the newsletter about reforming economies beyond transitiondocuments.worldbank.org/curated/en/... ·...

Beyond TransitionThe Newsletter About Reforming Economies

January � March 2007 • Volume 18, No. 1 http://www.worldbank.org/transitionnewsletterwww.cefir.ru

Theme of the Issue: EU Enlargement

EMU Enlargement: Why Flexibility MattersPhilipp Maier and Maarten Hendrikx 3

Gains from Risk�Sharing in the EUYuliya Demyanyk and Vadym Volosovych 4

Postponing Euro�Area Expectations?Tanel Ross 5

European Accession and Capacity�Building PrioritiesJohn S. Wilson, Xubei Luo, and Harry G. Broadman 6

Internal Labor Mobility and Regional Labor Market DisparitiesPierella Paci, Erwin Tiongson, Mateusz Walewski, Jacek Liwinski,Maria Stoilkova 8

Latvian Labor Market before and after EU Accession Mihails Hazans 10

The Impact of EU Accession on Poland's EconomyEwa Balcerowicz 11

Bulgaria's Integration into the Pan�European EconomyBartlomiej Kaminski and Francis Ng 13

Forming Preferences on European Integration: the Case ofSlovakiaTim Haughton and Darina Malova 15

Insert: Whither Europe? 16

Credit Expansion in Emerging Europe 17

New Findings

The Economic Cost of Smoking in Russia Michael Lokshin and Zurab Sajaia 18

Insert: Smoking in Albania 19

Deregulating Business in RussiaEkaterina Zhuravskaya, Evgeny Yakovlev 20

Land and Real Estate Transactions for Businesses in RussiaGregory Kisunko and Jacqueline Coolidge 21

Insert: Land Issues: Barriers for Small Businesses 22

Foreign Bank Profitability in Central and Eastern EuropeOlena Havrylchyk and Emilia Jurzyk 23

Banking in Ukraine: Changes Looming?Natalya Dushkevych and Valentin Zelenyuk 24

World Bank Agenda 25

New Books and Working Papers 27

Conference Diary 30

Photo: ECA, the World Bank

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Beyond Transition • January�March 2007

2 ·

From the Editor:

Dear Reader,

As with the previous issue of BT, which discussed the economic prospects of the Central Asianstates, this issue also has a geographic focus. It examines the recent experiences of Central andEastern European countries as new EU members, as well as their prospects. The issue highlightsthe challenges these countries face as they prepare to join the eurozone (Slovenia is already theEMU member) and analyzes some of the economic and political consequences of EU accession.The New Member States (NMS) have much higher inflation volatility compared to the old mem-bers, so their EMU membership could come with substantial adjustment costs (Maier andHendrikx). Yet, for small countries the losses from being outside the EMU may outweigh the costsassociated with the membership: the Bank of Estonia has calculated that the country can cumu-latively lose 10 percentage points of GDP growth in five years due to delayed membership (Ross).Tighter financial integration can help the NMS to improve risk sharing. The potential welfaregains in this case can amount to 5.2% of consumption (Demyanyk and Volosovych).

Reducing barriers to labor mobility and trade would allow the NMS to decrease adjustment costs. Pierella Paci et al. provideconcrete recommendations on how to improve labor market flexibility. The proposed measures include the facilitation of com-muting, investments in education and lifelong learning, and improvements in social protection systems. Mihails Hazans reviewsthe recent trends in the Latvian labor market and documents the increase in external labor mobility and the narrowing of theethnic gap after EU accession. As for the trade dimension, since the new members are still lagging behind in port efficiency, cus-toms regimes, regulatory policy and IT infrastructure (Wilson, Luo and Broadman), they can gain relatively more compared tothe "old" members if they lower behind-the-border barriers to trade.

Country-specific evaluations of post-accession experiences offer interesting insights and valuable lessons for other countries. EvaBalcerowicz maintains that most fears regarding Poland's accession turned out to be unfounded and shows some unexpected ben-efits of EU membership, such as an increase in exports. The prospects of EU accession provided Bulgaria with powerful politicaland economic anchors to the reform process, which helped to boost the country's competitiveness (Kaminski and Ng). Positive eco-nomic developments in the post-accession period have perhaps contributed to public support for EU membership in Poland(Balcerowicz), and further EU enlargement and eurozone entry in Slovakia (Haughton and Malova).

In the New Findings section Michael Lokshin et al. explore one area where the transition countries still differ much from WesternEurope — that is, an individual's attention to health. In Russia and Albania, a whopping 60% of men smoke. The authors showthat the economic burden smokers impose on themselves and their societies is far from being trivial: smokers lose 15-28% inwages and GDP is decreased by 2%.

Other articles in the New Findings section look at financial deepening and development of the banking sector, highlightingthe role of foreign banks (Havrylchyk and Jurzyk; Dushkevych and Zelenyuk), as well as the barriers to doing business —specifically access to land for large and small businesses in Russia (Kisunko and Coolidge), which remains difficult despitederegulation.

Ksenia Yudaeva, Managing Editor

· 3

The World Bank & CEFIR

Theme of the Issue: EU Enlargement

The European Monetary Union(EMU) continues to expand with Sloveniabeing its newest member since January 1,2007 and several others in the waitingroom. As exchange rates become irrevo-cably linked to the euro, regional inflationdifferentials become an important adjust-ment mechanism: for instance, whencountries grow at different speeds, infla-tion differentials can emerge. Similarly,inflation differentials that emerge due toregions being hit by asymmetric shocksneed not concern a central bank. A moredifficult situation for a monetary policy-maker occurs when persistent inflationdifferentials emerge because of inflexiblelabor and product markets. These couldpotentially lead to large adjustment costs,a loss of public support for the euro anda weakening of the external value of theeuro. To avoid this, sufficient flexibility inlabor and product markets is importantto ensure smooth and sustainable nomi-nal and real convergence of the NewMember States (NMS).

The level of inflation dispersion in theEMU is close to levels observed in othermonetary unions (see Figure). For theEU25 (all EU members except for the UKand Denmark), however, the average levelof dispersion has been considerably high-

er. This is because the NMS are in aprocess of real and nominal economicconvergence. Taking into account currentnominal price levels and the recent speedof convergence, it is estimated that mostNMS need several decades to achieveprice level convergence (see Table). Thatis, if the NMS fixed their exchange ratesto the euro tomorrow, they would have ahigher average inflation rate than the cur-rent euro area member states for a sus-tained period of time.

Unable to Deliver MonetaryStability?

Arguably, monetary policy making bythe ECB would be easier if most memberstates were located closely around theaverage rate of inflation. In contrast, asituation where two groups of countriespersistently deviate from the union'saverage rate of inflation might expose themonetary union to tensions. As nominaland real convergence in the NMS is stillfar from being achieved, there is a riskthat in an enlarged monetary union, twogroups of countries will emerge that havea different rate of inflation, and hencedifferent needs for monetary policy.

While the economic impact of theNMS accession to the EMU would be

limited due to their relatively small eco-nomic weight, the NMS would representa substantial political/social factor as theyaccount for about 25% of an enlargedeuro area's population. The ECB may notbe able to deliver price stability for a con-siderable part of the population of anenlarged monetary union. Since 1999, theaverage share of total population that hasan inflation rate within a ± 1 percentagepoint band around the GDP-weightedaverage inflation rate is about 80% forthe current EMU and slightly more thanhalf for a hypothetical monetary union ofthe EMU and NMS.

ConclusionThe EMU has extended monetary sta-

bility throughout Europe. Arguably, oneof the factors contributing to the successof the EMU has been the high degree ofconvergence among its members whenthey formed the monetary union. To con-tinue the success story, European policy-makers should pay close attention to theeconomic circumstances of the candidatecountries. Inflation differentials can con-tribute to nominal and real adjustment,but may come with costs: insufficienteconomic flexibility increases the risk ofpersistent regional inflation divergence,which could raise adjustment costs, com-plicate monetary policymaking and erodepublic support for the euro. Policymakerstherefore need to be aware of the impor-tance of economic flexibility to ensuresmooth and sustainable convergence ofthe NMS to the euro area level.

Philipp Maier is Senior Analyst at theBank of Canada, and Maarten Hendrikx isEconomist at De Nederlandsche Bank. Thearticle is based on the authors' paper"Implications of EMU enlargement forEuropean monetary policy: A political econo-my view" published in "Kredit und Kapital"36, 137-166. The views expressed are theauthors' and need not represent the views ofthe institutions affiliated. The authors thank P.Cavelaars, D. Lecavalier, J. Lewis, L. Schembriand J. Swank for helpful comments. BT

EMU Enlargement: Why FlexibilityMatters

Philipp Maier and Maarten Hendrikx

Inflation dispersion Relative Price Index 2005, EU15=100

Country GDP Household Deflator Consumption

Czech Republic 54 56Estonia 56 63Latvia 48 55Lithuania 47 53Hungary 59 62Poland 52 58Slovakia 53 56Bulgaria 35 42Romania 43 52

Lowest 3 EurozonePortugal 80 82Greece 82 85Spain 87 87

Source: Lewis (2007), Eurostat

Note: Unweighted coefficient of variation ofregional inflation rates. Data for the USA (12FED districts) is averaged over 1951-1999, forGermany (9 Bundeslander) 1951-1996, forSpain (50 provinces) 1961-1998 and for EMU(13 countries) and EU25 1999-2007.

USA Germany Spain EMU EU25

1.5

1.0

0.5

0.0

Inflation differentials can contribute to nominal and real adjustment, but may come with costs

·4 Theme of the Issue: EU Enlargement


Gains from Risk�Sharing in the EU

Yuliya Demyanyk and Vadym Volosovych

In 2004 ten countries joined theEuropean Union. In addition to politicalunification, the EU is moving toward aunified market with a joint economicpolicy, single currency, and reducedrestrictions on flows of goods, services,labor, and capital.

Unrestricted international trade iswidely believed to be one of the mostbeneficial aspects of economic integra-tion. The merits of greater financialopenness and larger cross-border flowsof money are more often disputedbecause of the recent financial crises andfollowing instability they brought to anumber of the emerging markets. Inaddition, the economies within the euro-

zone cannot reduce the impact of adverse country-specific events (such assudden falls in output due to, for exam-ple, natural disasters) by monetary poli-cy instruments at a country level. This, inturn, can lead to the further instability ofindividual economies and the economyof the Union as a whole unless mecha-nisms that allow diversifying country-specific shocks are in place.

Diversification of economic andfinancial risks within a group of coun-tries is known in economic literature as"risk-sharing." In case of full risk-shar-ing, all country-specific output shocksare completely diversified across thegroup members so that individual coun-try's output volatility is not reflected inthat country's income (full income risk-sharing) or consumption (full consump-tion risk-sharing).

We estimate the benefits from finan-cial integration from international risk-sharing among the 25 EU countries anddo not discuss any other aspects of theintegration that may improve the well-being of the EU residents. We comparepotential gains form risk-sharing amongcountry-members and determine thecountries that would benefit the mostunder conditions of the larger Unionfully achieving risk-sharing.

Domestic MacroeconomicVolatility Higher for the NMS

The ten new EU countries have gener-ally higher and more volatile averageGDP per capita growth rates (4.2% peryear) compared to the rates of the EU-15(2.5% per year). The variability of outputgrowth is three times larger for the NMSthan for the EU-15. Both the rate of percapita consumption growth and its vari-ability follow a similar pattern.

Income risk-sharing gives insight onhow effectively a country uses interna-tional asset markets to insure nationalincome against country-specific outputshocks and thus how well it is integrated

into those markets. On average, the newEU countries have a larger degree ofincome risk-sharing than the EU-15members. The average extent of incomerisk-sharing is 26% for the new membersand 9% for the EU-15 (100% means fullrisk-sharing). This may not mean that thenew EU countries are more open to capi-tal flows. Instead, this may imply theymostly share risk within the EU, while theEU-15 countries are more likely toengage in risk-sharing with the rest of theworld, including investing in NorthAmerica and Asia.

Income risk-sharing would con-tribute to consumption risk-sharing (or"consumption smoothing"). On average,the EU-15 exhibits a much higher degreeof consumption risk-sharing (47%) thanthe new EU countries (15%). A lot ofconsumption smoothing within the EU-15 is achieved through internationaltransfers, national government spending,and corporate and private saving.

Larger Gains for the NMSTo quantify the potential benefits

from risk-sharing, we estimate a welfaregain from risk-sharing as a permanentincrease in the level of consumption of arepresentative individual when a countryachieves full risk-sharing. We estimatetotal potential welfare gains the countries

obtain from moving from financialautarky to full risk-sharing. The measureis estimated using GDP per capita dataunder the proposition that in autarky acountry consumes its own GDP andunder full risk-sharing it consumes a por-tion of pooled group-wide GDP. Judgingfrom the estimated extent of risk-sharing,none of the economies we study is infinancial autarky. Therefore, we also esti-mate unexploited gains from risk-sharingwhen a country moves from the actuallevel of consumption to the level underfull risk-sharing conditions.

The countries with more volatile out-put should, in theory, gain relativelymore than countries with stable outputfrom pooling the individual output risks.In addition, a country whose output iscounter-cyclical to other countries in theUnion would be "compensated" for sta-bilizing the group-wide output.

We find that the new EU memberscould on average gain more from finan-cial integration than the EU-15. The totalaverage welfare gains amount to 5.2%(permanent increase in the level of percapita consumption) for the new EUcountries and to 1.2% for the EU-15.The welfare gains are larger for smallereconomies and are especially large forLithuania, Estonia, Malta, the CzechRepublic and Slovakia. The averageunexploited welfare gains are againmuch larger for the NMS (6.6%) thanthose for the EU-15 (0.9%). The largervalue of the gain for the NMS is prima-rily attributed to a higher volatility andsometimes the counter-cyclical pattern ofoutput and consumption spending.

Thus, the empirical results show thatif financial integration advances and theEU member countries move closer to fullrisk-sharing conditions, the welfare gainswill be substantial for all the countries.

Vadym Volosovych is Assistant Professorof Economics at Florida Atlantic University,U.S. Yuliya Demyanyk is Economist atFederal Reserve Bank of St. Louis, U.S. Fulltext of the article is circulated as"Gains fromFinancial Integration in the European Union:Evidence for New and Old Members",Florida Atlantic University, mimeo. BT

The new EU countries could gain more from financial integration than the EU�15

All 25 countries will benefit from financial integration, and thetotal average welfare gains of the NMS could amount to 5.2%

· 5


Postponing Euro�Area Expectations?

Tanel Ross

For a number of the New MemberStates, including Estonia, adoption of theeuro is the key priority. This short articlediscusses some political and economicissues of the enlargement and provides abrief update on Estonia's position.

The starting point for the adoption ofthe euro is rather straightforward.Eliminating exchange rate risk and pro-moting real exchange rate stabilityboosts both intra-EU trade and GDPgrowth. Adopting the euro would fosterfinancial diversification and investmentflows. The enlargement of the eurozoneso far has provided substantial benefitsfor the new and old member states alike.

If the cost-benefit analysis is sostraightforward, why do doubts aboutthe pace and breadth of the eurozoneenlargement linger? In general, two linesof argument caution against a speedyenlargement. First, an economic line ofskepticism notes the eurozone and mostof the NMS are at different stages of theeconomic cycle (or medium to long termdevelopment). Second, a political line ofskepticism focuses on eurozone gover-nance and, indeed, on EU governance ingeneral.

Economic SkepticismThe economic line of skepticism

notes that the New Member States are ina fundamentally different cyclical posi-tion compared to the old ones. Economicconvergence leads to higher GDP andproductivity growth rates, a somewhathigher CPI inflation, and often to currentaccount deficits, as well. Nominalexchange rate flexibility, in this skepticalview, is needed at some point to adjust toa slower growth path. Premature entryto the eurozone would make that adjust-ment too painful.

These arguments, however, omit thesingle most important feature of theEMU — its members' economies shouldbe agile enough to make use of theopportunities a stable monetary frame-work provides. To this end, economicflexibility is needed in all eurozone mem-ber states. On some occasions, theBalassa-Samuelsson effect will push an

equilibrium inflation rate above theeurozone average. Yet on other occasionsshocks to retail trade or telecom servicesthat cannot be easily traded across thesingle market, would result in realexchange rate depreciation and lowerinflation. In either instance, divergenceof inflation rates is a result of normaland manageable economic adjustment,and is not a sign of weakness.

Clearly, eurozone members will con-tinue to specialize in the single marketand face asymmetric shocks. The diver-gence of inflation rates and externalpositions is thus expected to continue

irrespective of the enlargement. The cor-responding adjustment path of realexchange rates depends predominantlyon the flexibility of economic structures.Therefore, the suggestion that the NMSshould postpone joining the eurozonesimply because of rapid output growthor current account deficits is not entirelycorrect. Potential eurozone entrants arelikely to be flexible enough to adjust inthe currency union without recourse tonominal exchange rates.

Political SkepticismPolitical arguments that caution

against too rapid enlargement can bedivided into two broad categories, evenleaving aside general enlargementfatigue.

One of these arguments points to theassumption that the enlargement of theeurozone will be difficult without furtherpolitical integration. This implies thatthe credibility of the euro would sufferwithout closer coordination among fiscaland structural policies, or among otherpolicies.

The existing toolbox for policy coor-dination within the EU, however, isalready impressive. The renewedStability and Growth Pact and the newLisbon strategy for growth and jobstogether provide a full framework forcoordinating policy and applying peer

pressure. The fulfillment of commitmentsby individual member states would suf-fice for the efficient functioning of themonetary union for years to come.Enlargement of the eurozone would nothinder the proper functioning of any ofthese mechanisms.

Nor would the views of representa-tives of new entrants likely disrupt mone-tary management. Central bank gover-nors from the NMS, according to some,are somehow more accustomed to infla-tion rates exceeding 2%. Ironically, itcould be also argued that governors fromthe NMS would be too hawkish, as high-

er interest rates would be preferable intheir home countries.

