STUDIES OF ECONOMIES IN TRANSFORMATION Private Service Firms in a Transitional Economy Findings of a Survey in St. Petersburg Martha de Melo and Gur Ofer 1'1 . RECENT STUDIES OF ECONOMIES IN TRANSFORMATION PAPERS No. I Country Department 111, Europe and Central Asia Region, Food dnd Agricultural Policy Reforms in the Formner USSR- An Agenda for the Transition No. 2 Michalopoulos and Tarr, Trade and Payments Artrngements for States of dhe FOrner USSR No. 3 Country Department Ill, Europe and Central Asia Region, Statistical Handbook: States of the Fonner USSR No. 4 Barr, Income Transfers and the Social Safety Net in Russia No. 5 Country Department 111, Europe and Ccntral Asia Region, Foreign Direct Investment in the States of the Fonner USSR No. 6 Wallich, Fiscal Decentralization: Interg overnmenl Relations in Russta No. 7 Michalopoulos, Trade Issues in the New Independent States No. S The World Bank, Statisical Handbook 1993: States of the Former USSR No. 9 Holt. Trans port Strategies for the Russian Federation No. 10 Fong, The Rote of WVomen in Rebuilding dte Russian Economy STUDIES OF ECONOMIES IN TRANSFORMATION PAPER NUMBER 11 Private Service Firms in a Transitional Economy Findings of a Survey in St. Petersburg Martha de Melo and Gur Ofer The World Bank Washington, D.C. Copyright ) 1994 The Intemational Bank for Reconstruction and DevelopmentrHEWORLD BANK 1818 H Street, N.W. Washington, D.C- 20433, U.SA. All rights reserved Manufactured in the United Stares of America First printing May 1994 Papers in the Studies of Economics in Transformation series present the results of policy analysis and research on the states of the former USSR. The papers have been prepared by World Bank staff and consultants and issued by the World Bank's Europe and Central Asia Countnr Department III. Funding for the effort has been provided in part by the Technical Cooperation Program of the Wotld Bank for states of the former USSR. In light of the worldwide interesc in the problems and prospects of these countries, dissemination of these findings is encouraged for discussion and comment. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. Some sources cited in this paper may be informal documents that are not readily available. The boundaries, colors, denominations, and other information shown on any map in this.volume do not imply on the part of the World Bank Group any judgment on the legal stats of any territory or the endorsement or acceptance of such boundaries. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher at the address shown in the copyright notice above. The World Bank encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910,222 Rosewood Drive, Danvers, Massachusetts 01923, U.S.A. -he complete bacldist of publications from the World Bank is shown in the annual- Indx of Publcaidos, which contains an alphabetical title list (with full ordering information) and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, Department F, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'Iena, 75116 Paris, France. ISSN: 1014-997X Martha de Melo is lead economist in the Transition Economics Division of the Policy Research Department at the World Bank. Our Ofer is a professor of economics at Hebrew University in Jerusalem, IsraeL library of Congress Cataloging-in-Publication Data De Melo, Martha, 1941- Private service firms in a transitional economy : findings of a survey in St. Petersburg / Martha De Melo and Gur Ofer. p. cm. - (Studies of economies in transformation, ISSN 1014-997X ; paperno. 11) Includes bibliographical references. ISBN 0-8213-2797-6 1. Senrice industries-Russia (Federation)-Saint Petersburg. 2. Smal business-Russia (Federation)-Saint Petersburg. 3. Saint Petersburg (Russia)-Economic conditions. 4. Industrial surveys- Russia (Federation)-Saint Petersburg. 5. Russia (Federation)- Economic policy-1991- L Ofer, Gur. IL Tide. Ill. Series. ED9986.R93S253 1994 - 338.4-c20 94-4998 CIP Contents Foreword v Acknowledgmnt i Abstract nil 1 Inrodution 1 Servces and small business in a transitional economy The St. Petersburg survey 3 2 r and fins 7 The eurs 7 The firms 11 3 Wages, prices, and markets 27 Wages and prices 27 Markets 30 4 Constraints in the busns emniromat 37 The macroeconomic and legal environut 38 Public administration 39 Taxtion 42 The banking system and obtaining credit 43 Real estae 45 5 Policy reconnend dato 49 Improvements in the business wavironment 49 Specific government policies 51 Direct assistance during the transition 53 App : per ormace 57 Refereaces 67 Postsuipt 69 Boxes Box 1.1 Small and medium-size service firms are crucial to market economies 2 Box 2.1 Vladimir X: A "typical" entrepreneur 8 Box 2.2 Motives for entrepreneurs to diversify 16 Box 2.3 Real estate: the next boom 17 Box 2.4 Service firm entrepreneurs-on the frontier 23 Box 3.1 Transactions rely on personal connections - 31 Box 3.2 Job protection in the private sector 33 Box 5,1 Direct assistance to small and medium-size enterprises in other countries 52 Flgures Figure 2.1 The pace of private sector development in St. Petersburg 13 Figure 2.2 Average ownership of firms surveyed, January 1993 15 Figure 2.3 Financing patns in private finns 20 Tables Table 1.1 Structure of small enterprises and cooperatives in the service sector: Comparison of Statistical Office and survey data 4 Table 2.1 Main activities of private service firms in the survey 7 Table 2.2 Characteristics of owners by past job 10 Table 2.3 Firm size by revenue and employment 12 Table 2.4 Registered legal status by main activity 14 Table 2.5 Structure of labor force by main activity 18 Table 2.6 Structure of labor force by firm size 19 Table 2.7 Financing of firms by revenue size 21 Table 2.8 Characteristics of firms by owner's past job 22 Table 3.1 Average monlhly wage by main activity 28 Table 3.2 Chages in nominal and real wages by activity, June - December 1992: Comparison of St. Petersburg survey data and Russia as a whole 29 Table 3.3 Market orientation by owner's past job 35 Table 4.1 Ratings by entrepreneurs of attitudes of different groups towards the private sector 41 Box Tables Box Table 5.1 Policies toward small and medium-size enterprises in EU member states 52 Appendix Boxes Box Al Correlation of performance indicators and overall grades 59 Box A2 Generation of full-time employment by survey firms 60 Appendix Tables Table Al Ranking of firms' performance by main activity 61 Table A2 Ranking of firms' performance by owner's past job 63 Table A3 Ralking of firms' performance by main customer 64 Appendix Box Tables Box Table Al Correlation matrix of performance indicators and overall grades 59 Box Table A2 Generation of fill-time employment by survey firms 60 iv Foreword Privately owned service firms are crucial to found in most other Russian cities. Even so, St market economies. Because they are involved in Petersburg's service sector entrepreneurs have most transactions, such firms in some sense are encountered many problems that are experienced the markel The successful development of such -with more or less intensity-elsewhere in firms is vital to Russia and other ecooonies in Russia, as well as in. other economies in tmansition, yet little is known about the emergence transition. of service sector entrepreneurs and firms in the This study was prepared in the World Bank's former socialist economies or about the problems Policy Research Department and is intended for they face. policymakers, multiateral and bilateral aid This survey of private service finms in St. agencies, and other researchers or academics. Petersburg helps fill this gap. The study examines Foreign businesses and non-government in detail the origin and characteristics of 86 smal organizations interested in private sector and medium-size firms representative of the city's development in Russia may also find this report emerging private service sector and identifies key usefil. barriers to their growth. Ih then recommends policies to boost development of small and medium-size privately owned service firms in Russia and other economies in transition. St. Petersburg is not typical of Russia. The - 4, * city's historically close economic and cultur4l links with Europe, as well as the large number of Russell J. Cheetham professionals who have worked in the city's Director military-industrial complex, have contributed to a Country Department mI more favorable business enviromnent than that Europe and Central Asia Region v Ackno wledgments This paper presents the findings from a survey of entrepreneurs of St. Petersburg who shared tizeir private firms providing services in the St. experience with us-for their valuable Petersburg area. The survey was undertaken contributions to this research. Januax $' 17-27, 1993. The interview teams were Helpful comments on an earlier draft were headed by Martha de Melo, Gur Ofer, and Olga provided by Alan Gelb, Michael Gould, Costas Sandler from the World Bank; Tom Adshead and Michalopoulos, Enrique Rueda-Sabater, and Leila Joanna Chataway from the European Bank for Webster, who also provided us good and timely Reconstruction and Development; ind Eugene advice as well as interview response cards from Tankhilevich, Senior Researcher of the Russian service firms identified in the IBRD/EBRD survey Academy of Sciences Institute of Economic of manufacrtuing firms in St Petersburg. Forecasting. Olga Sandler also organized the field Lawrence MacDonald of the World Bank and work, the data files, and all the statistical work. Glenn Ruh provided useful editorial advice, and Elena Belova of the Leontief Center in St. Christopher Rollison gave excellent support Petersburg was the local Project Manager; and assistance. We would like to thank Dr. Irena interpreters were Tim Chernov, Kirill Kalinin, Karelina, Vice President of the Leontief Center Mlikhail Pelienko, and Julia Snirmova. We for the Center's hospitality and help with logistical thank all these colleagues-and especially the support in St Petersburg. Abstract This report presents the findings of a survey of and high taxes. Other problems included lack of private service firms in St. Petersburg. Services demand, finding good workers, and obtaining are defined as all sectors of the economy other satisfactory space. than agriculture, manufacturing, construction, and Considering the importance of rapid private utilities. Services are the largest and most dynamic sector development in services, entrepreneurs part of the emerging private sector in St. require more stable and supportive surroundings. Petersburg and elsewhere in Russia, yet relatively Based on the study's findings, dhe key little is known about private service firms. recommendations for policy reform are to: The report examines in some detail the characteristics of the city's new entrepreneurs and * Improve the business environment. Stabilizing their fir.s. It discusses wages, prices, and the the economy and raising credibility about the markets in which these firms operate, and it direction of reforms will reduce risk and provide analyses firm performance. Most entrepreneurs a solid base for investment, and hence growth. It were highly educated, energetic and resourceful; will also help to nonnalize financial markets and their fims were typically small but growing, interest rates, setting the -stage for increased diversifying, and self-financing. Wages and prices provision of bank credit. are flexible, but markets are still poorly *Strengthen core government institutions while developed. reducing intervention into markets. Government Despite a difficult business environment needs to contain expenditures, so that revenue characterized by high inflation and declining requirements arc reduced, and eliminate civil output, most firms were performing reasonably service corruption. Necessary regulations should well. Good performance was associated with new be simple, clear, well-publicized, standardized, firms unconnected with state enterprises, firms run long-term, and not retroactive. by academics or technical specialists, and firms * Reduce and simplify taxes. Reducing the selling primarily to other private companies. Poor number of taxes and simplifying and standardizing performance was associated with low total the tax code will assist small businesses, which revenue, privatized firms unconnected to state have difficulty coping with complex procedures enterprises, firms selling primarily to households, and frequent changes. Tax authorities should and consumer services activities. analyze the cumulative as well as individual The problems most frequently mentioned by effects of the tax system with a view to ensuring entrepreneurs were an unstable macroeconomic both equity and adequate incentives to and legal environment, the lack of bank financing, entrepreneurs. * Open the real esrate market and increase the reforms, special assistance for small businesses securily of ownership. Government should sell may be needed to encourage private sector excess real estate holdings of government entities, development during the transition. Such assistance permit c upward adjustment in real land rents, should include programs to encourage lending to and encourage creation of a competitive market small businesses by existing financial institutions for the renovation and rehabilitation of historic and to create business centers offering buildings. information, training, and technical assistance. * Provide equal treatment for different * Minimize direct government involvement in economic activities. Regulations, taxes, or other targeted assistance programs. The existing strains forms of government intervention should not on government and entrepreneurs' low confidence discriminate between different types of economic in government suggest that its involvement in activities, such as trade and manufacturing. Rather targeted assistance programs should be minimal. than tax traders heavily, government should Instead, government should concentrite on law reduce the distortions that make high profit enforcement, tax collection,, and .improved margins possible. efficienty of services, while the private * Offer special assistance to small businesses sector-supported in part by foreign aid-should during the traisition. In addition to policy handle small business assistance. vii~~~~~~~~~~~~~~~ I Introduction This report presents the finding of a survey of In the fonner Soviet Union the service sector private service firms in St. Petersburg, Russia. was run by the state and was extremely underde- Services are defined as all sectors of the economy veloped. Enterprise development began with the other than agriculture, manufacturing, construc- legalization of private activity in 1987; it contin- tion, and utilities. The focus is on services be- ues despite many difficulties. The development of cause they are the largest and most dynamic part small and medium-size enterprises in the service of the newly emerging private sector in St. Peters- sector, in particular, needs to be enoouraged burg and elsewhere in Russia, because the devel- during Russia's transition to a market economy opment of services is crucial to the transition to a because, in a sense, such firms are the market and market economy, and because relatively litfle is because, among all the tasks ahead, their develop- known about private service firms. The purpose of ment may be one of the easiest. the study is to explain the origin and characteris- The formation of a large sector of small and tics of private service firms, to identify the main medium-size enterprises can be achieved by difficulties they face, and to recommend policies creating new firms and down-sizing and privatiz- to facilitate stronger growth of services in Russia ing state firms, but closing the gap in services will and other transition economies. require a change in the structure of the economy. Even during the early stages of transition, the Services and small business in a creation of new firms will predominate, resulting transitional economy in substantial employment growth in the private sector.2 New, privately supplied consumer servic- In developed market economies, both the service es will improve the quality of life, thereby in- sector and the small-business private sector play creasing the political support for reforms. important roles in the economy (box 1.1). The Small and medium-size enterprise development two sectors overlap substantially, as most of the is relatively simple. Entrepreneurial demands and activity in the service sector is performed by risks assumed by new owners are not unreason- private small and medium-size enterprises, most able; indeed, starting a small enterprise can of which provide services. The last twenty years provide training for new entrepreneurs, who may have witnessed an increase in the importance of later diversify into more complex and demanding small and medium-size enterprises in most market activities. The requirements for technology and economies and a growing recognition of their capital assets are often modest, particularly in the contribution to growth and employment, innova- service sector. The experience in Eastern Europe tion and productivity, and competition.1 shows the importance of small and medium-size Box 1.1 Small and medium-size service firms are crucial to market economics Small businesses in the Organization for Economic Cooperation and Development (OECD) countries are defined by revenues, value of assets and employment. The most common definition is by employment, and die term "small and medium-size enterprises" is typically used for firms with fewer than 500 employees.-The term "small business" is applied to firms with fewer than 100, 200 or sometimes 250 employees and may be subdivided into several categories. The European Union uses the term "microenterprise" for small businesses with fewer than 10 employees. The following facts about services and small and medium-size enterprises demonstrate their importance: * The service sector-including transportation and communications, trade, financial and business services, personal services, and public services such as education and health-accounts for the major share of economic activity in OECD countries and has been growing in importance. Its average share of GNP was 51 percent in 1970 and 62 percent in 1990; its share of the labor force was 50 percent in 1970 and 67 percent in 1990. * Small and medium-size enterprises made up 99.8 percent of all enterprises and 57 percent of all private sector employment in the United States in 1990; enterprises with fewer than 100 employees accounted for 98 percent of enterprises and 43 percent of private sector employment. In the European Union small and medium-size enterprises accounted for 99.9 percent of all enterprises and 72 percent of private sector employment in 1986. * In the European Union, 73 percent of all small and medium-size enterprises are service firms, and 99.9 percent of ali service firms are small and medium-size enterprises. In the United States 69 percent of all employment in firms of this size was in the service sector in 1977, compared to 64 percent in 1987. Service firms Small and medium-size lirms Small and medium-sire service firms Source: OECD National Accounts, OECD 1985; U.S. Small Business Administration 1982, 1992; Storey 1982, 1983, 1987, 1991; Acs and Audretsch 1993. 2 enterprises, particularly service firms, in reversing information, we recommend policies and pro- the trend of declining output, creating new market grams to expedite small and medium-size enter- infrastructure, and generating rapid private sector prise and service sector development. development (Johnson 1992 and Grabowski 1993). The location of the survey in St. Petersburg But small and medium-size enterprise develop- was determined by the ready availability of a ment in Russia faces considerable difficulties. The sample of firms willing to be interviewed.5 in law on entrepreneurship is in place, but nt;'er many ways, the political and institutional setting laws-espeially on contracts and propurty in this, second largest city in Russia-with a rights-are not. Litigation and arbitration systems population of 5 million in the city and another 1.7 and law enforcement are poorly developed. The million in the surrounding Leningrad Oblast-is police are inexperienced and ineffective, and there similar to that of other large Russian cities. But is a high incidence of corruption in public admin- St. Petersburg also has some special cbaracteris- istration. Criminal "mafia" groups have become tics that make it particularly conducive to private widespread, extorting fees for the provision of sector development. "protection" and debt collection. St. Petersburg is a beautiful city with strong At the time of this survey, January 1993, the historical, cultural, and economic links to Western economic and political situation in Russia was Europe; it therefore has a particular appeal to highly unstable, increasing the uncertainty and foreign investors. It has one of the largest concen- risk involved in any entrepreneurial activity, trations of heavy and military industries in Russia especially for services. Russia has a long heritage and is an important center of research and devel- of negative social attitudes about services, which opment'I It has a large pool of highly trained were considered "nonproductive" under the social- academics and professionals in all fields. The ist system. Such attitudes are currently reflected in government of St. Petersburg is known for its discriminatory policies favoring manufacturing support of reform, and more than half of the over service firms. Trade firms, for example, are municipally-owned enterprises were privatized by subject to higher profit tax rates and rental rates the end of 1992. Even so, other aspects of reform, than manufacturing firms. There is also a lack of such as large-scale privatization or sales from the know-how and experience in running private large stock of municipal real estate, have lagged. service activities.3 The firms in this survey were chosen randomly from respondents to 3,000 interview requests, The St. Petersburg survey which were sent to a random sample from 10,000 firms registered by August 1992. Adjusting for Despite the importance of services and small inactive firms, about one in three firms respond- business development for Russia's transition to a ed. The firms included in the survey. were market economy, relatively little research has screened to satisfy three criteria more than 50 taken place.4 This survey of 86 private service percent of revenues from services, more than 50 firms in St. Petersburg was undertaken in January percent privately owned, and less than 50 percent 1993 to help fill the gap. To the authors' hmowl- foreign owned. No restrctions were placed on edge, it is the first survey of Russian private their legal form or number of employees. Not sector development to focus on services. included in the original sample or in the survey The purpose of the survey was to determine the are self-employed persons who need a license but origin of private service firms; the qualifications do not have to register as a legal entity.7 and motivations of the entrepreneurs; the firms' At the time of the survey, no independent characteristics, performance, and interaction with information was available on the structure of the markets they deal in; and the factors in the private sector service activities. Subsequendy, internal operation of the firms and in the external however, data on the structure of service activities business environment that encourage or impede of "small enterprises and cooperatives" in 1992 smooth operation and growth. Based on this were obtained from the St. Petersburg Statstical 3 Office. The correspondence between the survey sometimes meant that not every entrepreneur was data and the Statistcal Office data is quite close, asked every question.' In addition to straightfor- although not a]l the firms in the latter data set are ward reporting of the quantitative and qualitative private (table 1.1). For botz groups, the main information gathered, this reportuses cross-tabula- categories of services, in decreasing importance, tions and statistical correlations to test selected were: trade, business services, consumer services, hypotheses. health and education, transportation, and finance.' Entrepreneurs were assured of confidentiality, and most appeared to be frank in their qualitative Table 1.1: Structure of mmal enterprises responses. They occasionally considered some andcooperativ the senie sector: subjects sensitive, and a few entrepreneurs were andComparlsontof Sunid Ocs-anreluctant to discuss teir export activities, their Compariso of Stwailtcul Offic. and survey dm(percentshare) -revenues, or their relations wit the nmafia.u survey-data (percent sham) Some entrepreneurs may have adjusted -their responses about monthly revenues or wages to -Statisical Sunrve match more closely their tau declarations. Never- Main activity office data data teless, this and other quantitative data vary widely, and no systematic bias was evident-with Trade 39.7 37.2 the possible exception of a performance bias. A large number of firms had relatively good perfr- Business services 36.6 31.4 mance indicators (appendix), and it is possiblethat positive response to the interview request was greater among successful firms. Regardless of Consumer services 12.1 15.1 how represenive survey firms are of perfor- mance in the sector, their experiences are interest- Healnh and education 9.2 8.1 ing and provide insight into the new private sectr in Russia. Transportation 2.0 4.7 Finance 0.4 3.5 Notes T otal services 100.0 -100.0 1. The role of servicesas also expanded, rflectng shifts in demand in fkvor of services as income ris and lower productivity growth in servi thn in agrculture and Source: St. ritersburg Statistical Office, i s G 1993). Ma* Activity Ideta s fI r Sta. l Entpv an 2. For furthor evidence on the service Zap and ib implica- and Ccqpe,atlves A, St. Petenheap mid tions for economic growth in Russia, see Eaorly, do Lenihgd ragion in 7992. St. Petersburg, Melo and Ofer 1994. 1993. 