http:/lwww.worldbank.org/html/prddr/trans/WEB/trans.htm 22957 http://www.wdi.bus.umich.edu
THE NEWSLETTER ABOUT REFORMING ECONOMIES hi T. World BankGroup
1 fRAN S I T I 0 N Our Dream is a World Free of k=
IN E WV SbLE T T E R~ THE WILLIAM DAVIDSON INSTITUTE
Vol. 12, No. 3 July-August-September 2001
Aftermath of the September Terrorist Attacks-
A Slowdown in Transition Economies Too?
In the wake of the terrorist attacks on September 11, the economic fallout for Europe's transition economies depends on
developments in the United States. Since the countries of the European Union are the major trade partners of these econo-
mies, the key will be how much Western European growth slows in response to the weakening of the U.S. economy.
T he global economy will suffer in round of global trade talks-would not mies, but the Philippines is also on the
the aftermath of the terrorist at be deferred because of the events in the list. Central European external deficits
tacks on the United States, but it United States. (A meeting of the World are generally well financed by long-term
is too early to have a complete sense of Trade Organization is planned for later investment inflows.
the impact, said World Bank President this year in Qatar to discuss a new round
James Wolfensohn in a recent interview of trade negotiations.) In 2001, even before the September 11
with the Canadian National Post. A slow- terrorist attacks on the United States,
down in global trade and tourism as a re- Global Sluggishness the global economy was set to experi-
sult of fear of war will have a major effect ence its most severe slowdown since the
on developing countries and their people. Economists predict that the blow to U.S. 1974 oil price shock. In 2000 world
consumer confidence will lead to a more growth averaged 4.7 percent, the fast-
The recent events were caused not by pronounced global deflation. The terror- est pace since 1988. But the Economist
poverty, but by fanatics, the president ist attacks came at a time of significant Intelligence Unit estimates that in 2001
emphasized. Nevertheless, he said, if weakness in global growth, linked to the global economic growth will slow to only
people are poor and disadvantaged, risk bursting of the U.S. information technol- 2.4 percent, similar to the rate in 1993,
of conflict is increased. That makes the ogy bubble and the end of a 1 0-year pe- when Western Europe was in recession.
World Bank's efforts to alleviate poverty riod of rapid U.S. expansion. With Japan
and help countries improve their econo- in a long-term stagnation and euro-area The economic impact of the attacks will
mies even more crucial. "There are 6 bil- growth disappointing, the outlook for glo- be felt mainly during the fourth quarter
lion people on the planet, and 4.8 billion bal growth has hinged on the outlook for of 2001, when consumer and capital
live in developing countries; that is 80 the U.S. economy, which accounts for spending will be more subdued than pre-
percent of the world," he said. 30 percent of global output. Reduced viously expected. Although risks have
U.S. consumer spending would further increased, a recession can be avoided.
In the wake of the attacks on the United dampen growth in U.S. imports. Coun- Economic recovery next year will be
States, the World Bank and its sister tries depending on sales in the U.S. sluggish, however, with growth averag-
institution, the International Monetary market will feel the pinch of the Ameri- ing only 2.3 percent.
Fund, canceled their annual meetings, can slowdown. Moreover, uncertainty
usually held in September. No decision raises the risk premium on emerging Weakening Growth in Eastern Europe
has been made on meeting later or in market borrowing, an effect that will hit
another location. Wolfensohn voiced hardest in economies with the greatest Data for the first half of 2001 confirm a
hope that other international initiatives- external financing needs. Brazil and Ar- long-predicted slowdown in growth in the
such as an attempt to launch a new gentina stand out among these econo- transition region, although some econo-
Development Research Group The World Bank M The William Davidson lnstitute SITE LGI ___
FILE COPY
mies continue to grow faster than ex- transition. Real GDP growth for the re- tion of the forint (which will accelerate
pected. This follows good performance gion (weighted by GDP at purchasing following the recent widening of the ex-
in 2000, the most successful year of the power parity exchange rates) averaged change rate band), and a predicted mon-
6 percent, more than twice the rate in etary tightening (to compensate for fiscal
1999. Reforms enacted during the 1 990s slippage and nominal wage growth). For-
Cfonten ts00000 00i in many countries seem to have helped eign direct investment from the United
c : :; 0 000 0 ;0 fuel the growth. Average growth in the States is likely to slow as a result of the
region is expected to weaken in 2001, terrorist attacks. More than a third of
Demagogy behind Terrorists, Attack a to 4.5 percent. Eastern European coun- Hungary's $22 billion in foreign direct in-
Blessings of Globalization 4 tries may gain from the crisis, however, vestment has come from the United
Dangers of Globalization 8 if portfolio investors, seeing Latin States in the past 10 years, and there
America's emerging markets as too de- were $200 million in U.S. investments in
China at the Gates of WTO 10 pendent on trends in the U.S. economy, Hungary last year alone. Still, the effects
Discussion Forum about Russia seek diversification. of the slowdown in U.S. investment will
* Common Misconceptions 13 not be significant.
* Harmful Market Bolshevism 16 Predictions about economic develop-
Economic Recovery is Slowing 18 ments over the next year vary, but some In the Czech Republic, in contrast to
Bulgaria Rui 1 tendencies emerge from forecasts for the general trend, growth is expected
Bulgaria, Rpomania-Restruturing 19 selected economies in Central and East- to pick up. GDP growth of 3.5 percent
RomldBani Pvratyge 22 ern Europe and for China: is predicted for 2001, as long as the
World Bank Strategies 23 international environment remains calm.
LGIIOSI In the Russian Federation, the nega- The wild movements in U.S. security
Central Asia - tive impact from the terrorist attacks markets could hurt the Czech capital
* Reforms on the Silk Road 24 against the United States is expected market, however, as many local finan-
- Political Cultures and Attitudes 26 to be limited. Inadequate structural re- cial companies have invested in U.S.
• Preventing Water Conficts 28 forms, continuing appreciation of the bonds.
* Kazakhstan Migration Issues 30 ruble, and lower oil prices will be the
Improving Ukraine's Institutions 31 main constraints on economic growth. Most of the Balkan countries will share
William Davidson Institute (The United States accounts for a mere in the dominant regional trend of slow-
Wilnamc Davidsons insthetutst 8 percent of Russia's exports.) As a down in 2001. The Federal Republic
Century 33 in the Last major exporter of primary materials, min- of Yugoslavia has not yet fully reen-
Traps of Decentralizatyon in China3 3 erals, and oil and gas, Russia will ben- tered the international economy after
Report from the Fceld-zthei CzeChn efit if the prices for these commodities a decade of isolation, and the attacks
Privatization 36 F Czc rise as a result of protracted military on the United States are expected to
Privatzato 36 action. Oil and petrochemicals account have only limited effects. But no GDP
SITE for more than 80 percent of Russia's growth can be expected if foreign di-
Russia exports, and metals for another 10 per- rect investment fails to flow into the
The WTO: Myth and Reality 39 cent. (More details on page 18.) country. In Croatia, the tourist indus-
Workers' Mobility 42 try, among the main generators of
Reform Priorities 44 In Poland, some rebound is likely in the growth in 2000 and 2001, will probably
Budget Crisis in Poland 46 second half of 2001, but for the year as suffer next year. In Bulgaria, inflows
Business Climate Score Board 47 a whole growth is expected to reach only of foreign direct investment are likely
2.5 percent-the slowest rate of expan- to slow. Romania is expected to record
BOFIT sion since the early 1990s. Exporters significantly higher growth this year
New Aspects of the 1998 Crisis 49 losing markets in the European Union than last-4.5-5 percent, up from 1.6
FDI in the Baltics 50 may trim their workforces, which could percent. Depending on recovery in
Honoring Business Contracts 52 further increase unemployment (cur- Western Europe, the export-led eco-
rently 15.9 percent). (See also page 46.) nomic growth could hold on next year,
World Bank\IMF\EBRD Agenda 53 but strong financial inflows are needed
Conference Diary 56 In Hungary, growth is expected to slow to balance the widening trade deficit.
New Books and Working Papers 58 to 4.2 percent in 2001 as a result of a So far, the government has failed to at-
Bibliography of Selected MArtiesb 63 slowdown in EU imports, real apprecia- tract large foreign investors.
FIURANsI'ION, July-August-September 2001 The World Bank/The William Davidson Institute CQ 2001
China's growth next year is not ex- tive export sector (focusing on low-cost Based on reports of the U.K.-based
pected to dip below 8 percent. Fiscal consumer goods) will thrive in a defla- Economist Intelligence Unit and Oxford
expansion will continue to boost domes- tionary global economy, even if the U.S. Analytica, as well as news agency re-
tic demand, and the extremely competi- market becomes more difficult. ports.
An Economist's View: Poverty Did Not Cause the Terror Attacks
by Keith Marsden
If the United States and its allies are to win the fight against 1990s. Its total merchandise imports increased 8.5 percent
terrorism, they must not only employ their military might annually, compared with 4 percent for the European Union
discriminately and effectively against the perpetrators. They and 3 percent for Japan. And exports from Muslim states have
must also answer apologists who try to explain, and even been buoyant in both labor-intensive and new technology prod-
justify, terrorist actions by talking about the "basic roots" of ucts. For example, exports of clothing from Bangladesh rose
the conflict. When examined against factual evidence, their at a 25 percent annual rate during the 1990s, and Indonesia's
arguments turn out to be false or grossly exaggerated. by 10 percent. Exports of office machines and telecommuni-
cations equipment from Malaysia jumped 21 percent annu-
* Poverty. Islamic terrorists are said to be revolting against ally. Clearly, if the right policies are applied, the existing trading
the poverty imposed on Arab and other Muslim states by capi- system provides rapidly expanding market opportunities that
talism and its trading system. But information provided by benefit both Muslim exporters and global consumers.
their statistical authorities indicates that these states and
their peoples have benefited greatly from participation in the * Aid. Muslim countries received net official development as-
global economy. Data for 13 Arab countries show that their sistance totaling nearly $29 billion from 1993 to 1998 (the
gross national product rose at an average annual rate of 3.5 latest year available). Over that period Bangladesh received
percent during 1965-98, a more than threefold increase. $6.5 billion in official aid, Indonesia $5.4 billion, and Pakistan
Growth rates for Egypt, SaudiArabia, Syria, and Tunisia topped $4.9 billion. In 1998 aid inflow as a share of recipients' GNP
5 percent, a fivefold increase since 1965. The average per reached 13.8 percent in the West Bank and Gaza, 7.9 per-
capita income of an Arab nation (a term often employed by cent in Yemen, 7.1 percent in Jordan, and 2.2 percent in
Arab leaders) was $4,000 in purchasing power parity dollars Egypt-and just 1.1 percent in Israel.
in 1998, above that of East Asia, at $3,280. It would have
been substantially higher but for the civil wars in Algeria, Leba- In short, none of the arguments provides a convincing expla-
non, Sudan, and the Republic of Yemen and the Iraqi attacks nation or justification for Islamic terrorism. Schools and
on Iran and Kuwait. Economic growth in non-Arab Muslim mosques inculcate a doctrine that combines religious zeal,
states averaged 4.5 percent annually during 1965-98, reach- anger over perceived injustices, and glorification of self-sacri-
ing as high as 6.8 percent in Indonesia and Malaysia. By fice-a sacrifice that will be rewarded in an afterlife and win
comparison, growth averaged just 2.6 percent for the United the respect of families and a wider public. This dogma is rein-
States and 3.0 percent for all high-income countries over this forced by state- and clergy-dominated media and by the rela-
period. tive neglect of secular education. On average 43 percent of
adult females (15 years and older) and 23 percent of the men
* Trade. World Trade Organization rules, it is claimed, are are still illiterate in Arab countries. Government spending on
heavily weighted against Muslim states, and their access to education averages just 4.5 percent of GDP, compared with
U.S. markets has been largely restricted to oil. In fact, total military spending of 7.4 percent.
exports of manufactures from the Middle East rose at an an-
nual rate of 9 percent during the 1990s, and exports to North The international development community and civil society
America rose by an even higher 14 percent. Total merchan- organizations could play an important role in changing these
dise exports increased 13.5 percent annually from Malaysia, attitudes and priorities.
8.5 percent from Indonesia, and 6 percent from Morocco and
Tunisia, all topping the world rate of 5 percent. The United Based on a recent article in the Wall Street Journal Europe.
States offered the most dynamic major market during the The author is an economist living in Geneva.
(© 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001
Integration Spurs Growth, Poverty Reduction
by Paul Collier and David Dollar
Globalization-the growing integration of economies and societies that results from international flows of goods, services,
capital, people, and ideas-has increased growth and reduced poverty in a diverse group of countries, including China, India,
Uganda, and Vietnam. Integration accelerates development. Workers with the same skills-whether farmers, factory work-
ers, or pharmacists-are less productive and eam less in developing economies than in advanced ones. Integration through
trade, migration, foreign investment, and intemational telecommunications narrows these gaps by raising productivity in the
developing world.
T he first great wave of modern glo- (China) encouraged others to open up advanced regions accelerates technologi-
balization occurred between 1870 to trade and investment. cal learning. "Globalizers" have not just
and 1910. Transport costs fell liberalized trade and investment, they
while flows of trade, capital, and labor During the third wave of globalization, have also implemented sound institu-
increased. Between 1870 and 1914 which began in the late 1970s, develop- tions and policies for productive invest-
trade roughly doubled as a share of glo- ing countries with large populations (in- ment and growth.
bal income. International capital flows cluding China and India) began for the
were also extensive. A century ago glo- first time to open up to foreign trade and The expansion of China's participation
balization seemed as inevitable as it investment.(Opennesscanbemeasured in international trade since it initiated
does today. through tariff rates, the extent of nontariff reforms in 1978 has been one of the most
barriers, the share of trade in GDP, or remarkable features of its transformation.
But incompetent economic policies, the degree of distortion in the foreign Whilegrossnationalproduct(GNP)grew
widespread unemployment, and growing exchange market-that is, the size of by 9 percent a year in 1978-94, exports
nationalism quickly drove governments black market premiums.) Growth rates grew by about 14 percent and imports
into beggar-thy-neighbor protectionism. in these countries have accelerated as by 13 percent. In India, where an inward-
By the late 1940s trade as a share of they have integrated with the global oriented strategy brought disappointing
global income was back to its level in economy. Their experience is consistent results in terms of growth and poverty
1870-protectionism had offset 80 years with growth models in which technologi- reduction, the government in 1991 started
of progress in transportation. During this cal advance plays a key role in growth, a series of far-reaching reforms that lib-
period of autarky, global growth slowed: and integration of backward with more eralized the domestic economy and
growth in per capita incomes fell by about
a third and the number of poor people Demographic and Economic Indicators for Globalizing and
continued to rise. Moreover, world in- Non-Globalizing Developing Countries, 1980 and 1997
equality continued to rise-protectionism (population-weighted averages)
was not equalizing. Indicators 24 globalizers 49 non-globalizers
Population 1997 2.9 billion 1.1 billion
The second wave of globalization, from
1950 to the late 1970s, saw unprec- Per capita GDP, 1980 a $1,488 $1,947
Per capita GDP, 1997 a $2,485 $2,133
edented Integration among rich coun-
tries, which trade relationships restored Inflation, 1980 16% 17%
through a series of multilateral trade lib- Inflation, 1997 6% 9%
eralizations under the General Agree- Rule of law index, 1997 (world average = 0) -0.04 -0.48
ment on Tariffs and Trade (GATT). Most Average years of primary schooling, 1980 2.4 2.5
developing economies, in contrast, re- Average years of primary schooling, 1997 3.8 3.1
stricted their involvement in foreign trade Average years of secondary schooling, 1980 0.8 0.7
and investment, remained stuck in pri- Average years of secondary schooling, 1997 1.3 1.9
mary commodity exports, and were iso- Average years of tertiary schooling, 1980 0.08 0.09
lated from capital flows. But there were Average years of tertiary schooling, 1997 0.18 0.22
notable exceptions, and success stories a. Measured in terms of purchasing power parity.
like the Republic of Korea and Taiwan Source: Author and World Bank data.
1RiIANSI I ION, JIulv-August-September 2001 The World Bank/The William Davidson Institute © 2001
opened it to foreign trade and investment. to 3.5 percent in the last 40 years of the ($1,947); by 1997 they were richer (see
As a result per capita income rose more 20th century. Higher growth sustained table). Among the globalizers average in-
than 4 percent a year in the 1990s. Viet- over several decades makes a huge dif- flation was 16 percent in 1980, but by 1997
nam has also made a remarkable turn- ference in real living standards. Today it it had fallen to single digits. In 1980 the
around, and now has a far more open takes just two or three years for the world two groups of countries had similar edu-
economy than it did 10 years ago. economy to produce all the value it pro- cational attainments. But since then the
duced in the entire 19th century. globalizers have seen a much bigger in-
These examples provide persuasive evi- crease in the average years of primary
dence that openness to foreign trade and Convergence and Divergence in the schooling among the adult population. Fi-
investment-coupled with complementary Distribution of Wealth nally, in 1997 globalizers scored better on
reforms-can boost growth in developing an index measuring property rights and the
countries. During the most recent wave The tremendous increase in human rule of law. The same index is not avail-
of globalization some countries have seen wealth through about 1975 was very un- able for 1980, but countries such as China
their share of trade in GDP jump 50 per- equally distributed among countries. In and Hungary have clearly strengthened
cent or more. Other developing countries, 1913 the per capita income of rich coun- property rights as a part of overall reforms.
by contrast, actually trade less today tries was 16 times that of the poorest. Globalizing transition and developing coun-
than they did 20 years ago. Many of the Since then rich countries have grown tries have moved forward on a broad range
countries that have seen large increases faster-so today their per capita income of reforms, and their experience shows
in trade are the same ones that have re- is 64 times that of the poorest countries. how openness-coupled with other good
ceived the bulk of increased foreign in- economic and social policies-can con-
vestment in the developing world. But at the same time, there has been tribute to development.
convergence among and within nations
By 1995 foreign ownership of assets was that have integrated with the global Contrary to views that globalization is
equal to 57 percent of global income, up economy. Many of today's industrial increasing inequality within countries,
from 18 percent in 1980. The nature of countriesthatwererelativelypoorin 1820 there is no systematic relationship be-
capital flows has also changed. In the haveseenthefastestgrowthin percapita tween measures of globalization and
early 1900s such flows typically financed income, so among this group inequality changes in household inequality.
public infrastructure projects (canals, rail- has declined. Similarly, per capita in- Some countries open up and see in-
roads) or direct investments related to comes have converged within countries equality rise; in others the income gap
natural resources. Today most capital and regions. Evidence suggests that between rich and poor people narrows.
flows to developing countries are direct when economically backward regions In fact, the only countries that
investments, and a large share goes to integratewithmoreadvancedones,their achieved a large-scale reduction in
manufacturing and services. growth rates accelerate and their income poverty in the 1990s are those that
levels gradually converge. have become more open to foreign
These changes are related to lower trans- trade and investment. Consider Viet-
port costs, shorter transport times for During the 1990s globalizing developing nam. As it has opened up, it has seen
both people and goods, and the revolu- countries-including Brazil, China, Hun- a large increase in per capita GDP and
tionary progress in telecommunica- gary, India, and Mexico-saw annual no significant change in inequality.
tions-from surface telephones to fax growth rates accelerate to 5 percent, Poor people's income has risen dra-
machines to cellular phones to the while growth in industrial countries matically, and in just 10 years abso-
Internet. Since 1920 seagoing freight slowed to 2 percent. Among non-global- lute poverty dropped by half, from 75
charges have dropped by about two- izing developing countries, average percent of the population in 1988 to 37
thirds, air travel costs by 84 percent, and growth was negative in the 1990s. Thus percent in 1998. China, India, and
the cost of a three-minute telephone call in the 1990s the globalizers were catch- Uganda also experienced rapid poverty
from New York to London by99 percent. ing up with rich countries, while non- reduction as they integrated with the
Thus production in widely differing loca- globalizers continued to fall further global economy. Among globalizers the
tions can now be integrated in ways that behind. number of people living in absolute pov-
were simply impossible before. erty (less than $1 a day) fell by 120
In 1980 the globalizers were poorer (with million between 1993 and 1998-while
As integration increased, the annual per capita GDP averaging $1,488, mea- in the rest of the developing world the
growth rate of the world economy shot sured in terms of purchasing power par- number of poor people increased by 20
from 1.0 percent in the mid-19th century ity) than other developing countries million.
CO 2001 The World Bank/The William Davidson Institute TRANS1I1ON, July-August-September 2001
It is, however, important to comple- poor people will share in the benefits. Second, the successes of the 1990s
ment open trade policies with effective First, globalization is not inevitable. show that integration requires not
social protection measures such as un- It can be stopped and reversed-with just open trade policies, but also
employment insurance and food-for- dire consequences. Hence international sound institutions and policies in a
work schemes. (Closed economies cooperation is crucial for maintaining range of other areas (including firmly
obviously need safety nets as well since and extending an open system for trade established rule of law and vigilance
households are subject to shocks from and investment. Growing integration is against corruption). But weak institu-
business cycles, technological changes, controversial, as evidenced by demon- tions should not be an excuse to re-
natural disasters, and disease.) To the strators determined to prevent trade main closed. Countries can use the
extent that openness to trade raises na- agreements and other forms of interna- international market to improve eco-
tional income, it strengthens a society's tional cooperation. We have seen re- nomic governance and to provide
fiscal ability to provide these safety treats from global integration before, and needed infrastructure (such as for ports,
nets. the results were not pretty. Anytime power, and telecommunications).
there is a global slowdown, as has been
Lessons of Globalization occurring in 2001, there is a danger of Third, global production is remark-
a return of protectionism. Thus it is im- ably concentrated. Most of the world's
Globalization raises important issues portanttomoveaheadwithanewround GDP is produced in temperate regions
that influence the extent to which poor of trade liberalization and with efforts to within 100 kilometers of an ocean or a
countries will be able to deepen their improve the architecture for international major navigable river. Thus many parts
integration with rich ones and to which financial integration. of the world are not participating in
Addressing the Risks of Globalization
A recent poll of 20,000 people in 20 countries-including danger that the rules will favor the strong-for example,
developing countries such as Brazil, China, India, and Nige- rich and poor countries have different interests when it comes
ria-found that by a margin of two to one people thought that to intellectual property rights and global warming. Poor coun-
globalization would materially benefit their families. But more tries want to keep some knowledge as a public good, while
than half of those polled are convinced that globalization rich countries want to turn it into a private good to reward
threatens their country's unique culture. innovation. Poor countries will suffer the most from global
warming, while rich countries are generating most of the
As societies integrate culturally, in many ways they be- carbon dioxide that is causing the problem. In bargain-
come more diverse: IKEA has brought Swedish design to ing to achieve fair rules on such issues, poor countries
Russians, coexisting with Russian design. Indian immi- are handicapped by their poverty and fragmentation.
grants and McDonalds have brought chicken tikka and ham-
burgers to the United Kingdom, coexisting with fish and Still, despite widespread fears, there is no evidence that
chips. But without policies to foster local and other cultural environmental standards are falling. In fact, a recent study
traditions, globalization may lead to dominance by U.S. of air quality in major industrial centers of the new
culture. globalizers found that air quality has improved signifi-
cantly in all of them. Increased integration can help in
Globalization will usually weaken monopolies. As coun- this regard-for example, communities can exchange
tries open their markets, national monopoly producers face successful strategies for controlling pollution. As with
competition from foreign firms. But occasionally one firm core labor standards, some groups in rich countries are
will get a large enough global technological advantage that proposing that environmental regulations be policed
it acquires a temporary global monopoly. More commonly, through World Trade Organization sanctions. But such
oligopolies exert global market power. Such cases pose sanctions would risk being hijacked by protectionist lob-
severe challenges to national antitrust regulators. bies in rich countries, restricting the opportunities of poor
ones.
