http:l/www.worldbank.orgltransitionnewsletter T H E N E W S L E 7r T E R A B O U T R E F O R M I N G E C O N O M I E S ru~~~~ ~A 1 SNSI¶UION NEWSLETTER Vol. 13, No. 2 THE WORLD BANK in collaboration wvith. March-April 2002 STOCKHOLM SCHOOL OF ECONOMICS and THE WILLIAM DAVIDSON INSTITUTE EU Accession Challenges CEE Agriculture 24240 Agricultural reform in Central and Eastern Europe (CEE) has been one of the most intractable transition issues and is now proving to be problematic in EU accession talks. Crop yields, value added per worker, and fodder/livestock conversion rates are all well below thie EU average. Agricultural reform also encompasses potentially volatile social and political issues, ranging from underemployment to foreign ownership of agricultural land. Transition economies in CEE are struggling with several struc- vulnerable to the influence of newly revived peasant par- tural problems in relation to their agriculture sectors, namely: ties. Even in Hungary, where the collective sector was relatively * Subsistence focus. Agriculture is still primarily a subsis- successful, the Smallholder Party was able to insist on the rights tence rather than market-oriented sector. In many countries of former owners. In Bulgaria and Romania debates about land the restitution and privatization of cooperatives extended fami- reform oscillated between returning the full amount of land past lies' access to small plots of land, and these have offered an owners had held or returning only part of it. By the mid-1990s important safety net for households struggling to cope during both countries had extensive areas of tiny farm holdings. the economic transition. The European Cornmission's Novem- ber 2001 Regular Reports indicate that the only agricultural Second, the sector remains dominated by a few large subsector to have shown significant development is holdings and many extremely small holdings, with little semisubsistence. in between. The Commission blames the lack of progress on * Stalled restructuring. Structural reforms introduced in the the failure to issue definitive property titles and on ownership 1990s failed to modernize farming substantively. The size of restrictions. However, sociological factors are also pertinent the agricultural population has not declinEd significantly, and and several have influenced legislation: popular opposition to several countries have actually witnessed net migration from foreign ownership of agricultural land has led to prohibitions urban to rural areas. In Poland and Romania a substantial on ownership and demands for lengthy transition periods in proportion of the population relies on agricultural incomes. EU accession talks; concerns about preventing the re-emer- * Market failure. Progress in developing larid markets to create gence of kulaks (rich peasants) has led to the creation of a viable farming structures or in privatizing dornestic food process- legal ceiling on the amount of land a single family can own in ing industries to improve efficiency and respond to increased de- some states; and in Hungary, a fear of the revival of socialist mand has been minimal. Farms in the prevalent semisubsistence cooperatives led to prohibitions on corporations' ability to buy sector are below the average EU size and have little agricultural land (see article on page 10). machinery and few funds for investment. After 10 years of transi- tion, the structures that should enhance productivity and competi- Third, the transition period saw a revival of 1930s-style tiveness in factor and product markets-private firms and major rural underemployment. Since the mid-1 990s farmers individual holdings-have tended to stagnate or decline. Imports throughout CEE have suffered the effects of a combination of from the EU have been used to meet the increase in intemal de- high input costs and low farmgate prices. This has rendered mand, and except for Bulgaria and Hungary, all CEE states have agriculture unprofitable and, for many potential investors, has growing trade deficits with the EU. made the purchase of agricultural land unattractive. Many smallholders subsidize production from other sources, such Obstacles to Reform as pensions, child benefit payments, part-time jobs, or gov- ernment input subsidies, and have little left for investment. Several factors explain the failure to reform agriculture in Larger farms face similar constraints Foreign institutions have CEE. First, in the early 1990s weak glovernments were worked to create a Western-style credit market where, for WB Development Economics RA j| SITE WDI LGI &} BOFIT Urban Institute N INS KV MEN V." m~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ - || z * instance, future crop yields are accepted as collateral. 3 W hat s InsliLe However, interest rates tend to be prohibitively high, re- c payment periods tend to be short, and penalty rates X - Land Policies in Transition Countries 5 and clauses can easily lead to bankruptcy. s a. : Hungary's Twisted Land Market 10 The size and state of agriculture in CEE means that the 3: 0 sa |sector is in poor shape to integrate with the EU, particu- Ci FDI: Does the Rule of Law Matter? 11 larly as the Commission is under pressure to limit bud- getary spending increases resulting from enlargement, 4X) | Cultural Values and Russia's Small Business while current members receiving large agricultural pay- Environment 14 ments are eager to protect their own farmers. The EU reports note that to reach just 50 percent of the average @il Ukraine and the New Fad: Corporate Governance 17 productivity of the EU-15, the 10 CEE applicants would have to shed 4 million agricultural jobs This underlines The World Bank/IMF Agenda 19 the difficulties of reaching a compromise in accession talks. Why is FDI in Ukraine Trailing Behind? 20 Scenarios in New EU Study Addressing Roma Poverty in Slovakia 21 To sweeten the pot, a study published by the European World Bank Grants Versus Loan Dispute 26 Commission in March 2002, "Analysis of the Impact on Agricultural Markets and Incomes of EU Enlargement to New Books and Working Papers 27 the CCE Countries" (http://europa.eu.int/comm/agricul- ture/publi/reports/ceecimpact/index_en. htm) asserts that LGIOSI EU membership will significantly improve the prospects *Pitfalls of Foreign Aid: Lessons from Estonia 28 for farmers in the candidate countries. On January 30 the *Dancing with Donors: Opportunities for NGOs 31 Commission unveiled its proposals for agricultural sup- *The EU's Reform of External Aid 33 port to new members following their accession, whereby BOFIT farm aid will begin at 25 percent of the current level and *Pension Reform in the Baltic Countries 34 only reach the full level by 2013 (see Transition, January- *Research Scholarships 35 February 2002, "The EU Commission Proposes-and Got Hit from all Sides," page 9). The announcement provoked SITE widespread criticism in CEE and prompted high-level meet- *Financial Architecture in Transition 36 ings to discuss a common approach. The March study *The Latvian Labor Market: Signs of Normalization? 38 tries to dispel those criticisms and provide an economic The William Davidson Institute underpinning to the EU's proposals. *Variety, Jobs, and EU Enlargement 40 *Costs and Benefits of "Euroization" 42 The study considers four different policy scenarios: (a) *Why Do Governments Privatize? 46 the baseline position, which assumes nonaccession and *Mass Privatization and Partial State Ownership 47 unchanged agriculture policies in the CEE countries; (b) *Evidence from India 48 introducing the Common Agricultural Policy (CAP) with- *Recent WDI Working Papers 51 out direct payments (c) introducing the CAP with direct Conference Diary 52 payments and (d) agreeing to the candidate countries' negotiating positions. Even under the most pessimistic The Urban Institute restructuring scenarios EU accession should raise the *Russia's Compulsory Screening for HIV/AIDS 55 incomes of farmers in the candidate countries. Applying *Moldova's Economy Needs Decisive Action 56 EU market measures, such as intervention with zero di- *Moldova Needs Foreign Support 57 rect payments, is likely to increase farm incomes by some 30 percent in eight Central and Eastern European candidate countries (CEEC-8) by 2007 (the study did not cover Bulgaria and Romania). Increases would be par- ticularly significant in the Czech Republic (60 percent), TRANSITION, March-April 2002 ( 2002 The World Bank Latvia (59 percent), Estonia (55 percent), Slovakia (45 This is a clear indication of the ability to compete within I percent), and Poland (35 percent). the single market. Only pork production is expected to decline overall, highlighting this sector as one that is rela- Without EU membership until 2007, output (value of pro- tively competitive. Growth in poultry production following i i duction) in the CEEC-8 countries would likely increase rapid investment is likely to meet expanding demand in only slightly in the crops sector and continue to con- new markets. Integration into the single market is likely j a tract in the livestock sector. In the crops sector Slovakia to stimulate some specialization in agricultural produc- a is likely to achieve the highest growth (6 percent), while tion, with crop production benefiting in the CEE countries F crop output would contract in Lithuania (3 percent). The and livestock production in the EU-15. picture is far more pessimistic for livestock production, LnI with all the countries except for Slovenia, and to a lesser Enlargement will not create major market imbalances. In extent the Czech Republic, experiencing contractions the crop sector wheat surpluses should not cause a ma- in output. This is likely to be particularly marked in the jor problem, because EU wheat will be competitive on Baltics and Hungary. As a result, the CEEC-8's average world markets. The maize surplus of the CEE countries income would contract by 4 percent compared with 2002. could be entirely absorbed by the EU-15. Only rye and Without access to the EU's structural funds and rural other grains (mainly oats) could have difficulties finding development programs targeted to the semisubsistence outlets on world markets. For livestock, beef markets in sector to achieve full commercial standards, the required the EU-25 will be manageable if no major changes occur restructuring would be painful in consumer preferences. As long as quotas are based on recent reference periods, EU dairy markets will not The report argues that low levels of direct aid support encounter major disturbances after accession could ensure that all the CEE countries experience posi- tive income effects as a result of enlargement. As a start, Note that the report's simulations do not reflect additional in 2004 farmers in accession countries would receive positive income effects resulting from the enhanced rural direct aid equal to 25 percent of similar payments given development measures proposed by the Commission. to farmers in existing member states that would increase by 5 percent for the next three years, reaching 100 per- EU Candidates Not Persuaded cent by 2013. The Commission argues that too much aid is unhealthy, and that 100 percent direct aid could At a two-day meeting in Brussels in April, the latest undermine incentives for labor restructuring and create round of EU accession talks, candidates claimed that social distortions and inequalities. the EU appeared to be trying to extract everything pos- sible under the budget chapter while attempting to limit An average farm of 20 hectares in the CEEC-8 gener- or delay agricultural and infrastructure aid. Poland's chief ates income in the form of added value worth the equiva- negotiator Jan Truszczynski said that the EU is effec- lent of 1.2 national gross annual wage units compared tively trying to selectively apply its acquis communautaire, with 0.9 units in the EU-15 (see the figure). Accession the body of European community law the candidates without direct payments would increase such a farm's must enact before membership. He was referring to the income by 50 percent, equivalent to 1.8 wage units. Full Commission's proposal in late January that the direct direct payments based on recent reference periods in- agricultural subsidies available to farmers in current crease income by 117 percent to the equivalent of 2.6 member states should not be fully applied to the new wage units. With 100 percent direct payments as re- member states until 2013. Nevertheless, the EU is de- quested by the CEE countries income increases by manding that new members make full contributions to roughly 150 percent or 3 wage units. At such high levels the community budget from the day of their accession. of direct payments labor would be better served by re- maining in agriculture than seeking employment out- The EU's demand could strain budgets of the new side agriculture. member states in the first few years following acces- sion. As a result of various administrative hurdles and Even without direct payments for the candidate coun- fiscal rules applied by the EU, what subsidies the new tries the study anticipates an increase in cereal produc- members do receive will not show up in their budgets tion, leading to increased surpluses. The effects on beef immediately, yet the candidates' must make their ex- and dairy production would also be positive, but not pected contributions to the EU budget early in the year. enough to increase current production levels significantly. This could mean that in the first year or two following ( 2002 The World Bank TRANSITION, March-April 2002 * -. * 1 . 1I accession the new members pay more into the EU bud- not to have its progress toward completing talks this 3 get than they get back. It is no wonder that thus all can- year and becoming a member in 2004 delayed by other - , didates are seeking a gradual phasing in period before states' disputes over agriculture. 3i they must pay their full contributions to the EUJ budget. * Slovakia has a larger scale and more mechanized agriculture sector than Hungary and has expressed con- Divided They Fall? cern about the method the Commission used to calcu- w i8 I late production quotas. Slovakia wants the basis for the a. ,, c { Accession candidates have been attempting to form a calculation changed from 1995-99, when agriculture ex- li- joint front and find a coordinated response to the perienced a sharp downturn in consumption and output, ! Commission's proposals for agricultural aid following to a more recent period. ':accession. Differences in the size of the states' agricul- * The Czech Republic has urged the Commission to ture sectors and the progress of sectoral reform, as well differentiate between candidate countries, arguing that as disputes about priority and strategy, however, have its agriculture sector is on a par with those of current undermined their efforts. Poland's agriculture sector is EU members, and thus the rationale for low direct pay- considerably larger than in the other candidate coun- ments to facilitate structural reform should not be appli- tries. Semisubsistence agriculture is dominant in Po- cable. The Czech government was critical of the levels land, but is relatively unimportant in the Czech Republic, of funds offered, but its language was milder and more Slovakia, and Slovenia. Less than 5 percent of the Czech, conciliatory than that of its Polish counterpart. Slovak, and Hungarian work force is employed in agri- * In Poland support for EU accession has already fallen culture, compared with 18.8 percent of Poland's work to around 50 percent, compared with 80 percent in force. Individual candidate countries reacted to the Slovakia. The government has complained that offering Commission's proposals as follows: a lower level of subsidies will lead to unfair competition * Hungary joined the initial outcry over the proposals, between Polish and EU farmers, and the government's but has continued to emphasize that it will be able to junior coalition partner, the Polish Peasant Party Coali- integrate fully with the CAP by the end of 2002. Hungary tion, threatened to leave the government if Warsaw agreed is the leading CEE accession candidate and is anxious to the Commission's plan. Around 80 percent of state Relative Income of a 20-Hectare Farm, Selected CEE Countries for 2002 and Four Scenarios for 2007 (gross value added/gross average annual wage) 6 5 4 1. . -V>_; 3 2 0 El 2002 U baseline El CAP 0 CAP DP U CC Pos~it=ion Note: The four scenarios are equivalent to those described in the text. For scenario (b) in the text, denoted here by CAP, production quotas are based on a recent referenice period. For scenario (c), indicated in the figure by CAP DP, full direct payments are assumed and production quotas are based on a recent reference period. Scenario (d), the CC position, is implementation of the CAP with full direct payments and quotas, with both based on the positions of the candidate countries submitted before July 2001. Source: Commission report (March 2002). TRANSITION, March-April 2002 ©) 2002 The World Bank support for agriculture is spent on social insurance mans, Hungarians, and other minorities were expelled for farmers. Agricultural incomes are often well below from postwar Czechoslovakia and their property was I the national average, and direct payments of 25 per- confiscated. The incoming left-liberal Hungarian gov- x cent may be insufficient to generale the investment ernment promised to mend relations with its Visegrad j 1 , capital needed to accelerate structural reform. How- partners before formal negotiations on agriculture be- ever, the government is likely to acquiesce to EU de- tween current members and the candidate countries l D c mands to avoid the risk of stalling accession talks. begin in the second half of 2002. Spanish Agriculture ¢ 8 Minister Miguel Arias Canete, representing the cur-> c Cooperation between the Visegrad countries (the rent EU president Spain, held out some hope for flex- - Czech Republic, Hungary, Poland, and Slovakia) had ibility on the EU side during these negotiations stalled after outgoing Hungarian Prime Minister Viktor Orban called on the Czech Republic and Slovakia to (Excerpted from reports of Oxford Analytica, Oxford, U.K. revoke the Benes Decree, under which Sudeten Ger- and EU Commission and Reuters). Land Policies and Evolving Farm Structures in Transition Countries By Zvi Lerman, Csaba Csaki, and Gershon Feder Transition in agriculture includes abolishing central planning; reducing government intervention; elimi- nating price controls; developing functioning market services; and encouraging the emergence of rural credit institutions, technological improvement, new capital investment patterns, and agricultural labor adjustment. The most visible and widely debated component of this process, however, is land reform, that is, the transformation of farns operated on traditional socialist principles to operations based on market-oriented principles. The transition countries of Europe and Central Asia ac- land and employed 300 to 500 workers Product markets count for 19 percent of the world's arable land, including and input supply channels were largely controlled by state some of the most fertile soils in the world, and 7 percent organizations within an administrative command frame- of its population. As a result the region has the potential work, production targets were set centrally, and budget to generate an agricultural surplus that it could export. In constraints to contain underperformers were virtually non- the 1980s the rural population in the transition countries existent. This was the Soviet model of agriculture. averaged nearly 45 percent of the tctal population, while the share of agriculture in GDP and in employment aver- Despite pervasive collectivization, individual or private aged more than 20 percent. In the United States and the agriculture never disappeared entirely. Commercial pro- EU agriculture's share of the economy is much smaller, duction from the collective and state sector was supple- accounting for about 2 to 3 percent of GDP and employ- mented by agriculture based on household plots ment in the United States and about 5 percent in the EU. averaging less than 1 hectare, which in aggregate con- trolled about 5 percent of agricultural land. The house- Common Heritage: Huge Collective Farms and Tiny hold plots relied on part-time family labor and produced Household Plots mainly for subsistence, although part of the output al- ways found its way to farmers' markets in nearby towns. The countries of Central and Eastern Europe (CEE) and Compared with the socialized farms, household plots the CIS began their transition in 1989-91 with a com- achieved relatively high levels of productivity. In the former mon institutional and organizational heritage in agricul- Soviet Union the individual sector produced 20 percent ture: most land was cultivated in large-scale collective of gross agricultural output on 2 percent of the land. and state farms. About 60,000 of these farms controlled some 95 percent of all agricultural land and produced On state farms the state owned all the productive as- the bulk of commercially marketed output. The average sets and the farm workers were salaried state employ- socialist-era farm cultivated 2,000 to 3,000 hectares of ees. On collectives (Soviet Union terminology) and © 2002 The World Bank TRANHI ION, March-April 2002 Inefficiency of Socialist Agriculture Attribute Reasons for inefficiency Centrally prescribed production targets Lack of consumer orientation and insensitivity to market signals Soft budget constraints Lack of profit orientation and reliance on write-offs and subsidies Collective organization of production Free-riding, moral hazard, lack of individual incentives Large size of farms High monitoring costs, anonymity, lack of transparency Lifetime employment policy Inability to control costs by shedding labor No effective individual ownership Nontransferability of land and assets and lack of incentives associated of land and productive assets with property rights, workers did not own the fruits of their labor cooperatives (Eastern European terminology) the mem- and introducing hard budget constraints. At the sectoral F bers owned the productive assets jointly. They provided level it included shifting from collective to individual ag- the labor, and in principle were compensated through the riculture and corporate farms and downsizing farms in distribution of farm earnings instead of receiving salaries. line with the experience of market economies. The abolition of collective agriculture was to be accompa- Whether termed collectives or cooperatives, the social- nied by the privatization of land rights, which according ized farm structure was vastly different from the West- to Western thinking implies transferable property rights ern model of a cooperative. The main attribute of and functioning land markets. In addition to land, all cooperation-the principle of voluntary association for other movable and immovable property-livestock, ma- mutual benefit-was abandoned during Stalin's forced chinery, farm buildings-also had to be privatized as collectivization campaign in 1929-30. Instead, the cre- part of the transfer of all the factors of production from ation of all collective and cooperative farms often relied collective to individual responsibility. The ultimate aim on coercion. As a consequence, members of collec- was to change the entire system of producer incen- tives and cooperatives never enjoyed another basic at- tives so as to achieve a more efficient and competitive tribute of Western-style cooperation: the freedom of agriculture sector. exit. Despite far-reaching commonalities imposed on soci- The centrally planned environment, which insulated the eties and economies by the communist regimes, the farms from market signals, imposed central targets as agriculture sectors in CEE and the CIS are following a substitute for consumer preferences and allowed divergent market reform paths. The differences are as- farms to function indefinitely under soft budget con- sociated both with differences in the policies adopted straints without proper profit accountability, which was and in the specifics of implementation stemming from the main cause of the inefficiency of socialist agricul- cultural, social, and political differences that persisted ture. Inefficiency also resulted from the exceptionally throughout the Soviet era. large farm sizes and the collective organization of pro- duction (see the table). Most transition countries allow private ownership of al- most all farmland, and agricultural land remains largely This inefficiency manifested itself in food shortages, state owned only in Belarus and parts of Central Asia. rationing, and long lines at food stores in most social- Private ownership, however, is not synonymous with the ist countries. New investments in agriculture were pro- right to transfer ownership. The 10 CEE countries and ducing low returns and failed to sustain growth. (Editor's the 4 smaller CIS countries (Armenia, Azerbaijan, Geor- note: Hungary's agriculture was an exception. Starting gia, and Moldova) recognize private land ownership and in the late 1960s production increased spectacularly have no legal barriers to land transactions. In this re- because of the extensive support for private plots and spect these 14 countries have the most liberal land poli- agricultural producers' relative freedom to market their cies. Russia and Ukraine, which account for the bulk of products.) the region's farmland, legally recognize private land own- ership, but the buying and selling of land is restricted in Divergent Reform Paths practice, and land transactions are mainly limited to leas- ing. The Kyrgyz Republic recognized private land own- At the macroeconomic level the reform framework ership following the June 1998 referendum, but called for eliminating central controls, liberalizing prices, immediately imposed a five-year moratorium on all land TRANSITION, March-April 2002 D 2002 The World Bank transactions, thereby making the situation even less flex- decisions to a later stage, when the economic situation ible than before the referendum, when land was state had normalized and individuals had become more cog- , owned, but user' rights were secure! for 99 years and nizant of the implications of land transactions. To en- transferable. Belarus and the other Central Asian coun- sure that a temporary moratorium quickly achieves the E c - tries generally do not recognize private land ownership, intended educational effect, it should be accompanied 11 but differ in their attitudes toward land transactions. Land by appropriate information campaigns explaining prop- j ' use rights are transferable in Kazakhstan and Tajikistan, erty rights and land market transactions to the new land- I ¢° -6J but Belarus, Turkmenistan, and Uzbekistan prohibit any owners. , transactions in land. All the CEE countries and the smaller CIS countries' Successful market agriculture can develop on state- allocate land to beneficiaries in the form of actual plots. l I owned land. Consider, for example, Israel, where most In Kazakhstan, Russia, Ukraine, and the other CIS coun- Ml land is leased by the state to farmers for terms of 49 or tries beneficiaries usually receive paper shares that cer- _ 99 years. Security and transferability of tenure appear tify their entitlement to a certain amount of land within to be more important determinants of productivity and the local farm enterprise, without identifying a specific efficiency gains than legal property rights. In industrial physical plot (though they retained their small house- market economies many farmers are operators rather hold plots that they cultivated during the Soviet era). than landowners, that is, they cultivate land that they do The allocation of actual plots is clearly a better option in not own. Farmers in Belgium, France, and Germany terms of potential transferability and the impact on land rent more than 60 percent of the land they cultivate, markets. Owners of a plot of land can decide whether to while the overall tenancy rate in the 15 EU countries is farm it, sell it in return for a one-time lump sum, or lease 40 percent. In Canada farmers do nol own 30 percent of it to someone who can operate it more profitably, thereby farmed land. In the United States only 35 percent of retaining the property rights while earning a stream of farms are fully owner-operated. Another 55 percent are future returns. By contrast, paper shares represent par- a mixture of owned land and land leased from others, tial ownership of a large tract of shared land, which in and 10 percent are operated by farmers who do not own reality is managed and controlled by somebody else. any land. With the exception of Albania the CEE countries have cho- Pragmatic considerations suggest that temporary mora- sen to privatize land by restitution to former owners. The toriums on the buying and selling of land in transition CIS countries and Albania have adopted the "land to the countries may be necessary because of political or so- tiller" strategy: land is given to those who worked it without cial considerations. Policymakers in CEE and the CIS any payment and in an equitable manner. Hungary and are often concerned that immediately exposing new land- Romania have used a mixed strategy: land was restituted owners to the full range of land market transactions af- to former owners and also distributed without payment to ter decades of collectivism may lead to negative social agricultural workers in the interests of social equity. consequences, such as the excessive concentration of land in the hands of speculators and foreigners. This The common explanation for the restitution versus dis- accounts for the moratorium imposed in the Kyrgyz tribution dichotomy relates to the different lengths of Republic mentioned earlier. time since nationalization or collectivization, 80 years in the CIS and 50 years in CEE. This explanation clearly In some countries managers of former socialist farm en- carries a good deal of weight, but a number of cases terprises took advantage of the rural population's com- cast doubts on its general validity. In the CIS, Belarus, plete lack of experience with individual farm operation to Moldova, and Ukraine rejected the concept of restitu- entice them to sell their shares of formerly collective tion, even though the western parts of these countries land. Large segments of the rural population turned over were integrated into the Soviet Union after World War theirmainasset,andlandwasconceritratedinthehands 11, at the same time as the Baltic: states, and the of a small number of farm bosses. Had the government memory of private land ownership was much fresher temporarily restricted the buying and selling of land and than in Russia. In CEE Albania deviated from the gen- instead limited transferability to short- or medium-term eral practice of its neighbors and opted for distribution, lease transactions, it could probably have avoided this not restitution. This was probably a strictly political undesirable outcome. Such an approach to land trans- decision, and not necessarily one driven by rational ferability would allow rural people to postpone irrevocable economic considerations. C 2002 The World Bank TRANSITION, March-April 2002 Examination of the impacts of restitution versus distri- essentially perceive market agriculture as based on bution does not indicate anything that recommends the successors of the former collective and state farms, c t0 one strategy over the other. Both are guided by prin- which are to be subjected to a "horizontal" transfor- ;i ciples of fairness, although the beneficiaries are obvi- mation to improve productivity, but otherwise are to . ,lgously different. remain largely unchanged in scale and scope. Politi- cians in CEE, however, appear to have recognized Ot iii Domination of Collective Farm Structures the need for radical changes in the farm enterprise sector, including the introduction of hard budget con- Despite the reallocation of land, large collective and straints and the enforcement of strict bankruptcy pro- , corporate farms still play a much more prominent role cedures for failing farms, which radically changes the 'i j ? t in CEE and the CIS than in market economies, where organizational behavior of farm enterprises and sharp- i agriculture is primarily based on family farms. Vari- ens their response to market forces. While CIS poli- ous collective, cooperative, and corporate forms of farm cies show a definite bias toward successor farm organization continue to manage nearly 40 percent of enterprises at all levels of government, CEE policies agricultural land in CEE and 80 percent in the CIS. (In often favor individual farms and show a negative bias the CIS, 16 percent of agricultural land is cultivated in toward large corporate farms, thereby forcing them to household plots and private farms, compared with 63 shift even further toward new market-oriented forms of percent in the CEE countries). As a result, the distri- behavior. bution of farms by size in most transition countries retains the sharp duality that characterized socialist Former collective members in the CIS countries have agriculture: a high proportion of extremely small farms not rushed into individual farming, and on the whole (mainly household plots) controls a relatively small large corporate farms have not disintegrated, for the proportion of land and a small proportion of extremely following reasons: large farms controls a large proportion of land. In mar- * Individual risk aversion. Collective or cooperative ket economies, for example, in Canada, the United farms may provide lower incomes, but in a relatively States, and the EU, most land is concentrated in mid- safe, more stable environment. Overall, only a small sized farms. proportion of rural residents opt for exit from collec- tives, and the individual farming sector is mainly grow- Although large collective or corporate farms remain ing through increased numbers of household plots prominent throughout the region, important differences assigned to collective farm employees. in their organizational forms are beginning to emerge * Leasing to large organizations. Many of the new in the CIS and CEE. Most large CIS farms continue to landowners created by restitution left farming long ago operate like the old collectives, without significant and now have jobs and property in urban areas. They changes in size or management, although they are have no immediate personal use for their restituted now registered under a variety of names that sound land, yet would like to retain ownership of this asset like market-oriented entities (joint stock societies, lim- rather than sell it. Thus entrusting the land to a corpo- ited liability companies, partnerships) rather than ration or cooperative in return for lease payments kolkhozes. The corporate farms in CEE-now referred makes good economic sense. These new landown- to as companies rather than cooperatives--are sub- ers also have the option of leasing their land to other stantially smaller than the original collectives, aver- private individuals, but they may perceive this as aging less than 1,000 hectares, down from 3,000 to riskier than leasing to a large organization 5,000 hectares before the transition, and are begin- * Market