University of Strathclyde,
Economy, DP 2332, December 1999.   Lander. The paper traces the economic  Livingstone Tower 26 Richmond Street,
changes since 1989 and assesses the  GlasgowGI 1XH, Scotland, tel. 44-141-
Under communism, workers had their  convergence between West and East  548-3217, fax.: 44-141-552-4711.
wages set according to a centrally-de-  Germany during the last decade. Its three
termined wage grid that maintained an  main conclusions:                 Richard Rose, Young People in Politics:
extremely low rate of return on education.                               A Multi-Continental Survey, SPP 316,
Following the system change, the return  0 There has been significant convergence  1999.
increased dramatically and equally in all  in the administrative and economic realm,
ownership categories. Contrary to ear-  though persistent differences remain in the  While government today is in the hands
lier studies, inter-industry wage structure  level of output and incomes as well as lo-  of middle-aged and older people, young
changed substantially between 1989  cal capacities.                      people of today will become voters to-
and 1996.                           0 The Kohl government's policy towards  morrow. This paper compares the politi-
East German transition, driven by short-  cal attitudes and behavior of young,
Guido Friebel and Sergei M. Guriev, Why  term electoral considerations, focused al-  middle-aged, and older people in more
Russian Workers Do Not Move: At-  most entirely on financing a high standard  than 40 new democracies across west-
tachment of Workers Through In-Kind  of consumption and too little on fostering  ern Europe, eastern Europe, and Latin
Payments, DP 2368, January 2000.    investment and economic restructuring.   America. It is based on unique surveys of
0 There is, therefore, a considerable risk  the New Democracies and New Russia
Workers who receive in-kind payments are  that East Germany will remain a transfer-  Barometer, the Latinorbarometer, and the
less likely to move than workers who are  dependent economy for the foreseeable  European Commission's survey of voting
paid in cash, because they cannot raise the  future. However, endogenous institutional  for the European Parliament. The results
money to move in search of better jobs.  change in the labor market, showing its first show that all age groups usually support
Firms tend to exploitworkers whose options  signs in East Germany, may become im- democracy and reject undemocratic al-
they have eliminated. Surprisingly, this hap-  portant in overcoming the structural prob-  ternatives. Insofar as there are differ-
pens even in regions where a number of  lems in the new Lander.          ences between social groups, economic
firms compete for labor, because all the                                 prosperity and level of education are
firms may use attachment strategies. Their         *****                 more important than age.
C 2000 The World Bank/The William Davidson Institute                               TRANSITION, February 2000   X



Richard Rose, What Does Social Capital  20330, fax.: 39055-244-817, e-mail:  Gregg S. Robins, Banking in Transition
Add to Individual Welfare? An Empirical  ciusco@unicef-icdc.it Intemet: wwwunicef-  East Germany after Unification, De-
Analysis of Russia, SPP 318,1999.    icdc.org                              cember 1999, 272 pp.
Survey-based data about social capital net-  Bruce Brad bury and Markus Jantti, Child  Eckehard Rosenbaum, Frank Bonker, and
works in Russia indicate that in some cir-  Poverty Across Industrialized Nations,  Hans-Jurgen Wagener, Privatization, Cor-
cumstances they do produce some increase  Economic and Social Policy Series (EPS)  porate Governance and the Emergence
in individual welfare. However social capital  71, September 1999, 85 pp.  of Markets, December 1999, 304 pp.
should not be analyzed in isolation but as
part of a portfolio of resources that individu-  John Flemming and John Micklewright,  Johannes Stephan, Economic Transition
alsusetosecurewelfare.               Income Distribution, Economic Sys-  in Hungary and East Germany, Febru-
tems and Transition, EPS 70, May 1999,  ary 1999, 312 pp.
Claire Wallace, Xenophobia in Post-  94 pp.
Communist Europe, SPP 323, 1999.