3. Some services-mch as finnce, marketing, and other Each of the firms included in the survey re- businessservices-are almost completely new activities in sponded to a questionnaire, which was quite broad Russia. Others-such as trade ad household servic- and took an average of three hours to administer. es-existed before but require a new Vaproach to qualit. The queionnaire elicited both quantitative and qualitatve responses, and many of the latter were 4. The World Bank has sponred two previous surveys organized in a manner permitting statistical analyn- of aew prvate firms in Russia dia are largely mall and sis. occur because not every medium-size enterprises. One was a 1993 survey of 100 Mis ssing frequeimies occurnnecwse not esrersilmufacturing firms in SL Petsourg (Webster and question was applicable to every firm, because Champ 1993). The other was a 1992 survey of 180 firms entrepreneurs occasionall y refrained from answer- in eight locations; no report is avaiable. in addition, ing a question, and because time constraint Criano Codagnone and Andrei Veikher undertook a 4 nurvey of private businesss in St Petersbug in 1993, 7. In addition, thore are bolieved to be ny individuals, focusing on ntrepreneurship (Codagnone 1993). Otber in St. Petersburg and other pan of Russia, who are World Bunk sponsored surveys are focusing on state neither registred nor have a license and who are operat- enterprises or large privatized companies. ing out of their own homes, providing such services as taloring or consulting. S. These firms, everal of which were locAted in the Leningrad Region, outside St Petersburg proper, were S. The original survey sample included only one financiml identified in a study of manufacturing firms in St Peters- firm. Thus, as an exception to the rule of random selec- burg (Webster and Charap 1993). Of the 504 usble t don, two financial service firms-one bank and one responses, 35 percent were identified as services, 40 insurance company-were added, explaining the larger percents manufacuringand constnction, and 25 percent surey data share of fincial service firms in table 1. s "mixed" activities. Most firms indicating mixed activities re ikely to be service firms, many of them in 9. In general, missig fiequencies are well below fifty trade; local statistics indicate that 52 percent of small percent; the number of missing frequencies is indicated in enterprises and cooperaives are services. a footnote in the few instances where they exceed fifty percent. In general, pementages are calculated using the 6. The high concentration of heavy and militay industries number of responses to a given question as the denomin- in St. Petersburg also bas a cost, as production and tor. The questionnaire is available fiom the authors on income levels have fallen dramatically (Odink 1992). renuest. 5 2 Entrepreneurs and firms The entrepreneurs in the survey were on the Table 2.1: Main actvities of printo service whole highly educated, energetic and resourceful. firms in the survey The firms' main activities according to revenue shares, indicated that the largest group, trade, Main activity Number Percent included mostly wholesale and mixed wholesale and retail companies, with only five solely retail Trade 32 37 companies (including one kiosk owner) and three Wholesale trade 1 2 14 restaurants (table 2. 1). The second largest group, Retail trade 5 6 business services, included computer services, Mixed I unidentified trade 12 14 research and development, and lega! and manage- Restaurants 3 3 ment consulting. The third largest group, con- ut* sres 27 31 sumer services, included travel, repair, customi 6 tailoring, hairdressing, and publishing. The other Research and development 8 9 three groups-health and education (public-type Consulting, legal. and other 14 16 services that cater to both businesses and house- holds), transportation, and financial services-each Consumer servis 13 15 include only a few firms. Separate discussion of Tourism 4 5 these groups is minimized in view of the limited Publishing 1 1 number of observations.' Repair 4 5 Custom tailoring 2 2 The wntrenreuairs Hairdressing 2 2 Health and educatIon 7 8 The survey data provide an interesting picture of HIlh 3 3 the new entrepreneurs and their backgrounds. Educa2on 4 5 Entrepreneurs are individualistic by nature. They come primarily from the elite of the labor force Transpni 4 5 and are looking for both personal fulfillment and financial gain. The private sector has provided a Fnace 3 3 release valve for pent-up talent and ambition. Entrepreneurs typically rely heavily on themselves Total 86 100 and on personal contacts in their day-to-day business. Box 2A1 describes a "typical" en>repre- 7 Box 2.1 Vladimir X: A 'typical' ent reu Vladinur X doesn't exist; but his dreams about movng to the private sector, along with his subsequent frustrations and successes, are all reaL He is a fictional composite drawn from the entrepreneurs interviewed for the survey. The need for confidentiality prevents the presentation of individual case histories. Vladimir X worked 15 years for a state high-technology enterprise after receiving an engineering degree from the St. Petersburg Polytechnical Institute. Vladimir had not been satisfied with his job in the public sector because the enterprise was inefficient and he had little freedom in decision- making with respect to his own professional activities. When private sector activity was permitted in 1987, Vladimir began to dream of becoming his own boss and getting rich. In 1990, he and a friend quit their government jobs to start their own business. Vladimir and his partner started a household appliances repair business. They arranged a two- year lease on the ground floor of a run-down building in the historic section of St. Petersburg and acquired tools and equipment at a good price from the stat enterprise where they worked. The two friends initially employed seven people, including themselves, but business was slow as household incomes had fallen. They soon diversified into car repair, and doubled their work force during their second year of operation. Monthly revenues were low, but so were costs, and they maintained an adequate cash flow by requiring payment on delivery. Soon after opening business, they found themselves trading in spare parts and second-hand appliances. Trade was not only a natural extension of the repair business; it was a convenient way to generate undeclared cash income. Fortunately, Vladimir's trading activities have not yet attracted the attention of the "Lrafia." Vladimir is glad he went into business for himself, but says he did not expect so many difficuldties. Personnel problems are frequent, and it is almost impossible to keep abreast of tax and other regulations. Tension has developed with his partner, who would rather translate profits into a higher personal income than expand the business. Fortunately for Vladimir, his initial equity share was 60 percent, so he has operational control of the firm, subject to the occasional compromise. In spite of such problems, Vladimir is helping his cousin set up a service business to provide information on local real estate. The cousin is a computer expert and has access to information on current real estate holdings. He plans to develop his own data base that records the date and price of various real estate transactions. Both men want to know more about financial management techniques and plan to take an evening course to improve their knowledge. Vladimir complains a lot about the city govermment His complaints are not about the lack of subsidies or special programs for new entrepreneurs, but about excessive regulations, absence of information, and high taxes. But, despite these frustrations, he is determined to succeed. 8 neur, "Vladimir X," a composite of several a clear self-selection process. The prevalence of participants in the survey. entrepreneurs with previous experience in servic- .On the whole, entrepreneurs appeared to be es-even if the particular activity differed-is energetic and resourceful. The youngest entrepre- striking, given the relatively small share of all neur interviewed was 21, the oldest 70; however, workers in such activities under the previous most were between the ages of 30 and 55. Their regime. median age, 41 years, seems to strike a balance Entrepreneurs' stated motivations for moving to between adequate experience and daring or risk- the private sector were, in order of frequency: acceptance. Eleven of the 86 entrepreneurs inter- viewed were women; they were in trade and a The opportunity to make more money. restaurants (4); education and health (2); consum- * The desire to become independent. er services, such as hair dressing (2); and business * The opportunity to pursue their profession. services, such as computers and publishing (3). * The chance to pursue other interests. The high percentage of women in service indus- tries and managerial positions in the former Soviet A few entrepreneurs had previously worked in Union might lead one to expect a high share of the second economy while holding a state sector women among entrepreneurs.3 Systematic factors job, and several entrepreneurs were able to turn in the emerging private sector may discourage their personal hobbies into commercial activities, women from starting their orn businesses. Such specifically in such areas as computer program- factors mij t include a tendency for couples to mig, commercial design, and the arts. hedge their bets by maintaining one public sector job and a tendency for women to opt for the more from predictable, and probably shorter, public sector work schedule given their household Almostallownersofprvateenterprises-whether responsibilities. new start-ups or privatized state enterprises-were employed at one point in the public sector. While still working in the public sector, however, the Educalon, experience, and motivation entrepreneur belonged to one of three groups: managers of state-owned enterprises, academics Overall, the entrepreneurs interviewed were and technical specialists, or clerical/adminis- characterized by a very high level of education. trativelblue-collar workers (table 2.2) s Almost 85 percent had university education, compared to 77 percent for all Russian managers; *Fomer managers were either general manag- 20 percent had post-university education. Four- ers of state enterprises (12) or held other public teen entrepreneurs had only a high school Cmclud- sector managerial positions (29), representing ing technical/vocational) education or less. Most almost half the group. They were slightly older entrepreneurs had held high-level jobs in the past. than the survey average. They tended to have a Some 83 percent had held managerial, academic, university or technical education, and the vast or "specialist" jobs, indicating that they came majority had previously worked in state enterpris- from the elite of the labor force in terms of both es. formal education and human capital acquired on * Former academics and tecical specialists the job. were the best educated group (34). They ir-luded Most business owners worked previously in relatively few women; their median age was close companies or institutes that provided services of to the survey median. Many had completed post- some type or in service departments inside pro- university degrees and employed a high proportion duction companies; only six previously worked in of professionals in their firms. The majority manufacturing jobs and only three in construction. worked previously in academic institutes rather This close correspondence to previousjobs implies than state enterprises. g Table 2.2: Characteristics of owners by past job (pereent) Age Gender Education Previous work place Activity Ownership Above Number survey Higher State Academic Involved in Owner's past job of firms median Women education enterprises institutes Same other firms General or technical manager 38-41 59 17 80 85 5 47 50 Academic or technical specialist 31-34 47 6 97 19 68 31 56 White or blue collar worker 1 t 18 18 55 55 9 55 45 Total 81-86 49 13 84 57 29 42 52 Note: Chi-square values: age = 0.06, gender = 0.30. education = 0.00. previous work place = 0.00, activity = 0-26. ownership = 0.64. tThe chi-square statistic shows the probability that the data are distributed randomly across the cells-I * Former workers (11) were typically younger capitalizing on his experience and contacts abroad; and tended to have a lower level of education than a transport company owner, who formerly dis- the other two groups. Many previously worked in charged his energy in a high-risk sport, became state enterprises. engrossed in computerized management analysis and expansion plans. Such people are leaning fast Entrepreneurship as a human conversion program and testing their limits; new entrepreneurship is analogous to a coiled spring, previously tightly There is much talk in Russia about military constrained, which can now expand to its full conversion-the conversion of space and equip- potential. ment used in Russia's large defense sector to the One indicator of entrepreneurial spirit is owner- production of consumer goods. But far more ship stakes in other private companies. More than dynamic is the spontaneous 'human conversion half the entrepreneurs interviewed had part owner- program", whereby talented people in former state ship in at least one other company, and half of industries or academic institutes-managers, these in more than one (table 2.2).6 This pattern academics or technical specialists, and work- of multiple stakes is common among small busi- ers-choose a life of opportunity and risk as nessmen in the United States and Western Europe, entrepreneurs in the newly emerging private and it is interesting to note its prevalence at this sector. Some new owners of service firms got early stage of private sector development in their opporftuity through the privatization pro- Russia. Other entrepreneurs interviewed had gram, but the majority had to make their own virtually no formal relationship with other compa- opportnity, sometimes with help from their nies. Only a quarter were members of trade or previous workplace. other business associations; a sense of rivalry and Examples are many: a former captain of a lack of mutual Lust among firms appear to limit government cargo vessel started a travel company, such associations- 10 Although few entrepreneurs have formal busi- There was frequent reference to the need to pay a ness, finance or marketing skills, they are interest- govermment official in order to get something. ed in and capable of acquiring such skillsrapidly One person claimed he and others had made through training, self-study and foreign working hundreds of bribes within the last year and not visits. Many expressed interest in management one was refused. courses, market-related skills such as financial On the whole, entrepreneurs operated indepen- accounting and marketing, and foreign languages. dently, without outside support, although 40 percent had heard about special programs to help How do entrepreneurs operate in the private business with credit or with training. market economy? Three entrepreneurs mentioned the Soros Fund, one the British Know How Fund, and one the In most cases, owners demonstrated a fairly good programs of the European Union. There was understanding of market forces, including differ- considerable interest in such programs, but very ences between nominal and real values and the low expectations. About 15 percent of firms had effects of inflation and the exchange rate on their received some foreign technical assistance, mostly businesses. In many cases, they seemed to be from foreign firms; the rest was from foreign taking effective measures to protect themselves governments' training or technical cooperation against losses, including holding financial assets in programs. hard currency rather than rubles. Owners who were reluctant to take loans at negative real The firms interest rates often had good explanations-either that real rates were not as low as they might Most of the 86 firms in the survey were small in appear or that changes in input and output prices terms of revenue and number of employees. Firms were too unpredictable to make a financial plan. varied in size and made extensive use of part-time In a few cases, they seemed to suffer from "mon- and contract workers. The smaller firms were ey iilusion", whereby nominal and real values are typically owned by individuals; larger firms had confused- substantial corporate ownership. A number of the Entrepreneurs rely heavily on personal contacts newly established joint stock companies featured to accomplish business objectives, substituting inter-locking ownerships with parent, sister, and them for the information networks and standard subsidiary frins. The old system was represented government and business procedures that exist in by a relatively small number of leaseholds, coop- most market economies. Personal contacts origi- eratives, privatized firms owned by workers' nate in family relationships, ethnic or regional collectives, and privatized firms with residual state ties, work relationships, or military service. Such ownership. Common features were their tendency contacts are used to hire workers; to sell products, to diversify and their reliance on trade. Financing including exports to former soviet republics; and from banks was scrrce. to deal with the government, banks, and state enterprises. -lrm size Entrepreneurs also rely on bribes. Close to half the entrepreneurs disclosed the use of bribes in The firms in the survey varied widely in size, connection with their business activities. A quarter from a health care company with one person and of the firms said they used bribes to lease real monthly revenues of $100 (R10,000) to an insur- estate; a third, to obtain the equipment they ance/trading company with 1000 employees and needed; 20 percent, to obtain inputs; 10 percent, another trading company with monthly revenues to obtain financing; and a few, to help get licens- of $20 million (table 2.3).1 es. In addition, bribes were mentioned anecdotally The median monthly revenue for survey firms by several entrepreneurs who bad not responded during the last quarter of 1992 was $20,000 (R2 positively to the specific questions on this subject. million). As expected, revenues from trade were 11 high, because of the high value of goods pur- average is strongly affected by the inclusion of chased for a given value added. But the median several large firms in the survey, but the median revenue of the few finance and transport firns is quite typical of small and medium-size enter- interviewed were much higher, reflecting the high prises in Western Europe (Commission of the profitability of the former and the need of the European Community 1990, chapt. 3). Three- latter. to recover capital costs. The ninimum quarters of all firms surveyed had fewer than 40 monthly wage in the economy at large during the workers, and another 13 percent had 40 to 69 last quarter of 1992 was R900, and the average workers. Eight firms employed 100 to 400 work- mondtly wage about R10,800. Using these comp ers-ruree firms-a transportation company and arators, the minimum revenue per worker exceed- ed 5 times the minimum wage, Wt was only about two trade companies-had labor forces of 800 or two thirds the average wage. The maximum more. Using number of employees as a proxy for revenue per worker was far above the average size, firms providing business services tended to wage. be smaller than zverage, trade firms tended to be The median number of foil-time employees in larger than average, and consumer services about the survey was 13, and the average, 55. The average (table 2.3).' Table 2.3: Firm size by revwenue and employment Percentage of firms Monthly revenue Number of full-time w fewer IR 10001 workers than eight full- Number Number time Main activity of firms Averae Median of firms Average Median worker Trade 27 98,711 4,000. 32 95 25 16 Business services 26 9,200 1,500 27 22 11 33 Consumer services tl 6,522 600 13 40 17 31 Hlealth and education 7 985 500 7 10 7 57 Transportation 4 9,925 9,750 3a 5 6 67 Finance 2 38,750 38,750 3 146 41 0 Total 64 40,263 2,000 85 55 13 28 a These figures exclude one large transportation company for which the breakdown between full-time and contract workers is not available. 12 Ongins and legal status business services were new start-ups, suggesting that conditions of entry are particularly important More than two-thirds of the finns were new for such firms. Most firms became private-either start-ups, fully private from the beginning; only as new start ups or privatized companies-in 1990 one-third were privatized state enterprises. This is and 1991 (figure 2.1). As of January 1993, their contrary to the popular perception that privatiza- average age since becoming majority private was tion is more important to private sector develop- 21 months. ment than new start-ups. The distinction between At the time of registration, a new firm has a privatized firms and new start-ups, however, is number of legal forms to choose from. The not as sharp as one might expect. Of the new earliest legal forms available for registration were start-ups, most originated within a public ("host") privat individual, equivalent to self-employed; organization, often without any fbrmal arrange- small enterprise, cooperative, and leasehold.' As. ments but with important economic links. For might be expected, almost all firms with high example, the owner of the new start-up firm shares of individual ownership were registered as might 'moonlight" on the job at the host organiza- small or private individual enterprises. Enterprises tion, "rent" space from it (in theory or in fact), with fewer full-time workers tended to be regis- use its equipment, or provide it with services. In tered as small enterprises or private individuals. many cases such symbiotic relationships gradually About half of all firms were registered as joint eroded, leading to full separation, but 22 firms stock closed (JSC) or limited liabiliy, making classified as "start-ups" in the survey still main- owners not personally liable for their debts. The tained one or more of these relationships with joint stock dosed form was introduced only in their host organization. 1990, but it has more prestige because it can issue Of the privatized firms, most had become 100 preferred stocks and bonds and form subsidiaries. percent private by the time of the survey; only 12 A few older enterprises altered their legal status-to Of them still had partial public sector ownership. joint stock closed when this became possible. In A majority of the trade firms bad been privatized, addition, there was one commercal bank, one accounting for two-thirds of all privatizations. joint venture, one joint stock lawyers company, Almost 40 percent of consumer services had also and one non-state academic institute, all of similar been privatized. Most of the firms providing legal status to joint stock Closed, but covered by Figure 2.1: The pace of private sector development hi St. Peterburg iS 14 - 12 11 E 1981 1988 1989 .1990 1991 1992 UPrivate since sart-up PrivartizedI .13 Table 2.4: Regsterd legal sta by main acdvit Main activitV Business Consumer Health and Legal Status Trade services services education Transportation Finance Total Limited liability 9 6 6 2 1 1 25 Joint stock closed 8 5 3 1 0 1 18 Private individual 8 3 0 2 0 0 13 Small enterprise 1 6 2 0 1 0 10 Leasehold 5 0 0 0 1 0 6 Cooperative 1 3 1 1 1 0 7 Other 0 4 1 1 0 1 7 Total .32 27 13 7 4 3 86 Note: Chi-squarevaluc: 0.02. particular laws. Regisation as ajoint venture is * Owner and other private indivduals. Private no longer an option, and most joint ventures have individuals held an average 83 percent ownership converted to other legal forms. Only one enter- share. The owners interviewed held slightly more prise was registered as an open, or public, joint than half these ownership shares. In many cases, stock company (table 2.4). the other private individuals were family members or founding members who left a state enterprise or Ownership structure and interloclang shares institute with the owner to establish the new company. A quarter of the firms were completely Ownership of the 82 firms for which there was a owned by one person, and eight were majority clear ownersbip structure was heavily concentrated owned by one person, giving control to one owner in private hands-often in one individual. The in more than a third of all enterprises. In another degree of public ownership in the sample was 30 percent, the owner had a controlling share of generally small, as was the ownership of private 26-50 percent. companies and workers collectives. Interlocking * Workers. In eight enterprises, about one-third shareholdings were fairly common, however. of all privatized firms in the survey, workers' Only 5 percent of ownership shares were held by collectives held majority ownership, ranging from another private domestic company, but some firms 51 to 98 percent Their average ownership share had subsidiaries, and some had connections to was 7 percent. These were not cooperatives; they other firms through shares held by their private were privatized enterprises that chose the workers' individual owners (figure 212). ownership option (partial or total). In all but one, 14 residual ownership belonged to the "owner", who enterprise, reflecting a stage in the privatization in most cases had a higher personal share. process rather than a long-term commitment. Private domestic companies. In 11 firms, Several firms indicated that they belong to a partial ownership was held by another private group of firms-as a parent, sister, or subsid- company; in three, the other company had a iary-characterized by interlocking shares. Con- majority share. The average ownership share of sidering the relatively small size of most service private companies in the sample is 5 percent; but, firms and the recent introduction of company law within the group of companies with corporate in Russia, these interlocking shares suggest some ownership, the average is 39 percent. degree of business sophistication. These relation- * Private foreign companies. Three of the ships were often important to the firms' diversifi- companies had external partners. In all cases the cation strategy and a major vehicle for venture external partners were passive, interested mostly capital. For example, one food wholesaling com- in the export of raw materials to their countries pany also ran a restaurant and a retail store, had and almost not at all in investments in Russia. undertaken research and development for vegeta- When a foreign partner is more active, it tends to ble oil production, and had started to trade in insist on majority ownership, thereby excluding timber. And one transport comparny was linked to the firm from this study. a specialized trading firm forma;ly owned by the * Public ownership. Only 12 firms were partly entrepreneur's sister and a real estate operation owned by the Russian Federal government, state run by his brother. enterprises, or the city/oblast governments. For Interlocking shares may also provide a way to these 12 firms, the average public ownership share avoid or evade taxation. For example, they give was 20 percent, while for the entire sample, the an entrepreneur the flexibility to shift operations average public ownership share was 3 percent.'0 into another district of the city where officials In some cases, the state ownership share was may be more lenient. And they may facilitate compensation for space made available to the access to bank financing. Three firms were in the Figure 2.2: Average ownership of firms surveyed, January 1993 Other private partners 39% . Private domestic companies 5% Private investors outside ___________ ___._______ W orkers .. - . .. .. _ - *7% _ ~~~~~~. . . --.-...... -._..r .