failure, market imperfection. In an imper- ning to show greater sensitivity to market signals, in- fectly competitive environment, large farms may have cluding the ability to adjust their labor force to easier access to input supplies, product marketing operating needs in the interests of higher profitability. channels, and credit facilities. This gives them a prac- tical advantage relative to smaller, individual farms and Overall, the CEE corporate farms appear to be devel- encourages the creation of large corporate farms. Such oping the basic attributes of market-oriented opera- market imperfections are apparent in all market econo- tions that are still not apparent for most large farms in mies, and individual farmers often overcome them by the CIS. These emerging differences in farm organi- creating service cooperatives, that is, large corpora- zation are linked to differences in the philosophy be- tions that interface between the member farmers and hind the agricultural transition. CIS policymakers the imperfect market to exploit the special advantages TRANSITION, March-April 2002 C) 2002 The World Bank large-scale operations enjoy. The situation is more cess by assisting with the development of the insti- complex in CEE and the CIS. The markets in transi- tutional tools of individual land management, includ- i: , tion countries are still far from perfect, and the es- ing titling, registration, extension, and farmery! tablished large corporate farms thai have had decades education. ', of experience operating in the former socialist envi- * Break-up of the large corporate farms into smaller. , ronment may have substantial advantages in access and more manageable farms should be encouraged : 0, to these imperfect markets compar-ed with newly cre- in all countries. A level playing field is required that 0 ° ated and relatively inexperienced individual farmers. allows farms of all structures and sizes to operate if :' Farmers interviewed in areas with a substantial num- they can remain viable under market conditions. ber of individual farms display strong psychological * Dismantling large farm enterprises, as Imple-; resistance to the formation of service cooperatives, mented in Albania, Armenia, Georgia, and to a cer- ,! because they see too many similarities between the tain extent Romania, is the most direct, but not the collective organization they have left behind and the only path to agriculture creating a sector with a larger:X cooperative organization advocated as a market so- share of family farms. Distributing land and asset lution to their difficulties. shares can serve the same purpose, as is becoming * Regional and local power plajts and politics. In evident in Moldova. To be effective, however, the first many countries, especially in the CIS, the regional stage of allocating paper shares must be followed political system still retains many of the crude inter- by a second stage in which actual land and assets ventionist features that characterized the socialist are distributed to individuals. command economy. Even though regional govern- * A two-tier agricultural system that combines the ments no longer command central budgets that they advantages of individual enterprises with the econo- can distribute among their large farms, they often mies of scale of corporate organization is a pos- have access to other resources and authority mecha- sible strategic direction. Under such a system nisms they can use to force compliance with behav- individuals manage land and production and corpo- ior in their interests. Thus a symbiotic relationship rations or cooperatives provide services. This is simi- exists between the managers of large collective and lar to the system practiced in the Israeli moshav. corporate farms and regional authorities. The large * Individual farms are not necessarily small farms farms still represent the organizecl backbone of agri- To exploit the full potential of individual farming, the culture in each region, and even though they often strategy must ensure the relatively free transferabil- produce less than 50 percent of agricultural output, ity of land from the state to private users (either in they are much easier for the local authorities to con- the form of ownership or of long-term leases) and, trol and tax than the thousands of individual house- more important, among private users. This involves de- holds. This interplay between the managers of large veloping land market institutions, including titling, regis- collective farms and regional aut:horities preserves tration, cadastral services, and possibly mortgage the existing farm structure, suppressing the expected banking. Land policy should aim to eliminate restric- shift from collective to individual farming and to vi- tions on land transactions (including prohibitions on cor- able corporate farms that act like business entities porate land ownership, which persists in some CEE accountable to their shareholders. countries) and to lower fiscal and administrative barriers (taxes, fees, bureaucratic requirements). As for coun- Possible Strategic Directions tries that do not wish to recognize private land owner- ship, legitimizing rental markets and providing the legal The current situation has a number of implications and enforcement apparatus for long-term leases may for agricultural strategies, namely: prove to be a feasible objective in the medium term. International experience shows that as far as efficiency * Policymakers who wish to achieve a transition from and productivity are concerned, in most cases the trans- the former socialist structure to an efficient and vi- ferability and security of tenure are rnore important than able farm sector should promote individual agricul- formal ownership. ture. Albania, Armenia, Georgia, Moldova, and more recently Azerbaijan and the Kyrgyz Republic are ex- Gershon Feder is a reserach manager, Csaba Csaki is amples of countries moving tow3rd complete indi- a senior adviser at the World Bank; and Zvi Lerman is a vidual agriculture. In these countries governments and professor at the Faculty of Agriculture, Economics, and the international community should support the pro- Management at the Hebrew University of Jerusalem. © 2002 The World Bank TRANSIION, MarchI-April 2002 Hungary's Twisted Land Market Since its election in May 1998 the Hungarian government has pursued a land policy that favors private family farmers over both Hungarian corporate and collective farms and foreign investors. In May 1999 it tightened tenancy regulations to filter out so-called pocket contracts-illegal sales generally disguised as lease agreements-concluded between Hungarian landowners and foreign investors since 1994, when a ban on foreign land ownership came into effect. In 1991 compensation laws repriva-tized the land owned illegally to foreign investors, mainly to farmers in neigh- J X by collective and state farms, transferring plots of 1 to 2 boring Austria. Government sources estimate that for- hectares each to about 1.5 million individuals. Priorto 1989 eigners may have purchased about 5 percent of Hungary already had 1.4 million small farmers cultivating Hungarian land through pocket contracts. _ | holdings of no more than 1 hectare, thus by the mid- to late-1990s the number of private landowners had risen to Last August the government began to buy back Hungarian nearly 3 million, most of whose plots were too small for farmland from foreign owners who had acquired their prop- market-oriented farming. Moreover, a large proportion of erty through illegal land sales and redistributed the land those who received land under these laws were either pen- among Hungarian private farmers at a subsidized rate. These sioners or the urban heirs of former collective farm mem- subsidized land transfers were carried out through the Na- bers who did not wish to engage in agricultural production. tional Land Fund, a state-controlled bank set up in late 2001. The fund's stated purpose is to create a new tier of Parallel legislation adopted in 1992 privatized the pro- medium size family farms able to withstand the competi- ductive assets of collective and state farms. Capital other tive pressures of the internal market after EU accession. than land was concentrated in cooperatives set up by the members of socialist era collective farms and by Hungary is submitting a proposal to the EU to extend the private corporations owned by the former collective farm ban on foreigners' purchase of arable land for another three managers. Combined with land redistribution, this effec- years beyond the already agreed period of seven years tively separated land ownership from the productive as- after Hungary joins the EU if domestic land prices at the sets necessary for farming. end of the seven years are less than 80 percent of the EU average. The ban on arable land purchases by foreigners In 1994 the government adopted a highly restrictive land resident in Hungary will last for at least three years follow- law that excluded collective farms, the new agricultural ing Hungary's accession. The EU, however, warned Hun- corporations, and foreign investors from the property mar- gary against trying to renegotiate the agreement on the ket. This was presented as a way to help create a viable purchase of farmland by foreigners. Eneko Landaburu, family farming sector prior to EU accession; however, leader of the Commission's enlargement directorate, said banning land sales to Hungarian corporate entities and Hungary cannot hope to get the same deal as Poland. The foreign investors-the only agents with sufficient capital EU and Poland recently agreed that for 12 years Poland to purchase farmland-effectively killed the newly emerg- can maintain a system that ties the purchase of farmland ing land market preventing the gap between land and by foreigners to a permit, but does not ban it. asset ownership from being bridged. These restrictions also greatly depressed the price of Hungarian farmland- Hungary is not alone on the issue of foreign land owner- estimates indicate that Hungarian land is worth one 10th ship. The Czechs and Poles have voiced similar con- of the EU average-thereby creating opportunities for cerns. In May the Commission proposed a seven-year speculation and illegal transactions. grace period for the purchase of agricultural and forest land in Bulgaria, the Czech Republic, Hungary, Poland, The 1994 land legislation benefited those Hungarian pri- and Slovakia following accession. Such transitional peri- vate investors who had some capital to invest in land Ur- ods are not new. Sweden had similar restrictions on for- ban professionals probably acquired relatively large holdings eign land ownership before it joined the EU in 1995 that that they may decide to sell if the price of Hungarian land were eliminated by the end of 1999. Today virtually any rises after EU accession. Independent estimates suggest EU citizen can buy or sell land or property within the EU. that speculators own some 35 percent of Hungarian farm- land, or 2 million hectares of a total of 5.85 million. Mean- Based on reports of Oxford Analytica, Oxford, U.K., and while, many private landowners have sold their land the Hunqarian Press. TRANSITION, March-April 2002 C) 2002 The World Bank Foreign Direct Investment: Does the Rule of Law Matter? By John Hewko An extensive overhaul of a country's legislative and institutional framework is generally not a neces-l sary precondition for the postcc,mmunist countries of Eastern Europe and the former Soviet Union to j' c attract direct investment from large, multinational investors (although certain changes are generally ! - required to retain such investmient) or from smaller, entrepreneurial investors. A significantly more important factor for investors is the existence of genuine business opportunities. The conventional wisdom within the international devel- rise to an entire cottage industry of NGOs, consultants, ED opment community is that a transparent, modern, West- and government advisors with noble aims, but often with ern legal system is a prerequisite for foreign investors to few results to show for their efforts. venture into host states. The logic cf this argument de- rives from a neo-institutional theory of the behavior of An extensive overhaul of a country's legislative and insti- economic actors, which maintains that efficient and tutional framework is generally not a necessary precon- transparent legal systems reduce their transaction costs, dition for attracting direct investment from large, including those of foreign investors. 1-hus because trans- multinational investors (although retaining such invest- action costs increase the costs of direct investment, ment generally requires certain changes) or from smaller, foreign investors should be averse to investing in coun- entrepreneurial investors. Significantly more important tries with higher transaction costs, and will therefore factors for investors are the existence of real business gravitate toward states with more effective or efficient opportunities, the potential for high returns, the risk of legal regimes. expropriation, the ability to repatriate profits, the existing tax regimes, and an often superficial "feel" about the host Based on this assumption, governments, multilateral in- country. stitutions, development agencies, and various NGOs have expended considerable resources on legal and judicial The annual flow of foreign investment to the transition reform programs throughout the transitional and devel- economies reached $5 billion in 1993 and increased to oping world in the belief that countries could implement $11 billion in 1995 and $19 billion in 1997, well before the legal reforms and establish the rule of law in relatively European Bank for Reconstruction and Development had short order, and in the hope that once they had com- granted many of these countries higher scores on its le- pleted the reform process, foreign direct investment (FDI) gal reform scale. Clearly the factor enticing foreign inves- would finally begin to flow. tors could not have been the legal systems in the postcommunist countries: in the early 1990s their laws The Devil's in the Details and legal institutions were generally incapable of address- ing the many issues that arise in a market-based eco- The experience of most postcommunist societies, how- nomic system. Rather, early investors were drawn to these ever, demonstrates that legislative and institutional re- countries by their large, untapped markets; highly edu- form is an organic process not conducive to easy or quick cated, yet inexpensive, labor pool; and tremendous natu- solutions. Genuine reform requires that a new legal cul- ral resources. ture be developed and ingrained in a society, which takes considerable time-several generations-and effort. Un- Real Barriers fortunately, many of the early, ambitious international development programs to, for example, "reform country A common complaint among investors in those countries X's judiciary in three years," often did not appreciate the that were least successful in attracting FDI was that there long-term nature of legal reform. Consequently, they were was no one in a position of authority to take decisions. doomed to fail. They produced an avalanche of reviews, Nothing exasperates investors more than the need to studies, reports, recommendations, and other beautifully shuffle from ministry to ministry or to negotiate a seem- produced "deliverables" that host states often did not imple- ingly endless bureaucratic maze where everyone and no ment. The programs created false expectations and gave one is in a position to resolve issues or grant approvals. C) 2002 The World Bank TRANSITI ION, March-April 2002 As a result, an ideal legal system is not nearly as im- misplaced. When faced with an attractive business op- portant as the existence of a clear, consistent, and portunity most foreign investors are prepared to accept > g_ unambiguous decisionmaking process. the inadequacy of postcommunist countries' legisla- tion and legal systems. In countries such as Russia, the onerous tax regime , - DFj and inadequate accounting standards and practices This is especially true with respect to legislative reform wL. 0 served as a much greater source of investment disin- and foreign investment. Once foreign investors take the ; OQ centive than the lack of an ideal legal system. Anec- leap of faith and make an investment, they are generally dotal evidence from Russia indicates that most foreign not concerned about corruption in general or the need investors consider the recent tax reforms instituted un- for legal reform in the abstract. Rather, they focus on - . ' der the Putin administration (for example, lowering per- how specific aspects of the law and of the legal system .: - - sonal and corporate tax rates, decreasing social affect their particular business, not on the fact that the ` insurance contributions, and phasing out turnover taxes) ambiguity of a single word in an existing piece of legis- as the single most important action taken to encour- lation puts the legality of their proposed transaction at age foreign investment in that country. risk or that official X at window Y at ministry Z requires a bribe to issue a routine permit. As a result, most foreign Legislative reform efforts should emphasize the details, investors who have committed resources to a given coun- not the general concepts, and the specific, very often try are prepared to accept that, in general terms, the mundane, changes that need to made for existing leg- legislation and legal system are inadequate. They are islation to function within the cultural, political, and eco- also prepared to accept that a given piece of legislation nomic realities of the host countries. The international does not fully conform to an ideal standard. Their con- development community has traditionally focused on cerns tend to center around a short list of specific com- large, general concepts, with calls to modernize bank- plaints about the one piece of legislation or regulation ruptcy legislation, eliminate corruption, and establish that, if rectified, would greatly facilitate the success and an efficient and rule-based judiciary This approach is continued viability of their investment. Those Who Cannot See the Trees for the Forest In the mid-1 990s I spoke at a confer- visions could have been amended (in once again the failure to focus on the ence in London on a panel that in- some cases all that was needed was admittedly boring details was signifi- cluded Ukraine's prime minister and adding a word or a sentence), the le- cantly hurting the cause of meaning- minister of finance and several other gal barriers to project financing in ful legislative reform. prominent Ukrainian politicians. The Ukraine would have been largely elimi- topic for discussion was economic nated (of course, political and credit Thus efforts to reform commercial reform and development in Ukraine risk would still remain as an obstacle legislation should concentrate on un- to be addressed). derstanding the shortcomings of ex- One of the problems facing Ukraine isting laws in detail and suggesting was the lack of any meaningful inter- When I spoke, I summarized the key, changes to such existing legislation, national private sector financing. As specific changes to existing Ukrainian rather than proposing widespread the pool of funds available from mul- law needed to facilitate private sector changes to conform the country's leg- tilateral and intergovernmental lend- financing. The other participants' eyes islation to an ideal model. Often prob- ing institutions paled in comparison glazed over. I finished, received polite lems can be resolved by adding a with the amount of capital required to applause, and the Western experts and word or a sentence, rather than by develop the country's economy, the Ukrainian panelists continued their wholesale revision or by drafting a only long-term solution was, and is, discussion about macroeconomic sta- clarification to a vague provision or to attract considerable private sector bilization, current account deficits, and term. However, urging a country to financing. However, even if a given the need to "implement market re- adopt a series of often highly techni- financing transaction made eco- forms and stamp out corruption" in the cal and arcane changes is less ex- nomic sense, it was difficult, if not im- most general of terms. Although these citing than proposing a wide-ranging possible, to execute because of six are all admirable goals, those of us reform package, and certainly not as or seven seemingly insignificant pro- who were practitioners shook our conducive to developing a career as visions of Ukrainian law. If these pro- heads and went back to lamenting that a policy guru. TRANSITION, March-April 2002 C) 2002 The World Bank Unfortunately, many investor surveys carried out by the plays a significant role in creating demand for reform of development community tend to focus on broad areas legislation and enforcement institutions, something that ,c of concern: Is the current bankruptcy law effective? Do the literature and international institutions seem largely ,' the courts enforce contract rights effectively? Is the to have ignored. C D pledge law incomplete? Is the failure to enforce laws consistently, expeditiously, and impartially a concern? Thus a fundamental shift in how the international devel- L * aX When faced with these sorts of genaral questions most opment community views certain aspects of legal re- foreign investors will tend to respond that the situation form in postcommunist countries is required, particularly .c needs improvement Naturally they would prefer a better in the area of commercial legislaticin and regulations. bankruptcy law or commercial code or favor improved The community should shift away from a process al- enforcement mechanisms. Who would not? However, most exclusively driven and created by multilateral or- understanding what concerns foreign investors in gen- ganizations and NGOs to one that recognizes and eral terms is not particularly relevant. What is important expands the role of the private sector. Working with host is to isolate specific legislative provisions that need to countries, this new approach would establish a more di- be amended, and this can only be done by providing the rect and meaningful dialogue with foreign investors, per- legal and accounting advisors of foreign investors active haps through each country's chamber of commerce, focus in the country with extremely detailed survey question- on specific investor concerns within the framework of ex- naires that delve to the level of specific problematic isting legislation; and recognize that legislative reform is clauses of specific laws. a long and tedious process subject to a continuous cycle of incremental change and trial and error. New Approach Needed John Hewko is a partner in the law firm of Baker & Foreign investors and their advisors are much better McKenzie, and has spent the last 12 years practicing suited to identify the exact changes needed in the legis- law in Moscow, Kiev, and most recently, Prague. He Is lative framework to facilitate FDI than a guru flying in for currently a visiting scholar at the Carnegie Endowment a weekend of diagnostic analysis. Foreign investors are for International Peace. This article is a shortened ver- a dynamic force in the forefront of the push for change sion of the original Camegie Endowment Working Pa- and agents for such reform. This is particularly true in per, no. 26. such areas as training personnel and reforming the le- gal and accounting professions. Serious foreign inves- o tors, largely multinational firms, play a vital role in training and educating individuals and in developing a cadre of i citizens who understand and accept those practices and concepts that are critical to creating a civil society and respect the rule of law. Foreign investors are also effec- tive in providing training and transferring know-how and play a role in civil service and judicial reforms. The development community should address this situa- tion by channeling funds into long-term and sustained programs for training young locals as a matter of prior- ity. Thousands of a given country's best and brightest university graduates should be sent to the West for one- and two-year graduate study programs (but be required to return). One shudders at the thought of how many young graduates could have been trained with the mil- f lions the development community has spent on feasibil- ity studies, diagnostic reports, foreign consultants, and "We've been talking too much about traveling delegations. The development community eliminating corruption in public life. Now no should also work on creative mechanisms to harness party wants to govern with us." the tremendous training capability of tne private sector and to use it more fully. As noted earlier, foreign investment From the Hungarian magazine H6cipio. © 2002 The World Bank TRANSI I ION, NlarclI-April 2002 Cultural Values Are Key to Understanding * Russia's Small Business Environment By Emeric Solymossy Russia's small business sector confronts over-regulation, bureaucratic controls, and complicated taxa- tion, which reflect underlying socio-cultural values related to independent behavior, trust, and goal orientation and time. Those interested in dealing with antibusiness forces must understand these values and their origins. Formerly socialist countries with relatively high levels of Hierarchy of the Russian Legal System entrepreneurship (measured as the proportion of those I Constitution age 18 to 65 who are involved in entrepreneurial activity) Ct are enjoying greater economic prosperity than those with |Federal Constitutional Law lower levels of entrepreneurship. The Russian govern- Government Duma ment recognizes that a vibrant small business sector is Il Constitutional Court crucial for revitalizing the country's economy, but small Federal Laws and medium enterprises' contribution of 12 percent to overall GNP is still lower than in many other formerly I Presidential Decree i socialist countries, even though it has doubled since F Government Resolutions= 1997. The Global Entrepreneurship Monitor reported that [ I *l Instruction Russia's total entrepreneurial activity is less than three- , L * Resolution quarters that in Poland; about half that in Hungary and AAency Directive/ Orders the United States; and less than one-third that in Mexico and New Zealand, the two most entrepreneurial econo- Local Official(s) m ies. _ _ _ _ _ _ _ _ _ _ mie. | Business Person(s) Observers have suggested many reasons for Russia's Bureaucratic obstacles prevail at this lowest level. low levels of entrepreneurial activity. The three cited most While the legal system mandates that the laws shall frequently are the complex and hostile environment for not conflict with federal laws and that only the consti- businesses, the elaborate taxation system, and the tutional court is empowered to interpret the constitu- cumbersome business registration processes. tion, local officials have significant discretionary powers and great flexibility in how they administer While the national government is comparatively stable, the laws. This situation does not appear to have it is still in a state of transition. The concept of private changed from the former system. Personal connec- ownership is still new, and the infrastructure for support- tions and money can improve opportunities for ma- ing small and medium enterprise competition on the glo- neuvering successfully through the bureaucratic maze. bal marketplace is deficient. Nevertheless, the greatest Because of the variability in administration and differ- hurdle to small business growth may be Russia's legal ing interpretations of the law, business regulations are system, which lacks the checks and balances permit- not administered uniformly. This can be viewed either ted by the separation of executive, judicial, and legisla- as an absence of the rule of law or as inconsistent tive authority. The overriding standard is the constitution, enforcement. While entrepreneurs can appeal to the which serves as the apex of a hierarchy that rests upon constitutional court if edicts are administered in con- agency directives and orders and their administration tradiction to the constitution, the process is compli- by local officials (see the figure). Deputies or legislators cated and time consuming. Successful challenges are write laws, but cannot interpret them. The constitutional the exception rather than the norm. court is empowered to interpret the law, but cannot en- force it. Local administrators cannot write or interpret Inconsistent enforcement persists in part because the the law, but enforce it. Entrepreneurs must interact with business community lacks a strong lobby for affecting the legal system at this lowest, local level. legislative change. According to a report by the Institute TRANSITION, March-April 2002 c 2002 The World Bank for Private Sector Development and Strategic Analy- small business owners would find the concept of paying sis prepared in Moscow for the U.S. Agency for Inter- a business tax based on gross revenues incomprehen- national Development, the average business uses 49 sible, and would find the idea of paying taxes in advance person-days and $357 to register the business and 47 based on a bureaucratic administrator's "calculation" of a person-days and $576 to license the business, and what their sales or profits for the coming period would | '. receives an average of 9.4 visits per year from various be even more troubling. This suggested method of cal- monitoring and inspection agencies. Economic and culating taxes suggests that the system is based on l Trade Minister German Gref has proposed reducing social mistrust. It is founded on anticipation of abuse, X a U I- state control so as to lower businesses' administrative and encourages the creation of a shadow economy and burdens, but permitting more interpretation of the law evasion. I -- a at the local level could lead to even more inconsistent administration. Entrepreneurs made several recommendations for the government to consider as it deliberates ways to im-! This regulatory complexity is compcunded by the taxa- prove the vitality of Russia's small business sector, tion system. Entrepreneurs had to prepare 12 different namely: forms to pay their taxes in 2000, 16 forms in 2001, and * Simplifying the tax system. Not only do reporting re- must now complete 24 forms and present them to a tax quirements need to be simplified, but entrepreneurs official in person. This latter process averages three days should not have to submit tax forms in person every three months. As part of their tax liability trading * Distinguishing between existing enterprises, new ven- businesses are also required to unde!rgo a quarterly reg- tures, and the self-employed. New business should be istration process. The reasoning behind this frequent encouraged by allowing them to operate for one year registration is that small trading enl:erprises have diffi- tax free rather than mandating that they pay their first culties monitoring their sales, earnings, and taxation; year's taxes before they have started operating. however, this system, which is tani.amount to a quar- * Setting up information/advisory centers staffed by terly audit, appears to be based on distrust rather than competent personnel that offer free or inexpensive ser- trust and places no value on entrepreneurs' time. vices to the business community. Numerous such cen- ters were established early in the transition with financial A proposal by the Ministry of Economic Development and support from the U.S. Agency for International Develop- Trade calls for simplifying the tax system for small busi- ment, among others; however, because of decreasing nesses. Businesses would be classilied as small based external funding and economic difficulties, most have on the physical area the business occupies, for example, closed shop or become ineffective. the square footage of its buildings, and not on the num- ber of employees. The tax base would be determined Studies have repeatedly confirmed the role of education based on a single formula applied nationwide, rather than and support in encouraging small business formation applying different formulas in different regions as is the and growth. Russia's sociological factors and circum- case today. The tax rate would be cut from 20 to 15 per- stances are, however, unique, and call for even broader cent by eliminating the social tax. Businesses would, education and support. The need for education in the however, pay a 14 percent tax for social pension insur- functional skills of business management is unques- ance, which had previously been fully funded by the state. tioned, but educational programs that promote cultural change so that all those involved accept and embrace Certain small businesses, primarily those providing per- the economic principals and social expectations that sonal and business services, would be able to choose foster and promote a market-oriented economy must between two approaches to taxation. Both choices would also be provided. involve payment of a single tax that would replace the profit tax, value added tax, property lax, and local sales The important issues are philosophically and culturally tax. They could choose to pay an 8 percent tax on im- based. While social structures, trust, and time valua- puted revenues (8 percent of all estimated income as tion are distinct from each other, they interact to create estimated by the tax administrator regardless of offset- a daunting challenge to reform. ting expenses, without reconciliation, that is, without pledging any later reimbursement for adjusted income), During most of the 20h century a collective social or a 25 percent tax on imputed profits (again, estimated order was enforced in Russia and deviation by inde- by the tax administrator and without reconciliation). U.S. pendent action was not tolerated. Entrepreneurship, © 2002 The World Bank TRANSITION, March-April 2002 for Private Sector Development and Strategic Analy- small business owners would find the concept of paying sis prepared in Moscow for the U.S. Agency for Inter- a business tax based on gross revenues incomprehen- national Development, the average business uses 49 sible, and would find the idea of paying taxes in advance person-days and $357 to register the business and 47 based on a bureaucratic administrator's "calculation" of a person-days and $576 to license the business, and what their sales or profits for the coming period would | '. receives an average of 9.4 visits per year from various be even more troubling. This suggested method of cal- monitoring and inspection agencies. Economic and culating taxes suggests that the system is based on l Trade Minister German Gref has proposed reducing social mistrust. It is founded on anticipation of abuse, X a U I- state control so as to lower businesses' administrative and encourages the creation of a shadow economy and burdens, but permitting more interpretation of the law evasion. I -- a at the local level could lead to even more inconsistent administration. Entrepreneurs made several recommendations for the government to consider as it deliberates ways to im-! This