http://www.worldbank.org/html/prddr/trans/WEB/trans.htm                      http://wwwwdi.bus.umich.edu
THE NEWSLETTER ABOUT REFORMING ECONOMIES
TRNSJTION
Volume 10, Number I       The World Bank in collaboration with The William Davidson Institute     February 1999
Firm Performance, Conflict Prevention, Capital
Flight-World Bank Researchers on New Territories
Interview with Paul Collier and David Dollar
In the following interview with Transition editor Richard Hirschler, Development Research Director Paul Collier and Develop-
ment Research Group Manager David Dollar talk about three ongoing research programs: sutveying and comparing enterprise
performance across countries, understanding and helping to prevent ethnic and civil conflicts, and identifying the causes of
and preventing capital flight. The findings could be highly relevant for transition economies.
Q. What are the major new thrusts  sible to think only within the context of a  to what extent and why cost structures
of the research department that  nabonal market. Countries must determine  are out of line. The Bank has surveyed firms
might also involve the transition  if their manufacturing sectors are intema-  in several countries in East Asia and Af-
economies?                           tionally competitive. By having a compa-  rica, and we will extend this project to the
rable standardized survey, with detailed  transition countries. The Bank has already
A. One major new initiative is to collect  information on costs and performance, we  carried out surveys on how enterprises in
internationally comparable data on firm   will be able to benchmark a country's  the transition economies of Europe and
performance. Manufacturing has reached  manufacturing sector against intemational  Central Asia have been affected by cor-
a global scale, and it is no longer sen-  competition. That can help to determine  ruption and by government regulations.
Announcement
.go-<     We are pleased to announce that the Bank of Finland's Institute for Economies in Transition (BOFIT) has
joined forces with Transition and will contribute to both its financing and its editorial content. BOFIT is
\*aS   headed by Professor Pekka Sutela. Its primary mission is to monitor and provide economic analysis of
developments in economies in transition, particularly Russia and the Baltic states. It undertakes research
and analysis of economic policy, trade, and integration. Current topics include economic developments
and economic policy-stabilization policies in particular-in Russia and the Baltic states; banking and finance in Russia
and the Baltic states; the European Union's eastward integration; external economic relations of Russia and the Baltic
states; and privatization and corporate behavior in Russia and the Baltic states. The institute's regular publications-Baltic
Economies: The Quarter in Review; Russian Economy: The Month in Review; and Review of Economies in Transition-are
available on the Internet (see below). The institute also publishes scholarly books and participates in a number of national-
level seminars and international forums.
Address: Bank of Finland Institute for Economies in Transition (BOFIT), Aleksanterinkatu 36 A Helsinki, or: P.O.Box 160
FIN-00101 Helsinki. Email: bofit@bof.fl, tel. 358-9-183-2268, fax:358-9-183-2294, Intemet: http.//www.bof fi/env/eng/itlten.stm.
Development Research Group                                                                  The World Bank



Q. Who will benefit from  this re-  of commerce and manufacturers' asso-  knowledge that if host authorities have a
search-the member countries them-  ciations. Our data will show how enterprise  stake in the success of a joint project,
selves or multinationals that will be  performance in a particu-                        they are more eager to
able to invest their capital in the most  lar country compares                          participate and make
lucrative enterprises?               with enterprise perfor-                            commitments. In most
mance elsewhere in the                            countries government
A. The information will be beneficial to  world. The data will ana-                     agencies are entrusted to
all interested parties. First and foremost  lyze both weak spots and                    collect firm-level informa-
we will provide feedback to government,  strengths. Earlier polls                       tion. So ideally we could
but we will also share it with chambers  often relied on the opin-                      work with these agencies.
ions of the polled enter-                         In some countries private
prises. We are linking                            firms conduct these sur-
that information to hard                          veys, but we could work
Contents                    evidence on actual costs                           out arrangements with
and performance. This                             them as well. Assuming
Time to Rethink Privatization in Tran-    gives us a much firmer                       the research committee
sition Economies? 4                 basis for analysis. The survey is thus dis-  endorses the program, the World Bank
On Corruption:                     tinctive because it allows performance to  will finance a significant part of this
* Organized Crime and Corruption Are    be compared intemationally, it is compre-  project. Our research department will con-
Live and Well in Ukraine 6          hensive, and it is quantitative.     tribute significant resources. We have al-
* Dancing with Anticorruption 8                                          ready hired several new professionals with
* World Bank Finds New Ways to Di-    Q. Policymakers can also make good  expertise in this area. In East Asia we
agnose Corruption Symptoms 10       use of these microeconomic data.    are supporting a training program in which
government officials are being taught to
William Davidson Institute          A. Definitely. The surveys provide a basis  analyze the first round of data. In the
* Inefficient Private Enterprises ? 12    for monitoring and evaluating changes in  Bank, country economists and other staff
* Tax System and Incentives of Gov-   firm-level accomplishments. This informa-  can use the same information to write eco-
ernment Officials 13                tion could be important for countries, in-  nomic reports and private sector assess-
* Reform in Vietnam: The Response    cluding many transition economies, that  ments.
of New Private and State Firms 14   are in an early stage of global market pen-
Streamlining Corporate Governance in   etration and reform.              Q. What are the other new research
China's State Enterprises 17                                             areas?
Q. Would Russian enterprises be in-
Reader's Forum                      cluded in the survey?                A. An important field is the study of civil
* The Crisis in Russia  20                                               conflict, crime, and violence. We are try-
* In Russia: Real Economy and Vir-    A. We are ready to extend our survey to  ing to understand the causes of these phe-
tual Market 21                     the Russian Federation and to Poland,  nomena in order to help develop policies
The Russian Revolution in Accounting    followed by other transition economies,  to prevent them. We are also looking at
and Auditing 22                     assuming that the project attracts the  the factors that sustain conflicts once they
interest and support of the host govern-  have started. Understanding these factors
PrivestorszatiounLik Rhes W otential In-    ment and gains endorsement and back-  can facilitate resolution of the conflicts and
vestors around the World 25         ing within the vice-presidency of the  postconflict reconstruction in those bat-
DHL-Creating Business-Friendly    World Bank responsible for lending and  tered economies. The main work is just
Customs Regulations in Slovakia 26    nonlending operations in Eastern Europe  starting. We held a conference in Febru-
Milestones of Transition  28        and Central Asia.                    ary, with representatives from around the
Interview with Slovakia's Ivan Miklos 29                                 world, and we are building up an intema-
Q. Who will finance these surveys?  tional research team to study the process.
World Bank/lMF Agenda 30
Conference Diary 32                 A. We need some contribution, in the form   Q. Unfortunately, many transition
New Books and Working Papers 33     of staffing, from the country in which we  economies-including several suc-
Bibliography of Selected Articles 39  undertake these surveys. It is common  cessor states of the former Yugosla-
a  TRANSITION, February 1999                                        © 1999 The World Bank/The Wilham Davidson Institute



via and several countries in Central  drugs. The nature of these resources may  gions. Of course, large capital outflows
Asia, such as Tajikistan, Uzbekistan,  affect the way things develop. Corruption  are also a huge problem in many tran-
and Armenia-are suffering from the  seems a more practical way of extract-  sition countries, primarily Russia. Re-
effects of past and present conflicts.  ing extra rents from, say, oil revenues,  patriating that wealth would have
There are also open or suppressed  while civil war is a more feasible alterna-  dramatic effects on raising capital
hostilities toward minorities.       tive if the stake is wealth from opium,  stocks and boosting investment.
cocaine, diamonds, or gold. If a country
A. We are studying both open and la-  is rich in natural resources but still bur-  Capital outflows are driven by a com-
tent conflicts. One key research finding  dened by a lot of poverty and its people  bination of misaligned exchange rates,
so far is that policies                             are deprived of their po-  distorted relative prices, high invest-
that effectively prevent                            litical rights, that coun-  ment risk, and high indebtedness. So
conflicts are very differ-                         try has a lot to worry  if a country is heavily in debt, is seen
ent from policies that re-                          about.                 as highly risky, has distorted relative
solve conflicts after they                                                 prices and an overvalued exchange
have occurred. In our                               4. Ethnic and reli-  rate, private wealth is going to move
research we have also                               gious diversity. The  outside the country. Each of these fac-
included crime and vio-                             common  perception  tors is pertinent for many transition
lence, because  in                                  thatethnicand religious  economies. A number of them have
some countries you                                  diversity contributes to  unfavorable risk ratings. Some have
have the potential for                              civil strife is untrue: the  accumulated very high levels of indebt-
overt civil war while in                            greaterthedegreeofre-  edness. What can a country do about
other cases you have                                ligious diversity, the  it? The easiest area of policy interven-
"only" the mounting                                 safer the society. That  tion is to eliminate relative price dis-
problems of crime and violence. It is im-  is also true with ethnic diversity. Twenty  tortions and to set the exchange rate
portant to explore the common sources,  ethnic groups, for example, can live and  right. The risk rating is much harder
if any.                              interact very well. But it is also true that  to influence. It is possible to do so,
just two or three ethnic groups within a  however, if governments are consistent
Q. It must be a huge research area.  society can make each other a lot of  in their policies, abstain from sudden
Crime and violence can be con-  trouble, and the risk of open conflict in-  policy reversals, and adopt liberalized
nected to corruption, as it is unfold-  creases. So diversity is a source of  trade regimes through binding commit-
ing in Russia.                       safety, except where you have just two  ments with the World Trade Organi-
groups in the society.               zation, for example. Countries with
A. We'll just go through a few of the find-                                good economic policy are perceived
ings. We can distinguish four major  Q. What other research project is in  to be less risky. Thus potential inves-
causes of conflict:                  the foreground?                       tors can be persuaded that there is
no need to seek outside refuge for
1. Poverty. Govemmentsanddonors can  A. We are trying to analyze the major  their wealth. Adopting such policies
do a lot to prevent conflicts by reducing  causes of capital flight and identify ways  could evantually slow capital flight sig-
poverty. In fact, poverty reduction is the  to prevent it. We have estimated the  nificantly
single most effective measure of conflict  stock of private wealth in a number of
prevention.                          economies, looked at what proportion  A related topic is the effect of foreign aid
of that private wealth is held outside the  on private foreign capital flows. Foreign
2. Lack of political rights. Moving to a  country, and tried to determine what af-  aid reduces the perception of risk. Where
full democracy is equivalentto something  fects that proportion. Countries differ  appropriate economic policies are in
like 50 years of growth, so it is quite a  widely in terms of the amount of private  place, foreign aid has a particularly
powerful effect.                     wealth that is held abroad, and there  strong effect on risk ratings. As a con-
are fairly consistent patterns as to what  sequence, foreign aid "crowds in" foreign
3. Possession of natural resources.  drives capital outflows. This is a seri-  direct investment, helping to reverse capi-
Many conflicts are in effect a fight for con-  ous problem in Africa and the Middle  tal flight. In contrast, when countries have
trol over natural resources, which should  East, where around 40 percent of pri-  highly distorted policies, official aid does
be interpreted rather broadly to include  vate wealth is held outside these re-  not impede capital flight.
C) 1999 The World Bank/The William Davidson Institute                                 TRANSITION, February 1999   U



0
Time to Rethink Privatization in Transition
Economies?
byjohn Nellis
A       lmost everywhere in the world, Faced with these sobering results,  tensively before competitive policies and
including   Central  Europe,  many policymakers and observers,  institutional safeguards-recognized as
lA tprivatization has succeeded to im-  particularly in the smaller or more geo-  important but thought to be secondary-
provefirmperformance.Nevertheless,early  graphically isolated transition econo-  were put in place. These institutions
and albeit fragmentary evidence from Ar-  mies, have begun to question the  believed that the immediate need was
menia, Georgia, Kazakhstan, the Kyrgyz  wisdom of rapid mass privatization.  to rapidly create a constituency of prop-
Republic, Moldova, Mongolia, the Russian  Several factors have made them ques-  erty owners. Private ownership by itself,
Federabon, and Ukraine so far shows that:  tion this policy:              they believed, would provide sufficient
* The association between private own-  * First, the failure of privatization to im-  incentives to shareholders to monitor
ership and restructuring (changes posi-  prove performance in Russia has con-  managerial behavior and push fimms to
tioning the firm to survive and thrive in  vinced many decisionmakers that  good performance.
competitive markets) is weak or nonex-  privatization is unlikely to succeed in their
istent.                              countries, where the quality of industrial  But capitalism is revealed to require much
* Firms that are partially owned by the  assets and the business environment is  more than private ownership. It functions
state perform better than privatized com-  as bad or worse than in Russia.  because of the widespread acceptance
panies.                              * Second, recognition has become wide-  and enforcementof fundamental rules and
* Few differences are discernible be-  spread that the administrative and legal  safeguards that make the outcomes of
tween the performance of state-owned  mechanisms needed to transform rapa-  exchange secure, transparent, and pre-
and private firms.                   cious grasping into tolerable and produc-  dictable. Where such rules, safeguards,
* Clear performance improvements are  tive acquisitiveness are almost entirely  and institutions are absent-fairness,
evident only in the few firms that have  lacking.                         equity, and firm performance suffer. In an
been sold to foreign investors.      * Third, policymakers in the former So-  institutional vacuum none of the players
viet republics recognize that many as-  in a privatized firrn-workers, managers,
The farther East one travels, the less  pects of their economies are still under  creditors, investment fund shareholders,
prvatizationhasimprovedfirmperformance.  the influence if not the control of Rus-  civil servants managing the state's re-
ThefirstandlargestdisappointmentisRus-  sian supply, transport, energy, and  sidual share-is interested in or capable
sian privatization that has not lived up to  sometimes criminal networks.  of maintaining the long-run health of the
the expectations and pronouncements of  * Fourth, several countries that tried  assets. In  such  circumstances,
its architects. There and in other transition  mass privatization schemes, such as  privatization is more likely to lead to
countries, mass and rapid privatizabon has  Kazakhstan, Mongolia, Moldova, and  stagnation and decapitalization than to
tumed over generally mediocre assets to  Albania, have concluded thattheygained  improved financial results and en-
people who have neither the skills nor the  little from the effort. In those countries,  hanced efficiency.
financial resources to run them well. Most  divesting ownership to inexperienced in-
high-quality assets-sometimes by "spon-  vestors has not led to effective gover-  Should Privatized Firms Be Rena-
taneous privatization" that preceded official  nance of firm managers, many of whom  tionalized?
schemes, sometimes by manipulation of  failed to implement change and remain
voucher schemes, perhaps most often and  largely unaccountable for their actions.  Some observers thus have suggested
acutely during the non-voucher second                                     that further privatization be postponed
phases of privatization or during secondary  What Went Wrong?             until competitive forces and an enabling
trading-have gone to the resourceful, ag-                                 institutional or governmental framework
ile, and politically well-connected few. And  Critics place part of the blame on the  are in place. Others have even called for
only rarely have these new owners em-  international financial institutions, since  the renationalization of divested firms,
barked on the deep restructuring that might they required governments of transition  which would or could be "reprivatized" at
justify their acquisition of these assets.    economies to privatize rapidly and ex-  some later date.
E  TRANSITION, February 1999                                       i) 1999 The World Bank/The William Davidson Institute



Despite its prima facie (obvious) ap-  also hinder efficient management of  ment capacities. Exactly how this can
peal, renationalization of privatized en-  state-owned enterprises.        be done and what the role of extemal as-
terprises would  be a desperate                                            sistance is in this process remains un-
measure, with a high likelihood of fail-  The slightly less drastic argument runs  clear, however.
ure, particularly in those institutionally  as follows: in institutionally weak and
weak settings where the idea has been  politically fractured transition econo-  Can anything be done in the shorter
most strongly endorsed. To success-  mies, long removed from or never fully  term? Several transition governments
fully renationalize (and then reprivatize)  integrated into the Western commercial  have tried to compensate for managerial
previously state-owned firms, the state  tradition, the government should halt  and institutional deficiencies and lack of
would have to select some or all of the  privatization of the remaining portfolio.  political consensus by contracting out
most egregiously mismanaged enter-  Instead, it should shiftefforts to strength-  much or all of the privatization process
prises, put them back in its port-                                             to private agents and advisors. Es-
folio, manage them while there, Share of GDP derived from private sources   tonia, Poland, Bulgaria, Armenia,
and eventually sell them in a re-                                              and Uzbekistan have tried or are
sponsible manner. Unlike the Country           1980  1988  1994  1997           contemplating this approach. Al-
sales reariactizationsiwouldimav  Czech Republic   <1.0  <1.0  65    75        though proved successful in Esto-
thesereprivatizations wouldphave Hungary        3.5   7.1   55    75            nia, this method is far from beinga
to be conducted in an open, Poland             15.6*  18.8*  55    65           universal orspeedy solution (as the
transparent manner. Standard, Romania           4.5   -      35    60           Poles can attest). And the effec-
internationally accepted valua- Russia         <1.0  <1.0   50    70           tiveness of the effort still depends
tion procedures would have to be Slovakia      <1 .0  <1 .0   55    75          heavily on the capacity of the gov-
adopted, and internationally rec- United Stat  79.4  79.6   81.1  82.0          ernment.
ognized, financial and transacUntdSae          794     9.    811 20
tion advisors would have to be 'This is almost exclusively agricultural producton (Slay 1993).  As a consequence, reformer ele-
involved. All relevant information Slovakia and the Czech Republic.             ments in the transition governments
would need to be disclosed to Sources: Patterson 1993; European Bank for Reconstruction and and the intemational assistance com-
bidders, and bidding would have Development 1994, 1997; Bureau of Economic Analysis.  munity-international financial insti-
to be open to all interested par-                                              tutions, the European Community,
ties. No restrictions (such as maintain-  ening market-supporting institutions  bilateral donors-abandon speed as the
ing the same line of business or  (mainlypublicbutsomeprivateaswell),  priority. They shift their efforts to a neces-
retaining a certain number of employ-  with the goal of channeling present "wild  sarily slower form of case-by-case or ten-
ees) could be placed on the manage-  East" commercial activity into socially  der privatization, a more cautious, more
ment of the business after the sale.    productive and acceptable modes. Dis-  evolutionary, more govemment-led path of
cipline and competition should be im-  ownership transfer.
The problems with such a plan are ob-  posed on and in the remaining public
vious: how many transition govemments  enterprises, accompanied orfollowed by  What Should Policymakers Do Now?
outside (or even within) Central and  staged, incremental shifts in ownership
Eastern Europe could reasonably be  patterns, in a more or less evolutionary  Yes, it is time to rethink privatization; but
expected to undertake this process and  manner, "Chinese-style."           only in those transition settings where his-
handle it well? How many have the ca-                                     tory, geography and politics have channeled
pacity to prevent asset stripping in state-  Once again, the idea has a prima facie  seemingly laudable economic policy into
owned companies, or the technical and  appeal. But once again, the solution as-  less than optimal outcomes. In Russia
political capability to divest firms ac-  sumes the existence of an effective state  and elsewhere, both reformers and exter-
cording to this set of procedures? Re-  mechanism and institutional framework.  nal advisors, aid-providers promised too
grettably few. The irony is that a country  Where such a framework does not exist,  much of privatization. Reformers seemed
with the skills and will to run state-  the options-unsuccessful privatization or  at first to view ownership change as a suf-
owned firms in an effective and efficient  maintenance of inefficient enterprises in  ficient condition to bring about a new iib-
manner is usually the very same coun-  the hands of a weak and venal state-  eral order. Judgement of extemal advisors
try that can privatize successfully. Con-  are bleak. The medium- to long-term so-  and aid providers-less forgivably-may
versely, the forces and conditions that  lution is to build up the government's  have been clouded by hopes for fast and
lead governments to botch privatization  administrative, policymaking, and enforce-  relatively simple solutions.
© 1999 The World Bank/The William Davidson Institute                                  TRANSITION, February 1999



