28 lower than those of operating unofficially. Hence, the official liberalization effort has to be sufficiently bold (and credible) so as to lower expected official costs of doing business to a level below those of operating unofficially. Small liberalizing steps will affect only the marginal unofficial activity and, in addition, will generally undermine the credibility of the reformns in the eyes of economic agents. Consequently, partial or gradual liberalization is not an effective policy-making approach, particularly where there is a large unofficial economy.<sup>2 7</sup> The most visible (and aggregate) economic liberalization measures, such as removal of price ceilings and export quotas, while necessary, are insufficient in themselves to sufficiently lower the cost of operating unofficially. Deregulation, at both the micro and regional levels, is also required in order to address issues of harassment and the costs of discretionary enforcement of old regulations and laws (licenses, health and fire inspections, etc.). Thus, the concept of full economic liberalization should include deregulation as an integral component.

# 3. **Macroeconomic Stability**

The Ukrainian entrepreneurs' survey responses point to macroeconomic stability (and very low inflation) as one priority in ensuring that they operate more effectively, and officially. Lax budgetary and monetary policies, and the resulting high inflation, raise the expected benefits of unofficial activities and reduce their perceived risks and costs. Furthermore, they increase the costs of operating officially. Budgetary and credit handouts breed vested interests, which further fuel and perpetuate unofficial income flows, domestically and abroad. For instance, it appears evident that in Russia the episodes of large expansion of credit in 1992-93, which were channeled by the central bank into many large state enterprises, were also associated with a very significant (multibillion dollar) capital flight abroad.

Lax monetary policies and high inflation cloud financial accounting, making it easier to distort official reports. At the same time, they reduce the probability of getting caught (or of proving illegal behavior). Since domestic currency is increasingly perceived as a poor store of value and an inadequate means of financial transaction, there is strong inducement to operate in foreign currency. This is most often associated with unofficial activity, and with capital flight. More generally, lax government finances are increasingly perceived by the public as a sign of decay in the social fabric and as evidence of the state's inability to manage the official economy. This further provides a self-justification for unofficial activity behavior.

The arguments favoring rapid attainment of macroeconomic stability are therefore strengthened additionally when considering the behavior of economic agents in countries with official and unofficial economies. A sufficiently large drop in the relative costs and increase in the expected benefits of operating officially are required for the crossover process to be reversed. Hence, macroeconomic stabilization measures may need to be particularly bold, credible, and sustainable.