regulatory complexity is compcunded by the taxa- prove the vitality of Russia's small business sector, tion system. Entrepreneurs had to prepare 12 different namely: forms to pay their taxes in 2000, 16 forms in 2001, and * Simplifying the tax system. Not only do reporting re- must now complete 24 forms and present them to a tax quirements need to be simplified, but entrepreneurs official in person. This latter process averages three days should not have to submit tax forms in person every three months. As part of their tax liability trading * Distinguishing between existing enterprises, new ven- businesses are also required to unde!rgo a quarterly reg- tures, and the self-employed. New business should be istration process. The reasoning behind this frequent encouraged by allowing them to operate for one year registration is that small trading enl:erprises have diffi- tax free rather than mandating that they pay their first culties monitoring their sales, earnings, and taxation; year's taxes before they have started operating. however, this system, which is tani.amount to a quar- * Setting up information/advisory centers staffed by terly audit, appears to be based on distrust rather than competent personnel that offer free or inexpensive ser- trust and places no value on entrepreneurs' time. vices to the business community. Numerous such cen- ters were established early in the transition with financial A proposal by the Ministry of Economic Development and support from the U.S. Agency for International Develop- Trade calls for simplifying the tax system for small busi- ment, among others; however, because of decreasing nesses. Businesses would be classilied as small based external funding and economic difficulties, most have on the physical area the business occupies, for example, closed shop or become ineffective. the square footage of its buildings, and not on the num- ber of employees. The tax base would be determined Studies have repeatedly confirmed the role of education based on a single formula applied nationwide, rather than and support in encouraging small business formation applying different formulas in different regions as is the and growth. Russia's sociological factors and circum- case today. The tax rate would be cut from 20 to 15 per- stances are, however, unique, and call for even broader cent by eliminating the social tax. Businesses would, education and support. The need for education in the however, pay a 14 percent tax for social pension insur- functional skills of business management is unques- ance, which had previously been fully funded by the state. tioned, but educational programs that promote cultural change so that all those involved accept and embrace Certain small businesses, primarily those providing per- the economic principals and social expectations that sonal and business services, would be able to choose foster and promote a market-oriented economy must between two approaches to taxation. Both choices would also be provided. involve payment of a single tax that would replace the profit tax, value added tax, property lax, and local sales The important issues are philosophically and culturally tax. They could choose to pay an 8 percent tax on im- based. While social structures, trust, and time valua- puted revenues (8 percent of all estimated income as tion are distinct from each other, they interact to create estimated by the tax administrator regardless of offset- a daunting challenge to reform. ting expenses, without reconciliation, that is, without pledging any later reimbursement for adjusted income), During most of the 20h century a collective social or a 25 percent tax on imputed profits (again, estimated order was enforced in Russia and deviation by inde- by the tax administrator and without reconciliation). U.S. pendent action was not tolerated. Entrepreneurship, © 2002 The World Bank TRANSITION, March-April 2002 Ukraine and the New Fad: Corporate Governance By Alexander Krakovsky 04, When the Berlin Wall fell, the first economic advice the former Soviet bloc countries received was to;, X ii3 decentralize, deregulate, and mass privatize. Often multilateral institutions would set objective: I X privatization goals for each country to achieve before it could obtain the next tranche of aid or financ-, 3 ing. The multilateral institutions allso sent consultants to help the countries distribute privatization vouchers C C to their populations, run voucher auction centers, and distribute the shares of newly formed companies. Now these same consultants are often criticized by "transitologists" for focusing on share distribution and failing to address corporatec governance. Several centrally planned economies were replaced not corporate governance takes things one step further and by free markets, but by "kleptocracies." In the new deals with the nonbenevolence of corporate CEOs, board economy what mattered was control over assets, not members, and other agents toward the corporation. ownership. This led to two negative re!sults: first, the much- touted investment boom did not matearialize; and second, To be sure, if having full and costless information or the populations, who were sold on the idea of a market ability to make perfect contracts that spanned every pos- economy and private ownership, were disillusioned as sible state of the world were possible, then society could their shares became worthless. JLIst like they pushed contract with a central planner just as readily as with a mass privatization in the 1990s, the new focus of the butcher or a CEO. But life is not so simple, which is multilateral institutions has become corporate governance why modern economic theory tries to balance the moti- and all are actively pursuing corporate! governance projects vating factor of free enterprise with the role of govern- in Ukraine. Armed with a bag of corporate governance ments and other mechanisms in bringing about efficient cures, consultants are talking accounting reform, inde- outcomes. Correspondingly, corporate governance tries pendent boards, company law, ancl shareholder rights. to address the separation of ownership and manage- But are the consultants keeping an eye on the big pic- ment to bring the behavior of management as close as ture, or are they overlooking something again? possible in line with that of its constituency, the share- holders. Motivate and Regulate The World Bank defines corporate governance as that The free enterprise system is basecl on the premise that blend of law, regulation and appropriate voluntary private businesses are too complex for central planners to con- sector practices which enable the corporation to attract trol and run efficiently. Instead, individuals allowed to financial and human capital, perform efficiently, and freely pursue their own interests are better equipped to thereby perpetuate itself by generating long-term eco- run businesses, because their performance is directly nomic value for its shareholders, while respecting the linked to their individual utilities. In doing so, they pro- interest of stakeholders and society as a whole. This is duce goods and services and pursue cooperative net- an excellent definition, because it recognizes that good works based on the free exchange of goods and services. corporate governance is a carefully crafted balance be- The pressures of the marketplace direct the selfish ac- tween motivational forces and the forces that constrain tivities of individuals as if by an invisible hand-using or direct certain types of behavior. Just as the free enter- Adam Smith's terminology-into socially responsible prise system relies first on entrepreneurs' voluntary, self- paths. As he observed: "It is not from the benevolence of serving actions, a well-structured corporate governance the butcher, the brewer or the baker that we expect our regime must also first harness the voluntary behavior of dinner, but from their regard to their own interest." corporate agents and stakeholders. Regulations must enable the invisible hand to work, not hinder it, and not Of course, Adam Smith observed individual entrepreneurs enable the grabbing hand of regulators. of his time. The butcher, the baker. and the brewer are now large corporations. Consequently, corporate gover- How Public Are Public Companies? nance is a component of modern economics. Just as classic economics deals with the nonbenevolence of The choice between having a public or a private com- the butcher, brewer, and baker toward their customers, pany is a perfect example of balancing the need to c 2002 The World Bank TRANSIHION, March-April 2002 1 regulate and the need to allow as much free choice that underwent mass privatization were corporatized 1111| as possible. A public (publicly listed) company is and their shares distributed to the public in exchange one that at some point issued securities to distrib- for vouchers. The enterprises received no financing ute to the public without regard to the ability of those in return for the shares. The public cannot effectively 0 i ',I acquiring the securities to understand, evaluate, or control the companies. Without regulation sharehold- b j Ilicontrol the enterprise. Furthermore, public securi- ers are forced to rely on the insiders' benevolence. . !- ',ties are usually sold to diversified investors, each of The insiders are unlikely to willingly constrain them- _,which holds a relatively small stake in each enter- selves. .- prise, thereby not making it worthwhile for them to defend their rights on their own. Clearly such companies will not attract international or national capital flows in a transparent way. This .-g 1.llNational laws usually define public companies as leaves Ukrainian regulators with the task of trying to those that distributed securities either to more than protect the interests of shareholders in a large num- a certain number of shareholders (100 in the United ber of companies that do not even have the structure States) or to unsophisticated investors. Regulations to provide proper disclosure. While the Securities governing public companies usually focus on the Commission could, of course, bring back Soviet era proper disclosure of public information and the proper controls, that leaves the question posed by Joseph use of insider information, with the investing public Stiglitz: "Who is guarding the guards?" free to choose which companies to invest in. This is a perfect example of a balance between the free Flawed Remedies market's need to allow people to choose and the incomplete market's need to address inefficiencies Much of the talk about corporate governance reform through regulation. focused on institutional and legal mechanisms and the corruption-ridden judicial and regulatory systems. By tapping a public market the entrepreneur can ac- Stamping out corruption and building institutions cess capital at the lowest possible cost because of brings us back to "Who is guarding the guards?" competitive participation by a large pool of diversi- Without appropriate regulation, the new market oli- fied investors. The entrepreneur must decide whether garchs will do everything possible to preserve cor- the lower cost of capital justifies the added expense ruption. Institutional development cannot take place and constraints associated with regulation and dis- in a vacuum. It must go hand-in-hand with market closure, compared with the disclosure and structure solutions to corporate governance problems. To dem- options of privately financed companies, which de- onstrate just how sick the patient is, the following are pend entirely on their owners. some examples of how even the most commonsense remedies, if unqualified, would actually make the situ- The problem with the mass privatized companies is ation worse: that the only participants who influenced the creation * Remedy 1: Require that all publicly listed com- of corporate contracts were the general directors and panies adhere to International Accounting Stan- bureaucrats. They were not particularly interested in dards (IAS). Ukraine has 30,000 public companies, attracting shareholders, because shareholders or and in 2000 had 50 IAS certified accountants. Let us debt holders did not form the capital base of the cor- say that this number has now increased to 200. How- porations. Potential shareholders merely traded in ever, accountants who are qualified to be controllers their vouchers and had no freedom to choose any or audit managers need to have roughly 10 years of kind of alternative. There was no self-interest on the experience. Without the requisite institutional and part of the bureaucrats or directors to collect more human base, this requirement will simply reduce IAS vouchers, and therefore no motivation to constrain accounting to the lowest single denominator: ac- themselves, or even to form viable businesses. In- counts would be reported in a form that appears to stead, they did everything possible to lift controls be compliant with IAS. The insiders would still be and perpetuate their entrenchment in collecting rents able to run parallel structures lacking transparency. from the enterprises. * Remedy 2: Impose strict personal liability on board members and managers and permit class Equally, the decision to go public was not based on action suits. Any acquisition is normally followed by a rational choice. In Ukraine, all 30,000 enterprises a radical restructuring effort. Restructuring companies TRANSITION, March-April 2002 c 2002 The World Bank is even more perilous in Ukraine than buying them. The W orld Bank/IM F Restructuring usually means stripping away parallel IC structures as well as suppliers, customers, and rent Ag A collectors who have been bleeding the company. Such restructuring efforts are rare without a major conflict with the entrenched structures, and oppo- More Support to the CIS-7 'c GI nents of restructuring can turn io the judicial sys- tem. However, neither the judicial system nor During theirApril meeting in Washington, senior officials i companies have the capacity to handle law suits from four international finance institutions-the World against directors. A newly formed majority share- Bank, the IMF, the European Bank for Reconstruction holder currently needs to give fired managers 45 days and Development, and the Asian Development Bank- -. notice, which gives such managErs the time to take decided to increase their support for the seven poorest i all kinds of extraordinary measures to entrench them- CIS countries, namely, Armenia, Azerbaijan, Georgia, the @ selves. For example, to date the management of the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan. JSC Hotel Lybid has stayed in power for four years First announced during their London meeting in Febru- in this way. ary, the London Initiative will help these nations acceler- * Remedy 3: Require that majority shareholders ate poverty reduction and economic growth and stabilize offer a buyout to minority shareholders. This en- their fiscal and external debt positions. Nearly 20 million tails several problems, including agreement on how people in the CIS-7 countries continue to live in extreme to reach an objective price. Most majority stakes poverty. Provided that the CIS countries make serious were acquired in a less than transparent manner, with efforts to reform their economies, the international com- brokers making a huge margin. IFurthermore, some munity is prepared to provide more financial aid, including large sums may have been paid for swing votes. Also, grants, debt restructuring, or, if necessary, debt relief; majority stakes can be split to seemingly unrelated easier access to industrial countries' markets; coordi- holdings. The State has no capacity to investigate nated support for country-led poverty reduction programs; those cases, let alone enforce the rules. technical assistance; and policy advice. * Remedy 4: Educate "red" directors about cor- porate governance. These directors are most likely Wolfensohn in Central Asia those who designed their companies' corporate gov- ernance system (not the owners or shareholders) in An eight-day, five-country visit to Central Asia, pre- a way that would protect their jobs and rents. Rais- ceded by a stop in Russia to meet President Vladimir ing financing was not their concern. Improving the Putin, left World Bank President Wolfensohn im- corporate governance system wDuld prevent them pressed by the region's pivotal importance in terms of :_ from collecting rents, and could even cost them their energy, trade, security, and culture. During an account; jobs, thus they eagerly study corporate governance of his trip to a World Bank audience, Wolfensohn said not to improve the company, but to perpetuate their that he had set out particularly interested in the positions. region's Islamic history and its resurgence in recent, years. He came away with the sense that life in the The solution is a mixture of voluntary (market-driven) five countries of Central Asia is not driven by religious legal and regulatory actions. Mass privatization and considerations. Rather, the more militant Islamic concurrent development of the securities market did movements appear to be filling a political gap in those not take into account the impracticality of pure share countries. trading to accommodate the mass transfer of con- trolling stakes. A tendering mechanism could pro- Beyond politics, energy and natural resource manage- vide transparency to all shareholders, enabling them ment loom large in this region of 55 million people. With to sell their shares under clear conditions. An inde- their large reserves of oil and gas, Kazakhstan, Tajikistan, pendent body should supervise the fairness and hon- and Turkmenistan are eager to build pipelines and capi- esty of the tender, which should create a level playing talize on potential regional and global markets. field for all participants. Turkmenistan's government broached the possibility of a natural gas pipeline to Afghanistan, Pakistan, and In-, The author is president and CEO ol Ukraine Investment dia. Water-rich Tajikistan has significant hydroelectric Advisors, Inc. He can be reached at a,krakovsky@aol.com. Continued on page 24 c 2002 The World Bank TRANSI'I'ION, March-April 2002 'Why Is Foreign Direct Investment in Ukraine C, ;1Trailing Behind? ,' o -> Yw Ukraine has one of the lowest levels of foreign direct fall from 20 to 17 percent and profit taxes from 30 to 25 * investment (FDI) per capita in Eastern Europe and the percent. Implementation of a new system, however, is - C~ 'ut ;lCIS, and inconsistent government policy militates against likely to take a considerable number of years. ,`improved levels of FDI. During 1992-2001 FDI totaled * Lack of incentives and transparency in the privatization J "t¢ ,$4 4 billion, or around $88 per capita, compared with process. The government has been criticized by the re- il $3,100 per capita in the Czech Republic. Net FDI flow formers for the slow pace of the process and for not for 2001 was $531.2 million. According to estimates by privatizing any large enterprises via open and transpar- the Economist Intelligence Unit, as things stand now, ent tenders. Insider and asset-stripping deals are al- Ukraine's FDI prospects will not improve much during leged to dominate the privatization process. The State 2001-05: FDI per capita will equal $21, the same as in Property Fund, the government's main privatization arm, Belarus. Of 27 transition countries, only Tajikistan ($5), put privatization revenues at just Hrv 2.1 million Uzbekistan ($10), and the Kyrgyz Republic ($18) trailed ($395,000) in 2001, against a projected level of Hrv 5 9 behind Ukraine. billion. In December 2001 the Rada expanded the list of companies that are not to be privatized by adding sev- Last year, as in previous years, the largest share of in- eral strategic enterprises, the potentially most valuable vestment technically came from the United States (16.6 being the Zaria plant, one of the largest producers of percent), Cyprus (10.8 percent), the United Kingdom turbines for ships and gas compressor units in the CIS. (9 5 percent), and the Netherlands (8.4 percent), followed Strategically important enterprises still on the list to be by Russia and Germany (5 percent each). However, privatized in 2002 include: around 25 percent of all joint ventures have been cre- * A 25 percent stake in Ukrainian Mobile Communica- ated using offshore capital that originally came from tion at the preliminary starting price of Hrv 266.3 million Russian and Ukrainian businesses, therefore actual in- * A 37 percent stake in the telecommunications mo- vestment from other countries is not as significant as nopoly Ukrtelecom at Hrv 1.732 billion these figures suggest. * Large stakes in 12 power distribution companies for a total of Hrv 1.9 billion The following factors explain the low levels of investment: * Stakes of 25 percent in those power distribution com- panies privatized in 1998, to be offered for sale via stock * Lack of investment instruments. The collapse of the exchanges for nearly Hrv 172 9 million. Treasury bill market in the aftermath of the 1998 ruble crisis has continued to discourage foreign investors. Attracting much-needed capital by setting up special Despite some recovery and recent growth, foreign in- economic zones (SEZs) has proved to be controver- vestors still consider local debt and equity instruments sial. The authorities have tended to address the issue to be too risky and illiquid. of tax privileges and support for the establishment of * Lack of adequate corporate governance. Investors gen- an SEZ on a case-by-case basis, provoking criticism erally regard the ability to control an enterprise as the from the IMF and the World Bank, because this ap- only way to secure an investment, with a 70 to 75 per- proach means that such privileges vary for each SEZ. cent stake considered to be a safe share. Therefore for- Typical privileges granted to SEZs include exemptions eign buyers strived to attain majority stakes in enterprises from customs duties and sometimes from value added rather than the minority shareholdings or portfolio in- taxes for imported goods and services as well as a vestments typical in emerging markets. lower corporate profit tax (usually 20 percent as op- * Complex and high taxes. Taxation is now the single posed to the current base rate of 30 percent). The out- most important policy area affecting foreign investors (in going government started a review of SEZs and 1996 foreign investors were afforded the same right to suspended the creation of new ones. invest as national investors). Adoption of the new Tax Code was postponed until mid-2002. Once implemented, Based on reports of the international consulting firm Ox- it will radically change the taxation system to a consis- ford Analytica, Oxford, U.K., and the Economist Intelli- tent and convenient one. Value added tax rates could gence Unit, London. TRANSITION, March-April 2002 © 2002 The World Bank The Challenge of Addressing Roma Poverty in Slovakia i Life is difficult for many Roma in Slovakia. Although the overall poverty level is low--6 percent accord- ' ing to the most recent World Bank poverty assessment-the country does have severe pockets of pov- cJ erty. Living conditions are especially poor for Roma living in isolated settlements. Poverty in these c areas is multidimensional-related to high levels of unemployment, poor housing conditions, and lack , of access to basic public services-and is exacerbated by social exclusion. A recent joint report by the; World Bank, the Open Society Institute, and two Slovak NGOs, "Poverty and Welfare of Roma in the, Slovak Republic," coordinated in the Bank by Dena Ringold and Helen Shahriari, analyzes the major' ingredients of Roma poverty and vulnerability and suggests policy measures to improve living condi- tions and reduce poverty amon(g the Roma minority. The Slovak Republic has one of the largest Roma popu- (though a 1990 study found that even fewer Roma had lations in Europe. Although the 1991 census identified completed basic education). Roma children often face only 76,000 individuals as Roma, or just 1.4 percent of stiffer challenges in accessing education than other ethnic the population, informal estimates suggest that Slovakia groups. In addition to factors common among other poor actually has 420,000 to 500,000 Roma, accounting for households, such as economic constraints, limited ac- 8 to 10 percent of the population. Because of higher cess to quality education, and parents' education lev- birth rates among Roma than other population groups, els, Roma children face additional barriers, including low this share is likely to rise in coming years. demand for education within the community, geographic isolation, poor Slovak language proficiency, and low ex- Ghetto-Like Settlements pectations on the part of teachers. Roma children are also more likely to end up in special schools for the Slovakia's Roma are among those hardest hit by the pro- mentally and physically disabled, which limits their fu- cess of transition from central planning to a market economy. ture education and labor market prospects. Overall, Roma are poorer than other population groups and are worse off in terms of nearly all basic social indicators, A 1997 survey by the Ministry of Labor, Social Affairs, and including education and health status, housing conditions, Family estimated that in 1996 Roma accounted for 17 to and access to opportunities in the labor market and within 18 percent of the total unemployed, with this figure run- civil society. However, limited information on poverty among ning as high as 40 to 42 percent in eastern districts with Roma in Slovakia and their living conditions is available. To large Roma populations. Many Roma are forced to work address this gap the study included a qualitative survey of in the informal sector. Despite legislation prohibiting dis- conditions in Roma settlements. crimination, many Roma cite it as a significant barrier to employment and as a rationale for not searching for work In contrast with the situation of Romai living in other coun- outside their communities and villages. Long-term unem- tries in Central and Eastern Europe, more Roma in ployment is particularly high among Roma. Nearly all the Slovakia-an estimated 25 percent--live in settlements long-term unemployed Roma interviewed for this study, on the outskirts of villages and towns, mostly in the and especially those living in poorer segregated settle- poorer eastern regions of the country. In these com- ments, depend on social assistance benefits for income pletely segregated settlements formal unemployment support. This dependency reinforces negative stereotypes is close to 100 percent, and many settlements lack about Roma among the non-Roma population. access to electricity, water, and sewage and garbage collection. Most Roma do not own their homes or land. Social exclusion and discrimination against Roma se- verely affect access to employment opportunities, edu- Few Roma youth continue on to secondary education. cation, and public services. There are indications that According to the 1991 census, 77 percent of Roma had negative perceptions of Roma are worsening for a num- completed primary education, 8 percent had completed ber of reasons, including their declining social status, vocational training, and fewer than 2 percent had com- growing unemployment, and increasing dependency on pleted academic secondary education or university social benefits. Negative stereotypes are also reinforced C 2002 The World Bank TRANSI I ION, March-April 2002 ill X . j' by their geographic separation from the rest of the popula- to take advantage of opportunities through education, tion and the limited contact between Roma and non-Roma. employment, and access to public services should be c, OXF ij considered. A central question the study raises is how to develop an X X i^t effective strategy for addressing the needs of Roma liv- This does not imply that programs and policies should E0 . ing in settlements. The most segregated and geographi- revert to the type of forced assimilation prevalent during ¢ . i>,^s | cally isolated settlements face the greatest challenges the socialist period. Rather, policy and project design on all fronts, including access to employment opportu- need to be sensitive to Roma culture and communities' - nities and public services, while conditions in integrated desire to maintain their cultural identity. A number of settlements are more favorable. While adopting mea- successful projects use Roma mentors as liaisons be- sures to meet the immediate needs of residents of the tween Roma and non-Roma communities, for example, poorest settlements in the short run is important, in- Roma teacher assistants who work with parents or Roma -=- -Evesting in settlements over the long term may lead to peer advisors who assist with job placement can facili- further entrenchment of segregation and continued tate integration while simultaneously strengthening the marginalization and impoverishment. Roma community. Addressing the negative impacts of exclusion and segregation also involves overcoming di- There are no easy answers to this dilemma. The failure visions between Roma and non-Roma communities. One of socialist-era policies, which aimed at forced assimi- important vehicle for doing this is education, which can lation of Roma, indicate that encouraging Roma to leave help overcome cultural barriers through multicultural settlements is not a viable solution. At the same time, education and inclusion of the history and culture of Roma lessons from ongoing projects in Hungary and Slovakia and other minorities in the curriculum. Training teach- illustrate the importance of community involvement and ers, local government officials, and other social service participation in policies and projects. Thus a balanced personnel can be an important mechanism for address- package of short- and medium-term measures aimed at ing discrimination within public services. Public infor- improving immediate living conditions for Roma in the mation campaigns can also promote multiculturalism poorest settlements and expanding possibilities for Roma and raise awareness about discrimination. Slovak Roma History The oldest references to Roma living lessly persecuted them. Estimates in- Following the 1989 Velvet Revolution, ontheterritoryoftheSlovakRepublic dicate that some 500,000 European in April 1991 the Slovak government date back to 1322. The origins of Roma died in Nazi concentration adoptedthePrinciplesofGovernment Roma throughout Europe have long camps. Policy Regarding Roma, recognizing been a mysterious and controversial them as an independent ethnic mi- topic. Historical records indicate that The Czechoslovak socialist regime, nority with equal status to that of other Roma arrived in Europe from north- which came to power after World War minorities. One of the most signifi- ern India in waves between the 9th 11, adopted policies aimed at assimi- cant recent developments in Roma and 14th centuries, although some lating Roma and eliminating ethnic dif- affairs was the establishment of the Macedonian legends place Roma in ferences. The government refused to Office of the Plenipotentiary for Roma Europe at the time of Alexander the officially recognize Roma as an ethnic Communities following the 1998 elec- Great as early as the 4th century BC. minority, but rather identified them as tions. The office is charged with imple- Linguistic roots and limited docu- "citizens of gypsy origin." In 1959 the menting government policy regarding mentation suggest that Roma first government embarked on a violent Roma. The EU accession process came via Persia and the Caucasus campaign against nomads, and drew has also focused attention on Roma through the Byzantine Empire into up plans for "dispersal and transfer" issues in the Slovak Republic as well southern Europe. The reasons for that aimed to resettle Roma from ar- as in other countries in Central and their migration into Europe and the eas with large Roma communities in Eastern Europe that have large Roma paths they followed in moving into eastern Slovakia to Czech lands. This populations. Roma issues are ad- the continent are unknown. Alter- latter program was never fully imple- dressed under the political criteria for nately tolerated and persecuted since mented, although many Roma fami- accession, and the EU's PHARE as- their arrival, the Nazis viewed Roma lies were transported to the Czech sistance program is providing sub- as enemies of the state and relent- Republic against their will. stantial support in this area. TRANSInON, March-April 2002 © 2002 The World Bank Programs to Be Targeted or Not? Proposals A serious dilemma is whether programs and policies Programs at the national policy level should: X should be targeted toward Roma, directed more broadly * Address the unemployment problem by supporting j c at poor communities, or aimed at the population at micro, small, and medium enterprises and improving Cr0 large. Targeted programs can be lailored to meet the small entrepreneurs' access to credit. Encouraging self- ' .= C specific needs of Roma, but could create divisions employment and entrepreneurship can have a positive! 