It should be underlined that themembers of the Governing Council donot represent their central banks, but theentire eurozone. This applies equally tothe present and future members of theeurosystem. Nevertheless, local econom-ic conditions may still count in the vot-ing pattern on the board. It is interestingto note that in the Federal Open MarketCommittee (FOMC), regional condi-tions may have a stronger impact onboard members in Washington, DC thanon FOMC members from the regionalbanks.

Estonia will Stay on Course Estonia, by adhering to a fixed

exchange rate and the currency boardframework, has been a de facto memberof the common currency area since June1992. With complete liberalization ofcapital movement and full integration ofthe financial system with the Europeanmarkets, Estonia has been as close tocurrency union as an independent coun-try can possibly be. Hence, early adop-tion of the euro is the only realistic poli-cy goal. Estonia has met all theMaastricht criteria with ease — exceptfor the current interpretation of the infla-tion criterion.

Continued on p. 7

While honoring the Treaty, the interpretation of the inflation criterion could be given a fresh look

Estonia’s costs of delayed eurozone entry could amount to 10 per�centage points of a cumulative loss in GDP growth over five years



In the transition countries of Europereducing barriers to trade is increasinglyseen as the key policy priority to acceler-ate integration into the world economy,including through membership in theEuropean Union. A broad definition of"trade facilitation" involves not onlyimproved efficiency in logistics at portsand customs and the use of advancedtechnology, but also streamlined regula-tory policy, deeper harmonization ofstandards, and conformance to interna-tional norms.

EU membership should, over time,facilitate the movement of goodsbetween member states. The harmoniza-tion and implementation of the acquiscommunautaire also require new mem-ber countries to make major improve-ments to their overall economic environ-ment both at and behind the border.

In our research paper, we examine thefour dimensions of trade facilitation —increased port efficiency, customs re-gimes, regulatory policy, and information

technology infrastructure — in order toestimate the gains from trade to the CzechRepublic, Estonia, Hungary, Latvia,Lithuania, Poland, Slovakia and Slovenia(hereafter EU-8); and Bulgaria, Romania,and Turkey (candidate countries).

Facing Different ChallengesWe first measure how far a country's

performance is from the best-practicecountry in each of the four dimensions.The best-practice country is indexed to avalue of 1.0.

The 15 EU member countries are rel-atively advanced in all four areas, withan average value of 0.82, 0.87, 0.79, and0.78 in port efficiency, customs regimes,regulatory policy, and information tech-nology infrastructure, respectively. TheEU8 countries, however, are less devel-oped in these four areas with an averagevalue of 0.60, 0.73, 0.65, and 0.64,respectively. As for Bulgaria, Romaniaand Turkey, the development of theirtrade facilitation is further behind, withthe state of their customs regimes esti-mated at just 58% of the EU-15 level.

The level of development of the newand candidate member countries variesmost in port efficiency, where Estoniaand Latvia are the top performers with70% of the best EU-15 performers. Inregulatory policy, the development levelsof all the examined countries are morehomogeneous.

The three largest economies — theCzech Republic, Hungary, and Poland —are not only less developed than the EU-15 in trade facilitation as a whole,but also constrained in particular dimen-sions. Hungary's customs regimeapproaches 95% of the EU-15 level,while its ports efficiency does not exceed60% of the this level. The CzechRepublic is relatively developed in ITinfrastructure but much less so in portefficiency. Poland, the least developedamong the three, exhibits a level around70% of the EU-15 benchmark in all thefour areas. In sum, in order to achieve

the trade facilitation levels of the EU-15,the new member and candidate countrieshave to overcome different challenges.

Large Gains from Behind�the�Border Improvements

The new EU members have exhibitedrapid economic growth in the last sever-al years (around 2.5-3%), despite the rel-atively weak performance of WesternEurope and the world economy. Doeseconomic growth enable building tradefacilitation capacity? There may be arelationship, as the more developed acountry is, the more resources it candevote to investing in trade facilitationcapacity. By the same token, it is likelythat the larger the economy, the higherthe rate of return on investment inimproving trade facilitation.

Yet, the gap in economic develop-ment of the EU-15 and the EU-8 andcandidate countries does not fullyaccount for the lagged progress in thelatters’ trade facilitation capacity. Theonly exception is Estonia, which per-forms stronger than the benchmark levelin all four indicators but also has a farhigher GDP growth rate than the region-al average. Compared with Hungary, acountry with similar economic charac-teristics, Estonia is 40% more developedin port efficiency, 30% in IT infrastruc-ture and 20% in regulatory policy.

Does trade facilitation promotedevelopment? Our analysis suggests thatbarriers to trade facilitation in the EU-8and the candidate countries may weakentheir development potential. For exam-ple, export growth is one of the mostimportant factors that contributed torecent economic growth in the CzechRepublic, Hungary, and Poland. If infra-structure is upgraded and transactionscosts lowered, trade volumes could beexpanded.

Modeling the impact of hypotheticalimprovements in port efficiency, customsregimes, regulatory policy and IT by halfof the EU-15 level on bilateral trade

European Accession and Capacity�Building Priorities

John S. Wilson, Xubei Luo, and Harry G. Broadman

Almost 40% of the trade gains for the new members come from improvements in IT infrastructure

IT infrastructure

Regulatory policy

Customs regimes

Port efficiency

IT infrastructure

Regulatory policy

Customs regimes

Port efficiency

Candidate Members

EU 8

39%

14% 13%

34%

19%

23%19%

39%

Relative Trade Gains due to ImprovedTrade Facilitation Indicators

flows, we find that that behind-the-bor-der factors will lead to the increase ofimport and especially export volumes.For example, the greatest absolute tradegains — US$49 billion and US$62 billionrespectively — could be expected if portefficiency and IT infrastructure of thestudied countries reach half the averagelevel of the EU, and 70% of trade gainsare associated with export expansion.

Improvements in behind-the-borderfactors by half of the EU-15 average alsoresult in large relative trade gains ofaround 11%. For instance, Lithuania'strade volume would rise more than 25%if its IT infrastructure level reaches 50%of the EU level.

Trading Partners AlsoBenefit

Trade facilitation improvementsbenefit not only the countries thatimplement them, but also their tradingpartners. The more intense trade rela-tions are between countries, the greaterthe potential benefit partner countrieswill enjoy. Given the importance ofintra-regional trade between the EU-15and the EU-8 and the candidate coun-tries, the expected total trade gains toall of them may amount to almostUS$10 billion if all four dimensions oftrade facilitation improve by up to ahalf of the EU-15 level. Of these, 74%accrue to the EU-15 countries.

Almost 40% of the total estimatedtrade gains for the EU-8 and candidate

countries come from improvements in ITinfrastructure (see Figure). The secondlargest potential gains for EU-8 —almost 30% — come from port efficien-cy. These two dimensions should betherefore given a higher priority forimprovement. Bulgaria, Romania, and

Turkey receive more widely dispersedgains with investments in port efficiency,customs regimes and regulatory policy ataround 20% of the total trade gains.

In relative terms, the EU-8 and thecandidate countries will benefit morethan the "old" members, thanks to theexisting relatively intense trade relation-ships. In particular, their relative tradegains are quite large should the largesteconomies among them — the CzechRepublic, Hungary, and Poland —improve trade facilitation. For example,if Poland increases its IT infrastructureto half of the EU-15 average, the otherseven new member countries will enjoy atrade gain of 0.8%; Bulgaria, Romania,and Turkey will gain 0.25%, and the EU-15 — 0.29%.

Concluding RemarksAs our analysis has shown, improve-

ment in IT infrastructure could lead tothe largest gains for the new membersand the candidate countries. If clearance

procedures could be streamlined, theattendant time could be shortened andcosts saved.

In general, improvements in portfacilities and IT infrastructure may bemore costly than the administrativereforms at the center of customs regimes

and regulatory policy — but they couldhave correspondingly high payoffs. Theeligibility for additional EU financingwith accession should provide morescope for improvements in these areas.

John Wilson is at Development ResearchGroup, Xubei Luo is at Europe and CentralAsia Region, and Harry Broadman is atAfrica Region, the World Bank, Washington,DC. Full text of the authors' paper "Enteringthe Union: European Accession and CapacityBuilding Priorities" is available at:http://econ.worldbank.org (World BankPolicy Research Working Paper No. 3832).The findings, interpretations, and conclusionsexpressed in this paper are entirely those ofthe authors. They do not necessarily representthe view of the World Bank, its ExecutiveDirectors, or the countries they represent. Thefindings and conclusions here do not neces-sarily represent the views of U.K. governmentor the U.K. Department for InternationalDevelopment, which has provided supportfor the project. BT

· 7


Continued from p. 5

Against this backdrop, a few sugges-tions for future work could be made.

All the Treaty provisions should, ofcourse, be honored. Within this frame-work, however, taking a fresh look at theinterpretation of the inflation criterion ispossible. The three countries with thelowest inflation rates are not necessarilythe three best performers of the EU-25.Indeed, it has been almost customary inrecent convergence reports that two outof the three reference countries wereones with floating exchange rates thatmight not serve as the most suitablebenchmark for joining the currencyunion. Thus, new ways should beexplored, for instance, by taking intoaccount the european Central Bank's

explicit numerical target for calculatingthe reference value of the price stabilitycriterion, or only looking at the inflationrates of eurozone members.

The new interpretation of the criteri-on would not set an unwelcome prece-dent for any future enlargements. Itwould demonstrate that the adoption ofthe euro would be assessed only by eco-nomic policy merits. Indeed, it is notentirely clear why a combination of lowinflation and a fluctuating nominalexchange rate would be preferred to astrictly fixed rate when deliberating overeurozone membership.

It has been customary to ask whatwill happen if entry to the eurozone isindefinitely postponed. The Bank ofEstonia's calculations put the economiccosts of delay in terms of a cumulative

loss in GDP growth at 10 percentagepoints over five years compared to thebaseline. Of course, strong policies canreduce the impact of the postponementor even render it negligible. In any case,the fixed rate of exchange remains thesole anchor for Estonia's monetary poli-cy. Over the medium term the inflationrate is expected to move closer to theeurozone average thus providing anopportunity to adopt the euro in the notso distant future.

Tanel Ross is Director of Internationaland External Relations Department of theBank of Estonia. He has contributed this arti-cle to BT. The views expressed here are theauthor's and do not necessarily reflect thoseof the Bank of Estonia. BT

Improvements in trade facilitation in the New Member States andTurkey will also bring sizable benefits to EU15

The transition to a market economyhad dramatic labor market consequencesin many of the countries in CentralEurope and the Baltic region: the CzechRepublic, Estonia, Hungary, Latvia,Lithuania, Poland, Slovakia, andSlovenia. At the beginning of the transi-tion, these countries had essentially noofficial unemployment and a very egali-tarian distribution of wages. Structuralreforms led to a sharp decline in employ-ment with a related increase in unem-ployment and inactivity.

Many of these countries began toexperience an economic rebound by themid-1990s. However, the recovery had alimited impact on unemployment. Insome cases, the late 1990s brought fur-ther increases in unemployment in thewake of slumps in economic performanceand macroeconomic stabilization pro-grams designed to restore macroeconom-ic equilibrium and support structuralreforms. On the eve of the 2004 EUenlargement, most of these countries hadsubstantially higher unemployment ratesthan the EU average and, in Slovakia andPoland, considerably higher than those ofany other EU member. The wide and per-

sistent disparities in unemployment ratesacross the regions in Central Europe andthe Baltics are a particular concern.

Labor Mobility is an Impor�tant Adjustment Mechanism

The persistence of regional disparitiesover time indicates, in part, a lack offlexibility in the prevailing adjustmentmechanisms. In principle, adjustment toregional imbalances may take placemainly through a number of channels:

• Where unemployment is high,wages are expected to fall and theprospect of higher returns and lower unitlabor costs should attract more firmsinto the region as well as encourageexisting firms to hire more workers.

• If factors of productionrespond to unemployment disparities,capital should flow into lagging regionsin response to lower unit costs andworkers should move out of high unem-ployment, low wage regions into thosewhere the returns for labor are higher.

• Government action aimed ataddressing regional imbalances couldtake a number of forms.

Capital flows in Central Europe andthe Baltic region are generally not serv-ing to help correct regional imbalances.In particular, capital typically flows tobooming regions, where the human cap-ital stock is high and where economicactivity is concentrated. Wages adjustslightly but the measured wage elasticity(in absolute terms) may be insufficient tooffset persistent and high rates of unem-ployment. In addition the responsivenessof wages to unemployment may bedeclining as the level of unemploymentincreases so that at very high unemploy-ment levels wages may persist in stayingdown. Because adjustment mechanismshave not been effective in reducingregional unemployment disparities, labormobility is a potentially importantadjustment mechanism.

Labor Mobility is WeaklyRelated to Unemployment

Our findings are based on the 2004Labor Force Survey data and variouswaves of the International Social SurveyProgram as well as summary informa-tion from the Eurobarometer Survey.Our study focuses on internal labormigration alone, which, however, mayhave an impact on the results becauseinternational migration may serve as asubstitute for internal migration.

In the countries analyzed, internalmigration is found to be low, to havefallen over time, and to be generallylower than that of the older EU mem-bers. In addition, migration is, at best,weakly related to regional unemploy-ment rates. Moreover, commuting ratesare higher than migration rates but varysubstantially across countries. In 2004,commuters accounted for 1% of allemployed workers in Poland and for10% of such workers in Hungary. Incontrast, internal migrants accounted forless than 1% of all employed workers,on average. There is also evidence thatcommuting rates are growing.



Internal Labor Mobility and RegionalLabor Market Disparities

Pierella Paci, Erwin Tiongson, Mateusz Walewski, Jacek Liwinski, Maria Stoilkova

In Central Europe and the Baltic region, commuting — but not migration — may facilitate transitions outof unemployment

Figure 1: Minimum and Maximum Regional Unemployment Rates (NUTS 3)*, 2004

*NUTS is the EU’s system of classifying territorial units.Source: Eurostat and World Bank staff estimates

50454035302520151050

Minimum Maximum

Central Europe and the Baltics EU�15 Other compara�tor countries

Czec

h Re

p.

Esto

nia

Hun

gary

Latv

ia

Lith

uani

a

Pola

nd

Slov

ak R

ep.

Slov

enia

Aus

tria

Den

mar

k

Finl

and

Fran

ce

Gre

ece

Irela

nd Italy

Net

herla

nds

Spai

n

Swed

en UK

Bulg

aria

Nor

way

Rom

ania

Central Europe and the Baltics average

Unsurprisingly the probabilities ofboth commuting and migration are high-est among men, the young and the bettereducated and among single or separat-ed/widowed workers. In Lithuania andthe Czech Republic, those who areengaged in continuing education or train-ing are also more likely to commute.Commuting appears to be much moreprevalent among workers employed bylarge firms. With respect to previousemployment status, commuting mayfacilitate the transition out of joblessness.However, in the Czech Republic andHungary, there is evidence that being pre-viously unemployed is associated withlower probability of migration. This sug-gests that, at least in the case of internallabor migration, the already employedand the better skilled are more able tobenefit from better employment opportu-nities in other regions than the unem-ployed. In addition, some occupations orworkers in selected sectors are muchmore mobile than others. For example,agricultural workers tend to be lessmobile than service or industry sectorworkers. At more disaggregated levels ofemployment sector, construction workersare relatively more mobile while educa-tion and health workers seem less mobile.

For understanding the growth and per-sistence of regional unemployment ratedisparities, some findings are noteworthy:

• Migration is generally notresponsive in a consistent way to region-al economic indicators but commuting is.

• Commuting but not migrationmay facilitate transitions out of jobless-ness as, in general, those previously inac-tive or unemployed are more likely tocommute. In contrast, unemployment isonly weakly associated with a higherprobability of migration.

Furthermore, the results of the analy-sis of individual preferences suggest thathabits matter: many individuals expressa stronger attachment to their local com-munities and such attachment, in turn, isreflected in lower propensities tomigrate. In addition, workers rely oninformal sources of employment infor-mation. In regions where unemploymentis high, informal job search methods maybe much less effective outside the unem-ployed worker's region of residence.

Policy ImplicationsAppropriate policy measures are nec-

essary to promote labor market flexibili-

ty. In particular, we propose the follow-ing policy considerations:

• Promote measures to facilitatecommuting. Measures to facilitate com-muting, rather than migration, may bemore viable in areas where residentialmobility is traditionally low and wherethere are institutional barriers to chang-ing residences. In addition, since most ofthe studied countries are relativelysmall, commuting is a more attractiveoption than migration. Policy interven-tions to encourage commuting includereducing the monetary and time costs oftransport, such as improvements ininfrastructure and enhancing efficiencyof the transport services market via acombination of private provision andpublic regulation.

• Invest in education and lifelonglearning. As our findings suggest, thoseunemployed who are left behind in lag-ging regions are predominantly the lowskilled workers with the lowest employ-ment prospects. As such, investments ineducation and training may facilitate theadjustment process, as workers acquirethe necessary skills to find jobs in moredynamic regions and move away fromlagging parts of the country.

• Enhance flexibility in labormarkets. For those left behind in laggingregions, a policy package designed tosupport job creation, encourage capitalto move into the area and enhance pro-ductivity is critical. Policy measuresdesigned to promote wage flexibility inlocal labor markets — such as throughdecentralized wage bargaining systems —are a critical component of this package.

• Ensure that social protectiondoes not inhibit mobility. There is com-

pelling empirical evidence demonstratingthat generous unemployment and wel-fare benefits may serve to dampen labormobility, by raising reservation wagesand reducing the incentive to look forwork among unemployed workers. It hasalso been observed that regional dispari-ties in real disposable per capita incomemay not be as large as suggested by dif-ferences in regional per capita income.This is due in large part to different pricelevels and social transfers. The policychallenge is to strike the right balance —providing unemployment and welfarebenefits to mitigate income shocks whilepreserving job search incentives by thetightening of eligibility criteria.