___________ -. - Govemment and state enterprises Owner interviewed 44*%, process of creating their own banks, and another small and relatively new. About half drew 10 to four firms had small ownership shares in existing 50 percent of their revenue from secondary activi- banks. In two cases, banks owned partial shares in ties, and those firms deriving all their current firms. Some interlocking shares were in "shell" income from a single activity such as trade, had companies whose sole use was to maintain an several diverse businesses; for example, both existing bank account, since it is difficult to open wholesale and retail trade, or trade in very differ- a new one. ent product lines. Moreover, aside from the activity mix observed at the time of the survey, it Diversification and the special role of trade is estimated that well over two thirds of all firms had changed their activities during the previous A number of firrs surveyed were undertaking a year (box 2.2). variety of activities, many of which were in flux." The most prevalent activity was trade. More Trade activities were common, and many firms than a third of the firms cited trade as their main were beginning to use profits from trade to help activity, and another third indicated secondary finance other activities. activities in trade. Diversification into trade was The firms surveyed tended to be highly diversi- also common, with a third of all firms having fied, especially considering that they were mostly moved into trade or new areas of trade during the Box 2.2 Motives for entrepreneurs to diversify Diversification over time appears to have several motivations: *Profit-seeldng. The most comunon motive for diversification was profit-seeking. Most entrepre- neurs understand imperfect competition and are looking for a niche, be it bear tracking for tourists in Karelia or constructing underground shopping malls. They are willing to move from one activity to another, gaining experience-through trial and error-with what works and what does not. Often the profit motive was fueled by a desire to accumulate sufficient capital to finance a research and development idea that originated when the entrepreneur was still working in the public sector. Thus, whereas some firms had diversified away from goods production, for example, other firms were diversiying back. Six companies were moving into manufacturing, and eight others were planning to move into either manufacturing or agriculture. Still others were moving into new service areas, such as hotel management and art exhibitions. Only one firm was planning to expand into research and development. * Risk reduction. Another common motive was risk reduction. In order to achieve more balanced activities and hence reduce risk, one entrepreneur was moving out of trade into furniture manufacturing and livestock. He was also hoping to invest in a joint stock municipal utility which was selling shares. * Desperation. Some entrepreneurs diversify out of need and sometimes out of fear and desperation, especially entrepreneurs in activities facing declining demand. Six films were phasing out their research and development activities, and eight were giving up manufacturing. The demand for various consumer services (tourism, sport clubs, private medical services) was also down. A hairdresser in downtown St. Petersburg, whose clients could no longer afford a wash and set, was diversifying into facials, pedicures, and a snack bar to attract new business. Export traders, wbo suffered from the break-up of the Soviet Union and increasing export restrictions in 1992, were frantically searching for alternative activities, both in and out of trade. 16 previous year and a quarter planning to move into operating a variety of trade companies, trying to trade in the next six months. Only three firms had accumulate funds for subsequent investment. curtailed trade operations during the past year, High profits in trade derive from three main and only two reported plans to leave trade in the sources. One is the abrupt price increase associat- future. Within trade, however, several entrepre- ed with the disrupted domestic distribution system neurs were moving away from trade in foodstuffs, in Russia. Under such circumstances, monopoly where margins have narrowed and supplies, trade profits accrue to those who enter early and especially from the Ukraine, have been disrupted. continue uilail the margins are bid down. A second But trade is no longer the only lucrative- pursuit. source of high profits is the trade barrier imposed Some entrepreneurs are moving into real estate, across regional boundaries. A third source is the which together with financial services, looks like continued sale of goods by state companies below the next boom (box 2.3). market prices. In part, such sales are supported by The importance of trade, which has a quick benevolent officials who try to keep prices below turnaround and may initially require relatively clearing levels with subsidies (including import little capital, can be linked to the lack of institu- subsidies) and controls. They are also the product tional credit available to entrepreneurs. As one of corruption, sometimes referred to as a "redistri- owner explained, trade is the major source of bution of property rights." The interviewees "primitive capitalist accumulation". In one case, a supplied many examples. In reality, private medical research group resorted to trade in sugar trade-wholesale and retail-is still new to Russia and was planning to start a fast-food chain. In and faces large expansion potential, even if another case, an entrepreneur who wanted to trade margins are "ewlining for some categories buy a small state manufactur:-g enterprise was of goods. Box 2.3 Real estate: the next boom Only one company in this survey was engaged in real estate as its main revenue activity, and another had real estate as a secondary activity. Three companies had construction as a second activity. However, real estate, and also construction and renovation, is an increasingly popular commercial activity in St. Petersburg. Seven companies in the survey reported new or increased activities in real estate, construction, and renovation in the past year; and another seven stated plans to go into these areas. Other firms indicated less specific plans, often oriented to obtaining satisfactory work space for their activities. Such ventures are not easy. One entrepreneur saw his renovation costs increase by several multiples of general inflation and had to scale down his renovation schedule dramatically to fit his cash flow. Many entrepreneurs understood the potential for huge profits from the privatization of land, housing, and commercial structures. As in trade, some profits will come from exploiting the low valuation of state property; other profits will come from trading in real estate. The real estate market is likely to be developed more rapidly than the stock market and will therefore attract people wanting to invest in real assets as an alternative to hard currency holdings, almost the only inflation hedge at present. The unique character of the historical center of St. Petersburg will be a focal point for rehabilitation and renovation and is already attracting considerable foreign interest. 17 Empioyment structure, skill adequacy, workers in tables 2.5 and 2.6, which show the and training structure of employment by main activity and firm size, is only 23, as compared to 55 in table 2.3. Although the majority of employees in the firms Data on part-time and contract workers are surveyed worked full time, firms aiso employed presented by number and also by full-time part-time workers and workers on contract, equivalent. 12 particularly in small family firms and small The majority of the labor force in most firms transport firms. Most firms were providing some consisted of a core of full-time workers-a sign of type of training to upgrade their employees' skills, stability. About one-third of all full-time workers and only trade and fmance firms expressed sub- - . stantial dissatisfaction with their employees' skill in this sample of 60 firms were owners and their level. families. This large share reflects the fact that Information was gathered on three categories of many small firms were family businesses, and workers in the surveyed firms: owners and fanily several large firms were cooperatives or privatized members working full time, other full-time em- firms bought by worker collectives, where every- ployees, and part time and contract workers. one working for the enterprise was a part owner. Complete information was available for only 60 Owners and family members accounted for a fims, and the larger firms are disproportionately particularly high share of workers in consumer absent. Thus, the average number of full-time and business services. Table 2.5: Structure of labor force by main activity (average number of employees) Total full-time Part-time and contract plus part- time and Number Owners Other full- Total full- Number of Full-time contact Main activity of firms and family time time workers equivalents equivalents Trade 21 3 23 26 20 8 34 Businessservices 22 1i 10 22 25 14 36 Consumer services 9 15 18 33 16 7 40 Health and education 6 2 9 11 a 2 13 Tranrortation 2 2 2 4 59 44 47 Finance 0 - - - - - - Total 60 8 16 23 21 11 34 NUote: Onlry firms that provided detailed data on labor force are included. This accounts for the differences with table 2.3. Discrepancies in numbers are due to rounding. 18 More than half the Mull-time workers were with other jobs, in -many cases in the state sector, classified as "professionals" having formal aca- who were supplermenting their incomes and testing demic or technical training above high school. private sector prospects. Part-time employees gave This share is much higher than for the entire entrepreneurs flexibility in the level of activity and Russian labor force, including the service sector.'3 an opporatnity to test new workers. Contract As in other countries, business and financial workers were also used to enhance flexibility and services had the highest share of professionals, t whereas trade and consumer services had the Ptrt-time and contract workers made up 32 lowest. Women accounted for 47 percent of all full-time workers-a lower percentage than in the prcent of fulltime equivalent workers for all entire labor force of Russia and substantially flrms. They were particularly important as taxi lower than in any service activity in-the state drivers in the small sample of transport firms and sector. This fact may reflect the factors discussed in busmess services brokerage firms, which hired above that systematically discourage women from scientists and other specialists when contract work entering the private sector. was available. In small firms with less than eight At least 70 percent of all firms employed part- regular full-time workers, part-time workers made time or contract workers. Almost half of these up three-quarters of the labor input; they repre- employed more than 10, and 15 percent employed sented about 40 percent in medium small firms of more than 100. Part-time workers included people 8 to 39 employees. Table iL6: Structure of labor force by firm size (average number of employees) Total full-time Part-time and contract plus part- time and Number of full-time Number Owners Other full- Total full- Number of Full-time contract workers of lirms and family time time workers equivalents equvalents Fewer than 8 22 2 2 4 1 9 13 17 8to39 30 3 14 17 25 11 28 40to99 4 2 53 56 10 6 61 1 W or mre 4 78 64 142 1 6 6 149 Total 60 8 16 23 21 I 1 34 Note: Only firms that provided detailed data on labor force are included. This accounts for the differences with table 2.3. Discrepancies in numbers are due to rounding. 19 Space and capital eqipmenr space was obtained from the owner's previous enterprise and in other cases through personal Firms occupied on average about 700 square connections. One property owner occupied his meters of workspace; median space was about 200 own privatized apartment but was not sure wheth- square meters. Almost half the firms found the er or not he should be using it for business pur- size of their space sufficient for their needs. poses. About 40 percent complained that their space was With the exception of transport, equipment too small, and a few others said that it was badly needs of most firms were modest. Forty percent located. Because ownership of commercial real of the companies required only office equipment estate (including land) has just become legal in for intemal use and to provide such services as principle and only a few deals have been made, photocopying and communications. Activity- fewer than 10 percent of firms actually owned specific equipment for trade and restaurants, their space; the other firms rented space. repair, research and development, and design was Most workspace in St. Petersburg is rented rarely of high value. In a third of the firms the from a state enterprise, a public institute, or a equipment was all new, and in half it was new or government agency. More than half the firms held mosdy new. long term leases, most directly with government Fewer than a tird of firms had imported agencies or through the Municipal Property equipment. Office equipment had a higher import Agency (MU). Long-term leases are typically for share, was typically bought from a private trade 15 years with option to buy but are renewable firm, and was owned rather than leased. Special- every year. Uncertainty about renewal left most ized equipment was to a large extent used, domes- entrepreneurs unwilling to invest in the improve- tically produced, and leased or bought from state ment of their workspace. Somne firms had enterprises. In one case the equipment was report- short-term leases of a year or less and were afraid ed to be stolen from a state enterprise. of being asked to leave, a fear that had material- More than threequarters of firms owned all ized for a few. Most short-term leases were from their equipment, and the fewer than 15 percent public institutes such as schools but also from the that borrowed or leased mest of their equipment city and other private companies. In some cases, did so from the owner's previous enterprise. Only Figure 2.3: Financig pattems hi prvate fims 100 SC) Other sources 70 c 60 _ \ ii ~~~~~~~~~~~~~~~Commercial credit *a60 0 50 -1 \ Govemment programs X40 _\ Prafits 30 _ \ 20 _ .*Personal resouFces Initially Current lExpansion operatins ' 20 Table 2.7: Financing of firms by revenue sine percent) Monthly revenue - {~~~~~R 1,000) Lassthan 1O Wto 1,000 to 1,O0tW 100,000 or Total for al Source of funds 100 999 9,999 99,999 more firms kiddly I whim fsblshmd or privatzed Personal resources 100 77 62 60 13 65 Commercial credit 0 8 6 12 25 9 Profits from business 0 7 15 0 25 9 Other sources 0 9 17 28 38 18 Nunber of Fifns 2 23 26 17 4 72 Cumet operatons Personal resources 53 0 8 3 0 5 Commercial credit 0 13 6 B 13 8 Profits from business 48 75 67 73 88 71 Othersources 0 12 20 16 0 15 Nwnber of Fins 2 21 29 15 5 72 EwNmion Personal resources 0 6 4 0 0 3 Commercial credit 0 8 1 15 0 6 Profts from business 100 81 96 85 100 88 Oher sources 0 6 0 0 0 2 Nwrnber of Finms 2 20 21 12 3 58 one firm worked with equipment rented from credit were those with higher revenues Firms clients. Two firms had no equipment, one because complained of high interest rates, although nomi- it contracted out its work.2' nal interest rates appeared highly negative in real terms. A variety of factors contributed to higher Finang real rates in practice as well as some entreprene- urs' reluctance to borrow. Financing patterns for firms in St. Petersburg Firm financing at the time of establishment, for were typical of finacing paterns for small private day to day operations and for new investments companies elsewhere in the world. Most financing was provided mainly by the original owners and at the time of establishment came from the own- from the firms' profits (figure 2.3). On average, ersn' own resources, and most financing for subse- firms were established with 62 percent of financ- quent operation and investment came from inteal ing from the owner, 5 percent from family and profits. A minority of firms obtained credit and on friends, and 8 percent from early profits-a total very short terms; firms that did receive bank of three-quarters of all resources. Working capital 21 Tabla 2.8: Charactertics of firms by owners past job (percent) Owner- ship Foreign history Activity aid Size Average Finance number and Health of full- Owner's Nurnber Pd- business Consumer and Transpor- Re- time -pastjob of firms vatized Trade services services education tation ceived workers General or technical manager 364? 51 51 22 20 2 5 14 59 Academic or technical specialist 37-34 12 21 49 1 2 15 0 29 62 White or blue colar worker 17017 27 36 27 9 9 18 0 20 TOTAL 77-86 33 37 35 15 8 5 1 8 55 Noe: Chi-square values: origin = 0.01, activity = 0.02, foreign aid = 0.52. Using regression analysis, no statisticaly significant relations were found between owner's past job and size. and subsequent investments were financed from at the time of establishment and depended more inernal profits by 70 and 88 percent respectively, on owners' capital. Leaseholds were established with new owners' and family money contributing with more reliance on credit and profits and less 3 to 5 percent.5 Share capital from companies and on owners' capital than all other forms, and they banks provided 8, 1, and 0 percent respectively continued to receive more credits for later invest- during the three stages, leaving 15, 20, and 7 ments. Trade firms had more access to bank pacent to credits, nearly half of which came from credits for start-up and generated early profits for customers' advances." 1 hus, bank credits contrib- reinvestment. uted only from 7 to 11 percent to financing at At the time of the survey, 22 percent of the each stage, and government programs contributed firms had outstanding loans from financial institu- only 1 to 2 percent. tions. Several had loans from friends and one In general, firms with higher revenues and from another enterprise. Since the survey includes higher employment had better access to credits, some large private firms, and since such firms are especially at the time of establishment. Firms with more likely to receive credit, the percent of small lower revenues received little credit at any stage, business receiving institutional credit is clearly but other patterns are also evident (table 2.7). below the norm in industrial countries, where Frms registered as small enterprises, private between a quarter and a half of small and medi- individuals and cooperatives received little credit um-size enterprises obtain credit. 22 Box 2.4 Service finn eitrepreneurs-on the frontier Service firm entrepreneurs are the real pioneers in the transition economies-and St. Petersburg is no exception. They have to be, because most services were systematically suppressed in socialist economies. The groundbreaking role of service firms is clear compared to private manufacturing firms interviewed in a similar survey (Webster and Charap 1993): * More diverse entrepreneurs. Entrepreneurs in service firms were more diverse than those in manufacturing. Many brought experience from public administration and academic institutions rather than from state enterprises and a higher share were women-13 percent, compared to only 1 percent in manufacturing. Their age range was greater, although their average age and educational level were quite similar. * Younger, more independentfirms. Service firms were somewhat younger and less dependent on state enterprises than manufacturing firms, and only half as many were still legally connected to state enterprises. Service firms owned a larger share of their equipment, a greater percentage of which was new and imported. They obtained only half their equipment, largely office equipment, from state enterprises, whereas manufacturing firms obtained virtually all their equipment from state enterprises. *More competftion. Output markets were more competitive for service firms than manufacturing firms. Five out of every six service firms reported having serious competitors, twice as many as manufacturing firms, and fewer service firms were dependent on one large customer. Two-thirds of service firms reported an increase in the number of competitors during the previous year compared to only one-third of manufacturing firms, even though services sold a larger share of business locally. * New mnrkets. A quarter of all service firms experienced an increase in demand because they entered new markets, compared to only 5 percent of manufacturing firm-s. Although export revenues were low, as many service firms as manufacturing firms were engaged in export. Partly as a result of diversification and entry into new markets, the performance of service firms was somewhat. bewer, and they appeared to be more oriented toward future expansion. Service frm complained most about the uncertain macroeconomic and legal enviromnent and the lack of financing-both per- ceived as impediments to expansion. Manufacturing firms complained most frequently about taxes. 23 Loan terms were unusual by international to be more diverse, more independeit, facing standards, although not surprising given Russia's more competition, and more expansive than high inflation. ThLere was not one medium- or private manufacturing firms (box 2.4). long-term loan, although several owners said their short-term credit lines could be rolled over. Two Notes outstanding loans were for 12 months; the rest for five months or less. Nominal interest rates ap- 1. The U.N. ISIC coding system was used to classify peared to be extremely negative in real terms, activities (see United Nations 1990: 53-70). Exceptions ranging between 14 and 240 percent annually; the are that tourist services, repair services, pubishing median rate was about 120 percent annualy,, services, and custom tailoring are excluded from transpor- tation, trade, and manufacturing respectively ad included during a period when inflation was about 2,000 under consumer services, as is the practice in many percent. In reality, real rates were much higher countries. due to discounting up-front, extra fees, and bribes. 2. Interviewees are referred to as "entrepreneurs' or In sum, most firms either relied on reinvest- "owners". However, seven interviewees were managers, ment of their own profits or found a silent partner not f cin the most important ownoer. to provide office space or financing for in-kind return or a share of profits. For this and other 3. In 1989, women accounted for 75 to 90 percent of the reasons such as low demand, about a quarter of labor force in service industries in the Soviet Union. Their the firms declared that they were not actively shares in managerialpositions were: public administration, seeking a loan. A number of firms were looking 49 percent; social institutions, 40 percent; and production for a "serious" fbreign partner to provide bard sectors, 26 pement (Goskomsmt of the USSR, 7he , . . . ~~~~~~Naitonol Economzy of the USSR, 1988: 40. Women in the currency financing, take a long term interest in USSR, 1991: i6-19). the company, and help identify export markets. The fact that entrepreneurs were ready, indeed 4. The educational level of mnagers in services in the anxious to finance investments and trade deals USSR was likely to be less than the average, given the tirough equity rather than bank credit highlights ideological bias against services. However, the only data both the very high risk and difficulty of obtaining located is for communications, where the proportion of bank credit. Several firms were making equigty thos with higher education was 59 percent (see Center of investments in banks to assure adequate supplies Information and Publishing of the Russian Federation, -nvesment m bnks t sssre aequat suplles 1991: 115). of credit in the future. 5. Data on the background of entrepreneurs nationwide Paterns of business characterisics are unavailable, but a comparison of this survey's service firm owners with dat on owners of manufacturing firms Despite the diversity of business characteristics in the St. Petersburg area (Webster and Champ 1993) illusktted above, some clear patterns emerged. indicates that more service firm owners came from government or academic institutions and more had a Firms o-wrned by former managers were more background as technical, rather than general, managers likely to be privatized and to engage in trade (table 2.8). Firms owned by academics or techni- 6. En* c' ;,uare statistics in table 2.2 indicate that cal specialists were more likely to be new ownership is the only characteristic shown with high start-ups, to be smaller, to engage in business probability of random distribution among the three services, and to receive foreign aid in some form. categories of entrepreneurs. Firms owned by white or blue collar workers - ~~~7. Rubles are convenled to U.S. dollar using an eseimftdd were more likely to be small, and they received purchasig power parity exchange rte of 100 rublesl$i. no foreign assistance. Overarching these distinc- This compares to the nominal exchange me of 400 tions, however, was a general sense that service rublesl$1 in the fourth quarter of 1992 on the Moscow firm entrepreneurs are on the frontier. They tend Internafional Currency Exchange Market. 24 S. Only registred firms are included in die survey; self- workers was calculated on tho basis of weekly hours as employed caftmen and service providers may operate reported or, for those who reported the number of part with a license without rgistering. time workers but did not provide information on hours, the median of 17 hours per week for all those reporting. 9. AD but one of the firms registered as leasehold had an- option to buy. 13. Less than a third of the Rusian (non-collective farm) labor force have "higher or technicalK education (Goskom- 10. MUthougb one criterion for inclusion in the survey statoftheUSSR, 1Y91a: 111-14). was that a finn have loss than 50 percent state ownership, one finn had exactly 50 percent state ownership, divided between two state enterrises. It was included since one u14. This is senficanto h dtfferent from the private of these state enterprises was being privatized within a nufacturmg sector where faraiig out or leasing the few weeks. Without this fim, the stae average s is equipment of others was more common (Webster and only 15 percent. Chamap 1993). 11. Firms declare many activities at the time of rotra- 15. For most firms, the main use of profits is rein- tion in order to avoid the need to re-register, but they may vestmenL Otheruses are paying bonuses and higher wages undrtako only a few. For this reason, entrepreneurs were to workers, investing in inventories, and investment in questioned directly about the revenue shares of their ham cu-rrncY financial assets. firm's current mix of activities, past experience with diversification, and future plans for expansion. 16. Customer advances are particularly important for working ciLpital in business services and health and 12. The full-time oquivalent for part-time and contmct education serices. 25 Wages, prices, and markets Wages, prices, and the markets in which fm Average monthly wages in December 1992 operate are intimatey linked. In a market econo- were reported to be R16,400 for professionals, my, wages vary to reflect the supply and demand R14,700 for non-professionals, and R15,500 for labor, and prices fluctuate to facilitate market overall (table 3. 