8 o among communities because of resentment that some impact on Roma as well as on non-Roma households. groups are receiving special treatment. Broadly based * Lower the nonwage costs of labor by reducing the programs may be easier to administer, may be more currently high payroll taxes and nonwage labor costs, ) popular politically, and may facilitate integration and which discourage employers from hiring unskilled labor! cohesion; however, untargeted prcgrams could be ill- because it makes such labor proportionately more ex- I suited for reaching the poorest and most isolated Roma pensive than more skilled workers. settlements. * Improve housing conditions by bringing isolated settlements into the mainstream utility networks, thereby In a number of areas policy approcches toward Roma enhancing their access to utilities and public services. that differ in focus and are more intensive than those While inhabitants should be charged for utilities, subsi- aimed at the majority population are justified. For ex- dies may be needed for low-income households. Other ample, specific interventions are needed to address the important measures could include clarifying property most immediate issues of poverty in settlements, low rights and introducing incentives for local governments school attendance, and lack of employment opportuni- and communities to provide services in settlements. ties. Because Roma comprise a large and increasing * Expand income-generating opportunities for Roma share of the Slovak population, the risks of inaction are workers by enforcing antidiscrimination legislation, re- high, including the growth of an underclass, which has ducing the nonwage costs of labor and other biases the potential to undermine economic growth and increase working against unskilled labor, and improving on-the- social inequalities. job training and re-training opportunities. * Increase the educational attainment of Roma by The multifaceted nature of poverty in Roma settlements reducing the barriers that keep children from starting also highlights the need for interventions that cut across school, addressing the language constraint, training policy areas. For example, a housing project could in- teachers (including Roma teachers and teachers' as- volve Roma in constructing and upgrading infrastructure, sistants), increasing preschool attendance, and facili- thereby providing participants with training in construc- tating secondary school attendance. tion, as well as employment, durin(g the course of the * Improve access to health care in remote areas by project. Similarly, an education project could include improving local infrastructure such as roads and tele- exposure to public health issues or the provision of so- communications; increasing outreach activities; and cial assistance support through school lunches and enhancing public health awareness, particularly about access to educational materials. reproductive health and contraception. * Address exclusion through antidiscrimination legis- Regardless of whether or not programs and policies are lation; public education and information campaigns; explicitly designated for Roma, Roma involvement in multicultural education; and training for public officials program design, implementation, and evaluation is es- such as mayors, health practitioners, and other public sential. Roma NGOs and the Office of the Plenipoten- servants. tiary for Roma Communities will be important elements * Improve access to credit, an important aspect of of this process. Non-Roma involvement is also critical. increasing opportunities for Roma and other low-income Roma who lack opportunities for interaction with other groups to engage in entrepreneurial activity. NGOs can Roma communities and non-Roma are cut off from wider play an important role in training and capacity building society, including the labor market. education, and a Partnerships between these organizations and banks wide range of public services. Increasing contacts and are needed to establish credit mechanisms. partnerships between non-Roma arid Roma will facili- * Reform social assistance to improve incentives to tate the inclusion of Roma and address the mistrust work and reduce the risk of falling into a dependency and miscommunication that limit local and community trap. Reducing disincentives to labor market participation development. is a reform priority for Slovakia. This could be achieved C 2002 The World Bank TRANSITION, March-April 2002 i. l: by adopting a scheme to phase out benefits so that other small enterprise activities has pursued one of the employed workers earning low wages would still be more successful antipoverty programs in the region. entitled to a smaller fraction of their benefits. The re- The success of Autonomia's projects, as measured by -,s '<-3 , form also needs to focus on enhancing the roles of the repayment rate of its loans, has increased greatly X C ,, social workers working with poor communities. For since it was established in 1990: in 1998 repayment ' C iimany Roma in the most isolated settlements, social rates reached nearly 80 percent, compared with 10 0 ° workers function as the main contact point with the percent during the first year. Autonomia attributes this - outside non-Roma world. Social workers can serve as improvement to the involvement of trained monitors, referral agents to other social services and provide in- some of whom are Roma, who work closely with project formation about employment opportunities, counseling, teams throughout the implementation process. , ( ,f 1land other types of support. Autonomia is now expanding its programs to other countries in the region, including Slovakia. - Hungary's Autonomia Foundation, which provides grants and interest-free loans to Roma entrepreneurs The full report is available on http://www.worldbank.skl undertaking livestock breeding, home gardening, and news.htm-romaseminar. The World Bank/IMF Agenda (continued) Continued from page 19 40 years). This project will increase the quantity of safe blood available at the busiest hospitals in the country's potential and could be a source of water for the entire main urban centers. The project will also extend the region. provision of safe blood services to other smaller hospi- tals in the country. Wolfensohn noted that a great deal of work would need to be carried out in such priority areas as developing the Romania: Rural Development, Adaptable Program countries' financial sectors, implementing legal reforms, Loan (APL), Phase 1: $40 million (grace period 4 years, and improving the investment climate through more trans- maturity 17 years). During the first phase of up to four parent regulation and investments in social infrastruc- years the project will focus on building local capacity for ture. According to Wolfensohn, aid to Central Asia as a making rural investments in a limited pilot area and pro- whole could reach $1.5 billion over the next three years. viding investment grant funding for road and water and sanitation subprojects. Total project cost is $53.42 mil- Recent World Bank Loans lion, including $8.78 million from the Romanian govern- ment and funding from local communities. Romania China: Sustainable Forestry Development, IBRD joined the World Bank in 1972, and since 1990 commit- Loan, $93.9 million, with $16 million Global Environ- ments to the country have amounted to more than $3 ment Facility grant (grace period 7 years, maturity 16 billion for 31 projects. The APL loan, approved by the years). The project's goal is to protect some of China's Bank's Board of Executive Directors in September 1997, most important remaining natural forests and associ- permits greater flexibility than traditional instruments for ated biodiversity. It also aims to protect vital watersheds supporting long-term, complex reforms and programs and reduce the risk of downstream flooding and to en- sure a supply of wood to meet China's growing demand Ukraine: Private Sector Development, Adaptable in a way that takes pressure off forests elsewhere in Program Loan (APL), Phase 1: $30 million (grace Asia. The forestry sector plays a critical role in the Chi- period 8 years, maturity: 20 years). The objective of this nese economy, providing 40 percent of rural household loan is to increase the competitiveness of Ukraine's energy, almost all the lumber and panel products for the enterprise sector, focusing on improving the regulatory large construction sector, and raw material for the large environment for private business, and to provide inten- domestic pulp and paper industry. sive training to Ukrainian business managers and con- sultants to support enterprise restructuring, in Vietnam: Regional Blood Transfusion Centers, IDA collaboration with the government of Ukraine. The first Credit, $38.2 million (grace period 10 years, maturity phase of the project will be initiated in four pilot oblasts- TRANSITION, March-April 2002 C 2002 The World Bank Chernovtsy, Khmelnitsky, Volyn, and Zhitomir-and will be Inspections included the distribution of World Bank loans. extended to further oblasts and enterprises in the second Russian prosecutors are still investigating what happened phase ($30 million). Since Ukraine joined the World Bank to a $4.8 billion IMF loan received in 1998 that some claim in 1992, commitments to the country have totaled more may have been laundered through a New York bank, said | than $3.4 billion for 24 operations. the head inspector of the Russian parliament's audit agency. i3 "This work is not finished," Stepashin said on April 20 on World Bank Loan Helps China Combat Russia's state-controlled Mayak radio. "The sum remains I ' 3 ° Tuberculosis very serious. It's more than $4 billion that we cannot seem .i to find." He predicted that the investigation by the Russian On March 21 the World Bank agreed to provide a $104 Prosecutor-General's Office would be completed this year. million loan to China to treat hundreds of thousands of , // people suffering from infectious tuber-culosis and support a Russian investigators have not commented publicly on the j sustainable work program for the o)untry's strengthened case. Stepashin also said that Audit Chamber investiga- National Tuberculosis Control Program. The U.K. Depart- tions had revealed financial violations by government offi- ment for International Developmenl is providing a £28.3 cials at the time the IMF loan was received in 1998, just million grant to enable the Bank loan to be on-lent to the months before Russia defaulted on tens of billions of dol- provinces at a concessional rate. Despite remarkable im- lars in debt and plunged into financial crisis. Stepashin provements in overall health status in the past decades, gave no details of the violations. The IMF has said that an China's health services remain inadequate and regional audit found no evidence that the Fund's loans had been disparities in access are large. Tuberculosis is the leading misused or involved in alleged corruption and money laun- infectious cause of death in China, with more than 400 dering. The audit came after U.S. federal prosecutors al- million infected people, and with 1.3 million new cases and leged in 1999 that the Bank of New York had served as a 150,000 tuberculosis deaths each year. conduit for $7 billion in Russian money. Some reports al- leged the funds included IMF loans. Albania in No-Man's Loan-Land IFC Helps Small Businesses in Romania The World Bank may cut back its aid to Albania over the next three years, as the country's economy has grown The International Finance Corporation (IFC), the pri- steadily and per capita income is now above the threshold vate sector arm of the World Bank Group, has invested for the world's poorest states. Between July 2002 and June $2.025 million to help establish Microfinance Bank 2005 the Balkan nation of 3 million people-according to MIRO S.A., a bank that:'will provide credit and other the World Bank's base-line scenairio-will receive $131 financial services to micro- and small enterprises in million from IDA, whose soft loans are destined for the Romania. The IFC investment consists of a share pur- poorest countries. This figure is lower than the $158.3 mil- chase of $2.025 million in MIRO amounting to 22.5 lion that Albania received in the previous three-year period percent of the bank's shareholding. The Bank's paid-in ending in June 2002. If Albania's economy performs well, it capital will be $9 million, which includes IFC's share will receive the same amount as it has during the previous purchase and investments by IFC's partners. the Eu- three years. Since Albania joined the Bank in 1991 it has ropean Bank for Reconstruction and Development, received some $570 million for 4:3 projects. As Eugen Deutsche Entwicklungsgesellschaft, CommerzbankAG, Scanteie, the World Bank representa..ive forAlbania, pointed and Internationale Micro Investitionen AG. out, GDP growth has been solid andl the income per capita ishigherthanthe$885 IDAthreshold. However, eventhough ...lnvests $25 Million in Bank of Shanghai Albania has posted annual growth of more than 7 percent in the last four years, it is not yet wealthy enough to qualify IFC has signed an agreement with the Bank of Shang- for the IBRD's "semi-commercial" loans. hai (BOS) to invest $25 million in the bank, raising its stake from 5 to 7 percent. BOS was established in Russia Probes Fate of 1998 IMF Loan 1995 through the merger of 99 urban credit coopera- tives in Shanghai. IFC's cooperation with BOS led to Based on Audit Chamber inspections, the misuse of fed- an IFC equity investment in 1999 for a 5 percent stake eral budget funds last year totaled Rub 14 billion, the in the bank, IFC's first investment in a Chinese bank. chamber's chief, former Prime Minister Sergey Stepashin, Since then BOS has made substantial progress in in- told the Duma's Budget and Taxes Committee on April 22. troducing international standards and best practices C 2002 The World Bank TRANSITrrON, March-April 2002 1, to improve the bank's corporate governance, manage- in Ho Chi Minh City, contributing to the building and ment, and processing. This new investment by IFC is operations of a new campus. This is the first foreign- 1' part of a capital increase undertaken by BOS. Also par- owned university in Vietnam. The Asian Development ticipating in the capital increase are the Hong Kong and Bank will also provide a loan of $7.25 million in support Shanghai Banking Corporation and the Shanghai Com- of the project. mercial Bank of Hong Kong for an equity stake of 8 and 3 * c percent, respectively. The investment of the two foreign The university will offer undergraduate and graduate de- li banks is significant, because it represents the first in- gree programs, English and other foreign language ' . vestments by foreign commercial banks in a domestic training, corporate training, and continuing education - ', :- eChinese bank. programs. It will be wholly owned by the Royal ' . Q S ll Melbourne Institute of Technology of Australia. This is I! ... and Supports Vietnam's Higher Education the first education project under the government of Vietnam's new law to promote foreign private invest- IFC has invested $7.25 million in the Royal Melbourne ment in the areas of health, education, science, and Institute of Technology International University, based research. No Deal Yet in World Bank Grants Versus Loan Dispute British and U.S. officials meeting in London in early have to be filled by a substantial increase in donor con- May again failed to agree on topping up the coffers of tributions. If overall development assistance budgets IDA, the World Bank's soft loan financing arm. The continue to shrink, sustaining a substantial grant win- last replenishment of IDA funds three years ago runs dow within IDA would not be possible. out on June 30. The two countries have been at odds since last year over the Bank's request for $12.5 billion U.S. negotiators asserted that IDA's high repayment of extra cash for IDA, which lends on highly record is not an accurate reflection of its financial situ- concessional terms to the world's poorest countries. ation. They said that in the past decade the Group of The United States initially proposed that IDA raise the Seven and others have agreed to forgive most or all the proportion of funds it gives out as grants to 50 percent. repayments due from earlier bilateral aid loans. IDA has become, in effect, a preferred creditor. Donor coun- For the World Bank this means that 50 percent of IDA tries have been willing to forego repayments of their old funds would be converted into grants. The rationale be- bilateral loans to ensure that debts to IDA can be re- hind this proposal is that many developing countries paid. U.S. Treasury officials also asserted that most cannot afford any additional debt. Loans to chronically foreign aid is increasingly being provided on grant terms: indebted and impoverished countries, even at low in- almost 99 percent of bilateral official development as- terest rates, mean debt build-up. In many instances, sistance from richer countries now takes the form of the U.S. administration argued, grants are a more ap- grants, up from 78 percent in 1989. Many of the coun- propriate way of providing assistance for long-term tries most resistant to IDA grants give most or all of needs. Investments in social sector programs are cru- their bilateral aid to poor countries as grants. They noted cial, but their growth effects are not realized until many that while the United Kingdom was strongly opposing years in the future, and thus generate little income to the concept of IDA grants, the U.K. chancellor of the help repay loans. exchequer had given a speech in New York supporting the establishment of a new multibillion dollar trust fund The United Kingdom is opposed to the U.S. idea and to address the millennium development goals by means is against allowing more than 10 percent of IDA funds of grants. to be given out as grants on the grounds that a large grants scheme would deplete IDA's resources over time. Several European countries have indicated they could go Backed by several other European countries, the United as high as 18 percent of IDA funds being given out as Kingdom argues that a switch to grants on this scale grants, but no deal has yet been struck. Delegates at the would deprive the World Bank of future income (about talks also discussed the possibility of using the grants in 40 percent of IDA's resources come from reflows from conjunction with other funding for global programs such previous loans). If IDA provided grants, this gap would as combating HIV/AIDS or helping countries emerging TRANSITION, March-April 2002 C 2002 The World Bank from conflict. This could be more acceptable to the New Books and European nations. N e c The U.S. Treasury has also hinted that it might increase W orking Papers a its contributions to IDA by 18 percent over the previous The Macroeconomics and Growth Group regrets that it IDA round. If performance benchmiarks were met, U.S. is unable to provide the publications listed. ; 0 CM contributions to IDA would be stepped up from $850 mil- a ' lion in the first year, to $950 million) in the second year, World Bank Publications ' .I i and to $1.05 billion in the third year. In this case IDA ' income would be reduced by only 4 percent over 20. ... . I,''-' To receive ordering and price information for World Bank l .' ,/ years. publications contact the World Bank, PO. Box 960 The U.S. government's performance targets are, how- Herndon, VA 20172, United States; tel.: 703-661-1580, The S ovenmetXs erfrmace arges ae, ow-fax. 703-661-1501, email: books@worldbank.org, URL ever, controversial, as they imply that a neutral method- . . http://www.worldbank.org/publications, or visit the World i ology for assessinBank InfoShop at 701 18th Street, N.W., Washington, countries can be found. Furthermore, warn some ob- D C t 701 18 Stet N. Wi servers, converting IDA loans to grants is only the first D.C., tel.: 202-458-5454. step on a slippery slope of implementing the recom- mendations of the Meltzer Commission. The commis- Working Papers sion, which reported to Congress in 2000, recommended http//econ.worldbank. org that the World Bank Group be transformed into a grant- Dominique van de Walle, The Static and Dynamic In-: making institution. It proposed that the World Bank cidence of Vietnam's Public Safety Net, WPS 2791, should cease making loans (except in certain circum- March 2, 2002 stances), focusing instead on special purpose grants, increased aid effectiveness, and evaluation of results, Vietnam's social welfare programs do not adequately proposals that some experts say seem to resemble the protect and promote the poor. Increased spending, with reform agenda of the current U.S administration. Adam better coverage and targeting, could help poor and vul Lerrick and Alan Meltzer, coaui:hors of the report, n erab ehold the a or's ana that stressed that grants would be linked to projects, moni- -e l h tored for results, and paid only for p)erformance. Despite coverage and payments to households are low and have had a negligible impact on poverty. In principle, better the similarities, U.S. Treasury officials deny that the targeting could improve the impact of current outlays administration's proposal was derived from the Meltzer The analysis also shows that the system was ineffec- W Commission's report. tive in protecting households that were vulnerable to shocks. Finally, the results suggest that even though: Treasury Secretary Paul O'Neiill however, has argued thrisageercnnrtonfpvry-ltdpo- that the World Bank could be more effective if it gave grams and greater household participation in poorer cor- money to health, education and sanitation projects in grams, greater send parei(absorer com- munes, the system spends more (absolutely and the developing world, instead of lending money to gov- relatively) on the poor in richer communes. ernments that sometimes waste the resources." Re- .re ely Domnihep in rer c munes. To order: Dominique van de Walle, email: dvande I C sponding to such criticisms the World Bank's recent walle@worldbank.org- study, "The Role and Effectiveness of Development As- sistance: Lessons from World Bank Experience" by Adam Wagstaff, Inequalities in Health in Develop- Rogers Halsey, pointed out: "Project outcomes, as mea- ing Countries: Swimming against the Tide? WPS sured by the World Bank's independent Operations 2 0 Evaluations Department, have improved sharply over the 2795, February 2002, 40 pp. past decade The Bank increased the share of projects rated as satisfactorily attaining key project objectives Large inequalities in health are apparently not associ- ated with large inequalities in income or with small shares , from well below 60 percent in the late 1 980s to above 80 of publicly financed health spending. They are, however, percent today." associated with higher per capita incomes. Health inequali- ties rise with rising per capita incomes partly because Source: World Bank, Reuters, Varder Caceres Salazar from Bretton Woods Project. Continued on page 59 W C) 2002 The World Bank TRANSITION, March-April 2002 Z s-~ " Articles provided by: .. - /,Local Government TV -e.:is 8§t and Public Service Open So Institute *.-E O .: Reform Initiative C,;-. . 116The spring 2002 issue of the Local Government Brief, published by the Local Government and Public Service d jx ,.:. continue to grow over the coming years. In 2001 the EU highest priority, it should not surprise us if we find it contributed 63 percent of Estonia's total foreign aid. To difficult to establish a positive causal connection be- ^^-t datethePHAREprogramhascontributedatotalofE253 tween aid and development." In addition, as T. I, million of aid to Estonia, most of which has gone to the Carothers observed in his 1999 report entitled "Aid- f ' 3 education and financial sectors, social services, social ing Democracy Abroad, the Learning Curve, foreign integration, and governance. Since 2000 another EU aid evaluations tend to focus more on outputs than - ; . .-;- * program, the Instrument for Structural Policies for Pre- on effects. That is, they tend to look at what activi- ~jI.iN g 1 Accession (ISPA), has also become a significant donor ties the project sponsored, how many people were W < fglis 7 TRANSITION, March-April 2002 (C) 2002 LGI/OSI D 2002 The World Bank dS.t. TRANSTION, Mal-prl20 t3C - ' trained, what equipment was donated, how many next. Also many aid administrators are resistant to criti- consultant-days were used, and so forth, instead of as- cal reflection. Foreign aid is a competitive business. sessing the real impact of aid, for example, whether civil Donors are not motivated to share their knowledge and servants performed better, decisionmaking became more best ideas with each another or to make critical reviews cM o transparent, local democracy developed, and so on. of their own performance public to the extent that, even if they produce reports for external consumption, such Experience has shown that not all foreign aid has been publications are usually public relations efforts and not 3 ° used to fulfill the goals that were stated when giving the objective overviews of lessons learned. This lack of ac- C aid. For example, A. Tucker, in his similarly titled study, cumulated knowledge about foreign aid has negative published in 1995, provides shocking evidence of cor- consequences for both donors and recipients, and the ruption and greed in Western academic aid to Eastern extent of cross-learning among different regions or among Europe. Several foreign aid plans allocate substantial different sectors or programs in recipient countries is amounts of money for foreign consultants, which makes insufficient. This leads many organizations to constantly the total sums of aid look good, but critics have ques- reinvent the wheel when they embark on new projects. tioned the real impact of such consultancies on achiev- ing the stated end results. As Alan Mayhew put it in the In some cases in Estonia donors have gone as far as to "EU's Policy toward the CEE": "The member states of start large-scale projects in fields they have already the European Union tend to regard PHARE as an em- worked on in the recent past without any systematic ployment program for their own ccnsultants." analysis of the results of previous projects The evalua- tion of PHARE public administration reform programs Difficulties in evaluating the impa,,t of foreign aid are conducted by an independent agency in 1998 indicated closely linked to a number of broader problems. The that the three PHARE projects mentioned earlier were first is the lack of policy planning and strategic man- not integrated with each other. There was no sign of agement in the recipient country or organization. lessons learned from previous failed projects and there There is little donors can do if recipients do not have was no synergy between them. The evaluation also failed clear policies and strategic management in place. How- to discover any links with other programs launched with ever, recipient countries or organizations should identify the help of foreign aid that addressed the same issues. their own priorities and set realistic goals and action plans in order to specify the need for external aid to The third problem is donors' poor knowledge of a donors. If the objective of aid is to have a real impact on recipient country or organization. Often short-term for- a country's development, then foreign aid should be part eign consultants are poorly informed about the country or of existing plans. Even if strategic. goals are in place, organization for which they are consulting. This leads to aid recipients may have problems in communicating their a situation where many aid providers seem to have uni- needs to donors. The 1998 evaluation of PHARE public versal models in mind on how to promote changes in administration reform programs indicated that the three their respective field, be it the development of a market PHARE projects that had addressed public administra- economy or democratization. The general idea behind tion reform in 1993-95 had failed because the Estonian such universal models seems to be an understanding government did not have a coherent concept for public that the use of the same template, including institutions administration reform at the time the projects were de- and processes, can lead to similar positive consequences signed and implemented. in each country. Thus consultants' recommendations can easily be biased toward their own limited experience of The second problem is a lack of information and their home countries or gleaned from a few recipient coun- failure to learn from previous aid programs. Some tries in which they previously worked. Many foreign con- of the more experienced people and organizations are sultants are unaware of the variety of different approaches gaining considerable expertise in aid administration and employed in countries other than their own. Aid providers in particular countries' problems; hiowever, they rarely promote what they know best, which is almost always share their knowledge in written form, and when they do their own country's approach to a specific issue. More- it is usually only for their own internal use. People in the over, consultants sometimes introduce idealized models business of dispensing foreign aid are much more in- that do not work in their own countries clined toward action than retrospective reflection. Bu- reaucratic imperatives reinforce this tendency, above all, Foreign consultants should have broad comparative the pressure to keep moving from one project to the knowledge about their topic and should be given enough © 2002 The World Bank © 2002 LGI/OS1 TRANS] I ION, March-April 2002 s ,- 'itime to learn about the recipient country or organiza- understanding different actors'interests and actual power il tion. In this regard long-term consultants are more likely is imperative. Often foreign aid cannot substantially 1! to succeed than short-term consultants. Aid recipients modify an unfavorable configuration of interests or coun- C h' .= should be able to identify precisely what they want from teract powerful local actors. Nevertheless, aid can some- t I ag jl! donors and particular consultants. Only in this way they times affect interests and power in minor but worthwhile ^ -O s 1' can avoid "one size fits all" solutions. ways by changing particular actors' perceptions and 1-t , g !,1 knowledge. For example, by realizing that central gov- *c 1 The fourth problem is the missing link to power. ernment officials are likely to oppose decentralization , Often the objective of foreign aid is to reshape institu- because they fear a loss of control, aid providers can - tions, laws, or procedures in transition countries, but design training programs for senior central government this remains a self-contained effort. For example, merely officials and politicians rather than simply training local sponsoring the writing of new laws barely scratches the government officials. - . surface. The new drafts are often not enacted into law, or if they are, the relevant state institutions usually lack To sum up, donors and their local partners should iden- the capacity to implement or enforce them and no bud- tify the key players in society-politicians or senior ad- getary provisions are made to pay for the costs of imple- ministrators-who are likely to be of help in implementing mentation. Reform projects that are funded, planned, plans or policies developed with the assistance of for- managed, and evaluated by foreigners are only occa- eign aid. These key people should be involved in the sionally backed by real commitment from those in the foreign aid project from the earliest planning phase, recipient countries. Local decisionmakers may feel a thereby increasing their commitment to and ownership lack of ownership of foreign aid programs, because these of a particular project. Clarifying the responsibilities of are likely to be disconnected from the important exist- donors and local leaders would also be useful, for in- ing institutions in a given society, namely, politicians, stance, who is responsible for making changes happen, top administrators, or influential lobbying groups. For- to avoid later disillusion. No simple remedies are avail- eign aid initiatives that are aimed at local government able that donors and aid recipients can use to make the reform should have a clear understanding of local power foreign aid process more efficient. Both need to bear the relationships. problems in mind to make foreign aid more useful and rewarding for both parties. Promoters of democracy have often acted on the as- sumption that a key obstacle to democratization in coun- The author is head of the Department of Public Admin- tries coming out of long periods of authoritarian or istration, University of Tartu, Estonia. She can be con- totalitarian rule is an overly strong central government. tact by email at mailto:randma@ut.ee. They have oriented their work to strengthen NGOs and local governments, and thereby counterbalance the domi- nant power of the central government. Thus the core of Cost Effective Health Care many decentralization projects is the provision of train- ing and technical assistance for local government insti- tutions and officials, including technical skills pertinent to local government work, such as the design and imple- mentation of local elections, service delivery, budgeting, resource mobilization, and project planning and man- agement. While decentralization raises many economic, admin- istrative, and social issues, it is above all a political issue. It is about power, about whether those holding most of it in society are willing to give significant por- tions of it away. Even when a country is in a demo- "That man who's telling you to get up isn't a cratic transition, the leading holders of power and miracle healer but a clerk from the health central government officials are usually reluctant to insurance company." devolve real authority to local governments. Therefore for foreign aid to have a real impact, identifying and From the Czech magazine Slovo TRANSITrION, March-April 2002 © 2002 LGI/OSI C) 2002 The World Bank Dancing with Donors: Opportunities for NGOs , By Kenneth Davey K X This is not an objective analysis by an unbiased source. It is full of the prejudices of a writer who for the K last 30 years has been part of l:he donors' mercenary army of consultants, their salaries paid from the 1 e g fees earned from donors' advisory and research projects and scholarships, working for the U.K. Depart- i X ment for International Development (DFID) and in 18 countries for the World Bank. Donors take themselves incredibly seriously. They have bad guys, for reform or against reform. Consultants rarely to justify themselves to their own funders, whether do- give adequate weight to the political costs of their rec- l -/ mestic taxpayers or charitable givers, and habitually ommendations or to the need for user-friendly explana- exaggerate their own influence and usefulness. Never- tions and dissemination. theless, they are important, individually or collectively. They deploy considerable resources, which have an The financial resources donors deploy vary not only in impact, good or bad, on the poliiical, economic, and volume, but also in their net addition to the recipient social development of recipient c;ountries. These re- economy. Some programs look far less generous once sources are intellectual and political as well as finan- expenditures on donor personnel are deducted. Another cial. Thus NGOs concerned with social and economic factor that is difficult to measure is the hidden costs to development in recipient countries cannot ignore donors. the recipient of the time and administrative attention expended in negotiating with donors. The World Bank, Understanding Donors for example, lends large amounts of money, but levies a heavy cost through its demands for data and discus- Donors claim to know what is best for the country they sion. Transaction costs are even heavier in the case of are seeking to aid. They base this riot only on their good EU funding, but at least it comes in grant form. Even intentions, but also on their intellectual resources and though the process of obtaining EU funds is exasperat- their access to international expertise and experience. ingly protracted, it does provide some Central and East- The organization of this expertise varies. Sometimes it ern European governments with far greater investment is in-house. The World Bank has a huge apparatus of finance than they have been able to generate from other sectoral policy and research departments, while the DFID sources. employs a growing army of advisors, backed up by ex- ternal resource centers." The EU, by contrast, employs Donors habitually apply pressure for the adoption of par- few specialists directly. All depend on consultants to a ticular reforms and measures, whose success is also varying extent. variable. Donors' ability to overcome domestic skepti- cism or political and bureaucratic inertia is limited ex- The quality of these intellectual resources is highly vari- cept in crisis conditions (usually fiscal). Donors are able. The best are represented by teams who develop probably most effective when supporting a reform agenda long-term familiarity with particular issues and regions, actively promoted by domestic factions; they come in collaborate extensively with local