The picture during transition, like that un-
This study of xenophobia is based on New  der socialism, is varied. Russia has ex-  Other Publications
Democracies Barometer V, a survey in  perienced very sharp increases in
Spring 1998 of Poland, Hungary, the Czech  measured inequality to well above the  King Banaian, The Ukrainian Economy
Republic, Slovakia, Slovenia, Croatia, the  top of the OECD range. The Czech Re-  Since Independence, Studies of Com-
Federal Republic of Yugoslavia, Bulgaria,  public, Hungary, and Poland have seen  munism in Transition, Edward Elgar,
Romania, Ukraine, and Belarus. Xenopho-  more modest rises.                United States, 1999,173 pp.
bic attitudes were particularly strong in Hun-
gary, Poland, the Czech Republic, and  John Micklewirght and Kitty Steward, Is  If the cure for the Ukrainian economy is to
Slovakia. This may be a response to in-  Child Welfare Converging in the Euro-  be treatment ratherthan trauma, afew les-
creasing immigration since the transition  pean Union?, EPS 69, June 1999, 129  sonsseemtobeavailabletoguidereform-
from Communism and their role as a mi-  pp.                                ers. First, a sequencing of reforms that was
gration "buffer zone" between East and                                     appropriate at the outset of transition is
West. Xenophobia was stronger among                 *                      quite possibly not appropriate after tran-
older people and those with low education.                                 sition has muddled along for several years.
People who are xenophobic feel threatened  Macmillan Press Publications    The losers from transition are by this time
by international powers-Russia, Germany,                                   unlikely to be overwhelmed by a rush of
and the United States-as well as by inter-  To order: Fiona Woodruffe-Peacock,  reforms along all three fronts, as occurred
nal minorities and migrants. Xenophobia is  Macmillan Press, Houndmills, Basing-  in the shock therapies in central Europe.
also associated with distrust of democratic  stoke, RG21 6XS, United Kingdom, fax.: They have proven themselves willing to
institutions and reform regimes. Xeno-  01256-330688, e-mail: f.woodruffe-  endure much to fight over the share of
phobes are also likely to support authori-  peacock@macmillan.co.uk        transformation's costs that they will pay.
tarian political alternatives. Xenophobia is                               By this time their positions are entrenched
strongly associated with national pride and  Irwin Collier, Herwig Roggemann, Oliver  and reinforced. The time for shock therapy,
with resistance to multiculturalism. Xeno-  Scholz, and HorstTomann (editors), Wel-  then, has long passed.
phobes prefer assimilation for minorities  fare States in Transition, February 1999,
and rejection of international integration,  224 pp.                       Second, those who resist reforms may be
seeing citizenship as inherited with nation-                               willing to accept a degree of stabilization
ality rather than based on place of birth.    Hubert Gabrisch and Rudiger Pohl (edi-  that gives the illusion that the reform pro-
tors), EU Enlargement and Its Macro-  cess has started. Inflation alone will cause
economic Effects in Eastern Europe:  a transition to fail, but its relative absence
Currencies, Prices, Investment and  will not alone cause a transition to succeed.
Innocenti Occasional Papers, UNICEF  Competitiveness, January 1999,256 pp.  If one can make a good case for Western
donors' reluctance to lend to Ukraine it is
To order: Innocenti Occasional Papers,  Emil J. Kirchner (editor), Decentraliza-  the recognition that the problem is no
UNICEF International Child Develop-  tion and Transition in the Visegrad:  longer stabilization. The National Bank of
ment Centre, Piazza SantissimaAnnuziata,  Poland, Hungary, the Czech Republic  Ukraine, for instance, is fully pledged to fi-
12, 50122, Florence, Italy, tel.: 39-055-  and Slovakia, May 1999, 256 pp.  nancial reforms and would not wish to turn
E  TRANSITION, February 2000                                       C) 2000 The World Bank/The William Davidson Institute



back to hyperinflation even if the IMF never  historical crossroad.        tel.: 061-1328-151, fax: 061-342-760,
lent it another dollar. The problem for the  To order: Edward Elgar Publishing, 136  email: recnikm@ier.si, Internet: http://
IMF is that its most cost-effective opera-  West Street, Suite 202, Northampton,  wwwiersi/
tions are those involving reform of central  Massachusetts 01060, United States, teL.:
banks. Changing attitudes toward mo-  413-584-5551, fax.: 413-584-9933, e-  Fiscal Transition in Kazakhstan, Asian
nopoly and free prices is not a job to which  mail: rhenning@e-elgar.com, Internet:  Development Bank, Philippines, February
it is well suited. Yet that is the problem it http.-//www.e-elgarco.uk     1999, 367 pp.