But the admission of error should not be  term,  case-by-case  and  tender  owned enterprises in the Russian Fed-
overdone. When it can be carried out  privatization as well as reprivatization  eration, Morocco, Kenya, Estonia,
correctly, privatization is clearly the right  should proceed, in cooperation with the  Moldova, Egypt, and Vietnam. This ar-
course of action. In most of Central and  international assistance community, in  ticle is based on a presentation he gave
Eastern Europe and the Baltic States,  the hope of producing success stories  at the IMF Conference "A Decade of
privatization has proven its usefulness.  that will lead by example.      Transition: Achievements and Chal-
Difficulties that privatization had to face                               lenges," held in Washington D.C. in
in institutionally-weak settings were not  John Nellis is a senior manager in the  February 1999. A longer version of the
clear at the outset of transition-and  Private Sector Development Depart-  presentation will be published in the
those who claim they have long perceived  ment. He has worked extensively on the  June issue of the IMF Quarterly, Fi-
this did not come forward with a clear  restructuring and privatization of state-  nance and Development.
alternative strategy.
One must continually ask, what was and Organized Crime and Corruption
is the alternative to privatization? Is it not
clear that Russia would be better off to- Are Alive and Well in Ukraine
day had it not undertaken the mass
privatization program of 1992-94? Sev-  by Louise 1. Shelley
eral other institutionally-weak transition
economies-Belarus, Bulgaria, Roma-          rime and corruption have in  Criminals and Public Officials: Part-
nia, and Ukraine, for example-that es-      creased dramatically in Ukraine  ners in Extortion
chewed, delayed, or approached              overthe pastfive years.As else-
privatization more cautiously, have little  where in the former Soviet Union, the  The most pernicious element of the
to show for it (though in no case, of  endemic corruption of the Soviet period  crime phenomenon in Ukraine is the
course, is privatization or its absence,  have been replaced in Ukraine by orga-  criminal-political nexus, the alliance
what explains the "whole story"). States  nized crime and rampant corruption. Both  among former Party elite, members of
that delay privatization usually find that  threaten the country's stability, under-  the law enforcement and security ap-
enterprises make irresistible claims on  mine its transition to a market economy,  paratuses, and gangs of organized crimi-
nonexistent resources, threatening the  deter foreign and domestic investment,  nals. Much crime in Ukraine combines
whole of the reform process.         and accelerate capital flight.       government officials' access to informa-
tion or goods with the use or threat of
Where,  then,  does  this  leave  Theeffectontheeconomyhasbeense-  force by organized criminals. The
policymakers? What policy prescrip-  vere. After nearly six years of indepen-  country's privatization program, for ex-
tions can be drawn from this experience?  dence, total foreign investment in Ukraine  ample, was undermined by former Party
* Privatization is generally the preferred  is a paltry $1.4 billion, and some $15-  officials and a criminal elite, who ap-
course of action. But the institutional un-  $20 billion is believed to have left the coun-  propriated state resources by stripping
derpinnings of capitalism must be in place  try illegally, at least partly in response to  assets from banks and enterprises.
if prvatization is to be effective and socially  corruption and organized crime. Many
acceptable in the short term. Where they  major multinational corporations have  Drug traffickers, as well as other domes-
are present, privatization should proceed.  decided not to do business in Ukraine,  tic and foreign crime groups, launder
* If these underpinnings are not in place  the second most populous country in  money through casinos, exchange bu-
but the government is effectively work-  Europe. In the spring of 1997, for example,  reaus, and the banks. And banks pro-
ing to create or reinforce them, it may  several U.S. companies that had consid-  vide criminal groups with information
make sense to delay privatization until  ered investing a total of $1 billion in  about businesses' profitability and as-
this effort bears fruit. Hungary and Po-  Ukraine changed their minds, indicating  sets, which they use to extort money
land offer cases in point.          that the business environment there is too  from them. Criminals and public officials
* Where the government is unwilling to  risky. Motorola also decided not to invest  often collude in this effort. Criminals, for
or incapable of creating the necessary  in the country after losing its bid to de-  example, extort money from businesses
institutional framework, the long-term  velop a mobile phone network to the Kyiv  by threatening to sell the information
course of action is to support measures  Star company, a Ukrainian firm with close  they illegally obtain from banks to the
enhancing will and capacity. In the short  ties to the government.        tax police. Tax officials are sometimes
a  TRANSITION, February 1999                                       © 1999 The World Bank/The William Davidson Institute



willing to share their information about  [Lazarenko is suspected of having stolen   nians believe that the government is do-
businesses with crime groups in return  $2 million in state funds and stashed  ingagoodjobatfighting organized crime.
for a share of the money they extort from   some $4 million in a Swiss bank during  The country's president, Leonid Kuchma,
businesses. The consequence is that  his premiership. In February 1999   has acknolwedged that the government
both companies and individuals try to  Ukraine's Supreme Council stripped the  has not created an environment that is
avoid keeping large sums in financial in-  former premier of his parliamentary im-  conducive to honest businesses.
stitutions, preferring to hide or divert it in-  munity, and a warrant was issued for his
stead (through barter deals, for example,  arrest. The Editor]             When Ukraine became an independent
or by moving money abroad).                                                state it had almost no expertise in
Corruption Is Perceived as Worst in  fighting crime and corruption. Its insti-
Public officials in Ukraine are poorly paid  the World                     tutional capacity to improve the per-
and face many opportunities to benefit                                     formance of the police and prosecutors
from their positions. Business activities  A survey of enterprise managers by the  was also limited. As a result, the coun-
are regulated by as many as 32 laws,  Ukrainian Market Reform Education Pro-  try lacks adequate law enforcement
about 30 presidential decrees, and more  gram in June 1998 found that 96 percent  and an independent judiciary with which
than 80 resolutions; 32 ministries and  of respondents attributed the stagnation  to block the influence of organized
departments have the right to issue li-  andfailureofprivatizedfirmstohightaxes.  crime. Unless Ukraine adopts the nec-
censesforvarious activities. This bureau-  They also cited current tax policies as  essary criminal laws and procedures;
cratic labyrinth creates vast opportunities  reasons for massive tax evasion and the  passes civil laws that regulate markets,
for corruption. At the same time, taxes  expanding shadow economy. The survey  the banking industry, and commercial
are high, creating incentives for busi-  indicated that about 70 percent of enter-  transactions; and establishes a viable
nesses to pay off officials rather than pay  prises operate in the shadow economy.  tax policy, it will not be able to deal
taxes. A number of parliamentary depu-  These companies have no protection from   effectively with the problem of corrup-
ties oppose tax cuts for fear that they will  corruption and are open targets for brib-  tion.
tempt many private firms out of the shadow   ery and other forms of extortion. Almost
economy, thus eliminating lucrative cor-  two-thirdsofthesurveyedenterpriseman-  In September 1996 President Kuchma
ruption-related opportunities for them-  agers regard corruption among central  endorsed a national anticrime program
selves.                              government officials and local civil ser-  that sought to tighten criminal laws,
vants as a major cause of their problems.  introduce financial reforms, and in-
The infiltration of Ukrainian legislatures  Stateregulationandinterferencewithbusi-  crease civic education  and technical
by criminals became a serious problem.  ness activities was the fourth major ob-  assistance. The Ministry of Interior as-
More than 20 members of the Parlia-  stacle facing private enterprises, with 36  sumed a lead role in law enforcement
ment would be tried on criminal charges  percent identifying it as a problem.  and the president's administration was
if they were stripped of their parliamen-                                  assigned a key role in implementation.
tary immunity, according to Hryhory  Ukrainian enterprises appear to be more  As for now, however, the crack-down on
Omelchenko, a member of the Parlia-  concerned about pervasive bureaucratic  corruption and other serious financial
mentary Committee on Fighting Orga-  corruption than enterprises in any other  reform measures remains in the plan-
nized Crime and Corruption. Forty-four  country surveyed, including enterprises  ning phase.
legislators, elected to local political bod-  in notoriously corrupt Indonesia. Another
ies, also have criminal backgrounds.    measure of corruption, Transparency   Louise I. Shelley is director of the Cen-
International's 1998 corruption percep-  ter for the Study of Transnational Orga-
The problem of corruption extends to the  tions index, also confirms the serious-  nized Crime and Corruption at American
very highest levels of government in  ness of the problem. That index ranked   University.
Ukraine. Serious accusations of em-  Ukraine 70th out of 85 countries. (Russia
bezzlement of Western aid funds have  was ranked 76th.)                     This article is based on her study "Or-
been made against the speaker of the                                       ganized Crime and Corruption in
Parliament, O.M. Tkacenko. Pavio  What Can Be Done?                        Ukraine: Impediments to the Develop-
Lazarenko, Ukraine's prime minister in                                     ment of a Free Market Economy,"which
1996-97, reportedly made tens of millions  The government has proved unable to deal  appeared in Demokratizatsiya-The
of dollars annually through his company's  with the problem effectively. According to  Journal of Post-Soviet Democratization
license to import natural gas and Oil.  a recent survey, only 7 percent of Ukrai-  (Fall 1998).
© 1999 The World Bank/The William Davidson Institute                                 TRANSITION, February 1999   U



Dancing with Anticorruption: Is Government
Complicity in Corruption a Form of Economic
Protectionism?
By Ivan Krastev
Seven centuries ago Dante placed those  sia and Bulgaria as well as for the col-  tion economies. First, postcommunist
guilty of treachery in the deepest and  lapse of the Asian miracle. The credibil-  governments are necessarily of two
darkest circles of Hell. Historians point  ity of govemments and political leaders  minds about corruption. And, second, an
to political reasons for his dislike of cor-  has begun to hinge on the intensity of  anticorruption campaign is a very useful
ruption. Bribery was deemed responsible  their commitments to fighting corruption.  platform for attacking reformist policies
forthe failures of the Italian republics and                            and reform-minded governments. The
for the success of Dante's political en-  The end of the Cold War, the spread of  protectionist character of present-day
emies.                              democracy, the new power of the free  corruption is one of the principal reasons
media, the increasing globalization of  for the selective approach of the reform-
Nowadays, reports of bribery and other  trade, and the rise of free-market econo-  ist governments in grappling with it. At
abuses of public office can be found not  mies are commonly listed among the  the same time, reform-minded govern-
only in new editions of Dante's Infemo  factors that explain the emergence of a  ments view anticorruption rhetoric as a
but also on the front pages of newspa-  new consensus on anticorruption. In  dangerous instrument that may abet the
pers and magazines. Stories of the per-  Washington, the consensus of the de-  rise of populist and antireformist alter-
vasiveness of corruption in Russia,  velopment community could be summa-  natives.
Mexico, and Nigeria-just to name a  rized as: "more reform means less
few-make for exciting reading. Italian  corruption." Not only has anticorruption  Corruption as a hidden form of pro-
"clean hands" and postcommunist "dirty  become fashionable, but the terms of the  tectionism
linen" have become two of the most redo-  debate have radically changed. At the
lent catchphrases of the post-Cold War  beginning of the century, corruption was  Multinational companies-foreign inves-
world.                              analyzed mainly in cultural and political  tors in general-and international finan-
terms; in communist circles, it was  cial institutions are the driving forces in
But why has corruption become such an  viewed as a "bourgeois legacy."  today's global anticorruption campaign.
important topic for public debate? Be-                                  Transparency International's Corruption
hind this question lies another: How sin-  Today, corruption is debated mainly in  Index registers the evaluations of "clean-
cere are today's postcommunist  economic terms. Some fifty years ago,  ness" given to specific countries by the
governments in their declared war on  corruption was considered a reflection  officers of multinational corporations. In
corruption?                         of the moral fallibility of human nature,  the traditional perception of bribery, the
while today the focus is on opportuni-  "conversion" of multinational companies
In a paper written for the IMF, "Corrup-  ties and incentives: anticorruption poli-  from sources of corruption into fighters
tion Around the World: Causes, Conse-  cies aim to restrict the demand and  against corruption is a dramatic change.
quences, Scope, and Cures," Vito Tanzi  supply of acts of corruption. Some thirty  To illustrate the extent to which foreign
argues that it is difficult to measure  years ago, economists and political sci-  capital was once seen as a source of
whether corruption is more widespread  entists-Samuel Huntington among  corruption, I have only to point out that in
today than earlier, and if so, to what ex-  them-argued that corruption could play  the Bulgarian language, all French, Ger-
tent; but it is also obvious to everyone,  a positive role in the process of modern-  man, and English words for doing busi-
Tanzi adds, that corruption has become  ization. Today, no one assigns corrup-  ness-Geschaft, for example-have the
a key issue for both understanding and  tion a constructive role.       connotation of performing a corrupt act.
reforming the current state of affairs (IMF
Working Paper, May 1998). Corruption  Two important sides of the issue are  In the 1960s and 70s, foreign investors
is widely held responsible for the failure  neglected in the present-day obsession  considered corruption to be a useful ve-
of market reforms in countries like Rus-  with corruption, especially in the transi-  hicle for opening up and modemizing the
a  TRANSITION, February 1999                                      ( 1999 The World Bank/The Williamn Davidson Institute



economies of developing countries. Cor-  corruption market because they are  in the prewar period. In the communist
ruption was an instrument for breaking the  plugged into existing networks and be-  period, the accusations of corruption were
official protectionist barriers that were tol-  cause they possess local knowledge. In  successfully used to attack communist
erated and in some cases encouraged by  other words, a corrupted business envi-  reformers. In the late 1980s, anticorrup-
the governments of developing countries.  ronment is much more favorable to local  tion rhetoric was heavily used by com-
businesses than a transparent market.  munist hard-liners to attack Gorbachev's
In the new world of global finance and  This 'patriotic" side of corruption is one  perestroika. This brief backward glance
free  trade, protectionism  is  an  of the major reasons for the much la-  at the anticorruption rhetoric of this cen-
unaffordable luxury for most govern-  mented ineffectiveness of anticorruption  tury in Bulgaria serves to remind us that
ments. In the transition economies of  campaigns and the (tacit) unwillingness  the new war on corruption declared by
Central and Eastern Europe, protection-  of postcommunist govemments to crack  the IMF and World Bank can be counter-
ism is simply unthinkable. Their need for  down seriously on corrupt practices.    productive if it does not take into account
market reforms and their dependence on                                   the cultural and political hinterland within
foreign investment and on World Bank  The protectionist nature of present-day  which this war takes place.
and IMF financing has forced the  corruption complicates the attitude of
postcommunist states to open their  postcommunist governments toward  The success of anticorruption rhetoric is
economies and to adopt nonprotectionist  their own official anticorruption policies.  endangered, in  the  context of
legislation. But in this new openness,  For instance, we can expect the Bulgar-  postcommunist politics, because the
postcommunist industries have had to  ian government to focus its efforts on  majority of the public sees corruption as
face the harsh reality that they are in  fighting the illegal import of foreign goods  a direct result of market reforms. Pub-
fact uncompetitive.                 into the Bulgarian market rather than on  lic-opinion polls testify that, for the los-
fighting the illegal export of untaxed Bul-  ers in the transition, privatization of state
A look at the Transparency International  garian goods. This symbiosis between  assets is the quintessential example of
Corruption Index reveals that the least  corruption and protectionism is crucial  corruption. The success of politicians,
competitive countries are the most cor-  in understanding the ambiguous, half-  like Alexander Lukashenka in Belarus
rupt. The correlation could suggest that  hearted, and selective policies of the  and Alexander Lebed in Russia, illus-
corruption is a major factor contribut-  postcommunist governments.      trates that the anticorruption platform can
ing to uncompetitiveness. But a differ-                                  be misused by antireform populists. In
ent conclusion may be closer to the  One of the major assumptions of the  an ideological environment where there
truth: corruption is a response to  present campaign against corruption is  are no plausible altematives to democ-
uncompetitiveness. Postcommunist  that anticorruption rhetoric and anticor-  racy and a free market, anticorruption
governments are torn between their  ruption "sensitivity" are part of the reform  rhetoric can, in a distorted way, occupy
commitment to free trade and openness  effort. But a review of the history of anti-  the place of a policy alternative.
and their desire to create a favorable  corruption rhetoric demonstrates that
environment for noncompetitive local  such an assumption is misleading. In  Current campaigns and debates neglect
businesses.                         Bulgaria, at the turn of the century, anti-  this dangerous side of anticorruption
corruption rhetoric was associated with  rhetoric. We now hear plenty of anticor-
Compared with the normal markets of  virulent hostility toward modernity and  ruption rhetoric and even see some mod-
goods and services, corrupted markets  modernization. Corruption was concep-  est successes in combating corruption.
are characterized by the very high value  tualized as the essence of moderniza-  But the dance with anticorruption could
to be placed on local knowledge. In or-  tion, as the all-corrosive force bent on  be a dangerous one if, at the end, some-
der to corrupt public officials, one can-  destroying traditional morality and tradi-  one like Lukashenka takes the floor.
not rely simply on offering the biggest  tional community.
bribe in the biggest brown-paper bag.                                    Ivan Krastev is the director of the Centre
The market in corruption services is a  In the 1920s and 30s, Bulgaria wit-  for Liberal Strategies, Sofia, and a fellow
clandestine, closed market. In order to  nessed a heated anticorruption debate  at the Collegium Budapest, Institute for
be competitive in this market, one has  provoked by the rise in the incidents of  Advanced Studies. This article is a reprint
to know whether to give a bribe, to whom   bribery and by growth in the black mar-  of the original piece, published in the East
to give the bribe, how to give the bribe,  ket. In its essence, this debate was a  European Constitutional Review, Vol.7,
and when to give the bribe. Local busi-  part of the deep anticapitalist sentiments  No.3., Summer 1998, p.56,, Intemet web-
nesses are much better positioned in the  that had captured people's imagination  site:http.//wwwlawnyu.edu/eecr/
© 1999 The World Bank/The William Davidson Institute                               TRANSITION, February 1999  *



World Bank Finds New Ways to Diagnose
Corruption Symptoms
by Daniel Kaufmann, Sanjay Pradhan, and Randi Ryterman
Over the past year the World Bank has  The newest method of measuring cor-  common form of corruption is embezzle-
helped Albania, Georgia, and Latvia mea-  ruption is to survey the parties to cor-  ment of public funds. In Albania and Latvia
sure corruption and design strategies to  ruption-including household members,  the most common form is theft of state
combat it and improve governance. All  enterprise managers, and public offi-  property. Bribery in procurement is com-
three countries are now refining and  cials-and ask them about the costs and  mon in all three countries.
implementing these strategies.        private returns of paying bribes to obtain
public services, special privileges, and  Institutional causes of corruption also
Using Surveys to Measure Corruption   government jobs. When approached with  differ across the three countries, sug-
appropriate survey instruments and in-  gesting different priorities for reform. In
Until recently, systematically measuring  terviewing techniques, respondents are  Albania a weak judiciary is one of the
corruption in government institutions and  willing to discuss agency-specific cor-  main causes of corruption; regulatory
assessing its economic and social costs  ruption with remarkable candor.     failures are less important. Regulatory
was considered impossible. Data con-                                         failures are more serious in Georgia and
sisted only of general measurements of  What Do Survey Data Reveal?          Latvia, both in terms of excessive regu-
public and expert perceptions of aggregate                                   lations and the discretion granted to
corruption in a country. Recent research,  Detailed surveys of corruption were con-  regulators enforcing them.
however, has analyzed cross-country per-  ducted in Albania, Georgia, and Latvia.
ceptions of corruption and compared them   Preliminary results provide a disturbing  The survey data can help establish priori-
with institutional and other correlates. This  picture of systemic and deeply institution-  ties for reform in each of these areas. For
work has shed light on the causes and  alized corruption that reduces public wel-  example, detailed statistics were collected
consequences of corruption (by showing,  fare and taxes private sector activity. The  on the bribes paid by enterprises to regu-
for example, that corruption is higher in  portrait that emerges is different in each  lators in different agencies. This informa-
countries that repress civil liberties).  country. In Georgia, for example, the most  tion can be used to determine which
agencies are receiving the largest share
of side payments (see figure on this page).
Purchasing  Public Positions                                Several important findings emerge from
C o4-    60           these survey data. First, corruption is
Cutoms     r                41                            costly for firms, and they would be will-
Tax inspectors, _                         4      52                     ing to pay higher taxes if it were elimi-
252
Natural resource                            43                           nated (see table on next page). In Albania
licensers l             "427 133                                   and Latvia bribes account for 7 percent
Judges 1                    132  39                              of revenue in firms that admit to paying
7-W942-2S-i8 1                                Albania    them. In Georgia bribes account for 15
Ordinary police        =            =340                  * Albania      percent of firms' revenue. Lost fiscal rev-
Investigators/  3     2DEl Georgia                        enues are high in all three countries,
prosesctutors        1       4  -  I                     Latvia      especially in Georgia.
Local officialsi2
Local officials==r 24                                     Corruption has serious implications for
Ministers _A f4                                                    public finance in other ways as well. A
1 9  1   1   1    large number of small bribes are paid to
0            20           40           60            80   officials to avoid paying taxes, customs
Percent of public officials believed to have purchased their positions  duties, and other liabilities to the state,
Based on 1998 World nnk--srveys of po1,ilc offi-als In these Ou,tr..s- 218 pUbliC  reducing fiscal revenues Moreover other
oflidin In Latvia (wIth L tvla  F-otS; 350 pubilo offlols In Georg1 n  wIth GORBI); nd  r  f
97 pTbRlANIN Felba In A1tWnma    m                                                                     oth ACER)r
ElTRANSITION, February 1999                                           1999 The World Bank/The William Davidson Institute