But policy has its limits. Individualsmay be unwilling to relocate, despite thepromise of better employment prospects,due to a legacy of central planning andpermanently secure jobs. Attachments tolocal communities, ancestral lands, andsocial networks, among other reasonsencourage individuals to stay.Furthermore, employment is often notthe only motivation for geographicmobility; family matters, housing ameni-ties, utility costs, and living standards areoften important determinants of mobili-ty. The report finds evidence that prefer-ences, attitudes and habits do restrainindividual mobility.

This summary is based on Pierella Paci,Erwin R. Tiongson, Mateusz Walewski, JacekLiwinski, Maria M. Stoilkova (2007)“Internal Labor Mobility in Central Europeand the Baltic Region”, World Bank WorkingPaper No. 105, Washington, DC. The reportwas written prior to the 2007 EU enlarge-ment process. BT

· 9


Figure 2. Migrants and Commuters: Labor Force Survey 2004(In percent of the employed population; NUTS3 level unless otherwise indicated)

Source: LFS and World Bank staff estimates

CzechRep. (NUTS2)

12%

10%

8%

6%

4%

2%

0%CzechRep.

Estonia Hungary(NUTS2)

Hungary Latvia Lithuania Poland(NUTS2)

Slovakia

Migrants Commuters


Beyond Transition • January �March 2007

Latvian Labor Market before andafter EU Accession

Mihails Hazans

Between 2002 and 2005, the Latvianlabor market witnessed dramaticchanges related both to unprecedentedeconomic growth — 28% in three years— and to a massive outflow of the laborforce after EU enlargement in May 2004.This emerging shortage of labor has ledto strong growth of real wages andreduction of unemployment. Moreover,it has improved the labor market posi-tion of ethnic minorities, the elderly,fixed-term workers, the low-skilled, andother disadvantaged groups. Wagegrowth, in turn, has increased laborforce participation, resulting in furtherincrease of employment rates. In fact,employment rate in Latvia has been ris-ing faster than in any other NewMember State and faster than in the"old" EU except Spain.

We conduct a detailed analysis ofthese changes before and after Latvia'sEU accession, using micro-level datafrom Latvian Labor Force surveys for2002-2005.

Unemployment Risk MuchMore Even

Unemployment risk has becomespread much more evenly across socialgroups. Unemployment rates havedeclined in all age groups for men and inmost age groups for women; and youthunemployment is no longer considered aserious problem.

Latvia's regions have become lesspolarized in terms of both unemploy-ment and earnings. While wages in thecapital city remain significantly higherthan in the rest of the country, andwages in Latgale region significantlylower than in other regions, both gapshave declined since 2002. Similarly, therural-urban earnings gap has declinedconsiderably in the three year period —in fact, in 2005, average earnings ofrural workers were statistically indistin-guishable from their peers in urbanareas. Plausibly, two factors — improvedinternal labor mobility and the externalmobility shock in connection to theaccession — have contributed to thesepositive developments.

Ethnic Gap Narrowed While the minority population still

has a somewhat lower employment rate,the overall gap reduced from more thansix percentage points in 2002 to less thanthree percentage points in 2005.Moreover, the increase in employmentbetween 2002 and 2005 took place pri-marily (and as far as women are con-cerned, exclusively) within minority pop-ulation. For men, ethnic gaps both inparticipation and employment disap-peared. The ethnic gap in employmentrates narrowed in all age groups exceptthe young and the elderly. Nevertheless,for people with tertiary education the

ethnic gap in employment remains sub-stantial at ten percentage points, and hasnot changed significantly since 2002.

Latvians are over-represented inhighly skilled non-manual occupations,in non-market services and agriculture,and in the public sector. Non-Latviansare found more frequently in skilledmanual and elementary occupations, inindustry and market services, and in theprivate sector. "Vertical" segregation(among nine main groups of occupation)is modest, on average; just 12% of non-Latvians would have to change occupa-tion to make their occupational distribu-tion identical to that of Latvians. Thiscan be largely explained, according to arecent survey of employees in Latvia, bydifferences in language skills. Amongemployees with good Latvian languageskills just 7% would have to changeoccupation to make their occupationaldistribution identical to that of nativeLatvian speakers, while for workers withmedium and poor Latvian languageskills 25% and 49%, respectively, wouldhave to change their occupation.

There also exists a wage gap of 9.6%between ethnic groups, which is almostcompletely unexplained by education,age, occupation or similar characteris-tics. However, once differences inLatvian language skills are accountedfor, the "unexplained" gap in earnings(compared to native Latvian speakers)becomes substantially smaller: 4%, 7%,and 1% for workers with good, medium,and poor knowledge of Latvian languagerespectively (see Table).

Returns to EducationUnchanged

What has not changed much in 2005compared to 2002, are the high returnsto tertiary education and low returns tosecondary education — by internationalstandards. In 2005, people with highereducation earned, on average, 76% morecompared to people with basic educa-tion, other things being equal; this differ-

Labor market flexibility in Latvia has considerably improved after the EU accession

Occupational Segregation and Wage Gaps between Native Latvian Speakersand Other Workers, by Self�Reported Latvian Language Skills Level.

Full�time Employees Aged 18�64, 2005, Percent

Native 62.3 � � � �Good 19.9 7.0 �2.1 �5.7 3.8Medium 12.2 24.7 10.0 3.0 6.8Poor 5.4 49.0 13.4 12.4 0.9

Source: Calculations based on data from survey of wage earners for the national program of labormarket studies.

Knowledgeof LatvianLanguage

Share ofWorkers

Duncan Index ofOccupationalSegregation

GrossWage Dif�ferential

ProductivityDifferential

UnexplainedWage Gap

· 11


ential was especially high for females,native Latvians, public sector employeesand the rural population. Returns to sec-ondary education remained modest at10-20%.

As in many post-communist countries(but unlike the Czech Republic for exam-ple), returns to experience in Latvia havebeen decreasing compared to the socialistwage setting system and are at anextraordinarily low level. In a typicalindustrialized country age-earnings pro-file in most education groups rises up tothe age of 50 (except for female collegegraduates, for whom the peak is recorded

somewhat earlier), after which it decreas-es. In Latvia, the male earnings profilepeaks at the age of 38 for workers withhigher education, and at 34 for workerswith secondary and basic education. Theearnings of a 38-year-old and a 23-year-old only differ by 9% for men and 7%for women — this is a remarkably smalldifference compared to the US, where theearnings difference between the same agecategories amounts to a whopping 100%for men and 70% for women. However,compared to 2002, return to experiencehas slightly increased for highly skilledmale workers.

In sum, the findings of our study sug-gest that labor market flexibility inLatvia improved considerably after theEU accession. Responding to strong eco-nomic growth combined with increasedexternal labor mobility, the Latvianlabor market in just three years under-went changes on a scale which is wellbeyond expectations.

Mihails Hazans is Associate Professor atthe University of Latvia. The full text of hispaper is available at: http://ssrn.com/abstract=971198 BT

Ewa Balcerowicz

Poland's integration into the EU hasbeen a gradual and lengthy process, andit is not yet complete. It is important tonote that the developments in the Polisheconomy in 2004-2006 were influencedto a large extent by institutional and reg-ulatory reforms undertaken in the yearsprior to the accession.

The transposition of EU legislationallowed Poland to profoundly reform theway in which its economy is regulatedand restrict government intervention inthe private sector. Changes in such areasas financial markets, company and com-petition law, accounting, and intellectualproperty rights have created a betterenvironment for business and have led toeconomic growth. Poland has also bene-fited from access to EU structural funds,which can potentially contribute to theimprovement of public infrastructure.

Various studies undertaken beforethe enlargement estimated gains fromthe enlargement at 1.3-2.1% of addi-

tional GDP growth per year. Estimatesby CASE showed that trade liberaliza-tion and the reduction of technical barri-ers would bring an increase of 3.4% toPoland's GDP in the long run. The realwages of unskilled workers in Polandwere estimated to increase by 1.7%.

Economy Grew 4.2% a YearIn the first two years of EU member-

ship, Poland enjoyed sound economicgrowth at an average rate of 4.2% ayear, and the trend seems to have contin-ued in 2006. At such a rate, Polandranked eighth among the EU-25 coun-tries, yet lagged behind other new mem-bers, such as the Baltic states andSlovakia. Poland's convergence with"old" members is clearly taking place: itsGDP per capita (in PPS) increased from40% of the EU-15 average in 1997 to46% in 2005, but the pace is too slowand on account of this Poland lagsbehind most of the New Member States.

Contrary to pessimistic expectations,export growth rate outpaced that ofimports and the foreign trade deficitshrank for a sixth consecutive year. In2005-2006 the trade balance with theEU countries became positive, implyingthat the current trade deficit has beengenerated by trade with non-EU coun-tries. Adoption of the Common CustomsTariffs for trade with third countries ledto a drop in average tariffs from 8.9% to4.1%. Not surprisingly, imports fromdeveloping countries (mainly China)rapidly increased. Exports to third coun-tries (mainly to Russia and Ukraine) alsoreached record levels, helped by exportsubsidies to trade in foodstuffs that nowalso apply to Poland. Liberalization oftrade in foodstuffs generated an increaseof Polish exports to the EU.

FDI Reaches Record High As forecasted, there was a spectacu-

lar increase in FDI inflows in the year ofthe accession compared to 2003 (seeFigure). Altogether EUR 10.29 billionwas invested in 2004, nearly reachingthe peak level of 2000, when most priva-tization deals occurred. In 2005 FDIinflows went down by 22%, howeverforecasts for 2006 are very good.Portfolio investment in Poland alsoincreased.

Most fears concerning EU entry turned out to be unfounded, except for the increase in prices

The Impact of EU Accession on Poland's Economy

GDP, Exports and Imports in 1997�2005, Growth Rates (%)

1997 1998 1999 2000 2001 2002 2003 2004 2005

GDP 7.1 5.0 4.5 4.2 1.1 1.4 3.8 5.3 3.4Exports 12.2 14.4 �2,5 23.2 3.1 4.8 14.2 14.0 8.1Imports 21.4 18.6 1.0 15.5 �5,3 2.7 9.3 15.2 4.9

Source: Poland's Central Statistical Office data

Until now, Poland has been the mainrecipient of FDI among the recent EUentrants, and understandably so, consid-ering the size of the Polish economy. Inrelative terms, however, the cumulativeforeign investments in Poland have beenless impressive: they amount to only31% of GDP, which places Poland closeto the end of the rankings (ahead of onlySlovenia and Romania).

The EU-15 was the major investor inPoland, accounting for over 83% of totalFDI at the end of 2005. The Netherlands,Germany and France topped the list withalmost 61% of the cumulative FDI inflowto Poland. Capital flows to Poland fromother New Member States, although stillat a low 2% of cumulative investments,have recently been increasing.

Also Polish investments abroadincreased spectacularly, more than dou-bling in 2004 (to EUR 636 million) com-pared to the previous year, and jumpingfurther to EUR 2,493 million in 2005.

Increased MigrationPressured Wages butIncreased Remittances

As forecasted, the external mobilityof the labor force intensified after the EUaccession, and as predicted, the inflowswere mostly concentrated to the threeEU countries that had opened their labormarkets: the UK, Ireland and Germany.In 2004, approximately 250,000 Polesstayed abroad for at least two months,and most of them worked. This is 20%more than in 2003.

Polish migrants are generally youngerand relatively better educated than thepopulation on average, and the share of

young people (below35 years) amongmigrants furtherincreased: from 51%in 2000 to 61% in2004. The migrantsare, unfortunately,very often overquali-fied for jobs theytake abroad.

Fears that themassive migrationfrom Central Europewill have a devastat-ing effect on destina-tion countries haveturned out to beunfounded. The sizeof inflows to the UK,

Ireland and Germany turned out to bebelow these countries' absorptive capac-ity, according to the World Bank. Theinflow of foreign workers supplementeddomestic labor rather than replaced it,and the wages in destination countriesremained stable.

In Poland, shortages of skilled work-ers have been noted in several sectors,particularly in health care. Wage pres-sures have increased, mainly in agricul-ture and construction. As a result, Polandmay be forced to import labor, and willhave to relax its immigration policy vis-a-vis non-EU countries. On the positiveside, Poland has benefited from increasedremittances and expects to regain someof the labor that has acquired new skillsand knowledge.

Using EU FundsIn 2004, Poland was a net beneficiary

in the EU budget. Net transfers reachedEUR 1.7 billion and accounted for0.75% of the country's gross nationalincome (GNI). The supply of EU funds toPoland is expected to reach 1.5% of GNIin 2007 and 3.25% of GNI in 2008.Among the new financial instrumentsavailable to Poland since the accession,funds for agriculture and rural develop-ment and transfers for structural reformsaccounted for the biggest shares of trans-fers, at 27% and 23%, respectively.

Yet absorption of EU budget fundshas been slow. The decentralized systemof managing structural programs, thepoor quality of relevant legislation, insuf-ficient public financing for infrastructuredevelopment projects and the co-financ-ing of infrastructural investments, andthe inadequate capacity of public admin-

istration are to blame for the slowabsorption. During 2006, the situationimproved, as domestic regulation con-cerning the use of EU funds was relaxedand administrative capacity increased.

Public Attitude MorePositive

The share of people who positivelyassess the impact of EU membership onPoland has been constantly growing.Two years after the integration, 54% ofrespondents believed that EU member-ship brought more benefits than it didcosts for the country. This is 15 percent-age points more than after the first threemonths and 8 percentage points morethan after the first year of the accession.

The positive perception of Poland'sEU accession and its impact on the coun-try and personal well-being dominates inall socio-demographic groups and acrossthe political spectrum, and is especiallyvisible among those who are younger,wealthier, have completed tertiary educa-tion, and live in big cities. According topublic opinion, the most important benefits are the possibility to legallywork in other member countries, openborders, support to agriculture, and theavailability of EU funds.

ConclusionsThe widespread fears raised in

Poland concerning EU entry turned outto be unfounded, except for, to someextent, the increase in prices after theaccession. However the monetary policysecured price stability in the years of2004-2006. Simultaneously there werepositive phenomena which were unex-pected. Contrary to pessimistic expecta-tions, the rate of growth for exports out-paced the rate of growth for imports.Polish exports of foodstuffs to the EUflourished. Surprisingly, public supportfor Poland's EU membership has beenconstantly and substantially increasingsince accession.

Finally, it should be noted that untilnow no precise assessment of the totalimpact of the accession on Poland'seconomy has been made.

Ewa Balcerowicz is the President of theBoard of CASE — Center for Social andEconomic Research. Full text of the paper canbe accessed at: http://www.case.com.pl/upload/publikacja_plik/13286555_sa335.pdf(Studies and Analyses No. 335, 2007). BT



Foreign Direct Investment and Foreign PortfolioInvestment in Poland,1997�2005 (in ECU/EUR million)

Foreign DirectInvestment

Foreign PortfolioInvestment

CurrentAccountDeficit

14000

12000

10000

8000

6000

4000

2000

0

1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: National Bank of Poland

· 13


Bulgaria's Integration into the Pan�European Economy

Bartlomiej Kaminski and Francis Ng

Bulgaria stands apart from new EUmembers in one important respect whichhas had huge implications for theprocess of industrial realignment to pan-European markets: while the country ini-tially moved swiftly to implement first-generation reforms in 1991, the originalbold program of dismantling centralplanning and overcoming transforma-tional recession was quickly abandonedwith the re-introduction of central con-trols. To make things worse, progresstowards creating institutional conditionsconducive to development driven by pri-vate entrepreneurial dynamism has beenuneven since the collapse of central plan-ning in 1989-1990.

It appears that weaknesses in statecapacity combined with the state's cap-ture by private interests groups stood inthe way of moving quickly along withstructural reforms until the 1996 finan-cial collapse. The consequence of this wasanother transformational recession, withtwo consecutive years, 1996 and 1997, offalling aggregate output. Bulgaria, togeth-er with Romania and Moldova, are theonly transition economies that experi-enced this second transformational reces-sion, i.e., at least two consecutive years ofcontracting aggregate output. Technically,the Czech economy also experienced twoconsecutive years of falling aggregate out-put in 1997-1998. But the contraction of0.8% and 1% was just a fraction of thefall experienced in a single year byBulgaria, Moldova or Romania.

“Real” Structural ReformsOnly in 1997

Hence, the real transition to competi-tive markets began only in 1997. In con-trast to the first aborted transition, theconditions under which the second stabi-lization program was launched in 1997were much more adverse and demandingthan the ones in 1991. For one thing,almost half a decade of mismanagementwiped out the financial sector and led toa massive stripping of assets of state

owned firms. Many state owned firms,which five years earlier might have beensuccessfully privatized, lost any attractionto potential investors, foreign and domes-tic alike. Furthermore, human capitalskills that were still available in early1996 either disappeared due to migrationor were simply depleted because of a lackof employment opportunities.

In consequence, it took much longerfor the usual returns from macrostability,privatization and liberalizing structuralreforms to materialize. Delayed —almosta decade into transition — structuralreforms combined with a historicallyhigh dependence on "socialist trade" haddeeply affected Bulgaria's path of restruc-turing and integrating into world mar-kets. While initially Bulgaria’s progressaway from central planning appeared tobe similar in terms of macroeconomic

and export performance to that of otherbold reformers, the differences surfacedrather dramatically during and immedi-ately after the second transformationalrecession. The abolition of the statemonopoly over foreign trade combinedwith the collapse of "socialist markets"initially resulted in an impressive reorien-tation of exports, albeit from very lowlevels, to EU markets. However, stagna-tion replaced initial growth in 1996-99.Had it not been for the rapid expansionof clothing exports under the EU-drivenoutward processing, total exports wouldhave significantly contracted.

Improved Competitivenessof Bulgarian Producers

Thanks to structural reforms and aliberal regional trading environment,Bulgaria successfully, though belatedly,began taking advantage of opportunitiesoffered by participation in the EU-drivenEastern Enlargement regional integra-tion project. Unfinished reform of the

economic regime, on hold until the 1996financial crisis, was responsible for lack-luster foreign trade performance, astrong indication of the absence ofindustrial restructuring and develop-ment. The 2000-04 period witnessedimprovements in export performanceindicating that liberal reforms have acti-vated some creative restructuring.