1).1 These averages were about 25 clearing of goods and services. Wage and price percent higher than the national average wage of flexibility is both a prerequisite and a characteris- R13,000 in December 1992, and much higher tic of a market economy. But despite wage and than the minimum wage of R900.2 The high pro- price flexibility, markets are still poorly developed portion of professional employees in the firms in St. Petersburg as well as in other parts of surveyed suggests that they might have a high Russia. average wage, but the low wage level typically found in services would suggest that they might Wages and prices have a low average wage.' On balance, wages in the firms surveyed did not appear to be particular- The survey shows ta wages and prices are ly high, considering the substantial non-wage flexible and that pricing rules used by entrepre- benefits received by state workers. neurs were heavily influenced by market consider- The average wage masked wide salary differen- ations. The average wage in survey firms was tials among activities and among individuals. similar to the average public sector wage, but it Among activities, trade salaries were two-thirds varied substantially across activities, with the higher. Among individuals, monthly salaries average wage in trade much higher than else- ranged from as low as R900 (the minimum wage) where. Real wages appear to have declined some- to as high as R150,000, more than twelve times what during the six months before the survey, the average. Such high wages were unlikely to be lowering living standards of employees but help- reported to tax authorities, since wages m excess ing firms to remain profitable- of four times the minimum wage are incikded in profits for tax purposes. In any case, the reported Wages are moderate bu wirable range. i wages was much wider than under the old regime and probably wider than in the state Although average wages in the private sector were sector. Interestingly, the reported gap between the not dramatically higher than in the public sector, average wages of professionals and non-profes- there was high variability among firms as well as sionals seemed rather narrow-not surprising across activities. Non-wage benefits in the private given the traditional underpayment of profession- sector appeared to be relatively modest. als in Russia compared to blue collar workers. 27 Table 3.1: Average monthly wage by main activity Average wage in rubles Main activity Number of firms Professionals Other employees Overall Trade 22 26,134 17,801 20,766 Business services 22 115070 13,464 11.580 Cansumer services 11 14,473 12,386 12,738 Health and education 7 23,015 5,074 13,532 Transportation 1 0 15.000 15.000 Finance 0 Total 63 16,401 14,695 -15,474 The median cost of fringe benefits provided by Trends in real wages the firms surveyed amounted to an estimated 20 percent of basic salary.' This level is relatively Survey data provide conflicting information on modest by international standards and is probably trends in real wages during the preceding six lower than in the public sector, where substantial months. Two sets of observations on changes in wages in kind are rationalized as protecting nominal wages in survey firms were made, one workers against inflation and accommodating for 59 firms and the other for 42 firms (table 3.2). firms suffering from cash shortage. Owners The smaller group also provided data on changes reported giving their workers a variety of goods in product prices. The differences in wage data and services, including: paid vacation (typically between the two sets of observations are signifi- one month), meals, take-home food and clothing, cant, due to very large nominal wage increases in transportation allowances, loans, presents of two health and education firms and several trade various kinds, ant personal use of the firm's firms in rhe larger set. On balance private sector equipment. Only a few reported provision or wage trends appear to be similar to those in the finacial coverage of healthcare, pensions, and public sector, as an average of real-wage indices miscellaneous social benefits in addition to those from the two data sets is similar to the 9 percent covered by the payroll tax. decline in public sector real wages reported by Despite the relatively modest fringe benefits, Goskomstat for the same period. total labor costs for finns were relatively high Of course, changes in real wages are perceived because of the high payroll tax of about 50 per- difrerenty by difftrent economic agents. From the cent, covering personal income tax withholding point of view of employees, their living standard (typically 11 percent) and the bro;.d social security will change with a change in their real consumer tax (39 percent) for pensions, healthcare, and wage, where the consumer-price index (CPU is unemployment insurance. In all, a firm's labor used as the -deflator. For example, it may be costs amounted to about 1.7 times the take-home difficult to attract workers ffom the public sector wage, not including the excess wage tax (see to consumer services, where the real consumer Section 4 on Taxation). wage clearly declined in late 1992. 28 Table 3.2: Changes In nomind nd ra wages by actvty. June - Deocmber 1992: Comparson of St. Petersburg survy dat and Russia a whol (June 1992 - 1001 Firms with wage dat Firms with both wage and pvice daft All Russia index of price Index of Index of Index Index of of finns' Index of Index of CPI - of CPI - firms' real Index of CP - Main Number nominal deflated Nunber nomnal deflated main producer nominal deflated activity of firrns wages waoes of firms waes wages activity waes wages wges Trade 21 285 109 12 208 81 242 88 266 102 Business a services 21 225 88 ye 212 83 332 81 235 90 C:onsumer b services 70 197 77 7 207 83 337 74 241 92 Health and c education 5 803 305 3 223 85 718 49 200 77 Transpor- tation 2 371 144 2 371 144 386 91 224 86 Total 59 266 103 42 211 83 310 81 238 91 Note: Survey data exdude one financial firmthat increased wages by 1,200 percent Survey averages are weighted by firm employment Consumer Price Index (CPIU for Russia at end December 1992 was 261. a Wages in scince. W Wages in housing and communal services. C Average wage for education and health. From the point of view of entrepreneurs, their in only a quarWr of the firms. If this is an overall profitability depends in part on their ability to pattern, private entpre rs have been able to raise output prices faster than wages. Thus, benefit from inflation-hancing profitability by profitability will increase with a decline in the real raising their output prices faster than the general producer wage, an index of nominal wages paid price level. divided by an index of the firm's output price. Such conclusions need to be interprted with According to the group of 42 firms where wage caution, howeer. First, they are based on a small and output price data were available, the real number of firms. Second, high inflation creas a producer wage declined almost everywhere, and problem of measurement became of unsynchron- it declined most in health and education, where ized price and wage adjustments. Third, entrepre- output prices rose rapidly. The real producer wage neurs complained exesively about inflation, of the median firm declined by a third, and it rose suggesting that the costs of risk and uncetainty 29 arising from inflation outweigh the benefits of a charging different prices to different customers lower real producer wage. explained this practice by differences in product Furthermore, the data on wage and price quality, size of orders, and the customers' ability changes for individual firms show wide variation. to pay. The ability-to-pay argument was motivat- Output price increases ranged from 0 to 6,000 ed in most cases by profit and in some cases by percent, and wage increases ranged from 0 to social conscience. 1,200 percent. Changes in the real producer wage The only price controls mentioned by any of for individual firms ranged from 20 to 400 per- the owners was a 25 percent trade markup limit, cent. Such wide ranges highlight the uncertainties which by January 1993 applied to only a few facing firms with respect to changes in their consumer goods such as bread, milk, meat, and income and profits over very short periods of alcohol. Some said they respected the markup time. They also help to explain the reluctance of limit; most said fthey ignored it. Actual trade some entrepreneurs to take commercial bank markups mentioned ranged from 5 to-SO0percent, credits at what appear to be negative real interest with most ranging from 20 to 30 percent, close to the 25 percent legal limit. Anecdotes collected during the survey suggested that markups on Output prices reflect market demand special deals can be much higher, however, reaching several hundred percent. Output prices in the private sector reflected the fact that prices of most goods and services in Mrkets Russia have been set firee. At the time of the Markets for labor, capital equipment, intermediate survey the state order system still existed for some products, butthe associated price controls affected iputs, and outputs were all functioning, but not fir' inputs, not outputs. Most owners efficiently. The labor market operated largely on an informal basis, as did segments of the other their output prices frequently and took market markets (box 3.1). A small share of firms adver- demand ito acrcount. tised 'their services or job vacancies, but most Sixty percent of the owners said they based firns relied on existing supplier or customer their pricing policies on considerations of demand relationships or on personal connections. Some and competition, while one-third emphasized costs owners experienced difficulty in labor recruitment, anld profits. When asked how they determined fBespecially for professionals. Firing employees is trade markups, traders in particular emphasized relatively easy; two-thirds of the owners had fired demand: 'I charge a little less than the competi- someone in the previous year. tion in- order to increase my income" or "The Suppliers and customers are increasing in lower the markup, the larger the volume and the markets for capital equipment, intermediate profits.'" Some said they charged "a little bit less" inputs, and outputs, yet problems persist. Most than big companies, and others said they charged enterprises could obtain whatever capital equip- 2 to 3 times the "official" prices published by the ment they wanted as long as they were willing to mayor's office. In any case, most owners seemed pay the price, but finding spare parts-especially to understand the principles of market pricing. for old domestic equipment-was a big problem. Almost half the owners said they changed their Many firms experienced difficulties in obtaining prices every week, and another quarter changed intermediate inputs-both goods and services-in them once a month. The remaining quarter part because the input markets were still domi- changed their prices once every few months. Two nated by state enterprises, although the number of or three firms kept their prices constant for longer suppliers was said to be increasing. Output mar- periods, but in hard currency. Half the firms kets also experienced some increase in competition offered printed price lists for their products, and over the past year. They were more diverse, with slightly more than half said they were charging private companies and households each accounting uniform prices to all customers. Those who were for a third of all customers. 30 Box 3.1 Transactions rely on personal connections In "The F-Connection: Families, Friends and Firms and the Organization of Exchange," Yoram Ben-Porath analyses the conditions for the distribution of transactions among family, friends, other personal contacts, and firms. (Populaion and Development Review, 6 (1): 1-30) The more simple, uniform, predictable, and common the transaction is, the more likely it will be carried out in an impersonal market with minimum transaction costs. The more subtle, unique, complex, :nultifaced, variable-over-time, and long-term the transaction is, the more likely it is to take place through personal connections. Transactions by enterprises in St. Petersburg are primarily the latter. The private service sector is still very heavily dependent on family, friends, and personal business contacts; reliance on other firms for transactions is progressing slowly. The invisible hand of the market and the impartial hand of the law play very limited roles. A well established legal infrastructure and more experience with markets are required to move transactions away from costly and less efficient personal connections to the impersonality of the market. Fully 70 percent of firms recruited new employees through personal contacts, and another 10 percent through people showing up at the door. Business service firms recruited almost entirely through personal contacts. Only 7 percent of firms-largely in trading-recruited through a govermment or private employment exchange, and only 6 percent used advertising. A few other firms recruited direcdy at a school or academy or through a business contact. Although a third of all finns said they found their customers mainly through advertising, twice as many found them through personal contacts, business contacts, people "off the street," or word of mouth. Personal connections are common among small businesses in developed market economies. Small firms everywhere use personal information and contacts to hire, buy, sell, get credit, and clear their tax forms. Informal networks among small frms are considered necessary to help offset the market power of large firms and their ability to execute many transactions inside the firm. In St. Petersburg and throughout Russia, however reliance on personally determined exchanges and the personal factor within each transaction are much more important. The lbor market difficulty recruiting other employees, although one entrepreneur commented that the average citizen More than half the entrepreneurs reported having is less interested in working for a private firm problems recruiting professionals, while only 30 since late 1992 when wages increased in public percent reported problems recruiting other em- enterprises. The need for an improved employ- ployees. Trading firms experienced the most ment exchange and skills certification was men- difficulty recruiting professional and non-professi- tioned by several entrepreneurs. onal employees, possibly because of the lack of Entrepreneurs said they had difficulty locating experience in trading under central planning and professional managers "in the American sense" the poor image of trade as an "unproductive" and people with knowledge and practical experi- activity. Non-trading firms experienced little ence in specialized areas such as tourism, for- 31 warding, finance, insurance, accountancy, and an staff level was 13 full-time employees. In about foreign languages. In recruiting non-professional half the firms at least one employee left voluntari- employees, a shortage of bookkeepers and con- ly. Close to 200 employees left one firm more or struction workers was mentioned. More general less voluntarily, where the equipment was no complaints about dishonesty and the absence of longer usable because of age and neglect. Fower work ethic were mentioned for both professionals people left voluntarily in trade, where salaries and other employees, as was the difficulty of were high. It is not clear how voluntary depar- offering a competitive wage. tures should be interpreted, since, as several A majority of owners said their workers were owners pointed out, it is always possible to make sufficiently skilled, but 40 percent said they were life difficult for an employee so that he will leave not. Dissatisfaction about workers' skill levels was voluntarily. concentrated in trade and finance. All three firms Relations between employer and employee are in finance and 60 percent of the firms in trade governed by an employment contract, which said that workers were not sufficiently skilled for covers the tenns of employment including firing. their jobs. A common complaint was the lack of Terms of employment are, in turn, regulated by market related skills and skills in such new areas the Law on Employment and the Law on Enter- as management, marketing, accounting, tourism, prises and Entrepreneurship Activity, which and law. Seventy percent of all firms provided include provision of a guaranteed minimum wage some training to their work force or financed and social security. outside training. More than half of all firms About two-thirds of entrepreneurs said that provided training in accounting; other popular their employees were not represented by a union training was in market-related skills, training in or workers' council. A third said they were, and new technologies includingcomputers, and foreign two said they didn't know. In firms without a languages. union, most entrepreneurs simply said "we don't Entrepreneurs say the most serious problem need it" or "it doesn't make sense". Employees in with employees is their character and attitude. a few firms had formed their own internal collec- Many satisfied employers emphasized the impor- tive, council, or association without any outside tance of being able to choose the best available affiliation. job candidates. One hospital head said he retained only one nurse in ten. A perhaps symbolic story, 7he market for capital equipment told by one entrepreneur, concerned the manager of a private hotel who refused to employ someone Capital equipment currently avLailable in Russia who had previously worked in a state-run hotel, includes imports as well as new and used domestic on the grounds that the person would have already equipment, although recent changes in the tax acquired bad habits. regime has made imported capital equipment less Weak work ethics, including dishonesty, poor competitive. The biggest problem associated with work effort, and lack of responsibility were often capital equipment, experienced by 43 percent of cited as causes for firing workers, which was firms, concerned availability of spare parts. relatively easy (box 3.2). Sixty-five percent of the Several interviewees commented that state firms owners had fired someone during the previous did not like dealing with small firms and aat year. Trading firms were the most likely to fire an bribes were necessary to get parts. By contrast, employee, and this may explain in part why only a quarter of the firms reported problems with recruitment -was more difficult for these firms. repair and maintenance services, in part because One firm engaged in trade and commerce had some firms have learned to handle this in-hou!we. fired 100 employees in the previous year. The Problems with repair services included low quali- median number of dismissals for all fims that ty, unfamiliarity of repair persons with impoaid fired someone was 4 employees, where the medi- equipment, and cost. 32 Box 3.2 Job protedion in the private sector About half the owners said their employees have no protection against losing their jobs. More than a third said employees are protected by job security laws and the rest said they are protected by other measures. The difference in response seems to reflect the fact that the Russian Federation Law on Employment, dated April 1991, is more theoretical than real. According to this law, the employer-employee relation should be covered by a labor contract that includes a pr.-, sion for firing with reason. Even without such a contract, however, owners are able to fire an employee with reason. A reason is not hard to find, but an employer must give the employee a warning. Typically, the employer might encourage the employee to leave voluntarily by offering reduced working time or a low salary for long hours. Where there are structural changes within a firm, it may be possible to place skilled workers elsewhere. Where employees are working on a term- contract, the employer can simply refuse to renew.- Ultimately if the employee refuses to leave, the employer can file a petition to fire and go to court. Only one owner complained that the current labor law is too restrictive, and one said the required four month separation pay is too costly. Although lack of job security is clearly a strain on employees, the many complaints by owners about the lack of honesty and work ethic-punctuality, effort, sobriety-suggest that during this transition period, it is important to emphasize the rewards of good employee behavior and the consequences of bad. Firing is an extreme, but probably necessary, way of responding to poor performance. Other than the labor law, measures that help protect employees from being dismissed include protection provided by the labor contract, employee participation as shareholders or members of a cooperative, and restrictions on firing associated with the lease of property from a state enterprise. A more intractable problem for some entrepreneurs was the difficulty of getting rid of a dishonest or unreliable co-owner and finding an honest partner to share management and financial responsibilities. Most enterprises could obtain whatever capital states. The most significant problems were cost, equipment they wanted, as long as they were lack of money, and availability. A few firms had willing to pay the price. Most firms did not pmblems obtaining foreign exchange. experience problems in acquiring the domestic A majority of firms reported many suppliers for equipment they wanted. For those that did, the their main equipment, a substantial minority main problems were lack of money to purchase reported a limited choice, and a few dealt with a equipment and high prices. Other complaints monopoly seller. As one would expect, those who included poor quality and inadequate supply. In d b es we e wauld restrited fact, quality of domestic equipment is a problem. paid bribes were mamly dealng in restricted Trucks, for example, do not meet international markets. Only 10 percent of firms dealing with safety and environmental standards. Some firms many sellers paid bribes, whereas one-third of experienced problems acquiring imported equip- firms dealing with monopolies or a limited num- ment, including equipment from former soviet ber of sellers paid bribes. 33 Marets for inputs Firms were almost equally divided between those that dealt with many suppliers and those that The principle inputs to service firms vary enor- dealt with a limited number; only rarely did a mously. For firms engaged in wholesale or retail firm face a single-source supplier. Almost half the trade, they included a variety of traded goods, firms believed there was some price competition especially food, clothes, construction materials, among their suppliers. Another third thought there and computers. For other firms, they included was a lot of price competition, and the rest said such goods as paper, spare parts, metal, oil there was none. About three-quarters of the products, fabric, hair products, textbooks, art owners thought the number of suppliers had work, and medical supplies. Forty percent of the increased over the last year-in part because of firms experienced problems in obtaining these imports, availability of previously hoarded goods, inputs. and a new willingness by factories to sell to In addition to goods, inputs included a variety anyone willing to pay. Only a third thought the of externally provided services including banking, variety and quality of the inputs supplied had which most firms used. Half the firms purchased improved; and a few firms indicated that the transportation and legal services from outside quality or the variety of inputs had de- suppliers, and between a third and a half pur- creased-notably in foodstuffs, because of disrup- chased advertising, training, and security services. tions in supplies from Ukraine, and in spare parts, Less than twenty percent purchased accounting, because of the reluctance of state enterprises to consulting, insurance, real estate, and information supply the private sector.S processing services outside the firm. Building renovation, cleaning, and parking were other Markets for oputs services sometimes purchased from the outside. Nearly 30 percent of the owners provided services Although state enterprises were clearly the most directly in support of economic reform-particu- important source of inputs, the structure of cus- larly financial and legal consulting-to both public tomers for outputs was more diverse. Individuals and private companies. and private companies each accounted for about a Some entrepreneurs found the following servic- third of the firms' customers. State owned enter- es difficult to obtain: insurance; advertising; prises accounted for another quarter. Goverment building renovation; repair; real estate services administration accounted for 6 percent, and such as dealing with industrial space, foreigners, exports for 2 percent. Individuals were the single or housing; training in such actvities as banking most important client group for consumer services and pert.onal services; and information services and trade. Domestic-owned private companies such as locating new technology, information were the single most important client group for about domestic laws and regulations, and directo- business services. Business services and trade also ries of domestic and foreign businesses in a given earned more than a quarter of their revenues from field. Other entrepreneurs complained about the state enterprises. quality and cost of existing legal and bookkeeping Fifty-seven percent of firns received less than services or transportation. a quarter of their revenues from a single custom- Owners were asked to estimate the share of er. About 30 percent received only a quarter to a their intermediate inputs purchased from various half of their revenues from one customer. The sources. The most important sources were: remaining firms received more than half their revenues from a single customer, typically a state * State enterprises-58 percent enterprise. Business services firms tended to be * Private companies-25 percent dependent on a single large customer, with only * Individuals-10 percent 30 percent not having at least one customer * Imports-7 percent providing a quarter of their revenues. 