specialists, and try hard useful as scapegoats. The incentives for complying with to develop locally appropriate solutions as well as the donor pressure are rarely only the access to their money. capacity to sustain them. The worst are the "body shops" The prospects of accession to the EU has undoubtedly that parachute in expertise in prepeickaged systems. In- overcome political obstacles to much reform that has house staff of the multilateral agencias tend to be long on had strong but insufficient indigenous support. academic qualifications and short on hands-on experi- ence. A besetting sin of donor staff and consultants alike Donor interventions are subject to various constraints is adherence to fashion. World Bank staff, in particular, and conflicts of interest. They obviously have set agen- have always been overcritical of the solutions they have das. DFID programs are heavily influenced by U.K. De- promoted in the past and overoptimistic about those they velopment Secretary Clare Short 's concerns about are proposing now. They are often prone to simplistic poverty and social exclusion. Cutting public expendi- perceptions of national situations, with a Hollywood refer- ture and economic liberalization are hallmarks of the ence frame within which people are either good guys or IMF's standard prescription. Donors also tend to have © 2002 The World Bank C 2002 LGI/OSI TRANSITION, March-April 2002 standard tricks of the trade: the IMF always sells trea- the recipient country. Occasionally, but increasingly, the sury systems; the DFID likes to set up civil service de- roles are reversed, with tenders open only to host coun- c D _ ,partments; and the U.S. Agency for International try organizations with international consultants playing o 0 Development (USAID) has a worldwide crusade to pro- a supporting role. m. I.' mote municipal bonds, with dire consequences for some to C CM 1' municipal budgets. Competing for and managing donor consulting contracts 3 ° G 1'; is a demanding business, requiring the ability to identify c , Some donors are hamstrung by the jealous eyes of their opportunities, compile tenders (often at short notice), own masters. Congressional paranoia holds the USAID and comply with complex procedures. It is a game in in thrall; accusations about nepotism in the award of con- which local subsidiaries of international consulting firms tracts often bring EU programs to a standstill. Nor are like PriceWaterhouseCoopers or KPMG have a strong donor agencies necessarily more cohesive than other large comparative advantage. Some of the indigenous think 9, organizations. The World Bank 's macroeconomists urge tanks have geared themselves toward this market, sup- governments to cut public spending, while their sectoral ported in a number of cases by the Open Society Insti- departments lend ministries money to increase it. tute. This presents the nongovernmental sector with a growing opportunity not only to do lucrative business, Thus donors are at their worst when trying to impose but more significantly, to influence national development standard policies and practices taken from "home" ex- by working directly with donors. NGOs with strong pro- perience. They are at their best when supporting host fessional networks could exploit these opportunities for expertise in the analysis of options, acting as partners themselves as organizations or for their specialist col- but not dictators in the development and application of laborators by entering the tendering game or allying them- reformed policies and practices. At the risk of cliche, selves with firms and organizations who are already this is an interactive and exploratory process, requiring playing it. a readiness to listen and defer to others, which meshes uneasily with the innate arrogance of the donor role. Access to Opinion Generally donors are more vulnerable than they seem, more anxious about criticism and underperformance than Donors and their consultants are often isolated from they would admit, and more open to constructive coop- public contact and opinion. They interact with sections eration with organizations and individuals who gain their of the bureaucracy and are informed almost entirely by confidence. its perceptions and interests. They may be uncomfort- able about this, but lack the opportunity, contacts, or Roles for NGOs mandate to test their analysis or recommendations against other sources of information and opinion. Direct In some spheres NGOs are now seen as natural part- contact with known critics and opponents of the govern- ners in the design and implementation of official pro- ment may be diplomatically unacceptable. grams. This is mainly in the social sector, where NGOs often have special expertise in particular mental and Politically neutral NGOs can be helpful in such situa- medical conditions and can mobilize community re- tions by providing an acceptable forum for debating is- sponses to supplement government resources. In poorer sues and ideas with a wider audience. Roundtables, countries and communities NGOs may also be seen as workshops, and seminars organized by universities or partners in the development of physical infrastructure, civil society institutions may provide opportunities for off such as water supply, irrigation, or waste management the record discussions where participants are not inhib- ited by the need to take an official position. In such spheres donor programs are increasingly built around partnerships between government and NGOs. Trying out innovations in the public sector is often diffi- There is a far wider tendency, however, for donors to cult, because they require changes in the law or in bud- include national resources in the design and execution getary practices. Introduced nationwide, the cost of of their programs. Donor projects are typically executed failure may be severe. NGOs may have the capacity to by consultants chosen through public tender. Interna- experiment with fewer legal and bureaucratic impedi- tional consultants, or consultants from the donor coun- ments and very localized risk. Thus they may offer do- try under bilateral aid, are increasingly mandated by terms nors more flexible test beds for reformed policies and of reference to tender in harness with an organization in practices. T1ANSIm-ON, March-April 2002 © 2002 LGI/OSI @ 2002 The World Bank NGOs may also reach the point where dancing with Conclusion donors means totally opposing the content or execution of donor programs. Being nongovernmental should en- Communication between NGOs and donors does not able organizations to express outright opposition to do- need to be confined to the exchange of petrol bombs nor interventions that they believe are detrimental to and tear gas on the streets of Genoa. More con- national interests. The positive linkages suggested in structive channels are available and both parties may > C this article should help avert the need for this, but they be increasingly ready to explore them Donor orga- 3 should not weaken NGOs' ability to voice criticism where nizations are less monolithic and more self-critical x other methods of influence have failed. than they appear to the external world. Opportuni- ties for positive engagement with a wider range of NGOs' may well feel powerless ag3inst the combined expertise and opinion within host countries are in- forces of donors and government, but many NGOs are creasing. This is a chance for NGOs to become a part of international networks that may well take up their more constructive force in national affairs, but ex- cause with greater effect, particularly if the experience ploiting it requires more than passionate commitment. is replicated elsewhere. Local government associations, Professionalism in the justification and presentation for example, have an independent line to Brussels of ideas and in the cultivation of contacts is also through member state associations and the Committee essential. of the Regions. What is important, however, is a well- presented case. Evidence of the detrimental impacts of Kenneth Davey is a member of the LGI Steering Com- donor approaches needs to be well documented and mittee and a lecturer at the Institute of Local Gov- accompanied by alternative solutions to the problems emient Studies, University of Birtningham, U.K. He donors are addressing. can be reached by email at k.j.davey@bham.ac.uk. The EU's Refoirm of External Aid By Claus Schultze The EU is one of the major actors involved in international programs have acquired a reputation for slow and unre- cooperation and development assislance. The EU and sponsive delivery services, poor quality, and excessively its member states provide some 55 percent of total offi- centralized and rigid procedures. This is why the Commis- cial development assistance and more than two-thirds of sion, as part of its wider administrative reform efforts, is international grant aid. In addition to being the largest currently engaged in revamping its external assistance poli- donor of humanitarian aid in the world, the European Com- cies, programs, and procedures. mission manages roughly 10 percent of official develop- ment assistance worldwide, amounting to E9.6 billion in In its 2000 report "Communication on the Reform of the 2001. One-third of this aid goes to Africa, the Caribbean, Management of External Assistance," the Commission and the Pacific islands and two-thirds goes to Central outlined its reform program. Since then it has published and Eastern Europe and the newly industrializing states, two annual reports describing the progress achieved and the Balkans, the Middle East, the Mediterranean coun- pointing to the challenges that lie ahead. tries, and Asia and Latin America. In total, the EU finances projects in more than 140 countries. Unlike many other One of the cornerstones of this reform agenda has been to EU funding programs, such as agricLilture and structural unite the project cycle-from identification to evaluation- funds (which are administered largely through the EU under one roof by creating the Europe Aid Cooperation member states), the EU's external assistance is directly Office (AidCo). Until AidCo's creation in 2000, a complex managed by the European Commission. and fragmented structure of different layers and geographi- cal units within the administration and outside external The growing importance of the EU's role in external assis- bodies devised and managed aid. Since then, large seg- tance has, however, not been matched by appropriate ad- ments of the programming responsibility have been trans- justments in human resources, structures, and ferred to AidCo. This new organization has also absorbed management capabilities. Hence its external assistance the contracting responsibility, which was formerly split c 2002 The World Bank © 2002 LGI/OSI TRANSIrIION, March-April 2002 between the Public Service for External Relations and a Development Strategies, a London-based development large number of technical assistance offices. It has also consulting firm, recently pointed out that the welcome taken over the implementation and evaluation tasks of increase in aid disbursement since the creation of AidCo o - . ^ '" g 1l the now largely disbanded technical assistance offices. has often been accompanied by a further deterioration on the ground and a weakening of the prominent poverty fo- . 0- c The Commission's Directorate General for External Re- cus of EU aid. It added that improving this situation will * - wi lations and Directorate General for Development Aid are depend crucially on the Commission's ability to learn from -- ;Q s now largely responsible for elaborating the strategic frame- past mistakes and create an atmosphere of open debate ,il works (country strategies) within which AidCo operates. and dialogue (European Voice, March 21-27). With the exceptions of pre-accession aid and the EU 's , humanitarian aid, AidCo is now responsible for the prac- With the creation of AidCo the Commission clearly took tical side of most EU external aid operations, that is, a step in the right direction and demonstrated its de- *. identifying and preparing projects and programs, mak- termination to focus on the right issues and continue ing financing decisions, implementing activities, and to reform its disbursement practices. Thus the institu- monitoring and evaluation. tion is likely to live up to the quality standards set by I other donors. It should make progress in its efforts to -- . >m-' I Another cornerstone of the EU 's external assistance re- coordinate the EU's external relations policies and pro- form is large-scale devolution of project management to grams and those of its member states, a task that the Commission delegations in the beneficiary countries, requires not only administrative reform, but the good- which will have more responsibilities for allocating and will of all the ministries and governments involved. managing funds tailored to local needs. The Commission is also seeking to enhance the transparency and visibil- The author researches EU govemance at the Free Uni- ity of its activities and management practices, and to this versity of Brussels. His email address is: claus. end has improved and extended its Internet services. schultze@vub.ac.be. ^ Bank of Finland Institute for Economies in Transition Current Issues in Pension Reform in the Baltic Countries By Tuuli Koivu The Baltic states inherited pay-as-you-go (PAYG) pen- three-pillar system that would ensure long-term sion systems from the former Soviet Union. Under a affordability of the welfare system while preserving an PAYG system, those who work pay for current pension- adequate social safety net for all citizens. The first pillar ers' benefits. These systems rapidly became unsus- would be a scaled down PAYG system. The second pillar tainable after independence because of demographic would be a fully funded system of privately managed sav- shifts, whereby populations are aging (see the figure) ings accounts financed from payroll taxes. The third pillar and birth rates are falling, and rising unemployment. Given would be based on voluntary pension fund contributions. the absence of a strong link between their contributions and their benefits, employees had little incentive to pay The first pension reforms involved downsizing PAYG PAYG taxes. The Baltic states soon realized that their systems by raising the retirement age, eliminating ex- pension systems could no longer guarantee pensioners tra benefits, and strengthening the link between contri- iig.~ , *1 a sufficient standard of living. In the second half of 2001 butions and benefits. Next the voluntary pension scheme , S, ,,the average monthly old-age pension was just E102 in was created in 1998-99. Even though contributions are ,Z' .^ Latvia, E101 in Estonia, and E89 in Lithuania. tax deductible, voluntary schemes have yet to become popular. In Latvia, which has made the most progress, The Baltic countries started to reform their pension as of September 2001 only 9,100 people were partici- .;. ' - schemes in the mid-1990s. The objective was to adopt a pating in private pension plans. TRANSITION, March-April 2002 © 2002 BOFIT C 2002 The World Bank .. . Proportion of the Population Aged 60 Years and may also improve the efficiency of labor markets. The z } Older, Selected European Countries, 2000 and 2050 model is expected to stimulate savings, which could in- 5 Percent crease investment in projects that irnprove productivity . so However, empirical data offer little to support this optimis- i 45 - _ _ _ tic view. Proponents of three-pillar systems even claim' Il 3 4 2000 _ _ - l that they will accelerate the development of financial, j 0 'a 30o markets, but regulations constraining investment are likely 3° 25 - -J- |_| -t - -[ | Q -i _ to limit the impact of such systems on capital markets. 5 andII I the system's high administrative costs, but the most ~il~ diffficult problem in pension reform by far is financing the ' ¢ s; < o s a, 3t E - ,t, transition costs. The more workers who participate and - L :1 X , n n9 the larger the contributions to the second pillar, the higher Source: United Nations, World Population Prospects: the transition costs. The Baltic countries estimate that The 2000 Revision. the transition will cost 0.5 to 1 percent of GDP annually for 5 to 10 years. They will likely finance part of the costs Latvia's second pillar has been in place since July 2001. from privatization funds and borrow the rest. Lithuania Second-pillar contributions are mandatory for employ- has considered borrowing from the World Bank. Thanks ees under 30 and optional for those aged 30 to 49. Few to their relatively modest external debt levels, borrowing have chosen to participate in the scheime. Contributions should not cause any problems in the Baltic countries. will rise gradually from 2 percent of income in 2001-06 to 10 percent from 2010 onward, and contributions to The author is an economist at BOFIT This article was pub- the first pillar will be reduced propornionally. The Trea- lished in the January issue of the Baltic Economies-Bi- sury will initially manage second-pillar funds to reduce monthly Review and is available on http.//wvwwboffiVbofl/. administrative costs. The funds will be primarily invested in state securities and bank time derposits. As of 2003 Research Scholarships participants will have the right to choose who will man- age their savings from among a group of reputable in- The Bank of Finland's Institute for Economies in Transition vestment companies licensed by the state. (BOFIT) is looking for visiting researchers for 2003. BOFIT conducts high-level research on transition economics and In Estonia, workers born during or after 1983 will start monitors economic developments in Russia and the Baltic making mandatory pension fund contributions in July states. The research focuses on (but is not limited to) issues 2002. They will pay 2 percent of their income and the related to macroeconomic performance, the public sector, and Tax Board will contribute 4 percent or a fifth of the 20 financial markets in transition economies. The institute pub- percent social tax that employees currently pay under lishes two research-oriented discussion paper series and the first pillar of the social security sy,stem. The state regular economic reviews. Scholarships for two to six months will cover payments transferred from the Tax Board. are available for 2003 for high-level research projects in areas pertinent to the institute's research objectives. Lithuania has yet to pass legislation on its second pil- lar. Under a Cabinet proposal the second pillar would Those interested in applying are invited to send a brief research take effect in 2004. The system would require workers proposal, a curriculum vitae detailing their academic and re- up to 30 years old to contribute 5 percent of their in- search background, the names of two or three references, and come to the second pillar. a copy of an earlier paper selected by the applicant to Bank of Finland, Institute for Economies in Transition, PO. Box 160, Three-pillar pension systems should provide a higher rate Helsinki, Finland; fax: +358-9-183-2294, email: bofit@bof.fi. The of return on savings than PAYG systems, and thus allow deadline for applications for the 2003 program is June 14,2002. the state to provide the present level of benefits without raising the contribution rate, even when the number of For further information contact likka Korhonen, Research Su- pensioners increases and the number oF employees de- pervisor, tel.: +358-9-183-2986, email: iikka.korhonen@boffi, clines. By providing a clearer connection between life- or Jouko Rautava, Acting Head of Institute, tel.: +358-9-183- time contributions and pension benefits, the new system 2297, email: jouko.rautava@bof.fi. © 2002 The World Bank © 2002 BOFIT TRANSI FION, March-April 2002 Articles provided by: c O ffi SITE Stockholm Institute of Transition Economics STOCKHOLM SCHOOL OF ECONOMICS 0. oSs The Great Divide and Beyond: Financial Architecture in Transition By Erik Berglof and Patrick Bolton A growing and deepening divide has opened up between countries where economic development has taken off and those caught in a vicious cycle of institutional backwardness and macroeconomic instabil- ity. This "great divide" is apparent in almost every measure of economic performance, such as GDP growth, investment, government finances, growth in inequality, general institutional infrastructure, and increasingly in measures of financial development. Countries that have made it to the "right" side of the while most transition economies remained mired in re- divide (Hungary, Poland, Slovenia, the Baltic states) have cession and economic decline. Some countries experi- pursued a remarkable diversity of policies aimed at fi- enced financial development, at least as traditionally nancial development. Yet strikingly, the basic financial measured, without economic growth. Indeed, in several architecture of these front-runners today is remarkably cases financial development undermined real sector similar: strongly dominated by commercial banks, in- development. Other countries grew without much finan- creasingly foreign owned, that lend primarily to govern- cial development. In general, the financial sector has ment. Stock markets are highly volatile and illiquid, and played a small role in restructuring the manufacturing their sustainability is in question as the numbers of listed sector in the transition countries. firms are stagnating, or even falling. Enterprises rely most on internally generated funds, and essentially all exter- We find that the great divide opened up in the wake of nal long-term finance comes from foreign direct invest- price liberalization and the ensuing banking crises and ment. bailouts. It was governments' ability to achieve macro- economic stability and fiscal responsibility, together with The great divide in economic and financial development a commitment to refrain from excessively bailing out [_ and the convergence in financial architecture among the failing banks or loss-making enterprises, that determined successful countries raise fundamental questions of how whether economic andfinancial development took off. In institutional reforms and financial development have in- other words, strong government with a sound fiscal base V: i teracted with economic growth. Does financial develop- is the main predictor of positive future economic perfor- ment lead to economic growth, or do financial institutions mance in transition economies. and markets develop in response to pressures from the real sector? Or are both financial development and eco- Fiscal responsibility promotes both financial develop- nomic growth driven by some underlying variable? Is ment and economic growth through two important chan- skipping stages of financial development possible, or nels: first, it limits the extent of crowding out of private must all countries go through a phase of bank-oriented investment by government borrowing; and second, it financial architecture? Financial transition represents a lends credibility to the government's undertaking to unique opportunity to shed new light on these important maintain macroeconomic stability, an essential condi- issues. tion for private investment. No doubt specific initial con- ditions and underlying country characteristics facilitate Needed: Strong Government with the emergence of strong and fiscally sound governments a Sound Fiscal Base capable of enforcing the rule of law. We conclude that financial development does not ex- The convergence in financial architecture among the front- |plain why a small group of countries developed and grew runner countries is consistent with a view in the literature TRANSI IION, March-April 2002 C 2002 SITE C 2002 The World Bank that suggests a link between the level of economic ness of government and fiscal irresponsibility that un- development and the design of financial systems. Coun- dermine financial development. tries that have attempted to jump-start the develop- * Western Europe can play an important role in provid- ment of financial markets have all reverted to more ing outside anchors for the financial and economic de- X bank-oriented financial systems. In a weak institutional velopment of transition countries. The process of X , environment, depositors must be convinced that banks accession to the EU has made a critical contribution will not abscond with their money or become involved in to relieving domestic political constraints in the transi- - excessively risky projects. This may also help explain tion countries of Central and Eastern Europe. The pres- whybankslendtogovernmentsratherthantoenterprises. sure to meet the criteria for EU membership was essential for the adoption and enforcement of laws and Lessons Learned regulations and for building basic institutions. Perhaps even more important, the widely shared aspiration to Ten years later, we can point to a number of lessons rejoin Europe has given strong direction to, and strength- learned, namely: ened the commitment of, the governments of these * One of the most striking observations of the past de- countries. Providing such anchors for the countries on cade of financial transition is the irnportance of fiscal the wrong side of the great divide is a major challenge discipline at the initial juncture. This is the critical point for the future. when the great divide opens up. * Countries on the wrong side of this divide become Erik Bergl6f is the director of SITE. Patrick Bolton is a caught in a vicious circle of macroeconomic instability professor of economics at Princeton University. For the and repeated relapses in financial development. At best full version of this paper see the Journal of Economic financial development in these countries has little effect Perspectives, vol. 16, no. 1, Winter 2002, pp. 77-100. on economic growth, and may even be counterproduc- tive by softening firms' budget constraints. * By contrast, in countries on the right side of the great Enlargement and Beyond: Baltic Rim Heads of divide financial development seems to have been posi- State Address Stockholm Confer-ence on Baltic tively correlated with economic growth. Sea Region Security and Cooperation * Despite a great variety of financial transition policies pursued in these countries, their finzincial architecture SITE joined the U.S. Embassy in Stockholm, the Swed- appears to have converged to a bank-based system with ish Institute for International Affairs, and the Stockholm substantial foreign ownership. International Peace Research Institute in hosting the * On the positive side, the financial sector has contrib- Sixth Stockholm Conference on Baltic Sea Region Se- uted to hardening budget constraints, but on the nega- curity and Cooperation, held at the Stockholm School of tive side, banks have not yet begun extending significant Economics on April 24, 2002. long-term finance, nor have they actively promoted re- structuring in the industrial sector. This series of highly regarded annual events gives politi- * Even though the transition process is, in essence, a cal and economic leaders from Russia, the Baltic states, problem of institutional reform and build-up, the early EU member countries, and the United States an oppor- economic literature on transition mainly took a macro- tunity to explore ways to create a safer and stronger economic perspective, emphasizing price liberalization Euro-Atlantic community. This year the meeting featured and policies toward stability. Ironically, even though this keynote speeches and two panel sessions that ad- perspective has been criticized for ignoring underlying dressed the relationship between Russia and an enlarged institutions and the role of the financial sector in devel- EU, the Common European Economic Space, and an opment, the financial transition pattern of the past de- expanded NATO. cade suggests that the focus on macroe!conomic stability and fiscal responsibility turns out to have been well placed. Featured speakers included Polish President Aleksandr * Sound government finances create favorable condi- Kwasniewski, Lithuanian President Valdas Adamkus, tions not only for financial development, but also for proper Swedish Prime Minister Goran Persson, German Deputy enforcement of the law. Writing new laws or transferring Defense Minister Walther Stutzle, and U.S. Deputy As- them more or less wholesale from abroad is relatively easy. sistant Secretary of State Heather Conley. Reginald Dale Ensuring proper enforcement is much more difficult. In our of the International Herald Tribune moderated the two view lack of enforcement emanates from the same weak- panel sessions. (C 2002 The World Bank © 2002 SITE TRANSITION, March-April 2002 ;- 'The Latvian Labor Market: Signs of - i *Normalization? : X .- By Morten Hansen and Romans Pancs , L B'(. 11 * ' ' t: !!How does one define the emergence of a normal market economy? Preliminary results on the behavior * w '4@q ,of the Latvian labor market suggest that the 1998 Russian ruble crisis marked a turning point in normal- ization, according to a report by the Baltic International Centre for Economic Policy Studies (BICEPS), which studied this issue in collaboration with the Centre for European and Transition Studies at the 11i University of Latvia. Anyone who has worked with transition economies will Throughout 1997 and into 1998 Latvia had enjoyed high be familiar with the difficulty of finding stable macroeco- growth rates of 6 tolO percent per year, but growth nomic relationships, and often of obtaining data to esti- dropped sharply in the third and fourth quarters of 1998, mate such relationships. Besides being annoying for and was negative during the first two quarters of 1999. researchers, this poses a serious impediment to Then the economy rebounded, and since 2000 growth policymakers. Thus an important question is the extent rates have again been sizable, suggesting that the ef- to which a transition economy has "normalized," that is, fects of the Russian crisis are essentially over. to what extent have certain standard macroeconomic relationships emerged and become stable. Here we do The unemployment rate, having hovered around 6 or 7 not offer any general definition of normalization or of how percent from 1995 through mid-1998, increased for 10 to test it, but in a tentative search for normalization we successive months starting in July 1998 and ending in look at one specific case related to the Latvian labor April 1999. Thereafter, through December 2000, unem- market ployment rates slowly decreased, or at least did not increase. We managed to obtain data on job vacancies in Latvia and used these, together with information about unem- The GDP and unemployment effects seem to suggest ployment and inflation, to investigate two market the following: economy relationships: the Beveridge curve, which pos- * The Latvian economy was enjoying strong economic its a negative relationship between unemployment and growth prior to the Russian crisis. vacancies, and the Phillips curve, which posits a similar * The Russian crisis, although seemingly dire from an relationship between inflation and unemployment. While exchange rate and exports point of view, was relatively it may be too early to identify a stable Phillips curve easily overcome. relationship, the Beveridge curve provides easily inter- * The unemployment rate responded to the Russian pretable and useful information about the Latvian labor crisis as one would have expected. market and how it responded to the Russian crisis shock * The increase in unemployment was severe, reflecting of 1998. the severe drop in exports, but did not last for long. * The Latvian economy is clearly enjoying strong pro- Impact of the Russian Crisis ductivity gains. Even given the increasing unemploy- ment in early 1999, the economy is growing quite fast On August 17, 1998, Russia devalued the ruble and de- again. faulted on Treasury bills and on interest payments to several Paris Club creditors. Within a year the ruble price Beveridge and Phillips Curves of Latvian lats had more than quadrupled, a massive devaluation by any standards. Latvian exports to Rus- GDP and unemployment trends responded to the sia reacted predictably: whereas Latvian exports to Rus- negative economic shock of the Russian crisis in sia had accounted for21 percentof total exports in 1997, textbook fashion, which is not surprising given the this figure had declined to only 7 percent in 1999 and aggregate nature of these indicators. Of interest, how- 4.2 percent in 2001. GDP growth and unemployment ever, is whether other key relationships responded reacted similarly. similarly. TRANSITION, March-April 2002 © 2002 SITE C) 2002 The World Bank We looked at the Phillips and Beveridge curves, with the demand for and the supply of labor. Usually labor the latter being of particular interest to us (see the fig- markets are characterized by large gross flows into or s ures). The Phillips curve should be viewed with caution. out of employment. The Beveridge curve, which shows' The high inflation-low unemployment points represent the joint movement of job vacancies and the unemploy- , C early years, when inflation was higher but was adjusting ment rate, can reveal interesting information about the downwards. The Russian crisis increased unemploy- matching process, that is, how the supply of labor may ment, but seemingly had little impact on inflation. or may not match the demand for labor. The Beveridge curve, however, seemns readily interpret- Two types of shocks affected the relationship: able. It represents the relationship between job vacan- * Negative shocks to economic activity-the rate of job cies and unemployment, reflecting the segmentation of destruction increases at the same time as the rate of the labor market. Because of skills differences, excess job creation decreases demand for one type of labor may coexist with excess * Reallocation shocks-changes in the intensity of re- supply of another type of labor. In Latvia the lack of geo- allocation of labor from one sector to another. graphical mobility results in another mismatch between The Russian crisis is an example of the former category, Beveridge Curve, May 1996-May 2002 and the conclusions to be drawn from the relationship are relatively simple. With GDP growth increasing dur- 0.40- ing 1997, the vacancy rate increased because of a higher demand for labor, but the unemployment rate barely fell, c 0.35 A an interesting observation and one worthy of further study. The vacancy rate peaked in August 1998, just before a) 0.30 i the Russian crisis. Then, as the crisis hit, the unem- Aug 2000 ployment rate increased sharply while the rate of vacan- )i cies fell, a response fully consistent with what one would CO 0.25- expect from a negative economic shock. As unemploy- 0U \8 X / Feb 1999 ment peaked in April 1999, vacancies were apparently 0.20- filled more easily. When the unemployment rate subse- quently dropped again, reflecting the rather quick rever- 0.15 sion to high economic growth, the demand for labor was 7 8 9 10 11 again high, as reflected in a higher vacancy rate. Cur- rently, the Beveridge relationship seems to have reverted Unemployment (percent) to where it stood before the Russian crisis. Phillips Curve, To sum up, the Beveridge curve indicates that the Latvian Phillips1997Decue,ber 2001 labor market behaved more or less as expected in a January 1 997-December 2001 market economy. This is in contrast to the rather shape- 12 less and erratic behavior observed before 1998 Our con- clusions should offer encouragement to policymakers 10- as well as suggest directions for future research. 