30 lowering the fixed costs of crossing over. A substantial perceived fixed cost by unofficial activities contemplating crossover is that of being taxed or otherwise penalized for past underpayments when exposing themselves to the official economy. To reduce such fixed costs, policy makers may consider an amnesty for past taxes and related fees up to a certain date tied to the institution of the new policies.<sup>30</sup> Finally, in assessing the optimal tax rates themselves, due consideration needs to be given to the size and dynamics of the unofficial economy. The unofficial economy is being implicitly taxed, as we have reported--even if the revenues do not accrue to the budget. Particularly where the unofficial economy is large, the official tax rates need to be designed in such a way that the overall burden on enterprises is lowered below that of operating unofficially. As compared with economies where the unofficial economy is small (and/or very costly), the optimal tax rates are thus likely to be lower where the unofficial economy share is relatively large.

# **5.** Foreign Exchange Management: Full Unification or Escape?

A sizable unofficial economy would encompass a large share of unofficial foreign exchange transactions and holdings, both domestically and abroad. This in turn impairs macroeconomic and balance-of-payment management. Attempts by a government to clamp down on these activities through prohibition of foreign exchange transactions or imposition of high surrender requirements (at less than the street-market rate) would only exacerbate the loss of state control over foreign exchange management. This is because the perceived cost of doing business officially increases by more than the cost of doing business unofficially when governments impose such administrative sanctions. The official (implicit) tax rate on foreign exchange transactions from a dual or multiple exchange rate drives the entrepreneur to choose nonofficial channels. Full unification of the exchange rate therefore becomes the inescapable policy implication in order to stem the flow to unofficial activities (and capital flight) and to attract unofficial activities back to officialdom.

These benefits of unification of the exchange rate regime are not a mere theoretical construct. Data from Ukraine's official auction for foreign exchange, already operating for almost three years, provides compelling evidence. During periods when the official exchange rate was less than 70 percent of the (street) market rate, the (nongovernment) foreign exchange supply to the auction was about $50 million per quarter. Conversely, during times when the official rate has exceeded 80 percent of the street rate, supply to the official auction has averaged about $550 million per quarter, as shown in Figure A3 in the Annex. In other words, the annualized difference in supply between a quasi-unified and nonunified exchange rate auction is about $2.2 billion.

# 6. **Privatization: On the Fallacy of Equity Versus Speed**

From early on in the FSU transition there has been a debate as to the optimal speed, scope, and type of privatization of the enterprise sector. Among other points debated, many have argued for gradualism (and partiality) on the basis of equity and implementation efficiency, so as