Composition of Corruption in Georgia                            Fighting Corruption
Contact with road police                                     Anticorruption programs in Albania, Geor-
Building permits                                             gia, and Latvia share several common
State banking services                                              features. All three countries sought as-
Lease of state-owned      Phone line installation                   sistance from the World Bank in design-
commercial real estateI             Enterprise registraton          ing reforms to improve governance; all
Registration of ownership ofvn
physicalorrealproperty                        Waterandelectricity      three are committed to open and trans-
parent policymaking, including collect-
ing detailed data on corruption and
Border crossing at customs -sponsoringpublicworkshopstodiscuss
Weights and measurements  sosrn   ulcwrsost  ics
inspecton       the data and the policy agenda. All three
countries initiated policy processes that
lllFireandsanitaryinspections  should culminate in anticorruption pro-
Exportor import permit                                                     grams for public administration reform,
Clearances for procurement                                                  including civil service, public finance, and
or privatization                                                       judiciary and regulatory reform.
Inspecton by tax or financial                 Daniel Kaufmann is Division Manager,
authorities
Regulatory Reform and Private Enter-
based on a World Bank - GORBI survev of 350 entemrises in Mav 1998.           prise, Economic Development Institute.
Sanjay Pradhan is Sector Leader, Eu-
types of bribes (such as unofficial pay-  households admit to paying bribes; in  rope and Central Asia. Randi Ryterman
ments to public officials for special privi-  Latvia the figure is 12 percent. Although  is Senior Public Sector Management
leges, such  as favorable judicial  richer households are more likely to pay   Specialist, Europe and Central Asia.
decisions, that do not have direct fiscal  bribes, the burden of corruption (measured   This article is adapted from "New Fron-
implications) may crowd out payment of  as the fraction of income paid in bribes) is  tiers in Diagnosing and Combating Cor-
taxes and other liabilities to the state.    much greater for poorer households.   ruption," PREM  Notes No. 7, 1998.
Tax Revenues Lost as a Result of  Third, bureaucrats pay for lucrative po-
Corruption in Albania, Georgia, and   sitions. In Albania, Georgia, and Latvia    Corrupt Bureaucrat
Latvia (percent)                         the price of obtaining 'high-rent" posi-
Measure       Albania Georgia Latvia  tions is well known among public offi-
Enterprises willing to pay higher taxes if  cials and the general public, suggesting
corruption were eliminatedthat corruption Is deeply institutional-                    1 5       tSt
corruptio  were eliminad  ized (see figure above). Higher prices
are paid for jobs in agencies and ac-                                 -
Additional taxes those enterprises would  tivities that households and enterprises
be willing to if corruption were eliminated   report as being the most corrupt, sug-    .          i I        \  .
gesting that corrupt officials rationally
11      22       15    "invest" when buying public offices.    ,I' ,c
Additional taxes all enterprises would be                                                        -./    .  , n5
willing to pay if corruption were eliminated   Th  pt   of corpto  difer acros
(as perent oftotal rvenue)The pattern of corruption differs across         X      f.-              ;[,l 
(as percen of totalrevenuethe three countries. Ministerial positions  Y
6   are purchased more often in Latvia than     t       i  ,
Source: 1998 World Bank survey of 483 enter-  inAlbania and Georgia forexample and                    X
prise managers in Latvia (Latvia Facts), 350
managers in Georgia (GORBI), and 356 manag-  lower-level positions are purchased less
ers in Albania (ACER).                    often. These findings suggests that grand
corruption may be more of a problem in
Second, corruption disproportionately   Latvia, while petty corruption is more se-
hurts the poor. In Georgia 14 percent of  rious in Albania and Georgia.            From Vitaliy Kartamyshev's collection.
O 1999 The World Bank/The William Davidson Institute                                           TRANSITION, February 1999   E



William Davidson Institute : ::
Latest from the Davidson Institute's Publication Profiles
Can Private Enterprise Ownership Be Inefficient?
Roger H. Gordon, Chong-en Bai, and David D. Li
hy has rapid privatization of  War II, effective tax rates rose in order  lege. All three are Research Fellows
W            state enterprises in some  to finance the war. The increase would  of the Davidson Institute. Their study
Eastern European countries  have been even more dramatic if price  "Efficiency Losses From Tax Distor-
and the former Soviet Union failed to bring  incentives had been used more heavily.  tions vs. Govemment Control," forth-
about dramatically higher performance?  If the former Communist regimes had  coming in European  Economic
Why have China and Poland grown much  relied on private ownership, tax rates  Review.
more rapidly than many other countries,  would have been extremely high in order
even though they have not been aggres-  to induce the desired shift in resources   Recent working papers of the
sive in privatizing? If private ownership is  toward heavy industry.     William Davidson Institute:
so clearly dominant, why has state con-                                 Internet: http:/Iwww.wdi.bus.umich.eduf
trol of enterprises been such a common  States have considerable flexibility in
phenomenon historically, not only in the  terms of the ways in which they can   Fruin, W. Mark, and Penelope Prime.
formerly socialist economies but in many  relinquish control over the economy.  Competing Strategies of FDI and
Western countries as well? If state con-  China, for example, freed output prices  Technology Transfer to China:
trol is inefficient, why did the U.S. gov-  quickly, while liberalizing wage rates  American and Japanese Firms.
ernment maintain extensive control over  and interest rates more slowly. Output  WP 218, January 1999.
military production, rely on the draft rather  decisions were decentralized, state en-
than price incentives to recruit soldiers,  terprises were not allowed to lay off their  Bowlus, Audra J., and Terry Sicular.
and ration resources for the military dur-  workers, credit was rationed, and state   Household Structure and Labor
ing World War II?                   enterprises were given incentives to re-  Demand in Agriculture: Testing for
invest their retained profits. More re-  Separability in Rural China. WP
The apparent paradox may reflect the  cently, remaining price distortions have   219, January 1999.
fact that private enterprises may be so-  been largely eliminated and labor and
cially inefficient when they face large  capital decisions have been almost en-  Perlow, Leslie. Managerial, Exper-
price distortions, whether from high tax  tirely decentralized. State-owned firms   tise and Team Centered Forms of
rates or explicit price controls. These  are now being rapidly privatized.  Organizing: A Cross-Cultural Ex-
distortions generate efficiency losses                                   ploration of Independence in En-
roughly proportional to the square of the  Other countries that have engaged in  gineering Work. WP 220, January
implicit tax rate. In contrast, the effi-  privatization in recent years have seen   1999.
ciency loss from  state ownership  sharp drops in tax and nontax distor-
should be largely independent of these  tions. When privatization has occurred   Kinoshita,Yuko. Technology Spill-
implicit tax rates, since managers can  without a substantial reduction in tax   overs through Foreign Direct In-
be compensated based on true produc-  rates, as in Russia, efficiency costs  vestment. WP 221, January 1999.
tivity rather than after-tax profits. The  of the high tax rates have been obvi-
efficiency loss from state enterprises  ous, raising questions about the in-  Wallace, Rodney. The Relationship
may thus be less than that from private  ternal consistency of this set of  between Opaque Markets and
ownership when price distortions be-  policies.                          High Speed Growth: How Good In-
come large enough.                                                       formation Interferes with Invest-
Roger Gordon and David Li are pro-  ment in a Rapidly Changing
Historically, there seems to have been a  fessors of Economics at the Univer-  Environment. WP 222, January
close association between state owner-  sity of Michigan. Chong-En Bai is a   1999.
ship and high tax rates. During World  profesor of Economics at Boston Col-
*  TRANSITION, February 1999                                     (D 1999 The World Bank/The William Davidson Institute



Taxation and Government Incentives-Eastern Europe versus
China
by Roger H. Gordon and David D. Li
During the transition period, governments  be closely tied to that of the old state  remains difficult in most of these coun-
in Eastern Europe and the former Soviet  firms. The success of political parties  tries, where cash transactions are sig-
Unionofficiallysupportedtheentryofnew  linkedtotheformerCommunistpartypro-  nificant. As a result, in most cases
private firms. In practice, however, the  vides supporting evidence for this alter-  financial incentives on officials still favor
state often hindered the process (by  native explanation. Once elected, officials  the old state firms. The Chinese have ap-
denying bank credit or access to office  face strong financial incentives to aid  parently avoided these distorted incen-
space to new firms, for example, or pro-  existing state firms, particularly firms in  tives in part by developing a nonstate firm
viding loans to state firms that would  industries that are in the best position  with close enough ties to local govern-
never repay them). In contrast, officials  to use bribes to influence government be-  ments to facilitate the collection of tax
in China (at least at the local level) have  havior. Even fully informed voters who  revenue.
been stronglysupportiveofnewentrants,  care only about overall efficiency may
and these new entrants have been the  still prefer to vote for parties whose ide-  Ironically, the model suggests that the best
key source of economic growth in China.  ology supports state-owned firms.  way to induce officials to be supportive of
new private firms is to raise the effective
The main reason for the sharp differences  If the source of tax revenue has impor-  tax rate on these firms. Previous research
in the behavior of officials in the two re-  tant effects on the behavior of govemment  has focused on the fact that such taxes
gions is their differing sources of govern-  officials-as the experience in China and  will discourage private investment in these
ment revenue. Local tax revenue in China  Eastern Europe would suggest-the be-  firms. By encouraging public support and
comes almost entirely from profits taxes  havior of officials should change when the  investment, however, these taxes may aid
and other fees on new entrants. In con-  source of tax revenue changes. In par-  rather than hinder the rate of growth of the
trast, in Eastern Europe and at the na-  ticular, the recent shift in China toward  private sector. Certainly, past work has ig-
tional level in China, profits and payroll  the shared use of a value-added tax by  nored entirely the role of the tax system in
taxes on the old state enterprises repre-  the national as well as local governments  influencing the incentives faced by govern-
sent a disproportionate share of tax rev-  should give the national government a new   ment officials.
enue. Since officials in both regions draw  interest in nonstate firms. It should also
on public funds for their personal use, they  reduce the conflicts of interest between  Roger H. Gordon and David D. Li are pro-
have a strong financial incentive to use their  national and local governments, which  fessors of economics at the University of
power to try to increase future tax revenue.  have been intense in the past.While value-  Michigan and research fellows at the Wil-
At the local level in China, they could do  added taxes have also been introduced  liam Davidson Institute. An earlier version
this by raising the profits of new entrants,  in most of the other transiton economies,  of this article appeared as William
and officials have clearly pursued these  collecting revenue from new private firms  Davidson Institute Working Paper No. 56.
incentives very aggressively and cre-
atively. In Eastern Europe, in contrast,    The Great Illusion
to increase future tax revenue officials    T   Ge 1 lio 1___________
needed to raise the profits of the old state
enterprises. This gave officials an incen-
tive to suppress competition from both
new entrants and imports and to induce
existing firms to collude on price. Many
aspects of government behavior seem
consistent with these incentives.
The key alternative explanation for the
obstructive behavior of Eastem European    "Gentlemen the- Europe you would like to catch-up with ceased to exist
officials has been the pressure they face                          in 476 A.D."
from voters, whose current welfare may  From the Hungarian magazine H6cipo
© 1999 The World Bank/The William Davidson Institute                                  TRANSITION,February 1999  U



Enterprise Reform in Vietnam: The Response of
New Private and State Firms
Two working papers reviewed byjed Friedman
Vietnam has achieved high rates of growth since the implementation of Doi Moi ("renovation" in Vietnamese), a spate of market-
oriented reforms adopted in the late 1980s. Enterprise reform, an important strand of Doi Moi, reorganized the state sector,
permitted new private firms, and actively encouraged foreign investment in productive units. Output from firms of all three major
ownership types-state firms, new private firms, and partly or wholly owned foreign firms-increased throughout the past decade.
Although many interesting questions were raised by this dynamic period, few studies have explored the impact of Doi Moi on firm
behavior and performance. Two recent papers focus on this topic. McMillan and Woodruff (1998) examine the types of networks
that develop among both new firms and recently privatized cooperatives. Malesky and others (1998) review state sector reform
and attempt to determine the degree of implementation of reform of state enterprises at the firm level.
How Do Interfirm Relationships Affect Trade in Vietnam?
McMillan and Woodruff (1998) use a  with them and then to monitor them once  to invoke the law. The knowledge that a
survey of Vietnamese private firms to  they start to transact. The punishment  customer received a bank loan may give
examine interfirm relationships and the  for nonpayment of a debt can be bilat-  a seller some assurance that trade credit
role interfirm networks play in facilitat-  eral (the creditor refuses to continue to  will be repaid.
ing trade. Trading relations in Vietnam   deal with the debtor) or communal (other
are shaped by two market frictions-  firms are told of the bad debt and black-  These informal devices are effective in
the difficulty of locating trading partners  list the debtor).            allowing deals to be made in the absence
and the absence of formal third-party                                     of a legal system, but informal contrac-
enforcement of contracts. To some  McMillan and Woodruff measure the  tual enforcement comes with efficiency
degree these frictions offset each  amount of trade credit the firm grants to  costs. Exclusion is the corollary of on-
other. The high search costs found in  the partner as an indicator of a firm's  going relationships. Continuing to deal
Vietnamese markets impel firms to  trust in its trading partner. They find that  with customary trading partner may
cooperate. Simultaneous transactions  the cost of finding alternative trading part-  mean refusing to deal with new entrants.
in goods and credit introduce a pos-  ners facilitates trade credit. Search  In fact, according to McMillan and Woo-
sible substitute for the legal system   costs are undoubtedly  higher in  druff,firmssometimesforgobetterdeals
because, if the customer is in some  Vietnam's transition economy, which  from outsiders.
way locked into the relationship, the  lacks information-generating market in-
supplier can cut off trade in goods if frastructure, than in industrial economies.  Small firms appear to use networks dif-
the debt is not repaid. The authors seek  Moreover, interfirm credit is needed more  ferently from large firms. Small firms and
to understand how these informal rela-  in Vietnam than in industrial economies  slow-growing firms rely on family net-
tionships work, what the determinants  because firms have less access to  works; large firms and fast-growing firms
of successful cooperation are, and  banks. Such credit is necessarily infor-  do not. This evidence suggests that to
whether the reliance on informal con-  mal, because the legal system offers  be successful, rather than just to sur-
tractihg entails any costs.          little protection to creditors. Reputation  vive, a firm must somehow break out of
is also an important factor. When a firm  its reliance on family-based links. Inter-
They find that strong bilateral relation-  has access to information about the cus-  firm networks remain significant even for
ships exist between many firms. These  tomer from its other trading partners or  large firms, however, in that they use
relationships are embedded in two types  (to a lessor degree) from family mem-  other firms in the industry as sources of
of networks: one based on pre-existing  bers, it is more likely to extend trade  information about new suppliers. Per-
ties of family or friendship, the other on  credit to a potential customer. Firms are  haps a network of firms in the same in-
communication among manufacturers of  also more likely to receive trade credit if  dustry, being an open network in the
similar kinds of goods. Private firms use  they receive a bank loan. This may re-  sense of allowing entry and exit, does
both of these networks, to investigate  flect the inefficiency of Vietnam's bank-  not limit a firm's success in the way that
potential trading partners before dealing  ing system and the inability of creditors  a family-based network does.
M   TRANSITION, Februar,y 1999                                     C) 1999 The World Bankffhe William Davidson Institute



How Have Reforms Changed Behavior by State Enterprises in
Vietnam?
Malesky and others (1998) focus on the  * Introduce both foreign and domestic  tially reduced. The liquidation of 5,000
implementation of enterprise reform at  competition.                      of 12,000 firms sent a signal that firms
the firm level and how these reforms have                                 will be allowed to fail. Managerial inter-
changed the behavior of state enter-  * Allow prices to reflect market scarcity.  views revealed that cost control and fi-
prises. The state sector in Vietnam has                                   nancial performance are now the most
traditionally accounted for a very small  * Create management boards and re-  important priorities of operations man-
portion of GDP compared with that in  structuring the management hierarchy.  agement. However, several managers
Eastern Europe, the former Soviet Union,                                  still believe that the government will bail
or China. In 1996 Vietnam's state sec-  * Adopt new management techniques.  their firms out if necessary and hence
tor produced only 29 percent of GDP,  All six of these components have been  adopt unrealistic strategies for expan-
mostly through manufacturing and other  addressed in law at various levels. The  sion. Establishing a credible hard bud-
industries. Nevertheless, the indebted-  study by Malesky and others offers a  get constraint is thus still a priority for
ness of the state sector may present  firm-level perspective that allows key ar-  Vietnamese policymakers.
severe problems in Vietnam's future.  eas in which implementation is lax to be
Total debt by state enterprises is worth  identified. Their findings in the six areas  * Competition. Reformers in Vietnam
about $30 billion-20 percent more than  are summarized below.             hope to eradicate longstanding mo-
the entire turnover of the state sector and                               nopoly control and prices through an in-
equal to the country's total GNP in 1997.  * Enterprise autonomy. Making enter-  fiux of foreign and domestic competition.
This situation underscores the need for  prises autonomous means allowing  Competition can be fostered by disman-
Vietnamese govemment officials to push  them to set prices and select the mix of  tling import or investment licenses, out-
ahead with reform of state enterprises.  inputs and outputs that they deem ap-  put quotas, control over prices, and other
Initial reform of state enterprises included  propriate without ministry or other gov-  interventions that give certain firms ad-
the liquidation or merger of many small  ernment intervention. The movement to  vantages over others. Managerial re-
and unprofitable companies (5,000 of  conglomerate state enterprises into state  sponses illustrate that they are facing
12,000 state enterprises were eliminated  corporations is a clear example of top-  competition from both foreign and domes-
in 1989) as well as the combination of  down decisionmaking from the govern-  tic suppliers. This competition has led
many surviving state enterprises into  ment that contradicts and works against  state enterprises to engage in customer-
larger business groups or conglomerates.  implementation of autonomy. Malesky  focused decisionmaking. A competitive
Other reform programs have yet to wit-  and others find that top managers are  labor market for skilled staff and manag-
ness equally dramatic results. Despite  more likely to be responsible for change  ers has developed. Conglomeration has
well-designed reform laws (governing the  than the ministries, although the minis-  counteracted competition by giving mo-
introduction of corporate governance  tries still play a significant role (ministry  nopoly power to certain state corpora-
plans, enterprise autonomy, better ac-  interference is evident in strategic deci-  tions,  although  in  some  state
counting standards and internal manage-  sions and through management boards).  corporations member companies may
ment practices, and more competition),  Firms do not have complete autonomy  still be competing against each other or
implementation has been lax.        in staffing decisions, as illustrated by the  their parent corporation.
strong number of respondents who were
Malesky and others surveyed top and  not worried about dismissal or demotion.  * Prices. State enterprises need to set
mid-level managers and a nonrandom   Managers did identify profits as the most  prices that reflect market scarcity and
sample of state enterprise managers and  important determinant of decisionmak-  the true costs of production. Toward that
employees. They identified six key steps  ing, however.                   end firms appear to be paying market
essential for successful reform:                                          prices for inputs, perhaps partly due to
* Hard budget constraints. Ideally,  prefabrication. Firms recognize a need
* Grant enterprises autonomy and elimi-  state enterprises should bear all the  for the competitive pricing of outputs,
nate bureaucratic centralism.        costs of failure; subsidies, low-cost  although they are often unhappy with the
loans, tax benefits, and interenterprise  results. The record on wage compensa-
* Impose hard budget constraints.   loans to state firms should be substan-  tion is mixed. Many firms have estab-
© 1999 The World Bank/The William Davidson Institute                                TRANSITION February 1999