As global trade becomes more firmly based on a legal frame-
work, the power of developing countries could increase: This box is drawn from recent World Bank research on
the weak need rules more than the strong. But there is a globalization (http.//www.worldbank.org/research/growth).
f TRANSI[iIlON, July-August-September2001 The World Bank/The William Davidson Institute C/ 2001
globalization. Some countries have been climate, development assistance to ad- think twice about restricting trade. Doing
handicapped by unfavorable geography, dress education and health problems, so would impose further hardships on poor
such as being landlocked and prone to and migration to more favorable locations. people in developing countries. Important
disease. Others have suffered from weak environmental and social issues need to
policies, institutions, and governance (in- Finally, much of the controversy about be addressed, but not by restricting trad-
cluding unstable property rights and rule global economic integration has to do ing opportunities of poor countries.
of law). Still others have been hurt by with its effects on politics, culture, soci-
civil wars. Reducing poverty in these lo- ety, and the environment. Thus poverty is Paul Collier is director and David Dollar
cations will require a combination of just one issue-but it is an important one. is research manager of the Development
policy reforms to improve the investment Anyone concerned about poverty should Research Group, World Bank.
Globalization and Migration
During the 1870-1910wave of globalization, 60 million people Combining OECD capital and technology with developing
migrated from Europe-primarily from less developed re- country labor has the potential to generate mutual eco-
gions-to the United States and other parts of the new world. nomic benefits. Some of those benefits can come through
These flows were a powerful force for wage convergence. the flow of capital and production to developing countries.
Emigration is estimated to have raised Irish wages by 32 But geographic factors make it unlikely that capital flows
percent, Italian by 28 percent, and Norwegian by 10 per- and trade will eliminate the economic rationale for migra-
cent. Meanwhile, immigration lowered Argentine wages by tion. Too many parts of the developing world have poor
22 percent, Australian by 15 percent, Canadian by 16 per- institutions and weak infrastructure that will not attract
cent, and U.S. by 8 percent. Labor flows between develop- production. Moreover, some production networks in indus-
ing countries were also extensive in the early periods of trial countries are too deeply rooted to move. Institutional
globalization, though they are less well documented. About and policy reforms and infrastructure investments in lag-
10 percent of the world's population moved permanently to a ging developing countries could address the first concern
new country, and even more migrated from rural to urban and reduce-though not eliminate-economic pressures
areas within countries. for migration.
The same forces operate today. A study following individual, The experiences of Mexico and the United States illus-
legal migrants from Mexico to the United States found that trate how migration can benefit both economies. About 7
on average they left jobs paying $31 a week and on arrival in million Mexican citizens live legally in the United States,
the United States could immediately earn $278 a week- along with another 3 million undocumented Mexican work-
nine times as much. Similarly, Indonesian workers earn 28 ers. These workers represent about 10 percent of Mexico's
cents a day at home, compared with $2 a day or more in population and an even larger share of its labor force. Their
neighboring Malaysia. Thus there are huge real gains to work in the United States takes pressure off Mexico's
workers who migrate to more developed economies. labor market (raising wages there) and generates a sig-
nificant flow of remittances to relatives back home. In the
Although there are strong economic pressures for migration, United States this labor inflow was a key factor in the
legal migration is highly restricted. Thus when it comes to labor sustained growth with low inflation of the 1990s. Still, mi-
flows, today's world is much less globalized than it was a hun- gration is estimated to have reduced the relative wages of
dred years ago. Only about 2 percent of the world's population unskilled U.S. workers by 5 percent-highlighting again
consists of migrants living in countries not of their citizenship. that globalization typically produces winners and losers.
At the same time, pressures for migration are mounting. The
labor force in OECD countries is aging, while the labor force in OECD countries not only tend to be highly restrictive about
the developing world is surging because of high birth rates. migration, they also tend to discriminate in favor of edu-
Each year 83 million people are added to the world's popula- cated workers (causing a "brain drain" from developing
tion-82 million of them in developing countries. Without more countries). Labor flows would do more to reduce poverty
migration, the ratio of workers to retirees in Japan and the Eu- in developing countries if immigration policies in indus-
ropean Union will fall from five to one today to three to one in trial countries were more neutral and allowed more un-
2015, straining social security systems. skilled workers to immigrate.
(O 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 l
Globalization Is No Shortcut to Development
by Dani Rodrik
"Global integration shouldn't become a substitute for a development strategy," warns Dani Rodrik, professor of international
political economy at the John F. Kennedy School of Government at Harvard University, in a recent article ("Trading in Illu-
sions," Foreign Policy, March/April 2001). In his view, by focusing on intemational integration, governments in poor nations
might divert human resources, administrative capabilities, and political capital away from more urgent development priorities
such as education, public health, industrial capacity, and social cohesion.
ismantling barriers to trade and to adopt them. But setting institutional tion for girls? When it comes to legal
D investment will not solve the priorities to maximize integration with reform, should governments focus on
challenges of development. In- the global economy has real opportu- importing legal codes and standards or
tegrating countries must also comply nity costs. World Bank trade econo- on improving domestic legal institu-
with a long list of admission require- mist Michael Finger estimates that a tions? In public health, should govern-
ments, including new patent rules and typical developing country must spend ments promote the reverse engineering
more rigorous banking standards. Suc- $150 million to implement require- of patented basic medicines and the
cessful trade liberalization should involve ments under just three WTO agree- importation of low-cost generic drugs
tax reform to make up for lost tariff rev- ments-those on customs valuation, from unauthorized suppliers-even if
enues, social safety nets to compensate sanitary and phytosanitary measures, doing so means violating WTO rules
displaced workers, administrative reform and trade-related intellectual property against such practices? (Consider
to bring trade practices into compliance rights. As Finger notes, this sum Brazil's recent confrontation with Roche,
with World Trade Organization (WTO) equalsayear'sdevelopmentbudgetfor the Swiss pharmaceutical company,
rules, labor market reform to enhance many of the world's least developed over distributing a generic version of a
worker mobility across industries, tech- countries. patented AIDS drug.) How should gov-
nological assistance to upgrade firms ernments choose their exchange rate
hurt by competition from imports, and Should governments in developing coun- regimes? Since the early 1960s nearly
training programs to ensure that export- tries train more bank auditors and ac- every growth boom in the developing
oriented firms and investors have access countants, even if those investments world has been accompanied by a con-
to skilled workers. mean fewer secondary school teachers trolled depreciation of the domestic cur-
or reduced spending on primary educa- rency. Yet financial openness makes it
The Group of Seven industrial countries
(G-7) has established international
codes and standards for fiscal transpar- EVl NTUAL,. Two WILL
ency, monetary and financial policy, vN I ONEw% N ONLY ONE. _
bank supervision, data dissemination, . i
corporate governance, and accounting.
The Financial Stability Forum, a G-7
organization, considers 12 of these
standards essential for creating sound -
financial systems in developing coun-
tries. Another 59 standards are consid-
ered relevant for sound financial ,GIVENIAT AINT
systems. The prescribed comprehen- L LPiU BE LYIg N Z_iO
sive institutional reforms took industrial A N,i
countries generations to accomplish.
Most of the institutional reforms on the
integration agenda are perfectly sensible,
and in a world without financial, admin-
istrative, or political constraints there ...........
would be little argument about the need From Montreal Canada, Aislin The Gazette
T RANNSI inON. July-August-September 200I The World Bank/The William Davidson Institute (D 2001
all but impossible to manage the ex- aged to eke growth out of existing in- long-term economic growth have usu-
change rate. stitutions, imperfect as they may have ally combined the opportunities offered
been. (China followed a highly unortho- by world markets with a growth strat-
World markets are a source of tech- dox two-track strategy, violating almost egy that mobilizes the capabilities of
nology and capital; it would be silly for every rule in the guidebook-including, domestic institutions and investors.
the developing world not to exploit such most notably, the requirement of pri- Public enterprises during the Meiji res-
opportunities. But globalization is not vate property rights.) toration in Japan, township and village
a shortcut to development. Success- enterprises in China, an export pro-
ful strategies for economic growth re- Asia's experience highlights a deeper cessing zone in Mauritius, extensive
quire a judicious blend of imported point. A sound overall development credit subsidies in the Republic of Ko-
practices and domestic institutional in- strategy that produces high economic rea, infant industry protection in Brazil
novations. Policymakers should forge growth is far more effective in achiev- in the 1960s and 1970s-these are
a domestic growth strategy by relying ing integration with the world economy among the innovations that have been
on domestic investors and institutions. than a purely integrationist strategy instrumental in kick-starting invest-
that relies on openness to work its ment and growth in the past. Few of
The fastest-growing countries-China, magic. A relatively protected economy these experiments have worked as
India, and others in East and South- like Vietnam is integrating with the well when transplanted to other set-
east Asia-have liberalized trade and world economy much more rapidly than tings, underscoring the decisive impor-
investment. But they have done so in an open economy like Haiti because tance of local conditions. To be
an unorthodox manner-gradually, se- Vietnam, unlike Haiti, has a reason- effective, development strategies need
quentially, and only after an initial pe- ably functional economy and polity. to be tailored to domestic institutional
riod of high growth-and as part of a strengths. There is simply no alterna-
broader policy package with many un- Policymakers need to know which tive to a homegrown business plan.
conventional features. Significant im- strategies will produce the desired re-
port liberalization did not occur until a suits and whether the prescriptions of The author is professor of economics
transition was made to high economic the current orthodoxy are up to the and international affairs at Columbia
growth. And all these countries man- task. Countries that have achieved University.
Measuring Globalization
According to a recent study by A.T. Kearney Consulting (pub- share of international trade (exports and imports of goods
lished in Foreign Policy, January/February 2001), Singapore and services) in GDP, as well as the convergence of do-
is the world's most global country, leading a group of na- mestic and world prices.
tions that have become integrated through cross-border flows * Financial globalization is measured by income payments
of goods, services, capital, people, and communications. and receipts, inflows and outflows of foreign direct invest-
These countries display more equitable patterns of income ment, and inflows and outflows of portfolio capital, all mea-
distribution and lower levels of corruption than countries that sured as a share of GDP.
are less global. The study also found that the sharp rise in * Globalization of personal contact is measured by inter-
Intemet access among advanced economies more than off- national tourists and travelers as a share of population, min-
set the slow growth in traditional economic measures of in- utes of incoming and outgoing international telephone calls
tegration, such as cross-border trade. This situation has per capita, and transfer payments and receipts as a share
produced a growing "globalization gap" between industrial of GDP.
and developing nations, because overall integration levels * Internet connectivity is measured by the number of Internet
among emerging markets have barely increased. users, the number of Internet hosts, and the number of se-
cure servers, all measured on a per capita basis.
The globalization index is based on data from 50 industrial
countries and key emerging markets representing nearly 80 According to the index, the 20 most global countries (in de-
percent of the world's population and more than 95 percent scending order) are Singapore, the Netherlands, Sweden,
of global economic output. The index encompasses the fol- Switzerland, Finland, Ireland, Austria, the United Kingdom,
lowing key indicators of global integration: Norway, Canada, Denmark, the United States, Italy, Germany,
* Globalization in goods and services is measured by the Portugal, France, Hungary, Spain, Israel, and Malaysia.
© 2001 The World BanklThe William Davidson Institute TRANSITION, July-August-September 2001 *
WTO Accession Will Accelerate Reforms in China
An Action Plan to Address the Most Pressing Issues
by Chi Fulin
C hina's accession to the World as well as the new opportunities for the infrastructure and public utilities.
Trade Organization (WTO) will country. Though infrastructure management has
accelerate its market-oriented changed tremendously in recent years,
reforms, integrating it with the interna- *Improving the efficiency and trans- the state still holds a monopoly in sec-
tional trade system. Initially, China was parency of the public administration tors such as telecommunications, civil
to complete the transformation of its will also strengthen law enforcement. aviation, railways, and power. In its Tenth
economic system by 2010. Now, to com- The central government is required to Five-Year Plan the government pledged
pete effectively in global markets, China guarantee uniform countrywide imple- to reform the management of these in-
must shorten that transition period to mentation of WTO regulations on intel- dustries along with related government
three to five years. Reforms will focus lectual property rights and foreign trade departments, to introduce competition
on transforming state-owned enter- and investment. Regulations must be andstreamlineadministrativeprocesses.
prises, redressing the ownership struc- made accessible to the public. Institu- These moves should be made accord-
ture, improving the financial system, tions responsible for implementation ing to the principle of separating govern-
modernizing the tax regime, and stream- must guarantee faithful enforcement of ment from enterprises so that the
lining public administration. China will these laws and policies. relationship between government, enter-
also further open its markets. The pres- prises, and the market truly meets the
ence of foreign enterprises-especially *Strengthening corporate gover- requirements of a socialist market
in services-will bring major changes, nancebyacceleratingthetransforma- economy. Direct state ownership should
such as competition for state enterprises tion of state-owned enterprises be replaced by effective regulations, as
that until now have held a monopoly po- (SOEs) to joint stock companies. The in mature market economies.
sition. The main areas of reform are de- state's shareholding in many enter-
scribed below. prises should be reduced to a reason- Monopolies waste resources, constrain
able level, a move facilitated by earlier efficiency, inhibit innovation, and place
Governance, Transparency, and the successes of state enterprise restruc- a heavy burden on consumers. Thus
Private Sector turing through the introduction of the establishing an environment that stimu-
shareholding system. Private enter- lates fair competition is of utmost im-
- Moving ahead with public adminis- prises should ensure modern corporate portance. Institutional barriers that
tration reform. Bureaucratic intervention governance by striking a proper balance prevent private enterprises from compet-
in solving disputes between businesses among boards of directors, supervisory ing as equals should be eliminated. As
should give way-in line with WTO regu- boards, and general managers. envisaged, the laws and regulations gov-
lations-to the rule of law, including ar- erning telecommunications, civil aviation,
bitration courts. Market prices, taxes, *Supporting the development of railways, and power will soon be modi-
and exchange rates will connect China nonstate enterprises. Reforms should fied and clarified to provide nondiscrimi-
with global markets. The government's fundamentally improve the environment natory market access to nonstate
approach will be more service-oriented. in which private enterprises operate, domestic and foreign companies involved
treating them as equals in areas such in infrastructure and public utilities.
* Increasing transparency to enhance as financing-through market access,
public understanding of and support property rights, and subsidized loans or Commercial Banks, Bad Debts, and
for reform. The public should be kept the establishment of an investment in- the Financial Sector
informed about China's commitments to surance fund.
the international community and the ex- *Transforming state-owned commer-
pected reforms, to help them prepare for Infrastructure and Public Utilities cial banks to joint stock ownership
the consequences of the WTO acces- while spinning off their bad assets that
sion. People should be informed of both *Separating the government from accumulated from the debt of state en-
the obligations and the rights involved, enterprises is the key to reform for terprises. Instead of receiving state sup-
* TRANSITION, July-August-September 2001 The World Bank/The William Davidson Institute © 2001
port, banks should raise money in capi- Changcheng, Dongfang, and Xinda- company should be set up by the cen-
tal markets. But before this transforma- were created to deal with the bad loans tral and local governments to operate,
tion occurs, their huge stock of bad debts of state-owned commercial banks. But manage, and dissolve bad assets. This
should be resolved. In 1999 four asset more radical methods are needed: tem- company would oversee the four asset
management companies-Huarong, porarily, so an authoritative debt trust management companies, which could
China's Local Trade Barriers: A Hard Nut to Crack
"Building a unified, fair, and regulated market is important for our investment environment and stop investing in China,"
[China's] entry into the World Trade Organization," said Shi pointed out a recent report by the State Planning Commis-
Liwen, chairman of China's biggest construction company, sion. "This will further undermine the attempts by domestic
Shanghai Construction Group, in a recent interview with Bruce makers to attract investment and advanced technology."
Gilley of the Wall Street Joumal. Shi complained at the March
2001 annual meeting of the National People's Congress that Double-digit export growth, economists say, partly reflects
his company often found it impossible to operate outside the inability to sell domestically, just as China's absorption
Shanghai because of local protectionism. He told the meet- of huge foreign investment partly reflects the diversion of
ing, "We have to break down sector monopolies, break much of the country's savings into inefficient state enter-
through departmental blockades, and get rid of local protec- prises. Interprovincial trade has fallen from 37 percent of
tionism." national retail trade in 1985 to about 25 percent today. De-
spite a huge expansion of national highways, ports, and air
China contains 1.3 billion people in 27 provinces and 4 vast cargo facilities, the average distance traveled by a freight
province-level cities. And as Gilley points out in his article, shipment fell to 310 kilometers in 2000 from 395 kilometers
internal trade barriers are extensive. Henan and Anhui prov- in 1978.
inces, for example, ban imports of tobacco products from
Guizhou, while a bottle of Beijing's Yanjing beer that costs The State Planning Commission has suggested revamping
the equivalent of 18 cents in the capital costs $1 in Sichuan the fiscal system so that local officials do not collect tax
province because of provincial fees and taxes. Internal trade payments directly from local state enterprises. This move
of agricultural products like grain, flour, and soybeans is would weaken incentives to protect firms, though the firms'
impeded, while the marketing of bottled water and medicine provision of jobs and social services would remain a key
is heavily restricted by local standards. local concern. Another idea is to stop linking the promotion
of local cadres to the economic growth of their localities.
Small provincial banks are impeded from opening branches That move would reduce incentives for cadres to rely on
outside their home regions in order to shield the four main market barriers to boost local output. "Local authorities are
state banks from competition. Companies can hardly open obsessed with local GDP growth rates-the leading criteria
subsidiaries or buy other companies outside their home for evaluating cadre performance-and so make full use of
bases. Interprovincial investment is also deterred by the ju- their administrative powers to assist local enterprises," says
diciary: local courts usually rule in favor of local companies. Lin Jiabin of the Development Research Council, the cabinet's
"Local courts have become the courts of localities. They think tank.
protect local interests," said Xiao Yang, China's top judge,
in a 2000 speech. While those ideas remain on the drawing board, the central
government has made more general efforts to reduce local
These local barriers blocking the free flow of goods and capi- government control over economic activities. State enterprise
tal result in higher prices, less efficient investment, and ex- privatization, regulatory streamlining, and the creation of au-
cess capacity in many sectors. Nearly every province has a tonomous economic bodies-handling things like technical
maker of washing machines, color televisions, and refrigera- standards and stock exchange listings-are meant to limit
tors. China also has 120 car manufacturers-most of them local governments' ability to meddle in the economy. Legal
surviving on various forms of local protection. The central reforms could also play a role. One change proposed by
government wants to cut the number to half a dozen, but 22 legal scholars is the passage of an interstate commerce
provinces and cities have declared the sector to be a core clause like that in the U.S. Constitution. That clause allows
industry for the coming decade. "If we don't overcome local the federal government to override state attempts to erect
protectionism, the world's large car-makers will lose faith in protectionist barriers.
©) 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 m
raise capital from the public. State- At the same time, prices should be ing a competitive, dynamic environ-
owned commercial banks would then further deregulated to allow farmers to ment for promoting talented manag-
be able to sell bad debt to these asset adjust their product mix to market de- ers. The emergence of a knowledge
management companies, which would mand. Large nonstate companies economy in the United States is linked
be granted broad scope-strictly su- should be allowed to compete in the with the spread of the concept of hu-
pervised-over business activities. foreign trade of agricultural products. man capital in economics-a concept
Reforming the distribution of agricul- which recognizes that knowledge and
*Accelerating the development of tural products will eliminate regional skills are more important than mate-
nonstate financial institutions.Thefi- monopolies and lower costs. This rial and financial capital. Performance
nancial sector has always been a state move assumes the establishment of an can be linked to compensation not only
monopoly. China's prospective WTO agricultural information system provid- through salaries and bonuses but also
membership has increased pressure for ing data on distribution, transportation, through stock options. In China egali-
developing private financial institutions, storage facilities, bidding, and market- tarianism in the income distribution
which would promote competition and ing. With wholesale markets playing a system should be reformed to give
make domestic banks more competi- leading role, agricultural production can priority to efficiency without sacrific-
tive with foreign financial institutions. once again surge. ing equity. Innovative technical and
Accordingly, laws regulating commer- research staff and well-performing
cial banks and insurance companies *Introducing rural land reform and a managers can be strongly encouraged
should be updated to permit state- market for land use rights. Frag- by stock options. In general, stock
owned and private enterprises to oper- mented farming operations have pre- ownership by employees can promote
ate in the financial sector and establish vented the application of advanced corporate unity. At the same time, a
banks, insurance companies, and in- production technologies, the improve- sound social security system should
vestment funds. ment of product quality, and the estab- be set up to ensure the basic liveli-
lishment of modern farming organization. hoods of unemployed and low-income
-Strengthening the management and Chinese producers are not competitive workers.
supervision of banks, investment with large-scale farms in industrial
companies, and securities markets by countries; thus renewing the rural land *Reforming the residential registra-
enacting new laws in accordance with system is imperative. Farmers' long- tion system, which restricts the move-
international standards. In this way fi- term land use rights should be made ment of rural residents into cities. A
nancial institutions' market access, transferable and should be allowed to new, more flexible residential registra-
asset evaluations, reserve require- be used as mortgage or investment. tion system should be created, dis-
ments, internal controls, and informa- Long-term land use rights are a pre- mantling the segmentation between
tion disclosure can be regulated. But condition for capitalization, which will rural and urban administration. An in-
China should exercise caution, open- enable farmers to purchase rural land tegrated labor market should be estab-
ing its financial market step by step to and get involved in larger-scale farm- lished by connecting local labor
foreign investors to protect itself from ing. Better land use rights will also ac- markets, thereby ensuring the market-
destabilizing speculation. celerate agricultural modernization. The driven allocation of human resources.
government should help develop the
Agriculture and Rural Development market for rural land use rights, speci- Chi Fulin is executive director of the
fying rules for market access and trans- Haikou-based China Institute for Re-
oLiberalizing trade of farm products. actions processes as well as stipulating form and Development, 57 Renmin
Although prices have been liberalized the contract rights and obligations of Ave., Haikou. Hainan, 570208, China.
for most agricultural products, the state sellers and buyers. Farmers' land use Tel.: 86-898-625-8793, fax: 86-898-625-
still dominates the purchase, sale, and rights should be guaranteed by law. 8777, email: cird2@public.hk.hi.cn.
import and export of staple agricultural
products such as foodstuffs, cotton, Human Resources
and vegetable oil. This setup places a
heavy burden on public finances and *Reforming the mechanism for hu-
is hindering WTO accession. Thus man resource selection. The rigid tra-
trade in foodstuffs, cotton, and veg- ditional practice of leaders selecting
etable oil should be diversified, allow- managers from a narrow circle of can-
ing the entry of nonstate companies. didates should be changed by creat-
TitANSIIION, July-August-September 2001 The World Bank/The William Davidson Institute © 2001
Discussion Forum
Ten Years That Have Shaken Russia-Conflicting Assessments of the
Results
To commemorate the 10th anniversary of the misfired Moscow coup that buried the Soviet Union, a series of studies have
analyzed Russia's economic and social progress over the past decade. Here we offer two very different views. The first is from
Anders Aslund, the well-known Swedish scholar who has long been an adviser to the Russian govemment. The second is
from the equally distinguished Peter Reddaway, a professor of political science at the George Washington University. We also
provide a snapshot of the current state of the Russian economy
Think Again-Some Common Misconceptions about Russia
by Anders Aslund
"The Russian Economy Has Col- incomplete reforms. Russia's level of forms,suchasprivatizationandprice
lapsed"-according to official Rus- economic development remains where liberalization, that were launched too
sian statistics, gross domestic product it was during the Soviet era, roughly on fast and too soon.
(GDP) plummeted 44 percent between par with Brazil's.