8 Morten Hansen is a visiting professor at EuroFaculty, Ca >, University of Latvia, and can be reached at mhansen@eurofaculty.lv. Romans Pancs is a student ° 4 - May1998 at the University of Latvia and can be reached at 4 -4 rpancs@latnet.lv. This research was supported by a grant from the (CERGE-EI) Foundation under a Glo- April 1999 bal Development Network (GDN) program. All the opin- 0 - l ions expressed are those of the authors and have not 6 7 8 9 1 0 11 been endorsed by CERGE-EI or the GDN. A longer version of this paper may be found on the BICEPS Unemployment (percent) web site: www.biceps.org. © 2002 The World Bank © 2002 SITE TRANSrInON, March-April 2002 T!lHE WILLIAm DAvIDsoN INSTITUTE AT TIUN1VHRRrrY fP MUIInOAN BURrNERS SCRXNL Starting with the this issue of the Transition Newsletter we will regularly summarize the William Davidson Institute's (WDI's) working papers dealing with EU enlargement. To see the full set of working papers on this topic visit WDI's web site at www.wdi.bus.umich.edu. A*IVariety, Jobs, and EU Enlargement By Tito Boeri and Joaquim Oliveira Martins q Two key factors that have allowed the rapidly growing economies of Central and Eastern Europe (CEE) to cope with their external constraints have been their relatively low unit labor costs and the initial undervaluation of their exchange rates. Their accession to the EU will inevitably reduce both sources of competitiveness of Eastern European exports, as real wages are likely to catch up to Western European levels and current EU members are pushing the countries to enforce labor market and social regula- tions that will increase their labor costs. Our analysis suggests that the ongoing success of transition, notably of those countries that upon accession will likely face increasing pressures for real wage con- vergence with the EU, will depend significantly on the speed with which they reallocate labor from homogenized to diversified goods producers. Small, open economies can grow faster than their neigh- total trade tumover, while countries of the Organisation for in , bors without running into a balance of payment crisis if EconomicCo-operation and Development(OECD) accounted u J -they succeed in increasing the number of differentiated for more than 40 percent of trade flows and the rest of the - goods produced domestically. Increased variety in these world for another 16 percent. Six years later, in 1995, the _ countries after trade liberalization is an unambiguous picture had changed substantially. Exports to the Russian sign that consumers coming from the empty shelves of Federation represented only some 10 percent of CEE trade, * the pretransition era have a strong taste for variety, and imports from Russia were less than 15 percent of total im- hence that new varieties can create their own demand. ports, and the share of intraregional trade was well below 10 * However, increasing variety will involve intensifying the percent of total trade. The share of trade turnover with the worker reallocation process, because production is still rest of the world also decreased somewhat compared with largely concentrated in homogeneous goods and scale- the pretransition era, while the industrial market economies, 4 intensive industries and enterprise density is significantly mainly the EU, accounted for almost 70 percent of both the i lower than in Western Europe. exports and imports of Central and Eastem Europe. Output Collapsed, Not Trade Another feature of the transition economies' trade pattems has been their persistent specialization in heavy, energy- After 1989 all the transition countries experienced one of intensive industries and low-skilled segments of the manu- the most marked depressions ever observed in recent eco- facturing sector, despite having a relatively well-educated nomic history. Between 1989 and 1991 GDP declined by labor force and cheaper labor relative to their Western coun- as much as 30 percent in Eastern European countries terparts. Only Hungary and Slovenia have a comparative such as Bulgaria and Romania. While this depression is advantage in light industries and are also significant net ex- well documented in the literature, the fact that trade vol- porters in industries such as electrical machinery, plastics, umes did not collapse in line with output has received much and pharmaceutical products. This is a clear sign of a more less attention. While these countries were experiencing a advanced stage of transition. deep economic depression, imports were relatively buoy- ant throughout the region with the exception of Bulgaria. Product Variety and Transition By 1989 approximately a quarter of CEE countries'trade Surprisingly, the literature on transition economies has was with the former Soviet Union. Intraregional trade in overlooked a crucial dimension of structural change, namely, Eastern Europe accounted for roughly 15 to 16 percent of the shift from homogenized goods to differentiated goods TRANSITION, March-April 2002 ©D 2002 The William Davidson Institute © 2002 The World Bank and, in particular, to many different product variet- of homogenized goods and, in the long-run, intra- ies. Why were varieties lacking before the start of industry trade will dominate. transition? Under central planning, resources were systematically diverted away from final consumption Support of Start-Up Activities goods, and countries maintained limited trade rela- tions with Western countries that were confined to According to our analysis, the depression in the transi- T exports of raw materials and intermediate goods. tion countries was related to shifts in the structure of Moreover, increasing the number of varieties of goods consumption rewarding differentiated products and iner- available to consumers generally requires growth in tia by the previous supply structure in adapting to this the number of firms, but enterprise creation in these shock. Two facts support this explanation of a supply- countries faced practically insurmountable entry bar- driven depression. First, aggregate investment fell less riers. Socialist firms were also characterized by a than output. Second, while GDP and industrial produc- high degree of vertical integration, which even under tion were collapsing, imports did not fall, and actually a market system does not favor the development of grew rapidly after the early phase ol transition. An im- product varieties. portant feature of our model is that the demand shift occurs without exogenous changes in preferences. One of the first steps of the transition toward a mar- ket economy was opening up to trade, and hence lift- Our results are also consistent with the increase in enter- ing restrictions against domestic consumers' purchase prise density registered in all the transition economies of differentiated goods. Put another way, demand since 1990. The positive relationship between enterprise started to matter in the determination of equilibrium. density and levels of real income per capita holds rea- Accordingly, the countries imported a large number sonably well in both the transition and the Western Euro- of product varieties. Domestic production of varieties pean countries. The countries more advanced in the has also begun, but gradually. The build-up of a net- transition, such as the Czech Republic, Hungary, and work of variety producers is, after all, a time consum- Slovenia, are also the countries with the highest GDP per ing and costly process. Insofar as this process capita and enterprise density. Moreover, the countries requires new business start-ups, this implies large where enterprise density was higher from the start dis- sunk entry costs and high failure rates. Entry barriers played lower and less protracted declines in output, for were particularly high in Eastern Europe because of a example, output fell more in Poland than in Hungary. lack of market institutions, entrepreneurship, and fi- nancial intermediaries channeling resources to new The soaring trade deficits that appeared in the early enterprise creation. The stronger the entry barriers, stages of transition and reappeared in 1996 and 1997 the fewer the business start-ups, and the slower the are also in line with our analysis. Insofar as the number development of new varieties. of domestic variety producers is far from its long-run equilibrium, increases in real wages (associated with At the outset of transition, trade was liberalized. This catch-up effects, for instance) translate into increased involved a sudden increase in the number of varieties demand for varieties that are largely imported. Overall, available and consumers can now finally spread their the only way to sustain real wage growth over the long- consumption overthe large numberofvarieties produced run is by an increase in varieties, a cgrowth that creates in the West. However, Eastern European countries must its own demand. initially be net exporters of their homogenized goods in order to finance imports of varieties. Insofar as they start In many transition countries the bottoming out of the producing varieties domestically, then they can also recession has been associated with demand in the OECD export varieties as trade becomes increasingly of the countries for homogeneous goods produced in the East. intra-industry (horizontal) type. However, entry of variety However, sustainable growth can only come from the is a long process. Meanwhile, coping, with external con- development of many small, specialized units in the straints forces transition countries tc sell cheap, homo- manufacturing sector, that is, growth in the long-run can geneous goods abroad. Trade in varieties is balanced only come from an increase in enterprise density. only when enterprise density in the East converges to the levels prevailing in the West. Thus to summarize, Although entry is the driving force behind long-term eco- transition economies initially experience a large trade nomic growth, in the short run it diverts resources away deficit in differentiated goods financed by large exports from production, thereby inducing output losses. These C 2002 The World Bank © 2002 The William Davidson Institute TRANSIFION, March-April 2002 X initial losses are larger the wider the gap between the will be followed by the transfer of know-how and learn- inherited enterprise density and that prevailing in the ing and the creation of a critical mass of dynamic and c long run. The recovery from the transitional recession innovative small and medium enterprises. Nevertheless, c is slower the higher the barriers to the entry of new much remains to be done to reduce barriers to the en- CD a firms. Steps to reduce such barriers are likely to speed try and survival of new firms in transition economies. o C 5 up the transition significantly and reduce its costs in 0 0 Cocuso * °iu terms of forgone output. Conclusion After the initial explosion of new business start-ups, The success of transition, notably of those countries the pace of new firm creation is slowing down consid- that, upon entering the EU will likely face increasing erably, yet the transition countries are still far from pressures for real wage convergence with the EU, will reaching enterprise densities comparable to those of depend on the speed with which they reallocate labor -- OECD countries. Most of the development of a new from homogenized to diversified goods producers. From private sector has occurred in "gap-filling" service ac- a historical perspective, high costs of entry have to be tivities rather than in manufacturing. The environment accompanied by generous unemployment benefits to is still unfavorable to the development of small firms in start the reallocation process on a sufficiently large manufacturing because of the high real interest rates, scale. Unemployment benefits, however, ended up in- the lack of venture capital, the interlocking structure of creasing the social security burden on the active popu- banks and large corporations, and an absence of infra- lation. A better way to start the process would have structure for the development of small firms. been to reduce the obstacles to starting up new activi- ties and, conditional on that, have lower unemployment Trade liberalization has been a major shock for these benefits in place. Although being wise after the event is countries and has been associated with dramatic out- easy, some lessons are still useful for those countries put falls and a rise in unemployment. Some scholars lagging behind in the transition process. argue that trade should have been liberalized only gradu- ally; however, opening up to trade has played a crucial Tito Boeri is a professor of economics at Bocconi Univer- role in paving the way for the entry of new firms. Trade sity, Milan and IGIER and a WDI research fellow Joaquim also promoted subcontracting in some sectors, such Oliveira Martins is an economist at the OECD. This sum- as machinery and apparel, and the hope is that this mary is based on their WDI Working Paper no. 301. Costs and Benefits of "Euroization" in Central and Eastern Europe By D. Mario Nuti The current simultaneous EU enlargement and monetary unification are about to create unprecedented economic segmentation in Europe. Previous enlargement and deepening processes treated old and new members equally. Countries were either part of or outside the European Community. Any other diversifi- cation existed already and was not generated by the progress and pattern of European integration. Membership of the European Monetary Union (EMU) is * Meeting other Maastricht Treaty standards for mon- an integral part of the acquis communautaire, which new etary and financial convergence in relation to public debt and old members alike are committed to implement. It and deficits, inflation, and interest rates. (Failure to is subject to three qualifications: achieve these standards delayed Greek membership in * Requesting possible derogations (exceptions from the the EMU until the June 2000 Lisbon summit). rule), such as those negotiated by Denmark and the United Kingdom. No new member is expected to re- Therefore even if all the new members opted to join the quest derogations. EMU at the earliest possible date, Europe would be * Participating successfully in the exchange rate mecha- segmented into at least the following four groups: nism for at least two years before joining the EMU (Swe- * Members of both the EU and the EMU. This group den has failed to implement the mechanism to date). currently consists of 12 countries, including Greece. TRANSIrION, March-April 2002 © 2002 The William Davidson Institute c 2002 The World Bank * Members of the EU that are self-excluded from the 1992 exchange rate mechanism crisis and its abandon- EMU (Denmark, Sweden, and the United Kingdom), soon ment by Italy and the United Kingdom. , s to be joined by the next batch of new members. A * Ten Central European applicant countries-Bulgaria, Additional benefits of euroization include the following c, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, * Lower transaction costs, just like for EMU members. Poland, Romania, the Slovak Republic, and Slovenia- * Greater economic integration, both through increased .- 4a Ii CL o plus Cyprus, Malta, and Turkey, followed, or perhaps trade and more foreign direct investment, especially if a w overtaken by in the case of Croatia, countries in south- euroization is accompanied by mutual trade liberaliza- 0 , I- eastern Europe. All these countries' admission to the tion, or possibly a free trade area without the consider-, EU is subject to economic and political conditions and able restrictions still impeding trade with current will be staggered over time, beginning no earlier than candidates for EU accession. Ar1.' A 2 2003-04. * Probably lower basic interest rates in the presence of * The rest of Europe and other countries of the former a currency board than would otherwise be the case Soviet Union, which are excluded from the EMU for the (though interest rates are invariably higher than in the foreseeable future. reference country, because they are subject to risk pre- miums for any individual country or borrower). Interest Those countries that wish to secure a closer mon- rates might be even lower if the domestic currency was etary integration with the EMU either before or instead replaced by the euro. of EMU membership, have two possible and, most important, unilateral ways to do so. First, they could Whether a country chose the option of a currency board adopt a currency board to manago a domestic cur- or currency replacement, euroization would involve auto- rency linked to the euro. One unit of the currency matic, self-regulating adjustments in the money supply. could be made equivalent to E1 at rno extra cost. Sec- These would be determined by trends in domestically ond, and a more drastic alternative, would be to offi- held foreign assets, which would expand given a balance cially adopt the euro as the national currency. of payments surplus and contract during times of defi- cits, as is supposed to happen under a gold standard. Advantages of Euroization Unlike partial, unofficial euroization, total and official The prevailing view, both in the economic literature currency replacement would not complicate the choice and in policy circles, is that euroization has immedi- of intermediate targets of monetary policy by introduc- ate positive net advantages, especially in transition ing a dual currency component in the money supply, countries where government institutions lack the cred- and would not pass on the shocks of exchange rate ibility and track record needed to successfully adopt adjustments to producers and financial institutions. Ini- alternative exchange rate regimes 3nd the monetary tially, euroization might be accompanied by a degree of policies necessary to back them. undervaluation of the old currency with respect to the euro, a weakness that might be compounded by an ini- An argument for euroization (or dollarization) is na- tial weakness of the euro with respect to other hard cur- tional governments' consequent ability to overcome rencies (as in 1999-2000). Undervaluation might be a their difficulties in borrowing internationally in their blessing in disguise from the viewpoint of competitive- domestic currency. Euroization also avoids both the ness and employment (though not of inflation). volatility and inflationary bias of floating rates and the vulnerability to speculative crises resuiting from fixed Disadvantages of Early Euroization rates that are not irrevocably fixed. Even successful fixed exchange rate regimes can become vulnerable While different approaches to euroization could yield the as a result of their own success, because they at- expected net advantages, this is not a foregone conclusion. tract capital inflows that lead to real revaluation, The issue is not just one of a possible rejection of euroization thereby undermining competitiveness. At some point on grounds of national pride, with countries hanging on to a those flows can be easily, suddenly, and massively domestic currency as a symbol of national sovereignty and reversed. Unlike pegs subject to irntermittent adjust- thereby causing temporary or permanent exclusion from ments, irrevocably fixed rates do not encourage specu- the EMU. Whether approaches to euroization can succeed lation, as demonstrated by the experience of EMU is an empirical issue that depends on the relative strength of members since May 1998 in contrast to the September the associated disadvantages, bearing in mind that local C 2002 The World Bank © 2002 The William Davidson Institute TRANSITION, March-April 2002 Z I, adoption of the euro as the domestic currency-whether currency, contrary to what is widely believed, a govern- as a banknote or as backing for domestic banknotes- ment cannot acquire the other currency's credibility. c _ !! is not the same as being a member of the EMU. ' ~ 3 I' Peg to the Euro? m Ct r lt A number of distinct disadvantages are associated with o the operation of a currency board with respect to EMU In addition to the disadvantages caused by euroization 3 0--w 1ll membership, namely: falling short of full EMU membership, the euro may is . uta ' be unsustainable as a pegging currency in any form * Initial endowment of a currency board regime with for three main reasons. ' sufficient foreign exchange reserves to back the entire ; currency in circulation (whether new or unchanged) at First, the euro may not be the preferred currency in the permanently fixed exchange rate preselected by the the country's invoicing practices in foreign trade. A ... government Estonia benefited from the return of 11 tons large part of the external debt of a number of coun- of gold thatit had senttothe Westbefore 1940. Lithuania tries is in U.S. dollars. In 1997 the share of dollar- also benefited from the return of 6 tons of gold as well as denominated external debt was 77.9 percent in the purchases of gold from the IMF. Other countries might Czech Republic, 75.1 percent in Bulgaria, 61 6 per- be less fortunate. Poland (with $26 billion in reserves, cent in Lithuania, and 46 percent in Poland, com- that is, twice the amount needed to back or replace its pared with deutschmark-denominated debt shares domestic currency), the Czech Republic, and Slovenia of 4.7, 4.7, 6.2, and 9.9 percent, respectively. For are likely to be able to afford euroization, while Hungary such countries any devaluation of the euro with re- and Slovakia may not be able to. spect to the dollar, as occurred during the first 18 * Loss of seigniorage, that is, loss of the revenues ob- months of the euro's existence in 1999-2000, would tained by issuing domestic currency. Under the currency raise the domestic burden of foreign debt service, board option this loss could be offset, at least in part, by and a significant re-denomination of external debt interest earned on reserves. Also, countries could agree would have to accompany inaction in relation to the on an arrangement to share seigniorage with the Euro- euro. pean Currency Board (ECB). The International Monetary StabilityAct of 2000, introduced in the U.S. Senate by the Second, the ECB's monetary policy would be un- chair of the Joint Economic Committee, Senator Connie suitable for the fundamentals of the countries under- Mack, contemplated such an arrangement for dollarized taking euroization. Apart from providing liquidity to countries. According to Larry Summers, then U.S. Trea- euroized countries against foreign exchange, the ECB sury secretary: "In the long term, finding ways of bribing would have no obligation to consider their particular people to dollarize, or at least give back the extra currency needs, just as the International Monetary Stability that is earned when dollarization takes place, ought to be Act quoted earlier states that "the Federal Reserve an international priority" (part of his statement made before System has no obligation to consider the economic the U.S. Senate Joint Economic Committee, 1999). The conditions of dollarized countries when formulating same argument would apply to euroization. or implementing monetary policy" (Section 2.b). * Lack of a lender of last resort, which would involve a considerable degree of financial fragility. This is particu- Third, the stabilization needs of transition economies larly serious in the early stages of transition. The Inter- may not leave much margin for an independent mon- national Monetary Stability Act (Section 2.b) specifically etary policy, which is totally lost when using any states that: "The Federal Reserve System has no obli- fixed exchange rate regime. However, the instant gation to act as a lender of last resort to the financial abatement of inflation may not necessarily be the systems of dollarized countries." The mythical advan- best policy, as confirmed by the dominant success tage of a currency board is that the domestic currency of the Polish economy, which for all the talk of shock is fully backed by foreign exchange, and thus the board therapy has been disinflated at an excruciatingly could lend as a last resort only using any excess re- gradual rate. Moreover, all Central and Eastern Eu- serves it might have over and above what it required to ropean transition economies are facing challenging back the domestic currency. Such reserves would be issues of social welfare reform on a greater scale substantial in Poland, but not anywhere else in the area. than the rest of Europe. Before worrying about con- * Impossibility of entirely eliminating the risk of a parity vergence, many transition regions such as Kosovo change. By linking its domestic currency to a more credible or Serbia have to worry about reconstruction. TRANSITION, March-April 2002 © 2002 The William Davidson Institute c 2002 The World Bank All the arguments in this section make a case not the different role of the ECB would be an immensely against unilateral euroization as such, but against important difference, because in a strictly euroized coun- early membership of the EMU. However, seeing that try it would not act as a central bank. That is, the ECB the main, indeed the only, point of urilateral euroization would not be a lender of last resort It would act as an a is to replicate the effects of joining the EMU earlier than institute of issue, but would not have any responsibility ' a would otherwise be possible, these eire also arguments toward a euroized, non-EMU member country in decid- X against unilateral euroization. ing its monetary or exchange rate policy. io -K Speed of Convergence Ultimately the net balance of costs and benefits, both for the euroized country and for the EU and its mem- A great deal of attention has been given to both financial bers, is an empirical question that depends on the de- and monetary convergence as represented by the gree of monetary, real, and institutional convergence Maastricht criteria and to the progress of systemic tran- already achieved before euroization and its subsequent X sition. On both counts the picture is encouraging, at least progress; the initial endowment of currency reserves; for the front-runners lined up for accession, but it is also the initial currency of choice for invoicing and payment misleading. Their government deficits and debt as shares practices in foreign trade; the size and denomination of of GDP are below or near Maastricht parameters; infla- foreign debt; the already existing degree of use of for- tion and interest rates are much higher, but still within eign exchange in the domestic economy; the interna- striking distance in most cases; and the progress of tran- tional credibility of domestic monetary institutions; and sition as recorded by the European Bank for Reconstruc- the degree of cooperation between domestic and Euro- tion and Development, especially in privatization and pean institutions, both political and monetary. foreign trade, is impressive. However, the Maastricht cri- teria ignore essential and worrying features of transition Observers and officials are probably being overoptimis- economies, such as quasi-fiscal defic:its and debt result- tic in their evaluations of current trends in financial and ing from public contingent commitments, extrabudgetary monetary convergence, and especially in institutional funds, and hidden subsidies. They also ignore and real convergence. Euroization may well result in nonperforming loans on the balance sheets of state banks, positive net advantages, but these should not be taken the low share of credit for the private sector, the low capi- for granted. Meanwhile, the unexploited potential for talization and/or low liquidity of financial markets through- greater economic integration through greater trade ac- out transition economies, and the extraordinary volatility cess to EU markets should not be neglected. of their rates of return. D. Mario Nuti is a professor of economics at the Univer- Once quasi-fiscal items are taken into account, even sity of Rome "La Sapienza" and the London Business seemingly virtuous candidates lose much of their at- School and a WDI research fellow. This summary is traction. The share of credit going to the private sector based on his WDI Working Paper no. 340. appears to be inversely related to the share of bad loans. Transition economies seem to have either low market RuthlessFightAgainstCorruption capitalization or a low ratio of value traded to market 1_|_ capitalization of their stock markets. )l1 These considerations suggest that greater caution is 0 needed in assessing the progress of new members' con- vergence to a single EU standard, and therefore in evalu- 1 ating the net advantages of both their membership in the EMU and of possible EMU membership surrogates. Cautious Approach Recommended Cm To the uninformed the arrangements of the current EMU "These people don't get itl They are so area and those of the wider euro area enlarged to in- arrogant. They think I can be corrupted with clude strict euroization and/or eurci-backed local cur- a mere 30 million." rency would be absolutely indistinguishable. However, From the Hungarian magazine H6cip6 ' 2002 The World Bank © 2002 The William Davidson Institute TRANSITION, March-April 2002 I!Why Do Governments Privatize? S 1lN By Loren Brandt, Hongbin Li, and Joanne Roberts 1i1 Since the early 1980s, privatization has become a widely used strategy for addressing problems in state- ; ] owned enterprises. Its use has not been limited to firms in the former socialist countries, but extends to state- i8- , .~J3dIJ~owned firms that were established in predominantly market economies after World War II. In both cases 'I governments want to increase enterprise efficiency by improving corporate governance, need to reduce ' government subsidies and raise fiscal revenues, and aim to limit government interference in the economy. 'ii' Ij While the literature has paid considerable attention to the firm's budget constraints, the human capital of the I ..