lished complex wage scales based on  duced, management layers eliminated,  met with varied success. While some
worker productivity; others have been  and reporting policies streamlined. The  firms have attempted to encourage inno-
unable to eliminate seniority-based pay  number of internal administrative divisions  vation by rewarding creative problem solv-
scales that do not account for productiv-  should be reduced and a coordinated  ing, most managers did not consider it
ity. Some state enterprises have had dif-  hierarchy introduced that gives more re-  vital. Top managers are more concerned
ficulty receiving ministry approval for  sponsibility and accountability to lower-  than lower-level managers about stimu-
promotions of their employees.     level managers.                      lating creative energies. Although man-
agers claim they want to keep employees
* Management reform. Reforms  * New management techniques. If  on the cutting edge of knowledge, they
adopted in Vietnam envision a new and  other reforms are achieved, management  are more likely to use internal than exter-
independent management board replac-  can begin to act independently and fo-  nal training programs. External education
ing the relevant governing people's com-  cus on improving productivity by adopt-  is reserved only for higher-level manag-
mittee or ministry. In fact, management  ing modern management techniques.  ers out of fearthat beneficiaries of expen-
boards have been left untouched or only  The authors focus on four such tech-  sive training would leave the enterprise
slightly changed. Most members are still  niques: promoting a shared vision, en-  for more lucrative jobs.
appointed by the ministries. Lower-level  couraging innovation, promoting internal
management reform has been slow and  and external employee education pro-  In spite of the uneven adoption of reform
incremental but has made strides. In  grams, and streamlining internal pro-  programs, state firms have been able to
many firms departments have been re-  cesses. Adoption of these techniques has  achieve high levels of growth. State en-
Conference Announcements of the Davidson Institute
International Conference on Transition Economics,    consider the impacts capital markets and labor markets and
July 22-25, 1999, Beijing, China                    the social transformation have on public policy debates.
Organized by: The William Davidson Institute. In commemo-  Corporate Governance Conference
ration of the 20th Anniversary of the start of China's eco-  September 23-25, 1999, Ann Arbor, Michigan, United States
nomic reforms. The conference will be cosponsored by the
Ford Foundation, CEPR, and the World Bank. The local or-  Organized by: Davidson Institute Area Directors Merritt Fox
ganizing and hosting institution is Tsinghua University. Its  and Michael Heller.
dean, China's Premier Zhu Rongji, will be the patron of the  To date, sophisticated work on corporate governance has fo-
conference. The conference will have two days of academic  cused on advanced market economies. In the post socialist
proceedings and one day of policy-oriented presentations  context, high-quality corporate finance and institutional eco-
and  discussions. The policy day  featuring high-level  nomics scholars have usually done little more than convey
policymakers and academics, will focus on Chinags eco-  the received theory to transition policymakers. The unique
policymakers and academics, will focus on China's eco- contribution of the conferences and edited volume will be to
nomic record in comparison to that of the Commonwealth of focus on the reverse concern: what, if anything, do the reform
Independent States and Central and Eastern Europe. The   .'
acaependmic conferesanc    beba  al and .     em   experiences of transition countries teach about corporate gov-
academic conference wlill be based on theoretical and em-emnetorgnral?Cprteovnncshlrswl
pirical papers in all areas of transition. These papers will be  emanc theoryneral   Copor ate governnce schola
presntedby slectd Daidso  andCEPRreserch el-present the principal papers; discussants will include schol-
presented by selected Davidson and CEPR research fel-  ar  ftasto  cnmc  n  oprt  oenne
ars of transition economics and corporate governance.
lows, as well as invited Chinese and other academics.
Conference on Accounting
Foreign Investment Conference                        October 14-16, 1999, Ann Arbor, Michigan, United States
June 17-20, 1999, Ann Arbor, Michigan, United States
Organized by: Davidson Institute Area Director for Account-
Organized by: Davidson Institute Area Director Bernard  ing William Lanen.
Yeung.                                              Information for the Accounting conference will be announced
This conference will focus on the impact of foreign invest-  shortly.
ment in transition economies in the past, present, and fu-  For more information on these conferences, please contact
ture and take into consideration the influence of foreign  Ms. Sharon Nakpairat, Research Manager, tel. (734) 936-0041,
investment on emerging markets' growth. Presenters will  email: sharonch@umich.edu.
*  TRANSITION, February 1999                                      X) 1999 The World BankWThe William Davidson Institute



terprises lack complete autonomy, how-  r                         Co p r t
ever, with the govemment continuing to Streamlining  Corporate
interfere in personnel decisions and to
mandate conglomeration. To ensure con- Governance in  China s State
tinued economic growth, reform must be
fully implemented.                  Enterprises
Some of the reform programs men-  by Chi Fulin
tioned above, such as the imposition        hina started to corporatize its  thus effectively precluding any indepen-
entail a leveling of the playing field be-   state enterprises in the early  dent role for them. This arrangement sug-
tween state and nonstate firms. The         1990s in an effort to establish a  gests that reform  of the property
benefits from such reform would be  modern enterprise system. So far more  ownership system in state enterprises
twofold. Private fis  in Vietnam have  than 800 enterprises have                   is still unfinished.
labored under restrictive conditions, in-  been converted into public
cluding the inability to import or export  companies, listed on the                50 percentofthe shares of pub-
directly without the aid of a state sec-enter-
direcrtly withontdthe lai of accsstat s-  prises have been turned into            licly listed joint stock) compa-
tor party and lack of access to formal
channels of credit. As McMillan and  joint-stock companies or lim-                 nies (70-80 percent in some
Woodruff point out, private firms have  ited liability companies.                  enterprises). With such an own-
adapted to the absence of well-devel-                                              ership structure and in an envi-
oped markets and availability of bank  ,\Although significant progress             ronment in which govemment
credit through the development of net-  toward corporatizing state   _-.-administrators are hardly dis-
works. This adaptation has allowed  enterprises has been made in the past  tinguishablefromenterpriseoperators,com-
them to grow despite the restrictions  several years, some serious problems  paniesfinditdifficulttofreethemselvesfrom
faced. Lifting such restrictions would  remain. Enterprises are organized irra-  the binding constraints of govemment de-
surely benefit private firms. Proceed-  tionally, and the state bureaucracy regu-  partments, and their boards of directors are
ing with state sector reform and en-  larly intervenes in their operations.  notabletoperformtheirduties. Ownership
suring the implementation of reform at  Despite the reform's emphasis on de-  structure should therefore be diversified as
the firm level would spur growth not only  centralizing power, "insider' administra-  soon as possible.
in the state sector but among nonstate  tive appointees are able to exert control
firms as well.                      over enterprises. Illegal or unregulated  The state should give up its majority in-
operations drain the assets of state en-  terest in state enterprises in the competi-
Jed Friedman is a graduate student in  terprises. These obstacles impede the  tive sectors, which is both unnecessary
economics at the University of Michigan.  development of effective corporate gov-  and inefficient. Corporate governance
ernance at a critical junction in China's  based on state ownership can hardly be
McMillan, John, and Christopher Woo-  economic transition.               effective. Even large state enterprises
druff. 1998. "Interfirm Relationships                                    need a properly diversified ownership
and Informal Credit in Vietnam." Wil-  The Business of Reform Remains    structure. Collectives and individual en-
liam Davidson Institute Working Paper  Unfinished                        trepreneurs, not the state, should take
No. 132.                                                                 over ownership of these enterprises. The
Despite corporatization, some enter-  state should also withdraw its assets al-
Malesky, Edmund, Vu Thanh Hung, Vu  prises have been unwilling to undertake  together from small and medium-sized
Thi Dieu Anh, National Economics Uni-  any real change in their governance struc-  enterprises in the competitive sectors.
versity in Vietnam, and Nancy K. Napier.  tures and still adhere to the old man-  This would boost their operations and fa-
"The Model and the Reality: Assess-  agement and operational systems. In  cilitate their corporatization.
ment of Vietnamese SOE Reform-  about 20 percent of listed companies,
Implementation at the Firm Level."  the same person serves as both chair of  Bureaucratic Control Must Be Elimi-
William Davidson Institute Working Pa-  the board of directors and general man-  nated
per No. 154.                        ager. In many transformed enterprises
government departments continue to  Poorly regulated corporatization and the
select the chair and general manager,  intensification of administrative control
C 1999 The World Bank/The William Davidson Institute                               TRANSITION, February 1999   C



na- worsened the problem of "insider  The Company Law should be amended  soon as possible. Management of state
contr i" in China. While strengthening  to improve corporatization. Also, imple-  assets should not mean that different
supervision and diversifying administrative  menting regulations need to be drafted  government departments take charge of
control, we need to study the causes of  as soon as possible. The amendments  the enterprises; that would eliminate the
this problem and take effective measures:  should focus on such issues as how to  role of the board of directors. The law
enable shareholder meetings to function  would help both the government and en-
* The appointment of top management  as the highest decisionmaking body of  terprises to perform their respective
by government departments should be  the enterprise, improve the structure as  roles, and it would facilitate the market-
abandoned as soon as possible. For en-  well as the code of conduct of the board  oriented management of state assets.
terprises that have undergone systemic  of directors, strengthen the function of the
reform, top management should be se-  supervisory board, and regulate manage-  The strategic restructuring of the state
lected by the board of directors. At the  rial control. Enforcement of the law must  economy should be accelerated. State-
same time, supportive personnel system   be strengthened, with listed joint-stock  owned assets should be withdrawn
reform should be pursued.           companies used as the first "testing  from the competitive sectors as soon
grounds" for checking the effectiveness  as possible. By doing so the govern-
* Profits should be adequately allocated  of enforcement.                ment can concentrate on providing ser-
to genuine entrepreneurs who invest in                                   vices in the public domain (including
state enterprises and transform them   The Government Should Pull Back  health and education). The separation
into profitable enterprises. Entrepreneurs  from State Enterprises       of government administration from en-
are these enterprises' most precious and                                terprise operations would provide favor-
scarce resource. They should be able  Solving various problems encountered  able conditions for investment in
to retain a high percentage of their en-  in establishing effective corporate gov-  state-owned assets, safeguarding the
terprises' shares; in some small enter-  ernance also involves reform of govern-  rights and interests of both the state as
prises, they should be allowed to  ment administration. It is difficult to  a shareholder and investors, who are
become the largest shareholder. China  develop effective corporate governance  ready to bolster these companies with
should also deal with the strange but  without efficient management of state  their ideas and resources.
common phenomenon of "age 58-59." It assets, removal of state assets from the
refers to the traditional preretirement  competitive sectors, and true autonomy  Chi Fulin is Executive Director of the
practice in which managers of state en-  of enterprises and diversification of the  Haikou-based China Institute for Reform
terprises try to grab as much they can,  ownership structure.            and Development (CIRD), inHainanProv-
sometimes through  unscrupulous                                         ince. An earlier version of this article
means, before leaving the firm.     A law regulating management of state  appeared in the Far Eastern Economic
assets should be drafted and issued as  Review (Februaty 19, 1999).
* Enterprise employees-both workers
and managers-should be able to be-
come enterprise owners. Shareholding  Trimming  the  State Sector: Big Bang
by management can create strong in-  Chinese St  1?
centives for developing a participatory              Y  e
mechanism and effective corporate gov-
ernance.                            Call it a Big Bang, Chinese-style. No one  matic in the coastal and southern prov-
knows exactly how many companies  inces, where almost all state enterprises
The Company Law Needs to Be  have been sold so far. But it has been  had been sold.
Amended                             the largest transfer of industrial property
since Mao Zedong nationalized Chinese  In the mid-1 990s China had about 300,000
The Company Law was issued in 1994.  industry in the 1950s. The State Eco-  state companies, engaged in manufactur-
Implementing the law has proved difficult.  nomic and Trade Commission (SETC)  ing, trade, retailing, finance, and services.
Violation of the law and loose law en-  estimates that as of November, 1998,  By the middle of the next decade, only a
forcement are common, and some com-  Liaoning Province, in the northeast, for-  much smaller core of "strategic" indus-
panies routinely run illegal operations.  merly a bastion of state industry and  tries-such as communications, power,
The law itself has severai loopholes and  conservative thinking, had shed 60 per-  and heavy industries, such as steel and
needs amending to keep pace with the  cent of its small and medium-sized state  oil-are likely to remain entirely in state
progress of the reform.             companies. Results were even more dra-  hands. Capital that had been monopolized
*  TRANSITION, February 1999                                       © 1999 The World Bank/The William Davidson Institute



by inefficient state companies will be freed  Other reform moves are aimed at chang-  panies. The government is also creatiny
for more productive uses. The reforms are  ing the environment in which state com-  a network of asset management bu-
likely to establish a firmer foundation for  panies operate. For example, last year  reaus under the Ministry of Finance to
long-term growth.                   the government demoted the last of the  exercise ownership rights and respon-
industrial ministries that once told com-  sibilities. So far the bureaus seem in-
Nothing better illustrates the new atti-  panieswhattoproduce,turningtheminto  effectual in elbowing aside local
tude than a draft constitutional amend-  bureaus of the SETC with a long-term  officials, who are accustomed to inter-
ment, expected to win legislative approval  planning function. It also banned govern-  vening in company affairs. The power
in March 1999, that endorses the private  ment and party offices from running busi-  to appoint managers at large compa-
sector as an important part of the  nesses, which often led to conflicts of  nies remains with the central party per-
economy. Fan Gang, director of the Na-  interest. It approved a law to curb stock  sonnel department and provincial
tional Economic Research Institute, is  market fraud so that the markets can  governments, further complicating
skeptical that state companies can be  more effectively channel capital to well-  chains of command.
turned around through internal restruc-  performing companies. And it decided to
turing and mergers, but he notes that  let Guangdong International Trust & In-  The government hopes that restructur-
these measures could make companies  vestment Corp. go bankrupt, signaling a  ing state companies into fewer, larger
more attractiveforfuturesale,something  new willingness to let the market disci-  conglomerates will make oversight
he believes cannot be ruled                                                       easier. But officials are also
out. "The government's will-   "                                                  studying other options. As early
ingness to make changes    "      hina  should  make  its state                   as 1995 the SETC asked the
has itself changed," he says.  companies  as much  like  private   World Bank to organize a con-
"Five years ago, officials                                                       ference to examine other coun-
wanted to hold everything;            ones  as possible."                         tries'methods for managing state
now they only want to hold                                                        assets and enforcing corporate
big companies." Even the definition of  pline badly managed state companies.  governance. The chief recommendation:
which companies are large has been al-                                    China should make its state companies
tered so that fewer fall into the must-hold  Privatization shifts the problems off gov-  as much like private ones as possible, with
category, he notes.                  ernment shoulders, but it does not au-  separate legal identities, commercially ori-
tomatically solve them. The new owners  ented managers, transparent operations,
According to Ji Xiaonan, a senior official at  often face heavy debts and glutted mar-  and minimal political interference. Even
SETC, companies must have more than  kets. For most companies, the main  then, economists said, the sector will be
500 million yuan worth of both sales and  change is sudden financial discipline,  a drag on growth unless it is kept small.
assets to count as large, suggesting that  as banks hold private companies to
heavily capitalized companies maybecome  standards of risk that they waive for  Some of China's most influential econo-
saleable if their sales performance slips  state enterprises. For very large com-  mists, such as Li Yining, have long been
badly. In the past, about 5,000 companies  panies, privatization may not be fea-  making such arguments. As vice chair-
were considered large. It is not clear how  sible. China's private sector lacks the  man of the national legislature's finance
many will meet the new definition.   capital to buy very large companies,  committee, Li is helping draft a law on
even at firesale prices, says Dai  management of state assets. "My per-
Since 1993 more than 6,000 state com-  Yuanchen, a senior economist at the  sonal view is you can't have the govern-
panies of all sizes have been reorganized  Chinese Academy of Social Sciences.  ment represent the assets," he says.
as shareholding companies. Although  "If the state sector was sold all at once  He envisions a state investment com-
the state usually remains the major  to society, who could buy it?" he asks.  pany that manages a portfolio of trans-
shareholder, mergers and acquisitions  "Who would want it?" Some cities have  ferable holdings, shifting funds either to
are quietly increasing the private stake  been unable to unload their worst small   g p       g
in many of these firms. In apparent rec-  companies, even for free.       chase hgr profsrote
ognition of that fact, the government is                                  industries for development.
preparing to allow companies with as little  As an owner, the Chinese state has been
as 51 percent state ownership to list on  amazingly forgiving of bad performance.  Excerpted from Kathy Wi/helm's article
the two domestic stock markets. Previ-  Premier Zhu Rongji wants to change this  "Out Of Business" published in the Far
ously, only companies with 75 percent  and has sent teams of senior officials  Eastern Economic Review, Hong Kong,
state ownership were allowed to list.    around the country to audit large com-  on February 19.
i) 1999 The World BanklThe William Davidson Institute                               TRANSITION, February, 1999  U



Reader's Forum
The Crisis in Russia Must Not Be Ignored
by Michael D. Intriligator
An event of immense historical significance,  tarism. Russia, a country with enormous  Another scenario would be the breakup
with profound implications for the world, is  stockpiles of nuclear and chemical weap-  of Russia into smaller states or the con-
being largely ignored. It is the catastrophic  ons, is at the brink, and it could return  tinued collapse of legal authority, leading
economic and political situation in Russia,  to militarism and authoritarian rule.  to chaos and anarchy, with criminal
which poses long-term dangers to both                                      gangs taking over whole regions of the
Russia itself and to the world at large and  Complacency on this issue is truly re-  country. There are other scenarios, few if
represents probably the greatest threat to  markable. During the Cold War era the  any of which bode well for global secu-
global security today. While the problems  West had a total fixation on the Soviet  rity. Virtually all involve potential dangers
of Kosovo are important, those of Russia  Union and its potential military threat,  in Europe, Asia, and other regions of the
are a thousand times more important. But especially its nuclear weapons. Now   world. Several involve the possibility of
they are getting very little attention.  many tend to regard this problem as  another Cold War or even the use of
"solved" with the dissolution of the So-  nuclear or chemical weapons, whether
What had been a crisis situation in the  viet Union, the end of the Warsaw Pact,  by intent or by accident in a chaotic situ-
Russian economy has become a true ca-  the advent of democracies in the former  ation.
tastrophe as a result of the desperate moves  Eastern bloc, and their transition from
taken by the Russian govemment on Au-  socialist to market economies. The prob-  In his 1938 book, While England Slept,
gust 17, 1998. Those measures included  lem of the future of Russia is, however,  Winston Churchill criticized Britain for fo-
devaluation of the ruble, default on foreign  by no means solved, and we ignore it at  cusing on domestic issues and ignoring
debt, and freezing of bank accounts.  our peril. Russia's future evolution could  the threat from Nazi Germany that erupted
totally undermine global security. In-  in war the following year. There are strik-
The subsequent replacement of the gov-  deed, the present situation is remark-  ing similarities between Russia today and
ernmentbyanewoneheadedbyYevgeny  ably similar to the one that prevailed  the Weimarrepublic thatpreceded Hitler's
Primakov possibly signals the beginning  between the World Wars. Depending on  ascension to power in 1933-loss of em-
of a new set of policies that will reverse  what happens in Russia, the current pe-  pire and status, economic collapse, de-
the collapse of the economy. Primakov  riod may represent the lull between "Cold  struction of the middle class. The question
certainly deserves our support and help,  War I" and "Cold War II."        has often been raised as to how the Ger-
as his govemment may represent the last                                    man people, a highly civilized and edu-
for democracy in Russia. But reversing the  Several possible scenarios could have  cated people, could have democratically
disaster of the Russian economy will be  substantial impacts on Russia and the  installed Hitler. Of the various answers that
extremely difficult at best.         rest of the world. One scenario would be  have been proposed, perhaps the best is
the advent of a new authoritarian regime-  the simplest: desperate people will do des-
The Russian economy is in a state of  in effect a new Stalin. This result could  perate things. The same could happen in
collapse. A few wealthy bankers are  come about through the democratic elec-  Russia, with comparably disastrous re-
largely in control, criminalization is ex-  tion of an extremist president who would  sults. Just as Britain "slept' in the 1930s,
tensive, and most transactions are  take advantage of the 1993 constitution,  the United States may be "sleeping" to-
handled by barter or are not paid for at  which grants the president sweeping pow-  day, focusing on domestic issues and ig-
all. All other systems that are part of a  ers. It could also happen following a  noring the problems of Russia. It is time
modern state-health, education, the  putsch, similar to that of August 1991, or  for us to wake up and to help Russia over-
environment-are failing. The Russians  a coup, which would repeat earlier Rus-  come its problems.
themselves are beginning to lose hope  sian history. The result would be to turn
in their own future and are turning to new  the current epoch into nothing more than   Michael D. Intriligatoris professor of eco-
leaders. Many of these new leaders  an interlude between two authoritarian   nomics, political science, and policy
would return to authoritarian rule,  regimes, similar to the brief periods of  studies at the University of Califomia at
whether communist or fascist, typically  democracy that Russia experienced in  Los Angeles and vice chairof Economists
combined with ultranationalism and mili-  1917 and Iran experienced in 1979.  Allied for Arms Reduction (ECAAR).
d  TRANSITION, February 1999                                        ( 1999 The World Bank/The William Davidson Institute