First, although one might haveexpected a stronger rebound in Bulgaria'sexports after a contraction in 1998-1999,performance over 2002-2003 showed asignificant improvement in the ability ofBulgarian producers to withstand com-petitive pressures in global markets. Thisrefers also to their competitiveness in asingle European market for industrialproducts, the so-called pan-Europeanmarket. Particularly noteworthy is thefact that the largest increases occurred in

2002 and 2003. Rates of export growthstood at 12% and 31% respectively,despite the fact that the latter was taintedby the significant increase in the intensityof competition in preferential marketsdue to the removal of all tariffs on indus-trial products among signatories of thePan-European Cumulation of OriginAgreement. The Agreement paved theway for the establishment in 2002 of asingle European trading bloc for industri-al products, encompassing the EU-25,EFTA, Bulgaria, Romania and Turkey.

Second, progress in implementationof structural reforms and converging tothe EU acquis communautaire led to asignificant enhancement in the quality ofthe domestic business climate.

Last but not least, there was a signif-icant increase in FDI inflows accountingon average for around 8% of GDP over2000-03. Although clothing andfootwear dominated its export basket in2003, there were some shift towardsskilled labor and capital intensiveexports usually associated with FDI.

The gap in export peformance between EU�8 and Bulgaria has been slowly closing in recent years

Structural reforms were delayed almost a decade, but in 2000�2004 export performance improved and FDI increased



The evolution of Bulgaria's totalexports in terms of factor intensitiesbefore the second transformational reces-sion was a testimony to aborted econom-ic reforms. It not only defied expectationsderived from the experience of otherCentral European economies and its pro-duction factor endowments but also dra-matically increased the cost of adjustmentto market conditions for the economy.

De�Industrialization inEarly 1990s

The derailed economic reformsappear to have been responsible for avery unusual evolution of the factor con-tent of Bulgaria's exports indicating avery significant de-industrialization thatoccurred during 1991-1995. Three dif-ferent phases in the evolution of the fac-tor content of EU-oriented exports illus-trated this process. While the first phasein 1992-93 witnessed what turned out tobe peak levels in the share of unskilledlabor intensive products in EU-orientedexports from these countries, the secondphase, 1994-1996, witnessed a majorrealignment in the export growth pat-tern, with skilled labor and capital inten-sive products emerging as major contrib-utors to Bulgaria's exports.

The third phase following the 1996crisis was reminiscent of developments inthe early 1990s in European transitioneconomies that launched radical first-gen-eration reforms in terms of both itsdynamism and change in export offer.While 1996-2000 witnessed little or nogains in the overall competitiveness ofBulgarian producers in world markets,except for clothing mainly in EU markets,there has been a significant increase in thepresence of Bulgarian exporters in worldmarkets more recently, especially in 2003.Although exports of unskilled labor inten-sive products continued towering overother exports, the top performers in EU-15 markets (with an increase in EUimports of at least 2.85 times between

2000 and 2003), accounted for 16% ofBulgaria's EU-oriented exports in 2003 upfrom 4% in 2000. The star performers aremostly from the electro-engineering sec-tors indicating the shift towards moreprocessed goods. Among emerging fastgrowers, i.e., products whose exportsgrowth exceeded annual changes in EUimport demand by at least 30% in 2000-2003, capital intensive products stood out.

Shift Towards HigherTechnology Content

New exports came mainly fromrestructured industrial capacities, augur-ing well for future competitiveness ininternational markets. Of the electro-engi-neering products that performed well onEU-15 markets exports of machinery topthe list, contributing almost 40% to thetotal of top performers' exports. In conse-quence, the share of manufacturing inBulgaria's trade did not only significantlyincrease but there was a shift towardsproducts with higher technology contentand capital goods. Simultaneously, theshare of traditional inputs, i.e., productsused for further processing, in Bulgaria'sexports were accompanied by a markedincrease in the share of machinery. This,combined with the increase of more tech-nologically advanced manufacturing inBulgaria's exports, suggests a gradualshift towards more processed exports.

The gap between Central and EasternEuropean economies and Bulgaria interms of export performance and its fac-tor embodiments appears to have beenclosing, albeit slowly, as exports of capitaland skilled-labor intensive productsbegan growing. While overall Bulgariahas a long way to catch up with othernew EU members in terms of participat-ing in "producer-driven" network trade,there were healthy symptoms of growthin 2001-2003. Bulgarian producers didnot become part of the division of laborbased on production fragmentation invertically integrated sectors on any signif-

icant scale. But by 2002 they had madesignificant strides in information commu-nication technology products and auto-motive parts with the share of parts andengineering products growing from 3.1%of Bulgaria's EU-oriented exports in 1998to 5.4% in 2003. Furthermore, the shifttowards furniture (more exactly, furnitureparts) within "buyer-driven" networks'exports, information communicationfinal products and automotive parts with-in "producer-driven" exports and strongexpansion of exports of other parts andengineering products point to significantprogress in industrial restructuring andensuing gains in competitiveness.

Lessons LearntBulgaria's economic development as

observed through the lens of its EU-ori-ented exports offers valuable lessons forother economies. First, subsidization ofexports is not sustainable and ultimatelyleads to a very high cost of adjustment.Second, the prospects of deeper, policy-induced integration into a more devel-oped region provide powerful politicaland economic anchors to the reformsprocess. Last but not least, the returnsusually associated with liberal reforms,i.e., gains in competitiveness combinedwith shifts towards products in line witha country's endowments in productionfactors take time. They began to surfaceonly around three years after the reformprocess was launched. In contrast to theperiod preceding the second transforma-tional recession, gains in competitivenessderived from corporate and industrialrestructuring and not from subsidies.

Bartlomiej Kaminski is AssociateProfessor at the Department of Government& Politics, University of Maryland; FrancisNg is a trade economist at DevelopmentResearch Group, World Bank, Washington,DC. Full text of the paper can be viewed at:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=922989 BT

Bulgaria and Romania: Strong Growth, Likely to Moderate in 2007

2004 2005 2006 2004 2005 2006 2004 2005 2006 2004 2005 2006Bulgaria 6.6 6.2 6.1 12.7 8.5 9.0 17.1 6.7 6.1 9.1 14.5 15.9Romania 8.5 4.1 7.7 13.9 8.1 10.6 5.4 2.2 7.1 8.9 6.6 9.4

Real GDP growth Real Exports Growth FDI Net (% of GDP)Growth of Industr. Output

Source: the World Bank

· 15


Forming Preferences on EuropeanIntegration: the Case of Slovakia

What shapes a country's stance onEuropean integration? We use Slovakiaas a case study to illuminate preferenceformation in the New Member Statesand explore a number of explanations,highlighted in previous research.

History and Its LegaciesSlovakia's sinuous transition path is

an important component in explainingthe country's stance on further integra-tion. During the mid 1990s, due to acombination of nationalist policies, aseries of murky privatization deals and adisregard for democratic norms,Slovakia became what MadeleineAlbright called "the black hole ofEurope" and was consequently not invit-ed to begin accession negotiations in1997. The new broad-based coalitiongovernment led by Mikulas Dzurinda in1998 placed a high priority on EU acces-sion, and in 1999 Slovakia was invited tobegin negotiations.

For most of the period until May2004 the focus of debates was on catchingup with other prospective entrants andachieving membership per se rather thanwhat type of a European Union the coun-try wanted to belong to. This allowed thegovernment to shape the country's stanceon EU integration, particularly in the firstyears of membership. With accessionachieved, parties, which had EU entry atthe centre of their campaign, shifted focusto more ideological concerns.

In addition, the process of accessionhelped to strengthen the power of theexecutive and weaken the parliament.This has important consequences fordomestic politics, because it is structural-ly easier for the government to pursue aradical agenda if there are no strongdomestic institutional brakes.

SizeAs a relatively small state, Slovakia is

likely to have a stronger preference formore powerful common institutions andcede some degree of sovereignty. Indeed,

the country knows that by acting unilat-erally it is unlikely to have much impactin foreign affairs, but acting in concertthrough EU channels it may have moreinfluence. One area where Slovakia builton its expertise and displayed activisttendencies has been enlargementtowards the Western Balkans.

IdeologyDuring Dzurinda's second term as

prime minister there was an increasedemphasis on the ideological dimensionof politics. After 2002 the governmentbegan to implement radical socio-eco-nomic reforms, such as the introductionof a flat tax, cuts in welfare benefits, aswell as pension and health reforms. Forthese, the EU represented a threat. Theformation of a more leftist-orientatedcoalition government in 2006, however,suggests that ideology is less importantthan had been earlier thought. Indeed,despite parties of a different ideologicalhue holding the reins of power there hasbeen a striking continuity of policy vis-a-vis the EU.

Public OpinionPublic opinion can play a significant

role in constraining a government'sEuropean policy. In Slovakia, citizensare satisfied with being members: thelatest Eurobarometer survey suggests61% consider membership a "goodthing", well above the 53% EU average.Public opinion supports eurozone entry,further EU enlargement and integrationin defense and security policy, butopposes harmonization in the fiscalsphere and, thus, has been in line withthe governments' positions on a range ofEuropean issues.

Powerful Groups, Depen�dency, and Party Politics

Slovakia is dependent on theEuropean Union, both as a significantnet recipient of EU funds (3.27% ofGNI), and as an exporter. This suggests

that Slovakia would be very much infavor of further economic integration.

Although many societal groups suchas trade unions are rather weak, others,most notably big businesses haveappeared to be much more powerful.Slovakia's neo-liberal economic agendaunder the Dzurinda-led governmentbecame increasingly fuelled by powerfulbusiness lobbies. This pressure has con-tinued since the new government cameto power. Businesses have pushed foreasier access to European markets andthe fast adoption of the euro, but haveopposed harmonization, especially in thefiscal sphere.

The influence of business interestgroups has been facilitated by domesticparty politics. The political scene hasbeen fluid over the past years, with manynew parties — often elite creations —formed. Not only do elite-created partiestend to be closely associated with theirfounders and leaders, they also oftenlack developed mechanisms of accounta-bility, and can be dependent on andbeholden to the generosity of initialfinancial backers.

ConclusionsThus, we contend that ideology is

not such a good indicator of shapingpreferences. Rather, preferences arebased on the country's recent historyand size, and linked to the nature ofparty politics and the power of particu-lar interest groups, with the latter beingparticularly important in the socio-eco-nomic domain.

Attempting to assess preference for-mation and the behavior of the NMS ismade more complicated by the fact thatwhile two of the variables are largelyfixed (size and history), two others aresubject to change. Indeed, there are someindications that party politics is becom-ing less fluid in Slovakia. The 2006 elec-tions, for example, were the first sinceindependence when no new partiesentered the legislature. Additionally,

Preferences are based on the country’s history, size, party politics and the power of interest groups

Tim Haughton and Darina Malova



The IMF-World Bank seminar, held in Singapore in 2006,brought together distinguished speakers representing found-ing, new and aspiring European members, and the Asian eco-nomic community representatives to debate the future ofEurope and implications for Asian integration. Panelists dis-cussed some of the findings emerging from the reflection andconsultations that have taken place in Europe over the lastyear, with a particular focus on the following questions:

• What is the future of the constitution? Will it beabandoned in favor of a "political declaration" or will it beresurrected in a slimmed down version?

• Might the rejection of the constitution and thepopular vote of no confidence promote a return to theapproach of quiet incremental reform that has served the EUso well in the past?

• Where should Europe's borders lie? Is Europe's cur-rent neighborhood policy working?

• Can Europe's "social model" survive in the face ofglobal pressure?

Mr. Joaquin Almunia (Commissioner for Economic andMonetary Affairs at the European Commission) argued thatthe failure of the constitutional process in France and theNetherlands has indeed created a political crisis as a growingUnion needs a new distribution of responsibilities betweennational and supra-national levels. However, there may be anew window of opportunity with the 2007 German presi-dency, and elections in France and the Netherlands. Further,Europe is far from paralyzed by the set-back on the constitu-tion as evidenced by the important decisions made in the lastyear on integration and expansion. In addition, the econom-ic situation in the EU improved last year. In sum, there is apolitical problem but the EU is gaining momentum econom-ically and forging ahead on political integration.

Mr. Leszek Balcerowicz (President of the National Bankof Poland) emphasized that the constitution is not essentialfrom an economic perspective. Instead the EU should focuson the Lisbon agenda and the country level actions to achieveit. This includes reducing fiscal pressures — Europe is over-taxed compared to Asia, and this is because European coun-tries spend too much particularly on social protection: publicexpenditure to GDP ratio in Europe is around 40% com-pared to only 20% among the Asian Tigers. In addition, thecountries need to do more to deregulate, especially in labormarkets. More can also be done at the European level: thiswill require abiding by the growth and stability pact. As to

integration of service markets, the much weakened final ver-sion of the adopted service directive needs to be strengthenedif Europe is to develop a single market for services that cancompete with the US. However, an appropriate communica-tion strategy will be essential to any further reforms.

H.E. Ali Babacan (Turkish Minister of State in charge ofEconomy) agreed with the importance of communication,arguing that the rejection of the constitutional treaty waslargely due to voters' perception that Brussels is removedfrom their cares and concerns. As to the limited economicdynamism of the EU, it can be helped by further enlargementand the associated growth in the goods and labor markets.In addition, the integration of Turkey into the EU wouldpromote democracy, security and stability, and therefore befully in line with the original goals of the European project.It will also help demonstrate that democracy and Islam canco-exist and provide a bridge between civilization that iscrucial to the safety of the EU.

H.E. Heidemaries Wieczorek-Zeul (German Minister ofEconomic Co-operation and Development) reminded theaudience that the creation of the Union sprang from a deepreaction to war and dictatorship — with membership alsohelping democratic achievements in countries such as Spain,Portugal and Greece. The hope is that the adaptability thatthe EU has shown in the process can now be expanded to theMiddle East. The rejection of the constitution was a set-backbut one that should be interpreted as a vote of no confidenceon the economic and political process, and motivated by afear of globalization. As to the social model of WesternEurope, it does need reform but remains an important modelthat helps assure people they will not be at the mercy of mar-ket forces. Countries without this kind of safety net revert toprotectionism during economic downturns. Europe's socialmodel represents a good way of smoothing globalization'simpact on households.

What could Asia learn from European integration? Mr.Haruhiko Kuroda (President of the Asian DevelopmentBank) noted that Asia's integration has been rapid and mar-ket driven, mostly through trade and investment: intra-regional trade, at 55%, is similar to that of the EU. Indeed,regional economic integration has been one of the successfulfactors of the region. ASEAN may now need to work on theinstitutional and political elements of this integration. Theexperience of the EU with small country bias and subsidiar-ity principles will be helpful. BT

Whither Europe?

domestic interest groups, such as tradeunions, clearly have the potential tobecome more organized and influential inshaping policy. At the same time the busi-ness lobby may not necessarily retain itspowerful position.

More broadly, the overarching basesof political contestation in Slovakiauntil the early 2000s, such as the char-acter of the political regime, illiberal

democracy, nationalism and entry intoEuro-Atlantic clubs, have largely gone.The contemporary political scene hasbecome focused primarily on domesticissues of distribution, allocation andsocio-economic organization.

Tim Haughton is Senior Lecturer at theUniversity of Birmingham, UK, and Darina

Malova is Professor at Comenius Universityin Bratislava, Slovakia. The article is based onthe authors' paper presented at JohnsHopkins University-SAIS Conference in April2007. The authors thank the UniversityAssociation for Contemporary EuropeanStudies for according funds through itsFellowship scheme to Tim Haughton and theSlovak Research and Development Agency(No. APVV-0660-06) for funding DarinaMalova's research. BT

Eastern and Central European coun-tries entered the EU with reformed andrelatively modern banking systems.Despite the impressive progress, all of theNMS face the challenge of financial sys-tem deepening and remain far behind theeurozone in respect of financial depth ofbank and non-bank financial institutions,and capital market development. In somecountries, such as Latvia and Romania,the total assets of financial institutionsstill constitute less than 50% of GDP. Inmost NMS, foreign-owned banks domi-nate the banking system.

Rapid Credit ExpansionOver the last decade, bank credit to

the private sector has expanded impres-sively in almost all countries, at an aver-age annual compounded rate of 24%. Thegrowth of bank lending was particularlystrong and sustained in SoutheasternEurope (SEE) — Romania and Bulgaria— and the Baltic countries. The creditexpansion of the last two years is largelya result of increased loans to households,while growth in the corporate sector hasremained modest. The latter has been dueto an improvement in companies’ earn-ings, accumulation of liquid funds andaccess to external lending. This raisesquestions about the productive impact ofthe observed credit growth.

Among loans to households, housingloans have been growing particularly fast.Between 2004 and 2005 alone, such loansincreased 95% in Bulgaria and around90% in Latvia and Lithuania. However,compared to the EU-15, the level of resi-dential mortgage debt remains rather low,

below 30% in the Baltic countries andHungary and below 10% in other coun-tries (compared to e.g. over 70% in UK).

The demand for credit has grownbecause of increases in disposable incomeand higher confidence related to EUaccession, falling inflation and interestrates, stable or appreciating local curren-cies, and better investment opportunities.The increased supply of bank loans hasbeen driven primarily by financial sectorderegulation and deepening (due to largeprivatizations in the sector and increasedcompetition from foreign banks).

Large MacroeconomicImbalances in Some Countries

An analysis of the current financialhealth of banks suggests that generallythey are well-capitalized and profitable.They have also visibly improved the qual-ity of credit portfolios. For example, in theCzech Republic the ratio of non-perform-ing loans (NLP) to total loans decreasedfrom around 13% in 2001 to 4.3% in2005, and in Slovakia from almost 25%to 5.5%. Banking supervision has alsoimproved significantly. Yet, the low ratiosof NLP today are no guarantee of low lev-els in the future, and credit quality may bedeteriorating. Besides, less sound banksare equally engaged in lending and maybe taking even higher risks. Moreover,there is no guarantee that parent banks offoreign owned banks would come to therescue in case of trouble.

