Op-ed

Doing business in Eastern Europe: Entrepreneurs see signs of progress

International Herald Tribune, 14 December 2002

by Steven Fries and Joel Hellman

Just over four years ago, Russia's financial crisis sparked fresh uncertainty in global markets and dealt a blow to the fragile economies of the former Soviet bloc. Stabilisation and growth have since returned more rapidly than anyone might have predicted - but foreign investors have remained hesitant. Doubts remain about unlevel playing fields and the quality of the business environment, especially as one moves south and east beyond EU accession territory. But change in these areas is especially difficult to assess across 28 countries. That's why the European Bank for Reconstruction and Development and the World Bank have launched an unprecedented effort to listen to the firms of the transition economies - through 10,000 face-to-face interviews - and hear their own assessments of the obstacles they face. The results are surprising.

The 1999 and 2002 rounds of the survey show that aspects of the region's business environment have improved dramatically, especially in the countries of South-eastern Europe and the former Soviet Union that remain off the radar screen of most foreign investors. Discriminatory practices that favoured the old socialist dinosaurs over small firms and start-ups have begun to diminish. Tax regimes have improved. Finance and infrastructure are less of an obstacle.

Even corruption is starting to diminish, as fewer firms report paying bribes. And those that do pay less as a share of their annual sales revenue - an average of 1.5 per cent in 2002, down from 2 per cent in 1999. Moreover, the relatively high obstacles faced by small, entrepreneurial firms are coming down. In 1999, the "bribe tax" paid by these firms was almost double that paid by large, state-owned enterprises; in 2002, they are about the same. It's a double dose of welcomed news then: while the gap between front-runner and laggard transition countries is starting to close, entrepreneurs and new businesses see greater opportunities to overcome legacies of the socialist past.

A degree of investor skepticism

Of course, a degree of investor skepticism about the sustainability of recent growth and good performance in the region is understandable. Is this just an inevitable bounceback from the deep, prolonged recession that many countries faced in the early years of transition - or the start of a sustainable expansion? Have the vested interests whose sustenance came from extracting privileges, grabbing assets and manipulating markets seen the advantages of innovation and investment in the future?

The answers lie in two key areas where the survey results show that progress continues to disappoint: business regulation and the judicial system. Onerous regulation and arbitrary bureaucratic interference in business decisions continue largely unabated in many countries of the region. Courts still have a long way to go in providing timely enforcement of property rights and contracts.

Part of the problem comes from states still too weak to reign in their own officials or to enforce their own rules and laws. Just as important are relationships between politicians and powerful firms that are still too cozy and too opaque, creating incentives to keep regulatory barriers high and courts weak. Despite the improvements in the business environment, the 10,000 firms we surveyed still perceive in many countries of the region a vast inequality of influence in which their collective voice can be drowned out by the interests of political cronies and powerful financial-industrial groups.

Build on recent successes

If policymakers across the region want to encourage dynamic new firms, draw in much-needed foreign investment, and attract back some of the billions of dollars that their own businesses have parked abroad, then they need to build on recent successes. They need to hear the collective voice of their own entrpreneurs marking the considerable progress of the past few years, but pointing out the still substantial challenges that remain.

With so many commentators bemoaning the failures of development and questioning the impact of the advice and assistance of the donor community, the progress revealed by the firms in our survey is encouraging news. Most welcome is the more rapid pace of change in several countries once thought to be trapped in a no man's land between central planning and a market economy with insecure property rights, arbitrary state intervention and Wild West corruption. Firms across the region are becoming more dynamic and responsive to market pressures.

We hope potential foreign investors hear the voices revealed in these surveys - to engage their interest, and to gain a realistic assessment of the opportunities, challenges and risks.

Details of this year's survey are highlighted in the EBRD's Transition Report 2002 and forthcoming World Bank publications. In three years' time, we will listen again to hear if the current period of relatively strong growth in the region was used to redouble reform efforts, or as an excuse for complacency.

Mr Fries is Deputy Chief Economist of the EBRD. Mr Hellman is Lead Public Sector Specialist at the World Bank.