now must face if it still wishes to help
Ukraine.                             Giuseppe Casale (editor), Social Dia-  This book evaluates several closely re-
logue in Central and Eastern Europe,  lated aspects of fiscal transition in
Third, attitudes change only slowly, and  International Labour Office, Hungary, 1999,  Kazakhstan, namely: tax reform, budget-
some attitudes toward a market economy  343 pp.                            ing, and reform of intergovernmental fis-
have been gravelydamaged by corruption.  To order: Intemational Labour Office, CH-  cal relations. In tax reform, Kazakhstan
By privatizing slowly and favoring mana-  1211 Geneva 22, Switzerland.     has made more progress than other
gerial/worker buyouts (particularly for en-                                former Soviet states. The new tax code,
terprises desired by the various clans) the  Petr Chadraba and Reiner Springer (edi-  which became effective on July 1, 1995,
government has exposed itself to criticism  tors), Proceedings of the 7th Annual  is comprehensive, modern, and investor-
of the whole concept of private enterprise.  Conference on Marketing Strategies  friendly. By comparison, budgeting and in-
This has provided the left with leverage to  for Central and Eastern Europe, De-  tergovernmental fiscal relations have
slow and harass the privatization process.  cember 1-3,1999, Vienna, Austria.  hardly advanced beyond the Soviet sys-
But 55 percent of state-owned enterprises  To order: Gertrude.Seidelmann@wu-  tem. Expenditure assignment is not
still operated at a loss at the end of 1998,  wien.ac.at                   specified by law. The budgetary system
producing goods without markets, and                                       deprives district governments of control
thus relying on barter and arrears to fi-  Cuba in Transition-Volume 9,1999.   over the level and composition of public
nancetheiroperations. Moving forward on  To order: ASCE Books, PO Box 7372,  expenditures. It is inadequate for plan-
privatization from here must mean redress  Silver Spring, Maryland 20907-7372,  ning, monitoring expenditures, and evalu-
of the issue of fairness in distribution of  United States tel./fax.: 301-587-1664,  ating performance.
state property.                      e-mail: jalonso@erols.com.
The system of tax sharing lacks transpar-
Last, if the shadow economy is as large  Joze Pavlic Damijan, Efficiency of Free  ency, simplicity, and logic; both the assign-
as estimated, growth could be restored by  Trade Agreements: Did the Reduction  ment of taxes among districts and sharing
bringing it out of the shadow. Oleg Soskin  of Trade Barriers Have Any Effect on  rates set for regulating taxes are essen-
argues that the way to a new Ukraine is to  Increasing Trade Between Slovenia  tially irrelevant. Budgetary officials, both
bring a healthy shadow economy out by  and the CEFTA Countries?, Working  central and district, are under constant
lowering taxes and clearing arrears using  Paper No. 4, 1999, 19 pp.       pressure to increase budgetary allocations
national debt. But tax holidays are only one                              to lower-level govemments. The book con-
aspect of bringing firms out of the shad-  Trade liberalization as part of the Central  tains specific proposals on expenditure
ows. The shadow market has operated  European Free Trade Agreement did not assignment, formulation, and execution,
effectively without access to formal credit  have any direct impact on expansion of  and further control, audit, and evaluation
markets. Creating effective private credit two-way trade. Increase of Slovenian ex-  of the budgetary process.