In Russia There Is a Real Economy-and Virtual Market
by Boris Petkov
Russia's abrupt shift from a centralized  more coherent management (or at least  tion. Commercial banks focus their
state plan, in which all information  less mismanagement) could certainly  operations on short-term lending and
within the economic system was inte-  have helped to prevent much of the loss  are hesitant to extend long-term in-
grated, to an overly liberalized and un-  of output and employment. When  vestment credits. Admittedly, cutting
derdeveloped market system was ill  people's lives are affected, each frac-  interest rates is tricky, since in the
advised. Still, prospects for recovery  tion of a percentage point decline in  absence of capital controls, funds
from the financial (and economic) cri-  output matters significantly.    leave the country as foreign exchange
sis of mid-August, though bleak, are                                     outflow when the central bank in-
not nonexistent. Russia is still a large  What, then, should the authorities re-  creases liquidity. Introducing controls
market with great potential demand.  ally do? Revitalizing the economy un-  would have a much more positive ef-
The country can stabilize its economy.  der the burden of debt, capital flight,  fect than the conventional defense of
The question is how to accomplish the  and the world at the brink of recession  increasing interest rates, which re-
change (social transformation) with  (commodity prices and basic goods  tards economic activity.
minimum cost in human and capital  prices falling) is a difficult task. How-
terms.                              ever, the rebuilding has to begin by  The government has to decide along
using the available capital, not by cre-  what lines the country's industry will
There are different views and explana-  atively destroying it. A strong regula-  develop. The structure has to be broad
tions of the causes of the crisis in Rus-  tory system must be created before  enough to allow for technological
sia. The main problem is usually seen  privatizing (too late perhaps for this  changes and gradual renewal of capi-
as the lack of efficiency and competi-  measure). The importance of building  tal stock. It should also reflect the fact
tiveness. Confusing and misleading  up a proper financial system cannot be  that under normal conditions the Rus-
comments concerning value creation  overemphasised. It is urgently needed  sian economy is much closer to the
and destruction in the real economy  to facilitate transactions, provide  self-sufficient than to the open-
then follow. Those comments oversim-  credit, and attract deposits. The lack  economy model. Its external sector is
plifythematterandleaveitunexplained.  of liquidity within the economic sys-  relatively small relative to its output.
The meaning of 'value-subtraction" is  tem has to be overcome. This task is  Stabilization of investment demand
only relative; it is valid only for exchange  made more difficult if investors believe  should be pursued, and a policy of in-
purposes. This is to say that a particu-  that the financial markets are con-  creasing investment spending should
lar productive activity does not yield  stantly in equilibrium.          be implemented.
profit. However, the product (commodi-
ties) that lost market value during the  The central bank of Russia has an im-  It is unlikely that the development of
process of production has its utility in-  portant role to play. It should aim at  Russia's financial markets will come to
tact for the consumer. No doubt those  reducing speculation and liquidity pref-  a halt. However, if the capital market is
goods are not up to the contemporary  erence in particular. The difficulty of  to achieve depth and volume, regulation
standard of quality and efficiency in use,  the situation calls as well for the es-  has to be tightened and the rights and
but they are the ones effectively de-  tablishment of limits on short-term   responsibilities of the participants clari-
manded at that stage of economic de-  open positions of the banking sector.  fied. Only after those measures are
velopment. The majority of the people                                    implemented will it become possible for
cannot afford the better brands (mostly  Currently, commercial banks engage  the real economy sector to overcome
imported), no matter what their prefer-  in speculative activities, such as the  the severe liquidity crunch and start
ences are.                          purchase of currency forwards. Those  growing.
activities essentially consist of redis-
Itis importanttonotethattheconsumer  tributing the IMF loans and domestic  Borislav Petkov is with the Financial
choice effect is overstated at best un-  savings to hedge funds investors and  Markets Department of the Central
der normal economic conditions and be-  themselves. The loser of last resort  Bank of Iceland. He can be reached at
comes irrelevant for any practical  is, of course, the Russian taxpayer.  3545-699-600(tel.), 3545-699-906 (fax),
purposes in a crisis. Better policy and  Little if anything is invested in produc-  or boris.petkov@sedlabanki.is (email).
i) 1999 The World Bank/The William Davidson Institute                              TRANSITION, February 1999  U



The Russian Revolution in Accounting and
Auditing
by AdolfJ. H. Enthoven
A       ccounting in Russia was verywell  the Soviet Union broke apart. As early  the principle normative documentation
developed before the 1917 revo-  as 1991 crucial accounting changes  "Regulation on Accounting and Report-
lution and reflected Western  were made. These changes included  ing in the Russian Federation," which
European developments in this area.  tighter adherence to international ac-  essentially created a new Russian ac-
Since the revolution, accounting has  counting norms, publication of a new  counting system.
been marked by the struggle between  national chart of accounts, and passage
the Bzyantine and Western traditions.  of a requirement that companies issue  Most of the work of transforming the ac-
The Byzantine tradition, which reached  new financial statements, similar to those  counting system in Russia is being done
its peak during the reign of Stalin, em-  used in industrial countries. At the same  by the Ministry of Finance, with the as-
phasizes the control function of account-  time, preparations were underway for  sistance of international institutions, in-
ing. The Western tradition focuses on  radical changes in accounting and au-  cluding the World Bank, the United
accounting as a decisionmaking tool.   diting regulation and methodology. In  Nations, the European Union, and the
1992 the government approved by decree  major intemational accounting firms. The
Accounting in the Soviet Union
In the Soviet Union accounting was con-  Recent study on accounting in Russia
sidered a means of safeguarding social-
ist property and of meeting the goals of
state plans. Accordingly, the authorities
exerted strict control and monitoring over
firms' business activities and financial
performance. Enterprises were moni-
tored on how well they managed their
assets, used the factors of production,
and complied with norms regulating the
amount and composition of current as-
sets. Control also extended to the pro-
duction of goods and services, the cost
of production, and financial profit and its
use.
Beginning in 1985, when Gorbachev an- -
nounced the transition from a centrally
planned economy to a market-oriented
one, accounting became subject to
change once more. These changes,
which came from above, were inconsis-
tent, evasive, and prone to error.
A New Accounting System Emerges
The unified Soviet system of accounting
that had been developed over many de-g
cades began to disintegrate as soon as
TRANSTION, February 1999                                           1999 The World Bank/The William Davidson Institute



legislature is considering a multilevel sys-  ters) for cooperatives. In 1987 the first  istrators, management accounting (pro-
tem of accounting:                  basic regulations for joint venture opera-  viding internal financial reports to assist
tions were issued. Auditing for joint ven-  management in making decisions) has
* The highest level would be the Law  tures was to conform  to Western  been largely unknown until very recently.
on Accounting and Auditing, which  (international) practice in that audits  Activity-based costing (which allocates
would be adopted as one of the basic  were to be performed by independent  costs back to particular activities or
laws of Russia.                     Soviet auditors (commercial auditing or-  events, reducing the risk of inaccuracies
ganizations) for a fee.             and errors that are prevalent in the tradi-
* The second level would comprise                                        tional costing methods) barely exists.
mandatory regulations concerning the  In the past three years Russia's Minis-  Cost accounting is made more difficult
conceptual framework of accounting.   try of Finance has been working closely  because of the absence of true pricing
with the World Bank to improve audit-  in Russia, where barter is common.
* The third level would include ac-  ing. Once approved by the govemment
counting standards (normative docu-  the Basic Concept of Auditing will cover  Remaining Challenges
ments). By the end of 1998 a series of  regulation in all major areas, including
national accounting standards had been  preparation and application of auditing  There is reason for pessimism in the
put into operation.                 standards, quality control of auditing  short term and optimism in the long term
work, and responsibility of auditors. All  over the future of accounting in Russia.
* The fourth level would comprise  regulations will be in accordance with in-  Russia's autocratic past together with
guidelines, manuals, and instruc-  ternational auditing postulates and stan-  the Communist experiment between
tions to help practitioners.        dards.                               1917-88 have had a major impact on the
frame of mind, the institutional infrastruc-
The Soviet constitution mandated that a  A good system of auditing still has some  ture, the legal environment, and basic
single accounting and statistical system   way to go in Russia. Deficiencies include  human motivational factors in Russia. It
be adopted, under the direction of the  the following:                   is hard to transform or adapt the Rus-
government. Accounting in Russia is still                                sian scene overnight; considerable pa-
regulated by different governmental bod-  * The public still is not clear about the  tience will be needed by all parties
ies, and a variety of accounting meth-  role of auditing or who auditors are.  concerned.
ods can be used in practice. The level of
centralization has been declining, how-  * Even some enterprise managers think  In the longer run, there is reason for op-
ever, and a well-shaped system of ac-  auditors are tax inspectors.      timism. The Russian people are highly
counting regulation has been created.                                    intelligent and well-educated, and they
* The large number of accountants (be-  possess sound skills. They have shown
The New Phenomenon of Auditing   fore perestroika there were about 3 mil-  great resilience in the past, and they are
lion accountants in the Soviet Union, and  well geared to modern socioeconomic
Auditing-that is, an independent  the number increased after that) and the  norms. The basic propensities are in the
accountant's review of a company's fi-  low level of their qualifications retards  right order.
nancial statements to ensure that they  efforts to improve auditing.
were prepared in compliance with gen-                                    Nonetheless, certain critical issues need
erally accepted accounting principles-  * Professional bodies of accountants and  to be addressed:
is new to Russia and the former Soviet  auditors are not as active as they should
Union. Throughout Russian history, the  be.                              1. The legal infrastructure and legal
pervasive power of the state and the lim-                                reforms in all areas of economic ac-
ited existence of private ownership ham-  Soviet and Russian accounting method-  tivity need foremost attention. No so-
pered the emergence of an auditing  ology has traditionally focused solely on  ciety can work effectively and efficiently
profession. The notion of an independent  financial accounting (that is, reporting  without such legal reforms, including
controller was completely alien.    financial information to interested exter-  commercial laws, tax laws, companies
nal parties, such as the Gosplan and  acts, corporate governance rules, and
The situation has gradually changed  ministries). Although cost accounting  accounting and auditing regulations
since 1987. The first step was the cre-  and cost analysis have been practiced  (acts). Such legal reforms require effec-
ation of the Articles of Association (Char-  extensively, mostly by enterprise admin-  tive enforcement vehicles, but equally im-
© 1999 The World Bank/The William Davidson Institute                               TRANSITION, February 1999  m



portant is the basic acceptance and will-  spectors and administrators need to be  The sound practice of management ac-
ingness to adhere to legal norms by all  upgraded and updated to make them   counting still leaves much to be desired,
parties concerned.                   more suitable for modern society. In the  however.
past their prime objective was tax col-
2. Financial accounting and report-  lection, and they knew little about tax  6. The theory and practice of corpo-
ing need to be brought into line with  assessment, accounting or auditing. Tax  rate finance and banking need to be
international accounting standards.  policy and economic policy also need  developed. The notion that bank ac-
Greater transparency is needed. While  to be more closely linked.         counting should involve both accounting
Russia will tend to stick to its uniform                                  and evaluation of investments (project
charts of accounts (like France and many  4. Auditing, a new field in Russia,  and feasibility studies) is fairly new.
other countries), accounting measure-  needs to be improved. Separate ex-
ment and disclosure are expected to be  aminations for accountants and audi-  7. Education and training need to
adapted to conform to international stan-  tors should be considered.     continue. Educational institutions in
dards.                                                                    Russia have transformed themselves
5. Management accounting and cost  and now teach modern international fi-
3. Tax reform, which is proceeding  management need to be used more  nancial management methodologies.
very slowly, needs to be acceler-  widely. Management accounting as  The eagerness of students to learn new
ated. Too many taxes still prevail, ham-  practiced in the West is a new area in  techniques is laudable. The wave of
pering  both  tax  adherence  and  Russia. Management accounting for  Russia's future lies in its younger gen-
collection. A more equitable tax system   planning and control is now taught at  eration, who are very eager to adopt and
and procedures are warranted. Tax in-  all major universities and institutions.  adapt new methodologies. Accounting
has become a favorite discipline at
World Class Act                                                         schools.
; t ; 0-,.tE 5             i< 0 X ;0  s8. Professional institutions need to
t   k 00it     i;0  0 ;4 lt0 t  X0V00000Wt 0; i00 ifbe strengthened. The Association of
0 t0000.j.  it00$  ,1 Na  V -0\0Accountants and the professional au-
Nv v:V      00  0S   4 j    00 X:j3/:0 0000 :0  Vditing bodies remain weak, as the Min-
istry of Finance still maintains tight
N.                             ES 80. t; < i i Sg ................... 0 0 F ) controls. Professional bodies can be
orv f S 0 .. * w.s; . - ,  C
X  f ;;0:    :  v    >   * M.    expected to gain greater autonomy in
the years to come. They need to es-
tablish closer international links and
increase the scope of their activities
/' Ai   R                       < <> 0 0 0 +to include training, publications, con-
tinuing education, membership activi-
ties, and ethics codes.
The international community should con-
tinue to assist Russia (and other coun-
<a            g0fI >;   , f.*.  tries in the region) in its efforts to
establish accounting procedures that are
,,00 2>8   2;,.  i)tv6         in line with international standards. Bet-
ter accounting in these economies would
benefit not only those countries but in-
vestors and trading partners in other
/                           f                            <> >t w<> - i g ; countres as well.
"Ladies and Gentlemen, for the first time ever, we will present Mr.   Adolf J. H. Enthoven is professor of ac-
Kovacs, a poor pensioner, who will jump without a social safety net."    counting for InernationalAccounting De-
velopment at the University of Texas at
From the Hungarian magazine H6cipo                                        Dallas.
M   TRANSITION, February 1999                                      (D 1999 The World Bank/The William Davidson Institute



Attracting Capital via the Internet:
PrivatizationLink Reaches Potential
Investors around the World
by Birgit Braunwieser
A       privatization agency official in  known about their planned divestures.  profiles of enterprises slated for dives-
Tajikistan completesadocument  Marketing via the Internet is much less  titure, including information on each
on the upcoming tender for the  expensive than marketing through tradi-  enterprise's ownership structure,
Tajik cotton ginneries slated for           tional channels, such as ad-  workforce, and fixed assets. In addi-
divestiture. Moments later he               vertising in the Financial Times  tion, the site describes the divestiture
posts the document on the                   or the Economist and mailing  plan, indicates the closing date for
Internet, where it is instantly             out expensive materials. Dis-  bids, and provides recent financial data
accessible to potential inves-              closing detailed information at  that help investors assess the firm's
tors all over the world. Supple-            every stage of the privatization  current and potential market position.
mental information, including               process via the Internet also  Background information on national
company descriptions, back-                 helps make the privatization  privatization programs is also pro-
ground information on the Tajik             program more transparent. In  vided.
privatization program, analyti-             addition, using the Internet
cal reports on progress to date, and  helps familiarize privatization agencies  The Business Directory contains use-
relevant legal information, is also avail-  with modern information technology and  ful contact information for key players
able on the agency's Web site.      modern marketing techniques.        in privatization, including privatization
agency personnel, bankers, and advi-
This outpouring of information from a re-  What Is PrivatizationLink?   sors. The Virtual Library includes texts
gion in which access to information was                                 of privatization laws, data on transac-
once extremely limited is remarkable.  Launched last June, PrivatizationLink  tions and revenues, links to other Web
Even more remarkable is the fact that the  (www.privatizationlink.com) is a joint  sites, bibliographical references, and
Internet is being used in transition econo-  initiative between the Multilateral In-  the full texts of privatization studies.
mies not only by universities and non-  vestment Guarantee Agency (MIGA)  News & Events describes recent and
governmental organizations-elements of  and the Private Sector Development  upcoming privatization transactions.
an emerging civil society that might be  Units of the Regions in the World Bank.
expected to embrace information technol-  The project's initiators recognized that  The site is designed to provide poten-
ogy-but also by the government.     many privatization programs in transi-  tial investors with everything they need
tion economies and developing coun-  to know about privatizations in some
State privatization agencies-which ben-  tries were unable to attract sufficient  50 countries. Data from Web sites
efit from technical assistance from multi-  numbers of qualified bidders because  maintained by national privatization
and bilateral donororganizationsand are  resource constraints forced the agen-  agencies can be accessed  and
generally better equipped and staffed  cies to cut back on their marketing ef-  searched from the privatization site.
with younger, more dynamic personnel  forts. As a result, many potential  In addition, World Bank data on coun-
than other government bodies-are es-  foreign investors were unaware of their  tries that do not have their own Web
pecially keen on the Internet. In fact,  offerings.                     sites are accessible.
privatization agencies in 23 of the 27
countries in the region report upcoming  PrivatizationLink was designed to fill  Birgit Braunwieser is PrivatizationLink
privatization transactions on-line.  this information gap by providing in-  content coordinator for MIGA. She can
vestors around the world easy access  be reached at 202-473-3075 (telephone)
These agencies have discovered that the  to information about planned divesti-  or 202-522-2650 (fax).
Internet allows them to reach potential  tures of state-owned enterprises. The
investors who would otherwise not have  project's Web site features company
© 1999 The World Bank/The William Davidson Institute                              TRANSITION, February 1999  m