1989 and 1998. The economic mayhem that preceded
Moreover, Russia has not developed a the collapse of the Soviet Union-the
But this figure is grossly exaggerated. new "virtual economy" based on barter legacy of years of gradual, inadequate
Under communism everyone padded rather than money. The share of barter reforms-left former President Boris
output to reach the targets of the planned transactions in Russian industry peaked Yeltsin with few choices but to move.
economy, but no one cared about the at 54 percent in August 1998, but the
quality or even the usefulness of the financial crash curtailed this system of Russia toward a market economy. But
items produced. For instance, the So- hidden subsidies that had been the norm this situation was not unique to Russia,
viet Union manufactured more than six for Russian enterprises. Nonmonetary which is why more than 20 other former
times as many tractors as the United transactions fell like a stone once Rus- communist countries also pursued mar-
States, yet its agricultural output lagged sian industry realized that it could no ket reforms. The most successful of
far behind because production was so longer depend on the state and would these countries, with high growth and
wasteful. Much of Soviet manufacturing have to earn real money in the market- contained corruption (notably Estonia
was unfit for consumption, so Russians place. Today the virtual economy is mar- and Poland), undertook far more radical
flocked to the imported goods that ginal. reforms. Nearly all of Russia's current
flooded the market following the liberal- problems-widespread corruption, ex-
ization of foreign trade. Thus the subse- According to the latest official data, Rus- cessive state intervention, high tax rates,
quent decline in the production of useless sia achieved GDP growth of 5.4 percent lingering inflation, limited rule of law-
goods and unneeded inputs was not a in 1999 and 8.3 percent in 2000-and reflect insufficient reform efforts.
tragedy but a desirable change. At least growth continues today. While many sys-
one-fifth of Soviet output fell into one of temic problems remain, Russia appears Russia has experienced rapid economic
these categories, and the estimated to have attained a critical mass of mar- growth and considerable structural im-
GDP of the Soviet era should be reduced ket reforms and privatization. (Several provements in the wake of the financial
accordingly. other countries in the region, such as crash that shook the world in August
Kazakhstan, have made similar achieve- 1998. That crisis reduced the wealth and
After communism the statistical mea- ments and are also booming.) Consid- political power of two of Russia's most
sure of output shrank far more than its ering the enormous distortions left behind corrupt groups: oligarchic tycoons and
actual level. The underground economy by communism, that is a splendid feat. regional governors. More surprisingly, the
accounts for at least one-quarter of this crash convinced both the communists
purported contraction. Thus the Russian "Shock Therapy Was a Failure"- and the general public that there was no
economy has not collapsed. Rather, until Russia's economic and social troubles alternative to a real market economy.
1998 it stagnated because of sluggish, are the result of radical economic re- Until fairly recently Russia's real prob-
D 2001 The World Bank/The William Davidson Institute TRANSIIION, July-August-September 2001 m
lem was too little shock and too much Russia. As a result Ukraine's privatization The obvious solution to these problems
corrupt state therapy in the form of sub- has been worse than Russia's, with more was a low, flat tax rate. Earlier this year
sidies to the country's elite. ownership going to managers and em- Russia introduced a flat income tax of
ployees and less being sold on open just 13 percent (a rate that the United
"Privatization Has Generated Only Cor- markets. Ukraine's corporate governance States and Western Europe could only
ruption" also remains far worse than Russia's, dream about). Income tax revenues in-
where nearly 800 enterprises actually stantly jumped 70 percent as people
Instead of saying that privatization has paid dividends to their shareholders in abandoned expensive schemes for
generated corruption, it would be more 2000. avoiding taxes.
accurate to say that it has generated
national wealth. Since 1997 Russia's "Russia Cannot Collect Taxes" "Russia's Infrastructure Is Falling
private sector has accounted for 70 per- Apart"
cent of GDP. This allegation is based on sheer
disinformation. Russia collects one- Think again. Dramatic news stories, such
Corruption is usually defined as the third of its official GDP in general gov- as the tragic sinking of the submarine
misuseofpublicpowerforprivategain. ernment revenues-slightly more than Kursk and the fire that engulfed the
But privatization permanently deprives the United States, whose citizens com- Ostankino television tower in Moscow,
public servants of public property, so plain that taxes are too high. Not only have created the impression that Russia
they can no longer charge money for has Russian tax collection been high, is coming apart at the seams. In fact,
the privilege of using it. The bribery that it has also been very stable. Russia has seen extraordinary improve-
plagues Russia today is not related to ments in its infrastructure. Investment in
privatization. Rather, it is overwhelm- The misperception about Russian taxa- fixed assets (buildings, equipment) in-
ingly tied to law enforcement, tax col- tion is the result of superficial observa- creased 18 percent in 2000, reaching a
lection, and state intervention. tions. Most outsiders tend to focus on healthy 20 percent of GDP (higher than
federal revenues. But those represent the standard U.S. ratio of 16 percent).
In general, the higher is the level of only a part of total revenues, which also Admittedly, the Soviet Union had invest-
privatization that a former communist include regional and local tax revenues ment of about 30 percent of GDP, but that
country has attained, the higher is the as well as several extrabudgetary funds, was an indication of waste. The Soviet
economic growth that it has achieved. notably the pension fund. Another Unionwasnotoriousin itsneglectofinfra-
Russia is atypical in having been more source of confusion is that many ob- structure and maintenance. Today
successful with privatization than with servers, including some Russians, take privatization and market pricing have re-
other market reforms, such as price lib- for granted that Russia should have state vived much of Russia's infrastructure. Mar-
eralization. As a result people tend to revenues as high as Western Europe ket competition has fostered incredible
blame privatization for Russia's shortcom- or the former Soviet Union, ignoring that expansion in telecommunications. Airports
ings, while it would be more logical to such taxation harmed growth in both and airlines have similarly improved. Road
complain aboutthe dearth of otherreforms. places. For Russia a more plausible tax construction is up. New ports have been
Russian enterprises are hounded by rate, in line with its level of economic built around St. Petersburg. Whereas ru-
scores of state inspectorates that regu- development, would be 15-25 percent of ins once blighted the landscape of even
larly extort money from businesspeople. GDP. Moscow, modern-day Russia has initiated
a widespread building boom.
Strangely, the standard comparison is The real problem is not that Russia can-
between privatization in Russia and in not collect taxes, but that the govern- Maintenance problems persist, however,
Poland, with the allegation that Poland ment collects too much. These revenues where state monopolies linger-notably
privatized more slowly. In fact, Poland are spent improperly and aggravate cor- in the natural gas monopoly Gazprom,
started off with a bigger private sectorthan ruption. According to the World Bank, the state-owned oil pipeline monopoly,
did Russia. But Poland undertook more at least 16 percent of Russia's GDP went and some public utilities.
reforms in nearly all spheres-suggesting to enterprise subsidies in 1998. (Small
that, had Russia not privatized so fast, it wonder that state finances crashed.) "Russia Suffers from a Terminal
probablywould have been in the doldrums. Furthermore, tax collection is ruthless. Health Crisis"
The lawlessness of tax inspectors has
Ukraine has implemented most reforms, emerged as one of the most serious Granted, recent health statistics from
including privatization, more slowly than concerns of the post-Soviet era. Russia are shocking. Malie expect-
0 TRANSITION, July-August-September 2001 The World Bank/The William Davidson Institute >21
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cO 2001 The World Bank:'The William Davidson Institute TRANSITION, July-August-Sertember 2001
Kazakhstan Struggles with Migration Issues
by Akhas Tazhutov
A lthough Kazakhstan is the second largest country in are faced with the problems of overpopulation and a shortage of
the Commonwealth of Independent States and the ninth natural resources), which tends to increase progressively. The
largest in the world, its population has never exceeded sooner that policymakers and decisionmakers become aware of
18 million. At the same time, for the past century the country the situation and take appropriate measures, the sooner the
has been the scene of intensive migration movements. During country will be able to avoid the adverse consequences.
the first half of the 20th century waves of immigrants swept
into Kazakhstan. As a result the country's population, which Akhas Tazhutov is program coordinator, SOROS Foundation,
totaled 5 million at the turn of the century, increased to more Kazakhstan. His email address is atazhutov@soros.kz.
than 15 million in the 1960s (despite the loss in the early
1930s of almost half the indigenous population, which formed
an overwhelming majority at that time). LGI/OSI Publications
Later, migration out of the republic began to gain momentum. Emilia Kandeva, editor, Stabilization of Local Governments:
The nonindigenous, mainly European, population started to Local Governments in Central and Eastern Europe, vol-
leave. In the 1970s the country's leaders tried to halt the pro- ume 2. LGI Books, OSI Local Government and Public Service
cess, and granted travel allowances and other benefits to at- Reform Initiative, Budapest, 2001, 472 pp.
tract immigrants from other republics. These measures helped
stabilize migration. But with the disintegration of the Soviet This publication is part of an LGI Books series on local govem-
Union, the migration outflow from Kazakhstan accelerated. In ment systems in Central and Eastern Europe. This volume fo-
the first three years of Kazakhstan's independent statehood, cuses on eight countries in Southeastem Europe: Albania, Bosnia
1 .13 million people left the country while only 343,000 arrived. and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Moldova,
Over the past 10 years the population dropped by nearly 3.0 Romania, and FR Yugoslavia. The country chapters summarize
million, including 2.7 million Europeans (mainly Russians), local government structures and operations, and evaluate major
mainly because of mass emigration. Apparently the authori- development trends over the past decade. The country studies are
ties believed that the emigration of the nonindigenous popula- complemented with tables and figures in a comparable format.
tion would be compensated for by a natural increase in the
Kazakh population and repatriation of Kazakhs from abroad Each country chapter follows a similar pattern, but with a
without harming the general demographic situation. strong emphasis on country-specific characteristics. The main
sections of the country studies are:
But these expectations were never realized. In parallel with mass * Structure of local governments
emigration, a sharp decrease in the birth rate and a rapid in- * Local politics and decisionmaking
crease in the death rate now threaten to reach a critical "demo- * Relationship between state and local governments
graphic cross" situation, with subsequent depopulation. The inflow * Public participation
of Kazakh immigrants from abroad can hardly be compared with * Local service provision
the outflow of emigrants (180,000 compared with 2.5 million). * Local finances
Among European emigrants, 63 percent have been of working * Next steps and recommendations for reforms.
age, and only 13 percent have been retirees. So, the country's
creative labor potential suffered enormous losses. The book is recommended for policymakers in the region,
consultants working on local government issues in these coun-
The returnees, on the other hand, not only experience the imper- tries, and academic researchers, who may find timely infor-
fections of local legislation, bureaucracy, and corruption but also mation on Southeastern Europe. If you are interested in getting
face psychological alienation from both native "fellow" Kazakhs a copy of the book (free of charge for residents of Central and
and other "naturalized" Kazakhstanis. Action is needed to pre- Eastern Europe), please send the order form (available at http:l
vent the possibility of violent ethnic, religious, and social con- /Igi.osi.hu/index.html) to LGI.
flicts with unpredictable consequences.
Email: lgprog@osi.hu (subject line: "Volume I. order").
Kazakhstan is already experiencing migration pressure from the Mailing address: OSI LGI, H-1357 Budapest, POB 519, H-
outside (chiefly from its southern and eastern neighbors, which 1397 Budapest, Hungary.
E TRANSITION, July-August-September 2001 The World Bank/The William Davidson Institute C 2001
How Can Ukraine's Government Be Made More
Effective?
by Alex Sundakov
There is a general consensus among the Ukrainian government and foreign donors that the existing machinery of government is
not capable of designing and implementing the policies needed to achieve the govemment's objectives. Recent administrative
reforms have generated some improvements, but the government still lacks effective levers to achieve the transition of the
Ukrainian economy and society. Moreover, there is increasing concem that administrative reforms to date have not focused on
key priorities and have failed to address underlying problems. This is despite considerable donor involvement in the process.
All government agencies in Ukraine now function under three * Policy implementation is still dominated by legalistic de-
key influences: cisions; there is no built-in method for civil servants to learn
from mistakes and from each other; and time pressure in-
* Leftover Soviet elements, including the definition of the hibits wider use of experiments and pilot projects.
function of government, lack of initiative, day-to-day work
habits, and hierarchical relationships. * Advanced control mechanisms are missing from the pub-
lic administration, which does not support diagnosis for fu-
* Elements of spontaneous adaptation-the kind of change ture strategy design. Instead of planning activities, government
that occurs without deliberate design, forced by changes in units formulate unrealistic "concepts" and political state-
external circumstances. For example, whether they like it ments.
or not, government agencies have had to adapt to the exist-
ence of independent businesses and mass media. The Ideal Government
* Finally, change that has been driven by deliberate policy What would be the main characteristics of a government
action within the context of intentional administrative reform. machine that can deliver to a democratic, market-oriented
society?
In effect, old methods and practices have been superimposed
on the new economic structure, creating a situation where * It would be able to deal with legitimate conflicts of interest
the best intentions and efforts of political leaders and public consistently and predictably. Such conflicts would be re-
officials translate into substandard performance. The prob- solved based on well-understood policy, rather than at the
lem, by and large, is not with the individuals, but with the whim of an individual official.
poor fit between institutional arrangements and social needs.
* It would set the rules of the game but would not play the game
Obstacles to Policymaking itself. In particular, the machinery of government would not tilt the
playing field in favor of interests associated with officials.
Five factors hamper policy formulation and implementation:
* It would be under constant scrutiny, and would consult
* The government cannot prioritize among strategic issues and incorporate the views of the civil society.
and is unable to cut through organizational structures and
allocate reform responsibilities to specific ministers. In operational terms, these broad principles need to be trans-
lated into specific organizational and managerial features of
* Decisionmaking lacks open public consultation; govern- public agencies. In essence, transformation of the system
ment committees follow bureaucratic structures, which cre- of public administration will be complete once agencies are
ates tension between political advisers to the prime minister under fiscal control, are held accountable, and are profes-
and government civil servants. sional, transparent, and reliable (predictable).
* The delegation of responsibilities within the government The key acts of deliberate policy appear to be:
gives too much decisionmaking power to ministers, who at * Reducing the number of ministries.
the same time have very little control over policy formula- * Creating new agencies, such as an Antimonopoly Commit-
tion. tee, that are explicitly designed for the new policy objectives.
© 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 *
* Recent changes in decisionmaking at the Cabinet of Min- * In providing advice, donors are often reluctant to engage
isters level, which have highlighted the relative roles of politi- the civil service, and try to short-circuit the bureaucracy by
cal decisionmakers and civil servants. attaching advisers directly to politicians. But while it may be
important for foreign advisers to have the status of advisers
Donors' Responsibility to a minister (or prime minister), they will not be effective if
they stand outside the established decisionmaking process.
Donor activity plays a particularly important role in Ukraine's The bureaucracy will not go away; it will remain powerful,
reform process. This stems both from a lack of domestic and the best contribution an adviser can make is influencing
financial resources and from a lack of experienced and trained its work.
personnel. Donor advice is critical in shaping the debate.
Comparing arrangements for foreign technical assistance in * Foreign advice tends to be focused on what to do (such as
Central Europe-the countries in line for integration with the what policy to adopt) rather than on how to reach a rational
European Union-and in Ukraine reveals instructive differ- decision. Foreign advisers are paranoid about presenting
ences in approach. The key differences: Ukrainian decisionmakers with alternatives because they fear
that a "wrong" alternative will be chosen. Senior officials of-
* Central European countries had a unifying framework for ten express the view that foreign advisers are self-serving.
technical assistance-preparation for EU integration. By con- By contrast, successful examples of foreign assistance typi-
trast, it is difficult to identify a unifying principle for foreign cally involve a direct effort to improve the work of a particular
assistance in Ukraine. Donor priorities appear to be more institution, to set up a new process, or to provide advice
supply driven, and chosen according to political criteria. within an established process.
* Technical assistance projects in Central Europe appear to be * Few donor programs appear to be aimed at "teaching the
largely built around specific implementation benchmarks re- teachers." For example, many technical assistance programs
quired to transform institutions to EU standards. By contrast, involve study tours by Ukrainian officials to donor country
technical assistance to Ukraine rarely envisages implementa- institutions. But it is rare for such projects to require written
tion as the main product of a project. Rather, projects tend to reports by the returning officials, or to provide resources for
provide advice, on the expectation that the government will take follow-on seminars or the dissemination of collected mate-
care of implementation once the political will is present. rial. Most Ukrainian officials operate in extreme intellectual
isolation and have no Western peer groups. This inevitably
* Technical assistance projects in Central Europe tend to means that they fall back on Soviet habits of thought and
provide systematic access to information and personnel in action. The objective should be to integrate Ukrainian offi-
the West, integrating officials into international networks. cials with international networks of civil servants and policy
Projects in Ukraine tend to provide one-off training and spo- advisers.
radic access.
The main challenges facing Ukraine's system of public ad-
Elements of Better Assistance ministration are managerial rather than structural; there is
an urgent need to develop required skills and processes,
Some of these differences were an inevitable product of dif- while relatively little can be gained in the short term from
ferent social, economic, and political conditions in these coun- structural changes such as reallocating functions among
tries. But it is important to consider how much of the agencies. More important is improving decisionmaking, which
differences were really necessary, and how many Ukraine's should include strengthening strategic planning in order to
different approach to technical assistance may be delaying build consensus and develop collective wisdom; intensifying
its transition. public consultations to ensure appropriate feedback; and
enhancing policy management.
* In designing assistance projects, donors should take into
account how that assistance will be integrated with govern- Alex Sundakov is director of the New Zealand Institute of
ment processes, and in some cases should impose condi- Economic Research (NZIER). Email address: alexs
tions on how such processes should be changed before a @nzier.org.nz.
project can go ahead. A foreign consultant may write an ex-
cellent policy paper, but if that advice is not part of the inter- This article is based on his recent paper, "Public Sector
nal policy development process, it will be treated as a piece Reforms in Ukraine: On the Path of Transformation," LGI
of academic research and will have little effect. Discussion Paper 18, 2001.
E TRANSI1IN, July-August-September 2001 The World Bank/The William Davidson Institute C 2001
---
- - -
THE WILLIAM DAVIDSON INSTITUTE
AT THE UNIVERSITY OF MICHIGAN BUSlNESS SCHOOL
The Great Reversals: The Politics of Financial
Development in the 20th Century
by Raghuram Rajan and Luigi Zingales
A growing body of evidence indicates that the develop- create a viable financial sector. Or perhaps it has not inherited
ment of a country's financial sector greatly facilitates the right legal, cultural, or political system. In particular, the
latits growth. Why then do so many countries still have seminal work of La Porta, L6pez-de-Silanes, Shleifer, and
underdeveloped financial sectors? The simple answer, and Vishny (1997, 1998) shows that countries with a common law
one favored by many economists, is the absence of demand. origin (with law based on custom, usage, and court decisions)
According to this view, when opportunities that require financ- seem to have better minority investor protection and more
ing arise in an economy, the economy will develop the neces- highly developed equity markets. While there has been some
sary markets and institutions to finance them. For example, debate about the precise channel through which a country's
the enormous financing requirements of railroads in the United institutional inheritance affects its financial development, the
States ($1 billion by 1867 and $10 billion by 1890) led to the evidence of a strong empirical correlation in recent times be-
development of public markets for corporate debt and later for tween whether a country is financially developed and whether
stock, with 40 percent of this capital coming from Europe. it has British colonial origins is hard to ignore.
Financial institutions such as investment banks, including the
famous Morgan Bank, emerged to underwrite and distribute But one implication of the "structural" theories of financial de-
these securities and to reassure European investors that the velopment that has not been explored is that financial devel-
money was properly invested. Thus the financing needs of the opment should either take off permanently (for example, once
railroads led to the creation of a financial infrastructure in the a country attains the necessary social or human capital) or
United States, which was then available to finance industries remain permanently constrained (for example, if the inherited
that came later. What we have just described is nothing but legal system is hostile to investor protection and financial
the reverse of Say's Law-demand creates its own supply. markets).
Behind the Divergence To test this implication, we collected indicators of financial
development in developed countries over the 20th century. By
Certainly demand is a prime driver of financial development, most measures, countries were more financially developed in
but it cannot be the only explanation; demand cannot explain 1913 than in 1980 and only recently have surpassed their
why countries at similar levels of economic development differ 1913 levels of financial development. Furthermore, the pattern
so much in the level of their financial development. For ex- across countries in 1913 was quite different from that in the
ample, why was the stock market in France much bigger as a 1990s. In 1913, stock market capitalization in France as a
fraction of GDP than markets in the United States in 1913, fraction of GDP (0.78) was almost twice that in the United
even though per capita GDP in the United States was no lower States (0.41)-even though the French civil code is not friendly
than that in France? It is hard to imagine that the demand for to investors, according to La Porta and others (1998). By 1980,
financing in the United States at that time was inadequate- the situation had dramatically reversed-stock market capi-
the demand for more, and cheaper, credit was a recurrent talization as a fraction of GDP in France (0.09) was barely
theme in political debates in the United States, and the coun- one-fourth that in the United States (0.46). And in 1999, the
try was among the most industrialized in the world even then. two countries seemed to be converging (1.17 and 1.52).
An alternative explanation centers on structural impediments More generally, by most indicators the main countries of con-
that prevent supply from rising to meet demand. Perhaps a tinental Europe were more developed financially in 1913 than
country lacks the necessary social capital or "savoir faire" to the United States. In fact, in contrast to the findings of La
(D 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 *
Porta and others (1997) for the 1990s, we find that countries integration into the European Community. This faction argued
with common law systems were not more financially devel- that liberalization was necessary to preserve trade, and won
oped in 1913. What is especially interesting is that indicators the day. How could one ever hope to capture the strength of
of financial development fell in all countries after 1929, reach- such factions in a large-sample, cross-country study without
ing their nadir around 1980. Since then, there has been a a subjective country-by-country exercise?
revival of financial markets.
Free Trade Can Accelerate Financial Development
Influence of Interest Groups
Our theory suggests a way. Regardless of the nomenclature
A comprehensive theory should be able to explain the varia- of the party in power or the structure of government, we can
tion in financial development both overtime and between coun- use the extent of an economy's openness as a proxy for the
tries. In our view, the strength of political forces favoring financial strength of incumbents' opposition to financial development.
development should be a major aspect of such a theory. Clearly, While crude, this approach gives us an objective way to side-
there may be structural aspects to these forces, which we step the morass of trying to identify specific interest groups in
discuss shortly. But equally clearly, the prime mover is the different countries and their ability to exert power. Of course,
dominant interest group, so we propose an interest group there could be a more direct economic reason for trade to be
theory of financial development. correlated with financial market development. Our theory of-
fers an additional prediction that helps deal with this concern:
One challenge with such a theory is identifying who might it is at times that cross-border capital flows are plentiful that
oppose something as economically beneficial as financial trade should matter. We take these predictions to the data.
development. We believe that incumbents-especially in fi-
nance, but also in industry-can be hostile to arm's-length We find that in the initial decades of the 20th century and in the
markets because anonymous markets do not respect the value closing decades, both periods in which cross-border capital
of incumbency and instead can give birth to competition. Spe- flows were relatively plentiful, measures of a country's financial
cifically, financial markets disproportionately favor new entrants development are strongly correlated with exogenous measures
over incumbents. Nevertheless, it is possible to mute the in- of its openness to trade. This evidence is consistent with our
centives of incumbents to oppose financial sector develop- hypothesis that incumbents' incentives to oppose financial de-
ment. One such situation is when an economy experiences velopment are relatively muted when a country's borders are
both cross-border trade and capital flows. The resulting com- open. By contrast, in the intermediate periods (from the 1930s
petition from external sources, especially in financial mar- to the 1970s), when cross-border capital flows had dwindled to
kets, coupled with the constraints on government financing, a trickle (for reasons ranging from the autarkic policies adopted
makes it difficult and unprofitable for domestic incumbents to during the Great Depression to the Bretton Woods agreement
keep the domestic financial sector repressed. that favored trade at the expense of finance), we find that trade
openness did not have as strong a positive correlation (if any)
The greater challenge with any theory that suggests that poli- with financial development. These findings suggest that it takes
tics matters is how to test it. Structural measures of a openness in both product and financial markets to mute in-
country's political system are notoriously difficult to capture. cumbents' incentives to oppose financial development. They
It is no wonder that the evidence thus far is mixed. Apart from also suggest a reason for the decline in indicators of financial
differences in data and accuracy of measures, the difference development between the 1930s and the 1970s: cross-border
in results may stem from differences in the incentives of the flows, especially of capital, were relatively small.
interest group in power. But how do we identify the most pow-
erful interest group, and how do we determine its incentives? Finally, we attempt a synthesis of our private interest theory
with structural theories, which affords more testable implica-
The following example should illustrate the problems. In France, tions. It has been argued that in countries with a civil law
financial liberalization was kicked off in 1983 by a Socialist origin (with law based on written legal codes), policies can be
government. By many structural theories, France would be imposed more easily. This should imply that civil law coun-
an unlikely country to initiate liberalization, and socialists tries are much more prone to capture by focused private inter-
seem to be an unlikely interest group to push for it. A more ests, such as incumbents. If so, we would expect to see that
detailed study (Helleiner 1994) suggests that there was a lib- as cross-border financial flows ebbed in the 1930s, trade open-
eralizing faction in the French Socialist party, led by Prime ness became a much less potent force for financial market
Minister Pierre Mauroy and Finance Minister Jacques Dolors, development in civil law countries than in common law coun-
whose hand was strengthened by France's increased trade tries. By contrast, as financial flows resumed in the 1990s,
* TRANSI FION, July-August-September 2001 The World Bank/The William Davidson Institute C) 2001
incumbents in more open civil law countries should have had Raghuram Rajan is professor of finance at the University of
a stronger incentive and ability to press for financial develop- Chicago and visiting at the Massachusetts Institute of Tech-
ment, so that trade openness would become a more potent nology. Luigi Zingales is professor of finance at the University
force for financial market development in civil law countries. of Chicago. This paper is forthcoming as a Davidson Institute
This is in fact what we see in the data. Working Paper.