-.. differences in how firms have been privatized--primarily enterprise managers, the cost of monitoring the firm, because of the implications for firms' postprivatization and the bank's incentives and constraints. These fac- governance and performance-no work has been done tors ultimately determine how the value of the firm varies to explain differences in the use of privatization across with its ownership. While privatization can benefit a gov- countries. ernment because it eliminates the agency cost inherent in government ownership, it also implies a loss of politi- China has generally avoided privatization as a policy cal capital by the leader. In essence, the decision to tool for dealing with the ailing state enterprise sector privatize involves weighing these costs and benefits. and has limited state sector privatization to smaller state- owned firms, and then only in the last few years. In con- Theoretically, we find that privatization is more likely trast, since the mid-1990s China has undertaken when benefits to the government from owning firms are massive privatization of firms owned and managed by smaller, when leaders have low human capital, and when lower levels of government, namely, township and vil- managers have high human capital. We also find that lage enterprises. A growing number of local governments some factors have an ambiguous effect on privatization, have also shut down their firms. Ironically, these same including the hardness of the firm's budget constraints, firms are credited with having been the most dynamic the bank's concern about profits, the bank manager's segment of the Chinese economy since reform, and have human capital, and the costs associated with bank illi- been a major source of economic growth. Perhaps the quidity. However, when the budget constraint is much most striking thing about this process is that it has not harder for privately-owned than for government-owned occurred uniformly, and considerable heterogeneity is firms, these factors have unambiguously positive effects apparent across China. on privatization. Our objective is to explain the observed differences in In the empirical part of the paper, drawing on a unique privatization behavior. Our basic premise is that govern- dataset of township governments, firms, and local finan- ments and politicians derive a variety of economic, so- cial institutions we collected in 1998 and 2000, we test cial, and political benefits from the control over enterprises hypotheses generated from the theoretical model and that comes with ownership. The size of these benefits, explain the heterogeneity of privatization and shutdown however, is not determined in isolation, but depends on patterns across townships. The results of the empirical the rest of the economic environment, including, for ex- work support our theoretical predictions: privatization is ample, the choices of enterprise managers and the na- more likely when leaders have low human capital, when ture of local financial institutions. We argue that leaders find extracting benefits from government-owned differences in these institutions across localities affect firms difficult, when bank managers have high human the private and public returns to government ownership, capital, and when bank managers have good incentives and thus the incentives of governments and politicians and are more constrained by liquidity. Furthermore, we to privatize firms. find that when the government-owned firm's budget con- straint is hard, some of the foregoing effects on We develop a simple model to analyze how the interac- privatization become weaker. tions of three key players-the government, a bank, and a firm manager/owner-affect the privatization decision. Our Given the important role of financial institutions in the model links the govemment's privatization decision to its privatization process, in future work we plan to examine ability to extract benefits from ownership, the hardness of how these same institutions are influencing the returns TRANSITION, March-April 2002 © 2002 The William Davidson Institute © 2002 The World Bank to privatization. In addition to being a potential source of Loren Brandt is a professor of economics at the Univer- selection effects, banks also influence firm performance sity of Toronto and a WDI research fellow. Hongbin Li is through their willingness to lend arid their monitoring an assistant professor of economics at the Chinese Uni- role. Discrimination against private firms has been a versity of Hong Kong. Joanne Roberts is an assistant W e prominent feature of Chinese policy, and how important professor of economics at the University of Toronto. This this may be in shaping the benefits and returns to gov- article is a summary of the authors' study published as ernment divestiture remains to be seen. WDI Working Paper no. 429. , j5 ,g Mass Privatizaition and Partial State Ownership of 1F1irms in Transition Economies By John Bennet, Saul Estrin, aiid James Maw Since the fall of the Berlin Wall ithe transition economies have privatized tens of thousands of firms. Most countries have employed some form of mass privatization, distributing state assets at a zero price (or at a nominal price to cover administrative costs), and the state has frequently retained some shares. In this paper the authors show that such policies may be entirely rational for a government that seeks to maximize its own expected net revenue. The initial focus of our analysis is the ririvatization of firms more subtle effect by which, even if it can sell a firm's to insiders (their managers and workers) as has occurred entire assets at a positive price, the government may widely in Romania and Russia, for example. The model gain from retaining state ownership of a portion of the is extended to the case of privatization to outsiders, as shares and selling the remainder for a zero price. This has predominated in countries such as the Czech Re- result is more likely if the government's bargaining power public and Hungary. We model a game played by the is low, in which case it is less able to appropriate the government and potential buyers that determines the price net surplus generated by a corporate restructuring pro- to be paid for each share, the proportion of shares to be cess. sold, and the firm's output and Eimployment after privatization. In the basic framework all the gains gener- These general conclusions hold for both insider and ated by privatization arise because the new owners re- outsider privatization, though details differ between the structure the enterprise by cufting surplus labor. However, two cases. If private ownership does not affect labor we also explore the possibility that privatization directly efficiency, then with insider privatization the optimal improves company performance because of such factors approach may be for the government to retain some as increased managerial incentives. ownership and sell the remainder for a zero price. With outsider privatization, however, these policies are nec- The possibility of mass privatization arises from a con- essarily optimal for the government. Insider and out- straint on the range of bargains that the government sider privatization also lead, in general, to different can strike. We argue that in the sensitive political and amounts of restructuring. Assuming that the relation- institutional environment of transition economies gov- ship is the same under each type of privatization, then ernments could not have sold firms at a negative price. if firms are sold at positive prices, employment is This has two main implications: first, that the govern- greater, and therefore restructuring is less, with insider ment may gain from selling enterprises at a zero price, privatization than with outsider privatization. If, how- even when sale at a positive price is possible; and sec- ever, the non-negative price constraint binds, then the ond, that when privatization takes place at a zero price, possibility arises that insiders will restructure more than for the state to retain some shares may well be advan- outsiders. tageous. This analysis is consistent with the cross-country pat- The impact of the non-negative price constraint is not tern of privatization methods. The few countries, such simply to raise an equilibrium price to zero when it as Estonia and Hungary, where governments held would otherwise have been negative. There is also a strong bargaining positions relative to insiders or other © 2002 The World Bank © 2002 The William Davidson Institute TRANSIIION, MarcIh-April 2002 .C potential purchasers of state-owned enterprises es- John Bennet is a professor of economics and finance chewed mass privatization. They sold firms at positive at Brunel University, United Kingdom. Saul Estrin is a < .2 _ prices and retained few or no shareholdings. In most of professor of economics at the London Business School 0 the former Soviet Union and in the Balkans, however, and a WDI research fellow. James Maw is a professor a governments were much weaker in relation to insiders. of economics at the University of Wales Swansea. This jc gL In these countries mass privatizations and retained state article is a summary of the authors' study published as w 0 shareholdings were widespread WDI Working Paper no. 435. Partial Privatization and Firm Performance: Evidence from India By Nandini Gupta The economic transition of socialist economies and the trend toward privatization within both develop- ing and industrial market economies have generated a large empirical literature on the effects of ownership on firm performance. Most of these studies find that privatization has a positive impact on firms' profitability and efficiency. Most of the assets of the firms in these studies have been privatized and control rights have been transferred from the government to private owners. Surprisingly, little is known about the effects of partial privatization, in which control rights are not transferred, even though most privatization transactions of a significant size are partial sales of equity, often through the stock market. This paper uses information on the fraction of equity sold through partial privatizations in India to investigate whether the sale of minority stakes affects the performance of government-owned firms. India's privatization program has proceeded slowly, can use it in the executive job market as a public signal with an average of 16 percent of equity in 44 of 258 of their performance. government-owned firms sold in the 10 years follow- ing the adoption of a privatization policy in 1991. The India's adoption of a disinvestment policy was accom- pace has picked up slightly in recent years, with five panied by two other policies that allow us to investigate firms being sold to strategic partners in the last two the relative effects of privatization and competition. So- years, but the sale of noncontrolling shares remains called dereservation eliminated restrictions on private the primary method of privatization. entry into all but 4 of 17 sectors that used to be reserved for the public sector. At the same time the government The theoretical literature on privatization considers two liberalized restrictions on foreign equity investments in types of problems associated with government owner- all but a few sectors of the economy. While some have ship: the political problem whereby political interference argued that competition is more effective at shaping distorts managers' objectives and constraints, and the managers' incentives, others argue that so long as po- managerial problem whereby poor monitoring leads to litical interference and poor governance characterize low incentives among managers. In firms that have been public sector firms, inefficiencies cannot be fully ad- fully privatized it is difficult to identify whether the ob- dressed by increased competition. By controlling for served improvements in firm performance occur because changes in competitive conditions we are also able to the new owners pursue profit maximization rather than ensure that changes in firm behavior are not incorrectly other objectives, or because the new owners are better attributed to privatization. able to monitor managers. Partial privatization without transfer of control allows us to concentrate on the sec- Comparing the mean performance of firms in the years ond possibility. The firm remains under government con- prior to the first stage of partial privatization to average trol and subject to political interference, but the trading performance in the years following the first stage, we of shares on public stock markets provides current in- find significant differences in revenues, labor productiv- formation about the firm's performance as judged by ity, and the share of government loans in firms' total market participants. The state can use this information borrowing. Compared with average performance in the to monitor the managers more effectively, and managers prior years, sales and profits increase by 59 percentage TRANSITION, March-April 2002 © 2002 The William Davidson Institute © 2002 The World Bank points and 22.6 percentage points, respectively, and the restrictions on foreign participation has an adverse im- fraction of loans financed by the government declines by pact on sales. Unlike privatization, changes in competi-, 5.8 percentage points. By contrast, employment does tive conditions do not appear to affect productive not appearto change significantly after partial privatization. efficiency as measured by the average product of labor: ; S G To control for firm-specific and macroeconomic factors and returns to labor, but competitive pressures do affect Xi - that could account for performance change, we also esti- allocative efficiency, because they appear to reduce' mate firm fixed effects specifications to investigate the employment. These results suggest that a combination i o average impact of partial privatization on firm performance of privatization and policies to enhance competition can , using firms that remain wholly governrnent owned as the improve firm performance. control group. We find that a 10 percentage point de- crease in the share of government equity would increase We also find evidence that the share of government loans sales by 27 percentage points, profits by 15 percentage in total borrowing has a statistically significant negative points, average product of labor (sales over labor) by 6 impact on both sales and profits, which is consistent percentage points, and returns to labor (operating income with the view that the government may use loans to pur- over employment) by 8 percentage points; however, no sue objectives other than profit maximization. However, accompanying decline in employment occurs. soft budget constraints do not appear to affect the level of employment in these firms. The results also indicate that partial privatization contin- ues to have a significant impact on firm performance when Nandini Gupta is a visiting assistant professor of corpo- we control for competitive conditions. Firms in sectors rate strategy and international business at the Univer- that were previously reserved for the government react sity of Michigan Business School and a WDI research favorably to dereservation, as evidenced by significantly fellow. This article is a summary of the author's study higher sales revenues and profits. However, liberalizing published as WDI Working Paper no. 426. Recent WDI Working Papers Papers can be downloaded at no charge from http://www.wdi.bus.umich.edu. Alexeev, Michael, and William Pyle, A Note on Mea- WP 414, December 2001. Published in Joumal of Eco- suring the Unofficial Economy in the Former So- nomic Perspectives 16(2), February 2002. viet Republics, WP 436, September 2001. Berkowitz, Daniel, and David N. DeJong, Entrepreneur- Anand, Jaideep, Will Mitchell, and Jane Zhou, Trans- ship and Post-Socialist Growth, WP 406, October 2001. ferring Collective Knowledge: Collective and Frag- mented Teaching and Learning in the Chinese Auto Berkowitz, Daniel, and David N. DeJong, Policy Reform Industry, WP 420, December 2001. and Growth in Post-Soviet Russia, WP 405, October 2001. Forthcoming in European Economic Review. Angelucci, Manuela, Saul Estrin, Jozef Konings, and Zbigniew Zolkiewski, The Effect of Ownership and Berkowitz, Daniel, Katarina Pistor, and Jean-Francois Competitive Pressure on Firm PerFormance in Tran- Richard, Economic Development, Legality, and the sition Countries: Micro Evidence from Bulgaria, Transplant Effect, WP 410, September 2001 Forth- Romania, and Poland, WP 434, January 2002. coming in European Economic Review. Basu, Swati, Saul Estrin, and Jan Svejnar, Employment Boubakri, Narjess, Jean-Claude Cosset, and Omrance and Wages in Enterprises under Communism and Guedhami, Liberalization, Corporate Governance, in Transition: Evidence from Ceintral Europe and and the Performance of Newly Privatized Firms, Russia, WP 440, June 2000. WP 419, December 2001. Berglof, Erik, and Patrick Bolton, The Great Divide Bouev, Maxim, Labor Supply, Informal Economy, and and Beyond: Financial Architecture in Transition, Russian Transition, WP 408. May 2001. © 2002 The World Bank ©) 2002 The William Davidson Institute TRANSI lION, March-April 2002 s iI Brada, Josef C., and Ali M. Kutan, The End of Moder- Hanousek, Jan, and Gerard Roland, Banking Passiv- ate Inflation in Three Transition Economies? WP ity and Regulatory Failure in Emerging Markets: C [433, January 2002. Theory and Evidence from the Czech Republic, C '3S 3 ,, WP 424, July 2001. X 1Brixiova, Zuzana, and Ales Buli[, Growth Slowdown WP 444, November 2001. __ -. junder Central Planning: A Model of Poor Incen- J tr! '1 Etives, WP 448, March 2002. Ivanenko, Vlad, Testing Russia's Virtual Economy, t\JJ4,, ~~~~~~~~~~~WP 428, December 2001. Campos, Nauro F., and Yuko Kinoshita, Foreign Di- rect Investment as Technology Transferred: Some Jolliffe, Dean, The Gender Wage Gap in Bulgaria: Panel Evidence from the Transition Economies, WP A Semiparametric Estimation of Discrimination, 438, January 2002. WP 401, July 2001 Daianu, Daniel, and Radu Vranceanu, SubdLling High Jurajda, Stepan, and Katherine Terrell, What Drives Inflation in Romania. How to Better Monetary and the Speed of Job Reallocation during Episodes of Exchange Rate Mechanisms, WP 402, August 2001. Massive Adjustment? WP 432, January 2002. Da Rin, Marco, and Thomas Hellmann, Banks as Cata- Kale, Prashant, and Aldas Kriauciunas, The Impact lysts for Industrialization, WP 443, October 2001. of Socialist Imprinting and Search for Knowledge on Resource Change: An Empirical Study of Firms Durnev, Artyom, Randall Morck, and Bernard Yeung, Capi- in Lithuania, WP 446, March 2002. tal Markets and Capital Allocation: Implications for Economies in Transition, WP 417, November 2001. Kihlgren, Alessandro, Small Business in Russia: A Case Study of St. Petersburg, WP 439, January 2002. Dworkin, Terry Morehead, Whistleblowing, MNC's, and Peace, WP 437, February 2002. Kluve, Jochen, Hartmut Lehmann, and Christoph M. Schmidt, Disentangling Treatment Effects of Pol- Estrin, Saul, Competition and Corporate Governance ish Active Labor Market Policies: Evidence from in Transition, WP 431, December 2001. Published in Matched Samples, WP 447, January 2002. Journal of Economic Perspectives 16(2), February 2002. Lehmann, Hartmut, and Jonathan Wadsworth, Wage Fidrmuc, Jan, Migration and Regional Adjustment and Arrears and the Distribution of Earnings in Russia, Asymmetric Shocks in Transition Economies, WP 441, WP 421, December 2001 February 2002. Levine, Ross, Bank-Based or Market-Based Finan- Filer, Randall K., and Jan Hanousek, Data Watch. Re- cial Systems: Which Is Better? WP 442, February search Data from Transition Economies, WP 416, De- 2002. cember 2001. Published in Journal of Economic Perspectives 16(2), February 2002. Li, David D., and Changqi Wu, The Ownership School vs. the Management School of State Enterprise Fort, Timothy, and Cindy Schipani, The Role of the Cor- Reform: Evidence from China, WP 435, January poration in Fostering Sustainable Peace, WP 422, 2002. November 2001. Lin, Justin Yifu, Development Strategy, Viability, Gupta, Nandini, Partial Privatization and Firm Perfor- and Economic Convergence, WP 409, October 2001. mance: Evidence from India, WP 426, December 2001. Lizal, Lubomir, Determinants of Financial Distress: Halpern, L6szl6, and Gabor K6rosi, Mark-Ups in Hun- What Drives Bankruptcy in a Transition Economy? garian Corporate Sector, WP 411, August 2001. The Czech Republic Case, WP 451, January 2002. TRANSI1iON, March-April 2002 © 2002 The William Davidson Institute C 2002 The World Bank Maurel, Mathilde, Investment, Efficiency, and Credit Rationing: Evidence from Hungarian Panel Data, W DICon ere cesL' WP 403, November 2001. Labor Markets in Emerging Economies Conference i c c- Mayer, Don, Corporate Governance in the Cause April 1-6, 2002, San Jose, Costa Rica i l of Peace: An Environmental Perspective, WP 430, January 2002. The conference focuses on two main topics, namely, I w labor markets and public policy in a comparative per- i L. Miller, Darius P., and John J. Puthenpurackal, The spective: Latin America and Eastern Europe, and job I,- Costs, Wealth Effects, and Deterrninants of Inter- flows in transition economies. This is the second inter- (ii I j] national Capital Raising: Evidence from Public national conference on this subject sponsored jointly Yankee Bonds, WP 445, October 2001. by the German-based Institute for the Study of Labor (IZA) and WDI. The organizers are Hartmut Lehmann, L-.-. Nesteruk, Jeffrey, Conceptions of the Corporation IZA, and Katherine Terrell, WDI. and the Prospects of Sustainable Peace, WP 423, December 2001. Information: Erica Bush, email: ebush@umich.edu, or http://www.wdi.bus.umich.edu/events/. Orts, Eric W., War and the Business Corporation, WP 427, December 2001. Annual International Conference on Transition Economics Roland, Gerard, The Political Economy of Transi- June 21-23, 2002, Riga, Latvia tion, WP 413, December 2001. Journal of Economic Perspectives 16(2), February 2002. This conference, organized by the Center for Economic Policy Research and WDI, will be hosted this year by Salbu, Steven, The European Uni0n Data Privacy the Stockholm Institute of Transition Economics and the Directive and International Relations, WP 418, De- Baltic Institute Center for Economic Policy Studies. The cember 2001. conference will take place at the facilities of the Stockholm School of Economics. The Scientific Orga- Schipani, Cindy, and Liu Junhai, Corporate Gover- nizing Committee consists of Erik Berglof, Gerard nance in China: Then and Now, WP 407, November Roland, and Jan Svejnar. 2001. The conference will provide a forum for leading econo- Sgard, Jer6me, Direct Foreign Investments and Pro- mists and other social scientists working on transition ductivity Growth in Hungarian Firms, 1992-1999, and development issues to meet, present new research, WP 425, November 2001. develop collaborative relationships, and complete ongo- ing research. The conference will also bring together Stillman, Steven, The Response of Consumption in key policymakers in the region and researchers, facili- Russian Households to Economic Shocks, WP 412, tating discussion and the exchange of ideas. A special October 2001. feature of this year's conference will be a panel explor- ing the similarities and differences between issues and Svejnar, Jan, Transition Economies: Performance methods for dealing with them in transition and develop- and Challenges, WP 415, December 2001. Published ment economics. in Journal of Economic Perspectives 16(2), February 2002. Information: Jessica Mason, email: jmason@cepr. org, or http://www.wdi.bus. umich.edu/events!. Tadesse, Solomon, Financial Archilecture and Eco- nomic Performance: Internationeil Evidence, WP Fourth Annual Conference on Financial Market De- 449, August 2001. velopment in Emerging and Transition Economies December 16-17, 2002, Santiago, Chile Tavis, Lee A., Corporate Governarice and the Glo- bal Social Void, WP 450, October 2001. after 1989, This conference is organized by WDI with the School of WP 404, November 2001. Business of the Pontificia Universidad Catolica de Chile, D 2002 The World Bank © 2002 The William Davidson Institute TRANSITION, March-April 2002 XC theAmsterdam Centerfor International Finance Research The conference committee consists of Prof. Enrico 3 : at the University of Amsterdam, and International Re- Perotti, University of Amsterdam; Dr. Anna Meyendorff, c _ view of Finance. WDI; Prof. Eduardo Walker, Pontificia Universidad m 'f 3Catolica de Chile; and Prof. Sheridan Titman, University Call for papers: Like our previous international workshops of Texas, Austin. The sponsors will provide travel grants vL ff sin Amsterdam, at the London Business School, and at for invited speakers. Papers should be sent by July 1 in 3 w the Hong Kong Institute of Science and Technology, this electronic form to Erica Bush at ebush@umich.edu. .CC c #> annual conference is a small gathering of researchers focusing on the evolution of financial markets and corpo- For information on the previous conferences on this rate finance practices in emerging and transition econo- theme go to http://www.fee.uva.nl/fm/cifra/cifra.htm. mies. We are interested in theoretical and empirical papers on topics that include market development, banking, the If you would also like your paper to be considered for effects of the legal and contractual environment, publication in the International Review of Finance, please privatization, international corporate governance and fi- send three copies along with a $50 submission fee to nancing, corporate groups, international financial integra- Sheridan Titman, Department of Finance, College of tion, political risk, and the impact of reform policy on Business Administration, University of Texas, Austin, financial markets. Many papers presented at our previ- Texas 78712-1179, U.S A.; email titman@mail. ous conferences have recently appeared in top journals. utexas.edu. Conference Diary For the Record innovative ideas and market insights that add value to > International Agribusiness Conference: Moving up each link of the chain." the Food Chain and Adding Value April 7-9, 2002, Kyiv, Ukraine The agenda included sessions on the emergence of food processing and retail food marketing sectors, cor- The Ninth Annual Agribusiness Alliance Conference took porate governance, input distribution, privatization, and t place in April at Congress Hall. The CNFA Agribusiness land reform. Alliance-a group of 200 U.S., European, and multina- tional organizations representing agribusiness functions CNFA is a nonpartisan NGO dedicated to stimulating varying from production to financing, marketing, and economic growth and development in the world's tran- development assistance-hosted the conference, which sitional and emerging economies. It was founded in considered strategies for expanding agriculture, trade, the belief that opportunity and the incentive to earn a and investment opportunities in the rapidly developing profit, inherent to private enterprise, are among the business environment of the CIS. It was sponsored this most potent, sustainable engines of development. year by Tetra Pak, Chumak, and Rise. The conference featured Ukrainian Prime Minister Anatoly Kinach and Information: Michael Kunz, tel: 1-202-296-3920, 4_ Vice Prime Minister Leonid Kozachenko. email: mkunz@cnfa.org. The meeting provided a forum for more than 250 leaders Modernizing Government-Integrating Structural of private enterprises, national governments, and multi- and Budget Reforms for a Better-Performing Public r A lateral organizations from the United States, Europe, Sector and the CIS to engage in open, public dialogue, forge April 17-19, 2002, Melia White House Hotel, new market strategies, and share case studies of busi- London -" ness ventures. According to Fredrik Svinhufvud, the managing director of Tetra Pak Ukraine "To satisfy con- Information: Charlotte Ford, Marketing Executive, sumer needs with high-quality products, companies must Adam Smith Institute, Westminster Tower, 3 Albert consider the whole value chain starting with raw mate- Embankment, London SE1 7SP, United Kingdom, tel.: , rial production. This conference gave a rare opportunity 44-20-7735-6660, fax: 44-20-7793-0090, URL: for experienced CIS business leaders to exchange www.adamsmithinstitute.com. TRANSmiON, March-April 2002 C) 2002 The World Bank Forthcoming Organized by the World Bank and hosted by the Norwe- gian government, the conference will discuss possibilities Priority Environmental Projects for Accession for boosting the fight against global poverty. The 300 par- (PEPA) Progress Meeting ticipants include some of the world's leading development , June 10-11, 2002, Szentendre, Hungary experts, as well as policymakers and NGO representa- , tives. The speakers will include Jagdish N. Bhagwati of Topics: Long-term planning and financing strategies for Columbia University; Ernesto Zedillo, former president of 3 ts P3 meeting targets and obligations, anticipating and ad- Mexico; Kwesi Botchwey, Harvard University; and Murasoli F dressing problems with project implementation, the fu- Maran, India's minister of industry and commerce. Major, ture role of the European Community in general and the topics include trade policy, development aid and the mil- PEPA program in particular, and othlers. The meeting lennium development goals, failed states, migration, and will present successful case studies on topics such as political economy of crisis and reform. Eighteen workshops project prioritization, state aid legislation, and invest- will be organized by NGOs, research institutes, and aca- ment by smaller municipalities. The meeting will include demics. The full program is available at the conference's a number of break-out sessions an(i opportunities for web site: http://www.worldbank.org/abcde-europe. delegates to talk together informally, both on general subjects and in relation to specific issues, such as Information: World Bank Washington, D.C., Boris Pleskovic, PEPA's future role. tel.: 202-473-1062, email: bpleskovic@worldbank.org, Wor/d Bank Paris: Jean-Christophe Bas, tel 331-40693000, email: Information: Miroslav Chodak, Project Manager, Regional bas@worldbank.org. Environmental Center for Central and Eastem Europe, Ady Endre ut 9-11, 2000 Szentendre. Hungary; tel.: 36- 11th Conference of the Intemational Association for the 26-504-000, fax: 36-26-311-294, URL: http://wwwrec.org/ Economics of Participation: Participation Worldwide July 4-6, 2002, Catholic University of Brussels, Belgium International Conference on Transition Economics June 20-24, 2002, Riga, Latvia Conference themes: The biannual International Asso- ciation for the Economics of Participation conferences Organizers: The Centre for Economic Policy Research, provide an international forum for presenting and debat- the Stockholm Institute for Transition Economics, and ing current research and scholarship on the economics the Baltic International Centre for Economic Policy Stud- of participation. The major themes of the 2002 confer- ies (BICEPS) with The William Davidson Institute, Uni- ence will be the following: versity of Michigan. * Development and combination of forms of workers' participation around the world Leading economists and other social scientists work- * Theoretical and empirical studies on the economic ing on transition and development issues will meet to and social effects of participation discuss new research and to interact with key * Workers' participation across borders in a policymakers in the region. A special feature of the transnational and global context event will be a panel exploring the similarities and dif- * Employee participation and EU enlargement ferences between issues and apprcaches in transition * Employee ownership in transition economies and developing economics. * Workers' participation and social economy in devel- oping countries BICEPS is located in the historic art nouveau district 0 Workers' participation, social dialogue, and civil society. of Riga in a complex of buildings that also houses the Stockholm School of Economics in Riga and the Riga Information: Daniel Vaughan-Whitehead, Avenue du Graduate School of Law. Riga, Latvia's capital, is a Pesage, 127, B-1050 Bruxelles, Belgium, email: port city of just under 1 million inhabitants. Daniel. Vaughan-Whitehead@cec.eu.int. Information: Go to http://www. biceps.org. Seventh North-Western Banking Conference July 17-20, 2002, St. Petersburg, Russia Fourth Annual Bank Conference on Development Economics in Europe (ABCDE-Etirope) Topics: Clients and banks-from cooperation to partner- June 24-26, 2002, Oslo, Norway ship, which will include interaction between the banking C 2002 The World Bank TRANSITIr ON, March-April 2002 i . !'; '| and industrial sectors; banks' participation in the restruc- Papers and abstracts should include keywords, full ' . turing of enterprises and the realization of regional name and affiliation, address, email, and fax and phone projects; assisting industrial growth through trade and numbers of the author. We strongly support email sub- 5,|,$F3 i jl! project finance instruments; attracting foreign capital; missions. All papers must conform to standard journal -,-i -*'| banks and the organization of companies' bonded debt; style formats Please follow instructions provided on Wjil and other issues. Parallel sessions include legal regu- http://www.aeaweb.org/aer/styleguide.html. lation of banking activities (currency regulation and cur- , |i rency control, Federal Law on Counteraction to Selected papers will be published in a special issue of L Legalization of Income Obtained through Criminal Means, the journal Financijska teorija i praksa and possibly in i,|.!'-4 ji l! rloan security), leasing, and bank-to-bank relationships a conference volume. within Russia and the CIS. Information: Katarina Ott, Institute of Public Finance, * The participation fee is $970, which includes accommo- Katanciceva 5, 10000 Zagreb, Croatia; tel.: 385-1- dation at the St. Petersburg Hotel, meals, information 4819363, fax: 385-1-4819365, email: kott@ijf.hr, URL: materials, and an entertainment program (welcoming http://www.ijf.hr. party, boat trip around the rivers and canals of St. Pe- tersburg, a reception in one of the palaces). Confirm Marketing and Business Strategies for Central and participation by June 15, 2002. Eastern Europe December 5-7, 2002, Arcotel Hotel Wimberger, Vienna, Language: Russian. Austria Information: Organization Committee, tel.: 812-1185344, 118- This is the 1 0th annual conference of the Kellstadt Cen- 5342, fax: 812-1185341, e-mail: conference@psbank.spb.ru. ter for Marketing Analysis and Planning, DePaul Uni- versity, Chicago, and the Department of International Unofficial Activities in Transition Countries: 10 Years Business, University of Economics and Business Ad- of Experience ministration, Vienna. October 18-19, 2002, Zagreb, Croatia Empirical research, case studies, or discussion ses- This international conference will analyze the size, sions are sought that address such topics as com- scope, causes, consequences, and policy implications parative analysis of conditions of market entry in Central of unofficial (illegal, unrecorded, unreported, informal, and Eastern European (CEE) countries, market entry underground, hidden, shadow, parallel) activities in tran- through exports versus market entry via capital invest- sition countries during the past decade. The conference ment, acquisitions as opposed to joint ventures in CEE, aims to answer such questions as. marketing strategies to reach CEE consumers, mar- keting mix decisions for markets in CEE, financial strat- * Why have unofficial activities been so widespread in egies for opening CEE markets, and case studies of some transition countries and less important in others? CEE experiences by Western firms. * How did this develop? What have the consequences been? * Is some pattern or sequencing apparent in the devel- Abstracts of the papers, in English, should be received opment of unofficial activities connected with transition by September 15, 2002. The final papers must be and reforms? ready by November 1, 2002. For more information or * If so, can we derive any policy recommendations from to send abstracts contact either of the conference the experience of more advanced transition countries sponsors. that could usefully be offered to those that have not gone as far along this road? Information: Prof. Dr Reiner Springer Wirtschaftsuniversitat Wien, Althanstr. 51, 1090 Vienna, Austria; tel.: + 43- Prospective contributors are invited to submit an ap- 1-313 36/4371, fax: + 43-1-313 36/751, email: plication, abstract, and curriculum vitae before May Reiner.Springer@wu-wien.ac.at, or Prof. Dr. Petr 31 and a final paper before September 30. Travel and Chadraba, Kellstadt Center for Marketing Analysis and accommodation expenses will be paid for the authors Planning, DePaul University, 1 East Jackson Boule- of papers selected for presentation depending on avail- vard, Chicago, Illinois 60604; tel.: 312-362-6889, fax: able funds. 312-362-5647, email: pchadrab@depaul.edu. TRANSITION, March-April 2002 ©) 2002 The World Bank Articles provided by: The tJrb:a.r Irwtiti..ite v Problems with ]Russia's Compulsory Screening for HIV/AIDS By Kimberly Cartwright Russian policymakers and health officials have become increasingly alarmed about the growing inci- . dence of HIV infection. At the end of 2000, 51,952 new cases of HIV had been reported, a 258 percent increase over the previous year and a 1,183 percent increase over 1998. The chief of the Russian AIDS Center estimates that Russia will have 1 million cases by 2005; however, compulsory screening of the population does not seem to be a useful policy. In 1995, in response to the growing number of HIV infec- of the population-14 to 17 percent or 20 to 25 million tions, the Russian government passed a law to prevent people-was annually tested for HIV in the years follow-! the spread of AIDS. The law serves as the basis for the ing the 1995 repeal of mass screening anywhere from Federal Anti-AIDS Program. However, a host of factors one to four times. thwart these and other federally mandated laws and pro- grams from working effectively, massive indifference per- Why do the authorities continue to screen on what sists among public and private health practitioners, and appears to be an ad hoc basis? Screening for sexu- Russia has inadequate numbers of appropriately trained ally transmitted diseases has a long tradition in Rus- medical staff. In addition, at both the federal and re- sia, dating back to the late 1900s. Officials believe gional levels, officials and practitioners adhere to earlier that by counting and identifying all HIV-infected ifdi-t orders and policies that tended to reinforce common viduals, even if this means violating their civil liber-a prejudices about people who contract HIV. ties, they will slow down the pace of new infections M and eventually control the epidemic. They also be-, Thus it is no surprise that the architects of the federal lieve that it demonstrates to the public that they are law and federal programs have failed to allay the HIV aggressively taking concrete measures to fight HIV/I epidemic. They attribute their failure to insufficient fi- AIDS. nancing. This is certainly a factor. For three years the Russian government conducted stop-and-go negotiations Compulsory screening of major population groups in with the World Bank to secure financing for its anti-AIDS Russia, however, should be discontinued for a num- programs. Several weeks prior to the scheduled date for ber of reasons as follows: a new round of negotiations, which ultimately did not * Russia does not allocate enough resources for treat-: take place at the request of the Ministry of Health, we ing individuals with HIV/AIDS. The long-term goal of; conducted an institutional assessment of health care screening programs is to detect diseases early on: providers in Moscow and Nizhniy Novgorod for the World with the aim of reducing morbidity and mortality. For Bank. countries to achieve this goal they must have suffi- cient resources not only to detect, but also to treat Site visits and interviews revealed that the struggle to infected individuals. Since the start of the HIV epi- reduce the prevalence of HIV in Russ;ia faces more fun- demic in the mid-1990s, the Russian government has damental problems than a lack of funds or of legal en- been unable to provide sustained treatment to those forcement. Both federal and local government programs already infected. In 2000 just 600 people were pre-! are doing a poor job of reaching high-risk groups. scribed AZT cocktails at some point during their treatment. Instead, federal authorities-despite the 1995 law- * HIV prevalence is still relatively low and universal; still carry out compulsory mass screenings, includ- screening is not a sensitive tool for detecting new: ing employer-based screenings for HIV and other HIV infections. Of the 22 million people screened in: sexually transmitted diseases. A si(gnificant proportion 1999, just 18,707 (0.083 percent) were diagnosed as c 2002 The World Bank © 2002 The Urban Institute TRANSITION, March-April 2002 HIV-positive. There is also the risk of a high number of population and the retail cost of testing of $2, identi- 3 jlfalse positive tests. fying one HIV-positive case through employment- A E _ }* Compulsory screening may not be targeting high-risk based screening could cost taxpayers $3,508. Private t populations. Since the reporting categories are different expenditure on HIV testing in 2000 amounted to about & Ca 11from the mandatory screening groups, officials have no $93.5 million. 