Who Is Using                       Creating Business                                     uW
Ukraine's Privatization   F
Website?                           Friendly Customs                               tVfWEE.PRESS
Are people really making use of the  Regulations in  Slovakia
information available on-line? Who   by Robert Paterson
is using these Web sites?
Data on usage of the Ukrainian           y the summer of last year, cus-  Under the previous administration, a
State Property Fund's Web site       D   toms procedures in Slovakia  customs regime developed that the
shows considerable activity. Traf-       had become so cumbersome  U.S. Embassy described in the Slo-
fic on the site rose by more than   that foreign investors were starting to  vak press as "anti-foreigner." The issue
200 percent over the past three   sound alarm bells about the negative  that caused the most aggravation to
months, with about half of all us-   impact on future investment. To its  foreign investors was the $1 value limit,
ers coming from abroad (20 percent   credit, the new Slovak government re-  which required that any import worth
from the United States, 8 percent   acted quickly. The approach it has  more than $1 had to be certified by
from Germany, 8 percent from the   taken could serve as a model for other  customs officials. The limit represented
United Kingdom, 3 percent from    transition economies seeking to imple-  one of the lowest customs limits in the
Austria, and 3 percent from the    ment a more business-friendly cus-  world (the European Union value limit
Russian Federation).              toms regime.                        is 22 euros, about $28).
The Web site (http://www.ukrmassp.   Cumbersome Customs Procedures-  Other certification problems also slowed
kiev.ua/) was set up as part of a   Legacy of the Past                the process of importing. In order to im-
USAID-financed project to make the                                     port any product into the country, an im-
Ukrainian govemment more transpar-   The problems that the Slovak customs  porter had to complete a customs
ent and service oriented. The site pro-   authority has been dealing with over the  document, pay duties, pay the the Ex-
vides investors with information on    past few years are not unique. At the  port-import (Exim) Bank charge of 0.05
Ukraine's privatization program and   start of the decade, as domestic trade  percent of the product's value, and issue
upcoming tenders.                  and investment rose dramatically  a power of attorney giving the carrier the
throughout Eastern Europe, Commu-  right to clear the shipment. Additional cer-
All information on bid requirements   nist-era infrastructure and trade regu-  tificates were needed for the vast major-
is provided on-line, saving the Fund   lations proved woefully inadequate. As  ity of commodities. Every good went
the cost of printing and mailing ma-   recently as 1997, 9 out of 10 multina-  through thesame process, whether itwas
terials to potential investors. Re-   tionals operating in Central and East-  a child's toy valued at $2 or a shipment
quests for additional information can    ern Europe experienced customs  of clothing valued at $100,000. The sys-
be sent directly by e-mail to the ap-   problems, and more than half had lost  tem was bad for business and bad for the
propriate staff member at the State   revenue as a result of customs delays.  government, which lost money collecting
Property Fund. (Bids must still be   Only 12 percent of multinationals be-  duties on shipments worth relatively little.
submitted to the Fund by sealed en-   lieved that customs authorities under-  Procedures at the airport were so ineffi-
velope.)                           stood how businesses operate.       cient that DHL, the air express carrier in
Slovakia, had goods flown to Vienna and
By making more information about   The European Commission recently pub-  then trucked to Bratislava ratherthan flown
state-owned enterprises available,   lished a series of blueprints on customs  directly to Slovakia.
the site is helping to build the trust   reforms for countries interested in join-
of potential investors. Attracting   ing the EU (see Transition, June 1998).  First Steps to Streamline Customs
more interest will eventually attract   Many of the countries in the region are  Procedures
more bidders, which will increase   using those documents to try to tackle
the prices at which state firms are   some of the problems that importers are  TocomplywithaWorldTradeOrganisation
sold.                              encountering.                       (WTO) requirement, Slovakia agreed to
a  TRANSITION, February 1999                                      © 1999 The World Bank/The William Davidson Institute



abolish a 3 percent import surcharge by  ing at ways in which it can provide con-  lieves should be cancelled or modified.
October 1, 1998. More significantchanges  crete support to the Slovak customs  The government has promised to make
tookplaceinNovember,whenthenewad-  authority. For instance, DHL can help  additional changes, and a new EU-
ministration took office. The new coalition  Slovak customs interface with the United  friendly customs law should be unveiled
govemmenthasmovedquicklytoaddress  Nations Conference for Trade and  later this year.
some of the main concems that the busi-  Development's (UNCTAD) Automated
ness community had been voicing. In fact,  System for Customs Data (ASYCUDA)  Trade policy is definitely heading in the
the director of operations at the customs  program, which aims to computerize and  right direction in Slovakia, and investors
authority set himself the ambitious task of  simplify customs procedures. It can also  have welcomed the measures that have
making Slovak customs the most user-  help Slovakia meet further EU require-  been implemented so far. Overall, the
friendly customs authority in Europe.  ments and simplify and speed up some  program of customs reforms should be
of the administrative procedures cur-  a powerful weapon for Slovak govern-
The first step has been to create a friend-  rently being used.           ment officials to use in discussions with
lier environment for investors in general.                                the EU about raising Slovakia's status
In February, 1999 the Cabinet was put-  Win-Win Situation                 as an EU applicant. [See our interview
ting the finishing touches on its Support                                 with Slovakia's Deputy Prime Minister
for the Entry of Foreign Investors pro-  The changes made by the government  on page 29. The Editor.]
gram. This policy mandates that any  haveimprovedthetradeflowinandoutof
company that invests $5 million or more  Slovakia. The number of shipments that  Robert Paterson is the general manager
in Slovakia, creates jobs, and exports  are on hold at any one time waiting for  of DHL in Slovakia. DHL is the leading
60 percent of its output will be entitled  customs clearances is now one-sixth  air express carrier in Slovakia and the
to a five-year tax holiday. Research and  what it was several months ago. As a re-  largest importer into Central and East-
development costs will be written off for  sult of the changes, DHL is now consid-  em Europe.
an additional five years.            ering flying directly to Bratislava, rather
than transhipping goods from Vienna.    The newDHL CustomsReportwillbe avail-
The government has also looked at the                                     able in April. To order a free copy or pass
problems foreign investors face in get-  Reform takes time, and DHL is still  on any comments about customs in Cen-
ting goods in and out of the country once  making representations to the Slovak  tral and Eastem Europe, please contact
they have established operations in  government about the Exim fee and the  Dirk Singer, at 44 171 465 7700 (tele-
Slovakia. Most significantly, the $1 value  system of import certification that it be-  phone) or dirk-singer@msn.com (email).
limit was raised to 1,000 Slovak crowns
($26.39) in January, to bring it in line with   Labor Dispute in Russia
the EU norm. The Slovak customs au-     >
thority can now claim to have imple-
mented part of the EU customs regime
faster than many of its neighbours.
The changes make life considerably
easier for businesses. They also allow
resources to be diverted away from un-
productive tasks, such as processing
paperwork, toward more productive work, l
such as intercepting illegal shipments.          m 1you don'tpav
lill'-     s~~allary, we will sitator i-:l-
As the leading international air express
carrier, DHL has been sharing some of
the experiences it has gained from deal-  _ - M ;
ing with customs authorities in other parts     . -  .
of the world with the Slovak government.
In conjunction with its global headquar-
ters in Brussels, the company is look-  From the Russian Daily Izvestiya
C) 1999 The World Bank/The William Davidson Institute                               TRANSITION, February 1999   A



Milestones of Transition
Central and Eastern Europe          The EU currently provides a total of 859  that the Central Bank had paid an un-
million euros in aid to the former Soviet  disclosed and illegal commission to
EBRD redesigns a program for Cen-  republics through various programs; it  FMC. Sergei Dubinin, former head of
tral European trade. The European  is reevaluating the overall aid needs of  Russia's Central Bank, admitted that
Bank for Reconstruction and Develop-  the most affected countries.       Russia transferred a portion of its hard
ment (EBRD) has agreed to commit 100                                     currency reserves to FMC between 1993
million euros ($116 million) to a new   Russia                           and 1997, but he said that the transfers,
program that will provide a 100 percent                                  which included funds from the IMF, were
guarantee on trade-finance deals rather  Assets of 60 percent of 17 top Russia  an attempt to shield the money from for-
than the 80 percent covered previusly.  banks worthless. Alexander Smolensky,  eign creditors.
The program permits the EBRD to work  the chairman of the SBS-Agro group, the
with local affiliates of Western banks  country's second-largest retail bank be-  Direct foreign investments in Russia
as well as with Western or local banks.  fore economic crisis erupted in Rus-  were at $665 million in first nine
The 100millioneuroswilleffectivelybe  sia   in   August,   told   the  months of 1998. Portfolio investments
400 million euros a year if the program   Kommersant-Daily newspaper that his  came to almost $7.0 billion, according
is rolled over four times a year as ex-  group was restructuring and closing 7  to Russia's Central Bank. Russia had a
pected.                             of 12 banks. Making the situation  current account deficit of $5.6 billion at
harder still, the Finance Ministry is  the end of September.
Net private capital flows to emerg-  pulling billions of dollars of budget
ing Europe will remain stable this  funds out of private banks. The funds  Kazakhstan
year at around $40 billion, the Insti-  will instead be parked at state-owned
tute of International Finance (IIF) pre-  Sberbank and Vneshtorgbank. Billions  Kazakhstan posted a $1.7 billion
dicted in its latest report. That  of dollars are already being transferred  trade deficit last year owing to the fall
compares well with Latin America,  away from the commercial banks and  in world prices of the country's major
where net private capital flows are fore-  will continue to be withdrawn over the  exports: oil, metals, and grain, Prime
cast to fall sharply this year, from $88  course of the year. With federal gov-  Minister Balgimbayev announced on 9
billion to $54 billion. The IIF's projec-  ernment revenues for 1999 projected  February.At year's end, inflation was 1.9
tions suggest that investors are learn-  at 475 billion rubles ($23 billion at cur-  percent, significantly below the 9.5 per-
ing to distinguish among emerging  rent exchange rates), the loss of fed-  cent forecast. The average wage in
markets, but caveats remain: part of  eral funds will put a major crimp in bank  Kazakhstan remained the highest among
the $40 billion flowing to the region  liquidity and profits. It will also, the Fi-  ClScountries,attheequivalentof$120-
constitutes involuntary lending to Rus-  nance Ministry hopes, put an end to  130 monthly, while the average monthly
sia as interest arrears mount.      mismanagement of the funds.          pension rose to $48. The government
has paid nearly all pension arrears.
CIS                                 Criminal probe launched into Cen-  Kazakhstan attracted $2.2 billion in in-
tral Bank dealings. Russia's Central  vestments in 1998, up from the 1997
A number of former Soviet repub-  Bank is under close scrutiny following  level. Foreign trade in the first 11 months
lics were late reacting to the crisis  allegations that it channeled some $50  of 1998 fell by 7 percent. Exports fell by
in Russia and now find themselves in  billion of hard currency reserves to a tiny,  15 percent, compared with 1997, and
serious economic difficulties as a re-  offshore company from 1993 to 1997.  totaled $5.5 billion. Imports increased
sult, the European Commission con-  Formerprosecutor-generalYurySkuratov  during the same period by 1 percent,
cluded in a report released late  outlined the corruption scandal in a let-  totaling $7.13 billion.
February. Social and political pressures  ter to the Duma just before he resigned
also are building. Armenia, Belarus,  early February. Skuratov also said that  Moldova
Georgia, Kyrgz Republic, Moldova,  the Central Bank committed numerous
Tajikistan, and Ukraine have been hit  irregularities when it allowed Financial  Moldovan government's resignation
hardest by the Russian turmoil, mainly  Management Co. (FMC), a firm registered  underlines economic woes. While the
because their agricultural exports to the  in the Channel Island of Jersey, to handle  government originally forecast GDP
country have been sharply curtailed.  Russia's hard currency reserves. He said  growth of 6 percent for 1998 (revised to
M   TRANSITION, February 1999                                      0 1999 The World Bank/The William Davidson Institute



3 percent in June), it announced in De-  clined last year. In a losing battle to prop  lapse of the monthly wage from its June
cember that it expected a GDP decline  up the currency, the national bank saw   1998 peak of $52. Even those low wages
of fully 10 percent. That would make it its international reserves fall from almost  are often not paid (Michael Wyzan).
the only one of the nine smaller CIS  $365 million at the end of 1997 to about
countries (that is, excluding Kazakhstan,  $150 million at the close of 1998. The  We appreciate the contributions of Radio
Russia, and Ukraine) in which GDP de-  leu's nosedive has resulted in the col-  Free Europe and Johnson's Russia List
Interview with Ivan Miklos, Slovakia's Deputy
Prime Minister
"We Are Creating a Friendly Climate for Foreign Investors"
The 39 year old Slovak economist Ivan Miklos became deputy prime minister and chairman of the government's economy
council, following the election-victory of Slovakia's pro-market reform parties in September 1998. He served as privatization
minister in the Camogursky government during 1991-92 and laterjoined the Center for Economic and Social Analysis (MESA
10), a nonprofit, nongovemmental think-tank in Bratislava. He became head of the institute in 1997. Transition editor
Richard Hirschler interviewed Ivan Miklos during his recent visit to the World Bank's headquarters in Washington, D.C.
Q. According to the new government's  $1.6 billion is just a fraction of what neigh-  stead of rent-seeking. That will require
evaluations, Slovakia inherited eco-  boring countries receive-Hungary has  stronger domestic and foreign competi-
nomic crisis conditions from its prede-  received $20 billion in foreign direct in-  tion, an influx of foreign capital, restruc-
cessor. Considering the impressive 5  vestment. The government has to fix the  turing of state-owned banks, and
percent GDP growth last year, isn't that  problems of inefficient banks burdened by  strengthening of capital markets.
an overstatement?                   bad debt, underdeveloped capital mar-  Privatization procedures have to be re-
kets, and nonfunctioning bankruptcy pro-  viewed: 900 large enterprises have been
A. This high economic growth is clearly  cedures.                       privatized, in several cases, under sus-
unsustainable. Vladimir Meciar's govern-                                picious circumstances. The National
ment invested heavily in the state sec-  Q. So what is in the government's  Property Fund, our privatization agency,
tor, pursuing an expansionary fiscal  reform package?                   has to correct past mistakes-and,
policy. The huge fiscal deficit had to be                               where the selling price has been too low,
financed through government borrowing.  A. First, we have to stabilize the  charge more now or take back part of
The budget deficit last year reached al-  economy. This year, the fiscal deficit has  the shares.
most 20 billion koruna (about $550 mil- to be cut to 2 percent of GDP from last
lion), while the government debt,  year's 6 percent. It will not be easy. We  Q. It is known, for example, that 8
excluding that of local governments and  have to improve tax collection, and we  percent of the successful Slovnaft
public funds, totaled 156 billion koruna  may have to double the base rate of the  petrochemical company, whose
($4.3 billion), 20 percent of the GDP.  value added tax (VAT) from 6 to 12 per-  shares were actively traded on the
Imports surged, while exports fell. As a  cent, while lowering the top 25 percent  stock exchange, was sold in Febru-
result the current account deficit in the  rate to 15 percent, in accordance with  ary 1998 for half the market price to
past three years oscillated between 8  EU norms. Excise taxes may also go  a previously unknown company. Last
and 11 percent of GDP, and by the end  up. We will increase public transport  April, while still a member of the
of last year foreign debt reached $12 bil-  fees, freeze salaries in the public sec-  opposition, you said that "the Na-
lion. Despite the government's spending  tor, and slow investments in infrastruc-  tional Property Fund lost about 54
spree, enterprise restructuring was ab-  ture, including road construction.  billion Slovak koruna ($1.5 billion) in
sent. Crony-driven, nontransparent                                      the past 3 years. In 1997, the aver-
privatization proved counterproductive,  Second, we have to  accelerate  age selling price of state owned en-
and foreign investors stayed away.  microeconomicadjustment,proddingen-  terprises fell to 18 percent of its
Slovakia's foreign investment of about terprises to adopt a profit orientation in-  book-value. These data are a dem-
(D 1999 The World Bank/The William Davidson Institute                             TIANSITION, February 1999  U



onstration of unlimited pilferage of  corruption program, restructuring of en-  We have no significant differences now
state property under the Meciar gov-  terprises and banks, social system re-  and are working closely together to
ernment." Yet how can you renego-  form, and public administration reform.  achieve the same goals-primarily, to
tiate deals if the contracts were made  Slovakia's relationship with the Bank  ensure that Slovakia's economic and
according to the law?                has radically changed for the better  social development qualifies the coun-
since the new govemment took office.  try for EU membership.
A. That is exactly the point: many of
these deals were made unlawfully. Our
goal is to create a clean business envi- World BankIIMF Agenda
ronment-that is the only way we can
earn the trust of honestforeign investors.  Wolfensohn on New Development  be able to fix, cap, or collar (combining
This is the third element of our program:  Strategy                       cap and floor) the interest rate. Further,
to attract strategic investors through in-                                borrowers can tailor the repayment terms,
centives and by creating a friendly busi-  The World Bank will place stronger em-  adapting them to specific projects or to
ness climate in this country. We also  phasis on social, structural, and cultural  their country's debt management strategy.
have to restructure and privatize the big  issues in its projects, announced World  The freestanding hedging products-
commercial banks and many of the still  Bank President James Wolfensohn dur-  linked to existing IBRD loans-will help
state-owned strategic companies. In a  ing his presentation at the Bank fur Arbeit  borrowers manage theirrisks related to cur-
few months a 25-30 percent stake in  und Wirtschaft (Bawag) in Vienna on Feb-  rency, interest rate, and commodity price.
the telecommunications company  ruary 12. The new approach will be tried  Hedges will be offered on loan maturities
Slovenske Telekomunikacie will be sold  out over the next 12-18 months in 12 coun-  of up to 10-12 years andwill include swaps
through transparent international tender.  tries, with the involvement of NGOs, reli-  of currency, interest rates, and commodi-
We also have to radically reform public  gious groups, and other members of civil  ties. The IBRD will continue to offer cur-
administration, first within the present  society. The president presented a 13-  rency pool loans and LIBOR-based,
framework and, in a second stage by  point program that lists many of the ele-  variable-spread single currency loans. The
strengthening municipal and local gov-  ments necessary for sustained economic  existing fixed-rate single currency loan will
ernments. Last but not least, we also  development. The elements include a gov-  not be available as a new product from
have to streamline our social safety net  ernment free of systemic corruption; a le-  December 1, 1999. IBRD borrowers have
and bring an end to misuse of the unem-  gal framework and effective judicial system;  chosen single currency loans almost ex-
ployment benefit-nearly half a million  a well-supervised financial system; an  clusively (96 percent) since 1996.
people are registered as being without a  adequate social safety net; access to uni-
job, putting our unemployment rate at  versal primary education, health services,  IFC Reviews Russia's Strategy
16.3 percent. The health and education  and clean water; a sound environment and
system needs to be reformed too.     sufficient infrastructure; and an environment  The lntemational Finance Corporabon (IFC)
that enables citizens to preserve their cul-  is reviewing its operations strategy in Rus-
Q. How does the World Bank fit into  ture and identity.                   sia. Several projects are in difficulty as a
these ambitious plans?                                                    result of the August 1998 crisis. The IFC's
World Bank to Launch Flexible Fi-  potential losses, however, were minor com-
A. Primarily we have reopened negotia-  nancial Products                  pared with most other investors and inter-
tions with the World Bank on an enter-                                    national financial institutions. The IFC
prise and financial sector adjustment  The World Bank plans to introduce new   deferred more than $200 million worth of
loan (EFSAL) that could come in any-  loan and hedging products for its borrow-  investments in companies that later went
where from $90 million to $400 million.  ers as of September 1,1999, following a  bankrupt. Especially hard hit were the
Slovakia and the Bank had started to  go-ahead from the Board of Directors in  IFC's investments in the financial sector.
negotiate this loan two years ago and  mid-February. The new products will cost  Asof December31,1998,the IFCinvested
had made significant progress, but then  between 1/8 percent to 3/8 percent of the  $70 million in 10 financial sector projects.
the Meciar govemment suspended ne-  principal amount as transaction fees. Bor-  Investments in industry-$137 million in
gotiations. Now we have to update the  rowers of the new LIBOR-based fixed-  eight manufacturing projects-have also
program, but that shouldn't take long.  spread loan will be able to choose the  been affected, as bank deposits are fro-
We are also expecting technical assis-  currency of the loan and, if they want,  zen and production in the domestic mar-
tance from the Bank in four areas; anti-  change it at any time. Borrowers will also  ket is expected to drop in the medium term.
*  TRANSITION, February 1999                                       ©3 1999 The World Bank/The William Davidson Institute



The IFC still hopes that most industrial in-  Democrats Name IMF Commission  develop infrastructure (sewerage systems,
vestments will recover over time. The IFC's  Members                     roads, and drainage), social services (shel-
investments in the oil-gas and mining in-                                ters for the homeless and kindergartens),
dustries-$41.8 million in three projects-  The U.S. Democratic Party nominated  and income-generating activities. The $10
are less affected because they rely heavily  Paul Volcker, a former chairman of the  million loan is the first phase of an adapt-
on exports. In the future the IFC is prepared  Federal Reserve, and Jeffrey Sachs,  able program loan, totaling $20 million, that
to help restore Western investors' confi-  Harvard economics professor, to a com-  the Bank is providing to help reduce pov-
dence in Russia, support capital market in-  mission to examine the roles of the IMF  erty in Romania. In 1997, 30 percent of
stitutions, and continue earlier investments  and the World Bank. The Democrats' other  the population lived below the poverty line,
wherever possible. At the end of 1998 IFC's  three nominees are Richard Huber, chief  up from 22 percent in 1996.
investmentportfolioin Russia stood at$323  executive of Aetna; Esteban Torres, a
million, representing 27 projects.  former Democratic representative from   World Bank Loans to China Meet In-
California; and Jerome Levinson, a Latin  ternational Accounting Standards ...
$100 Million Loan for Kazakhstan    American expert from the Economic
Policy Institute. The Republican Party so  On February 23 the World Bank approved
On February 9 the World Bank approved  far has announced four of its six nomi-  loans and credits to China worth $32.9
a $100 million loan to Kazakhstan for  nees: Charles Calomiris, a Columbia  million to support efforts to modernize the
the reconstruction and maintenance of  University professor; Edwin Fuelner, presi-  country's accounting system. The project
roads. World Bank experts estimate that  dent of the Heritage Foundation; Manuel  has two components: to provide continu-
only 37 percent of the country's roads  Johnson, formervice chairman of the Fed-  ing professional education for certified
are in good condition. Since Kazakhstan  eral Reserve Board; and Lawrence Lind-  public accountants in the accounting prac-
joined the World Bank in 1992, the Bank  say, a former Fed board member.  tices of market economies, and to sup-
has committed approximately $1.75 bil-                                   port the Chinese government's efforts to
lion for 17 projects.               World Bank Promises Romania More  develop and promulgate intemationally
Support                             accepted accounting standards.
G-7 Endorses Financial Stability
Forum                               Romania is to geta $300 million loan from   . . . Rebuild Communities Devastated
the World Bank, as the first installment  by Floods ...
During its January 20 meeting in Bonn,  of a two-phase program aimed at con-
the G-7 agreed to establish a Financial  tinuing the country's reforms. The first-  With another $40 million IBRD loan and
Stability Forum that will bring together fi-  phase adjustment program will begin this  a $40 million equivalent IDA credit, ap-
nance ministries, central banks, and finan-  spring, alongside an IMF stabilization pro-  proved on February 9, China will rebuild
cial regulators to strengthen surveillance  gram. Andrew Vorkink, the Bank's direc-  schools, roads, water systems, hospi-
and supervision of the intemational finan-  tor for Romania, announced the World  tals, and clinics to restore basic services
cial system. The World Bank will have  Bank loans during a recent visit there.  to poor communities devastated by the
two representatives at the forum who will  Five million will go toward labor redeploy-  recent Yangtze River floods. The re-
set up a small secretariat in Basle. The  ment and is expected to create 22,000  peated flooding of the Yangtze River last
G-7 ministers remained openly divided  new jobs, a quarter of which will be in the  summer, said to be the worst in modern
over German-led plans to impose regula-  mining areas. Vorkink also announced  times, affected 79.6 million people in the
tions or currency trading bans to curb  plans for a $25 million technical assis-  provinces of Hubei, Hunan, and Jiangxi.
speculative market swings. Between now  tance loan, which will go toward bank re-
and the G-7 summit scheduled for June  structuring, improving the business  . . . Develop Anning Valley
in Cologne (Koln), Germany, the work will  environment, and privatization. Negotia-
focus on proposals for strengthening the  tions over a $40 million loan to help close  The incomes of more than 250,000 poor
IMF and the interim and development  loss-making mines and mitigate social  families in China's Anning Valley, a poor
committees. A first seminar devoted to  costs in mining areas were under way.   area of Sichuan province, would increase
exchange rate regimes, private sector                                    with the improvements in crop produc-
involvement in crisis resolution, and to  The World Bank signed a $10 million loan  tion, irrigation, and silk production funded
proposals for strengthening the IMF and  for Romania's Social Development Fund  through a new $90 million loan and a $30
the World Bank will convene on March  late January. Poor villages will be able  million equivalent credit. The loans were
11 in Germany.                      to apply to the fund for grant money to  approved on January 21.
© 1999 The World Bank/The William Davidson Institute                               TRANSITION, February 1999  U