Traps in Decentralizing Financial Institutions:
Some Interesting Lessons from China
by Albert Park and Minggao Shen
L iberalization and decentralization of the financial sec- at the expense of the principal. In the case of financing,
tor have been a main focus of reform for the past sev- borrowers can bribe local bank managers to approve loans.
eral decades in developing countries and more recently This idea is similar to that of Strausz (1997), who uses a
in transition economies. Financial liberalization transforms a principal-supervisor-agent framework to show that collusion
heavily regulated system into a market-oriented one. Decen- between the supervisor and the agent may occur if the princi-
tralization vests greater decisionmaking authority in local pal rewards the agent on the basis of information generated
managers so that they can compete effectively in a market by the supervisor. The principal hires a supervisor and del-
environment. Like other types of decentralization, financial egates control rights if and only if she can provide collusion-
decentralization aims at both promoting local (lenders') initia- proof contracts. Strausz (1997) shows that collusion can be
tive and exploiting local information so that better decisions deterred if the principal is able to commit to not renegotiating
can be made in allocating resources. the contracts between the principal and the supervisor.
Dewatripont and Maskin (1995) present a second motive for de- Second, another agency problem often observed in de-
centralization. They show that the division of large banks into small veloping and transition economies is government influ-
ones can serve as a commitment device that helps lenders harden ence. Local government leaders, as social planners for local
the budget constraints of borrowers. Unlike large banks, small communities, internalize not only the economic benefits of
banks are incapable of refinancing ongoing projects independently, running firms but also noneconomic ones. Local government
Other potential lenders may be unwilling to refinance projects if leaders may be concerned with, and frequently rewarded on
they have imperfect information about firm quality. Entrepreneurs the basis of, enterprise and employment creation, potential
with bad projects who anticipate refinancing thus may find that it is tax extraction, and indicators other than investment profitabil-
not profitable to seek financing in the first place. ity. This may lead them to support low-return projects and to
apply political pressure to local bank managers over whom
Other factors may undermine the potential benefits of decen- they may have influence. Policy lending and soft budget con-
tralization. The disadvantages of decentralization are associ- straints are a notorious problem plaguing financial institutions
ated with both agency problems and commitment failures, which in transition economies. Such problems are considered to be
are frequently observed in the underdeveloped markets or poor less serious at lower administrative levels, however.
regulatory environments commonly found in developing and tran-
sition economies. We consider two agency problems and one Finally, in contrast to Dewatripont and Maskin (1995), we ar-
commitment failure associated with decentralized systems: gue that even if decentralization improves local infor-
mation, lenders still will be inclined to refinance bad
* Collusion between local bank managers and borrowers. projects, which softens the budget constraint of borrowers.
* Collusion between local bank managers and local govern- In the context of a corporation, Cremer (1995) shows that
ment officials (or government influence), more information may hurt the principal's ability to refuse re-
* The commitment problem of lenders inclined to refinance negotiation. More accurate information may reduce the agent's
bad projects (excessive refinancing). incentive to work diligently to signal a strong ability to refuse
renegotiation. Berglof and Roland (1998) show that, contrary
First, in a decentralized world where information is to Dewatripont and Maskin's (1995) finding, decentralization
costly, agents may benefit from colluding with each other does not necessarily lead to hard budget constraints if the
© 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 X
lender's opportunity cost of refinancing is low and the lender can been allowed to decide for themselves whether or not to de-
afford to refinance. In particular, when the liquidation cost is high centralize loan decisionmaking to local bank managers.
because of inadequate institutional infrastructure, the lender may
lack the credibility to liquidate financially distressed projects. Interestingly, however, despite the apparent benefits of de-
centralization, our data show that increasingly commercial-
Surprisingly, we could find no empirical research on the valid- ized banks with more discretion to delegate lending authority
ity or relative importance of different theories explaining finan- have chosen to centralize control. We speculate that the cur-
cial decentralization. We use bank-level data on managerial rent trend toward centralization reflects severe agency and,
decisionmaking authority in a large transition economy to rig- especially, commitment problems. The financial transition in
orously test whether theory can explain observed heteroge- China is far from complete. Government interventions have
neity in the decentralization of lending authority in financial declined but not yet disappeared. Market institutions (such
institutions. The unique data set was collected in surveys of as secondary markets) and legal institutions remain poorly
rural financial institutions, enterprises, and local government developed. Centralization can help resolve agency and com-
officials in southern China in 1998. mitment problems, although probably at substantial cost in
lost information and reduced incentives for local managers.
The ongoing financial transition in China offers a particularly This outcome in China suggests that rapid commercialization
appropriate setting for empirical tests. China is an interesting of banking systems in transition economies will not automati-
case because banks recently became commercialized but cally lead to substantial improvement in financial intermedia-
supporting institutions are not fully developed, leading to rich tion unless core agency and commitment problems are solved
variation across space in the extent of decentralization and as well.
its causes. Financial reform in China aims at transforming
financial institutions from government-run banks to indepen- Albert Park is assistant professor of economics at the Uni-
dent financial intermediaries. Important aspects of China's versity of Michigan and a research fellow of the William
financial reform include the introduction of competition among Davidson Institute. He is currently visiting at the Fairbanks
state-owned banks in the early 1990s and the strengthening Center, Harvard University. Minggao Shen is professor of eco-
of profit incentives for managers. Most policy loans were trans- nomics at Stanford University. This paper is forthcoming as a
ferred to newly established policy banks. Individual banks have Davidson Institute Working Paper.
Report from the Field
A regular column written by recipients of the William Davidson Institute Fellowship in Business Journalism
After the Battle, Everybody's a General-but Czech Privatization
Really Was in Need of One...
by Jan Machacek
T here are at least three good reasons to stop and take sight is 20/20." No matter how one puts it, we can all agree
a look at the 10-year-old Czech privatization process. that it's easy to be smart now. It's so easy to look back and
First, the sale of Komercni Banka to the French see the weak points and identify the mistakes.
Societe G6nerale has brought the long, exhausting process
of bank privatization in the Czech Republic to an end. Sec- For example, the transformation of ownership in the Czech
ond, on a recent visit to Prague, former World Bank Chief Republic had no comparable precedent in scale and timing.
Economist Joseph Stiglitz called the Czech way of Foreign advisers could offer only limited advice because they
privatization a failure. And third, large-scale privatization has had only limited experience.
taken 10 years.
But even the limited advice might have been useful to those
Privatization Is a Must who ignored it. Many foreign advisers were brushed off and
criticized at the beginning of the 1990s for providing "cheap
There is a Czech saying, "After the battle, everybody is a advice for expensive money." That was hubris, which always
general." MyAmerican colleague offered up the saying "Hind- brings punishment.
* TRANSITION, July-August-September 2001 The World Bank/The William Davidson Institute ©D 2001
Everything in economic policy or economic transformation ver," the "Czech way," and many other shining ideas that later
has been tried somewhere, with results, costs, and benefits lost their luster.
that can be measured. One can always draw geographical
or historical parallels, or both, in any area one considers: No Good Way
taxation, pension reform, trade barriers, exchange rate policy,
anti-inflation measures, deregulation of energy production, The Czech Republic combined privatization methods. All seem
free trade and distribution, bank and capital market regula- bad at first glance, so why not combine them?
tion.
1. Selling companies to the highest bidder
Consider the challenge: rapid privatization of 99 percent of a In this method, the winning bidder pays the price of the com-
country's property, which had been nationalized (stolen) al- pany through a bank loan. Then he has to pay back opera-
most half a century before. This had never happened before tional and investment loans along with a "privatization loan."
and probably (hopefully) will not happen again anytime soon. He either tunnels the company and hurts smaller sharehold-
ers or goes bankrupt. Or he pays back none of the loans or
But privatization is a must. All reform governments have had just some of them, and the cost of the transformation goes to
to carry it out somehow, no matter how socialist or conser- the bank, which amasses bad loans. The real cost is passed
vative they claim to be. Private property, private interests, on to taxpayers, who finally save the bank. These loans didn't
and private capital are the foundation of the market. In a make sense on economic grounds. They were provided on
democracy, privatization is always an unpopular process, such a scale in the Czech Republic because of fraud, corrup-
used later by the opposition as a basis for attacks on the tion, and political pressure. Forty years of communism had
government. done little to prepare bankers to do good business.
The Czech Republic's voucher privatization experiment (the 2. Selling to the highest bidder, but ruling out the use of
distribution of property through vouchers) relied on public a bank loan to pay the bill
involvement, and enabled the government to use other meth- This method would have increased the chances of those who
ods of privatization to push through other reforms with politi- accumulated money under the communists or those with links
cal support. People developed an "illusion of participation." to nontransparent sources of money abroad.
The mixed results, including major fraud schemes, later be-
came a political tool for the opposition, enabling Milos 3.Sellingtotheentrepreneurwiththebestbusinessplan
Zeman's Czech Social Democratic Party (CSSD) to win the Nobody can properly evaluate a business plan. This method
elections in the end. is the most direct route to corruption and makes it likely that
companies will be bought with bribes.
Every Reform Country Differs
4. Selling to the current managers and experienced en-
Hungary and Poland privatized differently. Periodically (in polls trepreneurs
conducted in the early 1990s), around 80 percent of the popu- Current managers were rarely any good, and there were no
lation surveyed in these countries considered privatization a "experienced entrepreneurs" with a proven track record.
sham. Can such a privatization be called a success? Hardly.
5. Selling everything to foreign investors
Hungary sold most of what any foreigners were willing to buy This is clearly politically impossible except when absolutely
in order to pay back a huge foreign debt it inherited from the necessary. The opposition would fight tooth and nail against
communist regime. Paradoxically, this strategy served the "selling out" national assets and "selling the country" to for-
Hungarians well, although this "selling out the country" to for- eigners.
eigners was extremely unpopular.
6. Using voucher schemes
Poland gave foreign capital a larger opening, but most of its The Czech Republic combined a voucher scheme with all the
smaller companies were "privatized through bankruptcy." This methods mentioned above. The voucher scheme did not bring
strategy was relatively quick, but not very transparent. in new capital, and property control ended up too dispersed.
Czech communists didn't accumulate a major foreign debt. 7. Selling gradually through a stock exchange
That gave Czechs the luxury of talking about what limits there This method was impossible because no stock exchange
ought to be on foreign investment, and about the "family sil- existed yet.
© 200] The Wor]d Bank/The William Davidson Institute TRANSITION, July-August-September 2001
At the Top of the Learning Curve overtures to other lobbyists and vested interests. And it must
be friendly with the Civic Democratic Party (ODS), which
Banks in the Czech Republic should have been privatized to shares control over privatization and state-owned companies.
foreign direct investors fully and at the beginning of the reforms. Zeman's government has been successful in completing the
But almost no economists (forget about politicians for now) privatization of the banks. Congratulations. To a large extent,
called for this until 1994-95. Foreign direct investment should this was the only way to avoid a truly deep crisis. But other
have been given a lot more space from the beginning. The than concluding the privatization of Skoda Auto, the rest of its
voucher scheme should have been used on a much more lim- privatization efforts have been a complete failure (including
ited scale and should have been accompanied immediately by CEZ, Transgas, Unipetrol, SPT Telecom, Skoda Plzen, Ceske
standard capital market regulations. Nonprivatized banks should Radiokomunikace, and gas and energy distributors)-it isn't
not have been allowed to launch investment funds. And the moving ahead at all. The best opportunity to sell all those
investment funds collecting the vouchers should have been run companies has been wasted. The Czech privatization of the
by established foreign investment banks and companies. early 1990s is easy to criticize, but at least there was some.
Now, is privatization even possible?
From the start, foreign experts should have been asked to
help establish standard capital market regulations, a stan- Jan Machacek was a William Davidson Institute fellow in busi-
dard stock exchange, and regulatory bodies. From the start, ness journalism in 1997-98. He is currently a weekly colum-
the Czech Republic should have paid for hundreds of young nist on politics and the economy for the Prague Business
people to study and work abroad. Companies should have Journal. An award-winningjournalist, he formerly wrote for the
been sold outright because otherwise bureaucrats in charge investigative weekly Respekt. He can be reached at
of privatization become the major obstacles to it, especially jmachacek@pbj.cz. This article is reprinted from the Prague
when they sit on the boards of semiprivatized companies. Business Journal, July 16, 2001.
Standard bankruptcy proceedings should have been instituted
much sooner. The list goes on. Recent WDI Working Papers
Czech privatization can be called both a success and a fail- Papers can be downloaded at no charge from
ure. Outside of coal mining, there is no successfully priva- www.wdi.bus.umich.edu.
tized (profitable) large industrial company owned by Czechs.
The successful Czech-owned companies are new ones, es- Jones, Derek C., and Niels Mygind. Ownership and Pro-
tablished from scratch after the revolution, or very small com- ductive Efficiency: Evidence from Estonia. Working Pa-
panies. That's a major failure. But those who don't believe per (WP) 385, August 2001.
that Czech privatization is also a success should have seen Boeri, Tito, and Katherine Terrell. Institutional Determinants
the country 12 years ago. of Labor Reallocation in Transition. WP 384, June 2001.
The Current Government's Privatization Effort Mickiewicz, Tomasz, and Anna Zalweska. Deindustrialisation
and Structural Change during the Post-Communist Tran-
Once a country's reform potential has been squandered (people sition. WP 383, June 2001.
are generally receptive to reform for only a couple of years after Jurajda, Stepan, and Janet Mitchell. Markets and Growth.
any revolution), privatization gets stuck. More obstacles are WP 382, July 2001.
created when privatization is taken out of the hands of profes- Chase, Robert S. Labor Market Discrimination during Post-
sional economists and managers and given to the political party Communist Transition: A Monopsony Approach to the
secretariats. Maneuvering politicians and party bosses are Statust Transian Minority Wp to te
Status of Latvia's Russian Minority. WP 381, September
deeply locked into all kinds of vested interests. Some of them, 2000.
paradoxically, are economists who became politicians.
Chabellard, Frederic. Dollarization of Liabilities in Non-
Today's socialist government is also a schizophrenic one. It Tradable Goods Sector. WP 380, June 2001.
wants to control as many companies as possible (because
control over state-owned companies means power), but it also The Economics of Soft Legal Constraints. WP 379,
needs as much cash as possible to finance its incredible March 2001.
appetite for spending. Moreover, it wants to be friendly with
trade unions, which usually oppose privatization (as in the Ivanenko, Viad. Effective Tax Rates in Transition. WP 378,
case of energy production and distribution), and it makes warm May 2001.
* TRANSITION, July-August-September 2001 The World Bank/The William Davidson Institute © 2001
SITE
Stockholm Institute of Transition Economics
STOCKHOLM SCHOOL OF ECONOMICS
Russia and the World Trade Organization:
Myths and Reality
Many myths surround Russia's potential membership in the World Trade Organization (WTO). To dispel some of these
misconceptions, which are clouding the views of many in Russia about WTO membership, the Center for Economic and
Financial Research (CEFIR) sponsored a study to examine the concerns that lie behind the myths.
Myths That Impede Myth 2. WTO membership will open agricultural markets
to cheap products from abroad, and domestic producers
Myth 1. WTO membership means complete exposure of the will be unable to compete successfully. The Russian agri-
economy to global competition, leading to the displace- cultural sector will wither, and the country will become
ment of domestic industry followed by mass unemployment dependent on imported food products.
This myth rests on a number of assumptions: Almost every country in the world protects its agricultural sector.
* Current tariffs protect Russia's industry against competi- By world standards Russia's agricultural tariffs and subsidies
tion. are not very high. Joining the WTO is unlikely to exacerbate the
* WTO membership will lead to a drastic reduction in this current situation if, during accession negotiations, Russia reaches
tariff barrier. agreement on a high and stable tariff system for agriculture.
* WTO membership means that the government will lose the Moreover, WTO membership does not prohibit agricultural sub-
key instruments it uses to protect local industry. sidies. It requires only that countries establish a subsidy ceiling,
* Opening the economy as required by WTO membership which may not be exceeded. Recently, Russia negotiated with
amounts to a death sentence for domestic industry. the WTO a $16 billion ceiling for agricultural subsidies, well above
what Russia now spends or plans to spend on agriculture.
The truth is more complex:
* Current tariff rates are low, some 7-15 percent at the two- The claim that the Russian agricultural sector will wither once
digit industry level, too low to be very effective by international the economy becomes more open is unfounded. Many of the
standards. Moreover, customs administration functions so sector's problems will persist regardless of whether Russia
poorly that only about half the tariffs are collected. joins the WTO. Many of the current problems cannot be called
* Joining the WTO will not necessarily lead to a reduction in "development-inducing" by any definition-soft budget con-
tariffs. Tariff rates will be decided during accession negotia- straints, vague property rights, opportunistic behavior by man-
tions, and some tariffs may even be raised. Because the rates agers, and difficulties obtaining credit. Institutional reforms,
are likely to be fixed once the accession agreement is signed, including land reform, founded on a new system of incentives
government and industry must think carefully about the levels and greater specialization can propel Russian agriculture to a
of future tariffs. prominent place in the global economy.
* The government will not lose its ability to protect domestic
producers. Members of the WTO are permitted to implement Myth 3. The Russian banking system, insurance industry,
temporary defensive measures. Also, keeping the real ex- and pension funds are still too small to face foreign com-
change rate low can help protect domestic producers. petition. WTO membership will lead to a devolution of
* Although it is true that exposure to international competi- Russian financial institutions while international bankers
tion may be detrimental in the short run to some sectors of collect citizens' savings and move them abroad.
the Russian economy, such as the food and machine building
industries, the long-term consequences of not joining and not The main problems for the Russian financial sector relate to
restructuring are even more harmful. the poor investment climate and weak protection of creditors'
© 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 *
rights, not WTO membership. Similarly, a lifting of the con- not reform itself, Russian business may lose rather than ben-
trols on capital flight, much discussed in Russia these days, efit from WTO membership.
will not be enough to improve Russia's investment position
without reforms in laws and regulations, accounting proce- Myth 6. Regional free trade agreements are becoming
dures, corporate governance, and financial regulation. more important than the WTO. Membership in the WTO
will not offer Russia any special advantages, and may even
The monopolistic position of the Russian financial sector should weaken its position if the Customs Union with the Com-
be broken. After 10 years of isolation under infant industry monwealth of Independent States is abandoned.
protection, Russian banks are still unable to perform basic
functions. WTO membership does not mean that Russian If Russia joins the WTO, it will be able to acquire all the advan-
financial markets will immediately face foreign competition. tages of that organization. As for the Customs Union, all of its
Russian banks will have time to prepare themselves to oper- functions may be preserved through bilateral agreements or
ate in a more competitive environment. the establishment of a formal regional free trade association.
Myth 4. Tariff reduction will boost imports at the expense Myth 7. Because of Russia's geographic position, WTO
of foreign direct investment, membership will not improve the investment climate in
any significant way.
Theoretically, in countries with poor investment climates and
internal markets protected by tariffs, it is cheaper to build a David Ricardo long ago refuted the old argument of the irratio-
factory inside the country than to import goods. If the markets nality of trade in the context of high production costs for all
are open, goods will be produced abroad and imported. How- products by demonstrating that comparative advantage is more
ever, the experience of countries that have joined the WTO important than absolute advantage. True, a colder climate in-
demonstrates a different reality. WTO accession attracts for- creases transaction costs. But cold is not a decisive factor in
eign direct investment, both during the accession process the current development of the Russian economy. In growth
and once a country becomes a member. regressions, the geographic variable loses its significance
when bureaucratic corruption, an index of economic open-
With WTO membership, export-oriented Russian producers ness, and the quality of laws are controlled for.
will become more attractive for foreign investors. Guarantees
to protect the rights of creditors, a part of WTO membership, Myth 8. The problem of the Russian economy lies in the
will shield foreign investors from discrimination by regional "Russian character." Although the market economy may
authorities. Horizontal investments (those oriented toward the work elsewhere, peculiar features of the Russian culture
domestic market) will go to regions with greater concentra- that emphasize colleutivism preclude markets from func-
tions of population, and vertical investments (oriented toward tioning well in the country.
export) will move to border regions with concentrations of
skilled labor. Again, improving the investment climate is a pre- Markets function in Russia as they do anywhere else. The
requisite for achieving long-term economic growth-whether problem is that some parts of the Russian economy are still
Russia joins the WTO or not-since tariff rates are only a not functioning under market conditions. Many sectors re-
small part of the transaction costs motivating foreign inves- main unexposed to competition, so that growth of total factor
tors. productivity is slow in those sectors. However, Russian man-
agers have demonstrated their ability to survive under adverse
Myth 5. WTO membership limits opportunities for cor- conditions. Russians are highly educated, with a proven abil-
ruption in the bureaucracy, diminishing the need for ad- ity to adjust and compete. Reducing trade restrictions would
ministrative reform. tap more of the vast potential of the stock of Russia's human
capital.
This myth arises from a distrust of the government's ability to
reform itself. True, WTO membership provides foreign produc- Factor Mobility, Offering a Chance for Success
ers with tools to resolve conflicts with Russian authorities, so
that in cases of discrimination, Russian exports will be sub- Resolving many vital problems in Russia does not depend on
ject to fines and levies in global markets. However, WTO mem- WTO membership. The challenges of structural unemploy-
bership does not preclude the pressuring of domestic ment, a negative investment climate, and implementation of
businesses by the Russian authorities, which could continue. structural reforms will remain whether Russia joins the WTO
Administrative reform is thus a must. If the government does or not. However, the opportunities for success may turn out to
* TRANSITION, July-August-September 2001 The World Bank/The William Davidson Institute (C 2001
be greater, and the social costs lower, if Russia decides to successful sectors of the economy. For that to happen, trans-
become a member. To take advantage of these opportunities, action costs in capital markets need to be lowered. The state
the country needs to improve factor mobility across enter- can deal with this if it takes action in four areas: tax policy,
prises, sectors, and regions. So the question is: "What should deregulation, capital market development, and corporate gov-
Russia do once it joins the WTO?" ernance. Lowering the tax burden, in particular, could stimu-
late investment. Capital gains need to be made tax free, at
Competitiveness in the world economy depends on: least temporarily. Reform of the judicial system would curb
bureaucratic corruption and strengthen protection of prop-
* Labor mobility, both geographic and professional. erty rights.