The sharp increase in domesticdemand, especially household consump-tion, has spurred real GDP growth in theregion since 2000, but also contributed to

the emergence of largemacroeconomic imbal-ances in some countries.Output growth has beenparticularly rapid in theBaltic countries at around10% in 2000-2005. Inthese countries, stronginflationary pressures haveraised concern about over-heating. The domesticdemand boom has led to asurge in imports and largecurrent account deficits,especially in the Baltic and

SEE countries. External debt levels haveincreased sharply in some countries, withthe external debt-to-GDP ratio in Estoniaand Latvia reaching about 80% of GDPin 2005. Most countries have not takenadequate advantage of the strong growthto consolidate public finances and havebeen running pro-cyclical fiscal policies.

Thus, while credit expansion to a sig-nificant extent reflects a normal catching-up process by previously underdevelopedfinancial systems and credit to the privatesector as a share of GDP remains in linewith per capita incomes in the region,some countries, in particular the Balticand the SEE countries, have witnessed atrue credit boom that has contributed tosurging consumption and the overheatingof their economies. Slovenia, whichjoined the eurozone in January 2007,probably enjoys the best protectionagainst any potential financial distress.

International experience suggests thatprolonged, rapid credit growth coupledwith macroeconomic imbalances can eas-ily deteriorate into financial distress.Many countries have been concernedabout excessive credit growth and havetaken measures to control this. However,their effectiveness is unclear as credit con-tinued growing rapidly and macroeco-nomic imbalances remained large.

Policy AdviceA proactive policy response is needed

ranging from enhanced supervision andpossibly regulation to more hard-hittingmeasures, including tightening of mone-tary policy (where possible) and fiscalpolicies aimed at discouraging householdborrowing and stimulating private sav-ings. Authorities should also preparethemselves for the unlikely, but notimpossible scenario of a financial dis-tress, and put in place adequate contin-gency plans. Given the lessons learnedfrom previous experience, it is clear thatprudence should dominate the "growthversus imbalance" policy dilemma thatmany of the NMS face today.

Source: World Bank EU8+2 RegularEconomic Report, January 2007, www.world-bank.org/eu8-report. The report covers theNMS in Central and Eastern Europe. BT

· 17


Credit Expansion in Emerging EuropeSome countries have witnessed a true credit boom that has contributed to overheating of their economies

Bank Credit to the Private Sector (% of GDR, 1995/2001/2005)

Source: national Central Banks; World DevelopmentIndicators for 1995.

80

70

60

50

40

30

20

10

0CZ EE HU LV LT PL SK SI BG HR RO

1995 2001 2005

35,7

74,3

50,3

67,5

41,0

28,234,8

55,9

43,4

61,9

21,1

·18 New Findings


Michael Lokshin and Zurab Sajaia

Tobacco smoking is widely prevalentin Russia. About 50 million Russiansbetween the ages of 18 to 65 smoke, andeach year 375,000 Russians die of smok-ing-related illnesses. According to theWorld Health Organization, Russia hasthe world's fourth-highest rate of smok-ing. The last decade witnessed a sharpincrease in the number of smokers, espe-cially among the female and youngerpopulations. Russia is the third-largestmarket for tobacco in the world, withsmokers spending up to US$6 billion ontobacco products. Along with alcoholconsumption, smoking is a leading pub-lic health problem, and together theycontribute to Russia's declining life span.

In recent years, the Russian anti-smoking movement, assisted by the gov-ernment in its effort to reverse or slowpopulation decline, has made someprogress in controlling tobacco com-merce and consumption. As a result, theRussian Parliament has ratified severaldecrees and laws restricting smoking inpublic places and banning tobaccoadvertisements on television and radio.However, smoking is still on the marginsof Russia's policy agenda. Russia has notjoined the Framework Convention onTobacco Control that 167 countries hadsigned and 57 national parliaments hadendorsed by February 2005.

Economic Losses Ignored The anti-smoking debate in Russia

has focused mostly on the adverse effectsof smoking on health, and not so muchon the costs that smokers impose on theeconomy through the reduction in theirproductivity. But such costs could playan important role in the anti-smokingpolicy debate in Russia.

Our study provides the first empiricalestimates of the economic losses stem-ming from the negative effect smokinghas on wages in Russia. The analysis isbased on data from the Living StandardsSurvey conducted in the Tomsk region ofRussia in 2006. While the survey is notintended to represent the nation as a

whole, it provides information on a typ-ical Russian region. The Tomsk regionhas a population of about 1.1 millionpeople, many of whom live in urbanareas. Large industrial enterprises andresearch centers in the region provideemployment for the majority of theworkforce; the share of the public sectorin total employment is high.

30 to 35�Year�olds MostLikely to Smoke

In our sample of over 2,500 respon-dents, 61% of males and 14% of femalescategorized themselves as smokers. Theincidence of smoking is higher among themale rural population and female urbandwellers (see Table). The prevalence ofsmoking increases sharply with age, peak-ing at 30-35 years. The lower proportionof old-age smokers in the sample could beexplained by higher attrition rates in thatgroup. Accumulated over a lifetime, thenegative effects of smoking could lead toearlier exit from the labor market or evendeath. For both genders the prevalence ofsmoking declines with education. Morethan two-thirdsof men and about25% of womenwith high schooldiplomas smoke.Those propotionsdrop significantlyfor individualswith universitydegrees or higher.

On average,n o n - s m o k i n gmen earn morethan smokers:10,732 rubles permonth (aboutUS$400 at theexchange rate ofRUR27/US$1) vs.8,992 rubles(US$330), respec-tively, thus enjoy-ing about a 19%

unadjusted wage premium over smokers.The wage premium of non-smokingwomen was quite a bit lower at 6%,which translated to an approximatelyUS$15 "bonus".

Why Lower Wages?Several theories explain the lower

wages associated with smoking. Healtheffects of smoking are arguably the mostfrequently noted link; smoking causesvarious morbidities, which could there-fore result in lower labor productivity. Asecond, partially health-related explana-tion, is the higher costs to employers ofhiring a smoker relative to a non-smoker(for example, due to healthcare costsinduced by smoking). Even if smokersare equally productive or do not incurmore costs in employment, discrimina-tion against smokers in the workplacemay result in lower earnings for thosewho smoke. Finally, smoking could becorrelated with lower earnings becauseof the differences in preferences overpresent and future consumption betweensmokers and non-smokers.

Russian male smokers earn 14.8% less then non�smokers

The Economic Cost of Smoking in Russia

Prevalence of Smoking and Simulated Wage Losses

Men Women Total Men Women

Tomsk 55.1 18.6 35.0 �19.7 �4.1

Other Urban 55.7 14.4 33.5 �23.2 12.1

Rural 65.6 11.9 38.0 �9.7 �6.0

Age groups

25�30 60.3 17.7 39.2 �17.5 9.2

35�40 64.7 15.4 36.6 �11.9 �10.9

45�50 60.0 12.3 33.0 �14.9 0.4

55�60 51.2 9.4 29.9

Education

Secondary general or less 72.5 26.8 56.1 5.2 �16.4

University and higher 43.6 8.8 22.7 �19.3 3.6

Total 61.1 13.9 36.2 �14.8 �0.6

Prevalence of Smokingby Region, Age and

Education Groups(Mean)

SimulatedWage Losses

from Smoking(%) by Gender

Losses up to 2% of GDPIndividuals who choose to smoke

may be different from non-smokers insome unobserved dimensions that arenegatively correlated with wages. Thechallenge for our empirical strategy is toestimate the effect of smoking on wagescontrolling for such unobserved factors.The results of our estimations demon-strate that smoking indeed has anadverse effect on the wages of smokers.Controlling for observed individualcharacteristics, such as age, level of edu-cation, health status, and householdcomposition, we find that the smokingwage differential amounts to about10.9% for males and about 3.8% forfemales. Taking into account differencesin both observable and unobservablecharacteristics, our estimations showthat men earn about 14.8% less if theysmoke. No such effect of smoking onwages is found for women in this esti-mation. The estimates of the negativeeffect of smoking on wages in Russia arelarger than the estimates for Germanyand the U.S., where workers lose 4% to8% of their wages because of smoking.

The deleterious impact of smoking onwages is greater for younger men: thewages of smoking men aged 25-35 arealmost 18% lower than wages of non-smokers of the same age group. The neg-ative impact of smoking on wages is alsolarger for men and women with highereducational attainment.

Aggregating the individual wage loss-es from smoking at the regional level, wecan conclude that Tomsk region loses aconsiderable share of its revenue justfrom the reduction in productivity due tosmoking. On average, a male smokerloses about 1,125 rubles per month dueto smoking, and a loss in wages for asmoking woman is about 29 rubles permonth. Taking into account that thereare 154,000 men and 33,000 women inthe total work force who smoke, theTomsk region looses 2.1 billion rubles or2.0% of the regional GDP per year.

Obviously, the state would lose taxesif people reduce their cigarette consump-tion. However, the tobacco duties exist-ing in Russia are among the lowest in theworld. Tobacco companies pay only 65rubles per 1000 cigarettes plus 8% on

the sale price of cigarettes. If an individ-ual who smokes a pack of cigarettes perday quit smoking, the losses in taxes forthe state would be at least 10 times lowerthan the individual's losses in earnings.

We can conclude that the economiccost of smoking represents an importantcomponent of the burden smokersimpose on Russian society. The argu-ments presented here could be used in theanti-smoking debate because they showthat Russia bears an immediate loss fromsmoking, as opposed to the long-termhealth-based losses that lie beyond thedecision horizon of most policymakers.

Michael Lokshin is a Senior Economistand Zurab Sajaia is an economist at theDevelopment Economics Research Group, theWorld Bank, Washington, DC. The findingsand interpretation of this paper are those ofthe authors and should not be attributed tothe World Bank Group, its ExecutiveDirectors, or the countries they represent. Fulltext of the paper "The economic cost ofsmoking: Differences in wages betweensmokers and non-smokers in Russia" is avail-able from the authors. BT

· 19


In Albania, 60% of adult males and 18% of femalessmoked in 2002 and the number of smokers has been increas-ing rapidly over the last decade. Anti-smoking policies arehigh on the country's agenda. In January 2006, the govern-ment submitted a new draft law on tobacco and smoking thatoutlawed sales of cigarettes to minors younger than 18, andpresented stricter rules for the tobacco industry regarding thesale and advertising of tobacco products.

Data from the fourth round of the Albania LivingStandard Monitoring Survey allowed us to estimate forgoneearnings from smoking for working Albanian men (the pro-portion of female smokers in the sample was too small).Wefind that the incidence of smoking is similar among the urbanand rural male populations in Albania. The prevalence of cur-rent smokers is close to 50% among the least educated malesand declines for better-educated men. Only 25% of men witha university degree smoke. The propensity to smoke varies byreligion: the highest proportion of smokers (36%) is amongAlbanian Muslims, including Bektashi. Albanian Christianssmoke at a rate of about 30%.

The incidence of smoking increases with the age of therespondents. Less than 20% of 25 year old men classifiedthemselves as current smokers. The proportion of smokersincreases sharply for older age groups peaking at about 35%for men 38 years old and older.

On average, non-smokers earned about 26,300 lek permonth relative to 24,290 lek per month for smokers (8.3%difference). Wages of non-smokers are higher than wages of

smokers for all age groups with the largest gap in wagesobserved for workers between the ages of 35 and 50.

When controlling for productive human capital charac-teristics, such as education and knowledge of English, Italianand Greek, etc. we find a stronger dependence between wagesand these characteristics for non-smokers than for smokers.This supports the idea that smokers and non-smokers havedifferent preferences over present and future consumption.

For working Albanian men aged 25 to 60, our analysisshows that the wages of smokers are significantly lower thanthe wages of individuals who never smoked. Consistent withother studies for developed countries, the wage penalty differsdepending on how the observed and unobserved traits ofsmokers and non-smokers are addressed. A simple comparisonof mean wages produces the 8% difference, as shown above.When taking into account observable personal characteristics,we find that the negative wage effect of smoking is reduced to4%. However, considering both the differences in observableand unobservable characteristics of smokers and nonsmokers,the wage penalty for smoking becomes much larger: smokersexperience wage reductions of 21-28%. This indeed providesstrong evidence for the potential policy relevance of tobaccocontrol initiatives for developing countries such as Albania.

Source: "Forgone earnings from smoking: Evidence for a devel-oping country" by Michael Lokshin and Kathleen Beegle, both fromthe Development Economics Research Group, the World Bank. BT

Smoking in Albania

·20 New Findings


Deregulating Business in Russia

Ekaterina Zhuravskaya, Evgeny Yakovlev

Better progress in regions with more transparent, less corrupt and more fiscally�motivated governments

In recent years deregulation has beena popular topic on policymakers' agenda:in 2005 and 2006 alone, 55 countriesundertook reforms that lowered the costsof doing business, the World Bankreports. How can the reform achieve thedesired results at the local level if startedby the central government? What resultsdid deregulation of business activity bringto businesses and the population at large?

In addressing these questions, we usea unique combination of a deregulationpolicy experiment undertaken in Russiain the early 2000s and detailed paneldata on the actual regulatory burden onfirms across regions. The data come fromregularly-repeated surveys of 2,000 firmsin 20 regions of Russia about their actu-al levels of regulatory burden in eacharea of regulation affected by the reform.

Ambitious Reforms Between 2001 and 2004, Russia

passed laws that drastically simplifiedprocedures and reduced red tape associ-ated with entry regulation, and with theregulation of existing business. The lawsintroduced clear measurable limits toregulatory burden, for example, theyestablished that registering a businessrequires a trip to just one governmentagency (‘one-stop shop’) and takes nomore than a week; each inspectingagency, comes to inspect a business nomore frequently than once in two years;licenses are valid for no less than fiveyears. In addition, the reform foresaw asubstantial amount of ‘delicensing’, i.e.,the exemption from licensing of manybusiness activities which previously hadrequired licenses.

Prior to the reform, Russian firmssuffered from excessive regulatory bur-den. It was argued that over-regulationwas among the most important reasonsfor the country's poor economic per-formance during the first eight years oftransition. The proclaimed goal of thereform was to induce the entry andgrowth of small business.

In our study we, first, examinewhether the reform succeeded in bring-ing down administrative costs for firms.

Second, we study which institutional fac-tors affected the level of enforcement ofderegulation laws in different regions.And third, we estimate the causal effectof deregulation on outcomes — firmentry, employment in small businesses,public health, and pollution.

Transparent and Account�able Governments Succeed

To begin with, we compare the actualregulatory burden with the official levelestablished by the legislation and findthat official regulations are poorlyenforced and grossly understate the regu-latory burden, as much of the actual reg-ulation is in excess of the official levels.The difference in timing of the initialenactment of different deregulation lawsallows us to estimate the effect of theenactment on regulatory burden.Controlling for all regional characteris-tics, macro-economic shocks, and region-specific trends we find that, on average,the enactment of a deregulation law hasled to a significant reduction in regulato-ry burden for Russian firms in the area ofregulation affected by that law.

At the same time, reform progressexhibited a large regional variation.Therefore, looking only at the largestcities may give a misleading pictureabout the state of regulation in the coun-try as a whole. Moreover, the geographi-cal variation of regulatory burden ineach area of regulation prior to thereform's implementation had also beenvery large. So in examining what deter-mines the success of a deregulationreform at the regional level, we take intoaccount the pre-reform regional institu-tional environment. Based on our esti-mations we can conclude that four fac-tors significantly boost enforcement ofderegulation laws in a region:

• Government transparency; • Low corruption; • Presence of a strong industrial

lobby, i.e. the extent to which regionalauthorities are under the influence ofpowerful industrial groups;

• Strong fiscal incentives, i.e. theextent to which regional budgets are

comprised of local taxes rather thantransfers from the federal center.

Effect Similar for All FirmsInterestingly, these institutional fac-

tors affect in the same way both the entryderegulation and the liberalization of reg-ulations on established firms. Thisimplies that industrial lobbies acceleratederegulation in all areas of regulation anddo not use entry regulation to protectthemselves from potential competitors.

According to our estimates, deregula-tion had a positive significant effect onfirm entry and employment in smallbusiness. At the same time, no effect oneither pollution or public health (mor-bidity from poor-quality products) hasbeen recorded.

In concluding it is worth repeatingthat it is the regions with the least cor-rupt, transparent, accountable, and mostfiscally-motivated governments thatachieve most progress in deregulation.

The evidence allows us to evaluate thecompeting theories of the nature of regu-lation. Our findings are inconsistent withthe public interest theory because regionswith transparent and accountable gov-ernments are the ones that achieveprogress in deregulation, and moreover,deregulation does not have an adverseeffect on pollution or morbidity (twomarket failures that regulations are sup-posed to cure). The evidence is also hardto reconcile with the regulatory capturetheory because the presence of a politi-cally-powerful industrial lobby has thesame effect on regulation of entry andexisting business. Industrial lobbies accel-erate deregulation in all areas and do notuse entry regulation to protect themselvesfrom potential competitors. But, in accor-dance with ‘tollbooth’ theory, the leastcorrupt and most fiscally-motivated gov-ernments promote deregulation the most.

Ekaterina Zhuravskaya is AcademicDirector at CEFIR in Moscow; EvgenyYakovlev is a Ph.D. student at University ofCalifornia at Berkeley, USA. Full text of thepaper is available at www.cefir.ru(CEFIR/NES Working Paper No. 97). BT

· 21


Land and Real Estate Transactionsfor Businesses in RussiaGregory Kisunko and Jacqueline Coolidge

Land privatization in the RussianFederation has a checkered history, witha clear favorable policy not firmly estab-lished until the enactment of the 2001Land Code. Even after the enactment,many vital parameters of land privatiza-tion, including pricing parameters, havestill not been settled.

The new Land Code explicitly callsfor land to be privatized as follows:

• Land under buildings that wereprivatized earlier is supposed to be sold(or leased) to the owner of the buildingat an administered price within parame-ters set by federal legislation (this cate-gory accounts for the great majority ofland transactions involving businesses).

