Steven Fries Deputy Chief Economist The Business Environment, Employment and Enterprise Performance: Evidence from Transition Economies Steven Fries Deputy Chief Economist

Introduction What are the drivers of Investment, employment and growth of firms in transition economies? Business environment and governance are key Unique insights gained from the EBRD – World Bank Business Environment and Enterprise Performance Survey Business environment obstacles impose significant costs and constraints on firms Business environment and “state capture” also affect investment, jobs and firm growth 3

What is the Business Environment? Business taxation and regulation Provision of essential business services Access to infrastructure services and finance Provision of essential public goods Law and order Contract enforcement and protection of property rights Corruption in public administration and judiciary Exercise of undue influence by firms over state Creates uneven playing field for firms

How good is the business environment? Assessments from EBRD – WB Business Environment and Enterprise Performance Survey Based on first-hand assessments of local firms Implemented in 1999, 2002 and 2005 Questions on key aspects of the business environment, ties between firms and government and enterprise performance Shows how the business environment varies across dimensions and countries and over time and how it affects enterprise performance

Survey Sample, 2002 About 6,100 firms surveyed, up from 4,100 in 1999 Firm shares in industry services reflect GDP shares Within industry and services, representative of firm population Sector Industry Services % 39 61 Ownership New private Privatised State owned 68 18 14 Size (number of employees) Small (2 to 49) Medium (50 to 249) Large (250 to 9999) 19 Location Capital Large cities (not capital) Small cities Rural areas 32 25 23 3

How reliable are the business environment measures? Consistency checks performed on measures Comparison of qualitative measures with objective statistical measures (macroeconomic instability) Too pessimistic in the Kyrgyz Republic in 1999 and too optimistic in Azerbaijan in 2002 No evidence of excessive optimism or pessimism in business environment dimensions related to business cycle Significant consistency within BEEPS between qualitative and quantitative measures 3

How good is business environment in Eastern Europe and Central Asia? Improving but could be better Total 3

Largest business environment improvements in 2002 seen in the CIS … … and in some South-east European countries Change from 1999 to 2002 3

2002 Business environment perceptions Most South-east European countries below the median Business environment measures in 2002 3

Time tax if no bribes paid to public officials (per cent) Obstacles in the business environment impose significant costs on firms Time tax – evidence of the state’s “grabbing hand” Time tax if no bribes paid to public officials (per cent) Time tax if bribes paid to officials (per cent) 3

Obstacles in the business environment impose significant costs on firms Overall “bribe tax” is high in some countries Average bribe tax 3

Obstacles in the business environment impose significant costs on firms High crime losses in some countries Per cent of total sales 3

Obstacles in the business environment impose significant constraints on firms Working days lost due to infrastructure failures Days 3

Proportion of new investment financed from retained earnings Obstacles in the business environment impose significant constraints on firms Banking inefficiencies limit access to finance Proportion of new investment financed from retained earnings 3

Capital, employment and firm growth Capital investment is the major driver of growth Contribution of factors to real revenue growth Factors of production 3

Business environment and growth Variable Real growth Employment Real revenue fixed assets growth growth -0.15* -0.24* -0.39* (-3.06) (-2.85) (-6.95) Capacity utilisation rate in 1999 Acceleration of real GDP growth in 2001 v. 1999-2001 average 0.88* 1.16 1.42* (2.01) (1.52) (2.82) Country business environment in 1999 -10.03* 33.51* 1.93 (-2.58) (4.96) (0.43) Captor firm (laws and regulation) 10.58* 6.83 12.77* (2.49) (0.91) (2.59) External cost of capture (laws and regulations) 2.29 -0.33 -3.44 (0.90) (-0.07) (-1.19)

Firm ownership, size and growth Variable Real growth Employment Real revenue fixed assets growth growth -8.86* -3.56 -12.00* (-2.39) (0.58) (-2.83) State ownership New private ownership 18.26* 4.76 20.63* (6.30) (0.93) (6.23) Foreign ownership 7.94* 29.38* 5.98 (2.50) (5.33) (1.64) Log of employment 12.03* -47.65* 14.21* (5.24) (-12.99) (5.45) Log of employment squared -0.88* 4.22* -0.93* (-2.39) (8.78) (-2.81)

Competition and growth Variable Real growth Employment Real revenue fixed assets growth growth 0.32 5.22 -0.91 (0.11) (1.02) (-0.27 Price elasticity of demand - low Price elasticity of demand - moderate -6.10 -6.85 -10.03* (-1.84) (-1.19) (-2.65) Price elasticity of demand - high -5.20 -6.14 -14.27* (-1.77) (-1.21) (-4.28) Number of observations 4,444 4,654 4,549 Adjusted R - squared 0.04 0.09 0.07 [controls for sector and location within countries omitted]

State capture also affects productivity and growth State capture supports investment and growth of “captor firms”, but … Growth in fixed capital Real revenue growth Productivity growth Per cent increase, 1999-2001 3

State capture also affects productivity and growth … holds back the productivity of firms affected by capture Growth in fixed capital Real revenue growth Productivity growth Per cent increase, 1999-2001 3

Conclusion Reforms in transition economies are paying dividends A better business environment supports investment and growth of firms, but … … firms substitute capital for labour to become more competitive But significant obstacles remain to be addressed Business environment and state capture Wide variation across dimensions and countries Sustaining the reform drive should lead to even stronger firm performance More investment, higher productivity and potentially jobs BEEPS implemented again in 2005 to monitor progress 3