* Corporate mobility, the ability of a firm to innovate and change
its administrative structure. Information mobility: Russia needs to take advantage of
* Capital mobility. new information technologies. Greater access to the World
* Information mobility, a precondition for lowering transaction Wide Web will improve information mobility and aid the transfer
costs. of capital and labor to more productive economic sectors.
Although the Internet is a public infrastructure good (like a
Geographic mobility: WTO membership will allow Russia highway system), the private sector should share the cost
to restructure its economy faster, encouraging people to move of its financing.
to more productive sectors. Deregulation alone will not do it
for sectors and regions with depressed demand and high un- In sum, without greater mobility, Russia risks becoming
employment. The key measures for improving geographic trapped in a vicious (closed) cycle of survival without mod-
mobility are lowering administrative barriers, opening centers ernization, with moderate growth, at best, during years of
for support and retraining of migrants, getting informational high oil prices and stagnation or even depression during years
support from the mass media, and developing credit markets. of low prices for natural resources. With greater mobility-
Greater geographic mobility will increase regional competi- horizontal, vertical, and information mobility of capital and
tion for qualified labor. Regional governments will be forced to labor into the most promising sectors-Russia can be suc-
do more to keep labor and capital in the region. cessful in the global economy. Investing in the more pro-
gressive areas of the economy helps improves the quality of
Professional mobility: The Russian labor force is one of the education and contributes to higher mobility of the factors of
most educated in the world. To take advantage of this factor of production.
production, the state needs to do more to improve the profes-
sional mobility of labor. But an educated labor force is not The quality of human capital remains Russia's biggest com-
enough. Also needed is a willingness to learn and adjust to parative advantage. Human capital will be the driving force
the new realities of changing technologies and markets. For for investment in new sectors of the economy if Russia joins
Russia this may be even more of a problem than geographic the WTO. If Russia waits too long, however, the potential of
mobility, because unlike the system of secondary and higher this factor could be wasted, and the chance to break the
education, centers for retraining workers are not well devel- vicious cycle missed.
oped. Education should be regulated as a value added sector,
through a clear tax system and quality monitoring and imple- Thus the sooner Russia joins the WTO, the easier it will be
mentationofcontemporarystructuresofcorporategovernance to adjust to the new realities of the world economy. WTO
in nonstate institutions of higher learning. membership means more than lower tariffs. It also implies
deep structural changes in the economy as a whole. Such
Corporate mobility: The solution to corporate mobility is to structural reforms are essential for Russia to benefit from
improve the professional education of managers. The country WTO accession.
needs people who can move firms away from the hierarchical
system of governance to the contemporary, network-based The co-directors of this project are Vladimir Preobrazhensky,
system. Changes in organizational structures need to be supple- Club 2015; Sergei Guriev, CEFIR and New Economic Schoo;,
mented by development of professional consulting and account- and Ksenia Yudaeva, CEFIR. Maria Gorban, CEFIR, is
ing. WTO membership and exposure to international competition project coordinator. For the full text versions (Russian and
will provide positive stimuli for Russian firms to restructure. English) of the paper on which this article is based, see
www.cefir.org or www.cefir.ru. Information about Club 2015,
Capital mobility: One way to smooth the transition to WTO a group of leading Russian managers and specialists, and
rules is to allow greater capital mobility from depressed to more its activities can be found at wwwclub2015.ru.
C) 2001 The World Bank/The William Davidson Institute TRANSII[ON, July-August-September 2001
Mobility of Russian Workers Raises Productivity-
New Research on Job Creation and Destruction
by J. David Brown and John S. Earle
Is Russia restructuring? While it is evident from a variety of plete quantification of all job flows, they are well suited to a study
sources that an extraordinary number of jobs have been of job reallocation in the old industrial sector that was built up
destroyed in the Russian economy since radical reforms during the socialist period. The behavior of this sector is also of
began, much less is known about the character of this pro- particular interest in Russia and othertransition economies, where
cess: Is it Schumpeterian "creative destruction," weeding out socialist planning resulted in a large concentration of capital and
the least efficient jobs and making way for reallocations to more skilled labor and where the price, technology, and competition
productive uses? Or is it simply destruction, reflecting either shocks of transition have been particularly severe.
indiscriminate collapse throughout the economy or, worse, a
concentration of job losses in firms and sectors of relatively To study the impact of reforms, we examine whether job flow
high productivity? "Sclerosis" is a real possibility in Russia, patterns changed over the 15-year period of our data and
where governments may protect weak firms, where profitable began to resemble more closely the behavior in market econo-
companies are subject to public and private predation, and where mies. The analysis treats the "big-bang" liberalization of 1992
stripping of assets is practically a national sport. as the dividing line between what we refer to, for simplicity,
as the "pre-reform" and "post-reform" periods. We also ana-
Job Flows in the Old Industry lyze the persistence in job flows and the heterogeneity within
and across groups of firms, defined according to industry,
Following the methodology developed by Davis and Haltiwanger, region, size, ownership, product market concentration, im-
we analyze gross job flows job destruction, creation, realloca- port penetration, exports, labor market concentration, capi-
tion, and excess reallocation) in Russian industry using nearly tal intensity, electricity intensity, average wage, and labor
comprehensive data on large and medium-size manufacturing productivity. Again, our interest is whether economic reforms
firms with annual observations for 1985-99. While the data, like have produced patterns of job flows more akin to those in
those available for most countries, including in Eastern Europe market economies, a purpose for which our panel data are
and the former Soviet Union, do not lend themselves to a com- well suited.
Baltic Development Forum Summit on EU-Russia Relations
With the upcoming enlargement of the European Union, the ern Dimension Action Plan-monitoring progress and over-
Baltic Sea region is increasingly moving to the center of EU all implementation. The business-oriented theme will include
interests as well as EU-Russia relations. EU enlargement, the launch of a comprehensive strategy for business devel-
to include Estonia, Latvia, Lithuania, and Poland, offers great opment in the Baltic region designed by Michael E. Porter,
promise to the region-and great challenges. The Third An- Harvard University, and Orjan Solvell, Stockholm School of
nual Baltic Development Forum Summit, "Closing the Gap: Economics, in cooperation with SITE, the Baltic International
Creating a Win-Win Situation in the Baltic Sea Region," Centre for Economic Policy Studies (BICEPS) in Riga, and
will take place on 23-25 September in St. Petersburg, his- the Baltic Development Forum.
torically Russia's window city to Europe and the fulcrum of
its contact with the rest of the Baltic Sea region. The sum- Based in Copenhagen, the Baltic Development Forum
mit will bring together leading business executives, top poli- (www.bdforum.org) is the region's central summit organization,
ticians, high-ranking officials, and academics from the an exclusive forum for discussion and networking. Its mission is
countries of the region and beyond. to advance the growth potential of the Baltic Sea region through
a new partnership between leading politicians, high-ranking public
Speakers will address three main themes: mapping the fu- sector officials, business executives, academics, and media rep-
ture of Europe and the Baltic Sea region-in search of a resentatives. In organizing the summit, the Forum is joined by
coherent approach; mapping the region's core competen- the Pro Baltica Forum (www.probaltica.de) and the EastWest
cies-is business ready to harvest the fruits?; and the North- Institute (www.iews.org and www.iews-ffcp.ru).
E TRANSITlION, July-August-September 2001 The World Bank/The William Davidson Institute C) 2001
Behind the Job Allocation Process the old industrial sector. But we also note substantial changes
in the patterns of flows since 1992: an overall increase in flows
Besides measuring the patterns of job flows in the old industrial relative to the pre-reform period, and a large increase in the het-
sector in Russia, the most important contribution of our work is erogeneity of flows and of firm-level growth. We also find that the
the analysis of the impact of job impact of job flows on productiv-
flows on productivity, enabling us Next ABCDE Europe in Stockholm ity, while negligible before 1992,
to distinguish sources of aggre- turned strongly positive thereaf-
gate productivity change: em- The World Bank's Annual Bank Conference on Develop- ter; this result holds equally well
ployment reallocation across ment Economics (ABCDE) is one of the world's best known for job reallocation within indus-
industries, employment realloca- series of conferences for the presentation and discussion tries and between industries. Our
tion between firms within indus- of new knowledge about development. Since its first event regression results imply that
tries, and average within-firm in 1988, the conference has become increasingly impor- privatization and the unleashing
productivity growth. With these tant as the world's economies have become more intercon- of domestic product market com-
data we can assess whether la- nected and the distinction between development economies petition have strengthened the
bor reallocation has become and other disciplines has become more ambiguous. within-industry productivity ef-
more productive since reforms Stockholm is the fourth city in Europe to host the confer- fects. Thus even as the Russian
began. ence, which will take place June 24-26, 2002. The industrial sector goes through a
Stockholm ABCDE will be co-hosted by the World Bank difficult period of downsizing, the
Previous research on transition and the Swedish Ministry of Foreign Affairs. In cooperation overall direction of job realloca-
economies has documented with the main organizer, Boris Pleskovic, research admin- tion has changed to make de-
several important patterns: the istrator of the World Bank, SITE will have the role of aca- struction more creative.
rise in jobandworkerflowsas- demic coordinator of the conference. For additional
sociated with reforms, the rise information as it becomes available, see www.worldbank.org. J. David Brown is assistant pro-
in the proportion of worker fessor at SITE (David.Brown
flows associated with job flows, the greater rise in job de- @hhs.se), and John S. Earle
struction than in job creation, the dominance of small firms is associate professor at SITE and Central European Univer-
(generally new private start-ups) in job creation and of large sity in Hungary (John.Earle@ hhs.se). The full version of the
firms (generally privatized and state-owned enterprises) in job working paper can be downloaded at http://wwwhhs.se/site.
destruction, and the relatively large role played by intersectoral
shifts in excess job reallocation. Club 2015: Toward a Positive Future for Russia
After the August 1998 crisis a group of leading Russian managers
We employ our Russian data to examine these and other em-
pirical regularities. Compared to the data used in the previous and experts, feeling the urgency of assuming a more active role in
prua e a thev Russia's development, created Club 2015. This independent body
studies, our data have the advantage of covering a much longersektodiganpricaeinfwr-lkngntaivso
time span, reaching far back into the socialist period, and includ- seeks to design and participate in forward-looking initiatives to
ing essentially the entire sector of old firms inherited from the help Russia get past the crisis and return to a path of progress.
socialist period. Among the disadvantages of these data are the
inability to reliably track exit and entry or to measure flows in the Oe sc effor Bookr2015: Scea for ssiar aoje
dynamic small firm sector. Because of these limitations, we fo- l by Vladimiobrazensky. At at d semina se
cuson henatre f he ob llcaton roessin heoldsecor100 Russian decisionmakers in industry and government were
cus on the nature of the job allocation process in the old sector, invited to share their ideas about what they anticipate in Rus-
in particular investigating the degree to which job flows are pro- sia over the next 15 years. Participants identified future sce-
ductivity enhancing or "sclerosis" producing (unproductive firms narios grouped under three broad categories:
survive because of market imperfections and government poli- narioster.
cies). None of the previous studies of transition economies ex-
.. . . ~~~~~~~~* Change is absent or occurs too slowly-Tales of Lost Time.
amined the productivity consequences of job flows, a major gap * A positive and dynamic future.
in a literature that attempts to understand the role of labor mar-
kets in facilitating economic restructuring. Readers may access Book 2015, which includes scenario de-
scriptions, essays, and results of the Club's brainstorming ses-
Job Flows Improve Productivity sions, on the Club's Web site: http://www.club2015.ru. The
personal scenarios were written at the end of April 1999, and the
We find that job destruction is by far the dominant flow in the essays in July and August 1999. In the months that followed,
post-reform period, an unsurprising result given the focus on these scenarios were more or less confirmed by real events.
c 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 *
Is There a New Russia?
A report by the Center for Economic and Financial Research (CEFIR and SITE) sums up the economic
policy challenges facing the Russian government and suggests reform priorities.
The Russian economy is growing. Thanks to the ruble devaluation and favorable oil prices, growth is broader, involving more
industries and more regions, than ever before. More important, for the first time in a decade, Russia's political and economic
circumstances are conducive to the broad institutional reforms needed to put the economy on a path of sustainable growth.
Wide popular support has allowed President Putin to make significant progress in loosening the hold of the interest groups
that have blocked reform. and he has put his weight behind an ambitious reform program. The concentration of powers in the
presidency, however, holds major risks. Moreover the lack of clear reform priorities threatens to derail the government
program. The CEFIR report, based on the latest research and data analysis, helps define the challenges facing the Russian
government and establish reform priorities.
T he growth challenge facing Russia is daunting. Not only and increasing spillovers from new investment in manufactur-
are Russian firms dramatically less productive than their ing and services. Poor protection of property rights, espe-
counterparts in the West, but the productivity gap has cially weak enforcement of existing laws, undermines the
been increasing rapidly over the last decade. While Western incentives of investors as well as managers. More generally,
firms became more efficient, productivity fell in all major indus- the entire political and legal context-the business climate-
tries in Russia through most of the 1990s. Recently, with in- matters. The concentration of power at the federal level and
creased demand starting to reverse the decline in production within the executive branch has come at the expense of spe-
and firms now utilizing more of their capacity, productivity seems cial interests and the Russian regions. While this concentra-
to have improved. Vast additional improvements could be tion of power opens up an unprecedented opportunity to
achieved simply by introducing befter business organization, but implement critical structural reforms, it also creates a com-
managers have not had sufficient incentives to restructure their mitment problem. Experience from around the world shows
firms. The fragmentation of product and labor markets has weak- that when rules are unclear, or when the power of the ruler is
ened competitive pressures. And poorly functioning corporate unchecked, economic growth suffers.
governance and soft budget constraints have severed the link
between performance and consequences for managers. The main objective of the reform program should be to estab-
lish the checks and balances necessary for the government
Russia cannot achieve sustainable growth without new invest- to commit to stable institutional rules conducive to sustain-
ment. Investment declined for most of the 1990s, and the able economic growth. Russian-and foreign-entrepreneurs
capital stock has aged alarmingly. New investment is impor- and investors need stronger protection of property rights. In
tant not only in itself, but also because of the productivity particular, the privatization results, as deplorable as the pro-
improvements that accompany it, particularly foreign direct cess was, must be accepted once and for all. And allowing
investment. Regional data show strong positive spillovers from businesses to own land and streamlining the regulatory envi-
such investment, but the size of the spillovers depends criti- ronment are important for reducing the scope for bureaucratic
cally on the quality of human capital and the extent of eco- arbitrariness and corruption. But to contribute new risk capi-
nomic reforms. The high quality of Russia's human capital, tal, outside investors also need stronger protection against
an important component of productivity, can no longer be taken expropriation by insiders, and minority investors must have
for granted. Recent figures show that while the number of better assurances against the abuse of power by majority
university graduates is increasing, the quality of education is stakeholders. In the balance between the interests of strate-
deteriorating as a result of a "brain drain" and the exclusion of gic owners and minority investors, the growth challenge fac-
more and more young talent from the university system for ing the economy must come first. Russian industry
financial reasons. desperately needs strategic investment and thorough restruc-
turing to increase productivity.
Business Climate Matters
The Russian legal framework needs further improvement, but
On the whole, what promotes productivity improvements also enforcement is the critical task. Judicial reform should raise
generates more investment. Investments in the education the pay of judges and introduce discipline through clearer rules
system are critical for sustaining productivity improvements and more accountability through jury trials. Administrative re-
* TRANSI I [ON, .uly-August-September 2001 The World Bank/The William Davidson Institute (C 2001
form should also clarify the rules for allocating resources within are now under way, but implementation remains a daunting
the federal structure. Elements of healthy competition between challenge. The prospects for genuine bank restructuring are
and within levels of administration would help promote a bet- less encouraging. Implementing the reform program and bol-
ter business climate. Sustainable growth requires sustain- stering the long-term credibility of the new institutional rules
able institutions and predictable rules of the game. would be greatly furthered by deeper integration of Russia
into the world economy. As painful as it may be, accession to
Banking System Needs Upgrade the World Trade Organization is critical for putting Russia on
a path of sustainable growth. Preparations for membership
In the long term generating investment requires a functioning would improve enforcement of critical reforms and put addi-
financial system that transfers capital from savers to investors tional pressure on the Central Bank to reform the banking
and monitors how the funds are used. The Russian financial system. A free trade area with the European Union-and the
system-what remains of it after the financial crisis of August prospect of an even closer association-would provide a sense
1998-is very underdeveloped by international standards. The of direction and an outside anchor for Russia's reform pro-
banks play little or no role in the supply of capital for invest- gram. Ultimately, greater international accountability will also
ment. Credits to the private sector have increased significantly help the Putin presidency commit not to use the tremendous
since 1998, but little has been done to reform the banking sys- powers it has amassed.
tem. Poorly capitalized banks working in a soft regulatory envi-
ronment are unlikely to screen investment effectively or monitor SITE and CEFIR prepared this report for the Baltic Develop-
how funds are used. Unfortunately, the Central Bank, with the ment Forum as part of the Forum's Third Annual Summit (see
backing of the current administration, still lacks the political announcement on page 42). It is based on new research and
will to implement the necessary reforms. The prospect of a data analysis performed mainly at SITE and CEFIR. CEFIR
new financial crisis over the next couple of years, as the rev- is an independent economic think-tank based in Moscow and
enues from oil exports level off and the ruble appreciates fur- staffed by young Russian economists, many of whom received
ther, should focus attention and sharpen resolve. degrees from top Western universities but decided to return
to Russia. CEFIR researchers have presented papers on the
The key priorities are judicial, administrative, social, and bank- Russian economy at major international conferences and par-
ing sector reforms. Judicial, administrative, and social reforms ticipated in a number of policy advice projects.
Advisors in Action
0. .t - -a . . - - a
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0 6- . 0
Stroke! Stroke! Stroke!
From the Hungarian Daily Nepszabadsag
C) 2001 The World Bank/The William Davidson Institute TRA\SIlI ION, July-August-September 2001 *
Budget Crisis Looms in Poland
The administrative paralysis gripping Poland in advance of the September 23 parliamentary elections is beginning to under-
mine the economy. After a decade as the economic star of the transition economies, Poland is running into mounting
difficulties. Economic growth has slowed from an average of 5 percent in the past three years to below 2 percent. Foreign
direct investment is falling, and unemployment is rising rapidly and now stands at 16 percent. In less than two months the
zloty has declined some 16 percent against the euro. Standard & Poor's Ratings Group downgraded the zloty's long-term
outlook from positive to stable. In a July study by the Brussels-based Central European Opinion research group, more than
70 percent of Poles surveyed evaluated their country's present economic situation as "bad" or "very bad."
J ust after Finance Minister Jaroslaw and public sector wage increase to become prime minister after the elec-
Bauc warned that without urgent mechanisms, it risks long-term finan- tion, the SLD will review public finances,
austerity measures Poland's 2002 cial instability that could undermine its support education, reduce bureaucratic
budget deficit could balloon to 11 per- chances for entering the European costs, and implement tax measures
cent of projected gross domestic prod- Union with the first wave of applicants aimed at promoting exports, investment,
uct (88 billion zlotys), from an estimated in 2004. job creation, and small and medium-size
4.2 percent of GDP this year, Prime Min- enterprise development. Marek Belka,
ister Jerzy Buzek, in a surprise move, ThegovernmenthasuntilSeptember30, the party's most prominent economic
sacked him just three weeks before the a week after the election, to submit next policy figure and probably the next
election. Buzek argued that Bauc hadn't year's budget bill to parliament. As the government's finance minister, warned
informed the government quickly enough Democratic Left Alliance (SLD) is ex- that the SLD should not make unrealis-
about this perilous development. He ap- pected to win the general elections, the tic promises. Reduction of the 2002 bud-
pointed former Deputy Finance Minister new government is unlikely to be in get deficit to more acceptable levels will
Halina Wasilewska-Trenkner, an experi- place by then. Thus it will likely fall to require significant spending cuts. This
enced budget specialist, to Bauc's post. the outgoing government to introduce will be a precondition for continued for-
the necessary belt-tightening measures. eign direct investment inflows, needed
The 2001 budget, as drafted by the Fi- Among the proposals on the table are to finance the current account deficit
nance Ministry, overestimated value- an increase in the value-added tax on and modernize the economy in prepa-
added and excise tax revenues, despite some goods, a temporary 5 percent tax ration for EU membership. Moreover,
a two-year declining trend. "It would on imports, and a freeze on pensions high foreign debt repayments scheduled
take probably 15 to 20 billion zlotys and public sector wages. forthe coming years require unrestricted
($3.5 to $4.7 billion) in expenditure cuts and advantageous access to interna-
in next year's budget to make up for The new government has to tackle cor- tional financial markets.
errors in the 2001 budget," pointed out ruption and reestablish trust in the ad-
Witold Orlowski, director of the Indepen- ministration, notably in its privatization EU membership negotiations will also
dent Center for Economic Studies in policy. It must also breathe new life into limit the economic policy freedom of the
Lodz. He estimates that errors in the structural reform. Since the 1990s the SLD. The new government will likely be
2001 budget account for roughly one- pace has slowed in the face of opposi- strongly intent on joining the EU in 2004,
third of the money the government is tion from vested interests including bu- counting on the beneficial impact of EU
trying to come up with through spend- reaucrats, public sector managers, and funds to become visible to the elector-
ing cuts to keep the budget deficit for trade unions. The country urgently ate before the 2005 general election.
2002 under control. needs labor market liberalization and Paradoxically, relatively slow GDP
cuts in loss-making industries such as growth and high unemployment may
As a consequence, the government coal. Even the most successful of force the left-wing government to pro-
passed measures capping the 2002 defi- Poland's many entrepreneurs balk at ceed with unpopular structural and la-
cit at 40 billion zlotys, or about 5.1 per- hiring staff because of the high costs bor market liberalization measures, even
cent of projected GDP, but has failed so and complex employment rights. if those are totally absent from its cur-
far to agree on a plan for cufting the 30- rent economic program.
50 billion zlotys needed to reach that The SLD's economic program so far re-
target. Economists warn that unless mains quite vague. According to party Based on news agency and press re-
Poland revamps the budget's pension leader Leszek Miller, who is expected ports.
* TRANSirlON, July-August-September 2001 The World Bank/The William Davidson Institute (© 2001
New Scoreboard of Economist Intelligence Unit
Ranks Business Climates across the World
T he Netherlands is expected to be ment, foreign trade and exchange con- and most are drawn from national and
the best place in the world to con- trols, taxes, financing, the labor market, international statistical sources for the
duct business over the next five and infrastructure. Within these catego- historical period (1996-2000) and from
years, because of its political environ- ries the model assesses 70 indicators EIU forecasts for the prospective period
ment, its policy on foreign investment, its (ranging from 4 indicators for foreign trade (2001-05). The other indicators are quali-
liberal foreign trade and exchange regime, and exchange regimes to 11 for the po- tative (such as quality of the financial
and the availability of finance, according litical environment) affecting opportunities regulatory system) and are drawn from
to the latest business ranking of the Lon- for (or against) the conduct of business a range of data sources and business
don-based Economist Intelligence Unit for the last five years and the next five. surveys adjusted by the EIU for 1996-
(EIU), published in mid-August. 2000. All forecasts for the qualitative in-
Almost half the indicators are based on dicators covering 2001-05 are based on
All regions are expected to improve their quantitative data (such as GDP growth), EIU assessments.
operating environment over the next five
years, although their relative attractive-
ness will remain unchanged, predicts the Independent Mind
EIU. The biggest improvement will come
in Central and Eastern Europe, in part
reflecting the enormous scope for im-
provement from a weak starting position. _
Ratings of operating environments are
expected to advance from "moderate" to
"good" for Hungary (now ranked 27 out
of 60 major countries surveyed), Poland
(30), the Czech Republic (32), and
Slovakia (35) from poor to good. At the
bottom of the scoreboard, operating en-
vironments are expected to advance from
very poor" to "poor" forAzerbaijan, Viet-
nam, and Romania. The business envi-
ronment in Ukraine-ahead only of
Nigeria and Iran-is expected to remain
very poor."
