Interaction Among New Firm Formation, Privatization, and Business Environment in Transition Countries

(ProQuest: . denotes formulae omitted.)I.IntroductionThe creation of new private firms is key to a successful transition from socialism to a market economy. The formation of new firms accelerates reallocation and restructuring, which are the two core elements of transition identified by Blanchard (1997); these elements lead to increased productivity and competitiveness. In matured market economies, the entry of new firms increases efficiency because they are likely to enter the market with an efficient combination of capital and labor. New firms play a crucial role in the transition process given the structural imbalance in post-communist economies prior to transition. Furthermore, private firms are not subject to soft-budget constraints that prevail among state-owned enterprises in the socialist era (Kornai 1994). Transition countries implemented a large-scale privatization program to transform ownership from the state to a private entity. Policy makers expected the program to encourage entrepreneurship and the formation of new firms. This expectation appears to have been realized as shown in the significant average increase of shares of the private sector in 26 transition countries from 12% in 1990 to 68% in 2009.However, privatization per se does not increase the creation of new firms. Rather, the consequences of privatization are diversified according to the fundamental conditions of transition countries. In some cases, privatization may leave an insignificant effect on the entry of new firms despite a notable increase in the shares of the private sector. Moreover, excessive concentration on privatization could distract attention away from the central task of encouraging new start-ups (Murrell 1995). Mixtures of barriers exist in transition economies even after privatization. These barriers include complicated and time-consuming registration, ambiguous tax laws, and corruption. This finding implies that the aims of privatization, namely, competition and efficiency, are hard to achieve and may even produce negative effects without appropriate support for institutional reforms and favorable business environments. The case of the Russian oligarchy indicates that privatization with poor institutional quality and business environments may concentrate ownership in the wrong hands, which may retard the emergence of a free market. Havrylyshyn, and McGettigan (2000) reflected on these features and claimed that only privatization conditioned by good business environment contributes to an increase in new firm registrations. This finding suggests that the effects of privatization increases when it is combined with good market institutions. However, this conjecture was not empirically tested.The present study examines how reform in large-scale privatization and the business environment, as measured by start-up barriers, interactively affect the density of new firms across transition countries. Two datasets are used, namely, World Development Indicators (WDI) and the European Bank for Reconstruction and Development (EBRD) reform index. For new firm density, we use new business density in WDI, which was calculated as the number of new limited liability corporations registered in a calendar year per 1,000 people aged 15-64. WDI provides information on new firm density, start-up barriers, private credit, and real GDP per capita. Start-up barriers are measured by start-up costs, start-up day, and start-up procedures. We extract information on the degree of large-scale privatization reform from EBRD. The final dataset includes an unbalanced panel of 119 observations from 25 countries over a five-year period from 2005-2009.We find that large-scale privatization significantly contributes to the formation of new firms when the costs of start-up are low. However, the effect of large-scale privatization on new firm formation becomes negligible when firms face high start-up costs. The main difference between the present study and existing literature on institutions is the emphasis of previous studies on the role of various institutional factors1 in privatization process; by contrast, the present study indicates that business environments are directly correlated with the impact of privatization on the formation of new firms. …