• Vacant land intended for newconstruction is supposed to be privatizedby transparent auction or tender proce-dures (there have so far been relativelyfew transactions of this type).

The privatization procedure for landunder privatized buildings (the mostcommon procedure for acquisition ofland) involves an average of 11 stages,eight different agencies, 17 different doc-uments, 220 days, and about 70,000Rubles (about US$2,400) in official fees.The range, however, is quite large, fromlow figures of about 50 days in Rostovregion and 10,000 Rubles in Novgorodregion to high figures of over 400 days inNovosibirsk and 360,000 Rubles inMoscow region.

To date, most land of interest to busi-nesses is still owned or controlled bymunicipal governments, which gives themstrong "market power" as near-monopo-list landlords, while greater legal flexibili-ty over land rents (as opposed to buy-outprices and land taxes) provides a strongfiscal incentive to municipalities to try tomaintain their ownership rights, andencourage businesses to apply for leaserights instead of ownership rights. In tenout of 15 regions in our survey, more thanthree-quarters of land is owned or is inthe possession of the state or municipali-ties. Only in one region — Rostov — theshare of state and municipal lands is

much lower at 35%. The city of Moscowstands out with 100% of land still pub-licly owned. The remainder of the land isowned by legal entities and individuals,with individuals owning significantlymore land parcels than businesses do.

In addition, there is still considerableevidence of municipalities abusing theirmarket power through administrativebarriers, not necessarily to keep rentshigh, but more often to favor some firmsover others and/or exercise undue influ-ence over local business development.

Limited Access to Land asan Obstacle to Business

Businesses continuously complainthat there has been very little land priva-tization to date, and that the limitedamount of privatization that has takenplace has suffered from severe inconsis-tencies, non-transparency, and outrightfavoritism. While this problem is notunique to Russia, cross country compar-isons suggest that businesses in Russiaare even more likely to perceive "accessto land" as an obstacle, relative to manyother emerging markets.

In our study we investigate the prob-lems faced by businesses in carrying outland and real estate transactions inRussia. The analysis is based on a surveycarried out by the Foreign InvestmentAdvisory Service, which covered 15Russian regions and included informationfrom 517 business intermediaries thathelped clients with land and real estatetransactions in 2004, as well as 1,188legal entities and sole proprietors thatattempted, underwent or completed landand real estate transactions in that year.

Our analysis demonstrates that theprincipal factor influencing the level ofland privatization in a region (dominatedby privatization of land under buildings)is the pricing policy pursued by localauthorities. In those surveyed regionswhere the local government pricing poli-cy is at the low end of the range stipulat-ed by federal law, the rate of land priva-tization transactions is higher. A reduc-

tion of the official price from the higherto the lower end of the federally mandat-ed range is associated with a significantincrease in the rates of land privatization(more than doubling for some regions).

Excluding the pricing policy fromconsideration, the length of time requiredto complete the relevant proceduresbecomes the main factor influencing thelevel of land privatization; the longer theduration of the procedure, the lower therate of land privatization in a region. Adecrease in the average procedure dura-tion by one month increases the overallnumber of land privatization transactionsper 100,000 residents by about 11%.

If businesses are deterred from apply-ing for ownership rights, their only otherchoice is to apply for lease rights. Delaysassociated with land privatization proce-dures lead to an increase in the propor-tion of transactions for long-term landleases as opposed to land ownership. Ifthe delays are reduced by 25% fromtheir mean length, the rate of land leasetransactions would decrease by about 15percentage points in favor of land priva-tizations.

A second factor influencing land pri-vatization is the frequency of refusals bygovernment agencies in the course of aprocedure. The analysis demonstrates thatwhile processing land privatization appli-cations, government agencies tend torefuse the completion of such transactionstwice as much, on average, as land leaseprocedures, even though the proceduresand criteria are supposed to be the same.

More Corruption inComplex Procedures WithSunk Costs

Procedures in which applicants havesignificant sunk costs (e.g., they havealready purchased their land and are nowtrying to register their ownership rights)take about 34% more time than"reversible" procedures. Procedures inwhich sunk costs are involved are alsomore prone to corruption: the share of

Businesses complain about little land privatization, non�transparency and favoritism in the process

Questions, connected with the acquisition and renting ofland and premises, play an important role in the decision tocreate and expand small businesses. This is proved by the sixthround of monitoring the administrative barriers to small busi-ness development. The monitoring is carried out by CEFIRand comes in the form of yearly repeated surveys of 2,000firms in 20 regions of Russia. CEFIR has been conducting thesurvey since 2002 in order to evaluate the results of the dereg-ulation reform, started by the federal government in 2001.

The monitoring results show that about half the firmsface problems with land, while the problem of acquisitionand renting of land and premises was singled out as the mostserious problem connected with the federal regulations.

• The procedure duration. Purchase of land andpremises looks like a lottery: in some cases the procedure isrelatively fast (one to three months), while in others it dragson and takes more than six months. In 2003, more than athird of the firms, trying to acquire premises, had to spendover six months on the procedure; around 90% of the firms,

purchasing the land, could not finish the purchasing proce-dure within the six months. In 2006, the duration of suchprocedures did not change significantly.

• Purchasing federal property. The procedure for pur-chasing federal property was in 2003 — and still remains —the most expensive, time-consuming and the least transpar-ent. In 2006, the procedure duration for an average firm wasthree months.

• Costs connected with purchasing and renting landand premises. The survey results from 2004 show that thiswas not influenced by who the partner is in the transactions:whether it be a private party or the federal authorities.However, there was more pressure to give bribes while con-ducting the transaction with government agencies.

Thus, the survey results show that small businesses faceserious problems when trying to acquire premises and/orland plots. A significant number of entrepreneurs abandonplans to start or expand their business due to these difficul-ties. In order to decrease the arbitrariness of the local author-ities, the appropriate procedures must be simplified; this willbe a strong incentive for the development of small businessin Russia's regions.

Source: Centre for Economic and Financial Research, Moscow,www.cefir.ru. Questions, related to the purchasing and renting landand premises, have been added to the monitoring survey on the ini-tiative and with the financial help of the Foreign InvestmentAdvisory Service (FIAS). BT

stages involving unofficial payments ishigher by 11% as compared to the"reversible" ones.

More complex land procedures aremore prone to corruption. Each extrastage added to the procedure increasesthe percentage share of stages in whichunofficial payments were reported byabout 4 percentage points.

The procedure duration does not sig-nificantly affect the level of unofficialpayments. However, the official cost ofthe procedures, along with the complex-ities associated with them, has a signifi-cant effect on the level of unofficial pay-ments — the higher the official cost, thehigher the level of unofficial payments.

Established relationships with gov-ernment officials may help to reduce theduration of the process somewhat,although the effect is not significant.However, such connections cost moneyto maintain — intermediaries who haveconnections that they think can help inthe facilitation of their work chargemore for the completion of procedures.

The use of auctions or tenders is stillnot very common in many regions, and

while use of such mechanisms is associ-ated with higher rates of land privatiza-tion, there is not yet clear evidence thatthey are associated with other positiveoutcomes such as fewer delays or unoffi-cial payments.

Policy Recommendations• Unnecessary complexity should

be reduced in administrative proceduresfor businesses' access to land. Regionswith the simplest procedures shouldserve as a positive example for regionswith more complex procedures.

• For privatization of land underprivatized buildings, keeping adminis-tered land prices low helps to encourageland privatization transactions and helpsto develop a competitive secondary mar-ket in land. At the same time, if munici-palities cannot obtain revenues fromland rents, they may need some compen-sating source of revenue (e.g. enhancedland taxes) to maintain their fiscal bal-ances and to encourage their coopera-tion with land privatization.

• For many administrative proce-dures, a policy of "silent consent" with

time limits should be introduced.Officials should be required to provide awritten explanation, against establishedlegal or administrative criteria, for anyrefusal of applications for land privatiza-tion, within a stipulated time limit. If nodecision has been rendered by the timelimit, it should be deemed approved,with enforcement available through thecourts if necessary.

• Auctions and tenders for landprivatization should be further encour-aged, but need to be monitored closelyfor transparency and fairness.

Gregory Kisunko is Sr. Public SectorSpecialist at the Public Sector Group of thePoverty Reduction and EconomicManagement Network of the World Bank;Jacqueline Coolidge is Lead Investment PolicyOfficer at the Foreign Investment AdvisoryService (FIAS), which is a multi-donor facilityof the World Bank Group. Full text of thepaper "Survey of Land and Real EstateTransactions in the Russian Federation" canbe viewed at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=958175#PaperDownload (World Bank Policy ResearchWorking Paper No. 4115). BT

·22 New Findings


Land Issues: Barriers for Small Businesses

2004 22 60 30 7

2006 30 30 30 7

Purchase ofthe Federal

Property

Purchase ofPrivate

Property

Rent of theFederal

Property

Rent of thePrivate

Property

Duration (Days) for the Procedure of Acquiring Premises,Median Values

What determines bank profitability?What is the impact of ownership struc-ture and mode of entry on bank perform-ance? Clearly, compared to domesticbanks, foreign banks may be differentlyaffected by some common factors. Forexample, they may be less sensitive to thestructure of liabilities and local economicconditions. At the same time, they may beinfluenced by additional factors com-pared to local banks, for example, homecountry economic conditions and thestrategies of parent institutions.

Foreign banks are not a homoge-neous group, and they differ accordingto the mode of entry: greenfield banks(foreign banks newly established in acountry), and takeover banks (domesticbanks sold to private foreign investors).Greenfield banks are closely integratedwith parent institutions, depend on themfor capital and apply approved risk andportfolio management techniques. Incontrast, when taking over a bank, for-eign investors inherit personnel, infra-structure and client portfolio, and haveto spend time and money to modernizethe target. Additionally, as domesticbanks offered to foreign buyers are oftenilliquid and burdened with non-perform-ing loans, cleaning up and restructuringcosts fall, too, on the new owners.

We examine the sources of profitabil-ity using data on 419 commercial andsavings banks from 11 Central andEastern European countries (CEE),namely Bulgaria, Croatia, the CzechRepublic, Estonia, Hungary, Latvia,Lithuania, Poland, Romania, Slovakia,and Slovenia, between 1993 and 2004.This region has the world's highest share— 71% — of foreign investors in thebanking sector, with both greenfield andtakeover banks operating in all countries.

We decompose banks' profits into netinterest margin, net non-interest income,loan loss provisions and overhead costsand examine their relation to a set ofdomestic and international factors. Thisallows us to see whether being a part ofa multinational financial institution mat-

ters for the foreign banks' performanceand whether the performance of differ-ent types of banks converges over time.

Greenfield Banks MoreProfitable

First, our results clearly show that themode of entry for foreign banks is animportant determinant of their perform-ance. Profitability of takeover banks isnot different from that of domesticbanks, whereas greenfield banks earn0.95 percentage points higher return onassets than other banks. Higher prof-itability results from the lower costs ofgreenfield banks, and not from higherinterest or non-interest margins. Loanloss provisions and costs in an averagegreenfield bank are lower by 6.43 and

1.23 percentage points, respectively, thanin a domestic bank. Greenfield banks'better quality of loan portfolio might bedue to their superior skills in screeningpotential borrowers and their subse-quent monitoring. Alternatively, green-field banks may also target differentmarket segments, namely the largest andmost transparent enterprises, leavingriskier clients to domestic banks.

Second, we find that the mode ofentry determines foreign banks' vulnera-bility to local and international condi-tions. Greenfield banks are not sensitiveto domestic factors, such as the structureof their balance sheets, GDP growth andinterest rates. At the same time, they areaffected by the health of their parentinstitutions and interest rate changes inthe EU. This reflects very tight linksbetween greenfield institutions and par-ent banks, which support their sub-sidiaries in CEE. Interestingly, the prof-itability of takeover banks depends ontheir own level of capital, and is not sen-sitive to either the local macroeconomicenvironment or international factors.

Third, we find that the entry of for-eign banks (both greenfield and takeover)

has important spillover effects on the per-formance of domestic banks in CEE. Asthe participation of foreign banksincreases, the costs of domestic banksrise. This can be viewed as a "negative"spillover effect, but is explained by thefact that in countries with a low level ofeconomic development the costs ofdomestic banks rise in response to com-petition from foreign banks, because theyhave to invest in new technology andhuman capital to be able to compete.

Over time, however, a certain degreeof convergence occurs between bankswith different ownership structures. Theprofitability of greenfield banks decreas-es, as their costs rise. This is a sign of apositive spillover effect: with time,domestic banks become more competi-

tive, and greenfield banks can no longerearn abnormal profits.

ConclusionsThus, our analysis shows that the

performance of greenfield banks is supe-rior to the other types of bank, which isthe result of their modern managementand lending techniques, superior reputa-tion, and support from parent institu-tions. None of these factors appears toimprove the performance of takeoverbanks, but this could be due to the shorttime that has elapsed from the change ofownership and the significant burden ofbad loans that these banks inherited.

Foreign banks' entry has a positiveimpact on banking sector stability, sincethey are less sensitive to the domestic eco-nomic environment compared to domes-tic banks. Moreover, greenfield banksenjoy support from parent institutions.

Olena Havrylchyk is economist at CEPII,Paris, France and Emilia Jurzyk is a PhD stu-dent at the Department of Economics andLICOS, KU Leuven. Full text of the paper isavailable at: http://ssrn.com/abstract=965 BT

· 23


Foreign Bank Profitability in Centraland Eastern EuropeOlena Havrylchyk and Emilia Jurzyk

Performance of greenfield banks is superior to the other types of banks

Costs in a greenfield bank are lower by 1.23 percentage points

·24 New Findings


Banking in Ukraine: Changes Looming?

Natalya Dushkevych and Valentin Zelenyuk

During the last decade, the bankingindustry in Ukraine has exhibited anenormous growth in assets (see Figure).The number of commercial banks wentfrom 76 at the beginning of independ-ence to a peak number of 230 banks in1995 and to 193 banks in 2006. Thereremain only two state-owned banks withabout 12% of the total assets — a muchlower share than e.g. in the CzechRepublic (24%) or Russia (35%). Theindustry is quite competitive with no onebank having a dominant position. TheHerfindahl-Hirschman index of businessconcentration has stayed at around 400points for many years, which is similar tothe levels in the UK or France.

Big international players, such asCitibank, ING and HVB entered Ukrainebefore 2000 but did not make it into thetop 20 banks in terms of assets. The lasttwo years, however, showed a markedlyincreased interest from foreign investorsin Ukrainian banking. The new wave offoreign acquisitions started in 2005when Raiffeisen International purchasedthe second largest Ukrainian bank, Aval.Other big international players followedpromptly, increasing the proportion offoreign ownership from about 15% in2004 to about 30% by the end of 2006.

In 2006, about 65% of all FDI intoUkraine went to the banking industry.Not surprisingly, the prices skyrocketed:in early 2007, Swedbank agreed to payabout US$750 million for the 19thlargest Ukrainian bank, which was equal

to three quarters of what RaiffeisenInternational had paid for the secondlargest bank just 17 months earlier. Atthe same time, the stock market price forbanks taken over by international play-ers has increased dramatically, signallinga higher level of trust from investors.

However, it is also very likely that theproportion of domestic banks in Ukrainewill remain much higher than in theabove countries. This is because relativeto other transition countries (exceptRussia) Ukraine has many more largedomestically owned business groups,which own or control local banks. Forexample, the largest Ukrainian bank,Privatbank, is associated with one of thelargest FIGs in Ukraine, the Privat Group.

Industry Shakeout LikelyThanks to increased competition, the

Ukrainian banking industry is rankedhigher by the World Bank than in mosttransition and even some developedcountries. However, the weakness ofmany small banks, with some being onthe verge of bankruptcy, is likely to leadto an a massive exit of banks and theconsolidation of others. Internationalexperience shows that many industriesgo through a “shakeout” period aroundthe 15th year of their development. TheUkrainian banking, which is already inits 17th year, also demonstrates a decentlevel of maturity in providing primaryservices — another factor considered

critical for inducing anindustry shakeout.

A large wave of bank-ruptcies — the worst-casescenario — could be pre-vented (or minimized) byencouraging mergers andacquisitions of smallbanks, many of which suf-fer from managerial andmarketing deficiencies.Until recently, foreigninvestors have kept awayfrom buying such banks,mainly because of theirinadequate transparency.The recent legislative ini-tiatives should help to

increase transparency, yet the process hasbeen going too slowly despite increasingthreats.

What are the main risks to theUkrainian banking industry? One is theincreasing liquidity risk. Most of thebank liabilities are short-term depositsand current accounts, while most assetsare mortgages and other long and medi-um-term loans. This threat is unlikely tomaterialize if trust in the banking systemcontinues to increase, no large-scale neg-ative economic shocks ensue, economicgrowth continues and incomes keep ris-ing. Yet, the presence of so many uncer-tainties makes the system vulnerable.

The second is an increasing currencyrisk. While many loans are taken in USdollars, most deposits are made in thelocal currency (hryvnia). This is becausethe interest rate for dollar loans is 1.5times lower than for the hryvnia ones,while the exchange rate has remained vir-tually unchanged in the past years. Anexternal shock causing devaluation ofhryvnia is likely to cause a credit crisis, asmany borrowers with hryvnia-denomi-nated incomes will find it hard to meetobligations.

The National Bank has consideredvarious measures to discourage loans inhard currency. Yet, this is unlikely tosolve the problem as the "remedies" areapplied to the consequences rather thanto the root of the problem. In our opin-ion, a more market-oriented solutionwould entail switching from the peggedto floating exchange rate regime, togeth-er with inflation targeting. This shouldstimulate convergence of interest rates indomestic and hard currencies.

Overall, the industry dynamics sug-gest that the Ukrainian banking is aboutto go through substantial changes and theresult will depend on how well it address-es the risks and transparency issue.