The EIU's global business rankings
model measures the quality or attrac- - t -
tiveness of the business environment and
its key components in 60 countries, gen-
erating scores and rankings for the past
five years and the next five. Using EIU
economic forecasts and assessments
of likely business and political develop-
ments, the model examines 10 catego-
ries: the political environment, the
macroeconomic environment, market
opportunities, policies on free enterprise
and competition, policy on foreign invest- From the Hungarian Daily Nepszabadsag
© 2001 The World BankiThe William Davidson Institute TRANSIrION, July-August-September 2001 5
Business Environment Scores and Ranks
1996-2000 2001-05 Change in Change Qualitative assessment
Economy Total score Rank Total score Rank total score in rank 1996-2000 2001-05
Netherlands 8.67 2 8.84 1 0.17 1 verygood very good
United States 8.72 1 8.80 2 0.08 -1 very good very good
United Kingdom 8.62 4 8.75 3 0.14 1 verygood verygood
Canada 8.59 5 8.74 4 0.16 1 very good very good
Switzerland 8.40 7 8.65 5 0.25 2 very good very good
Ireland 8.30 8 8.59 6 0.29 2 very good very good
Finland 8.27 9 8.57 7 0.30 2 very good very good
Singapore 8.47 6 8.56 8 0.09 -2 very good very good
Sweden 8.11 10 8.52 9 0.41 1 verygood verygood
Hong Kong, China 8.64 3 8.51 10 -0.13 -7 verygood verygood
Germany 7.93 13 8.51 11 0.58 2 good verygood
Denmark 8.00 12 8.50 12 0.50 0 good verygood
Belgium 7.92 14 8.30 13 0.39 1 good very good
Australia 7.89 15 8.27 14 0.38 1 good very good
France 7.76 16 8.26 15 0.50 1 good very good
New Zealand 8.06 11 8.17 16 0.11 -5 verygood verygood
Norway 7.58 18 8.09 17 0.51 1 good very good
Taiwan, China 7.37 21 8.06 18 0.69 3 good very good
Austria 7.59 17 8.04 19 0.45 -2 good very good
Spain 7.42 19 8.00 20 0.59 -1 good very good
Chile 7.40 20 7.88 21 0.48 -1 good good
Italy 6.87 23 7.85 22 0.98 1 good good
Portugal 7.00 22 7.60 23 0.60 -1 good good
Israel 6.75 25 7.54 24 0.79 1 good good
Korea, Rep. of 6.33 29 7.38 25 1.04 4 moderate good
Japan 6.73 26 7.36 26 0.64 0 good good
Hungary 6.42 28 7.26 27 0.83 1 moderate good
Thailand 6.29 30 7.25 28 0.97 2 moderate good
Greece 6.12 33 7.15 29 1.03 4 moderate good
Poland 6.22 31 7.07 30 0.85 1 moderate good
Mexico 6.09 34 7.02 31 0.93 3 moderate good
Czech Republic 6.18 32 7.01 32 0.83 0 moderate good
Argentina 6.54 27 6.99 33 0.44 -6 good good
Malaysia 6.80 24 6.88 34 0.08 -10 good good
Slovakia 5.46 37 6.57 35 1.11 2 poor good
SouthAfrica 5.51 36 6.49 36 0.98 0 moderate moderate
Brazil 5.44 38 6.44 37 1.00 1 poor moderate
Philippines 5.52 35 6.44 38 0.92 -3 moderate moderate
India 5.19 45 6.42 39 1.23 6 poor moderate
Peru 5.40 41 6.17 40 0.77 1 poor moderate
China 5.33 44 6.15 41 0.82 3 poor moderate
Saudi Arabia 5.43 40 6.13 42 0.70 -2 poor moderate
Colombia 5.35 43 6.12 43 0.77 0 poor moderate
Egypt 5.44 39 6.07 44 0.64 -5 poor moderate
Sri Lanka 5.02 47 5.97 45 0.95 2 poor moderate
Turkey 5.35 42 5.94 46 0.59 -4 poor moderate
Bulgaria 4.03 56 5.94 47 1.91 9 very poor moderate
Indonesia 5.15 46 5.80 48 0.64 -2 poor moderate
Kazakhstan 4.30 52 5.59 49 1.29 3 very poor moderate
Russia 4.12 53 5.49 50 1.36 3 very poor poor
Ecuador 4.06 55 5.39 51 1.33 4 very poor poor
Azerbaijan 4.35 50 5.28 52 0.92 -2 very poor poor
Venezuela 4.73 48 5.27 53 0.54 -5 very poor poor
Vietnam 4.48 49 5.25 54 0.78 -5 very poor poor
Romania 4.10 54 5.24 55 1.14 -1 verypoor poor
Algeria 4.02 57 5.07 56 1.05 1 very poor poor
Pakistan 4.33 51 4.96 57 0.63 -6 verypoor verypoor
Ukraine 3.27 59 4.95 58 1.69 1 very poor very poor
Nigeria 4.01 58 4.64 59 0.63 -1 very poor very poor
Iran 3.24 60 4.20 60 0.96 0 very poor very poor
Average 6.28 - 6.98 - 0.70 - -
Median 6.25 - 7.04 - 0.79 -
Qualitative grades are assigned as follows: more than 8, very good; 6.5-8, good; 5.5-6.4, moderate; 5-5.4, poor; less than 5, very poor.
Source: Economist Intelligence Unit.
l3 TRA\SIrIION, July-August-September 2001 The World Bank/The William Davidson Institute © 2001
XBank of Finland
Institute for Economies in Transition
BOFIT Publications
(hftp://www.bo f.filbo fitl)
Nonresidents and the Russian Financial Crisis of 1998
by Alexei Medvedev
Traditional View of the Russian Crisis sary volatility to prices and exacerbated the government's fi-
nancial distress.
The Russian crisis of August 1998 is usually attributed to
purely domestic causes that surfaced following an almost 60 An empirical study by the author found that nonresidents were
percent decline in world oil prices in 1997-98. The fall in ex- indeed behind the major contractions in the T-bill market in
port revenues had a strong impact on incomes throughout the late 1997 and 1998 (table 1). Nonresident outflows from the
economy and, ultimately, on government finances. Federal market noticeably exceeded domestic outflows during all four
budget revenue fell sharply even in nominal terms in the spring major episodes, particularly the near collapse of the market
of 1998, while the stock of short-term T-bills (GKOs) grew in May 1998. Analysis revealed that this trend had a funda-
rapidly. Thus the earlier state policy of extensive domestic mental origin and did not merely reflect differences between
borrowing, especially in 1996, and the added bad luck of unfa- leading foreign and Russian market participants. Moreover,
vorable external conditions were the clear determinants of the major market contractions associated with external events
Russia's debt crisis. show that Russia suffered from contagion. This contagion was
probably related to a "wake-up call" effect, whereby a crisis in
Nonresidents in the T-Bill Market one country induces investors to reassess market fundamen-
tals in others. Empirical studies on the transmission of crises
Faced with the high cost of domestic debt service (almost 5 suggest that weaker economies are more vulnerable to con-
percent of GDP in 1996), the government sped up liberaliza- tagion, and this seems to apply to Russia in 1998.
tion of the T-bill market. Restrictions on nonresidents' partici-
pation were gradually softened, then eliminated at the The uncertainty over the July 1998 emergency loan from the
beginning of 1998. Nonresidents' share of the market (exclud- International Monetary Fund (IMF) resulted in large swings in
ing the central bank) had more than doubled by the end of foreign flows to the T-bill market. The IMF loan was intended
1997, to 40 percent. The Russian market benefited from the to boost confidence among foreigners, and for a while it had
inflow in 1997, with the interest rate on short-term debt (GKO) the expected effect. After the loan was announced, $1.7 bil-
reaching its historical floor of 13 percent in August 1997, a lion of nonresident money flowed in and The government man-
time when consumer price inflation was at an annual 15 per- aged to restructure part of its short-term debt but failed to
cent. control the situation in the longer term. One possible reason
that the market failed to recover after the loan was that the
The behavior of nonresident investors had its first adverse ef- financing was insufficient. Although the promised financing
fect in late autumn of 1997, when the Asian crisis was having was large (more than $20 billion), its timing was conditional
a global impact. The central bank intervened heavily in the T- and did not keep pace with the depletion of official foreign
bill market in an attempt to hold down interest rates. Contem- exchange reserves (about $1 billion a week in August).
poraneous market analysis suggests that nonresidents were
among the first to start selling T-bills and thereafter were be- Did Russia Benefit from Financial Liberalization?
hind all significant price fluctuations. This view seemingly con-
tradicts the traditional view that the Russian crisis was due to Even if foreign investors contributed strongly to the contrac-
purely domestic and nonfinancial external factors. One might tions in the T-bill market, that does not mean that Russia lost
suspect that the presence of nonresidents added unneces- from financial liberalization. Russia benefited from foreign in-
D 2001 The World Bank/The William Davidson Institute TRANSITION. July-August-September 2001 *
flows during most of 1997, when the costs of borrowing fell Table 1. The Path to Russia's August 1998 Crisis:
significantly. Later, however, the T-bill market suffered from Treasury Bill Interest Rates and Capital Outflows
several bouts of selling by nonresidents. The empirical evi- GKO interest Capital oufflows
dence can support two claims: rate (percent) (US$ billions)
Non-
Period Event Before After residents Residentsa
* Nonresidents played a decisive role in the 1998 debt crisis,
but they actually delayed a crisis that would have happened Nov.97 Asian crisis 18 37 3.0 1.8
earlier without their entry. Jan. 98 Indonesian currency
crisis 30 44 1.1 0.8
May 98 Indonesian currency
* Nonresidents played no decisive role in the crisis, which crisis 30 80 1.9 0.2
was fully attributable to domestic factors and unfavorable ex- Jul. 98 Uncertainty over
ternal conditions. IMF loan 50 120 1.1 0.2
a. Dealers only (licensed professional investors).
Both claims imply that nonresidents cannot be blamed for the Source: The author.
1998 debt crisis, although they had an unambiguous effect on
its timing. This conclusion leaves unresolved the larger issue Alexei Medvedev is senior economist at the Central Bank of
of what general role nonresidents played. But the study shows Russia. This is an unabridged version of his article published in
that the Russian experience clearly demonstrates the costs BOFIT's Russian Economy-The Month in Review, July 9, 2001.
and benefits of financial liberalization. It has also been published as BOFIT Discussion Paper 6/2001.
Foreign Direct Investment in the Baltics
by Tuuli Juurikkala
_ uumulative inflows of foreign direct investment (FDI) in pean economies. They ask, for example, what effects, if any,
the three Baltic countries reached $2 billion in 1999. FDI has had on economic growth. Countries courting FDI,
While FDI flows to Latvia and Lithuania started later including the Baltics, have made certain policy decisions
than those to Estonia, they have recently outpaced Estonia's. in an effort to create attractive investment climates. Stud-
At the end of 2000, FDI stocks stood at $2.6 billion in Esto- ies of spillover effects tend to validate such policies, finding
nia, $2.3 billion in Lithuania, and $2.1 billion in Latvia. positive effects on local production, including pressure to
raise quality and deliver products on time. These positive
High Relative Importance of Foreign Direct Investment spillover effects are strongly displayed in subcontractor re-
lationships between local suppliers and foreign-owned com-
Measured as a share of GDP, FDI has been relatively sub- panies.
stantial in all three Baltic countries. Estonia ranks third in FDI
per capita in Eastern Europe, after Hungary and the Czech From Privatization toward Greenfield Investment
Republic. FDI flows to Estonia and Latvia were equal to al-
most a third of gross domestic investment in 1997-99. One of the main factors behind the FDI inflows into Estonia,
Latvia, and Lithuania has been the privatization of formerly
FDI has also been significant for current account financing in state-owned companies. Privatization started soon after inde-
the Baltics. In 1997-99, FDI equaled 86 percent of Estonia's pendence and is now essentially complete except for large
current account deficit, 75 percent of Latvia's, and 51 percent transactions in infrastructure (especially the energy sector).
of Lithuania's. In Eastern Europe, FDI's significance for fi- Thus the focus of FDI is rapidly shifting to greenfield invest-
nancing the current account was highest in the Czech Re- ment. Denmark, Finland, and Sweden (along with Germany
public and Hungary and lowest in the Russian Federation, and the United States) have all established a strong investor
where capital imports in the form of FDI failed even to match presence in the Baltics. The leading sectors receiving FDI
the rate of capital flight. have been manufacturing, trade, transport and communica-
tions, and financial intermediation. Subcontracting plays a
Nevertheless, some commentators have questioned the ex- particularly large role in the electronic equipment and textile
tent of FDI's presumably positive effects on Eastern Euro- industries.
M TRA,si-ttON, July-August-September 2001 The World Bank/The William Davidson Institute © 2001
Competition or Cooperation? which have probably contributed to this year's increase in
FDI.
Interestingly, while all three Baltics use similar arguments to
attract FDI, they have done little to coordinate their strate- The harmonization of laws and regulations preceding acces-
gies. The standard advantages they list include the availabil- sion to the European Union makes the Baltics all the more
ity of low-cost skilled labor, good geographic location, and attractive for FDI. Over the long term, most foreign investment
political stability. But for the international investor, the rea- will probably flow from neighboring EU countries. Indeed, many
sons for investing in Estonia, Latvia, or Lithuania are essen- firms in these affluent neighbors already consider the Baltics
tially indistinguishable from those for investing in any country part of their home market.
in Central and Eastern Europe.
Tuuli Juurikkala is a researcher at the Helsinki School of Eco-
Recently, however, Estonia seems to have recognized the nomics. This is an unabridged version of her article published
need to distinguish itself from others competing for FDI. Eight in BOFIT's Baltic Economies-The Quarter in Review, August
months ago, it introduced tax breaks for reinvested earnings, 17, 2001. Forthcoming as BOFIT Discussion Paper 6/2001.
BOFIT Discussion Papers
Jarko Fidrmuc, The Endogeneity of Optimum Currency be toward self-employment. These results imply that the
Area Criteria, Intraindustry Trade and EMU Enlargement, Russian secondary labor market can provide long-term
DP 8/2001, 28 pp. benefits for the economy as an incubator for new busi-
nesses.
Mark De Broeck and Torsten Slok, Interpreting Real Ex-
change Rate Movements in Transition Countries, DP 7/ Laura Solanko, Fiscal Competition in Transition Econo-
2001, 41 pp. mies, 2001, DP 4/2001, 39 pp.
Several transition economies have experienced strong real Ville Kaitila, Accession Countries' Comparative Advan-
exchange rate appreciations. This paper tests the hypothesis tage in the Internal Market: A Trade and Factor Analy-
that these appreciations reflect underlying productivity gains sis, DP 3/2001, 45 pp.
in the tradable sector. Using panel data for 1993-98, it finds
clear evidence of productivity-driven exchange rate movements This paper analyzes trade between Central and Eastern Eu-
in Central and Eastern Europe and the Baltics. Transition ropean (CEE) countries and the European Union during 1993-
economies, particularly the EU accession countries that have 98. The comparative advantages of CEE countries have
begun to catch up, can expect to experience further produc- developed in quite different directions. Some countries have
tivity-driven real exchange rate appreciations. Evidence from evolved comparative advantage in industries requiring much
a large cross-section of non-transition economies suggests skilled labor, while others have moved in the opposite direc-
that catching up by 1 percent in productivity is associated tion. This differentiation is also reflected in degrees of capital
with a 0.4 percent real appreciation. intensity.
Alessandra Guariglia and Byung-Yeon Kim, The Dynamics Malgorzata Markiewicz, Quasi-fiscal Operations of Cen-
of Moonlighting: What Is Happening in the Russian In- tral Banks in Transition Economies, DP 2/2001, 37 pp.
formal Economy? DP 5/2001.
This paper reviews issues associated with quasi-fiscal opera-
This paper uses rounds 5-8 of the Russian Longitudinal tions of central banks in a sample of countries in Central and
Monitoring Survey to analyze the dynamics of moonlight- Eastern Europe and the former Soviet Union. Transparency in
ing by the working-age population. It finds that moonlight- fiscal and monetary accounts is at risk if the central bank
ing is transitory and is generally associated with career undertakes quasi-fiscal operations and the government falls
shifts. Survey respondents expressing a desire to switch short of providing full coverage of fiscal operations. The lack of
jobs in the past are more likely to moonlight in the present transparency in fiscal accounts of transition countries war-
and to switch jobs in the future. The career shifts tend to rants serious concern.
© 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 A
Enforcing Agribusiness Contracts
by Hamish R. Gow and Johan F. M. Swinnen
The May 2000 issue of Transition included a special section on foreign investment in emerging and transition economies.
While many important effects of foreign investment were discussed, there was little discussion of vertical spillover effects. In
our studies of Central and Eastern Europe and the former Soviet Union, we find that foreign direct investment (FDI) has
increased access to technology, inputs, and capital and spurred institutional innovations for private contract enforcement.
B eneficial effects of foreign invest- firms' already severe cash flow and prof- sell the grain to ensure payment. In Bul-
ment can spill over to domestic itability problems. Not just suppliers suf- garia a multinational input supplier, in
suppliers and customers in vari- fered; ultimately everyone ended up collaboration with a specialized com-
ous forms, such as finance and invest- worse off, as suppliers, expecting more pany, got involved in grain marketing in
ment assistance. In addition to reducing delays in the future, cut back on invest- order to ensure payments from the farms
liquidity constraints and improving ac- ments. As a result, supplies to compa- to which they had delivered inputs.
cess to finance, these assistance pro- nies declined, both in quantity and in * Form special purpose vehicles
grams are often part of innovative quality. Meanwhile changes in property (SPVs), companies owned jointly by the
enforcement mechanisms that prevent rights, restructuring, and macroeco- processor, input providers, and the bank
breaches of or "just" delays in contracts, nomic reforms affected farms' operation financing the project. The contract be-
which are widespread in many transi- and hencethevolumeandqualityoftheir tween the SPV and the farms includes
tion economies. In the absence of ef- output. output, inputs, and credit. An important
fective public contract enforcement advantage of these arrangements is that
mechanisms, such private mechanisms Foreign companies have tried to over- the partners in the SPV share the risk of
can be successful substitutes for en- come these contracting problems by in- contract breach. In Hungary a group of
forcing contracts and providing credible troducing innovations in contracting with sheep farmers set up a producers' co-
incentives for investments. The effect of their suppliers. In agribusiness, foreign operative through which they participated
this FDI-induced vertical contracting on investment has taken place in the food in an SPV-like joint company. The asso-
output, yields, and quality can be dra- distribution and the processing indus- ciationgavethemmorebargaining power
matic. tries, with foreign firms and banks sup- with other partners. just as a marketing
plying farms with inputs (such as or input purchasing cooperative does in
Under the communist regime, produc- fertilizer, pesticides, and machinery) and a traditional environment.
tion and processing were centrally credit. Some of the strategies these
planned and vertically integrated. The firms have used include the following: Through these schemes, food proces-
central authority enforced contracts, and sors increase the likelihood of their hon-
transacting parties faced a low (or zero) * Guarantee timely payments for farm- oring a contract, thereby rendering their
probability of facing delays. ers' products based on prespecified promises to do so more credible. As a
pledges of quality. result, farms are more likely to increase
Reforms caused several institutional * Introduce input provision programs by contract-specific investments and avoid
changes that lead to contract breaches. helping cash-starved farms obtain easier breaching contracts.
Privatization and restructuring split ver- access to inputs (seeds, fertilizer, chemi-
tically integrated chains into many au- cals, even bank credit). Inputs are often Hamish R. Gow is assistant professor
tonomous enterprises. Macroeconomic prepaid for and direct loans extended. at the University of Illinois at Urbana-
liberalization caused dramatic changes * Provide payment guarantees to input Champaign, United States, and a re-
in prices and financial shocks that, com- producers or banks for contract-related search associate at the Policy Research
bined with the absence of appropriate purchases. Group, Katholieke Universiteit Leuven,
contract enforcement mechanisms, led * Combine input and finance programs Belgium (hgow@uiuc.edu). Johan FM.
to delays throughout the economy, of- with technical support and extension Swinnen is an economic adviser with the
ten in the form of long delays in pay- programs. In Ukraine, for example, in European Commission and associate
ment for delivered products. With high return for providing agricultural machin- professor at the Policy Research Group,
inflation, the effects of these payment ery, a multinational company received Katholieke Universiteit Leuven, Belgium
delays were significant, exacerbating the right to harvest, transport, store, and (jo.swinnen@agrkuleuven.ac.be).
M TRANSI IION, July-August-September 2001 The World Bank/The William Davidson Institute & 2001
World Bank\1MF\EBR"vD Agenda
Nicholas Stern Calls for Changes to In fiscal 2001, IBRD loan commitments The quality of the region's portfolio
Global Trade Architecture amounted to $2.2 billion for 27 projects. broadly improved in the past fiscal year.
Some $539 million in IDA credits sup- The share of projects at risk fell from 17
The international communityshould make ported another 27 projects. The decline percent to 12 percent, and the share of
trade a more powerful tool for poverty re- in IBRD lending is due largely to delays commitments at risk from 30 percent to
duction by changing the global trade ar- in finalizing several loans to Turkey be- 16 percent. And only 10 percent of the
chitecture, argued Nicholas Stem, World cause of the economic crisis and the projects completed in fiscal 2001 were
Bank senior vice president and chief launch of a new reform program. These rated unsatisfactory with respect to
economist, at the opening of the new re- loans were approved at the start of fiscal reaching their development objectives,
search laboratory at the London School 2002. IDA lending, by contrast, increased down from 17 percent the year before.
of Economics in mid-July. He said that in all eligible countries of the region, with
countries can best achieve the goals of a particularly strong upswing in Bosrnia- World Bank and IMF Review Poverty
higher incomes, better education, and Herzegovina. Reduction Strategies
greater health and security for the poor
through a two-pillar development strategy: In fiscal 2001, IBRD disbursements The International Monetary Fund (IMF)
c Strengthen the investment climate or ($1.54 billion) shrank to half their level in and the World Bank invite public partici-
business environment to increase pro- the previous fiscal year ($3.2 billion). IDA pation in a comprehensive review of their
ductivity and create more jobs. disbursements ($230 million) also fell by Poverty Reduction Strategy. Launched
* Empower poor people to participate in half. In addition, the Bank gave $52.4 in 1999, the Poverty Reduction Strategy
growththroughhumandevelopmentand million in grants and $11.7 million in Papers(PRSPs)aredocumentsinwhich
social protection. blended (IBRD and IDA) assistance. governments outline their strategy for
Since 1990, the Bank has committed promoting growth and reducing poverty
Stern called on the international commu- $18 billion to borrowers in Europe and and the external financing needed. Rep-
nity to launch a "development round" fo- Central Asia. resentatives of the civil society, the World
cused on improving market access for
the developing countries and providing Europe and Central Asia Region Announces Operational Results for
assistance that would enable these Fiscal 2001
countries to eliminate internal trade bar- IBRDOIlALendingfor EC4Region irnFrD1 bojntry IUE4rmilicnM
riers, such as inadequate port infrastruc- ... ..... . ....
ture or inefficient customs services. y9bi,rR
Europe and Central Asia: Less Lend- T2jkstn M1 -.
ing and Disbursement, but an Im- 3:7,___
proved Portfolio Rrn2ai
Piobnd .
