productivity by 1.0 percentage points in 1992 while it increases productivity by about 0.9 percentage points in 1994.

This particular time-pattern in the regression coefficients -- starting negative and becoming (more) positive -- suggests the following interpretation. Initially, the allocation of financing favored subsequently worse performers, as the soft budget hypothesis would suggest. Politicians thus appear to have influenced bank lending by directing it to loss-making enterprises, leading to a negative relationship with subsequent enterprise restructuring. In later periods, relatively more financing went to firms which subsequently improve more. This suggest that the financial system improved as banks became more discriminating in their lending decisions and lent more to deserving firms, i.e., firms which subsequently improved. Banks thus appear to have become more independent of politicians over time, i.e., their loans became less subsidies and more genuine investments leading to productivity growth.

Comparing regressions with and without the bank financing variables (the latter is not reported) show that the inclusion of the bank lending variable does not diminish the importance of privatization. The privatization coefficients are significantly positive in both regressions and stay about the same while the explanatory power increases. This suggests that privatization and the imposition of financial discipline are complements rather than substitutes and lends further support to the SV model. It also suggests that once the initial productivity gains from privatization are obtained, financing becomes important to sustain TFP-growth.

Including the amount of net transfers each firm receives from the government as a separate variable does not change the privatization coefficients. The coefficients for SUBS are consistently negative, suggesting decreasing productivity growth by between 3.3 and 1.4 percentage points for each 100% change in subsidies. The coefficients do decline over time, however, suggesting that the allocation of subsidies has become more rational and the role of politicians in allocating subsidies has declined. Furthermore, since subsidies tend to be concentrated in only a few firms, especially in the later years, the magnitude of the overall effect of subsidies on overall enterprise restructuring is relatively small.

The majority of the coefficients on the country-time dummies are significant, but their signs differ across countries and over time - note that Slovenia is the base country. For 1992-93, the time dummy is significantly negative for Hungary, Poland, Romania and Slovakia, and significantly positive for the Czech Republic. For 1994-95, the time dummy is significantly negative for Bulgaria, and significantly positive for the Czech Republic, Poland and Slovakia. For the Czech Republic, the dummies are thus (significantly) positive over the whole period. The dummies for Hungary, Poland and Slovakia show an increase over time. Bulgaria and Romania show no improvement over time, or even a deterioration in some specifications (e.g., the coefficients for Bulgaria actually become significantly negative). This upward time pattern suggests that the external environment and overall institutional framework, including the degree of corruption, improved in most countries.

_Two-Step Estimation_ 16