Conference Diary
For the Record                      Organizer: Eurasia Forum.           President Development Economics and
Speaker: Boris Berezovsky, Executive  Chief Economist, the World Bank.
Trans CIS Projects: Prospects and  Secretary of the CIS.                Information: Boris Pleskovic, Research
Pitfalls                            Information: Eurasia Group, 113 Broad-  Advisory Staff, World Bank, 1818 H
February 23, 1999, New York, N.Y.,  way, Suite 1600, New York, NY 10010,  Street, N.W., Room MC4-391, Wash-
United States                       United States, tel. 212-366-9560, fax  ington, D.C. 20433, United States, tel.
212-366-9699, Email: kapoor@eurasia  202473-1062, fax 202-522-0304, Email:
Organizer: Eurasia Forum.           group.net orgo to wwweurasiagroup.net.  bpleskovic@worldbank.org.
Speaker: Valeryi Serov, Former Deputy
Prime Minister of the Russian Federation.  First ABCDE-Europe, 1999     Governance, Equity and Global Markets
Information: Eurasia Group, 113 Broad-  June 21-23, 1999, Paris, France  June 21-23, 1999
way, Suite 1600, New York, NY 10010,
United States, tel. 212-366-9560, fax  Keynote addresses by Lionel Jospin,  Keynote address: by Lionel Jospin,
212-366-9699, Email: kapoor@eurasia  Prime Minister, France; James D.  Prime Minister, France, and James D.
group.netorgotowww.eurasiagroup.net.  Wolfensohn, President, the World  Wolfensohn, President, the World Bank.
Bank; Joseph E. Stiglitz and Jean-  Chaired by: Joseph E. Stiglitz, World
Russia's Crisis and the Energy      Francois Rischard, the World Bank.  Bank, and Pierre-Alain Muet, CAE.
Market                              Session one: The New Comparative  Topics: New Comparative Economic
February 24, 1999, Houston, Texas,  Economic Systems-Roundtable: Insti-  Systems; Transition-The First Ten
United States                       tutional Infrastructure (Oliver Hart,  Years; Market Organization; Poverty
Mustapha Nabli, Katharina Pistor, Jean   Reduction; The New Global Economy;
Organizer: Caspian Basin Forum.     Tirole); Paper: Transition-The First Ten  Global Governance and Transparency.
Speaker: Boris Nemtsov, Former Rus-  Years (John S. Flemming). Session two:
sian Deputy Prime Minster.          Market Organization and Poverty Re-  Marketing Strategies for Central and
Information: Eurasia Group, 113 Broad-  duction-Roundtable: Capital and Labor  Eastern Europe
way, Suite 1600, New York, NY 10010,  Markets (Isher Judge Ahluwalia,  December 1-3, 1999, Vienna, Austria
United States, tel. 212-366-9560, fax  Masahiko Aoki, Assar Lindbeck); Pa-
212-366-9699, Email: kapoor@eurasia  per: Poverty and Inclusion (Anthony  Organizers: Kellstadt Center for Market-
group.net or go to www.eurasiagroup.net  Atkinson, Francois Bourguignon). Ses-  ing Analysis and Planning, DePaul Uni-
sion three: The New Global Economy;  versity, Chicago, Illinois, and the
Forthcoming                         Papers: Global Financial Markets (Ri-  Department of International Business
chard Portes), Global Externalities  Administration, University of Economics
chard~ ~ ~ ~ ~~~~n  Business Administration,lVienna.
Economic Stability in Russia and the CIS  (Domenico Sinscalco), and Global Gov-  and Business Administration, Vienna
March 8, 1999, New York, N.Y. United  ernance and Transparency. The first two  should be received by pAugust 31, g1999
States                              afternoons will each have four parallel
The final papers must be ready by Oc-
workshop sessions. June 2lst: New  tober 31, 1999. For more information or
Organizer: Eurasia Forum.           Thinking on Security In Labor Markets,  to send abstracts, contact either of the
Speaker: Boris Berezovsky, Executive  Knowledge, and Development; Gender  conference sponsors.
Secretary of the CIS.               Economics; Expertise and Democratic  Information: Prof. Dr. Reiner Springer,
Information: Eurasia Group, 113  Accountability; and Capital Flows and   Wirtschaftsuniversitat Wien, Althanstr.
Broadway, Suite 1600, New York, NY  Development. June 22nd: Social Insur-  51, 1090 Wien, Austria, tel. 43-1-313 36/
10010, United States, tel. 212-366-  ance and Social Security Reform, Trad-  4371, fax 43-1-313 36/751, Email:
9560, fax 212-366-9699, Email:  ing Blocs and Regional Integration,  Reiner.SpringerWwu-wien.ac.at; orProf.
kapoor@eurasia group.net or go to  Global Environment, and The Global  Dr. Petr Chadraba, Kellstadt Center for
www.eurasiagroup.net.               Financial Crises. Participation by invi-  Marketing Analysis and Planning,
tation only. The conference is spon-  DePaul University, I East Jackson
Russian Foreign Policy and the CIS  sored by Pierre-Alain Muet, Conseiller  Boulevard,Chicago, Illinois 60604, tel.
March 9, 1999, Washington, D.C.,  aupres du Premier Ministre, France;  312-362-6200, fax312-362-5647, Email:
United States                       and Joseph E. Stiglitz, Senior Vice  pchadrab@wppost.de paul.edu.
M   TRANSITION, February 1999                                     ( 1999 The World Bank/The William Davidson Institute



New Books and Working Papers
The Macroeconomics and Growth Group regrets that it is unable to provide the
publications listed.
World Bank Publications             Data from a sample of 125 countries in  Dimitri Vittas, Institutional Investors
1993 show that as national income rises,  and  Securities Markets: Which
Working Papers                      resources per school-age child increase.  Comes First? WPS 2032, 1998, 20 pp.
The increase occurs not primarily because
To receive ordering and price informa-  of larger budget allocations, however, or  Experience in the United States and the
tion for World Bank publications, con-  an easing of the demographic burden on  United Kingdom suggests that pension
tact the  World Bank, P.O. Box  the system but because teacher salaries  funds and insurance companies should
7247-8619, Philadelphia, PA 19170,  drop significantly relative to per capita  be promoted because they serve as a
United States, tel. 202-473-1155, fax  GNP. The extra resources associated with  countervailing force to commercial and
202-676-058, Email books@world  income growth allow a country first to  investment banks, stimulate financial
bank.org, Internet http://www.world  expand enrollments and improve class-  innovation, help modernize capital mar-
bank.org or http://www.worldbank.org/  room conditions and later to reduce the  kets, enhance transparency and disclo-
html/dec/Publications/Workpapers/  pupil-teacher ratio.                 sure, strengthen corporate governance,
tranecon.htm, or visit the World Bank  To order, contact Anahit Poghosyan,  and improve financial regulation. Mutual
bookstore in the United States, at 701  Room G8-064, tel. 202-473-0898, fax  funds, the third type of institutional in-
18th Street, N.W., Washington, D.C.,  202-522-3233, Email apoghosyan@   vestor, are unlikely to thrive without well-
or France, at 66, avenue d'lena, 75116  worldbank.org. The authors may be con-  regulated securities markets.
Paris.                              tacted at amingat@ku-bourgogne.fr or  To order, contact Agnes Yaptenco, Room
jtan@worldbank.org.                 MC3-446, tel. 202-473-8526, fax 202-522-
Klaus Deininger and Gershon Feder,                                      1155, Email ayaptencok@worldbank. org.
Land Institutions and Land Markets,  Ramon Lopez, Vinod Thomas, and Yan  The author maybe contacted at dvittas@
WPS 2014, 1998, 44 pp.              Wang, Addressing the Education   worldbankorg.
Puzzle: The Distribution of Education
Removing obstacles to the smooth func-  and Economic Reform, WPS 2031,  Simeon Djankov, Restructuring of In-
tioning of land rental markets and en-  1998, 70 pp.                    sider-Dominated Firms, WPS 2046,
hancing potential tenants' endowments                                   1999, 16 pp.
and bargaining power can significantly  In most countries, unequal distribution
increase both the welfare of the poor  of education has a negative impact on  Enterprise survey data from 1995-97 reveal
and the overall efficiency of resource al-  per capita income. Economic policies  that in Georgia and Moldova, restructuring
location. The authors draw policy con-  that suppress market forces tend to dra-  was achieved more rapidly in privatized
clusions about the transition from   matically reduce the impact of human  companies that were purchased by their
communal to individual and more for-  capital on development. Reform of trade,  managers than in companies in which
mal land rights and the scope for redis-  investment, and labor policies can in-  managers received significant ownership
tributive land reform.              crease the returns from education. Us-  stakes for free. The author concludes that
To order, contact Maria C. Femandez,  ing panel data from 12 Asian and Latin  managers' incentives to restructure de-
Room MC3-542, tel. 202-473-3766, fax  American countries for 1970-94, the  crease when they regard their newly ac-
202-522-1151, Email mfernandez2k  authors investigate the relationship be-  quired ownership as a windfall gain.
@worldbank.org. The authors may be  tween education, policy reform, and eco-  To order, contact Rose Vo, Room MC10-
contacted at kdeininger@worldbank.org  nomic growth.                    627, tel. 202-473-3722, fax 202-522-
or gfeder@worldbank.org.            To order, contact Tanya Shiel, Room G4-  2031, Email hvo1@worldbank.org. The
030, tel. 202-473-6317, fax 202-676-  author may be contacted at sdjankov@
Alain Mingat and Jee-Peng Tan, The  9810, Email tshiel~worldbank.org. The  worldbank.org.
Mechanics of Progress in Education:  authors may be contacted at vthomas@
Evidence from Cross-Country Data,  worldbank.org or ywang2k.world  Simeon Djankov, Ownership Structure
WPS 2015, 1998, 46 pp.              bank.org.                           and Enterprise Restructuring in Six
C) 1999 The World Bank/The William Davidson Institute                              TRANSITION, February 1999  0



Newly Independent States, WPS  MC2-501, tel. 202-473-1148, fax 202-522-  lization to EU Accession, No. 173,
2047, 1999, 20 pp.                  1154, Email: cbemardok@woddbankorg.  1999.
The author may be contacted at shang-
Ownership by managers is more com- ji_weik@harvard.edu.                 Luis M. Valdivieso, Macroeconomic
mon in countries in which privatization                                 Developments in the Baltics, Russia,
programs favored incumbent managers  Amy Jocelyn Glass and Kamal Saggi,  and Other Countries of the Former
(Georgia and Moldova) than in coun-  Multinational Firms and Technology  Soviet Union, 1992-97, No. 175, 28 pp.
tries that mainly adopted the mass  Transfer, WPS 2067, 1999 32 pp.
privatization approach (Kazakhstan                                      Other Publications
and the Kyrgyz Republic). Foreign own-  A developing country may attract foreign
ership, which is positively associated  direct investment for technology trans-  European Union Accession: The
with enterprise restructuring, is also  fer that increases local firm profits or for  Challenges for Public Liability Man-
higher in countries in which the mass  wage premiums that benefit workers. The  agement in Central Europe, Jointly
privatization approach was adopted.  benefits of either may not be great  with the European Commission, 1998,
Ownership by outside local investors  enough to make such investment more  144 pp.
or the state is not significantly corre-  attractive than exporting, however.
lated with restructuring. The study was  To order, contact Liii Tabada, Room MC3-  This volume is a collection of papers pre-
based on the changing pattern of own-  333, telephone 202-473-6896, fax 202-  sented during a two-day seminar hosted
ership of 960 privatized manufacturing  522-1159, Emailltabadagworldbank.org.  by the World Bank and the European
companies in six transition countries  Kamal Saggi may be contacted at  Commission in Brussels in December
between 1995 and 1997.              ksaggikWworldbank.org.              1997. The seminar was attended by all
To order, contact Rose Vo, Room                                         ten European Union (EU) applicant coun-
MCIO-627, tel. 202-473-3722, fax 202-  Policy Research Working Papers are also  tries (Bulgaria, the Czech Republic, Es-
522-2031, Email hvo1@worldbank.org.  posted on the Web at www. worldbank.org/  tonia, Hungary, Latvia, Lithuania, Poland,
The author may be contacted at  htmlldec/Publications/workpapers/  Romania, Slovakia, and Slovenia). The
sdjankov@worldbank.korg.            home.html.                          papers examine borrowing policies, in-
stitution building, portfolio optimization,
Shang-Jin Wei, Corruption in Eco-  Occasional Papers                    and the implications of the Euro and EU
nomic Development: Beneficial                                           accession for public debt management,
Grease, Minor Annoyance, or Major  Julian Berengaut and others, The Bal-  fiscal prudence, and the borrowing strat-
Obstacle? WPS 2048, 1999, 30 pp.   tic Countries: From Economic Stabi-  egies of Central European countries. The
Corruption is a major obstacle to eco-
nomic development. It reduces domes- Tax Advisory Service
tic investment, discourages foreign direct
investment, inflates government spend-
ing, and shifts government spending
away from education, health, and infra-
structure maintenance toward less effi-
cient (more manipulable) public projects.
Intemational pressure to fight corruption  - -
is useful, and laws and law enforcement
are indispensable. Most important, how-
ever, is reform of domestic institutions,
primarily public administration, and a
revamping of the civil service so that pub-
lic sector workers are recruited and pro-                                  -
moted based on merit and paid salaries                             -       --
that are competitive with those offered    "Mr. Entrepreneur, all I can suggest is escape while you can!"
in the private sector.
To order, contact Cynthia Bemardo, Room   From the Hungarian magazine Ho5cipo
*  TRANSITION, February 1999                                      © 1999 The World Bank/The William Davidson Institute



papers discuss the most effective tech-  for 46 primary commodities (for the  Review of Economies in Transition
niques formanaging public liabilities (sov-  next three years and for 2005 and
ereign debt) and explore ways in which  2010), detailed market reviews for 27  Laura Solanko, Issues in Intergovern-
prudent debt management could be pro-  major commodities, and expanded  mental Fiscal Relations: Possible
moted in Central Europe by creating a  sections on global and regional price  Lessons for Economies in Transition
regional network of experts.        indexes. Each issue will review major  5: 1-23, 1998.
market developments, highlighting
Pollution Prevention and Abatement  commodities that have shown the  Some concepts of standard fiscal feder-
Handbook 1998: Toward Cleaner Pro-  greatest price changes. The quarterly  alism do not apply to transition econo-
duction, In collaboration with UNIDO  will be available in both print and elec-  mies as they do elsewhere. For example,
(United Nations Industrial Development  tronic format. Full-service subscribers  normally undesirable interregional com-
Organization) and UNEP (United Nations  will receive monthly electronic up-  petition may actually benefit the transi-
Environment Programme), 1999,550 pp.  dates containing the most recent  tion process by forcing regions to alter
monthly prices and regional indexes.  their patterns of public spending. Prac-
To manage the environment rather than                                    tices such as in-kind transfers may carry
merely control pollution, policymakers  IMF Publications                 additional benefits in a transition environ-
must create a broad mix of incentives                                    ment. The paper makes extensive use of
and pressures. Guidelines used to pre-  To order, contact IMF Publication Ser-  observations from Russia's system of in-
pare World Bank Group projects, which  vices, 700 19th Street, NW, Washing-  tergovernmental relations.
are detailed in this handbook, can mini-  ton, DC, 20431, United States, tel.
mize the use of resources, protect hu-  202-623-7430, fax 202-623-7201, Email:  If the center does not know the true wealth
man health, and reduce the quantity of publications@imf.org, Intemet:http://  of the regions, any redistributive transfer
waste requiring treatment and disposal.  www.imf.org                     scheme has to be designed so that the
Such guidelines use commercially                                         rich regions also have incentives to reveal
proven and cost-effective technologies,  Working Papers                  their true wealth. In Russia 10 regions (of
follow regulatory trends, and promote                                    a total of 89) produce about 50 percent of
good industrial practices.          Monetary and Exchange Affairs De-  GDP. The 10 poorest regions rely on fed-
partment, Central Bank Autonomy,  eral transfers for more than half their bud-
Peter Quaak, Harrie Knoef, and Hubert and Inflation and Output Perfor-  get revenues. In other words, there is a
Stassen, Energy from Biomass: A Re-  mance in the Baltic States, Russia,  compelling need to design a system for
view of Combustion and Gassification  and Other Countries of the Former  equalizing transfers that is both transpar-
Technologies, Technical Paper No. 422,  Soviet Union, 1995-97, WP/99/4,  ent and relatively efficient and able to tackle
1999, 77 pp.                        1999.                                the problem of costly and incomplete in-
formation available to the federal govern-
Alternative fuel resources abound in the  Valerie CerraandAnuradhaDayal-Gulati,  ment. This calls for a new model of
form of agricultural and municipal waste  China's Trade Flows:Changing Price  intergovemmental transfers based on the
(biomass). This report reviews the state  Sensitivities and the Reform Process,  tradition of optimal income taxation.
of the art of biomass combustion and  WP/99/1, 1999.
gassification systems, identifying their                                 A certain degree of decentralization and
advantages and disadvantages. It en-  Marco Cangiano, Carlo Cottarelli, and  loosening of fiscal control may be inevi-
courages investment in these technolo-  Luis Cubeddu, Pension Developments  table during Russia's transition to a
gies to enable developing countries to  and Reforms in Transition Econo-  market economy. Since economists
better exploit their biomass resources  mies, WP/98/151, 1999.           know little about what happens when an
and help close the gap between their                                     economy shifts from one equilibrium to
energy needs and supply.            BOFIT Publications                   another, studying decentralization
schemes may provide useful knowledge.
Global Commodity Markets, a World  To order: Bank of Finland Institute for  Decentralization, after all, offers greater
Bank Quarterly, 80 pp.              Economies in Transition (BOFIT), P.O.  opportunities for implementing gradual or
Box 160, FIN-00101 Helsinki, tel. 3589-  partial reforms, because different reform
Each issue of this new World Bank  183-2268, Email: bofit@bof.fi, Internet:  approaches can be tested on a small
quarterly will contain price forecasts  http://www..boffi/bofit.         scale in different parts of the country.
© 1999 The World Bank/The William Davidson Institute                               TRANSITION, February 1999  U