34 Only 30 firms answered the question on chang- About three-quarters of the exporting firms are es in sales shares. More than 80 percent of the exporting to the former soviet states, and one firms selling to state enterprises experienced a quarter to the rest of the world. No details were decline in the share of sales to these companies, provided by firms exporting raw materials, but and about the same number experienced an in- most of the others were not aggressive at market- crease in their share of sales to private firms. One ing. One entrepreneur had a permanent arrange- explanation for the decline in the sales share of ment with a firm that represented him in the state enterprises was that they do not pay their Ukraine. Not surprisingly, constraints to exporting bills. As many firns increased their sales to were said to include delays in payments, govern- individuals as decreased them. ment bureaucracy, and marketing. Exporting is Most firms sold their services mainly locally discouraged through a variety of measures that and in surrounding towns. Another third sold penalize hard currency use-including mandatory mainly nationally, while only 5 percent mainly foreign exchange surrender requirements, delays exported-half to central Europe and the former and low rates in foreign exchange conversion by soviet states and half to other countries. Although the government, high fees by banks on foreign only 2 percent of output is exported, a quarter of exchange transactions, and visibility with mafia all firms, or 22 firms in all, are engaged in some groups. Nevertheless, 86 percent of exporting form of export. One explanation for the low firms experienced an increase in exports over the export share is that several trading firms engaged previous year. in export of raw materials (oil, timber, and met- Trade across new state borders was considered als) did not want to talk about these operations. very difficult by many entrepreneurs, especially Half of exporting firms are engaged primarily in because of difficulties with financial transactions. trade, another 20 percent are in trade as a second- A number of firms stopped trade with other ary activity, and the remainder provide services in former republics because of difficulties in getting tourism, transportation, design, and information paid. Two transporation firms had trucks and services. railway cars moving across state borders at the Table 3.3: Market orientation by owne's past job (average percentage shares) Customers Source Of inputs Number Public State Private House- Number State Private owner's past iob of firms admin. enterDr. comp. holds Exports of firms enterPr. comp. Imports General o- technical manager 37 1 27 20 47 0 28 69 13 6 Academic or technical specialist 31 7 27 43 13 5 22 49 28 9 White or blue collar worker 10 8 8 31 4 0 7 36 49 1 Total 78 4 24 31 33 2 57 57 23 6 35 time of the interview, although the rail transport and with individuals. Firms owned by academics was with an armed escort. Reports conflicted on or technical specialists were more likely to have difficulties crossing oblast or even rayon borders. more business relations with other private sector Several traders told heroic stories of armed es- firms, were more likely to import, and were the corts, the need for bribes, and huge profits for only firms engaged in export. Firms owned by successful trips. white- or blue-collar workers were more likely to About a fifth of the finns interviewed said they rely on private companies for their inputs and to had no serious competitors. About a third said sell to individuals. their main competitors were small private firms, and a fifth each indicated state enterprises or Notes institutes and large private firms respectively. Only a few mentioned cooperatives or imports as 1. Unloss otherwise specified, wages moan monodly serious competitors. A third of the firms said take-home saky as reported by the owner. Typically, more than 50 other firns were competing in the this meas after the personal income tax withholding of 11 to 14 percent. As with other financial data in the survey, same output market, and more than half said there there is nO clear case for a bias in reported wages. were 10 or more. Less than 10 percent said no -g: other fims were competing in the same outpUt 2. PlanEcon Report 9:28. The minimum wage w raised market. Most firms felt the pressure of competi- to R2,250 a month in Januaiy 1993 and has been in- tion and reacted by reducing prices, improving crawsed periodically since then. quality, and diversifying. Other strategies included cutting costs, increasing market share by expan- 3. According to Goskomsait of the USSR, wages in trade sion, and agreeing on market shares with competi- wero 85 percent of the national avenge; in hosing and cmm unal srvices, 60 percent; in science, 70 percet; tors. Some firms claimed to escape the pressures and in ancial sesrices, 250 percenL of compefition by main t their standards or charging lower prices. 4. This calculation was available for 42 firms, slightly lwss than half those surveyed. A sepawte question indicat- Emepreneurs and markes in perspective ed hat only 3 percent of all wages were paid in kind, but tbi estimate covers only specific goods purchased and A syntetic profile of firms' product markets 1 given to workers, not such digs as vacation tine or classified by their owner's past job shows rather c dear patter among the three categories of S. Only 41 firms, oriust under halof those interviewed, owners previously discussed (table 3.3). Firms answered the questions o the increase in the number of owned by former managers were more likely to input suppliers and the improvement in qualit and have more business relations with the state sector variecy. 36 4 Constraints in the business environment In the context of Russia's transition-with its Despite this relatively good performance, turbulent environment, declining output, and lack Russian firms face a number of difficulties. of private sector tradition-the performance of Entrepreneurs were asked about the three biggest firms surveyed looks surprisingly strong. Ap- problems affecting their business today, and the proximately 30 percent were rated highly success- most important of these were the external con- ful and another 40 percent moderately successful. straints discussed here. The single most frequently Seventeen firms were judged to be "muddling cited problem was the uncertain and unstable through", and five firms were evaluated as very macroeconomic and legal environment in which weak. The appendix on Firm Performance pro- firms must operate. The second most frequently vides a detailed statistical analysis of performance cited problem was the lack of bank financ- based on responses to the questionnaire and the ing-mainly for investment purposes, but also for interviewer's independent evaluation. One indica- working capital. Related to this were problems tor of success was employment generation: two- encountered with banking services. The third thirds of the firms expanded employment since problem was high taxes. Other constraints were start up or privatization, and another quarter lack of demand, getting good workers, and obtain- maintained their initial employment level. Less ing satisfactory workspace. than 10 percent reduced their labor force since Some problems of Russian entrepreneurs are becoming private. similar to those cited by small and medium-size There are several explanations for the relatively enterprises elsewhere, but others differ. The most good performance of survey firms. One is that common complaint all over the world is lack of successfil firms may have been more likely to financing and, where funds are available, high respond to the interview request letter, creating a interest rates. Other common complaints are-as positive bias in average performance. Service in Russia-high taxes, shortage of space, and lack firms, however, performed somewhat better than of demand. But small and medium-size enterprises manufacturing firms that responded to the same elsewhere also complain of insufficient supply of interview request letter. Another is that private skilled labor, unfair competition of large firms, business in St Petersburg has attracted very well and weakness of internal management and organi- educated individuals who learn fast, and it has zation. Rarely (the United States during the 1970s) developed into a critical mass that permits some is inflation mentioned as a problem, and rarely are firms to operate successfully by dealing primarily institutional barriers to entry mentioned. In Rus- with other private businesses. sia, most problems are considered secondary to 37 the enormous instability in the macroeconomic and on short-term projects and short production legal environment (Storey 1983; Hull 1987: cycles. Many insisted on cash-on-delivery pay- 82-88; Vivarelli 1991: 220; Hall 1989: 39-56; ment arrangements. Some introduced an "escala- Barber et. al. 1989). tor" clause in contracts to allow for price adjust- ments, and some firms priced their services in The macroeconomic and legal environment dollars, calculating the ruble equivalent for the customer at the time of payment. Frequent and The macroeconomic environment in Russia deteri- unexpected changes in relative prices were more orated dramatically in 1992 and has continued to disturbing for many entrepreneurs than the overall be highly unstable. For new entrepreneurs, it was increase in the price level. The fear that input and like learning to swim in a stormy open sea. output prices might move against them over the Inflation during 1992 reached 2300 percent and by short run-say three months-depressed their late 1993 exceeded an annualized rate of 1ooo demand for credit, even at extremely negative percent. Large and unexpected changes in relative interest rates. A worrisome corollary of high prices occurred, and a number of key prices were inflation was the volatility of the ruble/hard still under same degree of control. During l9g2 currency rate. Sometimes contracts were broken GNP declined by 19 percent, and by end-1992, iecauseofchanges.intheexchangerate,aggravat real wages had fallen by 32 percent. Real house- ing business relations. hold income had fallen by 26 percent since Janu- Uncertainty about the fsc ture course of refomn ry 1991, depressing demand by both businesses in Moscow was the second most frequently men- and households (PlanEcon Report 1993). toned concern. Survey interviews tok place The legal framework governing economic during the first month of the new Prime Minister relationships remained uncertain. Russia was still Chernomyrdin, and a number of interviewees operating under the amended constitution of the were worried that the reform policy of Gaidar Soviet Union. The right to engage in private would be reversed. They saw themselves the activity, fo most businesses, wasguaranteedby losers if such a reversal were to take place, atheit, "a mont Enter ses, wad Entraeprenr h although some entrepreneurs criticized Gaidar for Atit but lw onterprivesate andreporeatei raising taxes to reduce the deficit and then bailing Activity"', but laws on private and corporate outsaeetrrss oehls,piaeete - ~~~~~~~~~~~out state enterprises. Nonetheless, private entre- property rights and new contract laws were still r ,, , X spo not doptd. Nw las an decees ere tc- preneurs were providing essential political support nlot adopted. New laws and decrees were fre- frmre eom quently revised, and there was disagreement about mret rorms. their validity. The courts and arbitration systems decline in economic activity and the resulting low were poorly developed, income of the population created sluggish demand for many services-especially personal services Firms' trrrience vwith the macroeconomic such as private health care, hairdressing, restau- wad legal environment rants, and tourism. Some services-such as con- sulting, tailoring and hairdressing-also suffered The inescapable problem of macroeconomic from competition from unregistered individuals instability left entrepreneurs with three main operating out of their homes. In addition, there concerns, the first of which was inflation. Most was a drop in government research and develop- entrepreneurs seemed to understand the main ment contracts and in state enterprise demand for effects of inflation and realized that they should social services. In the area of consumer services, get rid of rubles and credits to customers as only the demand for food stayed at a satisfactory quickly as possible and hold any surplus assets in level. In the area of business services, demand for the form of real estate, goods, or hard currency. consulting and legal services was strong, mostly in To combat the effects of inflation, firms focused connection with the privatization process. 38 The major complaint of most interviewees with claim that in the past, visa quotas imposed by respect to the legal enviroment was the absence other countries were given to state enterprises of a stable and transparent body of laws and such as Intourist and Sputnik; other firms needed regulations, including tax laws. Existing laws to pay bribes to get a quota allocation. were badly defined, open to discretionary interpre- The St. Petersburg City Council had begun an tation by officials, and subject to frequent and investigation of what should be done in response unexpected changes. Frequent changes in stan- to President Yeltsin's Decree 1484 of November dardized forms for such things as registration, 20, 1992 on "Support for Small and Medium taxes, and exports obliged entrepreneurs to hire Businesses. No city-wide programs of technical consultants to help them deal with the red tape. assistance or credit for private business were yet Firms found little legal recourse in the face of available, although some federal grants were injustice; one interviewee reported a two year available to private firms, for example in the area bacldog in court cases. Given the overcrowded Of medical research. Several training programs agenda and long delays, entrepreneuxrs made litle existed, some of them supported by international use of the court system for debt collection or assistance from Germany, Finland and the United settlement of commercial disputes; some firms Kingdom. used government-sponsored arbitrage facilities. One importan function provided by local administration was registration and licensing of Public administration businesses. To establish itself, a firm must open a Public admidstradon bank account and register with the city authorities, Enterprises encountered problems in their with the tax office, and with the pension fund. For day-to-day dealings with both the federal govern- registraton the firm needed a charter, a legal ment and the St. Petersburg city a address, and several other documents, for exam- The unstable macroeconomic and legal environ- pie, showing the availability of a business space. m o f g f eIt used to be possible to have a post office box ment provided ferile ground for bureaucratic ad5 o inefficiencies and corruption, leading to frustration .provided by the mayor's office, but tis is and mirus on the part of entrepreneurs. In no longer possible. Small businessmen claimed and istust n epartof ntrerenurs.111 tba these box addresses helped them avoid the general, local government was expanding, adding tatdh new rgaizaion toaddess he eed oftrasi- mafia.- new organizations to address the needs of wfGenerally, all applications for registration were ron and satisfy the demands of new interest approved unless the activities were illegal or the groups. Chains of command between and Zamong documents or rules of operation of the firm were federal and local authorities were becoming less not in accordance with the law The nominal cost clear. The police force was inexperienced and of registration was R2,000 (ess than $4 at the ineffective. Criminal 'mafia"' groups were extort- January 1993 exchange rate) but city officials said ing fees for protection and debt collection. Polls that consulting firms would arrange for registra- indicated low public ratings for the mayor and the tion within a week for R20,000 to R30,000. Firms city council, with a survey in March 1993 indicat- also need to obtain licenses for a variety of ser- ing that only 14 percent of Petersburgers had vice activities, including transport, construction, confidence in the city council and only 22 percent renovation, banling, international finance, securi- in the mayor (Usova 1993). ties trading, trading of goods, legal services, Despite these problems, some improvements in education and training, publishing, hairdressing, the regulatory environment have been made. medical care, operation of casino, operation of Limits on trade margins and profits have been restaurant, sale of alcohol, foreign trade, and removed, and a more liberal passport system was dealing in foreign exchange. Formal provisions put in place, although foreign-country restrictions for exit have only recently come into force, with on Russian travelers have tightened and can be the new Law on Bankruptcy that took effect on aggravtd by govemment policy. Entrepreers March 1, 1993. 39 Firms' experience with the federal government complete their registration in less than a month-one did it in a day-and 85 percent were Although entrepreneurs spoke mainly about local able to register in less than 6 months. Coopera- authorities, they also pointed out problems with tives experienced more problems than other firms the federal government. Federal goverrunent in registering, as did a lawyers association that ministries-as well as state enterprises-were was similar to a cooperative. Some firms-newly sometimes seen as inefficient, corrupt, and dis- established banks and security traders and all open criminatory toward the private sector. Some joint stock companies-had to register with federal entrepreneurs complained that the govermnent authorities, a much more cumbersome process sanctioned such unfair state enterprise behavior as than local registration, as it requires traveling to charging private firms higher prices or refusing to Moscow. About half the firms hired an attorney as authorize purchases from private firms. Others a facilitator to help register and obtain activity- claimed that government authorities permitted specific licenses. Among those that did not, monopolistic behavior by state enterprises engaged several were lawyers themselves or had a lawyer in law, medicine, and building restoration and working in the firm, and several used personal renovation. Authorities allowed regions to set up contacts to facilitate the process.'. A "urnkey" administrative and fiscal barriers to free move- operation for starting a business was said to cost ment of goods, and refused to allow private R65,000 (about $650 or seventy times the monthly entrepreneurs to participate officially in interna- minimum wage at the time), including opening a tional professional conferences alongside or bank account, drawing up a charter, and registra- instead of state enterprise managers. tion. Approximately half the firms characterized as Firms' experience with local admdnistrarion problematic the process of registering or obtaining the licenses and permits they needed to operate. Although undoubtedly the city administration has Those who did complained that the process was efficient, honest, conscientious employees, many very tine consuming and that government officials entrepreneurs saw public officials as bureaucratic picked on every word. They also complained of and corrupt. Bribes and personal connections having to pay bribes. Several firms found it played an important role in obtaining favors from almost impossible to obtain a license to undertake the government. One owner claimed that he had education and training activities, and another to offered hundreds of bribes over the previous year open a bank. All in all, registration appeared to be or two, and not one was refused. When anotier more difficult and costly than it should have been. entrepreneur was asked how he acquired the lease for a nice building, he responded that he was a Security. Public safety was a concern, and some member of the oblast finance committee. Many finns hired private security guards to proyide entrepreneurs complained about excessive docu- round-the-clock protection. Thirty percent of mentation, conflicting regulations, and divergent entrepreneurs said they were subject to outside interpretation of laws and regulations by officials interference from the local mafia. This occwrred in different city districts. Other irritants mentioned in several forms, but the most common form was were a government decree delfning the assortment demands for "security" payments, which included of goods that each store had to carry and seeming- protection from other mafia groups. One entre- ly arbitrary increases in prices and fees of munici- preneur had his life threatened for undercutting pal enterprises such as building renovation design the standard price markup on imported consumer or billboards. goods, and another had his windows broken after refusing to make a payment. Some firms made Registration. Firms found registration more payment in the form of free or reduced-price time consuming than the norm as stated by city services. Once the relationship was established, officials. Only one third of all firms were able to the mafia might serve as debt collector. In this 40 capacity, it would collect not only the original not affect most finns. Additional complaints were debt to return to the creditor, but also some made about the water system, especially the multiple of the original amount as compensation intermittent lack of hot water, which seriously for its services. The mafia might also sit in on affected specialized firms such as hairdressers. -contract negotiations with another firms, to rein- The electricity supply, characterized as unstable, force the bargaining position of its client and help complicated the operation of modern equipment ensure compliance by the second party. such as computers. Shopkeepers and wholesale traders were most likely to be contacted by one of the three main Atitudes of public officials. Relatively few mafia groups active in St. Petersburg. One entre- entrepreneurs saw a positive attitude toward preneur said that each street retailer had to pay private business and profit-making on the part of 1,000 rubles a day to the mafia. Firms with public officials. Table 4.1 shows entrepreneurs' higher revenues and more employees suffered ratmgs of attitudes by public officials in St. from more interference. Such firms generally Petersburg compared to attitudes of state enter- made special arrangements with the police or the prise managers and the "average citizen". Only 19 mafia itself for protection. Other firms tried t percent of entrepreneurs thought that attitudes of keep a low profile. They maintained modest local officias were positive. Most of these thought offices or refrained from advertising or oensing a that the positive rhetoric on private sector devel- hard currency account. The St. Petersburg "yel- opment was unsupported by concrete action or low pages' were described by one interviewee as related to personal gain from bribes. a "hit list." In contrast, 40 percent thought that attitudes of state enterprise managers were positive, and 51 O.r public sevcs.Cmpercent thought that attitudes of the average -Le pulblic services. Complaints about public.. utilities were not among the major problems citizen were positive. Some entrepreneurs saw state enterprise managers as conservative, afraid expressed by entrepreneurs. About 15 percent of of losing their privileges and envious of others' firms had no complaints about public utiities. succe "They believe we are millionaies." Other fms typically had problems with one or Ohers saw them as activist, with their own two public utilities. but not all. Very small com- private business interests: "They al have their panies generally found the cost of utilities high. own-the clever ones.' A few entrepreneurs The most frequent complaint was about tele- commented that state enterprise managers appreci- communications. Some services such as facsimile ate the availability of new or improved services. and telex transmission were not readi;l available, and intra-city telephone lines were expensive and also hard to obtain-sometimes requiring an order from a city district council. One owner claimed it Table 4.1: Ratings by entrepreneurs of cost R150,000 just to change the name on the attitudes of different groups toward the telephone line of a state-owned store that was private sector (percent) privatized; others estimated the cost of this service between R4,000 and R15,000. Another owner had to pay for his own workers to run telephone lines Categary Negative Neutral Positive from the central exchange to his office. Telephone services were improving, however, with direct St Petersburg public dialing and an increasing number of available adminision 37 44 19 lines. Managers of state The second most frequent complaint about firms 30 30 40 public utilities was irregular operation of the overcrowded city bus system. The inter-city bus Average citizens 39 10 51 system was also characterized as bad, but it does 41 Many entrepreneurs rated public officials as plaints of entrepreneurs. As in many countries, no having a neutral attitude toward private business provisions for inflation accounting existed, so that and profit-making and thought officials just did inflation quickly eroded the real value of deduc- not care, although some pointed out that the tions based on depreciation allowance. One entre- attitude depended very much on the person with preneur estimated that 80 percent of his estimated whom they were dealing. In contrast, entrepre- before-tax profit was paid in taxes of various neurs saw private citizens as polarized-either kinds.' blaming the deteriorated quality of their lives on Entrepreneurs also complained about an exces- the market economy or seeing job opportunities sive number of taxes. Besides the major taxes for themselves and/or improvements in the supply mentioned above, firms interviewed paid: land tax of goods and services. (1.5 percent of land value), real estate tax (2.5 percent of building value), local police tax (1 Taxation percent of wages), advertising tax (5 percent of advertising costs), inventory tax (I percent- of The tax system in Russii has been subject to value of inventories), public transport tax (the continuous revision. When this survey took place, minimum monthly wage times the number of late January 1993, the main taxes were the val- employees), road tax (0.4 percent of sales), and ue-added tax (VAT) at 20 percent on most prod- car ownership tax (1.5 percent of value). Implicit ucts, the 32 percent profits tax, several payroll taxes included mandatory foreign exchange sur- taxes totaling 38 percent, and personal income tax render at an unfavorable rate and import-export with marginal rates from .12 to 60 percent. In quotas and licenses. addition, there were tariffs on imports and ex- Firms also complained abouttax administration. ports, excise taxes, contributions to extra-budget- This is not surprising, since in many countries ary funds such as the Road Fund, and an excess small businesses believe the tax code penalizes wage tax equal to the profit tax on any portion of them. Small size, lower administrative capacity, the average wage bill exceeding four times the and litfle chance of influencing tax authorities put minimum wage. At the local level, there were a them at a disadvantage. In St. Petersburg, entre- number of small taxes, bringing the total to about preneurs made these points and several others. 