Stimulating private enterprise in transition economies

The countries in central and eastern Europe have undergone fundamental change since the fall of the Berlin Wall. A substantial amount of state property has been privatised and most markets for goods and services are now liberalised. But the benefits of change have yet to reach large segments of the population. Unemployment has been increasing in many transition countries. The distribution of income and assets is becoming more uneven and is not being compensated by strong growth, which might make the disparities more acceptable.

A fundamental yet oft-neglected cause of these difficulties is that the transition to a market economy has not been accompanied by the broadbased creation of new private businesses, particularly small and medium-sized enterprises. A key reason for this is that the environment for new businesses is characterised by a multitude of adverse factors including onerous and complicated tax systems, the absence of a body of commercial law, administrative burdens, corruption, dysfunctional financial markets and a lack of knowhow.

Governments in countries in transition are increasingly aware of the need to create conditions conducive to the development of private business: Yet there is no clear vision in most countries of how to achieve this objective. Experience has shown that making any society more entrepreneurial is a multidimensional task that must birng a wide range of public, private and non-governmental actors to work together. The enormous political and cultural change required of transition countries, which has engaged them in the creation of a new civil society, poses additional difficulties.

This policy brief is based on research and case studies and discussions conducted within the framework of the OECD Forum for Entrepreneurship and Enterprise Development (FEED). It explains why policies to foster entrepreneurship are so important to enable countries in transition to develop into full-fledged market economies with business sectors able to compete in global markets, and into stable democracies with thriving civil societies. And it describes what the OECD is doing to help these countries to adopt appropriate policies in the overall context of the programmes managed by the Organisation’s Centre for Co-operation with Non-Members (CCNM).

Transition means the process of change from a centrally planned economy towards a market economy, a process that involves enormous change at every level of society. Countries going through this process are principally the republics of the former Soviet Union and the countries of central and eastern Europe formerly under communist rule. Transition countries which are dealt with within the framework of OECD work on entrepreneurship are: Albania, Armenia, Azerbaijan, Belarus, Bulgaria, Estonia, Georgia, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Mongolia, Romania, Russian Federation, Slovak Republic, Slovenia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

Why is entrepreneurship crucial for transition?

Entrepreneurship is central to the functioning of market economies. Entrepreneurs – people who start businesses and make them grow are essential agents of change in the process of transition. They introduce the new products and services needed in countries which for long concentrated on industrial and military production rather than on the needs of consumer markets.

Moreover entrepreneurship is critical to job creation in transition countries. Most of the former stateowned large industries have faced difficulties in becoming competitive in global markets. As a consequence, many have had to engage in mass layoffs. In addition, many jobs were lost in state administrations due to budget constraints and the need to restructure public services. Jobs created in new and growing small businesses must be the major source of new jobs for those made redundant.

What are the facts about business creation?

Ten years after transition began, we have some notion of how much progress has been made in the creation of a small business sector. While statistics on start-ups and small business development are scarce and often not directly comparable to small business data in OECD countries, the available data reveals some trends. We know, for example, that there was an impressive wave of business start-ups after the fall of the Berlin Wall. But for about four years now the number of annual start-ups has decreased. Also, there are strong differences in performance and pace of change among countries. For example, Poland with 38.5 million inhabitants has about two million small businesses, whereas Russia with a population of about 148.5 million records about 850,000 enterprises. Overall, the share of the economy represented by new and small businesses appears to be much lower than in OECD countries, an indication that important structural changes remain to be accomplished. 12 percent of Russian GDP and eight percent of GDP in Kazakhstan is attributed to small business. In European Union member countries the average is over 50 percent.

What obstacles does private enterprise face?

Starting a business is a challenge anywhere, but much more so in a transition economy. The obstacle most frequently mentioned by entrepreneurs concerns access to capital. Only about one in 20 startups can obtain bank credit. Most entrepreneurs need to rely on the resources of family and friends. Another obstacle is taxation. The main problem being that tax systems are opaque, expensive to comply with and extensive in number. The accumulation of many taxes (sometimes more than 20) can result in taxation in excess of earnings. Other problems include heavy administrative burdens and related corruption. Moreover, all of these obstacles have to be confronted in a setting in which there is little experience with starting and learning to run a private business.

What is the connection between entrepreneurship, democracy and civil society?

Entrepreneurship is more than just a an economic phenomenon. It is also important for the creation and stabilisation of democracy. First, widespread entrepreneurship is fundamental to the creation of a middle class and avoidance of extreme polarisation between rich and poor. The middle class is also a pillar of support for democracy Its members are the prime constituents of civil society. When a government system is not subject to the democratic control that a strong civil society underpins, endemic corruption and fierce defence of government or government controlled monopolies is likely

What is happening outside the big cities?