markets that provide equal access to pri-  ports to its CEFTA partners occurred in-  To order: Asian Development Bank, P0O.
vate and state borrowers is a critical com-  dependently of the agreement. Imports  Box 789, 0980 Manila, Philippines.
ponent of enterprise reform. Another is  from these countries would have increased
abolition of pricing boards that govern  even if Slovenia had not entered into the  Zoltan Hermann, Tamas M. Horvath, Gabor
what firms can charge for goods and ser-  agreement. With the imposition of barri-  Peteri, and Gabor Ungvari, Allocation of
vices.                               ers on trade with the former Yugoslav re-  Local Government Functions: Criteria
publicsandthenearcompletesuspension  and Conditions: Analysis and Policy
Whether or not these treatments are taken,  of bilateral trade that followed, Slovenia re-  Proposals for Hungary, FDICEE, 1999,
Ukraine will retain the attention of econo-  directed its imports to the cost-effective  17pp.
mists and political and other social scien-  markets of CEFTA countries.   To order: Robert D. Ebel, email: Rebel@
tists in years to come. A country as large  To order: Institute for Economic Research,  worldbank. org, Karen Hotra, email:
and populous as France, Ukraine sits at a  Kardeljevapl. 17, 1000 Ljubljana, Slovenia,  Khotra@worldbank.org.
(D 2000 The World Bank/The William Davidson Institute                                TRANSITION, February 2000  M



Colin Lawson, Allister McGregor and  now represents 50 percent of GDP. It has  tion, and privatization, and to allow mar-
Douglas Saltmarshe, Surviving and  led to a vicious circle of corruption, hid-  ket operations by creating a competitive
Thriving: Differentiation in a Peri-ur-  den firm activity, reduced public revenues,  environment where rules of the game are
ban Community in Northern Albania,  and a dramatic increase of income in-  clearly defined.
Occasional Paper 12, European Re-  equality. Corruption and poverty are the  To order: Institute of Public Finance,
search Institute, United Kingdom, 1999,  two sides of the same coin. Corruption  Katanciceva 5, 10000 Zagreb, Croatia,
37 pp.                               stifles private economic initiative and en-  tel.: 385-1481-9363, fax: 385-1481-9365,
trepreneurship.                      email: ured@ijf.hr.
Moldova in Transition: Economic Sur-  To order: Center for Strategic Studies and
vey, Centerfor Strategic Studies and Re-  Reforms, Str. Sfatul Tarii 27, Chisinau,  Gao Shangquan, Two Decades of Re-
forms 4, 1999,136 pp.                Republic of Moldova, MD-2012, tel.  form in China, World Scientific, Hong
3732-237-116, fax.: 3732-237-104, email:  Kong, 1999, 311 pp.
Many transition countries, including  cisr@un.md, Internet: http://cisr.home-
Moldova, had the illusion that it was pos-  page.org                       In setting up a socialist market economy,
sible to effectively combine, during the                                  it is necessary to draw on the market
transition period, socialist paternalism   Vedran Sosic and Michael Faulend, Is  economies' successful experience and
(statism) with market self-regulation. The  Unofficial Economy a Source of Cor-  take into account the laws of modern eco-
weakness of the state and the low level  ruption? Occasional Paper 9, November  nomics. In a socialist market economy, all
of political consent in Moldovan society  1999, 19.                        commodities and production factors go to
did not allow the state to implement re-                                   the market and the market mechanism
forms. In particular, the state proved in-  The unofficial economy in the transition  plays a basic role in the allocation of re-
capable of timely structural reforms,  process has had positive impacts that  sources. Where interests conflict, property
collecting taxes, or providing social sup-  should not be rejected a priori or con-  rghts are clearly defined. Enterprises com-
port to the needy. The property reform,  sidered exclusively as social shock-ab-  pete in the market and their managers are
based on rapid voucher-privatization, was  sorbers. Positive impacts of unofficial  responsible solely for profit and loss. Fur-
supposed to granteverybody"equal start-  economy-including stimulation of effi-  ther, it is necessary to establish a social
ing opportunities." In reality, it did little  ciency and growth-are important in  securitysysteminChinathatsupportsthe
more than turn poor-quality assets over  cases when the system is regulated to  unemployed, the elderly, and the sick, that
to a large number of poor owners and  such an extent that implementation of  avoids waste and overstaffing, and that is
channel high-quality assets to the "agile  regulations on the part of a company de-  separate from the government administra-
and connected."                      creases the overall welfare of society. A  tion.