25 different taxes; however, any one firm may be First, direct taxes paid by individual private liable for only half this number. businesses and households were a new phenome- Services received differential treatment under non and would take time to get used to. Second, the VAT, the profits tax, and import-export tariffs the tax system was still subject to frequent chang- and quotas. Services exempted from the VAT es and sometimes required prepayments or retro- included: city transit, passenger commuter service active payments. Advance payment of the profit other than air transport, housing rentals, financial tax is in fact authorized by law, with provision for operations, art and culture, education, medical retroactive adjustment. Tbird, tax collectors had services, and legal and translation services. Ser- greater discretion in dealing with taxpayers than in vices subject to higher profits tax rates included other developed countries. Fourth, poor tax middleman, or "brokerage" services for trade and accounting rules meant, for example, that contract investment at 45 percent and entertainment at 50 work could not be expensed but had to be paid out and 70 percent, depending on the type. Services of profits. were typically not subject to import-export tariffs Generally, firms complied superficially with the and quotas. tax law by paying a portion of the tax due, but they reduced the tax base through avoidance and Firms' experience ith xaion evasion. Almost all firms withheld the personal income tax on behalf of their employees, for the Entrepreneurs complained extensively about taxes. most part at the minimum rate of 12 percent. All High tax rates were one of the three major com- but one firm paid payroll taxes at an average rate 42 of 38 percent of total wages. Less than half the relatively few Russian banks offered the range and firms, however, pay the excess wage tax, and quality of services that can be found in good most firms tried to reduce payroll and profits banks elsewhere. taxes in various ways. Where possible, firms used Loan insurance, the main instrument used to cash transactions, since it was difficult to avoid cover the financial risk of lending for private paying taxes on bank transactions. They also paid business, is in its infancy, as is most insurance some wages in kind, padded the input bill, failed activity. The companies dealing in financial risk to report certain activities, redefined activities are typically linked in some way to banks. The subject to a higher profits tax, and shifted wages legal basis for insurance is only now being estab- or profits to another firm.4 lished; a new insurance law was passed in Janu- Firms could resort to legitimate means of ary, 1993. Most insurance activity is to cover the avoiding the profit and other taxes by applying for financial cost of lending; only a few companies discretionary tax treatment. Discretionary reduc- deal in shipping, property, car, and life insurance. tion in tax liabilities from local authorities could The processing of claims is slow, and the levels of be obtained for engaging in a charitable activity or public trust and know-how of insurance agents and reinvesting profits. One research and development actuaries are low. firm, for example, paid lower taxes because it All over the world, small and medium-size provided medical services to children, and a enterprises complain that the banking system trading firm ran a soup kitchen with the hope of refuses to extend credit to them and, when of- obtaining a reduction in taxes. A finn engaged fered, it is much more expensive than for large 100 percent in ecological activity could also get a enterprises (Bosworth 1989; Hall 1989, 1992; reduced tax rate. Prior to 1993, service firms with Storey 1982: esp. 148-178 and Ch. 11; Storey 15 employees or less could reinvest profits tax 1983; Storey et. al. 1987: 76-80; Vivarelli 1991; free for the first two years of operation, but this The State of SmaU Business 1992, Appendix B). advantage no longer exists. The reasons for this vary: the risk involved in small business activity may truly be higher, or The banicng system and obtaining aedit market and institutional imperfections may exist. In either case, small business may provide positive There were approximately 30 banks with about 60 social externalities, resulting in a gap between the branches in St. Petersburg, plus some branches of private cost as the bank sees it and the social cost. national banks. They offered a variety of tradition- To address this gap, most governments create al bank services, including facilitation of business special credit channels or guarantee instruments transactions and provision of short term credit. for small and medium-size enterprises, on a Virtually no funds were available for small and concessionary basis. Such a program has not yet medium-size enterprises from Central Bank of been established in Russia but could be especially Russia resources. Given high inflation, medium important for the entry of new firms, where and long-term credit was virtually non-existent. innovation is more important. Traditionally, banks in the former Soviet Union collected and transferred to the government Firms' experience mith baning servces substantial information on their pre-assigned clients. Indeed, they performed the roles of tax Ninety percent of firms relied on banking services inspector, tax collector, and auditor. Commercial in their day-to-day operation. The majority of banks have been instructed by the Central Bank of firms used a private commercial bank, a substan- Russia to continue this traditional role, verifying tial minority used state banks, and a few used a firm's compliance with tax liabilities such as the Sberbank, the state savings bank. On average, VAT before approving any withdrawals or bank entrepreneurs claimed that dtree-quarters of their transfers, including salary payments. Given these monthly transactions went through the banking continuing duties and various other constraints, system, although a much lower share is likely.5 43 The remaining transactions were made primarily Finns'experience with obtaining credit in cash rubles, with only a small fraction taking place in hard currency. No barter transactions Only short-term financing was available through were reported. the banking system. Medium or long-term financ- About 90 percent of entrepreneurs complained ing to start a new enterprise or to invest in an about banking services. The most common com- existing one was completely outside the realm of plaint was the delay in payments, particularly for possibility. Maturities usually extended from payments made outside the St. Petersburg area. several weeks to a year, the latter being very Several firms noted that the larger the bank exceptional. There were a few cases of credit lines transfer, the longer the delay-suggesting that with renewable annual contracts. Many firms in someone else was using their money. In the St. the sample were not able to obtain a loan for a Petersburg area, the average number of days period sufficiently long to cover even their com- required for a local bank transaction by firms mercial transactions, taking into account delays in surveyed was six, with a minimum of one day and deliveries and in payments. a maximum of 30 days-not excessively long, Nominal interest rates ranged from 80 to 240 even by western standards. The second most percent a year. Banks could charge these highly common complaint was high fees for services. negative real interest rates because they were Opening a foreign currency account was expen- paying either low or no interest on deposits. sive, as was an individual hard-currency transac- Nevertheless, about half the firms found interest dion, on which the bank took a fixed percentage. rates too high. There are several explanations Some banks also took a percentage of cash with- other than the sometimes assumed "money illu- drawals in rubles. As of January 1993 these fees sion" of people not familiar with inflation and the were falling, however, as a result of increasing need to distinguish between real and nominal competition among banks. values. One explanation is that actual interest rates The third most common complaint was difficul- were much higher than the quoted rates because of ty in withdrawing cash for purposes other than such additional charges as interest paid-up-front, payment of salaries. As a result, there was a which greatly increases the effective interest rate; premium on cash earnings, and firms often under- insurance premiums; and bribes. One entrepreneur reported cash earnings to their bank-and by claimed that his bank added unexplained extra extensions to the tax authorities-in order to pay charges over and above the agreed interest rate. cash for their inputs. Other complaints concerned Another explanation is that the volatility of rela- delays, mistakes, the lack of medium- and long- tive prices can make interest rates positive for a term financing, and lack of confidentiality. Re- particular firm in the short term; this could pres- garding confidentiality, banks were believed to ent a major problem since penalty rates for loans share information on firms with the government, not repaid on time were quite high, as much as 5 potential competitors, and the 'mafia." One percent a day. person said that the day after he applied for a loan To obtain a loan, a client had to have either the entire town talked about it. A few entepre- collateral, a guarantee from another company, or nears said that banks concentrated on their pre- loan insurance. Many firms had no collateral and ferred customers, frequently larger enterprises obtaining a guarantee from another company was owning shares in the bank, or that banks wanted not easy, unless the borrower was a part of a bribes for making loans. In the past, opening a formal or informal association. Insurance was too bank account had been difficult, though this expensive for many firms. Premiums charged for appeared to be changing with the increase in the loan insurance were typically one-half to two number of banks and the expansion of bank thirds the interest charges. For example, a six branches. week commercial loan with an interest rate of 18 44 percent would be charged an insurance premium by state enterprises. Official land and building of -9 to 12 percent of the loan. Such preniums rents had been recently raised several times, but dramatically increased the cost of borrowing. prices remained low. For example, annual land About a third of the firms said they were unable rents for commercial enterprises varied from R2 to obtain a bank loan because of inadequate to R270 per square meter ("Offices and Dachas in collateral or high premiums for financial risk Demand': 14-15). Building space rents were insurance. substantially higher. From the banks' point of view, both collateral At the time of the survey, very few outright and guarantees have serious limitations. Collateral sales or 49-year leases of public property had is not currently registered, and there are no taken place. The municipal administration, public procedures for sales when the borrower dehults. institutions, and state enterprises were all holding Thus, banks may end up owning firms that owe their assets in anticipation of higher prices. Devel- them money and not know what to do with them. opers therefore confronted much difficulty in obtaining entire buildings for development purpos- Real estate es, both in and out of the historic district. For most small private service firms, however, Real estate laws and practices in Russia were the 15-year-lease-plus-option-to-buy was the complex and unclear, although a recent decree relevant option. Most were interested in limited authorized the right of citizens to buy and sell space within a building, not the building itself. properties freely. In St. Petersburg, special limita- One possibility was to sublet from a public entity. tions on ownership, development, and transactions This was allowed, provided the public entity in the historic center of town compounded these obtained approval from the Municipal Property problems. In principle, non-historic buildings Committee (MKI), which charged a fee equal to could be bought, and anyone purchasing an entire 10 percent of the monthly payment. Renovated building and the equipment in it could also buy business space in the center-city was attracting the land underneath it. Historic buildings and the strong interest, particularly from foreign firms land under it could be leased for a maximum of that paid high prices, mainly in dollars. 49 years. Space within a building could be leased Shortage of adequate premises for small busi- for a maximum of 15 years, with an option to buy ness at desirable locations and at affordable prices when the law permitting purchase is passed. is also common in other countries. Small service Long-term leases plus the option to buy were firms have been crowded out by rising real estate allocated through auction and competition. Com- prices in downtown business dis- icts, and expan- petitions for leasing historic buildings are divided sion of small firms has often required moving to into commercial competitions-where the highest new premises (Storey 1983: 107-108). Testimony bidder takes the property-and non-ommercial to the general difficulty in this area is the involve- competitions, where renovation proposals are ment of many governments in the construction of evaluated by a committee on the basis of aesthet- "industrial parks" for rent. Problems with real ics and contribution to the value of the property. estate in St. Petersburg are more fundamental. Lease payments were set by a detailed regulation City officials need to create a real estate market, that distinguished between categories of lessors as promote reconstruction of the city center, and well as categories of property. Lessors were rationalize the system of long-term leasing. divided into six categories, each associated with a coefficient of adjustment to the basic rent for the Firms' experience with real estate property category. For example, a trading firm paid more than a manufacturing firm, and a Real estate was a popular topic of conversation foreigner paid more than a Russian citizen. Bud- among entrepreneurs and a major source of getary agencies including schools, hospitals, and concern. Half the enterprises obtained their space reserch institutes, paid the lowest rents, followed through long-term leases from state entities, and 45 one third from short-term leases. Many firms agreements. Small enterprises paying low rents disregarded the approval requirement for sublet- were particularly worried that the city would not ting and established informal arrangements with only increase rents but evict them if someone their landlords, sometimes an enterprise or an provided a sizeable bribe to obtain the space. institute where the entrepreneur had previously Given this history, small entrepreneurs wanted worked. to buy the property they occupied, or other suit- Entrepreneurs had three main concerns about able property, at the relatively low prices offered, real estate. Most important was the lack of securi- much below their real future value. They also ty concerning continuing use of space. The second wanted full property rights, in order to be able to was price. About half the owners said they could develop their properties without risk, to trade not afford to pay the prices demanded for suitable them, and to use them as a store of value, source space and location. Many moderately or highly of business finance, and collateral. They under- profitable firms also claimed that better space was stood that acquisition of properties at good prices available but was too expensive. Largely because could help them generate financial savings through of price, fewer than 30 percent of the interviewees real estate construction, renovation, and manage- said that suitable space for their business needs ment. was available and affordable. The third concern Additional problems with the real estate sector was availability: 10 percent of the owners said mentioned by some entrepreneurs included: they could not find a suitable space for their needs at any price, and a few other firms, on temporary * The monopoly position and pricing practices leases, feared having to move. of state renovation companies and their subsidiar- The complaints about high prices reflect the ies, which discouraged renovation by many entre- relatively recent and frequent increases in rent by preneurs, especially in the historic district. the St. Petersburg municipality-some retroactive * The lack of readily available information and within the contract period. When prices about space for rent or for purchase. soared in early 1991,the city was faced with the * The need to establish the right personal problem of lease agreements and property prices contacts or pay bribes in order to deal successfully quoted in nominal terms. To address the infla- with the asset authorities. tionary environment, the city introduced a pro- gram of rent indexation and attempted to reduce These problems tend to affect most severely the the large subsidy embodied in the old rents by smaller firms with weaker links with state enter- renegotiating lease agreements and property prises or state institutions. prices. Even before the increase in the general price level, rents covered only 20 to 25 percent of Notes the maintenance costs borne by the city, excluding depreciation and interest. This is one reason why - ~~~~~~~~~~~~~~1. Only 42 firms, or Just under half the tola number of building maintenance is generally poor in St. firms interviewed, answered the question on use of Petersburg; for example, two entrepreneurs jcijtoas. complained of major flooding in their buildings. The new lease regulations have provided a 2. The basic payroli taxes are payroll pension fund reasonable framework for lease stability, with (30.6%), individual supplementay pension fund (1%), lease payments indexed annually for inflation and soial soCurty (5.4%), and employment fund (1%). rents generally realigned to market prices every 5 years. The failure to respect leases in -the past, 3US. Sis dificu VAT ke ; was reduced from 28 to 20 however, led entrepreneurs to question whether percent on January 1, 1993, and the exchange rate used any lease regulations will be honored in the for madatory foreign exchange surrender (effectively a future. Many owners believed that bribes contrib- tax) ws improved. Import taxes have increased, and uted to the failurc of the city to honor lease hile to change ta brackets for progressive tas under 46 inflation results in increasing taxation in real tem. An excess wage tax, while another firm might have underrep- article in the Russian weekly, Commersant, highlights the orted workers to reduce the income nd payroUl taxes. problem of high taxes in Russia ("Will lAw-Abiding Firms Survive?"). S. As interviews proceeded, several entreproneurs ac- knowledged that their original estimate of non-bank 4. It is not clear what effect such incentives had on transactions was the 'book' information and that other employment levels reportd. One firm might have overre- non-bank transactions-in cash and in kind-were taking pottd workers to reduce the average wage and avoid the place. 47 Policy recommendations Private sector development of small and medium- es: improvements in the general business environ- size enterprises and the service sector is central to ment, specific govermnent policies, and direct the transition. While most development will be assistance programs during transition. undertaken directly by private entrepreneurs-and can be accomplished without massive government Improvements in the busins environneat intervention-a number of supporting policies at both the general and sector specific levels can The macroeconomic enuronment enhance the development of small and medium- size enterprises, thereby helping other aspects of From the entrepreneurs' perspective, the best the transition. The policies suggested here focus assistance to private sector development in Russia on easing the main internal and external problems is to stabilize the economy and pursue reforms. A expressed by the entrepreneurs interviewed in this relatively stable economy would reduce risk and survey. uncertainty, provide a solid base for investment The policy recommendations draw on three and growth, normalize financial markets and mamn sources of information: intert rates, and stabilize the pattern of demand. The weak demand for many consumer and some Knowledge of the unstable and uncertain macroeconomic, legal, and political environmnent business services, observed in this study and macroeconomic legal, and political enviromnent elsewhere, is one result of the general decline in m Russia, m which small and medium-size enter- . a it prises and service firms are expected to operate Weak demand may also result from the inraing with almost no experience and tradition. m creas * Lessons obtained from the survey on entrepr- disparity in income distribution, whereby the eneurs' characteristics, experience operating in buying power of lower- and middleincome Russia's emerging markets, and the most impor- - families is reduced and the very rich turn to taut constraints in their business environment. imports. The government's stabilization strategy * The stock of policies for small and mediu should apply constraints on demand in a way that size enterprises that have been undertaken in encouragesedemand fordomesticrconsumer goods, developed countries and other economies. which need to expand if restructuring is to occur. This strategy should also ensure that public sector Although the focus of this survey is on service wages do not compete with private sector wages; firms, the following policy recommendations are otherwise, private employers will not be able to applicable to all small and medium-size enterpris- attract public sector workers. 49 Covernmentadministration, regulkfionandservce business centers that would provide technical and financial management assistance to entrepreneurs. Entrepreneurs also favor a radical reduction in As part of the institutional development pro- federal and local government regulation and other cess, confidentiality within the banking system forms of interference. Necessary regulations needs to be established. At present it is difficult to should be simple, clear, well publicized, standard- prevent banks from giving or selling confidential ized, long term, not retroactive, and subject to information on firms to interested parties. Bank minimum discretionary power by public officials. management will need to enforce confidentiality A policy of maximum "hands-off" on the part of among its staff and to use the practice of confiden- the government may be more important than any tiality to attract good customers. It is also difficult active programs. to argue that the government should not use banks Important measures to foster growth in private as control centers for tax purposes when there is business could be instituted by the city govern- no effective tax administration; neverthieless, steps ment of St. Petersburg. A clear priority is elimi- should be taken to separate the financial and the nating corruption in the civil service. An equally fiscal functions of banks. dear priority is a reduction in the number of government employees, since tax levels can only 7he real estae market be lowered if government efficiency is improved and government expenditures are reduced. Public A normally functioning real estate market, with safety and protection against extortion are also properly defined property rights and a level important for private sector development, playing field for competing uses, is a key condi- Many entrepreneurs interviewed in this survey tion for private sector development. The elements complained about lack of information. Local of a well-functioning real estate market are likely government could provide useful and reliable to include: information to the public. Laws and regulations could be published in easy to obtain gazettes, and * Completion of the relevant legal infrastruc- up-to-date standard forms could be made available ture at the national level, including property and at well publicized business centers. At the time of condominium law. this survey, statistics were not generally available * A large increase in the supply of saleable and in St. Petersburg; the Statistical Bulletin, produced leasable property in St. Petersburg, requiring or by the former Goskomstat Agency, was provided encouraging budgetary agencies and public enter- confidentially to selected municipal employees. prises to release excess property for exarnple, This bulletin could be expanded and made avail- through a land tax. able to the public at a price that would pernit * Elimination of differential rents by lessors at partial cost recovery. Survey methods for collect- least to all non-government lessors. ing statistical information should be introduced to * Encouragement of a true competitive market reduce costs and increase coverage and relevance. in design, renovation, and rehabilitation of historic buildings. The banking system and access to credit In addition to helping provide industrial and Improved access to credit depends on actions on commercial real-estate for private sector develop- both the demand and supply side and a certain ment, a well-functioning real estate market will amount of institutional development Banks need help produce true equilibrium in prices, which are to develop skills for evaluating projects in connec- likely to end up much above public rents but tion with credit requests and credit guarantees. below some of the present commercial rents. It Firms need to leam how to develop and present would also help create a store of value and collat- good business proposals. Loan officers are already eral for obtaining loans for future private-sector being trained, and there are many proposals for investment. The privatization of commercial and 50 residential property will transfer resources to geographic trade barriers, price controls, state entrepreneurs and help them finance new invest- selling at artificially low prices, special privileges ments. Opening up the real estate sector will for people with connections, and administrative ultimately encourage ample new activity and restrictions on entry by competitors. employmenL opportunities for private sector activity in renovation, construction, maintenance, Specific government policies tourism, and business services such as real estate agencies, architects, engineers, and interior de- A rational x regime signers. The international appeal of St. Petersburg makes such a move even nuch more attractive Given the prevalence of tax avoidance and tax and rewarding. evasion, it is difficult to know the incidence of Land is only now beginning to be auctioned by various taxes and what revisions would be most the city of St. Petersburg, and the supply is helpful to the smallest, weakest firms, which limited by prior claims of state enterprises and complain most about the tax constraint. The VAT, budgetary agencies. Transactions for both whole profits tax, income tax, and payroll tax together buildings and space within buildings need to be appear to be on the high side, although individual- facilitated and made transparent. For example, in ly they may not differ much from rates sustained order to facilitate property ownership by small elsewhere. In any case, a rational tax regime, firms, the city might need to encourage the estab- which maintains incentives for growth and invest- lishment of commercial centers by real estate ment, is of central importance to small business- developers, who could arrange for financ- es.' A more rational tax regime may entail a ing, including part ownership by participating number of reforms, such as those suggested enterprises. below. One important reform is to simplify and ratio- Equa treaomentfor dfferent economic actiities nalize the many small taxes that constitute a fiancial and administrative burden on small Private business development should be treated businesses. Another is to eliminate some taxes consistently across all sectors. Regulations, taxes, altogether for private firms, which-unlike many and other forms of govermment intervention public enterprises-face severe budget constraints. should not discriminate between different types of Two candidates for elimination are the excess activities, such as trade or manufcturing. Trade wage tax and the inventory tax, which may be continues to suffer both from discriminatory appropriate for public finns but are inappropriate policies in tax rates and rental fees and a strong for private firms operating in a competitive envi- negative attitude on the part of the government ronment. The former penalizes a firm for seeking and the public. highly skilled employees and promoting productiv- Traders are profit maximizers. Their large ity improvement through wage increases; the latter profit margins reflect in part continuing price penalizes a firm for having a business that typical- controls, ambiguous regulations, and inter-oblast ly requires large inventories. Local governments and other spatial trade barriers. Traders also take may also be able to eliminate small, sometimes advantage of the weak law enforcement powers poorly conceived taxes, such as the tax on adver- and the rent-seeking penchant of many public tising, by raising the urban land tax. sector officials and managers to maximize their The fiscal implications of any tax revisions incomes. But many traders interviewed in this must be considered; a good data base can be survey also appeared to be real entrepreneurs who useful in simulating the effects of alternative were reinvesting rather than consuming their strategies. For example, it might be useful to profits. Rather than try to regulate prices and explore ways to promote the reinvestment of profits, the government's strategy should be to profits by small businesses. One possibility, which attack the source of distortions by eliminating would fit within the framework of a general tax 51 Box 5.1 Direct assistance to small and medium-size enterpr in other countries Almost all countries have special programs to assist small and medium-size enterprises. Programs are implemented by the central or local governments, by public not-for-profit institutions and trade associations, and through subsidies to private providers of programs. Areas of assistance in the European Union countries are presented in the following table: Poliies toward small and medium-size enterprises hi EU member states Technical assistance and Supply and Fiscal support Financing training contracting_ Belgium Denmark France Germany Greece Ireland- 71 _ Italy Luxembourg Netherlands Portugal Spain Urited Kingdom Mm n -I very few or no polir: mneasures relatively few policy measures relatively large number of policy measures Source: Derived from de Koning and Snijers (19921. 