Businesses are being created mainly in or around big cities and agglomerations in transition countries. For example, in Russia, 25 percent of all small businesses are located in Moscow. Rural areas, remote areas and former industrial sites appear to be years behind in the cycle of transition. This disparity tends to become self-reinforcing as the concentration of enterprises in cities improves the entrepreneurial environment in them. People are being drawn to the cities and some regions are being depopulated as their unemployment rises.

How has the Russian crisis affected private businesses?

The financial crisis, which unfolded in Russia beginning in the summer 1998, dealt a serious blow to Russian small business. The Russian Association of Small Businesses estimates that a quarter to a third of all small businesses reduced their operations at least temporarily and that many of them will be shut down indefinitely. The budgetary consequences of the crisis have created pressures to raise additional taxes from small businesses. This would put at further risk the sector of the economy that could provide the growth and the jobs necessary for the future economic development of the Russian Federation. An increased tax burden will move more enterprises into the informal economy, which is already estimated to represent around 30 percent of Russian GDP.

What should governments be doing?

Governments in transition countries have for some time now stated that the promotion of new and small business is a policy priority. Yet this objective has rarely been translated into an effective policy strategy or implemented with sufficient resources and political impetus. Many governments in transition countries are now considering how to reconstitute and improve their support for entrepreneurship. A first challenge is the need for a horizontal approach. There are many actors involved in shaping the environment for entrepreneurship. They include a range of ministries in the central government, regional and local administrations and financial institutions, to name a few. These actors need to be integrated in a common strategy designed to reduce excessive taxes and the tax compliance burden, lift excessive bureaucracy, fight corruption, guarantee law and contract enforcement, protect entrepreneurs against organised crime, improve the supply of financial instruments and services for entrepreneurs and provide affordable access to knowhow and training for small businessmen. In addition, attention must be paid to promoting entrepreneurship on the local level through local partnerships, development agencies, business incubators and other policy tools. Successful transition countries such as Poland, Hungary and the Czech Republic have applied these strategies.

A new role for the donors?

Foreign assistance donors have for some time concentrated their efforts on the process of privatisation, liberalisation of markets and the promotion of macroeconomic stability. The Russian crisis now demonstrates that institutional and policy reforms and the creation of a climate conducive to entrepreneurship are essential if the gains from privatisation and liberalisation are to be realised in terms of growth and stability. A number of donors and international organisations are now reconsidering their approach to transition countries. The US Agency for International Development has decreased its involvement in privatisation and concentrates more on entrepreneurship promotion. Similarly the European Bank for Reconstruction and Development (EBRD) has recognised the vital importance of reducing barriers to small business development.

What lessons apply elsewhere?

What can developing countries learn from the experiences of the transition process? First, entrepreneurship is important to any development strategy. Second, each country is ultimately responsible for its own economic development. The experience of transition countries has shown that it is not possible to kick-start an economy solely by injecting external finance. Only if a country creates the appropriate environment for entrepreneurship will it be able to launch a sustainable process of growth and job creation.

What does the OECD contribute?

Countries in transition asked the OECD for help in making entrepreneurship policies effective. A key element of the Organisation’s response has been the creation of several Forums for Entrepreneurship and Enterprise Development (or FEEDs). The forums engage policy-makers and entrepreneurship promotion practitioners in policy discussions and the exchange of experience.

Three forums are currently in operation. The Transition Economies FEED jointly run by the OECD and the United Nations Industrial Development Organization (UNIDO) addresses enterprise development in the New Independent States (NIS) of the former Soviet Union and the countries of the Black Sea region. A Baltic FEED addresses the needs of the three Baltic countries, Estonia, Latvia and Lithuania, as well as the Kaliningrad and St. Petersburg regions in Russia. A separate Russian Forum concentrates on the Russian Federation.

To permit in-depth discussion, each FEED is composed of two separate groups, one dealing with the framework conditions for entrepreneurship and the other dealing with programmes to support businesses through finance and advisory services. Countries are not simply encouraged to adopt the policy models of OECD countries, but rather to adapt these models to their circumstances. FEED delegates meet twice a year and one of their meetings is devoted to preparing policy recommendations to governments. Other international organisations and donors specialising in technical assistance or the provision of financial support participate in each Forum. They view the work of the OECD on the policy level as highly complementary to their own efforts.

Additional information about FEED can be obtained from the Private Sector Development Unit, located in the Directorate for Financial, Fiscal and Enterprise Affairs, OECD, Paris. The Unit can be reached by telephone at 33-145-24-78-45/78-64 and by fax at 33-1-45-24-18-32/18-42.

Copyright Organisation for Economic Cooperation and Development Apr 1999

Provided by ProQuest Information and Learning Company. All rights Reserved

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