The downward trend continues in lend- W X-
ing to Europe and Central Asia: in fiscal
2001, new World Bank commitments- :
IBRD loans and concessionary IDA cred- 4g Repit.i.
its-to the countries of the region totaled 1 5zain 4:
$2.7 billion for 54 projects, down from S : ..
$3.04 billion in fiscal 2000 and $5.29 bil- a a 1-
lion in fiscal 1999. Most lending went to .
Turkey ($1 billion), followed by the Rus- belwus - :,
sian Federation (almost $400 million) and PEerajan .4,
Poland ($155 million). Among sectors Area .
across the region, banking and finance _____ 3 _ - . .. - -._
come first (with $853 million), followed 0 20) 400 60J rBW 10u3 1231
by the social sectors and transportation. Source: World Bank.
© 2001 The World BanklThe William Davidson Institute TRANSIIION, July-August-September 2001 3
Bank, and the IMF also participate in the component of a well-functioning state and rule of law. The foundation has also helped
drafting of these documents. By the end an essential ingredient in long-term devel- make the law more accessible by sup-
of 2001, 15-20 countries intend to com- opment." Wolfensohn said that empirical porting public interest law centers around
plete their first strategy papers. The IMF evidence shows a large, significant, and the country.
and World Bank intend to review such is- causal relationship between improved rule
sues as the govemments' role in providing of law and higher income, higher literacy, Closure of World Bank's Budapest
leadership, the involvement of other par- and lower infant mortality. The difference Office
ticipants, coordination between aid donors in per capita income and infant mortality
and recipients, and the extent of support can be about 3 to 1 between a country The World Bank will close its Budapest
provided by IMF and Bank staff. (For more with relatively good legal and judicial insti- Regional Office in July 2002, World Bank
details go to http://www.worldbank.org/ tutions and those with inadequate institu- Country Director Roger Grawe said in an
poverty/strategies/.) tions, he said. interview with Reuters. Responsibility for
overseeing the Bank's activities in the
World Bank Launches New Environ- Addressing more than 350 judges, parlia- Czech Republic, Hungary, Moldova,
ment Strategy mentarians, scholars, lawyers, and gov- Slovakia, and Slovenia will shift to its War-
ernment and civil society representatives saw office. The move is a compliment to
Having moved from a "do no harm" ap- from 75 countries, the World Bank presi- Hungary's successful transition to a mar-
proach to the environment in the 1970s to dent said that the rule of law was essen- ket-based economy and reflects the
targeted, long-term environmental assis- tial in fighting corruption, empowering the country's aspiration to become a World
tance today, the World Bank has devel- poor-especially women-and ensuring a Bank donor rather than a borrower. Since
oped a broad environment portfolio worth properly functioning economy. "The rule of Hungary joined the World Bank 20 years
some $18 billion. In mid-July the World law needs to be improved in developing ago, the Bank has pledged some $4.2
Bank's Board endorsed a new environment and transition countries to be able to deal billion to the country, $500 million of which
strategy, one that should ensure that eco- most effectively with three key dimensions is still due for repayment. World Bank fi-
nomic growth does not come at the ex- of poverty-powerlessness, vulnerability, nancing helped overhaul the ailing state
pense of people's health and will not and lack of opportunity. The World Bank's pension system in 1998, privatize the
worsen pollution or degrade natural re- first involvement with legal reform focused banking sector, and boost education.
sources and ecosystems. The World on commercial law and on institutions
Bank's strategy spells outthree objectives: such as bank regulatory commissions. "After several false starts in moving to a
* Improving the quality of life-people's But over the past decade the focus has market-based economy, Hungary in the
health, livelihood, and vulnerability-as expanded to place legal reform at the cen- mid-1 990s developed sound fiscal policies
affected by environmental conditions. ter of the fight against poverty," he said. and began implementing privatization and
* Improving the quality of growth-by structural reforms," Grawe said. Although
supporting policy, regulatory, and insti- World Bank Supports Judiciary in "there was a lot of backsliding in the be-
tutional frameworks for sustainable en- Transition Economies ginning," Hungary achieved successes in
vironmental management and promoting privatizing the financial sector, improving
sustainable private development. In Armenia and Georgia, a variety of do- the legal system's efficiency, and increas-
* Protecting the quality of the regional nors, including the World Bank, are as- ing transparency in government. Grawe
and global commons, such as forests, sisting local judicial reform. The reforms said that the Czech Republic and Slovakia
biodiversity, the climate, and water re- include establishing a new court adminis- lagged behind Hungary because of de-
sources. tration system, strengthening the enforce- lays in privatization and a lack of trans-
ment function, upgrading the institutes parency in both the public and the private
President Wolfensohn: Rule of Law responsibleforjudicial training, and launch- sector. "In those countries, some of the
Central to Fighting Poverty ing a public information campaign. The fundamentals and transformation reforms
World Bank is also assisting new judicia- that were needed were postponed. Only
In St. Petersburg, Russia, in early July, ries in Bulgaria, Croatia, and Kazakhstan. now are they happening," Grawe said.
at the Second Global Conference on Law In Albania and Georgia, the Bank has sup-
and Justice, World Bank President ported the recertification of judges. And in IMF Urges Prague to Ease Monetary,
James D. Wolfensohn called on govern- Russia, a Bank loan has funded the Rus- Tighten Fiscal Policy
ments and the international community sian Foundation for Legal Reform, which
to recognize that "an effective legal and has been instrumental in developing text- The Czech Republic must find the cor-
judicial system is not a luxury, but a key books and educating the public about the rect balance in its economic policy to
* TRANSITION, July-August-September 2001 The World Bank/The William Davidson Institute © 2001
preserve its current economic recovery, refinance payments to the Fund in 2003. cial progress, notes a new IFC Discus-
the International Monetary Fund said in a The principal debt due to be repaid to sion Paper (no. 43), "Firm Size and the
reportonthecountryreleasedonJuly25. the IMF in 2003 stands at $2 billion. Business Environment: Worldwide Sur-
The Fund's directors agreed that a mod- Annual debt servicing will grow from vey Results," by Beatrice Weder and
erate monetary policy and a stricter fis- $14.3 billion in 2001-02 to nearly $19 Mirjam Schiffer, consultants in IFC's Eco-
cal policy would be the right mix. Fiscal billion in 2003. The next critical years nomics Department. The vast majority of
policyshouldnolongerstimulatedemand, are 2005, when payments will reach $16 firms have very small beginnings. Draw-
as the widening fiscal deficit could trans- billion, and 2006, when foreign debt pay- ing on a World Bank survey of 10,000 firms
late into a growing current account defi- ments will reach $14.5 billion, accord- in 80 countries, including the transition
cit. Along with causing a loss of export ing to Nezavisimaya Gazeta. economies, the authors find that small
markets, this trend could undermine eco- firms face steeper obstacles than large
nomic growth in the medium term, the IFC Investment in Russian Brewery ones, suffering from heavy taxes, strict
report says. The Fund urged reforms in Will Facilitate "Responsible Social tax regulations, difficulties in obtaining fi-
the legal and regulatory system, restruc- Drinking Policy" nancing, and inflation.
turing of the corporate sector, and reform
of the pension system. IFC will lend $27 million for a $50 million World Bank Warning: Billions Face
expansion of the brewing company Bravo Threat of Water Shortage
Loan Supports Structural Reforms in International in St. Petersburg, Russia.
Slovakia Additional financing will come from Russian A worldwide water shortage is likely to be-
and European banks. The project will help come severe over the next 25 years, an
The World Bank approved an Enterprise create new jobs, promote the development unprecedented global crisis affecting billions
and Financial Sector Adjustment Loan of small enterprises, and increase tax rev- of people. The World Bank recently reported
(EFSAL) of 200 million euro ($177.3 mil- enues. Itwill aid the transfer of efficienttech- that while today 300 million people live in
lion) for Slovakia, to reinforce the nologies and business management areas with serious to severe water short-
country's financial and corporate sector, techniques relating to marketing and qual- age, in 25 years the number will rise to 3
attract foreign investment, and support ity control, research and development, and billion-almost a third of the world's popu-
stronger economic growth. The loan will transport and distribution systems. The lation. Participants in the recent Stockholm
help finance the restructuring and project will also support the expansion of Water Symposium warned that the latest
privatization of large and medium-size distribution systems, which will mean in- predictions of fresh water availability por-
Slovak banks, improve central bank su- creased opportunities for small private en- tray a bleak future for the next generation.
pervision, settle a large block of bad loans, trepreneurs, and the development by the
and improve bankruptcy legislation. company of an employee training program Figures issued by the International Water
on health, safety, and environmental issues. Management Institute show that Asia and
The EFSAL funds will be released over an And the project will support a "responsible Sub-SaharanAfricawillbethemostseverely
18-month period. The first tranche (60 mil- social drinking policy" to help educate con- affected regions, with the shortage likely to
lion euro) will be deposited in a special ac- sumers and aid the government's efforts to extend well beyond semi-arid and arid re-
count of the Slovak Central Bank in reduce alcohol abuse. According to recent gions. "Urban centers will experience se-
September. The disbursement of the other estimates, the Russian beer market con- vere water shortages, but the rural poor will
two tranches (70 million euro each) will tinues to grow as consumers switch from suffer the most serious consequences,"
depend on Slovakia taking the agreed steps both hard liquor and lower-end beer to pre- Frank Rijsberman, the institute's director,
to back the reforms. The loan is repayable mium Russian beer. The major sharehold- said. "Many already lack access to potable
in 14 years, with payment of principal de- ers in Bravo Holdings Limited are Thor water and to the quantity and quality of
ferred for five years and the interest rate Bjorgolfsson and Magnus Thorsteinsson water needed to grow food and generate
0.25-0.30 percentage point above LIBOR. (Sweden) and the U.S.-based investment income." Increasing demand for water from
fund Capital International. both industry and agriculture is the leading
Russian Government to Resume cause of the projected shortage. Environ-
Talks with IMF Small Enterprises Are Key to Eco- mentalists have warned that water use
nomic and Social Progress, IFC Dis- must be reduced to protect lakes, rivers,
The Russian government intends to re- cussion Paper Notes and wetlands. In China, with 7 percent of
sume negotiations with the International the world's fresh water and 22 percent of
Monetary Fund in 2002 on a medium- The creation and development of small its population, 300 large cities already
term program in order to get a loan to enterprises are key to economic and so- face serious water shortages.
©0 2001 The World Bank/The William Davidson Institute TRANSIFION, July-August-September 2001 X
Conference Diary
For the Record September 15, 2001, Resort Issyk-Kul, Information: Nandini Gupta, assistant
Issyk-Kul Region, Kyrgyz Republic professor at the William Davidson Insti-
The Third Annual Conference on Fi- tute. Email: nandinig@umich.edu, Web
nancial Market Development in Organizer: Union of Kyrgyz Apprai- site: www.wdi.bus.umich.edu.
Emerging and Transition Economies sers, State Committee of Kyrgyz
Republic on State Propery Manage- Community Mobilization for Self-
This conference, with funding from the ment, Russian Society of Appraisers, Help Group Formation
Hong Kong University of Science and Belarussian Society of Valuers, Chem- September 21-28, 2001, Varanasi, India
Technology and the William Davidson In- onics International, and Corporate Tech-
stitute, and in cooperation with the nologies Center. (Languages: Kyrgyz, Achievingthemajorobjectiveofself-reli-
Amsterdam Center for International Fi- Russian, and English.) ance and sustainability for an income
nance Research (CIFRA) at the Univer- Topics: Globalization of professional generating and microenterprise develop-
sity of Amsterdam and the International valuation activity and standards, prob- ment program requires an effective link-
Review of Finance, took place in Hong lems of valuation techniques in countries age with a microcredit and savings
Kong (China) on June 28-30, 2001. Ten of the Commonwealth of Independent mechanism. This interplay between the
papers were presented, on topics rang- States (CIS) and ways of solving them, two subsystems of socioeconomic de-
ing from financial crisis in Asia and the educational and scientific research fields velopment has been particularly smooth
Russian Federation to the role of global- to valuation activity, property approach and effective in the case of self-help
ization in firms' financing choices. All the for valuation of enterprises in the CIS, groups. This course aimed to develop the
papers will be available as Working Pa- and valuation as one of the main bases competence and skills needed to train
pers on the William Davidson Institute Web of corporate management. others to organize self-help groups. The
site. (http://www.wdi. bus.umich.edu). Information: Dr. Nikolai Trifonov, Co- course enabled participants to learn ca-
ordination Council for Valuation in pacity building skills and networking to
Scientific-Practical Methods of Prop- CIS. Tel.: +375 29 6776776; email: encourage microenterprise creation.
erty Valuation. Further Development guild@user. unibel. by. Information: Aseed-Asia Office, Devel-
of Valuation Activities opment Manager, C-8/ 8007, Vasant
September 14, 2001, Resort Issyk-Kul, India: Ten Years of Economic Reforms Kunj, New Delhi-110071, India. Tel/fax:
Issyk-Kul Region, Kyrgyz Republic September 21-23, 2001, University of 91-11-6130635, 6130242, 6896151;
Michigan, Ann Arbor email: npsaseed@nda. vsnl.net.i.
Organizer: Union of Kyrgyz Apprai-
sers, State Committee of Kyrgyz This conference provided increased mo- forthcoming
Republic on State Propery Manage- mentum and visibility to India-related re-
ment, Russian Society of Appraisers, search in North America by bringing International Conference: Institu-
Belarussian Society of Valuers, Chem- together scholars whose empirical work tional and Organizational Dynamics
onics International, and Corporate Tech- can collectively shed light on emerging in the Post-Socialist Transformation
nologies Center. (Languages: Kyrgyz, patterns in the Indian economy and po- January 25-26, 2002, Amiens, France
Russian, and English.) litical system. Along with several young
Topics: Valuation and membership of the economists and business scholars, this Organizers: Le Centre de recherche sur
Kyrgyz Republic in the World Trade Orga- conference featured a number of senior l'industrie, les institutions et les
nization, valuation of water resources and researchers, including John Sutton of systbmes economiques d'Amiens
other natural wealth, valuation of the land the London School of Economics, Arvind (CRIISEA), University of Picardie; and
and adaptation of current methods to the Panagariya of the University of Maryland Organisation et efficacit6 de la produc-
conditions in the Kyrgyz Republic, results and the Asian Development Bank, and tion (OEP), University of Marne-la-Vall6e,
of the pilot project on city lands valuation, Abhijit Banerjee of the Massachusetts with the support of European Associa-
and peculiarities of the valuation for inves- Institute of Technology. tion of Comparative Economic Studies
tors and for mortgage crediting. Topics: Growth of the information technol- (EACES), East-West Network and East-
ogy sector, relative effect of privatization, West Journal of Economics and Busi-
Globalization of Valuation Activity, business groups, financial sector reforms, ness, Centre Interuniversitaire d'Etudes
International Congress of Appraisers and the role of credit. Hongroises, University La Sorbonne
*m TRANSrIION, July-August-September 2001 The World Bank/The William Davidson Institute ©C 2001
nouvelle. (Languages: English, some All papers accepted for presentation will be within-country spatial inequality and its
workshops in French.) published in CD-ROM conference proceed- determinants, especially during the in-
Topics: Post-socialist transformation: ings. Selected papers will be published in creased globalization of the last two de-
organizational, institutional, and sys- a special issue of the East-West Joumal cades. A broad view is taken of inequality,
temic approaches; the state and the of Economics and Business (refereed). covering the distribution of such variables
new social compromise; monetary and Authors of accepted papers will be informed as economic activity, economic structure,
financial institutionalization; nature, during the first week of October 2001. population, income, social indicators, in-
boundaries of the firm, and corporate frastructure, and public expenditure. While
governance; networks, entrepreneur- Spatial Inequality and Development the main focus is on empirical analysis of
ship, and industrial cooperation, insti- Conference recent history, contributions that concep-
tutional dynamics of the regional June 27-29, 2002, London School of Eco- tualize the measurement of spatial inequal-
integration (EU, CIE, Far Eastern Asia); nomics, London, UK ity or analyze its evolution in a longer
foreign investment: organizational and histoncal frame will also be considered.
institutional impact. Organizers: Cornell University, London
School of Economics, and World Insti- The papers presented at the conference
The transformation of former socialist tute for Development Economics Re- will be collected in a volume edited by
economies entailed new organizational search (WIDER). Professor Ravi Kanbur, Cornell University,
dynamics and the emergence of new in- and Professor Tony Venables, London
stitutions. At the origin of sometimes new Amid growing concern about increasing School of Economics, and published by
and more or less stable social forms, inequality, the spatial dimensions of in- a leading academic press. Decisions on
these mechanisms of collective action equality have begun to attract consider- papers accepted for presentation will be
deeply influenced the specific and the able policy interest. In China, India, communicated by end December 2001.
heterogeneous trajectories of the differ- Mexico, Russia, and South Africa, as Information: Abstracts (or, better, com-
ent transitions. After the redistribution of well as in most other developing and plete drafts) should be sent by Novem-
property rights, the implementation of a transition economies, there is a sense ber 30, 2001, to Ravi Kanbur, Comell
new legal and regulatory framework, the that the spatial and regional inequality University 309, Warren Hall, Ithaca, NY
sometimes problematic consolidation of of economic activity, incomes, and so- 14853, U. S.A.. Fax: 607 255 9984; email:
financial systems, and enterprise re- cial indicators is on the rise. sk145@cornell.edu.
structuring, former and new actors
(nomenklatura, foreign investors, small Spatial inequality is a dimension of over- Corporate Governance, Stakeholder
entrepreneurs, industrial groups, banks, all inequality, but it has added signifi- Accountability, and Sustainable Peace
state agencies, international organiza- cance when spatial and regional divisions November 2-4, 2001, University of Michi-
tions, employees) take part in the re- align with political and ethnic tensions gan, Ann Arbor
definition and the sharing of powers. to undermine social and political stabil-
They establish relations and form orga- ity. Also important in the policy debate Organizers: William Davidson Institute
nizational fields that constitute labora- is a perceived sense that increasing in- and the Aspen institute's Initiative for
tories for new rules and coordination ternal spatial inequality is related to Social Innovation through Business.
modes. greater openness of economies and to This conference will bring together a se-
globalization in general. lect group of academics, researchers,
Analysis of the emergence, develop- business executives, and NGO leaders
ment, and stabilization of the new or- Despite these important popular and to examine the provocative issue of
ganizational and institutional patterns policy concerns, there is remarkably whether corporate governance affects a
can contribute to an understanding of little systematic and coherent documen- region's sustainable peace.
the factors that influence the growth tation of the facts of what has happened Topics: Concepts of peace, corporate
pace of these economies, their ability to spatial and regional inequality over the purpose and governance, workers' rights
to create virtuous circles, their relations past 10-20 years. Correspondingly, and social justice, corruption and stabil-
with the advanced Western economies there is insufficient understanding of the ity in a technological age, and the busi-
(competitiveness, regional integration determinants of internal spatial inequal- ness of peace.
dynamics, and the like), their monetary ity in a globalizing world. Information: Professor Tim Fort, Uni-
and financial strength, impediments to versity of Michigan Business School.
the transformation process, and the The conference seeks to attract contri- Email: timfort@umich.edu, Web site:
characteristics of the late transitions. butions that document and analyze www.wdi.bus.umich.edu.
t 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 *
New Books and Working Papers
The Macroeconomics and Growth Group regrets that it is unable to provide the publications listed.
World Bank Publications bank.org, jmatesova@worldbank.org, or regularity that the share of income accru-
mshirley@worldbank.org. ing to the bottom quintile does not vary
To receive ordering and price informa- systematically with average income. This
tion for World Bank publications, con- Martin Rama, The Gender Implica- paper documents that empirical regularity
tact the World Bank, PO. Box 960, tions of Public Sector Downsizing: in a sample of 92 countries spanning the
Herndon, VA 20172, United States, tel.: The Reform Program of Vietnam, past four decades and shows that it holds
703-661-1580, fax: 703-661-1501, email: WPS 2573, March 2001, 37 pp. across regions, periods, income levels, and
books@worldbank.org, Web site: http:// growth rates. It also finds that several de-
www.worldbank.org/publications, or visit Men and women may be affected differ- terminants of growth-such as good rule
the World Bank InfoShop in the United ently by the transition from central plan- of law, openness to international trade, and
States, at 701 18th Street, NW, Wash- ning to a market economy and especially developed financial markets-have little
ington, DC (tel.: 202-458-5454). by the privatization and restructuring of systematic effect on the share of income
state-owned enterprises. During the mas- accruing to the bottom quintile. Conse-
World Bank Working Papers sive downsizing in Vietnam in the early quently, these factors benefit the poorest
1 990s, many more women than men fifth of society as much as everyone else.
Robert Cull, Jana Matesova, and Mary were laid off. But in the coming years, To order: Emily Khine, room MC3-347, tel.:
Shirley, Ownership Structure and the women will be less likely to be retrenched 202-473-7471, fax: 202-522-3518, email:
Temptation to Loot: Evidence from in large numbers. Labor redundancies are kkhine@worldbankorg, Web site: http://
Privatized Firms in the Czech Repub- concentrated in male-dominated sectors, econ.worldbank.org. The authors may be
lic, WPS 2568, March 2001, 39 pp. such as mining, transport, and construc- contacted at ddollar@worldbank.org or
tion; redundancies are smaller in female- akraay@worldbank.org.
Using a new data set on privatized firms dominated sectors, such as footwear,
in the Czech Republic, this paper ex- textiles, and garments. Moreover, tem- Patrick Belser and Martin Rama, State
amines how the design of privatization porary and short-term contracts are more Ownership and Labor Redundancy:
affects outcomes. Earlier studies of prevalent in female-dominated sectors, Estimates Based on Enterprise-Level
privatization in the Czech Republic fo- suggesting demand for women's work. Data from Vietnam, WPS 2599, May
cused largely on how the broad distri- 2001, 42 pp.
bution of shares through vouchers may In addition, assistance programs for redun-
have motivated the new owners to strip dant workers have potential gender biases. Privatizing or restructuring state-owned
assets from privatized firms. The paper Separation packages defined as a mul- enterprises may lead to massive layoffs,
finds evidence for static asset stripping, tiple of earnings favor men more, while but the number of redundant workers is
but also for "looting"-borrowing heavily lump-sum packages favor women more. usually unknown beforehand. Analysts
with no intent to repay and using the To order: Hedy Sladovich, room MC2- have used several approaches to predict-
loans for private purposes. This looting 204, tel.: 202-473-7698, fax: 202-522- ing the number of workers who will lose
occurred because the larger privatized 1154, email: hsladovich@worldbank.org, their jobs if state-owned enterprises are
companies had privileged access to Web site: http://econ.worldbank.org. privatized or restructured: drawing on
credit from state-controlled banks, The author may be contacted at mrama international experience, accepting es-
which had little incentive to enforce debt @worldbank.org. timates from current directors of state
contracts. The policy implications are enterprises, and inferring the number of
significant: financial incentives and regu- David Dollar and Aart Kraay, Growth Is redundancies from ad hoc indicators of
lation are as important as ownership Good for the Poor, WPS 2587, April profitability, productivity, or labor cost.
structure in the design of privatization. 2001, 50 pp.