'Aoqs .'way of evaluating whether screening is targeting the right w 8 w 0 groups. Summarizing the achievements of the 1993-95 While $2 for an HIV test does not seem high for an _.C !t# ILfederal program, Ministry of Health authorities wrote: individual, he or she is also required to pay to have "Russia is the only country in the world where costly blood drawn for syphilis testing, for bacterial testing of Iii and ineffective population screening is practiced. Man- a minimum set of sexually transmitted diseases, and !11, datory HIV screening is carried out on one-sixth of the for a skin evaluation. As in most cases the HIV test is ill total population on people who are not associated with administered along with these other tests and a - a risk category. These people are being screened for physician's examination, the HIV test ends up costing HIV several times a year, while high-risk groups are not significantly more than the $2 test fee, with the total being screened. In reality, most of those infected with cost of testing ranging from $14 to $25 in Nizhniy HIV who belong to a high-risk group voluntarily undergo Novgorod (prices based on four clinics) and $71 to $100 anonymous testing." in Moscow (prices based on three clinics). Consider- * Compulsory screening is expensive for the govern- ing that the average monthly salary was $30 in Nizhniy ment. According to Vadim Pokrovskiy, head of the Rus- Novgorod and $150 in Moscow at the time this study sian AIDS Center, the federal government spent was conducted (April 2000), testing is a considerable approximately Rub 20 million ($714,000) for HIV testing expense for citizens to bear several times a year. programs in 2000, or 56 percent of the amount spent on all HIV/AIDS activities financed by the federal program. Kimberly Cartwright is a research associate with the * Compulsory screening is expensive for citiztens. While Urban Institute. Research for this article was sup- the law guarantees free medical examinations in state ported by a grant to the World Bank from the U.K. health care institutions, most state health clinics charge Department for International Development and by the patients and employers for HIV testing. The employers Urban Institute. For a complete listing of citations often pass such costs on to their employees. Based on and methods used in the calculations contact the the overall prevalence rate of 57 HIV cases per 100,000 author at Kcartwri@ui.urban.org. Inertia Leads Nowhere: Moldova's Economy Needs Decisive Action By Valeriu Prohnitchi The first decade of transition from a planned economy to a market economy is nearly over in Moldova. This provides a good opportunity for analyzing economic developments in the country. While Moldova has accomplished much in relation to political and human rights, freedom, and democracy, an exten- sive review of the current economic situation presents a bleak picture. Moldova's economic deficiencies are partly explained by and trade relations with other countries except through the the initial conditions inherited from the former totalitarian Soviet Union. This is why during the initial stages of transi- regime and by Moldova's deep integration into the hyper- tion Moldova found that it lacked stable export markets, centralized Soviet economic system. While the Soviet established trade partners, and external marketing skills. economy was relatively developed, its politico-ideological fundaments were erroneous and fragile. All the compo- While the Soviet economic legacy was indeed burden- nents of economic activity-production, distribution and some, one cannot invoke the inherited structural distor- redistribution, and even consumption-were strictly con- tions as the main cause of Moldova's economic failures. trolled and guided by Moscow. Moldova had no economic This is confirmed by the economic performance of the TRANSITION, March-April 2002 C 2002 The Urban Institute D 2002 The World Bank Baltic states. Even though these countries were even In Moldova, the political and social instability and the more integrated into the Soviet economy and more de- extensive corruption, both associated with an unattrac-, , pendent on Eastern markets, unlike Moldova, they have tive business climate, undermined various attempts at * succeeded in capitalizing on their political independence reform, and the hesitant leadership's lack of manage- i g I to create the conditions necessary for economic pros- ment skills became apparent. The fact that the govern- X perity. ment changed 8 times in 11 years made matters worse. "cc I 0 Moldova Needs Foreign Support After one year in office, the Com- meet the conditions laid out in the particular, the sustainability of the munist Party of Moldova (CPM) is privatization contracts. 2002 budget. Other concerns in- facing a number of potentially diffi- clude Moldova's new Civil Code, in- cult challenges. One such challenge On April 30 Tarlev announced that tended to replace the Soviet code is the deteriorating fiscal situation. international lending agencies may and createa legal environment more In January government revenues resume aid to Moldova in June, dis- conducive to business. An IMF mis- were 15 percent below target, and bursing up to $130 million by the end sion is due to arrive for an economic on February 1 Prime Minister Vasile of the year. The World Bank and IMF review in May. Tarlev told union leaders that there froze lending to Moldova last year be- was no money to pay wage arrears cause of concerns about the slow Foreign funds are vital to prevent to public sector employees, in par- pace of reform. Tarlev, who met with economic collapse and help the ticular, to teachers and doctors. senior World Bank and IMF officials country avoid defaulting on its for- There are also some positive devel- during a visit to Washington, dis- eign debt. The government must opments. The GDP growth rate ac- closed that the World Bank Board pay $200 million to service foreign celerated to 6 percent last year, and plans to debate the $30 million third debts this year, including the prin- the CPM has grudgingly accepted Structural Adjustment Credit to cipal on $75 million of Eurobonds the idea that poverty reduction and Moldova on June 18. Moldova could in June. This amounts to about 70 economic improvement need con- receive the first tranche of the loan in percent of Moldova's budget. Before tinued market-oriented reforms. late June or early July. The World 2000 Moldova's debt repayments Bank previously made it clear that it amounted to around 10 percent of Foreign investment would help, but will not release the $30 million credit its budget, rising to 42 percent last Moldova's last majorprivatization was until the government pushes on with year. Moldova's debt currently two years ago. During the CPMs first privatization, market liberalization, amounts to $1.5 billion, or 105 per- year in office it demonstrated its re- poverty alleviation, and so on. This cent of GDP, mostly owed to the IMF, luctance to privatize, though the gov- means selling energy, telecommuni- the World Bank, the Paris Club of ernment will soon choose an adviser cations, and winery companies; main- sovereign creditors, and Russia (to to sell wineries and has passed a taining an independent energy whichMoldovaowessome$300mil- law governing the sale of tobacco fa- regulator; and liberalizing access to lion for energy). cilities. Selling fixed-line monopoly the Internet. Until that happens, the Mold-telecom and two energy dis- IMF, for its part, will not resume its If no debt restructuring or external tributors would help to restore inter- $142 million Poverty Reduction and assistance is forthcoming, the gov- national confidence, although the Growth Facility Program. ernment is likely to rely in the first most serious interest is likely to instance on central bank financing come from Russian and Ukrainian The IMF suspended cooperation with to meet its debt obligations. Once investors rather than from Western Moldova last year, after disbursing it has exhausted this option, a de- investors. In February the govern- $25 million of its $142 million lend- fault seems likely later in the year. ment published a list of 24 compa- ing program. An IMF mission visited nies earmarked for renationalization, Chisinau in March in an effort to re- Excerpted from reports of the in- including the U.K./U.S./Romanian vive cooperation. Even though infla- temational research group Oxford pharmaceuticals joint venture tion fell from 18.4 percent in 2000 to Analytica, Oxford, U.K. (see http:// Farmaco. The government claims 6.3 percent last year, the IMF is con- www.oxan.com/index.html) and most of these companies did not cerned about fiscal stability, and in Reuters and World Bank sources. © 2002 The World Bank © 2002 The Urban Institute TRANSIIION, March-April 2002 The Giurgiulesti oil terminal was supposed to have been gangs and racketeers whose networks give them under- built by 1999 on the Moldovan portion of the Danube ground control of the national economy represent an- { r River. It was not, and its fate is still uncertain. Senior other critical factor in relation to production and O public officials have been involved in scandalous cor- distribution. ruption affairs. The Air Force lost 30 military aircraft, i not in war, but because they were sold illegally. In ad- During these years of profound transformation marked 4 !Ii dition, Moldova has failed to diversify its energy suppli- by enormous social costs, Moldova has missed many - ,1' ers. In 1994 and 2000 the government refused of its initial opportunities-such as integrating into the repeatedly to contribute anything to the construction EU, diversifying its external markets and energy suppli- of a second reactor at Romania's Cernavoda nuclear ers, and capitalizing on the commercial opportunities . ' !',| power plant. from gaining "Danube country" status-and moved for- ward only through inertia. European integration is no E Although some positive developments in monetary and more than a rhetorical exercise used during election commercial policy took place, by and large Moldova's campaigns and is not a real concern of political elites social and economic transition has failed. In 2000 GDP and of civil society, as was signaled again by the com- was about one-third of its 1989 level. Based on official munists' victory during the last general elections in Feb- statistics that indicated a 6.1 percent real GDP increase ruary 2001. The current leaders are more preoccupied (in constant prices) last year, Moldova would require 17 by Moldova's integration into the Eurasian Economic to 18 years of similar average annual growth just to re- Community than into the EU. The impressive political turn to its 1989-90 output level. Plunged into huge inter- ascension of the communists, riding high on a wave of nal and external debts, the economy needs to perform nostalgia, followed widespread disappointment with the extremely well if Moldova wishes to honor its obliga- previous leadership, which was protecting its own inter- tions. While official unemployment is no more than 2 ests without capitalizing on the population's initial en- percent, estimates suggest that the real figure is around thusiasm for reform. 15 to 17 percent, an assessment indirectly confirmed by the massive exodus of citizens looking for better jobs The blame for Moldova's economic failures should not be abroad. laid only on its weak, inefficient, and meagerly financed public institutions. Much of the responsibility lies with The economy is negatively affected by structural distor- civil society, which is indifferent and lacks initiative. tions. Only a few other European countries are as highly Moldova has only a few think-tanks, concentrated in the dependent on agriculture (30 to 35 percent of GDP), capital, that focus on economic issues, and there are no which in turn implies an overwhelming dependence on discussions between public agencies and civil society climatic factors. At the same time, the share of the popu- organizations about national economical strategies, while lation employed in agriculture is considerably higher than classical economic theory has demonstrated that private the agrarian sector's contribution to GDP. Hence labor initiative is the main engine of any prosperous society. productivity is low in this sector, which is not yet market The country's future success will depend on well thought oriented, and remains mainly a source of subsistence out, decisive actions and personal courage, a success for the rural population. Industry is inefficient, mainly that could propel Moldova into becoming an equal mem- because of obsolete technology and worn out equip- ber of the family of European nations. ment, as well as archaic or nonexistent marketing sys- tems. Valeriu Prohnitchi is a researcher at the Institute for Development and Social Initiatives (Viitorul) in Moldova The lack of physical infrastructure, underdeveloped in- and a member of the Urban Institute's Transition Policy stitutions, and highly asymmetric market information im- Network. For more information on the Moldovan economy pede normal, transparent market flows. The state still or other Viitorul work contact the author at idis_viitorul retains a large monopoly in acquiring agricultural pro- @mdl.net or valeriu_prohnitchi@hotmail.com. duce and farmers are compelled to accept excessively low prices. The local market is limited, but access to external markets is difficult because Eastern markets are unstable, while European ones are closed to mer- chandise that does not reach Western quality standards. The well organized, sometimes transnational, criminal TRANSITION, March-April 2002 © 2002 The Urban Institute D 2002 The World Bank New Books and Working Papers The Macroeconomics and Growth Group regrets that it is unable to provide the publications listed. Continued from page 27 Benoit Bosquet, The Role of Natural Resources in .X Fundamental Tax Reform in the Russian Federa- 3: g 0 w technological change goes hand-in-hand with economic tion, WPS 2807, March 2002 11- growth, coupled with a tendency for the better-off to as- similate new technology ahead of the poor. The Russian Federation has one of the richest natural To order: Hedy Sladovich, room MC3-311, tel.: 202-473-7698, resource endowments in the world. Despite their impor- fax.: 202-522-1154, email: hsladovich@worldbank.org. tance in the Russian economy, natural resources do ii not contribute as much as they could to public revenues. Jocelyn A. Songco, Do Rural Infrastructure Invest- Large resource rents (excess payments or above nor- ments Benefit the Poor? Evaluating Linkages: A mal profits generated by natural resources in scarce Global View, A Focus on Vietnam, WPS 2796, Feb- supply) are dissipated through subsidies and wastage ruary 2002, 59 pp. or are appropriated by private interests. Failure to tax To order: Herawaty Sutrisna, room MC9-242, tel.: 202-458- this rent means levying taxes elsewhere (on capital and 8032, fax.: 202-522-1556, email: hsutrisna@worldbank.org. labor) to sustain revenues, thereby depressing invest- The author may be contacted at jas494@columbia.edu. ment and employment, or foregoing potential revenues. Failure to reinvest rent means that Russia perpetuates Dimitri Vittas, Policies to Promote Saving for Re- the tradition of exporting low value added raw materials tirement: A Synthetic Overview, WPS 2801, March and excessive capital outflows and retards its transition 2002, 35 pp. to sustainable economic development, The total appro- priated rent on oil and gas was estimated at $9 billion in Vittas argues that public and private pillars are essen- 1999 (in excess of $15 billion in 2000), or about 18 per- tial for a well-functioning pension system. Public pillars, cent of consolidated tax revenues. funded or unfunded, offer basic benefits that are inde- pendent of the performance of financial markets. As fi- A more appropriate natural resource taxation system would nancial markets suffer from prolonged, persistent, and enhance the fiscal role of natural resoLirces and improve large deviations from long-term trends, they cannot be incentives for resource conservation and environmental pro- relied on as the sole provider of pension benefits. Funded tection. The state still owns most natural resources, which pillars provide benefits that are based on long-term capi- theoretically facilitates changing resource pricing and taxa- tal accumulation and financial market performance, but tion. The cost of adjusting the tax system is relatively low they need to be privately managed to minimize depen- at this time, because Russian tax policy is undergoing dence on public sector institutions aind avoid govern- thorough reform. A seemingly desirable instrument-true ment dominance of the economy and financial markets. differentiation of rental payments-does not exist in Rus- sia despite legislative provisions that it should. Several The creation of a dual regulatory structure would allow greater natural resource taxes are specific taxes (set per volume), individual choice. One part would involve heavy regulation regardless of the market price or production cost. Such with constrained choice of investment funds, limits on oper- taxes favor profitable deposits and penalize marginal ones. ating fees and on account switching, and strong govern- To order: Doreen Duff, mail stop H4-407, tel.: 202-473- ment safeguards and guarantees. This would cater to those 9506, fax.: 202-522-2754, email: dduffl@worldbank. org. workers with low risk tolerance. The other part would be more liberal, but would be based on strong conduct rules. It Andrew Powell, A Capital Accord for Emerging Econo- would offer a greater choice of investment funds, allowing mies? WPS 2808, March 2002, 39 pp. multiple accounts and liberal account switching, imposing To order: Elena Mekhova, room MC9-622, tel.: 202-458- no limits on operating fees, and providing no or fewer state 5984, fax.: 202-522-2031, email: emekhova@worldbankorg. guarantees. This would cater to workers seeking a higher The author may be contacted at apowell@utdt.edu. return who are willing to tolerate a highe-r level of risk. To order: Priscilla Infante, room MC9-904, tel.: 202-473- Robert D. Ebel and Serdar Yilmaz, On the Measure- 7642, fax.: 202-522-7105, email: pinfante@worldbank.org. ment and Impact of Fiscal Decentralization, WPS © 2002 The World Bank TiRANsIlTIoN, March-April 2002 s | 2809, March 2002, 26 pp. possible. According to the authors, $40 billion to $70 To order: Michelle Morris, mail stop J4-403. tel.: 202- billion in additional assistance per year is necessary, C g _ ',473-7285, fax.: 202-676-9810, email: fiscal decen which would roughly represent a doubling of official aid c '-' tralization@worldbank.org. flows over their 2000 levels. 3 £~ l To order: Susan Brickland, room G8-015, tel.: 202-473-0944, o 0 4 Scott Walisten, Does Sequencing Matter? Regula- fax. 202-522-3235, email: sbrickland@worldbankorg. The 3 0 Wu tion and Privatization in Telecommunications Re- authors may be contacted at sdevarajan@woridbank.org, forms, WPS 2817, April 2002, 21 pp. mmiller5@worldbankorg, or eswanson@worldbank.org. In the early 1990s many Western advisers encouraged IgorArtemiev and Michael Haney, The Privatization of J) T Eastern European countries and the former Soviet Union the Russian Coal Industry: Policies and Processes to privatize firms quickly under the assumption that in the Transformation of a Major Industry, WPS 2820, * market institutions would develop once firms were pri- April 2002, 28 pp. vately owned. The thinking since then has emphasized the importance of establishing an institutional framework In the early 1990s the Russian Federation implemented conducive to promoting competition before privatizing mass privatization with swift ownership changes in many firms. To date, little empirical work has clarified the de- industries. A notable exception was the coal sector, once bate. Consistent with current thinking, Wallsten finds the world's largest, which was in deep crisis and unable that countries that established separate regulatory au- to function without massive subsidies. The government thorities prior to privatization saw increasecl telecom- undertook a far-reaching program of sectoral restructur- munications investment, fixed telecommunications ing, closing heavily loss-making mines and cutting sub- penetration, and cellular penetration compared with sidies. The positive impact of the restructuring program countries that did not. Moreover, he finds that investors led to a slow but sustained improvement in the coal are willing to pay more for telecommunications firms in industry's attractiveness to private investors. By the end countries that established a regulatory authority before of 2001 private operators accounted for some 77 per- privatization. This increased willingness to pay is con- cent of coal output. sistent with the hypothesis that investors require a risk To order: Victoria Joseph, room 19-031, tel.: 202-473-2155, premium to invest where regulatory rules remain unclear. fax.: 202-522-2029, email: vjoseph@worldbank.org. The To order: Paulina Sintim-Aboagye, room MC3-422, authors may be contacted at iartemiev@worldbank.org tel.: 202-473-7644, fax.: 202-522-1155, email: or mhaney@worldbank.org. psintimaboagye@ worldbank. org. Nicholas Minot and Bob Baulch, The Spatial Distribu- Leora F. Klapper and Inessa Love, Corporate Gover- tion of Poverty in Vietnam and the Potential for nance, Investor Protection, and Performance in Targeting, WPS 2829, April 2002, 43 pp. Emerging Markets, WPS 2818, April 2002, 32 pp. To order: Rina Bonfield, room MC3-354, tel.: 202-473-1248, To order Agnes Yaptenco, room MC3-446, tel.: 202-473- fax.: 202-522-3518, email: abonfield@woridbank.org. The 1823, fax.: 202-522-1155, email: ayaptenco@woridbank.org. authors may be contacted at n.minot@cgiar.org or The authors may be contacted at lklapper@woridbank.org b.baulch@lds.ac.uk. or ilove@worldbank.org. Lodovico Pizzati, Labor Market Implications of Switch- Shantayanan Devarajan, Margaret J. Miller, and Eric V. ing the Currency Peg in a General Equilibrium Model Swanson, Goals for Development: History, Prospects, for Lithuania, WPS 2830, April 2002, 24 pp. and Costs, WPS 2819, April 2002, 38 pp. On February 2, 2002, Lithuania switched its currency The millennium development goals set quantitative tar- anchor from the dollar to the euro. While pegging to the gets for poverty reduction and improvements in health, dollar (since April 1994) has proven successful through- education, gender equality, the environment, and other out the transition years, the recent decision to peg to aspects of human welfare. At existing rates of progress the euro was motivated by the increasing trade relations many countries will fall short of these goals. However, if with European economies. Pizzati does not argue which developing countries take steps to improve their poli- peg is more appropriate, but analyzes the implications cies and increased financial resources are made avail- of changing the exchange rate regime for different sec- able, significant additional progress toward the goals is tors and labor groups. TRANSI11ioN, March-April 2002 C) 2002 The World Bank While pegging to the euro entails more stability for the and country-specific studies have tended to focus on export sector, Lithuania is still more dependent on dollar- fiscal stabilization and its indicators, highlighting the based imports of primary goods from the CIS than on importance of quantitative fiscal adjustment to stabiliza- imports from other Baltic countries or from the Central tion outcomes. Less attention has been paid to the quali- ' European economies. Simulation results suggest that tative dimensions of fiscal adjustment in transition. while a euro peg will provide more stability to GDP and l ° 0 m C employment, it will also imply more volatility in prices, The authors conclude that while the quantitative magni- . w suggesting that under the new peg macroeconomic tude of the fiscal adjustment was dramatic, the quality X F policy should be more concerned about inflationary pres- of this adjustment has compromised the social and eco- . sures than before. From a sector-specific perspective, nomic objectives of transition, particularly in the CIS. pegging to the euro will provide a more stable demand They draw four main conclusions, namnely: for unskilled-intensive manufacturincl and commercial * Investments in public services fell in both absolute services, but other sectors, such as agriculture, will still and relative terms. face the same vulnerability to exchange rate movements. * Reduced spending on government transfers contrib- This suggests that additional policy measures may be uted to a sharp increase in income inequality in the CIS. needed to compensate for sector-specific divergences. * Fiscal risks increased during the transition To order: Lodovico Pizzati, room H4-.214, tel.: 202-473- * Initial conditions allowed the Central European and 2259, fax.: 202-614-0683, email: lpizzati@worldbank.org. Baltic countries to maintain higher expenditures, which may have contributed to their faster economic recovery Adam Wagstaff and Nga Nguyet Nguyen, Poverty and and political support for reforms. Survival Prospects of Vietnamese Children under Doi Moi, WPS 2832, April 2002, 35 pp. The authors argue that the challenge today for fiscal policy in these countries is to facilitate the transition, By international standards, and given its relatively low particularly in reallocating resources from large state- per capita income, Vietnam has achieved substantial owned enterprises to new small and medium firms and reductions in, and low levels of, infant and under-five providing priority public services and targeted transfers mortality. New evidence shows that under the economic to assist those adversely affected by transition and re- liberalization program known as Doi Moi, this reduction verse the deterioration in social outcomes in child mortality has been sustained, but the gains have To order:Alison Panton, room H4-156, tel.: 202-458-5433, been concentrated among the better-off. As a result, fax.: 202-522-2751, email: apanton@worldbank.org. The socioeconomic inequalities in child survival are evident authors may be contacted at aalam@worldbank.org or in Vietnam-a change from the early 1990s when none msundberg@worldbank.org. were apparent. The lack of progress among the poor will jeopardize Vietnam's chances of achieving the interna- Bob Baulch, Truong Thi Kim Chuyen, Dominique tional development goals for child mcrtality. The authors Haughton, and Jonathan Haughton, Ethnic Minority examine various policy scenarios, including expanding Development in Vietnam: A Socioeconomic Per- the coverage of health services, water, and sanitation, spective, WPS 2836, May 2002, 25 pp. and find that such measures, while useful, will have only To order Emily Khine, room MC3-301, tel.: 202-473-7471, a limited effect on the mortality of poor children. They fax.: 202-522-3518, email: kkhine@worldbank.org. Jonathan find that programs aimed at narrowing the gap between Haughton may be contacted atjhaughto@beaconhill.org. the poor and better-off may have large beneficial effects on the various determinants of child survival. David Dollar, Reform, Growth, and Poverty in Viet- To order: Hedy Sladovich, mail stop MC3-311, te/.: 202- nam, WPS 2837, May 2002, 33 pp. 473-7698, fax.: 202-522-1154, email: hsladovich @worldbank.org. The authors may be contacted at Vietnam grew rapidly in the 1990s, and yet by many awagstaff@worldbank.org or nngaiworldbank.org. measures its economic institutions are poor. Between the 1980s and 1990s Vietnam carried out significant Asad Alam and Mark Sundberg, A Decade of Fiscal economic reforms, notably, stabilization, the introduc- Transition, WPS 2835, May 2002, 27 pp. tion of positive real interest rates, trade liberalization, and initial property rights reform in agriculture, but un- Transition literature has emphasizEd stabilization and less it undertakes further reforms the country's high enterprise restructuring. Both cross-country analyses growth rate will decelerate. Vietnam's policies have c 2002 The World Bank TRANSIIION, March-April 2002 improved a good deal, but are still rather poor in com- According to the study, the development experience of parative perspective. A comparison of governance indi- the last 50 years suggests that neither the central plan- --. cators, financial sector issues, and the infrastructure of ning approaches of the 1950s and 1960s nor the mini- car"; 2 1!international integration reveals serious institutional weak- mal government, free market approach of the 1980s and --22, 1ll nesses in Vietnam that need to be addressed if a high early 1990s will achieve broad poverty gains. Instead, Igrowth rate is to be sustained. effective approaches to development must be country- . To order: Emily Khine, room MC3-301, tel.: 202-473- owned. While the private sector is the engine of growth, 7471, fax.: 202-522-3518, email: kkhine@worldbank.org. governments must provide a sound governance frame- -9. -_ ii: The author may be contactedatddollar@worldbank.org. work, help to create a functioning physical infrastruc- ture, and enable investments in people. These elements I l Paul Glewwe and Phong Nguyen, Economic Mobility are key to growth and poverty reduction, and can be in Vietnam in the 1990s, WPS 2838, May 2002, 26 pp. greatly enhanced by external assistance. (For the full --E3 text see: http://econ.worldbank.org/view.php?type Vietnam's high economic growth in the 1990s led to =5&id=13080.) sharp reductions in poverty, yet during the same period inequality increased. This increased inequality may be World Development Indicators 2002 (print edition less worrisome if Vietnamese households experience a and CD-ROM) high degree of income mobility over time. This is be- cause high mobility implies that the long-run distribu- Now in its sixth edition, World Development Indicators, tion of income is more equally distributed than the the World Bank's respected statistical publication, pre- short-run distribution, as some individuals or households sents the most current and accurate information on glo- are poor in some years, while others are poor in other bal development on both a national level and aggregated years. Authors examine economic mobility in Vietnam globally. This information allows readers to monitor the using recent household survey panel data. progress made toward meeting the goals endorsed by To order: Emily Khine, room MC3-347, tel.. 202-473- the United Nations and its member countries, the World 7471, fax.: 202-522-3518, email: kkhine@worldbank.org. Bank, and a host of partner organizations in September Paul Glewwe may be contacted at pglewwe@dept. 2001 in their millennium development goals. agecon. umn. edu. The 400-page print edition of World Development Indi- Other World Bank Publications cators 2002 allows readers to consult more than 80 tables and 600 indicators for 152 economies and 14 Roger Halsey, The Role and Effectiveness of Devel- country groups, as well as basic indicators for a further opment Assistance: Lessons from World Bank Ex- 55 economies. Key indicators for the latest year avail- perience, World Bank Research Paper, March 2002. able, important regional data, and income group analy- sis are also provided. In addition, six thematic Foreign aid is increasingly a catalyst for change, making it presentations of analytical commentary cover World possible for poor people to increase their incomes and to View, People, Environment, Economy, States and Mar- live longer, healthier, and more productive lives. Better allo- kets, and Global Links. cation of aid since the end of the Cold War means that it is more effective today at reducing poverty than ever before. The CD-ROM version contains 40 years of time series Nevertheless, while human development has proceeded data for more than 200 countries from 1960-2000, single- on an unforeseen scale, progress has not been uniform year observations, and spreadsheets on many topics. It across the globe, nor has development assistance always contains more than 1,000 country tables and the text been fully effective. AIDS reduced life expectancy in Sub- from the World Development Indicators 2002 print edi- Saharan Africa by three years in the 1990s, and average tion and the World Bank Atlas 2002. The Windows®- incomes in the region have been stagnant since 1965. based format permits users to search for and retrieve Many of the transition economies of Eastern Europe and data in spreadsheet form, create maps and charts, and Central Asia also suffered through sharp rises in poverty in fully download them into other popular software programs the 1990s. Some of the earlier structural adjustment pro- for study or presentation purposes. grams of the 1980s paid insufficient attention to countries' commitment to reform, to address governance issues, to Stoyan Tenev and Chunlin Zhang, Corporate Gover- institution building, and to mitigate social impacts. nance and Enterprise Reform in China: Building TRANSITION, March-April 2002 © 2002 The World Bank the Institutions of Modern Markets, International Fi- well as of Russia, to a financial crisis. Crises in Central l nance Corporation, 2002, 190 pp. and Eastern Europe are caused by much the same "sus- i - pects" as in others emerging markets, in particular, an As China continues in its evolution from a planned overvalued exchange rate. Weak exports and dwindling | economy to a market economy and from an agricultural currency reserves halve good predictive power for as- l to a manufacturing and service-oriented economy, is- sessing crisis vulnerabilities. C. sues arising from owner diversification, corporate gover- | -i nance, and labor resource allocation have come to the Marketta Jarvinen, Exchange Rate Regimes and l C forefront. In particular, the focus is on corporate gover- Nominal Convergence In The CEE Countries, No nance as the state continues its withdrawal from direct 4/2002, 40 pp. fIs> . ownership. 1 )'