Publication overview

Transition report 1997: Enterprise performance and growth

Abstract

Transition: the challenges of the coming years; Progress in market-oriented transition; Growth in transition economies: sources and obstacles; Structural change, restructuring and enterprise performance; Enhancing enterprise performance; Prospects for growth in transition economies; Macroeconomic trends.

Chapter 1: Transition: the challenges of the coming years

For the region as a whole, the process of transition is entering a new phase following the initial period of strong progress in liberalisation, privatisation, and the establishment of macroeconomic stability. In the second phase the key challenges will be to build, consolidate and strengthen the institutions, policies and practices which underpin a well-functioning market economy and the investment that supports growth. In responding to these challenges, good governance will be crucial. This must involve openness, transparency and credibility and the absence of bureaucratic interference and corruption. Such governance is vital to the emergence and maintenance of an effective competitive process. The private sector must also in this phase build the sound business practices which will lead to long-term success. Good governance both encourages and is supported by the development of civil society.

Chapter 2: Progress in market-oriented transition

The transition economies have continued to make progress in market reforms over the year, albeit at a slower pace than in the past. However, the pattern of reforms differs across countries, and progress is neither consistently strong across all areas of reform nor over time in each country. Several countries, including for instance Azerbaijan, Bulgaria and Turkmenistan, have advanced significantly after years of slow progress. Others, including Belarus and Uzbekistan, have taken steps backwards from already low levels of reform. The differences in the depth of reforms are increasingly the result of policy choices rather than the initial conditions in each country. A particularly encouraging development has been the commitment in several countries, including over the past year Albania, Bulgaria, the Czech Republic, Romania and Russia, to deepen reforms in the face of political challenges or economic crisis.

The EBRD's transition indicators have registered substantial progress over the past year in the privatisation of very large enterprises (in some cases involving the public utilities and energy sectors) and in banking reform. This is a fairly broad phenomenon, which now extends beyond the group of advanced reformers to countries ranging from south-eastern Europe to Russia and the Caucasus. However, institutional reforms to support capital markets and other non-bank financial sectors generally lag behind, and progress in enterprise restructuring and improving governance continues to be slow. An increasingly urgent challenge is the reform of government. While several countries are now tackling pensions reform, major problems remain, particularly in the CIS, concerning severe income inequality, haphazard and discriminating tax systems and corruption in the public administration.

Chapter 3: Growth in transition economies: sources and obstacles

Most transition economies are now growing. This is in contrast to the position only a few years ago, when many were experiencing extreme economic dislocation and rapid falls in output. Increases in output reflect in part the recovery from the effects of the collapse of the previous regime's central planning and from the initial challenges of market liberalisation. They also show the beginnings of market-driven growth. Basic questions for the analysis and formation of policy are whether this initial growth will be sustained and what measures will be needed to deliver rapid growth over the medium and long term.

Growth in transition economies hinges on the economic incentives faced by businesses and individuals, on how well markets function and on the new and evolving institutions and government policies. In particular, it is argued that the nature and strength of growth will be determined by the influence of competition among producers and the way that this stimulates new methods of doing business. The analytical approach of the Report is thus a market-driven perspective on the growth process, which focuses on innovation (the approach is commonly referred to as "Schumpeterian"). It is the responsibility of government to establish effective policies, to strengthen the institutional framework, and to conduct itself in a manner which will allow the competitive process to work to its full potential. Part of this responsibility lies in ensuring the provision of physical infrastructure and the development and maintenance of a skilled workforce, thereby enabling individuals and firms to participate effectively in, and share the benefits of, the market economy.

Chapter 4: Structural change, restructuring and enterprise performance

New market forces in transition economies have brought about significant structural change, with some sectors contracting (industry in all countries) and others expanding (services in the whole region and agriculture in some countries) in terms of shares of total employment. Trade flows of transition economies are also adjusting to the natural advantages of each country. In general, the emerging economic structures and patterns of trade specialisation are consistent with the operation of market forces. However, one area of change which conforms less well with market experience is the growth in employment in government services beyond those levels recorded in comparable market economies.

Evidence from market economies points to a number of factors that have a significant impact on enterprise performance, particularly product market competition, privatisation, corporate governance, government behaviour and the capabilities of the state. The experiences of transition economies confirm the importance of these factors. The weak capability of the state and arbitrary government behaviour in the transition countries have been significant impediments to new private businesses, particularly in the CIS. In contrast, increased competition resulting from greater levels of imports leads to productivity gains in competing domestic firms while privatisation and concentrated outside ownership of enterprises contribute to strong performance.