Ii kka Korhonen, P reli mi nary Tests  see whether the prices of individual stocks  eryone worse off than before. Thus for the
on Price Formation and Weak-  are even weak-form efficient.               time being China is best served by main-
Form Efficiency in Baltic Stock Ex-                                       taining a stable exchange rate, but in the
changes, 5: 25-31, 1998.             This study found evidence that, within  longertermChinamayhavetoreconsider
the Baltics, the stock exchanges of  the wisdom of its peg to the U.S. dollar.
Stock price indices in the three small  Tallinn and Riga influence each other as
Baltic stock exchanges are not even  well as the Lithuanian stock exchange.  Vladimir R. Evstigneev, Estimating the
weak-form efficient (that is, past returns  Only the U.S. stock market seems to  Opening-Up Shock: An Optimal Port-
do predict future returns). The Baltic ex-  influence the Baltic stock exchanges  folio Approach to Would-Be Integra-
changes are still very small, and trading  from outside the Baltics, however.  tion of the C.I.S. Financial Markets
there is quite thin. If some shares are                                   [Kazakhstan, Russia, and Ukraine] 6:
traded very infrequently, then their seldom-  Tom Nordman, Will China Catch the   22-61,1998.
changing prices will affect the index. This  Asian Flu? 5: 45-64, 1998.
could be the main reason for the failure of                               Other Publications
weak-form efficiency. However, one can-  China, not yet a fully open economy, has
not argue that investors could consistently  the means and resources to withstand  Baltic Economies-The Quarter in
benefit from the failure of weak-form effi-  pressures against its currency.  Review, http://www.bof.fi/bofitl
ciency, because transactions costs might
make such trading strategies unattrac-  China's exports have an import content of  This free on-line publication covers the
tive. A natural next step would be to test  50 percent, so a small devaluation would  most recent economic developments in
forthe informational efficiency of individual  make little difference, and a large devalua-  Estonia, Latvia and Lithuania. The Janu-
stocks. Information disclosure require-  tion would probably trigger a new round of  ary issue includes "The Effect of the
ments have been tightened in all the Bal-  competitive devaluations among the  Russian Crisis on the Baltic Countries."
tic states, and it would be interesting to  region's countries, in the end leaving ev-  by likka Korhonen.
Westernization                                                          Russian Economy-The Month in
Review, http://www.bof.fi/env/eng/it/
mreview/mreview.stm
I                                [2 |  _     f ; _Free on-line publication that reports on
| t          4       f   X        ~~~~~~~~~~X ;.       the Russian economy, including fiscal
I tX  _   vJ41    1+;   } \.,         policy and financial market develop-
7 d \. \    t] .Zz   81   3} .   ,  p-s   / | .}  -   ments. The January issue contains: 'Will
~ >                                                              \ iL, vf 1 2 It' f' Q! | | i Sthe Russian Federation Fall Apart?" by
i' *-si S, 1{ t 1s ;.62kLaura Solanko.
Economics Education and Research
Consortium (EERC)-Russia Publica-
j5~~i=    ~ tions, http://www.eerc.ru
__                        ^-  )i l | rTo order, contact EERC, 3 Kochnovsky
A\       -a        , ; gB _ , .       'Proezd, Suite 418, 125319 Moscow,
Russia, tel./fax 7-095-152-0601/0121,
e   Xl__4   LKK      k )-  I & =-     ~ _r                 Email eerc@eerc.ru.
l -    _      _X-*_Research in Transition,
-X t ¢_ _-:= .. -.  _     '.- _-;.5 a~ .i-, t--  5iz             http://www.eerc.ru/publications/
{_ _~8^'-, ,,  Z -- '8' ~" .> - : . J~>-. ' ._- ' '<newslett.htm
"It would be a big mistake to build a shopping mall to replace the
kindergarden, instead let's build a Macdonald's."              This free biannual publication, available
in both Russian and English, reports find-
From the Hungarian Daily Nepszabadsag
*  T ASiIION, February 1999                                        © 1999 The World Bank/The William Davidson Institute



ings by Russian and foreign economists  surance, and tax benefits that favor in-  some transition economies has often
in the field of transition economics. The  vestment.                      been due to severe political and resource
December 1998 issue, devoted to the                                       constraints. The existence of a large num-
Russian financial crisis, featured "A  Other Publications                 ber of nonviable firms is a major impedi-
Western View of the Russian Financial                                     ment to the successful implementation
Crisis," by Mario Nuti and Giovanni Urga;  Petr Chadraba and Reiner Springer (eds.),  of the transformation policy agenda. Re-
'Don't Trouble Trouble," by Evsey Gurvich  Proceedings of the Sixth Annual Con-  structuring these enterprises will continue
andArcady Dvorkovich; and "Government  ference on Marketing Strategies for  to require special efforts not only by na-
Bonds as Gambling Device," by Anatoly  Central and Eastern Europe, Decem-  tional policymakers but also by the inter-
Pervozvansky and others.             ber 2-4, 1998, Vienna, Austria.      national community at large. (See
To order, Email Gertrude.Seidelmann@wu-  economic indicators on next page).
Working Papers                       wien.ac.at.
http://www.eerc.rulpublications.htm                                       New  Publications Available On-
Transition Report 1998, Financial  Line-Special Issues
Klara Sabirianova, Investment in Human  Sector in Transition, European Bank
Capital During the Economic Transfor-  for Reconstruction and Development  International Journal of Not-for-Profit
mation in Russia, No. 4, 1999, 52 pp.   (EBRD), 1998, 235 pp.             Law (IJNL),
http://www.icnl.org/journal.html.
How have returns to schooling and work  Evidence from 452 banks in 16 transi-
experience changed in Russia during the  tion economies shows that macroeco-  This free quarterly journal reports on the
transformation period? Unconstrained  nomic instability is associated with low  status and development of laws affecting
wage setting increased the returns to  levels of banking activity, high interest  not-for-profit organizations in countries
schooling at the beginning of the eco-  margins, and, in some instances, high  around the world. The December 1998
nomic reforms (1992-94). The structural  rates of profitability. Concentration in the  issue includes "Registration of Associa-
changes that followed, however, along  banking sectors in many transition  tions in Central and Eastern Europe and
with the decline in value of some skills  economies has impeded the ability of  the Newly Independent States: A Survey,"
and the reduction in the supply of skilled  banks to mobilize savings. Smaller  by Rachel L. Holmes, and "NGO Legisla-
jobs, caused rates of return to school-  banks are expanding their customer  tion in Georgia," by Vasha Salamadze.
ing to decline. Returns to work experi-  loans more rapidly than larger banks.  To order, contact the Intemational Cen-
ence are also low, reflecting the changing  New banks and privatized banks also  ter for Not-for-Profit Law, 733 15th Street,
nature of the Russian economy, which  tend to be more profitable than state  NW, Suite 420, Washington, DC 20005,
rewards younger, more mobile people  banks. One constraint on the number of  United States, tel.202-624-0766, fax 202-
who adapt more easily. Compared with  new banks is the regulatory authority's  624-0767, Email infoicnlicnl.org.
workers in state-owned and privatized  capacity to supervise them effectively.
companies, workers at new private firms  Sufficient concentration of ownership fol-  Slovak Monthly Report,
enjoy greater returns to schooling and  lowing privatization is required in order  http://www.mesalO.sk.
smaller returns to experience.       to provide effective corporate governance.
This free publication by MESA 10 (the Cen-
A.D. Slastnikov, V.I.Arkin, and E.A.  1998 Economic Survey of Europe,  ter for Economic and Social Analysis, a
Shevtsova, Tax Incentives for In-  (third issue), The United Nations Eco-  major economic think tank in Slovakia) re-
vestment Projects in the Russian  nomic Commission for Europe, (UN/  portsonmajordevelopmentsintheSlovak
Economy, No. 3, 1999.                ECE) Geneva, December, 1998.         economy.
To order, contact the Bank of Finland Insti-
Investment has declined in Russia  As examination of Russia's economic cri-  tute for Economies in Transition (BOFIT)
since the beginning of the 1990s. The  sis reveals that economic policies can-  Aleksanteninkatu 36A Helsink, orPO.Box
decline is associated with political and  not be put in place in an institutional  160FIN-00101 Helsinki, tel. 358-9-183-2268,
economic instability, an excessive tax  vacuum. Assistance to create appropri-  fax 358-9-183-2294, Email: bofit@bof.fi.
burden, and a high rate of crime. In-  ate institutions should never have been  MESA and be reached at Hviezdoslavovo
centives for increasing investment  relegated to the rank of "second-genera-  nam. 17, 81102 Bratislava, Slovakia, tel.
should include state guarantees to in-  tion" transition issues. Lack of satisfac-  421-7-544-35-328, 544-34-009 fax.421-7-
vestors, development of investment in-  tory progress toward structural reform in  544-32-189, Email: mesa10@intemetsk.
©) 1999 The World Bank/The William Davidson Institute                                TRANSITION, February 1999  *



Basic economic indicators of transition economies, 1996-1999
(Rates of change and shares, percent)
GDP (growth rates)               Industrial ouput        Inflation     Unemployment
1998                          (growth         (per cent change,   rate (end of
rates)           Dec.iDec.)      period, percent)
April        October 1999
official Jan.-Jun. official             Jan.-Jun.
Country            1996   1997 forecast actual  forecast    1996  1997  1998  1996 1997  1998a 1996 1997 1998
Eastern Europe       4.1   2.8    4.3    3.5    3.3    4       6.0    5.4   4.4   ..         .    . 11.7  12.0  11.6
Albania              9.1  -7.0    10    ..       8-9    .. 13.6   -5.6  -3.0*  17.4   42.0 17.9  12.3  14.9  16.5
Bosnia and
Herzegovina b                                   .      *   87.6   35.7  21.1    3.2   12.2  3.7            390**
Bulgaria           -10.1  -6.9    3.0   11.9    4.5    3.7   3.8c -10.2  -0.7  311.1  578.7 18.8  12.5  13.7  11.4
Croatia              6.0   6.5    7.5    3.4    ..       5     3.1    6.8    5.8   3.5    4.0  6.0  15.9  17.6  16.8
Czec-h Republic      3.9   1.0  1.4-2.6 -1.7   -1.9  0-1        2.0    4.5    6.7   8.7    9.9 12.0   3.5   5.2   5.6
Hungary              1.3   4.4    4.0    4.8      5     5      3.4   11.1  13.6  20.0   18.4 14.2  10.5  10.4   9.1
Poland               6.1   6.9  5.6-5.8  5.9    5.6    5.1    8.3   10.8   8.4  18.7   13.2 12.1  13.2  10.3   9.6
Romania              3.9  -6.6    --    5.2    -4  2-3         6.3   -7.2 -19.1  56.8  151.7 55.3   6.3   8.8   8.8
Slovakia             6.6   6.5    5.0    6.1      6      ..    2.4    2.7   5.3   5.5    6.5  7.5  12.8  12.5  13.5
Slovenia             3.1   3.8   3.5-4   4.8      4     4       1.0    1.0   4.2    9.0    8.8  8.3  14.4  14.8  14.1
Macedonia, FYR       0.8   1.5    5.0    ..       .       .    3.2    1.6  10.3    0.3    4.5  2.0  39.8  42.5
Yugoslavia d         5.9   7.4   10.0   ..        6      ..     7.5    9.5  11.2  59.9   10.3 27.4  26.1  25.6  26.9
Baltic states        4.1   7.6    6.3    7.1    5.7    6       4.6    8.3   7.3   ..         .    .     6.4   6.3   5.9
Estonia              4.0  11.4   5.5-6   7.4   6.5-7   6       2.9   13.4   8.4  15.0   12.3 10.2   5.6   4.6   4.3
Latvia               3.3   6.5    5-6    6.4      5     4.5   5.5   13.8  10.1  13.2    7.0  6.1   7.2   6.7   7.2
Lithuania            4.7   6.1    7.0    7.3    5.5    7       5.0    0.7   3.9  13.1    8.5  6.1   6.2   6.7   5.5
cis                 -3.4   1.1    1.2    0.8   -2.6   .. -2.8    2.5   1.8   ..              .    .     6.6   7.5   7.8
Armenia              5.8   3.1    5-6    6.7      .      ..     1.4    0.9   3.2    5.6   21.8  6.7   9.7  11.0   8.7
Azerbaijan           1.3   5.8    ..      9.1     7      9    -6.7    0.3   0.7   6.8    0.3 -0.2   1.1   1.3   1.4
Belarus              2.8  10.4    7-8   12.5   10-12   ..      3.5   18.8  13.5  39.1   63.4 41.0   4.0   2.8   2.3
Georgia             11.0  11.3   11-13   8.9      .      ..    7.7    8.1    0.8  13.6    7.3  2.9   3.2   2.6
Kazakhstan           0.5   2.0    3.5    1.7      2     1.5   0.3    4.0   1.1  28.6   11.3  8.0   4.1   3.9   4.0
Kyrgyz Republic      7.1   9.9    3.6    5.0    3-4    ..      8.8   50.4  23.5  35.0   14.7 12.0   4.5   3.1   3.7
Moldova e           -7.8   1.3   3-3.5  -4.7   -5-7)   .. -6.5         -      2.3  15.1   11.1  4.3   1.5   1.7   2.0
Russian Federation -3.5   0.8   0-0.5  -0.5    -5        .. -4.0    1.9   0.1  21.8   11.0  6.5  10.0  11.3  11.5
Tajikistan         -16.7   1.7    ..      2.6     .      ..-23.9   -2.5  12.5  40.6  159.9 67.1   2.4   2.8   3.3
Turkmenistan         0.1 -1 5.0*          3.0*           .. 17.9  -30.0*  -5.0*
Ukraine            -10.0  -3.2    0.5    0.2   -1.5    1    -5.1   -1.8    0.7  39.7   10.1  7.7   1.5   2.8   3.4
Uzbekistan           1.7   5.2    6.0    4.0      .      ..    6.0    6.5   5.5  80.0   27.5  ..        0.3   0.3   0.4
Total above         -0.4   2.0    2.6    2.1       -      .     0.3    3.6   2.8   ..         .    .     8.1   8.8   8.9
Memorandum items:
CETE-5               5.0   5.4    4.7    4.6    4.6    ..      6.1    8.9   8.3   ..         .    . 11.2   9.8   9.3
SETE-7               2.1  -2.9    3.3    1.0    0.6    ..      5.7   -3.9  -7.3    ..         .    . 12.5  14.3  14.2
Ex-GDR Lander        3.2   1.7    ..      1.8     .      ..    4.3    5.0   8.6       .       .    .
Note: Aggregates are UN/ECE secretariat calculations, based on previous period weights at 1992 prices. Output measures are in real terms (constant
prices). Forecasts are those of national conjunctural institutes or government forecasts associated with the central budget formulation. Industrial
output refers to gross output, not the contribution of industry to GDP. Inflation refers to changes in the consumer price index. Unemployment generally
refers to registered unemployment at the end of the period (with the exception of the Russian Federation where it is the Goskomstat estimate according
to ILO definition and Estonia where it refers to job seekers). Aggregates shown are: Eastern Europe (the 12 countries below that line), with sub-
aggregates CETE-5 (central European transition economies: Czech Republic, Hungary, Poland, Slovakia, Slovenia) and SETE-7 (south European
transition economies: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Romania, The former Yugoslav Republic of Macedonia and Yugoslavia);
Baltic states (Estonia, Latvia, Lithuania); CIS (1 2 member countries of the Commonwealth of Independent States); and total transition economies.
a June 1998 over June 1997.
b Data reported by the Statistical Office of the Federation; these exclude the area of Republika Srpska.
c Bulgarian industrial output indices were recently recalculated according to a new methodology and old series reportedly have been revised back to
1 99 1. Here and in appendixtable BA4 the industrial output indices now cover gross output of all activities of industrial enterprises (and not gross output
of "pure" industry, as previously published). The figure for industrial output growth in 1996 according to the new methodology (3.8 per cent) differs
significantly from the figure for the rate of change of gross industrial output (-9.1 per cent) reported in the national accounts for the same year.
d Gross material product instead of GDP.
e Excluding Transnistria.
Source: National statstics; CIS Statistical Committee; direct communications from national statistical offices to U NIECE secretariat (IMF and Worid Bank
data for Albania).
M   TRANSITION, February 1999                                               ©D 1999 The World Bank/The William Davidson Institute



Bibliography of Selected Articles
Postsocialist Economies            Hungary's Stability Draws Invest-  Russia in Default: Money Can't Buy
ment. Global Finance (United States)  Me Love. Economist (United Kingdom)
Carre, J. Grey Economy and Tax Ad-  13:34-35, January 1999.            350:23-25, February 6-12, 1999.
ministration. Tax Tribune (Hungary) 98/
03, pp. 23-28, 1998.               Meifner, T. Bulgariens Erste Erfahrungen  Thornhill, J. Russian Roulette. Finan-
Mit Seinem Currency Board. Wirtschaft  cial Times (United Kingdom): 20, Janu-
Li, H. and H. F. Zou. Income Inequal-  im Wandel (Germany) 8:9-14, 1998.  ary 29, 1999.
ity is Not Harmful for Growth: Theory
and Evidence. Review of Development Tersman, G. The Baltic States: Stable  Treisman, D. Russia's Taxing Prob-
Economics (United Kingdom) 2(3):318-  Currencies Despite External Deficits.  lem. Foreign Policy (United Kingdom):
34, 1998.                           Stockholm Report on East European  55-66, 1998.
Economies (Sweden) 9:1-12, November
Li, H., L. Squire, and H.F. Zou. Explain-  1998.                       Woodruff, D. Why Market Liberalism
ing International and Intertemporal                                    and the Ruble's Value are Sinking
Variations in Income Inequality. The  T6th, E.N. Variations for Financing:  Together. East European Constitu-
Economic Journal (United Kingdom)  Money Must Follow the Patient. The  tional Review (United States) 7(4):73-
108:26-43, 1998.                   Hungarian Economy (Hungary) 26(3):20-  76, 1998.
21, December 1998.
Transition Countries Overall Make                                      Asia
Progress Towards Macroeconomic  CIS
Stabilization. IMF Survey/International                                Asher, M. South-East Asia's Eco-
Monetary Fund (International) 28:61-63,  An Investment Guide to Moldova.  nomic Crisis: Implications For Tax
February 22, 1999.                  Central European (United Kingdom)  Systems and Reform Strategies.
8:49-56, January 1999.             Bulletin for International Fiscal Docu-
Central and Eastern Europe and the                                     mentation (Netherlands) 53:25-34,
Baltics                            Berkowitz, D., D. N. DeJong,and S.  January 1999.
Husted. Quantifying Price Liberaliza-  Asian Economies: Ready For More?
Aima, K. Central Bank Independence  tion in Russia. Joumal of Comparative  Economist (United Kingdom) 350:70-71,
in the Baltic Countries. Suomen  Economics (United Kingdom) 26:735-  February 13-19, 1999.
Pankki Review of Economies in Transi-  60, December 1998.
tion (Finland) 4:5-34, 1998.                                           Clowes, D. The New Commercial Law
Johnston, R., and V. Buzhor. Russia Af-  in Vietnam. Comparative Law Yearbook
Blind, K. Current Foresight Activities  ter Yeltsin. The Intemational Economy  of International Business (United King-
in Central Europe. Technological Fore-  (United States) 13(1):44-47, January-Feb-  dom) 20: 317-325, 1998.
casting and Social Change (United  ruary 1999.
States) 60:15-35, January 1999.                                        Clowes, D. Vietnam Edges Ahead in
Miller, E. Case Study-An American  Equitization Process. Intemational Fi-
Bush, J. Catch a Rising Star. Central Company on Sakhalin: An Interpre-  nancial Law Review (United Kingdom)
European (United Kingdom) 8:25-32,  tive Story. Russian Far East Update  17(10): 25-28, 1998.
January 1999.                       (United States) 9(2): 5-7, February 1999.
Mending China. Economist (United
Central Europe: Converging Hopes.  1998 [Tax] Year in Review [Russia].  Kingdom) 350: 69-70, February 13-19,
Economist (United Kingdom) 350:74,  Tax Notes Intemational (United States)  1999.
February 13-19, 1999.               18: 7-64 January 4, 1999.
Saywell, T. Coming Clean: Chinese
Dinkova, D. Bulgaria's Internet: Non-  Reddaway, P. Russia: Where the  Firms Open Their Books as Securi-
profit Organizations are at the Fore-  West is Heading for a Fall. Washing-  ties Law Looms. Far Eastem Economic
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(D 1999 The World Bank/The William Davidson Institute                            TRANSITION, February 1999  M



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