52 Box 5.1 Direct assistance to small and medium-size enterprises in other countries (coninued) Fiscal support. Investment tax relief or tax credit, investment interest relief, and accelerated amortization programs, especially for start-ups. Financing: Direct government loans at low interest rates; government guarantees to special small and medium-size enterprise credit institutions; mutual guarantee organizations, with a government subsidy or partial guarantee, interest rate subsidies, and special venture capital programs. Technical assistance and training: Technical assistance in the development of new concepts, products or services; information gathering and dissemination; research and development support; training, including worker training and training of entrepreneurs in public regulations and in the principles of running a business. Supply and contracting: Programs to guarantee fair participation of small business in government purchases. law, is to allow a tax deduction for reinvested will also reduce pressures on the bureaucracy and profits up to a certain absolute level. It might also allow the government administration to cut staff. be useful to explore ways to improve tax compli- ance by small businesses. One possibility is to Direct assstance during the trAnsition substitute the profit tax on small firms (defined by number of employees or revenue level) with a The issue of whether or not to provide direct predetermined presumptive tax. The advantages of assistance to small and medium-size enterprises is a presumptive tax are that it facilitates collection not simple. Many countries, including the United and, with a zero marginal rate, it encourages States, have special programs to guide and assist expansion. A problem might arise, however, if it small business development (box 5.1). The ratio- is discretionary at the level of the tax collector in nale is that an entrepreneur starting a new, small the current environment. business is at a disadvantage compared to larger, established firms. The program addresses a tem- A special regultory regimefor small firms porary market failure, which needs to be corrected since small businesses make an important contri- As seen above, small firms are at a disadvantage bution to economic growth and job creation. In in coping with the administrative burden of regu- the United States, for example, nearly half the lations designed for larger finns. They may not non-publicly employed labor force works in firms have easy access to the accountants, lawyers, and with less than 100 employees, and this small other experts needed to handle the bureaucratic business sector currently creates about 80 percent requirements of these regulations, and the finan- of all new jobs. If such a rationale is -accepted for cial and administrative burden may be quite established market economies, it would seem to be heavy. It is therefore recommended to provide all the more valid for Russia, where private sector small firms, as much as possible, with simplified development has only begun. However, local regulations and short forms for registration, bank governments in Russia have less experience in reporting, and taxation. In addition to the help creating an enabling environment, and private such a simplified regime will provide to firms, it entrepreneurs have less knowledge about how to 53 establish themselves.7Therefore, adifferentinstitu- assistance, its most difficult tasks. Most business tional arrangement for support may be required. centers will have to be started from scratch. At Medium-term credit would help small business- the pilot program stage, they may have to be es expand faster than they could through self- established as joint ventures with foreign involve- financing. Such expansion is important given the ment, to capitalize on experience elsewhere. need for rapid restructuring of the Russian econo- Credit assistance might be channeled through my. In OECD countries, less than half of small existing financial institutions, where staff would businesses may have bank loans, but credit access be tested and trained. Training programs for the is much higher than in Russia and medium-term staff of the apex agency, the business centers, and credit plays an important role. Survey data have the credit facilities would be needed, as would a shown that perhaps a third to a half of small system of staff remuneration that links salaries businesses in the United States received bank with performance. The apex agency would need to loans in the late 1970's (Storey 1982: 148-59). formulate clear and transparent criteria for assis- At the same time, there are arguments against tance and require a full accounting of recipients. direct assistance whose efficiency and effective- In addition, it would need to monitor the efficien- ness programs in developing countries has been cy of the second-level institutions. questioned (Webster 1991). Special financing programs for small and medium-size enterprises in Business center. The business center would pro- particular have not always worked well. Regard- vide information on domestic laws; up-to-date tax, less of the importance of such activity, govern- registration, permit, and lease forms; and interna- ments often do not have the capacity and capabili- tional production and marketing information. ty to carry out efficient, well-focussed support Trade fairs are perhaps less relevant for service programs, firms than for manufacturing firms, but identifica- A synthesis of the two views on this issue tion as collective marketing opportunities has been argues in favor of special assistance to small and found to be particularly valuable to new private medium-size enterprises during the transition, firms (Levy 1993). In addition, the business though not necessarily as a permanent entitlement. center could provide communication facilities; Recent case studies have concluded that selected, promote contacts with foreign businessmen; and cost effective direct assistance programs can offer business incubators, technical advice in provide valuable support to new private firms financial management, and training and foreign (Levy 1994). These findings suggest a pilot study. The design of training programs should project approach and some innovation regarding take into account the high level of education of both the who and how of the organization. Assis- most entrepreneurs in St. Petersburg, and should tance should be provided to start-up firms on an capitalize on their ability for self study, given the equal basis with privatized firms. Some broad appropriate materials and references. Such assis- features of a direct assistance program are recom- tance is particularly important for service firms, mended below, followed by suggestions on sup- where entrepreneurs lack knowledge and experi- porting such programs. ence. Whether such activities should be provided together, whether there should be competing Broad Features of an assistance program centers, and how they should be financed are all questions that need to be explored-and are An assistance program might best be centered in undoubtedly being explored elsewhere in Russia. a head, or apex, agency that oversees one or more business centers and one or more credit facilities, Credit and equity assistance. The credit assis- legally separated from the business centers but tance program would help provide reliable, short- located near them: and medium-term credit on a confidential basis with no bribes. Such assistance should preferably Apex agency. The head agency would help be provided through existing banks that have establish both the business centers and the credit developed a good reputation with small business- 54 men. An equity investment channel should be Given the importance of export development in incorporated to offer equity and possibly venture improving incomes, technology, and business capital funding for interested firms that can pro- practices, the business center might recruit profes- vide attractive programs. Such equity financing sional foreign buyers-with partial expenses could be combined with credit in a package that paid-to provide information about market de- best fits the needs and liquidity profile of the firm. mand and product specifications. At the same Survey firms were more interested in obtaining time, such buyers could seek out potential export- equity funds with risk sharing than in borrowing ers of services or products their companies might at what they considered to be high interest rates. like to purchase. In addition, the center might Equity financing requires a deeper study of the organize low-cost learning trips abroad for do- requesting firm and might be provided by the mestic entrepreneurs to visit counterpart business- financing institution in conjunction with a foreign es for training and possible future collaboration, investor. and it might invite foreign investors to meet A distinction should be made between credit potential domestic partners. needs in domestic and foreign currency. A large The development of joint ventures with foreign share of the demand for credit is likely to be for business partners should be a major goal of an domestic resources, and therefore for domestic assistance program. Even though many of the currency. Government policy must create a level Russian enterprises are small now, some will playing field between small businesses and other grow quickly and could prove to be valuable sectors of the economy, such as state enterprises contacts for foreign investors. Foreigners may not and agriculture, so that small businesses have want to undertake a free-standing investrnent ready access to loans on similar terms. This is not under current circumstances but may be willing to currently the case. For example, two banks inter- provide modest amounts of capital and technical viewed in St. Petersburg bad virtually no central assistance to a joint venture. -Such joint ventures bank or other government loans; they claim that could, over time, become the leading enterprises such loans are reserved for state enterprises or in their fields-setting an example in their opera- other special programs that do not include their tion and business conduct, developing new mar- clients. kets and products, introducing new technologies, At present, the unregulated market interest rates and expanding exports. on local currency are negative in real terms, In all these areas of proposed assistance, local because the cost of funds is quite low; but interest surveys should be undertaken to determine firm rates are becoming increasingly less negative. characteristics, entrepreneurs' major constraints Pressures to subsidize interest rates for specific and needs, their willingness to buy shares in a sectors should be resisted, so that credit potential- business center or pay for various programs, and ly available for small businesses is not diverted. the availability of domestic consultants to supple- Some small businesses will continue to finance ment the staff of the business center in providing their activities through reinvested profits; but requested services. Some surveys should precede orderly and confidential access to credits, with the pilot programs; others may be part of them. some form of risk sharing, would encourage small Further information for monitoring purposes businesses to use credits, even if offered at posi- would be gathered as a byproduct of the business tive real interest rates. Credit facilities may be center's activities. able to continue to obtain low-cost domestic ruble deposits or gain access to local counterpart funds Who should support such programs? generated from the sale of goods acquired under commodity or other grant assistance. Local cur- Direct assistance programs require the support of rency funds at low, if not negative, real interest local government. As a minimum, local govern- rates could then be provided in conjunction with ments should allocate space and provide matching hard currency loans at standard commercial rates grants for some activities. But they should concen- to finance firms' foreign exchange needs. trate primarily on law enforcement, tax collecting 55 and increased internal efficiency-all areas where A highly desirable variant of this model entails increased effectiveness would benefit entrepre- participation in a business center or credit facility neurs. Local governments' lack of experience with by a foreign company. Once macroeconomic small business development, as well as their stabilization is achieved, foreign firms may see negative image with entrepreneurs, because of this as a useful way to enter and study the Russian corruption and inefficiency, raise serious doubts market, with future profits in mind. Under current about their participation in direct assistance to conditions, strong incentives would need to be firms. For this reason, the private sector itself provided through aid programs for foreign firm should take responsibility for small business participation-for example, by initial matching assistance-initially with foreign guidance and grants or risk-sharing loan guarantees. In all financial assistance. Competing private sector cases, both profit and non-profit variants are institutions such as a Chamber of Commerce or possible, including a start-up non-profit operation other business associations and sector-specific converted later into a normal business enterprise. groups, could organize competing business centers Given the huge differential in costs between in large cities. Several foreign agencies, including foreign and domestic staff or consultants, the the European Union, have talked about setting up assistance program should try to economize on the a business center in St. Petersburg, but so far use of foreigners. As a minimum, however, a none has been established, foreign technical advisor should be employed for Assistanceto small businhesses fom bilateral aid two to three years to organize and manage at least programs or international financial institutions the apex agency and possibly the business cen- might be oflred on a competitive basis to oblasts ter(s). A Russian counterpart would be trained to and cities as long as local authorities and small take over in a year or two, with the foreign andcitines as longafs locare autorities and pvall advisor shifting to a supportive role. Depending business associations are supportive of private on local demand, foreign consultants might be sector development. A conceptualy appealing recruited to tram the Russian staff, who would model is one where seed money is offered to then train bank credit evaluation officers, cor- assist one or more business centers on a pilot rci/indusial designers, domestic and foreign project bashs, pending efforts to obtain longer marketing specialists, and management consultants term financing from fee-for-service arrangements as necessary. Technical assistance programs to or external grant assistance. the seed money enterprises could make entrepreneurs aware of might be used for computeriion, foreign and available lines of credit from participating finan- local staff salaries, and matching grants to enter- cial institutions. prises for consulting, information and training services provided by the center. Matching grants Note might also be provided for small research and development projects that introduce new or im- 1. See Koning ad Snijder 30; Cross 1983: 109-110; proved t&chnologies; preparation of project pro- Storey 1983. Most of the tax concessions to small firms posals to interest foreign business co-investment; mentioned in these sources am indeed for new firms, and business plans for credit applications. which would include virtually all private firms in Russia. 56 Appendix: Firm performance This appendix examines the economic perfor- The main explanation, however, may lie in the mance of survey firms according to data supplied increasing demand for trade and business services by the owners, an overall performance grade created by market reforms and the collapse of the supplied by the interviewers, and a separate planning and centralized trade system. Private composite grade calculated on the basis of several service firms in St. Petersburg have performed performance indicators. 'he findings on perfor- somewhat better than comparable manufacturing pmance a nrcators. dmgs on Phr firms, giving credence to this view (box 2.4). mace are then related to the characteristics of the Also, relatively small new private firms have an entrepreneurs, the characteristics of the firms, advantage over larger firms in that they are more changes in prices and wages, constraints imposed flexible and free of residual responsibility for by the business environment, and entrepreneurs' social services, including housing. A recent complaints. survey of large privatized firms in Moscow and Judged in isolation, the firms' performance Vladimir oblasts supports this explanation (Web- record can be considered good, but not outstand- ster, Wackman, and Franz 1993). ing. Judged in the context of Russia's transition- Finally, the relatively good performance of with its turbulent environment, declining output, firms surveyed is consistent with the findings of wit itsturbulentenvironmen, declig o , the survey that the private sector in St. Petersburg and lack of private sector tradition-the perfor- has developed into a critical mass that permits mance~ ~ ~ ~ ~ ~~~ ~~~a develope looks reakal stron msstht gr mance record looks remarkably strong. some firms to operate successfully by dealing Several explanations for this good performance primarily with other private businesses, and it has are possible: First, there may be a sample bias in attracted well educated people who learn fast. that registered firms, from which the sample was Given the shrinking budget support for govern- drawn, may perform better than the undocumented ment agencies and research institutes, the private unregistered firms. Also, successful registered sector is likely to attract a very high caliber firms may have been more likely to respond to the entrepreneur all over Russia. interview request letter. Both sources of selection bias are possible although difficult to verify. The perfoce record Second, despite the generally negative effects of Several measures of performance arc examined nflation and volatility in relative prices, some here in an effort to identify success: firms---especially in trade and financial servic- es-can benefit from positive effects on liquidity * Eight performance indicators included in the and profit. questionnaire. 57 * An overall grade of I through 4, assigned to since starting operations, typically firing workers each firn by the interviewer and based pardy on employed by the original state enterprise. The the eight performance indicators and partly on a remaining firms did not change their employment qualitative impression of the firm, taking into level (box A2). account the qualities of the entrepreneur and a *Employment growth in fast six months. About personal inspection of the facilities. half increased employment; fewer than 15 percent * A composite grade calculated as the numeri- reduced employment. About 40 percent experi- cal average of the overall grade and values as- enced no change (box A2). signed to the six positively and significantly inter- * New equipment share. Fifty percent had more correlated performance indicators (box Al). than half their equipment new. One-third had 100 percent new equipment Four crude indicators of labor productivity * Expansion plans. The vast major.ity of entre- were also calculated to see if they were correlated preneurs had concrete expansion plans, some in with performance: sales per full-time worker, the their own lines, others in related or different ratio of wages to sales, net revenue (sales less activities. wages) per worker, and the change in the real producer wage over the last six months. The last The general impression left by the firms was three indicators correlated with profits, and the that performance was good, but not outstanding. second and third correlated with the overall According to the original grade given by inter- grades. None correlated wit the dynamic perfor- viewers, five firms were evaluated very weak and mance indicators, past or future. 17 as "muddling through". Together these ac- The eight performance indicators and the f counted for a quarter of the firms. More than 40 results were: percent of the firms were graded fairly successful, and about 30 percent highly successful. The most * Profitabilty. Eighty-four percent of firms succesful frms were highly profitable with reported positive operating profits for the last concrete expansion plans. The weaker firms repotedpostiv opratng rofts br he ast suffered from supply-side constraints (inputs, quarter of 1992; one-third were highly profitable. cred grnm interferene adn certainty Four firms were losing money and. 10 were credit, government interference and uncertainty) breaking even. and also from weakness of demand for their breakingevein. profits.Onequarterreport 3services. eChzange in profis. One quarter reported Table A l shows the two average overall grades declining profits since the early period of opera- and the six significantly correlated performance dion. Twenty percent reported no change, and indicators for each of the main activities. Con- more than half saw. rising profits. mr services typically experienced be- * Capacity uilizaton. Eighty percent of the low-average performance, and trading firms firms were selling at full capacity. Three quarters slightly above-average performance. Demand was of those that produced at full capacity said that sharply reduced for consumer services such as they could expand had there been higher demand. hairdressing, tailoring and watch repairing, as a Only one quarter cited supply constraints, internal result of the decline in real personal income. and external, as the effective limit on sales. Anecdotal accounts were heard of such firms Eighteen percent were below full capacitY because disappearing in the last few years. Within trade, of insufficient demand. firms in wholesale trade and restaurants seemed to * Sales growth in volume. Slightly more than a do better than average, but retail stores seemed to quarter of the firms reported a decline in the perform worse than average. Retail trade suffered volume of sales during the last quarter of 1992; partly from depressed demand and partly from the the rest saw increased sales. many constraints on trade and movement of * Employment growth since start up orprivat- goods-all raising transaction costs. Business iation. Almost two thirds of the firns -had in- services rank near average by most measures; creased employment since start-up or privatiza- their strongest perfornance indicator is employ- tion. Fewer than 10 percent reduced employment ment growth. 58 Box Al Correlation of performance indicators and overall grades Six of the pre-chosen performance indicators-profitability, growth in profits, growth in sales volume, employment growth since start-up or privatization, new equipment share, and expansion plans-were significantly correlated among themselves and also strongly correlated with the two overall grades. The mean and median values for the composite grade were virtually the same as for the original grade, and both grades were positively correlated with most of the six pre-chosen performance indicators. These results lend credibility to the evaluation process in that they reinforce each other. The correlation matrix shows, on a scale from 0 to 1, the strength of association between the column and row variables: Correlation matrix of performance indicators and overall grades Growth in New Expan- Com- Current Growth Growth employ equip- sion Original posite profits of profits of sales ment ment plans grade grade Current profits 1.00 Growth of profits 0.28 * 1.00 Growth of sales 0.20 0.54 * 1.00 Growth in employment 0.44 * 0.24 0.30 1.00 New equipment 0.30 * 0.05 0.16 0.18 1.00 Expansion plans 0.30 * 0.06 0.16 0.15 0.32 * 1.00 Original grade 0.59 * 0.30 0.37 0.44 * 0.45 * 0.28 * 1.00 Composite grade 0.62 * 0.69 0.71 * 0.55 . 