Chapter 5: Enhancing enterprise performance

To improve enterprise performance, two aspects of the transition are crucial. The first involves altering radically the relationship between government and enterprises and the second requires the establishment of effective mechanisms for privatisation and corporate governance of enterprises. An early widespread reform in changing the relationship between government and enterprises was the sharp reduction in budgetary subsidies. However, this was followed by new forms of government support (usually off-budget), including leniency regarding tax and payments arrears and the persistence of soft bank lending. Even with effective reduction in government support for enterprises, the competition that is vital for improving performance is weakened by barriers to business start-ups, many of which are erected by government. It is important to recognise that eliminating these impediments can lead to the creation of private sector jobs, which in turn eases the pressures for continued government support for weak enterprises.

The governance of most medium-sized and large enterprises requires dramatic change. Privatisation represents a first step, but the form of privatisation (involving a number of compromises) has not, in most cases, provided effective governance. Following privatisation, therefore, change is often required in the ownership structures and in the methods of corporate governance. Instrumental to this change will be development of the financial sector to provide an effective source of outside finance for investment and a market in which changes in ownership and control can take place.

Chapter 6: Prospects for growth in transition economies

While attempting to forecast precise long-term growth rates is not sensible, it is possible to identify two reasons for optimism and one for pessimism. The potential for large productivity gains from structural change and enterprise restructuring and the potential contributions to growth from the highly skilled workforces in the region are two reasons for optimism. The experience of western Europe and Japan following the Second World War illustrates the major contribution that the more efficient use of resources can make to growth. In addition, the skilled population of transition countries can play a valuable role in adapting technologies from advanced market economies. It is the combination of high levels of skills and significant technological deficits in transition economies that creates a strong potential for growth. Well-functioning markets will drive the actions and investments which can realise this potential.

The main reason for pessimism is the weakness in the region, at present, of the institutions, policies and practices which are needed to underpin a market economy. There are a number of important steps which many governments must take to improve the business climate and, in particular, to strengthen the institutions which support investment and innovation. The more advanced countries have made significant progress in this regard, and it is possible that looking back in 20 years' time some of the world's "tiger" economies will have been found in the region. However, this growth process should not be seen in any way as inevitable or automatic. Although the potential for growth is large, there is also a strong possibility of becoming trapped by resistance to change and vested interests.

Chapters 7 and 8: Macroeconomic trends

The resumption of economic growth is being witnessed in the region as a whole in 1997, at 1.5 to 2 per cent, after seven years of continuous decline in measured GDP. Eleven economies in the region, out of 26, are now growing at rates of 4 per cent or more. Nevertheless, the growth performance has been uneven across countries. Growth in eastern Europe has slowed for the third year in a row, with Albania, Bulgaria and Romania experiencing serious setbacks. On the other hand, economic contraction has finally come to an end in the CIS. This turnaround is largely due to the improving performance of Russia, which is likely to register in 1997 its first year of (mildly) positive growth. Growth in many of the advanced economies is currently driven by domestic demand and especially by private consumption, whereas exports were the driving force when growth first resumed. Prospects for 1998 are for higher growth in eastern Europe and positive growth for the CIS as a whole, with a more solid recovery in Russia.

Inflation performance has continued to improve despite several setbacks. Nine countries in the region now have inflation at less than 10 per cent per annum, and 18 countries at less than 20 per cent. The greater stability in prices in the CIS continues to be fragile. The past year has demonstrated continuing weaknesses in fiscal revenue performance and, as in previous years, these weaknesses have forced authorities into very heavy reliance on tight policies in pursuit of stabilisation.

External accounts have deteriorated sharply over the past two years, explained in part by the recovery in domestic demand. In 1996, more than half of all transition economies recorded current account deficits in excess of 5 per cent of GDP. These deficits have been financed by growing inflows of foreign private capital. Foreign direct investment alone is likely to reach US$ 16-18 billion in 1997, with half accounted for by Poland and Russia. In addition, international bond and commercial bank finance and money market investments have been surging, particularly into Russia, and may contribute another US$ 30-35 billion during 1997. These inflows are a sign of growing confidence in the region but they can bring their own problems. There is a danger of overheating, of excessive real exchange rate appreciation and of volatility, as the Czech Republic experienced in 1997. The growth of foreign indebtedness in some countries (including Armenia, Georgia, Kyrgyzstan, Moldova and Tajikistan, which largely rely on official external finance) will have to be handled carefully.