To order: Zeny Kranzer, room MC3-300, This paper estimates labor redundancy
tel.: 202-473-8526, fax: 202-522-1155, When average incomes rise, the aver- in Vietnam by comparing employment
email: zkranzer@worldbank.org, Web age incomes of the poorest fifth of soci- levels across enterprises with different
site: http://econ.worldbank.org. The au- ety rise proportionately. This is a degrees of state ownership. The results
thors may be contacted at rcull@world consequence of the strong empirical suggest that if the state share of capital
g TRA\SIIION, July-August-September 2001 The World Bank/The William Davidson Institute cC 2001
were reduced to zero, roughly half the To manage crises and contagion than servicing small local markets, can
workers in the corresponding enterprises * In the context of sound policies, mobi- supply large firms abroad. Foreign par-
would be redundant. This figure is more lize timely external liquidity of sufficient ticipation-through outsourcing or direct
than 10 times the estimate by the cur- magnitude to restore market confidence. investment-may offer direct access to
rent enterprise directors. The results also * At times of crisis, "bail in" private for- a parent company's global networks.
show a wide dispersion of redundancy eign creditors. When official resources Becoming part of a multinational's pro-
across sectors of activity. are too limited given the magnitude of duction and distribution network is a
To order: Hedy Sladovich, room MC3- the crisis or contagion, and when private cheap way to market products. But the
607, tel.: 202-473-7698, fax: 202-522- creditors are not amenable to coordina- unprecedented globalization of the pro-
1154, email: hsladovich@worldbank.org, tion, some involuntary private involve- duction process has brought the integra-
Web site: http://econ.worldbank.org. ment may be needed too. tion of trade and the disintegration of
Martin Rama may be contacted at * Keep in mind that there is no one-size- production, with deep implications for the
mrama@worldbank.org. fits-all monetary and fiscal stance for international division of labor.
responding to crises and contagion.
George R. G. Clarke, How the Quality Have Central European economies been
of Institutions Affects Technological To address the systemic consequences able to take advantage of the global frag-
Deepening in Developing Countries, of crises and contagion mentation and disintegration of produc-
WPS 2603, May 2001, 22 pp. * Move swiftly to establish domestic and tion and the division of labor? Ten
To order: Paulina Sintim-Aboagye, room international mechanisms for dealing with countries-Bulgaria, the Czech Repub-
MC3-422, tel.: 202-473-8526, fax: 202- the assets and liabilities of nonviable lic, Estonia, Hungary, Latvia, Lithuania,
522-1155, email: psintimaboagye@ banks and corporations. Poland, Romania, Slovakia, and Slovenia
worldbank.org, Web site: http://econ. * Cushion the effects of crisis on low- -have made large strides in readjusting
worldbank.org. The author may be con- income groups through social policies their production structures to international
tacted at gclarke@worldbank.org. to ameliorate the inevitable social ten- markets, mainly in the European Union.
sions associated with adjustment. And trade in industrial products has lost
Masahiro Kawai, Richard Newfarmer, and its pretransition idiosyncratic character.
Sergio Schmukler, Crisis and Conta- To develop an effective regional finan-
gion in East Asia: Nine Lessons, WPS cial architecture But progress in industrial integration with
2610, June 2001, 54 pp. * Improve mechanisms for preventing, the European Union has been uneven.
managing, and resolving crises and con- The first-tier economies (the Czech Re-
Currency and banking crises such as tagion at the regional level in ways con- public, Estonia, Hungary, Poland,
those originating in Mexico (1994), Thai- sistent with improvements in the global Slovakia, and Slovenia) are highly inte-
land (1997), and the Russian Federation financial architecture. grated in their trade in manufactures. The
(1998) tend to be associated and often To order: Emily Khine, room MC3-347, lower-tier economies (Bulgaria, Latvia,
take place together across countries. tel.: 202-473-7471, fax: 202-522-3518, Lithuania, and Romania) are much less
This paper investigates the origins of the email: kkhine@worldbank.org, Web so and, despite relatively low wages,
East Asian crisis, examines its conta- site: http://econ.worldbank.org. The au- have no comparative advantage in as-
gion effects, and discusses the follow- thors may be contacted at mkawai sembly in EU markets. Among first-tier
ing policy recommendations: @worldbank.org, rnewfarmer@world economies, three stand out: Estonia and
bank.org, or sschmukler@worldbankorg. Hungary (in integration into "information
To prevent crises and contagion revolution" markets) and Slovakia (in re-
* Avoid large current account deficits fi- Bartlomiej Kaminski and Francis Ng, structuring its automotive sector).
nanced through short-term private capi- Trade and Production Fragmenta- To order: Lili Tabada, room MC3-333, tel.:
tal inflows. tion: Central European Economies in 202-473-6896, fax: 202-522-1159, email:
* Aggressively regulate and supervise fi- European Union Networks of Produc- Itabada@worldbank.org, Web site:
nancial systems to ensure that banks tion and Marketing, WPS 2611, June http://econ.worldbank.org. The authors
and nonbank financial institutions man- 2001, 61 pp. may be contacted at bkaminski@
age risks prudently. worldbank.org or fng@worldbank.org.
* Put in place incentives for sound cor- Foreign involvement facilitates the trans-
porate finance to prevent high leverage ferofmanagerialandtechnologicalknow- David Dollar and Aart Kraay, Trade,
ratios and overreliance on foreign bor- how, so firms benefit from becoming part Growth, and Poverty, WPS 2615, June
rowing. of a network. Small producers, rather 2001, 45 pp.
C 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 2001
To order Emily Khine, room MC3-347, tel.: the EU Accession Countries: Third movement toward liberal and participa-
202-473-7471, fax: 202-522-3518, email: World Bank/FAO EU Accession Work- tory democracy allows convergence be-
kkhine@worldbank.org, Web site: http:// shop, Sofia, Bulgaria, June 17-20, tween the political and economic
econ.worldbank.org. The authors may be 2000, Technical Paper 504, May 2001, institutions of Asia and the West. There
contacted at ddollar@worldbank.org or 228 pp. is broad agreement among the contribu-
akraay@worldbank.org. tors that effective and sustainable devel-
The papers in this volume consider the opment is multifaceted and not based
World Bank Technical Papers reforms and policy changes required in only on changes in per capita income.
the rural sectors of 10 countries that have
Julian A. Lampietti, Anthony A. Kolb, started the process for accession to the Publishing Houses
Sumila Gulyani, and VahramAvenesyan, European Union-Bulgaria, the Czech
Utility Pricing and the Poor: Lessons Republic, Estonia, Hungary, Latvia, Kluwer Law International Publications
from Armenia, Technical Paper 497, Lithuania, Poland, Romania, Slovakia,
May 2001, 52 pp. and Slovenia. The papers were selected To order: Order Department, Kluwer Law
from presentations at the Third World International, Distribution Centre, PO.
This paper evaluatesArmenia's 1999 in- Bank/FAO EU Accession Workshop, Box 322, 3300AH Dordrecht, The Neth-
crease in electricity tariffs and its poten- heid in June 2000. erlands, tel.: 310-78-654-6454, fax: 310-
tial for improving cost recovery in the 78-654-6474, email: sales@kli.wkap.nl.
water sector, focusing on the accessi- Other World Bank Publications
bility and affordability of services for the Frank Emmert (ed.), European Union
poor. It recommends a two-stage ap- Aldo Baietti, Private Infrastructure in Law, December 2000, 704 pp.
proach to tariff reform. In the first stage, East Asia: Lessons Learned in the Af-
revenues should be increased by ensur- termath of the Crisis, April 2001, 90 pp. In 15 chapters, this book presents 100
ing payment from households that have leading cases covering the most impor-
reliable service but are not paying their Nat J. Colletta, Teck Ghee Lim, and Anita tant areas of law in the European Union.
bills. In the second stage, after collec- Kelles-Viitanen (eds.), Social Cohesion
tion capacity is strengthened, the utility and Conflict Prevention in Asia: Man- Jan Michiel Otto, Maurice V. Polak,
should adjust tariffs, based on improved aging Diversity through Develop- Jianfu Chen, and Yuwen Li (eds.), Law-
service and meter-based billing. ment, 2001, 500 pp. Making in the People's Republic of
China, November 2000, 320 pp.
Rodrigo Chaves, Susana Sanchez, Saul Finance for Growth: Policy Choices
Schor, and Emil Tesliuc, Financial in a Volatile World, A World Bank Palgrave Publishing
Markets, Credit Constraints, and In- Policy Research Report, World Bank and
vestment in Rural Romania, Techni- Oxford University Press, 2001, 200 pp. To order: http://www.palgrave.com/UK.
cal Paper 499. April 2001, 134 pp.
Farrukh lqbal and Jong-l1 You (eds.), De- Peter Naray, Russia and the World Trade
This study evaluates the performance of mocracy, Market Economics, and De- Organization, January 2001, 208 pp.
rural financial markets in Romania based velopment: An Asian Perspective,
on the 1998 rural household, rural enter- May 2001, 200 pp. The economic and social crisis in the
prise, and financial intermediary surveys Russian Federation is responsible for the
along with other official statistical data for This book, which contains papers by delay in its accession to the World Trade
1997. It presents empirical evidence show- such contributors as Francis Fukuyama, Organization (WTO). This book argues
ing that poor access to credit markets Amartya Sen, and Joseph Stiglitz, evalu- that Russia's reformers neglected the
constrains investment by households and ates the extent to which democracy is country's historical legacy, such as its
enterprises. The study recommends a necessary to the achievement of sus- weak legal system and underdeveloped
detailed government strategyto correctthe tainable development in Asia. The book political and economic institutions, and
observed shortcomings of rural financial argues that democracy and markets are that that will complicate the country's
markets and identifies new challenges complementary and that democracy is accession process. The book warns
likely to emerge. intrinsic to development. And it contends against a fundamentalist approach by the
that liberal and participatory democracy WTO, which could isolate Russia politi-
Csaba Csaki and Zvi Lerman (eds.), The encourages development by providing cally and economically, increasing risks
Challenge of Rural Development in legitimacy to reform efforts. Moreover, to the whole world.
m Ti.x\\sIIION, July-August-September2001 The World Bank/The William Davidson Institute 't 2001
Ashgate Publications/Russian and cratic polity after a long period of commu- IRES 2000/2, Central European Univer-
Eastern European Studies nist rule (the Russian Federation and East- sity, International Relations and Euro-
ern Europe) or military authoritarianism pean Studies, Hungary, December 2000,
To order: Ashgate Publishing Com- (Latin America), tracing the rocky course 39 pp.
pany, 2252 Ridge Road, Brookfield, VT of liberal economic policies during the 20th
05036-9704, United States, tel.: 802- century. In the enlargement of the European
276-3162, fax: 802-276-3837, email: Union, the growing diversity of issues,
orders@ashgate.com. Melanie Beresford, Economic Transi- inadequate funding, and scarce admin-
tion in Vietnam: Trade and Aid in the istrative capacity allow only a gradualist
John Bachtler and Ruth Downes (eds.), Demise of the Centrally Planned approach. The success of accession
Transition, Cohesion, and Regional Economy, February 2001, 176 pp. negotiations may be determined much
Policy in Central and Eastern Eu- more by external factors than parties to
rope, July 2000, 300 pp. This book gives a detailed and thorough bilateral talks seem to recognize.
account of how Vietnam's dependence To order: Central European University,
Kristin J. Broderick, The Economy and on Sovietaid during the 1960s and 1970s Nadoru. 9, H-1051, Budapest, Hungary,
Political Culture in New Democra- sustained but ultimately undermined the tel.: 361-327-3080, fax: 361-327-3243,
cies: An Analysis of Democratic Sup- centrally planned economy. Foreign aid email: csabal@ceu.hu.
port in Central and Eastern Europe, provided most of the resources that per-
October 2000, 21 pp. mitted planned industrialization. Yet, as Vladimir Gimpelson and Douglas
in other socialist countries, chronic short- Lippoldt, The Russian Labour Market:
Mike Geppert, Beyond the "Learning ages emerged, encouraging individuals Between Transition and Turmoil,
Organization," December 2000, 200 and enterprises to divert resources to Rowman and Littlefield Publishers,
pp. local uses, particularly when aid supplies United States, 2001.
were cut after 1975.
Rick Simon, Labor and Political Trans- This book examines the plight of Rus-
formation in Russia and Ukraine, De- P.J. Lloyd and Xiao-guang Zhang (eds.), sian workers and employers during the
cember 2000, 208 pp. China in the Global Economy, Febru- first decade of post-Soviet reforms, pro-
ary 2001, 360 pp. viding the first integrated analysis of the
Jeffrey Surovell, Capitalist Russia and Russian labor market. It assesses
the West, October 2000, 320 pp. Frederick Nixson, Bat Suvd, Puntsagdash changes in old jobs at former state en-
Luvsandorj, and Bernard Walters (eds.), terprises and evaluates job creation,
Hans van Zon, Central European In- The Mongolian Economy: A Manual of mostly in private businesses. It also ex-
dustry in the Information Age, August Applied Economics for a Country in amines the evolution of wages and the
2000, 164 pp. Transition, January 2001, 288 pp. availability of social protection to work-
ers. A special section considers the po-
Edward Elgar Publications The contributors to this volume argue that litical economy of labor market policy.
policymakers in Mongolia have exacer- The book draws on a rich array of survey
To order: Sandra Suarez, Edward Elgar bated the painfulness of the country's data and several years of fieldwork and
Publishing Inc., 136 West Street, Suite transition by underestimating the com- research.
202, Northampton, MA 01060, United plexity of the process and pursuing in- To order: http.//www.rowman/ittlefteld.coml
States, tel.: 413-584-5551, fax: 413-584- appropriate or at best overly optimistic Catalog/SingleBook.shtml?command
9933, email: ssuarez@e-elgar.com, policy reforms. =Search&db=ADB/CATALOG.db&eq
Web site: http.//www.e-elgar.co.uk. SKUdata=0742509117.
David Parker (ed.), Privatization and
Werner Baer and Joseph L. Love (eds.), Corporate Performance, February Lutz Hoffmann and Felicitas Mollers
Liberalization and Its Consequences, 2001, 688 pp. (eds.), Ukraine on the Road to Eu-
January 2001, 336 pp. rope, Physica-Verlag, Germany, 2001,
Other Publications 313 pp.
The essays in this volume describe, ana-
lyze, and compare the achievements and Laszl6 Csaba, Ostpolitik and Enlarge- To fulfill some of the key preconditions
failures of societies that adopted mar- ment of the EU: The Challenge of the for entry into the European Union,
ket-based economies within a demo- Millennium, CEU Working Papers, Ukraine must complete its administra-
© 2001 The World Bank/The William Davidson Institute TRANSITION, July-August-September 200 m
tive reform, transform its agricultural sec- To order: Greenwood Publishing Group economies, are often inefficient, poorly
tor, privatize its energy sector, continue to Inc., 88 Post Road West, Box 5007, targeted, and very expensive-and they
liberalize prices, improve relations with the Westport, CT 06881, United States, tel.: will become even more so as these long-
International Monetary Fund, attract more 203-226-3571, fax: 203-222-1502, Web term commitments come due. This study
foreign direct investment, and encourage site: http://info.greenwood.com/cgi-bin/ looks at public subsidies for mortgage in-
capital that fled the country to return. eupdget.pl?S=RV&I=0275970728. terest payments, housing construction,
Moreover, to achieve these targets, it must and down payments: income tax benefits
stabilize legislation and increase its pre- Martin Raiser, Maria L. Di Tommaso, for interest or home purchase costs; gov-
dictability, reduce barriers to imports, re- and Melvyn Weeks, The Measurement ernment loan guarantees and support for
duce corruption, cut taxes, eliminate and Determination of Institutional secondary mortgage facilities; sheltering
privileges for various enterprises, and "le- Change: Evidence from Transition of capital gains from housing sales; and
galize" at least part of the shadow Economies, Department of Applied contract savings schemes common in
economy. For its part, the EU should dem- Economics WP29, Cambridge Univer- Austria and Germany. The study under-
onstrate greater commitment to Ukraine's sity, United Kingdom, 2001, 34 pp. scores the lessons learned by nations fur-
future membership, accelerate the process ther along in the transition-lessons that
for granting the country associate status, Institution building is at the heart of the should serve as guidelines for the devel-
expand technical assistance to facilitate transition process. Without functioning opment of more efficient banking systems
the harmonization of laws and procedures, institutions, markets cannot work effec- and use of public resources in Southeast-
and support Ukraine's bid to accede to the tively and the transition process cannot ern Europe and the CIS countries.
World Trade Organization. be sustained-as the crisis in the Rus- To order: The Urban Institute, 2100 M
To order: Prof. Lutz Hoffmann, DIW- sian Federation shows. But institutional Street, NW, Washington, DC 20037,
German Institute for Economic Re- reform is poorly understood by research- United States, tel.: 202-833-7200, fax: 202-
search, Konigin-Luise-Strasse 5, 14195 ers and policymakers. This paper ana- 429-0687, email: paffairs@ui.urban.org,
Berlin, Germany, or Felicitas Mollers, lyzes the determinants of institutional Web site: http.//wwwurban.org.
Deutsche Bank AG, DB Research, change using a panel data set that in-
Grosse Gallusstrasse 10-14, 60311 cludes 25 transition economies. It finds Suresh Babu and Alisher Tashmatov
Frankfurt am Main, Germany strong evidence that economic reforms (eds.), Food Policy Reforms in Cen-
and political liberalization were more tral Asia, International Food Policy Re-
Leonid Polishchuk, Small Businesses powerfulforcesthanthechangesineco- search Institute (IFPRI), Washington,
in Russia: Institutional Environment, nomic structures induced by those re- D.C., 2000, 221 pp.
IRIS WP 240, University of Maryland, forms. It finds some evidence for a
Center for Institutional Reform and the positive spillover effect on institutional Progress in policy reforms has been frus-
Informal Sector, January 2001. changes from early reforms, such as lib- tratingly slow in thefive CentralAsian coun-
eralization and privatization, although the tries (Kazakhstan, the Kyrgyz Republic,
After a period of initial expansion, small and effect operates with a significant lag. Tajikistan, Turkmenistan, and Uzbekistan)
medium-size enterprises in the Russian To order: Cambridge University Department despite their own efforts and the external
Federation are stagnating or even declin- of Applied Economics, Austin Robinson advice and efforts of international and bi-
ing as a result of the lack of institutional Building, Sidgewick Avenue, Cambridge, lateral agencies to help them follow a dy-
foundations forthe sustainable development CB3 9DE, United Kingdom, tel.: 44-1223- namic growth path. Unless action is taken
and growth of private businesses. Small 335200, fax: 441-1223-335299, email: to jump-start their economies, the Central
businesses are caught in an institutional daeadmin@econ.cam.ac.uk, Web site: Asian countries may slide into a state of
trap of poor govemance that favors large http://www.econ.cam.ac.uk/dae. permanent transition, with enormous so-
firms. As long as this situation persists, cial and political costs. A conference was
small and medium-size enterprises will re- Raymond J. Struyk (ed.), Homeowner- held in Tashkent, Uzbekistan, in 1991 to
main under pressure. ship and Housing Finance Policy in help develop a regional understanding and
To order: http://www.iris.umd.edu/ the Former Soviet Bloc: Costly Popu- consensus on reducing poverty, improving
publications.asp. For more information: lism, The Urban Institute, Washington, food security, and moving toward sustain-
info@iris. econ. umd. edu. D.C., 2000, 220 pp. able natural resource management as well
as to develop a set of priorities for food,
Miron Rezun, Europe's Nightmare: Subsidy programs for new housing pur- agriculture, and natural resource policy
The Struggle for Kosovo, Praeger chases, created to address perceived research in Central Asia.
Publishers, February 2001, 240 pp. housing shortages in the transition To order a free copy: http://www.ifpri.org/.
M TRANSITION, July-August-September 2001 The World Bank/The William Davidson Institute At 2001
Bibliography of Selected Articles
Postsocialist Economies Hirschler, R. Changing of the Guards: Gara, M. The Emergence of Non-
The Role of International Finance In- Monetary Means of Payment in the
Bornstein, M. Post-privatization Enter- stitutions Alters in Hungary. Business Russian Economy. Post-Communist
prise Restructuring. Post-Communist Hungary(Hungary) 15(6): 9-13, 2001. Economies (United Kingdom) 13(1): 5-
Economies (United States) 13(2):189- 39, 2001.
203, 2001. Investing in Central and Eastern Eu-
rope: Financial Times Survey. Finan- Poirot, C. S., Jr. Financial Integra-
Hoguet, G. R. Benchmark Blues: cial Times (United Kingdom), suppl., pp. tion under Conditions of Chaotic
Agency Problems in the Construction i-vi, July 2, 2001. Hysteresis: The Russian Financial
of Global Emerging Market Bench- Crisis of 1998. Journal of Post-
marks and the Allocation of Global Poland: Financial Times Survey. Fi- Keynesian Economics (United States)
Capital. International Economy (United nancial Times (United Kingdom), suppl., 23(3): 485-507, spring 2001.
States) 15(3):44-47, May-June 2001. pp. i-vi, June 25, 2001.
Richter, A. Looking Beyond Transi-
Marangos, J. International Trade Poli- Slovenia: Financial Times Survey. Fi- tion in Central Eurasia. Open Soci-
cies for Transition Economies: The nancial Times (United Kingdom), suppl., ety News (United States) pp. 3-5, 2001.
Post-Keynesian Alternative. Journal pp. 11-14, July 9, 2001.
of Post-Keynesian Economics (United Russia: Financial Times Survey. Fi-
States) 23(4): 689-704, summer 2001. The 2001 Guide to Poland. Euromoney nancial Times (United Kingdom),
(United Kingdom) 385, suppl.: 1-9, May suppl., pp. i-viii, April 9, 2001.
Piazolo, D. Investment Behaviour in 2001.
Transition Countries and Computable Safavian, M. S., D. H. Graham, and C.
General Equilibrium Models. Applied Vachudova, M. A. The Trump Card of Gonzalez-Vega. Corruption and
Economics (United Kingdom), 33(7): Domestic Politics: Bargaining Over EU Microenterprises in Russia. World
829-37, July 2001. Enlargement. East European Constitu- Development (United States) 29(7):
tional Review (United States) 10(2/3): 93- 1215-24, July 2001.
Szapary, G. Transition Countries' 97, 2001.
Choice of Exchange Rate Regime in A Survey of Russia. Economist
the Run-Up to EMU Membership. Fi- Zile, R., and 1. Steinbuka. Latvia on the (United Kingdom) 360(8231), insert,
nance and Development, A Quarterly Way to the European Union. Finance pp. [1]-16, July 21-27, 2001.
Publication of the International Monetary and Development, A Quafterly Publication
Fund (International) 38(2): 26-29, June of the Intemational Monetary Fund (Inter- The 2001 Guide to Russia. Economy
2001. national) 38(2): 30-33, June2001. (United Kingdom) 383, suppl.: [11-11,
March 2001.
Central and Eastern Europe CIS
Wolfe, R., and G. Glinka. Break-
Aligica, P. D. Romania's Economic Achieving Food Security in Central through in Ukraine-A Successful
Policy: Before and After the Elec- Asia.FoodPolicy(lnternational)25(6):629- Bankruptcy Law in a Post-Socialist
tions. East European Constitutional 36, December 2000. Country. International Insolvency Re-
Review (United States) 10(1): 92-96, view (United Kingdom) 10(1): 59-65,
2001. Broadman, H. Competition and Business spring 2001.
Entry in Russia. Finance and Develop-
Croatia: Financial Times Survey. Fi- ment, A Quarterly Publication of the Inter- China
nancial Times (United Kingdom), pp. 31- national MonetaryFund(lntemational) 38(2):
34, June 19, 2001. 22-25, June 2001. Chen, W. The Politics of Cross-Tai-
wan Strait Relations. Journal of Chi-
D'Amato, E. Yugoslavia: After the Dash, P. L. Russia: The Demographic nese Political Science (United States)
Storm. Euromoney (United Kingdom) Labyrinth.EconomicandPoliticalWeekly 6(1): 1-15, 2001.
385: 108-12, 117-19, May 2001. (India) 36(11): 914-16, March 17-23,2001.
uc 2001 I'he World Bank/The William Davidson Institute TRANSITION, July-August-September 2001 n
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