Financial Times; Jan 16, 2002
By ROBERT ANDERSON and STEFAN WAGSTYL
"We are in no-man's land," says Miroslav Hornak, the chief executive of PSJ, a medium-sized Czech construction company. "Our problem is that we are not small but neither are we in the big league."
Since it was founded in 1990 by seven engineers just after the fall of communism, PSJ has grown rapidly and now claims to be the country's seventh largest construction company. Revenues are expected to be Kc4.5bn (Dollars 125m, Pounds 860m) this year, 30 per cent of which are from foreign activities.
But fast growth has created high fixed costs, while the company is still too small to win large state contracts or benefit from cheap bank financing.
The importance of new companies in pulling countries out of the economic graveyard of communism - and the challenges they still face - is highlighted in a report published yesterday by the World Bank.
In a review of the first decade of post-communist transition, the bank concludes that newly created private businesses are the strongest engine of economic change. New companies outperform enterprises that existed under communism on many counts including sales, exports, investment and job creation, says the report.
In the most advanced ex-communist economies - the Czech Republic, Hungary and Poland - enterprises created since 1990 already account for 50 per cent or more of employment, a figure broadly similar to the European Union average. By contrast, in less advanced economies in the former Soviet Union the figure is often below 20 per cent.
However, the report gives warning that transition states cannot solve their economic problems simply by promoting new enterprises and postponing the reform and liquidation of inefficient old enterprise. As long as such units enjoy "soft budget constraints", for example by receiving credit and foreign exchange on preferential terms and not being required to pay taxes, social security contributions, utility bills and bank debt, new entrants will not have a level playing field.
This has happened repeatedly, says the report, citing the examples of Romania and Bulgaria in the 1990s, where the debt overhang prevented the banks from lending to new enterprises.
Similarly, in Georgia, the Kyrgyz Republic, Moldova, Russia and Ukraine, old enterprises have been allowed to run significant arrears to the utility companies, while new and more energy-efficient enterprises have received less favourable treatment.
The report's authors say that reducing barriers to entry - a strategy of "encouragement" - must therefore be accompanied by a hardening of budget constraints on old and new companies - a strategy of "discipline".
These points are reflected in PSJ's experience. In 1994 the fast-emerging young company won a landmark contract to renovate the Obecni Dum, Prague's Art Nouveau Municipal House - but only because the city council was divided between two well-connected ex-communist competitors.
It then had great problems raising the Kc120m bond demanded, particularly as its state-owned bank withdrew its promise of a loan just days before the bond was due, allegedly after pressure from a disgruntled rival.
This untransparent business environment began to change when the Czech economy plunged into a three-year recession in 1997, leading to a banking crisis and the eventual privatisation of all four big state- owned banks. Privatisation dramatically restricted the scope for credit decisions to be made on friendly contacts, often forged in the communist era.
If the value of genuinely opening the economy to new companies is so clear, why did it take the Czech Republic so long to adopt the right policies, and why have many other ex-communist states, especially in the former Soviet Union, still not done so?
The World Bank report has an answer. The authors say that the winners from early stage of post-communist reforms - typically people closely linked with the former communist elite - may oppose subsequent reforms that would erode their initial gains.
"Many economies outside central Europe and the Baltics are stuck in a a no-man's land between plan and market," says the report. To escape from that trap, governments must try to extend the benefits of reform to as many people as possible by switching the funds spent on subsidising loss-making industries into healthcare, education and targeted social support for the poor. That helps to create more political support for further change.
The report says that the differing development levels of ex-communist countries influenced the progress they later made. But it insists that initial conditions are not decisive. Good policies can overcome disadvantages, just as bad policies can waste an initial advantage.
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