Natalya Dushkevych is at EERC (KyivSchool of Economics) and Kyiv EconomicsInstitute, KEI. Valentin Zelenyuk is at KyivEconomics Institute, KEI, EERC andMillennium Capital. The views expressed inthis article are those of the authors and do notrepresent the views of above organizations. BT

Two main risks of the Ukrainian banking industry are liquidity and currency risks

Annual Growth of Main Banking Indicators

80%

70%

60%

50%

40%

30%

20%

10%

0% 2002 2003 2004 2005 2006Own capital

Loans

AssetsDeposits of individuals

LiabilitiesDeposits of business

· 25Agenda


Knowledge Economy Forum: Adopt orInnovate?

The Sixth Annual Knowledge Economy Forum on"Technology Acquisition and Knowledge Networks" tookplace in Cambridge, England on April 17-19. Based on exam-ples of international best practice, the forum discussed criticalelements in enhancing the absorption of technology andknowledge by firms and explored the policy recommendationsthat support such processes in Europe and Central Asia (ECA).Cambridge's experience as one of the world's leading hubs forenterprise innovation provided important insights on the roleof universities, private entrepreneurs, and government in facil-itating technology and knowledge transfer to industry. Theacquisition of technology and know-how from around theworld offers greater potential for sustained economic growthin ECA in the short to medium term than innovation. Whilecountries in ECA are striving to emulate Western Europeanand Asian approaches as they face the challenges of competingin an increasingly integrated world, they cannot afford toignore what is happening further east. China and India havevast, increasingly well-educated populations whose talents arebeing tapped by local and international firms flourishing inwhat are relentlessly competitive business environments, whichhave developed largely thanks to these economies' ability toacquire cutting edge technology and eventually innovateindigenously. Ongoing research by the World Bank suggeststhat governments in ECA must do their part in supporting thecatch-up process by putting in place an incentive-compatibleregulatory framework conducive to technology acquisition bythe private sector and the creation of networks that can chan-nel knowledge across countries. For more information, visithttp://www.worldbank.org/eca/ke

Latvia and Hungary Graduate from WorldBank Assistance

The governments of the Republics of Latvia and Hungaryexchanged letters with ECA Vice-President Shigeo Katsu dur-ing the World Bank/IMF Spring Meetings April 14-15, signal-ing their "graduation" from World Bank borrower to donorstatus. Since Latvia became a member of the European Union,the partnership between Latvia and the World Bank hasfocused on measures to implement Latvia's convergence pro-gram, promote regional development, and strengthen gover-nance. Hungary, which is the largest donor to the InternationalDevelopment Association among the eight Central Europeancountries that joined the European Union in 2004, acknowl-edged its 25 years as a member of the World Bank and indi-cated its desire for a continued partnership with the Bankbased on knowledge sharing. For more information, visithttp://www.worldbank.org/eca

Roma Education Conference Calls forScaling up from Donors, Governments

Continued progress in improving equal access to qualityeducation for Roma will require strong commitments fromdonors and the backing of national governments, stressed the

participants of the conference "Education Reforms and RomaInclusion in Central and Eastern Europe," hosted by the RomaEducation Fund (REF) and the Government of Hungary onApril 2-3. The Roma Education Fund's first major conferencein its two years of operations brought together governmentrepresentatives, donors, and Roma civil society. REF Boardmember and World Bank Country Director Annette Dixon, aswell as Open Society Institute chairman George Soros in avideo message, called on donors to solidify their commitmentsto ensure that REF's successful projects can be scaled up, suchas school integration and access to preschool education.Conference participants shared their experiences in panel dis-cussions and roundtables, bringing to light best practice exam-ples, such as the importance of involving parents and the Romacommunity in education reforms, and the improved education-al outcomes for students in integrated classrooms. Severalinnovative examples of collaboration were shared, such as aprogram in Hungary that works with Roma secondary schoolstudents to prepare them for employment in the private sector.However, government cooperation is required to implementand enforce anti-discrimination and desegregation laws, andprojects must be tailored to the specific situation, as nopanacea exists for all cases. Donors, governments, and NGOsmust also work together to optimize the use of the EuropeanUnion's Structural Funds in the new member states. For moreinformation, visit http://www.romaeducationfund.hu

New Country Partnership Strategy inMacedonia Focuses on EU Accession

The World Bank's Board of Executive Directors discussedon March 27 the new Country Partnership Strategy (CPS) forthe Former Yugoslav Republic of Macedonia, which envisagesa lending program of up to US$280 million for the period2007-2010. Priorities of the new CPS are centered round thecountry's ambition to join the European Union and aim at sup-porting the government's program to accelerate economicgrowth and job creation. The CPS builds on the country'sprogress in firmly establishing macro-economic stability andwill support important reforms to further improve the condi-tions for private sector investment. In addition, it presses for-ward with reforms in key sectors where weaknesses in gover-nance continue to undermine the country's economic reforms.Improved transparency and accountability in service deliveryare critical to meet the government's program on growth, fos-ter human capital, and meet EU standards. The proposed activ-ities envisaged under the CPS focus on two pillars: a) fostergrowth and job creation, increase living standards for all, andb) public service delivery and supporting good governance. Formore information, visit http://www.worldbank.org/mk

World Bank Engages with Bulgaria in KeySectors to Hasten EU Convergence

Bulgaria's economy has grown steadily since 2000, and thispositive trend is expected to continue in the near future.However, raising productivity and employment to narrow theincome gap and facilitate convergence with other memberstates in the European Union will remain Bulgaria's main chal-lenge for the next few years. The World Bank Board of

·26


Agenda

Executive Directors approved three projects on March 21 thataim to strengthen the country's EU integration and conver-gence of living standards. The Social Sector InstitutionalReform Development Policy Loan will support Bulgaria'sreform agenda in the areas of health, education, and social pro-tection. The Second Trade and Transport Facilitation inSoutheast Europe will facilitate Bulgaria's national and inter-national trade and transport by improving the capacity, effi-ciency, and quality of services at selected EU border crossings,with a particular focus on the Trans-European TransportNetwork. The board of directors also approved additionalfinancing for the active Bulgaria Social Investment andEmployment Promotion Project. The project aims to improvethe standard of living in disadvantaged communities and makebetter use of the opportunities presented to Bulgaria by itsaccession to the European Union. For more information, visithttp://www.worldbank.org/bg

Armenia's Poverty Reduction AgendaStays on Track

The World Bank Board of Directors approved on March 8 aUS$28 million Poverty Reduction Support Credit for Armenia.This is the third project under a four-year program that willassist the government with the implementation of its PovertyReduction Strategy Program (PRSP). The credit will help sustainthe country's economic growth and poverty reduction efforts byproviding budget support and moving ahead with the high pri-ority reform agenda identified by the PRSP. The Armenianauthorities are currently completing a review of the PRSP inclose consultation with civil society and donors. During the nextphase of the PRSP process, the government will prepare anextensive analysis of the causes of poverty and identify the shortand long term challenges on the road to greater economicgrowth. While growth has only recently begun lowering unem-ployment levels in the country, currently standing at nearly one-third of the labor force, the nascent rise in employment levels hashad so far limited impact on the income of many households,particularly in the less productive sectors, such as agriculture.For more information, visit http://www.worldbank.org/am

Comprehensive Drought Strategies forCaucasus and Central Asia in New Report

Drought-susceptible countries in the Caucasus and CentralAsia must establish National Drought Plans that are well inte-grated into other disaster-management plans, stresses a newWorld Bank report. Drought Management and MitigationAssessment for Central Asia and the Caucasus: Regional andCountry Profiles and Strategies is the result of research and con-sultations conducted in eight countries over the past two years.The report was prompted by a severe and prolonged drought inthe region in 2000-2001, as well as the knowledge that expo-sure to drought will only increase in Central Asia, and with peo-ple in all eight countries vulnerable to drought conditions dueto lack of careful planning and poverty. Thus far, disaster-man-agement agencies have not adequately addressed the severity oflong-term drought impacts, focusing instead on more immedi-ate disasters. To access the materials in both English andRussian, visit http://www.worldbank.org/eca/drought

IDA Websites for Armenia and Bosnia Go Live

As part of the World Bank's focus on the results achievedthrough financing from the International DevelopmentAssociation (IDA) across the globe, IDA websites for Armeniaand Bosnia have gone online. IDA is undergoing its 15th roundof replenishment, known as IDA15. IDA lends money (known ascredits) on concessional terms. This means that IDA credits haveno interest charge and repayments are stretched over 35 to 40years, including a 10-year grace period. Since its inception, IDAcredits and grants have totaled US$161 billion, averaging US$7-9 billion a year in recent years. The Armenia and Bosnia IDAwebsites take a look at IDA's work in the country and its uniquerole in development and poverty reduction. The IDA story is toldthrough a succinct country study, short project profiles, inter-views with government officials, and photo slideshows. Formore information, visit http://www.worldbank.org/ida

This section has been provided courtesy of Merrell Tuck andChristina Lakatos, Europe and Central Asia External Affairs

In Moldova, a 70 percent Decrease in AIDSMortality

Moldova's health status markedly declined between 1990and 2000. Life expectancy at birth is one of the lowest inEurope (68 years in 2003). From the mid-1990's onward,HIV/AIDS prevalence increased by more than 25 times amongthe 15-49 age group, reaching 0.90% in 2003. Service-wise, thecountry was trying to maintain extensive facilities inheritedfrom Soviet times on a meager budget. Resources were skewedtoward large hospitals, which represented 70% of health spend-ing. The First Health Sector and HIV/AIDS Control Strategy,developed with assistance from IDA, the Dutch Governmentand other donors, helped the government set evidence-basedpolicy directions and provide a framework for coordinatingdonor assistance in the sector. IDA’s total contribution amount-ed to US$15.5 million. Collaboration between the Moldovangovernment, NGOs, and supporting donors has contributed tostabilizing life expectancy, a decrease in maternal and infantmortality, and 70 percent decrease in mortality due to AIDS.Health sector reforms created a new minimum benefits packageand improved rural access to health care. For more information,visit http://go.worldbank.org/IKYDS1WAN0.

New Country Director in Russia

Mr. Klaus Rohland has assumed the position of the CountryDirector and Resident Representative of the World Bank inRussia. He first joined the World Bank in 1981 as an advisor tothe German Executive Director and has since then held a num-ber of key positions in the Bank. His most recent posting was asthe Bank’s Country Director for Vietnam. The previous CountryDirector for Russia, Mrs. Kristalina Georgieva returned to theBank’s headquarters in Washington, D.C. She was appointed asDeputy Vice-President, Sustainable Development, a recentlyestablished department that combines infrastructure develop-ment, agriculture, environment and social development. Moreinformation: http://go.worldbank.org/XDF661E1P0 BT

· 27


New Books and Working Papers

World Bank Working Papershttp://econ.worldbank.org

Vojislav Maksimovic, Asli Demirguc-Kunt, MeghanaAyyagari

Firm Innovation in Emerging Markets: The Roles ofGovernance and Finance

March 2007, WPS 4157

The authors investigate the determinants of firm innovationin over 19,000 firms across 47 developing economies. Theydefine the innovation process as including not only core inno-vation such as the introduction of new products and new tech-nologies, but also other types of activities that promote knowl-edge transfers and adapt production processes. The authors findthat more innovative firms are large exporting firms with pri-vate owners, highly educated managers with mid-level manage-rial experience, and access to external finance. In contrast, firmsthat do not innovate much are typically state-owned firms with-out foreign competitors. The identity of the controlling share-holder seems to be particularly important for core innovation,with private firms, whose controlling shareholder is a financialinstitution, being the least innovative. While the use of externalfinance is associated with greater innovation by all privatefirms, it does not make state-owned firms more innovative.Financing from foreign banks is associated with higher levels ofinnovation compared with financing from domestic banks.

Mona HaddadTrade Integration in East Asia: the Role of China and

Production NetworksMarch 2007, WPS4160

Production networks have been at the heart of the recentgrowth in trade among East Asian countries. Fragmentationtrade, reflected mainly in the trade in parts and components, isexpanding more rapidly than the conventional trade in finalproducts. This is mainly due to the relatively more favorable pol-icy setting for international production, agglomeration benefitsarising from the early entry into this new form of specialization,considerable intercountry wage differentials in the region, lowertrade and transport costs, and specialization in products exhibit-ing increasing returns to scale. The economic integration ofChina has deepened production fragmentation in East Asia,countering fears of crowding out other countries for interna-tional specialization. International production fragmentation inEast Asia has intensified intraregional trade but has dependedheavily on extraregional trade in final goods. While productionnetworks centered on China have contributed significantly togrowth in East Asia, they also breed vulnerabilities. They havenot automatically led to technology spillovers but resulted in anextreme interdependence across East Asian countries.

Dragana Radevic, Irina Klytchnikova, and Patricia Silva Poverty and Environmental Impacts of Electricity Price

Reforms in MontenegroFebruary 2007, WPS 4127

The Government of Montenegro is preparing an electricitytariff reform due to recent developments in the national and

regional electricity markets. Electricity tariffs for residentialconsumers in Montenegro are likely to gradually increase by40% to over 100%. This significant price rise will impose aheavy burden on poor households and it may adversely affectthe environment. In an ex-ante investigation of the welfareimpact of this price increase on households in Montenegro, theauthors show that the anticipated price increase will result in asignificant increase in households' energy expenditures. A sim-ulation of alternative policy measures analyzes the impact ofdifferent tariff levels and structures on the poor and vulnerablehouseholds in particular. Higher electricity prices could alsosignificantly increase the proportion of households using fuelwood for heating.

Clifford Zinnes, Laura Bouriaud, Ioan Abrudan, ValyMarochko, Jeffrey R. Vincent, Jean-Daniel Saphores

Detecting Collusion in Timber Auctions: the Case ofRomania

December 2006, WPS4105

Romania was one of the first transition countries in Europeto introduce auctions for allocating standing timber in publicforests. In comparison with the former system of administrativeallocation at set prices timber auctions offer several potentialadvantages: greater revenue generation for the government, ahigher probability that tracts will be allocated to the firms thatvalue them most highly, and stronger incentives for technologi-cal change within industry and efficiency gains in the public sec-tor. Competition is the key to realizing these advantages.Unfortunately, collusion among bidders often limits competi-tion in timber auctions. The result is that tracts sell below theirfair market value, which undermines the advantages of auc-tions. The paper confirms that data from Romanian timber auc-tions can be used to determine the likelihood of collusion, andit suggests that collusion reduced winning bids in Suceava for-est directorate in 2002 and perhaps also in Neamt forest direc-torate. The paper concludes with a discussion of actions that thegovernment can take to reduce the incidence of collusion andminimize its impact on auction outcomes.

CASEhttp://www.case.com.pl

Maria Cernobrovciuc, Joanna Konieczna, Mariana Puntea,Marcin Sowa, Alexandru Stratulat

Prospects for EU-Moldova Economic RelationsCASE Reports No. 67

In recent years, external links with the Republic ofMoldova have been determined by the influence of two geopo-litical blocks, the CIS and the EU. Despite the strong ties withthe CIS, Moldova's relations with the EU are becomingincreasingly important particularly with regard to the econom-ic situation in the country. The report presents recent econom-ic trends in Moldova, analyzes the effects of recently proposedand implemented macroeconomic policies, and discusses someof the structural changes that have taken place during the lastfive years. It also provides a background of EU-Moldova rela-tions and describes the prospects of future economic relations.

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New Books and Working Papers

Finally, it reports on the current attitudes towards integrationwith the EU, based on an expert opinion poll, and concludeswith a set of recommendations for Moldovan policy-makers.

Malgorzata Jakubiak, Maryla Maliszewska, Irina Orlova,Vitaly Vavryschuk, .

Non-Tariff Barriers in Ukrainian Export to the EUCASE Reports No. 68

Overall EU tariffs for Ukrainian products are rather low andtraditional protection measures apply only to selective sectors.Moreover, the latter are expected to disappear within the nextfew years, following Ukraine’s WTO entry and the establish-ment of the EU-Ukraine free trade area in manufacturing goods.However, the EU often resorts to non-tariff barriers to trade,such as certification of origin, customs procedures and technicalstandards, to protect its own market, which may prove prohib-itive for Ukraine. The report explores whether and to whatextent the non-tariff barriers impede Ukrainian exports to theEU. It reviews the Ukrainian trade policy and the evolution ofbilateral trade flows with the EU, and discusses the experienceof Central and Eastern European countries in relation to over-coming non-tariff barriers and the extent to which this can beapplicable to Ukraine. Finally, the report presents the results ofthe survey on non-tariff barriers to trade faced by Ukrainianexporters and concludes with policy recommendations.

CEFIRhttp://www.cefir.ru

Irina DenisovaEntry to and Exit from Poverty in Russia: Evidence from

Longitudinal DataMarch 2007, CEFIR/NES Working Paper 98

More than 25 million Russians have incomes that arelower than the subsistence level. The study investigates howentry to and exit from poverty are shaped using survivalanalysis and utilizing the Russian Longitudinal MonitoringSurvey (RLMS) panel for 1994-2004. The study shows, amongother things, that the presence of children increases thechances of moving into poverty and decreases the chances ofleaving it, while a high share of adults with university degreesin the household and the urban residence have the oppositeeffect. Interestingly, economic upturns and downturns have anasymmetrical impact on poverty: economic growth lowers thechances of slipping into poverty but also reduces hazards frompoverty. This implies that poor households during economicupturn are those with serious problems and are to be paid spe-cial attention to.