systematic anti-corruption strategy  To order: World Scientific Publishing
The populist privatization method and the  based on three pillars should be imple-  Co., Ltd., PO. Box 128, Farrer Road,
slow pace of reform in the agro-industrial  mented:                        Singapore 912805.
sector inhibited the emergence of "real  0 Administrative and legal reform. Sim-
owners" and good corporate governance.  plifying and rationalizing the existing rules  Stephen Wegren, Agriculture and the
This in turn damped the export and employ-  would limit the discretionary power of pub-  State in Soviet and Post-Soviet Rus-
ment potential of the real sector. On the  lic servants and thereby reduce the scope  sia, University of Pittsburgh Press, 1999.
macroeconomic front, the efforts to reduce  of rent-seeking activities. The existing in-
inflation and the state budget deficit were  ternal controls should be strengthened,
not sustainable. Much of the success at-  with enhanced supervision of public ser-
tained by Moldova by the mid-1 990s in the  vants.                         Special Publications
area of macroeconomic stability was re-  * Exposure and punishment of corrupt
versed by the 1998 financial crisis in Rus-  public servants. The main goal of the "mo-  Koo Mediatinhe Trdans   Labou
sia. At present, there is a critical shortage  rality" approach is to form a negative pub-  Metsain Centranstion  Eur
Markets in Central and Eastern Eu-
of state funds forthe support of public ser-  lic opinion of corruption and detect the  rope, Forum Report of the Economic
vices, particularly primary health care and  weak points of the systems where corrup-  Policy Initiative, Institute for EastWest
basic education.                     tion occurs.                          Studies, United States, 1999, 135 pp.
* Reform of systems. This implies mac-  To order: Institute for EastWest Studies,
Noncompliancewith the lawhas also led to  roeconomic and structural reforms in gen-  700 Broadway, 2nd Floor, New York, NY
the state's inability to rein in the underground  eral. The aims are to reduce the role of  10003, tel.: 212-824-4100, fax.: 212-824-
economy, which has greatly expanded, and  the state through deregulation, liberaliza-  4149, e-mail: iews@cbiews.org.
TRANSITION, February 2000                                      ( 2000 The World Bank/The William Davidson Institute



Bibliography of Selected Articles
Postsocialist Economies            Stephan, P. B. Rationality and Corrup-  Reform Today (United States) 3:24-27,
tion in the Post-Socialist World. Con-  1999.
AEA Sessions Discuss Emerging Mar- necticut Journal of International Law
kets, the Euro, and Transition Econo-  (United States) 14(2):553, 1999.  Kim, T. A Rare Success From the CIS.
mies. IMF Survey/lnternational Monetary                                Euromoney (United Kingdom) 369:90-
Fund (International) 29(2):17, 20-23,  Utsch,A.,A. Rauch, R. Rothfuss, and M. 92,January2000.
January 24, 2000.                  Frese. Who Becomes a Small Scale En-
trepreneur in a PostSocialist Environ-  Russia: Investment. Business Week
Bonanno, P. Women: The Emerging  ment: On the Differences Between  (United States) 3671:58, March 6,2000.