0.58 * 0.34 0.74 1.00 significant at I % level * significant at 5% level The existence of concrete expansion plans was highly correlated with the original overall grade and with current profitability, but not with the main dynamic performance indicators like change in profits, sales, and employment. Perhaps the fastest growing firms had reached a consolidation stage. The two performance indicators not positively correlated wit the other iMnicaiors, and not-used to form the composite grade, are capacity util ization and recent employment growth. One hypothesis is that these indicators reflect the accelerated drop in Russia's GDP by some 20 percent in 1992. Limiting the creation of new jobs during such a slowdown in general demand would have been prudenL for otherwise successful and well managed firms. The lack of correlation would reflect the outcome of a combination of expanding firms and more careful but still successful ones. 59 Box A2 Generation of full-time Generation of full-tme employnmnt employment by survey rmis by survey firms Full-time employment grew rapidly, demon- Since start-up or In previous six strating the well-known role of the private _-privatized monthsr service sector in job creation. This can be Percent Percent explained in part by the firms' relatively Number of Number of modest needs for complementary capital Cateaory. of firms growth of flrns growth equipment, but it is remarkable given their : - limited access to bank finance for working capital and investment capital. The Box Table Trade l8 75 14 10 shows the generation of regular full-time employment by the survey firms. Business 76 291 18 11 services 16 21 lI The total number of workers in the firms Consumer surveyed increased by 36 percent since start- services 9 37 -9 -4 up or privatization and by nearly 10 percent Health and during the second half of 1992. Two-thirds of education 5 113 3 34 the firms expanded employment since statn up, and a quarter maintained their initial Transportation 2 -11 I 0 employment level. Fewer than 10 percent Finance 2 1,691 2 103 reduced their labor force since they became Toti 52 36 47 10 private. Over the second half of 1992, half the firms expanded their employment. Anoth- Number of fuli-me works er 40 percent experienced no change in em- Fewer than 8 13 43 12 10 ployment, and less than 15 percent reduced their labor force. 8 to 39 26 12 24 -9 40to99 7 120 7 21 Employment in some firms grew very fast. 100 or mote 6 33 4 13 In slightly less than half, employment growth since start-up or privatization was more than Total 52 36 47 10 100 percent and more than 1000 percent for Fim hisory five firms. Looking at the three main activity groups, employment in consumer services New start-ps 35 239 32 28 expanded the least and employment in busi- Completely ness services expanded the most, with em- prvatzed 72 41 77 9 ployment in trade also growing above aver- Privatized with age. This pattern continued over the last half residual state of 1992, except that employment in consumer ownership 5 -2 4 2 services actually declined. The most rapid employment growth was in firms with 40 to Total 99 employees and in firms that were indepen- dent since start-up. s~~ote: Average percentage.growth is weighted by dent. since start-up. the number of workers in each firm at the beginning oa the period. 60 Table Al: Ranking of firma' performance by main acIvity (1 - lowest, 4 - highest) Performance indicators Chango in employment Growth since stmrt Current of Growth up/ New Expsnsion Original Composite Main activity profits profits of sales privatized equipment plans arade arade Trade 3.3 3.2 3.4 2.9 3.0 2.9 3.0 3.1 Number of firms 32 30 29 18 21 27 32 32 Business services 3.1 2.7 3.1 3.4 2.6 2.8 3.0 3.0 Number of firms 27 27 27 16 21 25 27 27 Consumer services 2.7 * 2.1 2.6 2.7 2.7 2.8 2.8 2.6 Number of firms 13 12 13 9 12 13 13 13 Health and education 2.9 2.8 2.7 3.6 3.3 2.8 2.7 3.0 Number of fmrms 7 5 7 5 6 6 7 7 Transportation 3.5 * 2.9 2.5 1.5 2.0 3.0 3.0 2.7 Number of firns 4 4 4 2 4 3 4 4 Finance 4.0 4.0 4.0 4.0 4.0 3.0 4.0 3.8 Number of firms 3 3 3 2 3 3 3 3 Total 3.1 2.9 3.1 3.1 2.8 2.9 3.0 3.0 Number of firms 86 87 83 52 65 77 86 86 significant at 1 % level * significant at 5% level Note: In regression analysis, the following statistically significant relations were found: (il using trade as the 'norm', performance indicators marked above were found to be significantly lower for firms providing consumer services. {ii) using business services as the norm,' performance indicators marked above were found to be significantly higher for firms engaged in finance and transportation. Survey firms may also be considered reason- The relatively good performance of the firms ably successful by international standards, mea- surveyed as measured by profitability, volume sured against the high rate of failure worldwide growth, and expansion plans was in contrast to the among new small businesses. Only a quarter of economy at large and the failing state sector. the survey firms were evaluated as weak perform- Overall GNP in Russia declined by almost 20 ers, a pre-condition for bankruptcy. Since the percent during 1992. As a result, growth in survey records only one point in time, no direct services was affected by weak demand as well as bankruptcy comparison can be made. the unstable macroeconomic environment. Con- 61 sumer services clearly suffered from low demand, in the entrepreneur's previous activity was corre- and business services experienced some slackness lated negatively with performance. One possible in conventional demand, partially compensated by explanation is that such continuity reflects greater demand for new services in support of systemic conservatism, and hence less adaptability. Another and structural changes. Firms that provided such is that where the new market environment re- new services in support of economic reform had quires a radical departure from previous a higher original overall grade and higher profits practices, previous experience does not contribute than other business services. They faced higher significantly. demand and were able to raise their prices; they also enjoyed higher wages and labor productivity. Firm chzaracteristics and performance Internal and external factors Large firms tended to do better than small firms affecting performance according to a number of performance indicators, when measured by revenues but not number of A variety of internal and external factors are employees. This could be because higher employ- associated with performance. First, new start-ups ment was associated with lower productivity, or it outperformed privatized firms. Second, firms could be that successful firms were understating whose customers were other private companies their employee numbers for tax purposes. In ranked high on performance indicators, while general, privatized firms received lower ratings those selling to households ranked low. And third, than new start-ups on both performance indicators the ability to obtain bank credit correlated with and overall grades. In particular, privatized firms success; lack of credit was a major complaint of ranked lower on employment growth, growth of successful firms. It therefore appears that business sales, and growth of profits. services and credit facilities for small business Within the group of privatized firms, those with could foster more rapid growth. residual state ownership ranked higher on both the original overall grade and the composite grade, The entrepreneur and performance with somewhat higher performance indicators for growth in employment, sales, and profits. Lease- Does the entrepreneur make a difference? Two holds ranked lower on employment and sales characteristics that showed significant correlation growth but higher on current profits, suggesting with the firms' overall grades and profitability that they were shedding surplus labor. Among were the number of other firms owned by the new start-ups, those unconnected to a state enter- entrepreneur and the entrepreneur's level of prise ranked significantly higher on growvth in education. Both variables are associated with employment, sales, and profits. The age of firms, entrepreneurship and general knowledge, rather their history, the ownership share of the entrepre- than with prior managerial experience or specific neur, and the share of professionals in the labor skills. There w' r correlation between perfor- force were all uncorrelated with the performance mance and age, , or previous work place, but indicators. an association exists between performance levels The firm's level of satisfaction with its employ- and the three types of entrepreneur (table A2). ees was negatively correlated with the original Firms run by academics or technical specialists overall grade, the composite grade, and several received the highest grades and performed better other performance indicators. One bypothesis is by most criteria. This was true despite the fact that an entrepreneur's ability to recognize labor that firms run by former state managers were problems, and hence his dissatisfaction, was a sign more concentrated in trade, a more profitable of professionalism. In a number of successful activity. This finding suggests that in services the firms, including a private hospital and an invest- "insider" status, defined by previous managerial ment finn, the owners were concerned with rank and continuing connections to the state worker performance and instituted very strict system, is not particularly important. Continuity hiring policies. 62 Table A2: Ranking of firms' performance by owner's pest job (1 - lowest, 4 - highest) Performance Indicators Growth in employment Growth Growth since start- Current of atf upl New Expansion Original Composite Owner's past job profits profits sales privatized equipment plans grade arade General or technical manager 3.1 2.8 2.9 2.8 2.9 2.9 3.0 2.9 Nunberof flrms 41 38 40 24 32 38 41 41 Academic or technical specialist 3.3 3.0 3.4 3.5 2.8 2.9 3.1 3.1 Numberof rams 34 32 33 20 25 30 34 34 White or blue collar worker 2.9 2.8 2.8 3.1 2.3 2.8 2.8 2.7 Number of firns 7 I 1 70 8 12 9 1 71 Total 3.1 2.9 3.1 3.1 2.8 2.9 3.0 3.0 Number of frms 86 81 83 52 65 77 86 86 Note: In regression analysis, growth in employment was found to be significantly higher (at the 2% level) for firms with former general or technical managers as owners, using white or blue collar workers as the "norm." Prices and wages and performance with their performance, one of which was output markets (table A3). Firms selling to other firms in RelativelY higher growth rates of nominal prices the private sector performed better than those and wages were correlated with high profits but selling to the state; firms selling to households not a rise in profits. Large increases in real performed worst of all. This pattern holds true wages, using the producer price as deflator, did with respect to the overall grades, profitability, not correlate with profits and were negatively growth of profits and growth of sales. Firms correlated with the original overall grade. This selling mainly to households were typically those seems to suggest that firms able to raise prices that hadnee p t had a low shof were tYpically profitable unless they raised wages that had been privatzed; had a low share f even more. If their real producer wage increased professional workers; had low employment a lot, profitability declined. growth; and were run by former managers in state enterprises who were engaged in the same activi- Outside constrais and performance ty, had less education, owned no other companies, and were female. Retail trade outlets and whole- Only a few characteristics of the firms' business sale firms selling largely to private companies environment revealed some systematic correlation were among this group. 63 Table A3: Rankdng of fIrma' performance by main customer (1 lowest, 4 = highest) Performance indicators Growth In employment since start- Current Growth Growth up/ New Expansion Original Composite Main customer Profits of profits of sales privatized equipment plans grade arade State Sector 3.1 2.8 2.5 * 3.3 2.9 2.9 3.1 * 2.9 * Number of firms 18 17 18 1I 15 16 78 18 Private Firms 3.4 * 3.3 * 3.5 * 3.4 * 3.0 3.0 3.3 3.3 Number of ffrns 20 20 20 13 13 19 20 20 Households 2.7 " 2A * 2.4 2.5 2.4 2.8 2.6 ' 2.65 Number of finms 23 21 22 15 18 22 23 23 Total 3.1 2.8 2.9 3.0 2.7 2.6 3.0 2.9 Number of finms 61 58 60 39 46 57 61 67 * * significant at 1 level significant at 5% level Note: In regression analysis, the following statistically significant relations were found: (i) using sales to households as the 'norm,' performance indicators marked above were found to be significantly higher for firms selling to other private firms. (ii) using sales to private firms as the 'norm,' performance indicators marked above were found to be significantly lower for firms selling to households. (iii) using sales to private firms as the "norm," performance indicators marked abve were found to be significantly lower for firms selling to the state sector. Selling to state enterprises was positively receiving any form of foreign aid correlated only correlated with the original overall grade but with sporadically with indicators of good performance. no other perfbrmance variables. Selling to state Exporting outside the Former Soviet Union was enterprises and to state organizations took place in wealdy correlated with growth of profits, and less competitive markets, with high sales concen- having external connections was correlated wit tration, while selling to other private companies current profits and with growth of labor. was in a much more competitive environment. The use of bank credits was positively correlat- Selling to the state was correlated only with ed with both overall grades and positive trends in owning old equipment, a high increase in output profits and revenues. One would like to think that prices, and a high level of reveuue per worker. the causality runs from the quality of the firm and Engaging in exports, having a foreign partner, or the soundness of its expansion plans to its ability 64 to receive credit. Since receiving credits was complained most often about the unstable and correlated in the survey with the use of bribes and uncertain macroeconomic and legal environment. with previously working in the state sector, Credit problems werethe second most frequently howeve,, "informal transactions" or informal mentioned constraint of more successful firms, connections may also play a role. Alternatively, especially the lack of medium and long term given the frequent complaints about "too high credits. For companies with concrete expansion interest rates," obtaining credits at highly negative plans, the lack of financing was the biggest con- interest rates may reflect the cleverness of the straint for over half. Other constraints, in declin- owner who perceives a substantial interest rate int or of fr wer lack of demand subsidy.~~~~~~~~~~~~ Fialy trd im r betban ing order of frequency, were lack of demand, ss.iltdIrms are abletoobtain getting good workers, and obtaining satisfactory credit because they can use traded goods as collateral; this special factor may allow them to be space. more success*l. iBecause successful firms were relatively liquid, -more successflu. they complained much less about high taxes-the Constraint: and perormance main constraint mentioned by less successful -ibrnmce firms. The importance of taxes to the weak firms Entrepreneurs were questioned about the most may be explained by their severe shortage of important constraints they face in the business funds, a shortage that could be eased by lower environment. The more successful firms, as taxes but not by credit, since they were basically indicatedbythetwo overall grades and profits, ineligible. 65 References Acs, Zoltan J., and David B. Audretsch. 1993. Small Easterly, William, Martha de Melo, and Gur Ofer. FimsandEntrepreneurship: an East-West Perspective. January 1994. "Services as a Major Source of Growth New York: Cambridge University Press. in Russia and other Former Soviet States." Policy Research Department, World Bank, Washington, D.C. Ben-Porath, Yoram. 1980. "The F-Connection: Fami- lies, Friends and Firms and the Organization of Ex- Gibb, Allan. September 1992. Small Business Devel- change." Population and Development Review 6 (1): 1- opment in Central and Eastern Europe: Opportunity for 30. a Rethink?" Durham University Business School, Bosworth, Derek, and Chris Jacobs. 1989. "Man- Durham, England. agernent Attitudes, Behaviour, and Abilities as Barriers to Growth." Barriers to Growth in SmaU Firms, J. * - Barber, J., J. S. Metcalfe, and M. Porteous, e os. fs London and New York: Routledge. Statistika. Codagnone, Cristiano. June 1993. 'Entrepreneurship in Goskomstat of the USSR. 1991a. 7he National Econo- St. Petersburg," Department of Sociology, New York my of dhe USSR in 1990 (Narkhoz). Moscow: Finansy University. i Statistika. Commission of the European Community. 1990. Enter- Goskomstat of the USSh. 1991b. Women in the USSR prises in dhe European Community. Luxembourg: in 1991. Moscow: Finansy i Statistika. Office for Official Publications of the European Com- munity. Goskomstat of the Russian Federation. 1991. National ",h 1o The Economy of the Russian Federation in 1990. Moscow: Cross, Michael. 1983. "The United Kingdom." Th Iterrepublica Informnation and Publishing Center. Small Firb= An International Survey, David J. Storey, ed. London and Canberra: Croom Helm. Goskomstat of the Russian Federation, St. Petersburg de Koning, Aad, and Jacqueline Snijders. 1992. Committee for Statistics. 1993. MainActiviy Indicators 'Policy on Small- and Medium-sized Enterprises in for SmaU Enterprises and Cooperatives in St. Peters- Countries of the European Community." International burg and Leningrad Region. St. I'tersburg: Peterburg- Small Business Jowrnal 10 (3): 25-39. komstat. 67 Grabowski, Macicj. Juno 1993. 'Pioneers of Capital- . 1983. Tie Small Firmn an International ism: Some Evidence of Small Business Development in Survey. Now York: St. Martin's Press. East and Central European Countries," Provisional draft, Policy Research Department, World Bank, .1993.RoviewofStateofSmallBusinessand Washington, D.C. Entrepreneursihip in Atlantic Canada: First Annual Report on Small Busiess, 1991, by Atlantic Canada Griliches, Zvi, and Ernest R. Bemdt, eds. 1992. Opportunities Agency. Small Business Economics 5 Output Measurement in tde Service Sectors. Chicago: (March): 77-78. * University of Chicago Press. Storey, David, Kevin Keasey, Robert. Watson, and Hall, Graham. 1992. 'Reasons for Insolvency amongst Pooran Wynarczyk. 1987. 7he Performnce of Small Small Firms - A Review and Fresh Evidence.' Small Finms: Profits, Jobs and Failures. London and New Business Economics 4 (3): 237-250. York: Routledge. Haskins, Gay, with Allan Gibb, and Tony Hubert, eds. United Nations Statistical Office. 1990. International 1986. A Guide to Small Firns Assisrance in Europe. Standard Industrial Claswsifcation of All Economic AldeTshot, England: European Foundation for Manage- Activities. New York: United Nations. ment Development. ment Development. United States Small Business Administration. 1982. The Hull, Christopher, and Benny Hjem. 1987. Helping - of Small Business a Report of she President Small Firms Grow: An Implementation Approach. New Transmitted to the Congress. Washington, D.C.: U.S. York: Croom Helm. Government Printing Office. Johnson, Simon. April 1992. 'Private Business in . 1992. The State of SmaU Business: a Report astern Europe. " The Fuqua School of Business, Duke of the President Transmitted to she Congress. Wash- University, Durham, N.C. ington, D.C.: U.S. Govemment Printing Office. Brian.1994. " essful Small and -UWebster, Leila. 1991. "World Bank Lending for Small Levy, Brian. Febary . and Medium Enterprises: Fifteen Years of Experi- Medium Enterprises and Their Support Systems: A ence." World Bank Discussion Papers No. 113, World Comparative Analysis of Four Country Studies." Policy Bank, Washington, D.C. Research Department, World Bank, Washington, D.C. Odink, Nina. 1993. 'Economic Review of the Situation Webster, Leila, Harold Wackman, and Juergen Franz. in St. Petersburg, 1992. Leontief Center, St. Peters- DEcember 1993. 'Newly-Privatized Russian Enterpris- burg. - - es: a Survey. " Agriculture and Industry Division, Eturope and Central Asia Country Department m, 'Offices and Dachas in Demand.' 1993. Commersasn World Bank, Washington, D.C. (April 21): 14-15. Moscow. Webster, Leila and Joshua Charmp. 1993. "A Survey of Organization for Economic Development and Coopera- Private Manufacturers in St. Petersburg.' World Bank tion. 1985. 'Employment in Smail and Large Firms: Technical Paper No. 228. World Bank, Washington, Where Have the Jobs Come From?"_ OECD Employ- - D.C. ment Outlook (September): 64-82. Paris: OECD. Usova, Larisa. 1993. 'St. Petersburg's Fourth Revolu- OECD National Accounts. 1993. Paris: tion: A Pessimist's Monologue," Rossiya, (March 2-9). OECD. Moscow. PlanEcon, Inc. PlanEcon Report 9. March 9, 1993. (5- Vivarelli, Marco. 1991. "The Birth of New Enterpris- 6). Washington, D.C. es.' Small Business Economics 3 (3): 215-224. Storey, David. 1982. Entrepreneurship and the New 'Will Lw-AbidingFirms Survive?" 1993. Conmmersant Firm. New York: Praeger Publishers. (March 11): 18-22. Moscow. 68 Postscript In November 1993, a follow-up telephone survey kets. Imports have become more readily available, was conducted to determine what changes had with both positive and negative consequences. occurred during the intervening 10 months. All of Most entrepreneurs believed that the tax burden the firms in the original January 1993 survey were has increased. Many new taxes have been im- located, and 82 of the original 86 firms were posed, and tax inspection has strengthened, mak- interviewed. Despite continuing economic and ing it more difficult to avoid taxes. political upheavals, none of the firms had gone As in the original January 1993 survey, few out of business. firms had obtained commercial bank loans. Some Preliminary analysis of the data from the firms experienced no need for credit, but many follow-up survey indicates that most firms experi- finns were looking for lower interest rates and enced real growth in output, although demand longer-term credits. There appeared to be some remained a problem-especially for firms provid- demand for hard currency loans at slightly above ing personal services. Net growth in employment European market rates. Changes in the quality of continued, although many firns had started to hire banking services varied by bank. under long-term contract as a more flexible option Public transportationhas deteriorated, and finns to permanent employment. have received insufficient heat. Commercial The role of private firms in real estate, equip- dispute resolution was still ineffective, and the ment, and input markets for goods and services Mafia was expanding. Finns were still not receiv- seemed to be increasing, and most firms felt that ing foreign technical assistance from official competition was increasing in their output mar- sources. 69 Distributors of World Bank Publications ARCIINIINA The Middle litObervr ITALY PORTUCAL Ca"e Hirsch, SRL 4l,6udliferl Lkoe Commimlondrla Sa_1 SPA LlvrdaPreu Calaie Cuane Cair Via Duia Di Galabrs 1/U1 Rul OD Carno 70.74 Dlorid 165, 4th Flor-Ofe. 411465 Cusil Poetal So2 1200 ULbon 1332SSuMnsAlm FINLAND 50125FLr Sna alkemminen Klrjakauppa SAUDI ALINIA,QATAR AUSTRALIA, PAPUA NEW CUINEA, pr. lIo 128 JAPAN la rarookStor FIJI,SOLOMONISLANDS, uF0101 HIeslki10 Easrn BookS5rvtc P.O DouJl96 VANUATU, AND WESTURN SAMOA Hongo3-Chome, Bfunkyo-ku 113 Rlyadh 11471 D.A.InorrnatlonSrvcw FRANCE Tukyo 648 Whltehome Road World Dank PubIkAdons SINcAPORP. TAIWAN, Mltcham 31312 6,avnusd'34 KENYA MYANMARKBRUNEI Vktoda 75116 Pars Alrica OOkServiceLAJ LUd. CowerAia Padtk Pam Ud. Quar Hous, Mhangano Seet Glden Wih hullding AUSTRIA GERMANY PA Duet 45248 41, Kslling Pudding, 404.3 Gmrldand Co. UNO-V*rlu Nairobi Singapon'1334 CvbenJI1 Poppelidor r AlI eSS A-l0ll Witn i Bonn I KOREA, REPUBLIC OF SOUTH AFRICA,K BTSWANA Pan Korea Bok Corpoatlon Formlngla USr. BANCLADESH HONG KONC, MACAO PA Dom 101, Kwangwwhmun Oxford Unive rty Pre Micra InduArin Devlopment Asia 2000 Ltd. Seoul Southem AaanceSor1rty (MIDAS) 44. Wyndh; w- P.Q Box 1141 Hous 5, Road 16 - Wln7ngCiSntR KoreanStock Dook Canh Cape Town BOW Dhanrnondl R/Arm 2nd Roor P.O. Box 34 Dhaka 1209 Cnml Hong Kong Yaeoldo FPor ssbs4bp aidesm: Seoul Intwrnonal SubKriptiOn ServiCE Breah 4flc HUNGARY -PO Box 4109S5 Pln. Vbew,lst Floor Foundation for MarketEonomy MALAYSIA Craighall 100 Agabad Comnmencal Area Dombovar[Uti7-19 Univerity of Mlaya Cooperatve lohannoburg 2024 ODttttgong4lW H-1ill Budapest Bckshop,UUmitad P- P om 11t27,Ian PantailHum SPAIN BELGIUM INDIA 59700 KuaL Lumpur Mundi-Prna 1.broe.SA. Jun De LHnY Allied Publshes Private Ltd. Caseto37 Av. du Rod 202 751 Mount Road ME)ICO 28001 Madrid 1060 Urumls Mtadras- 02 INFC Apartado Pbstal 224-60 Llbresa Intermdonl AlDO CANADA unWcA o55C 14060 flalpmn. Mexico DO Condu de CAnL 391 Le Diffuseur 15 IN. Heredla Mug ONN Banlona ISIA Boul de Mrtagne sward Estate NErHtLANDS BIuchSrvlIsu&bO c Bomb tm y -400 M Do Undleboomi/lOrPubilkatia SRI LANKA AND TlIE hALDIVES 14B SE P.O. No 202 Lake Houe Bookahop 13/14 Asf All Road 7480 AŁ 14aakslgen PRO. Box 244 Raciuf Publishing CD. NNV Defh -110002 100. Sir Chitttmpalam A. 1294 Alpma Read NEW ZEALAND Cardiner ilawatha Ottawa,Ontario 17Chittrann Aenue EDSCONZ Ltd. Colomb*2 X1s3wB akutt 70 072 PlPtvakeMsll Bag 99924 New Market SWEDBE CHILE layadeva Hoelel Bulding Auckland Forsingk tlim: Invertec IGI SA. h Min Rod, Cdhinpr FritzsFsckboelfortaa Av. SantA Mada 6401 B re-56009- NIGERIA Regdngsaptan 112, BDo 15 EdIfidoWINEC,Clf 201 University Prem LIat- S-10327?Sockholm Santiago 3u1129 KadSdS heeCrownsfBuodlgJecho Cram Road PrivaeMsll BgSo095 Forsuiscr*iu, odrs CHINA Hyderabad - S0 027 Iadan Waennren-WilasnaA China Fnancdl & Ecnok -- P. a Box 1305 Publishing Hous srarthna Flats, 2nd Floor NORWAY S.171 25 Sorm S.Da Fe Si Dong 314 Near Thakore BaugNavrangpurs Narves Inoraation Canter Being Ahmedabed-380 9 Baok lepunent SWiTZWLAND P.Cr DO 6125 Efilad Persistk titls: COLOM1IA Pgjo House N.O6MOso6 LbrluHeP yot Infernace Lda. 16-A Ashok Murg Case posSe 3212 ApartLdcAaoo3427 Lucknww-22601 PAKISTAN CH 1002 LAunae Bogto DE. Mima Book Agency Central Bazr Roed 65,ShaluraM Quild-eAzarm Fmrsuhscr4*an ndes: COTE DIVOIRE 60 Dalai Nagr P.a BoxN Hm Lbralie Payat Cente didAion etdeflhfuoLon Naeur4400 Lthore540W0 ServledesAbonmamenb Afcdanesa(CEDDA Cas post e3312 04 B.P. 541 INDONESIA PERU CH 1002 Lausne Abid jan 04 Plateau FL Indira Limited Edlorbl Ddearrlo SA Jalan Eorobudur2f Aparldo324 THAILAND CYPRUS P.O. BoXi Ua Centra Deprutment Store Center of Applied Researh Jalerta itz 306 9bom toad Cyprus Colkge PHIUPPINES Bangkok 6, Dogern Sheet EngaId lntAN lntctonal Book Ceter PO. Box 2W06 Kowlab Publihe Sulte 17113 Ctyland 10 TRINIDAD & TOBAGO, ANTIGUA Nicosla PO. Box 19575-511 Condominium Tower I BARBUDA. BARBADOS. Tehrni Ayla Avenue, H.V dela DOMINICA, GRENADA, GUYANA, DENMARX Costa Extension JAMAICA, MONTSERRAT, ST SamfundsUtteratur IRELAND MacaiL Metro MNanil T MEVISST.SE LUCA, Roe U le 11 GavemmentSuppIksAgeny ST. VINCENT & GRENADINES DK-1970 Fderisberg C S rrtRd POLAND SystaticStudissUnit Dublin 2 International PubiLshing Service #9 Watts Stret DOMINICAN REPUBUC UL Plea31/37 Curepe Editora Taller. C. porkA ISRAEL t0-i77Warzwa Trinidad,Westldles Restauracifn e Isabel Ia CatSes 309 Yozmnot Uterature Ltd. ApartadodeCorreo2190Z-1 P. fox5WS5 Parsuber*tin ordrs UNIMD KINGDOM Santo DomInso Tel Aviv 61560 .IS ourmals Mnuinfa Ltd. ULOklren3 PM Box3 ECYIT, ARAB REPUBUC OF 02-96 Warsaws Altos. Hampsire WU34 ZPG Al Ahram England Al Gala Sheet Cairo The World Bank HLeidquerters European Office Tokyo Office 18181-I Sirer, NXW. 66, oncnie d'linim Kokusni Building H W:lihltguni, D.C. 20433, U.S.A. 75116 l'nris, Frunce I-1 Morunttcil 3-chomne -hlYtda-kti, Tokyo 100, arpan Teleplhonle: (202) 477.1234 Teleplihone: (I) 40.69.30.00 rueulnille: (202) 477.6391 FncslInile: (1)40.69.30.66 Telephlon1e: (3)3214-5001 Telex: wt 64145 wORLIMNINK Telex: 640651 Fclmesl Ic: (3) 3214-3657 RCA 248423 wom.mLw Telex: 26838 Cilile Addre: INTfIAPRAfl WASIIINOTONIMC , r- t:r!a : !:ouns ri -t ; lri it H B 1-151 Cover design by Debby Malovany ISBN 0-8213-2797-6