Ariane Lambert-Mogiliansky, Konstantin Sonin, EkaterinaZhuravskaya

Are Russian Commercial Courts Biased? Evidence from aBankruptcy Law Transplant

March 2007, CEFIR/NES Working Paper 99

The authors study the nature of judicial bias in bankruptcyproceedings following the enactment of the 1998 bankruptcylaw in Russia. The two main findings are as follows. First,

regional political characteristics affected judicial decisionsabout the number and types of bankruptcy proceedings initiat-ed after the law took effect. Controlling for indicators of firms'insolvency and the quality of the regional judiciary, re-organi-zation procedures were significantly more frequent in regionswith politically popular governors and governors who had hos-tile relations with the federal center. Poor judicial quality wasalso associated with a higher incidence of re-organizations.Second, the quality of the regional judiciary affected the per-formance of firms under the re-organization procedure: inregions with low quality judges, firms that were re-organizedaccording to the 1998 law had significantly lower growth insales, labor productivity, and product variety compared tofirms not subject to bankruptcy proceedings. In contrast, inregions with high quality judges, firms in re-organization out-performed firms not in bankruptcy proceedings. This effect ofjudicial quality on the performance of re-organized firms wasstronger when governors were politically popular. These find-ings are consistent with the view that politically strong gover-nors subverted the enforcement of the 1998 bankruptcy law.

Other Publications

Andrei V. VernikovRussia's Banking Sector Transition: Where to?BOFIT Discussion Paper 5/ 2007http://www.bof.fi/bofit_en/

This paper applies an analytical paradigm of institutionaleconomics to the transition of the Russian banking sector,focusing on the interplay between ownership change and insti-tutional change. It finds that the state's withdrawal from com-mercial banking has been inconsistent and limited in scope. Tothis day, core banks have yet to be privatized and the state hasmade a comeback as owner of the dominant market partici-pants. The paper also looks at the new institutions importedinto Russia to regulate banking and finance, including rule oflaw, competition, deposit insurance, bankruptcy, and corporategovernance. The unfortunate combination of this new institu-tional overlay and traditional local norms of behavior havebrought Russia to an impasse — the banking sector's owner-ship structure hinders further advancement of market institu-tions. Indeed, one may now be witnessing a retreat from theoriginal market-based goals of transition.

Barry Bosworth, Susan M. CollinsAccounting for Growth: Comparing China and IndiaFebruary 2007, NBER Working Paper 12943http://www.nber.org/papers/w12943

The authors compare the recent economic performances ofChina and India using a simple growth accounting frameworkthat produces estimates of the contribution of labor, capital,education, and total factor productivity (TPF) for the three sec-tors of agriculture, industry, and services as well as for theaggregate economy. The growth accounts show a roughly equaldivision in each country between the contributions of capitalaccumulation and TFP to growth in output per worker over theperiod 1978-2004, and an acceleration of growth when theperiod is divided at 1993. However, the magnitude of output

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growth in China is roughly double that of India at the aggre-gate level, and also higher in each of the three sectors in bothsub-periods. In China the post-1993 acceleration was concen-trated mostly in industry, which contributed nearly 60% ofChina's aggregate productivity growth. In contrast, 45% of thegrowth in India in the second sub-period came in services.Reallocation of workers from agriculture to industry and serv-ices has contributed 1.2 percentage points to productivitygrowth in each country.

Guido Friebel, Elena PanovaInsider Privatization and Careers — A Study of a Russian

Firm in TransitionMarch 2007, NBER Working Paper 12998http://www.nber.org/papers/w12998

The paper studies how transition has affected humanresources policies of a Russian heavy industry firm. The dataset contains personnel files of 1,538 white-collar workers over17 years: from 1984 to 2000. The authors find that until 1991,still in Soviet times, the firm featured stable patterns of upwardmobility that looked quite similar to career paths in westernfirms. From 1992 when liberalization reforms began, to 2000,no similar career paths were observed. The reason is that in alltiers of the firm's hierarchy except for the lowest one, moremanagers were hired from the outside, and fewer managers leftthe firm. As a result, the firm became "toploaded", and pro-motions were blocked. A possible reason is extremely weakoutsider property rights enforcement in Russia.

Celine AllardInflation in Poland: How Much Can Globalization Explain?IMF Working Paper WP/07/41February 2007, IMF Working Paper 07/41

The paper analyzes how globalization has affected inflationin the EU's New Members States and Poland in particular since1995. It finds prices have become less sensitive to domesticeconomic conditions as trade integration rose, possibly becausemonetary policy incentives increasingly shifted toward meetingprice stability objectives. Quantitatively, globalization appearsto have lowered Polish prices by 0.5-1 percentage point annu-ally since 1995, substantially more than in advancedeconomies. However, future inflation-dampening effects in theNMS are likely to be smaller as the pace of increases in tradeopenness moderates.

Pasquale TridicoRegional Human Development in Transition Economics:

The Role of Institutions Universite degli Studi Roma Tre, Working Paper 70http://host.uniroma3.it/dipartimenti/economia/pdf/wp70.pdf

The aim of this paper is to analyze regional difference inhuman development in Poland. The author constructs HumanDevelopment Regional Indexes for 16 Polish regions anddescribes the income and non-income dimensions of humanlife. During transition, western Polish regions experiencedhigher growth of GDP per capita than eastern regions. Yet, thishas not produced a higher level of non-income dimension indi-cators — education and life expectancy. On the contrary, east-

ern regions, although they have a lower level of GDP per capi-ta, have a higher level of non-income indicators. The authorfinds that in the east, social norms and group preferences aremore oriented towards social policies and public services, whilein the west the norms and preferences are more orientedtowards a market economy.

Markku KotilainenFree Trade between the EU and Russia — Sectoral Effects

and Impacts on Northwest RussiaWorking Paper No. 1087The Research Institute of the Finnish Economy,

http://www.etla.fi/eng/julkaisuhaku.php

The paper analyzes the implications of free trade betweenthe EU-25 and Russia using a computable general equilibriummodel, with a focus on the regions in Northwest Russia. Freetrade on its own would have a negative terms-of-trade effect inRussia and cause a small decline in welfare. If coupled with anincrease in productivity, welfare would increase. This empha-sizes the importance of reforms in the Russian economy.Ferrous and non-ferrous metallurgy, machine-building andmetal working, and wood and paper are the principal losersdue to free trade. At the same time, production in capitalgoods, fuel industry, and services increases. Due to its produc-tion structure, the Northwest seems to benefit slightly less thanRussia on average in terms of the volume of GDP.

Alexandra Ferreira LopesThe Costs of EMU for Transition CountriesREPEC: http://repec.org/mmf2006/up.7815.1140017467.pdf

Should the Czech Republic, Hungary and Poland — thebiggest economies that joined the EU in 2004 — adopt the euro?The author constructs a model to evaluate the economic costs ofthe loss of autonomy of the monetary policy as a result of join-ing the EMU. The findings suggest that EMU membership canbe a costly decision to these countries. The decision of enteringthe EMU is more costly when technological shocks are stronger,when correlation of the monetary policy shocks is weaker, whenconsumers are more risk averse and when the import sharebetween the countries studied and the EMU is lower.

Floro Ernesto Caroleo, Francesco Pastore A New Regional Geography of Europe? The Labor Market

Impact of the EU EnlargementsIZA Discussion Paper No. 2620 Available at SSRN: http://ssrn.com/abstract=969620

The aim of this paper is to summarize research ideas andoutcomes on how the changing political and economic map ofEurope affects labor markets in both the old and new EU mem-ber states. The specific focus of the discussion is on the micro-economic foundations of structural change and its spatiallyasymmetric impact on local labor markets. The issues dis-cussed include: regional job and worker turnover; the impactof migration on regional unemployment differences; a region-al dimension of gender differences; human capital as a factorof regional convergence; the impact of trade and FDI onregional labor markets; hidden economy and hidden employ-ment; national and EU regional policy. BT

·


30 Conference Diary

2nd annual Emerging Markets Private EquityConference (EMPEC 2007)

June 4-5, 2007, Moscow, Russia

The conference titled “Russia and Other EmergingMarkets: Investors Knocking at the Gates” is organized by theInternational Council of Institutional Investors. EMPEC 2007provides insights and opportunities with respect to privateequity, venture capital and real estate investments in emergingmarkets of Russia and CIS republics. The list of speakersincludes representatives of the Russian governments, foreignand Russian investment banks, venture funds, and internation-al organizations.

Information: http://www.empec.org/2007/index.php?lang=ru

Globalization, EMU and the Reshaping of EuropeanEconomies

June 22, 2007, Florence, Italy

While European economies have become increasingly inte-grated over the last 15-20 years, there are striking differencesin the degree of product and labor market liberalization, theorganization and reform of the welfare and public finance sys-tems, and the degree of openness to international capital mar-kets. Rates of R&D expenditures and investment in new tech-nologies are far from converging. The workshop organizerswelcome submission of theoretical, empirical and policy con-tributions addressing these issues. The main goal of the work-shop is to shed light on the roots of the differences in Europeancountries ability to reap the benefits of regional and global eco-nomic integration.

More information: www.cepr.org

European Summer School on Industrial Dynamics September 3-9, 2007, Dubrovnik, Croatia

The 2007 edition will be dedicated to the special topic ofthe "Economics of Science". Applications are invited fromPhD students and young scholars on the following topics:

• The economics of public research (university funding,science policy)

• The labor market for scientists• Scientists' careers, networks, and productivity• The commercialization of academic research• Any other topic related to economic aspects of scien-

tific enquiry.

More information: http://www.unibocconi.it/essid2007

WIDER Conference: Southern Engines of GlobalGrowth: China, India, Brazil, and South Africa (CIBS)

September 7-8, 2007, Helsinki, Finland

This conference focuses on the inter-linkages between CIBSand the global economy, including the impact of theseeconomies on their respective regions. The main themes aregrowth, trade, international finance, global governance andgeopolitics. The conference is expected to cover the following(non-exhaustive) topics:

• Implications of CIBS growth for other economies:opportunities, challenges and threats;

• Growth paths and development prospects of CIBS,including possible setbacks, and lessons for other countries;

• Commodity and services trade: the changing patternsof trade, competitive and complementary trade relationships,and volatility in commodity prices;

• Capital flows and financial markets: the role, determi-nants and spillover effects of FDI, government strategies inattracting FDI, prevention of financial crisis, exchange rateregimes, capital account control;

• CIBS’ role in WTO negotiations, regional tradearrangements and the implications for Southern economies;

• Possible consequence for energy demand, climatechange and regional tensions;

• Technology transfer, intellectual property rights, andnational research policies;

• Political economy and international governanceissues, including implications for foreign policies.

More information: http://www.wider.unu.edu/conference/conference-2007-2/conference-2007-2.htm

First Summer School on “Transnationality of Migrants”September 9, 2007, Lake Garda, Italy

The school intends to provide an intensive training coursefor PhD students and young researchers who are working in thefields of international economics and development. This year itwill focus on the main analytical and empirical approaches tothe study of the impact of international migration on the hostcountry. The school is open to 40 students from all countries.Students are expected to attend the school full time. The schoolis organized as part of the Marie Curie Research TrainingNetwork on “Transnationality of Migrants”.

More information: www.cepr.org

CEPR/ESI 11th Annual Conference on GlobalImbalances, Competitiveness and Emerging Markets

September 28, 2007, Pretoria, South Africa

The topic of the conference will cover the following areas: • Implications of global imbalances for banking, finan-

cial markets and financial stability in mature and emergingmarkets;

• Impact of global imbalances on monetary policy inemerging markets (with special emphasis on the followingchannels: carry trades, capital flows, liquidity, asset inflationand exchange rates);

• Modeling competitiveness and balance of paymentsissues associated with mature and emerging markets. Theintention is to have three policy lectures by senior centralbankers.

The organizers will select the three best papers for presen-tation at the conference in a special session of central bankresearch papers and will award the best of these three paperswith the CEPR/ESI Prize 2007 for the Best Central BankResearch Paper.

More information: www.cepr.org BT

· 31


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"EMU Enlargement: Why Flexibility Matters" by PhilippMaier and Maarten Hendrikx

Aksoy, Y., De Grauwe, P. and Dewachter, H., 2002. "Do asym-metries matter for European Monetary policy?" EuropeanEconomic Review 46 (2002), 443-469.

Berk, J. and Swank, J., 2007. "Regional real exchange ratesand Phillips curves in monetary unions: Evidence from the US andEMU". De Nederlandsche Bank, mimeo.

Lewis, J., 2007. "Hitting and hoping? Meeting the exchangerate and inflation criteria during a period of nominal conver-gence", DNB Working Paper, no. 130.

Maier, P. and Bezoen, S., 2004. "Supporting and bashing ofcentral banks: The Bundesbank and the European Central Bank",European Journal of Political Economy 20, 923-939.

"Gains from Risk-Sharing in the EU" by Yuliya Demyanyk andVadym Volosovych

Kalemli-Ozcan, S., B. Sorensen and O. Yosha, 2001. "RegionalIntegration, Industrial Specialization and the Asymmetry of Shocksacross Regions," Journal of International Economics 55, 107-137.

Sorensen, B. and O. Yosha, 1998. "International Risk Sharingand European Monetary Unification," Journal of InternationalEconomics 45, 211-238.

van Wincoop, E., 1994. "Welfare Gains from InternationalRisk Sharing," Journal of Monetary Economics 34, 175-200.

"Postponing Euro-Area Expectations?" by Tanel Ross

Meade, Ellen E. and D. Nathan Sheets, 2005. "RegionalInfluences on FOMC Voting Patterns". Journal of Money, Creditand Banking, Vol. 37, No. 4, pp. 661-677.

“Latvian Labor Market before and after EU Accession” byMihails Hazans

Hazans M., 2007. "Coping With Growth and Emigration:Latvian Labor Market Before and After EU Accession", SSRN:http://ssrn.com/abstract=971198

"The Impact of EU Accession on Poland's Economy" by EwaBalcerowicz

CASE, 2006. “The Polish Economic Outlook. Trends,Analyses, Forecasts”. Quarterly No. 3 (30).

CBOS, 2006. “Bilans dwoch lat czlonkostwa Polski w UniiEuropejskiej. Komunikat z badan” (“An Evaluation of the twoyears of Poland's membership in the European Union”. Surveyresults), April, available at http://www2.ukie.gov.pl/

European Commission, 2006. "Enlargement, Two Years After:An Economic Evaluation". Occasional Papers, no. 24. Bureau ofEuropean Policy Advisers and DG ECFIN, May, available athttp://europa.eu.int/comm/economy finance/index en.htm

European Commission, 2006. Economic Forecasts Autumn2006, European Economy, DG ECFIN, No 5, available athttp://ec.europa.eu

Maliszewska M, 2004. "The EU Enlargement: Benefits of theSingle Market Expansion for Current and New Member States".CASE Studies & Analyses, no. 273, at http://www.case.com.pl

World Bank, 2006. “World Bank EU-8” Quarterly EconomicReport, Part II: Special Topic: Labor Migration from the New EUMember States.

"The Economic Cost of Smoking in Russia" by MichaelLokshin and Zurab Sajaia

Becker, G., and K. Murphy, 1988. "A Theory of RationalAddiction." Journal of Political Economy, Vol. 96: 675-700

Chaloupka, F., 1991. "Rational Addictive Behavior andCigarette Smoking." Journal of Political Economy, Vol. 99: 722-734

Heineck, G., and J. Schwarze, 2003. "Substance Use andEarnings: The Case of Smokers in Germany." Discussion Paper #743, IZA, Germany

Hoad, N., and D. Clay, 1992. "Smoking Impairs the Responseto a Physical Training Regime: a Study of Officer Cadets." Journalof the Royal Army Medical Corps, Vol. 138:115-117

Levine, P., Gustafson, T., and A. Valenchik, 1997. "More BadNews for Smokers? The Effect of Cigarette Smoking on Wages."Industrial and Labor Relations Review, Vol. 50: 493-509

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"Deregulating Business in Russia" by Ekaterina Zhuravskaya,Evgeny Yakovlev

De Soto, Hernando, 1990. “The Other Path”. New York:Harper and Row.

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Shleifer, Andrei and Robert W. Vishny., 1993. "Corruption."Quarterly Journal of Economics 108(3):599-617.

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"Land and Real Estate Transactions for Businesses in Russia"by Gregory Kisunko and Jacqueline Coolidge

FIAS, 2006. "Survey of Land and Real Estate Transactions inthe Russian Federation", available at: http://www.fias.net/ifcext/fias.nsf/AttachmentsByTitle/LandSrv_CrossRegRep_Mar2006.pdf/$FILE/LandSrv_CrossRegRep_Mar2006.pdf

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Khakhalin, Andre A. and Stephen B. Butler, "Privatization ofEnterprise Land in the Russian Federation: 1992-2003", preparedfor USAID, unpublished manuscript.

Muir and Shen, "Land Markets: Promoting the Private Sectorby Improving Access to Land", World Bank Group ViewpointNote, http://rru.worldbank.org/PublicPolicyJournal/Summary.aspx?id=300

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"Banking in Ukraine: Changes Looming?" by NatalyaDushkevych and Valentin Zelenyuk

Sherif K., Borish M., Gross A., 2003. “State-owned Banks inthe Transition: Origins, Evolutions and Policy Responces”. WorldBank.

Carbo-Valverde S. et. al., 2006. “Cross-Country Comparisonsof Competition and Pricing Power in European Banking”.Presentation on the 42 Annual Conference of Bank Structure andCompetition.

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Beyond TransitionManaging Editor: Ksenia Yudaeva(Center of Strategic Research, Moscow)

Editorial Board:Alan Gelb, Director, Development Policy(The World Bank, Washington, DC)

Pradeep Mitra, Chief Economist Europe & Central Asia Region (The WorldBank, Washington, DC)

Boris Pleskovic, Research Manager,Development Economics (The WorldBank, Washington, DC)

Erik Berglof (EBRD, London)

Editor in Chief: Olga Mosina (CEFIR atNES, Moscow)E-mail: [email protected]

Co-ordinating Editor: Andrew Austin(CERGE-EI, Prague)Production Manager: Julia Babich(CEFIR at NES, Moscow)Layout: Ekaterina Yakovleva

The World Bank 1818 H Street, N. W.Mail Stop: MC3-302Washington D.C. 20433, USAhttp://www.worldbank.org

CEFIR at NESCentre for Economic and FinancialResearch at New Economic SchoolNakhimovsky prospekt, 47, office 720117418 Moscow, RussiaTel. +7 495-105 5002http://www.cefir.ru

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