Economic Force. Economic Reform   Entrepreneurs and Managers in East
Today (United States) 3:2-3,1999.  German. Journal of Small Business Man- Serova, E. von Braun, J., and P. Wehrheim.
agement(United States) 37(3):31, 1999.  The Impact of Financial Crisis on
Carothers, T. Western Civil-Society Aid                                Russia's Agro-food Sector. European
to Eastern Europe and the Former  Central and Eastern Europe           Review ofAgricultural Economics (United
Soviet Union. East European Constitu-                                  Kingdom) 26(3):349-370, March 1999.
tional Review (United States) 8(4):54-62,  Estonia: Economic Integration Poses
1999.                              Policy Challenges to Countries Seek- Asia
ing EU Accession. IMF Survey/lnterna-
Dingsdale,A. NewGeographies ofPost-  tional Monetary Fund (International)  Coughlin, C. C., and E. Segev. Foreign
Socialist Europe. The Geographical 29(3):42-44, February 7, 2000.      Direct Investment in China: A Spatial
Jouma/ (United States) 165(2): 145,1999.                               Econometric Study. World Economy
Jones, C. Slovenia: Independent  (United Kingdom) 23(1):1-23, January
Growth Effects of Institutional Change  Stance. Banker (United Kingdom)  2000.
and European Integration. Economic  150(887):49-50, January 2000.
Systems (Germany) 23(4):305-330,                                       Edison, H., P. Luangaram, and M. Miller.
1999.                              Jones, C. Top Marks in Central Europe. Asset Bubbles, Leverage and "Life-
Banker (United Kingdom) 150(887):45-  boats": Elements of the EastAsian Cri-
Krygier, M. Traps for Young Players in  47, January 2000.              sis. Economic Journal: The Journal of
Times of Transition-Falicies and Con-                                  the Royal Economic Society(United King-
fusions of Postcommunist Research.  Kiuranov, D. Democratization Patterns  dom) 110(460):309-34, January2000.
East European Constitutional Review  for Romani NGOs in the Balkans. NGO
(United States) 8(4):63-67, 1999.  News (Hungary) 14:11,2000.          Fan, S. Technological Change, Tech-
nical and Allocative Efficiency in Chi-
McKinnon, R., R. Chariton, and L.  Konopielko, L. Foreign Banks' Entry  nese Agriculture: The Case of Rice
Konopielko. The Emergence of Con-  into Central and East European Mar-  Production inJiangsu.JournalofInter-
tractual Savings Sectors in Transition  kets: Motives and Activities. Post-Com-  national Development (United Kingdom)
Economies: Business and Policy in  munist Economies (United Kingdom)  12(1):1-12,January2000.
the Rise of the Non-State Pension  11(4):463-85, 1999.
Fund. The Journal of European Finan-                                   Ye, A. L. More Haste, Less Speed: The
cial Services (International) 3(3):24-47,  CIS                         Secret to Investing in China. Interna-
July 1999.                                                             tionalFinancialLawReview(United King-
Arnade, C. and M. Gopinath. Financial  dom) 18(1):17-19 January 2000.
Megginson, W. Privatization. Foreign  Constraints and Output Targets in
Policy (United States) 118:14-27, 2000.  Russian Agricultural Production. Jour-  Yifu Lin, J., and D. Tao Yang. Food Avail-
nal of International Development (United  ability, Entitlements and the Chinese
Nam, M. Washington Consensus or  Kingdom) 12(1):71-84, January2000.    Famine of 1959-61. Economic Journal:
Washington Confusion? Foreign                                          The Journal of the Royal Economic So-
Policy (United States) 118:87-103,  Elizbarashvili, N. Promoting a National  ciety(United Kingdom) 110(460):136-58,
2000.                              Reform Agenda in Georgia. Economic  January2000.
(D 2000 The World Bank/The William Davidson Institute                            TRANSITION, February 2000



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