New bottles

Most of the former centrally planned economies in central Europe and Russia have either completed or have nearly completed the first stage of the transition to a market economy. This has involved the creation of the institutions of a market economy and the instruments whereby de novo private firms and newly privatised state enterprises will operate in a predominantly market-determined environment.

ensuring that these instruments and institutions function efficiently, particularly the means of corporate governance needed to channel capital to potential growth sectors, may prove more difficult and will determine the success of the transition itself and the nature of the economic systems that will emerge.

The Central European University Privatisation Project has overseen a number of studies which have resulted in original and stimulating publications. These two volumes maintain the high standards of their predecessors. The first, which concentrates on the creation of efficient systems of corporate governance, is based on the premise that transition economies have few choices from those in existing market economies.

The contributions to the second volume take a more evolutionary approach, illustrated by David Stark's distinction between "transition" and "transformation". In the former, the ultimate goal of a functioning market economy is pre-determined and the principal problem is seen as how to replace an obsolete set of communist institutions with more efficient capitalist ones. In the case of "transformation", change is seen as an evolutionary process in which actors and institutions adapt to cope with changing external conditions.

The contributors to the first volume accept that systems of corporate governance will be required to perform different functions in transition economies than in mature market ones and will have to exercise more responsibility for restructuring obsolete and overstaffed enterprises.

Does this imply that a closer, long-term relationship between banks and productive enterprises, typified by the German and Japanese financial systems, would be better than a system modelled on the more liquid stock markets typical of the Anglo-Saxon system? The empirical studies in volume one suggest not. Peter Dittus and Stephen Prowse argue that banks should not own shares in productive enterprises in transition economies as the banking sector itself is not exposed to competition and remains susceptible to state control. Furthermore banking personnel in transition economies are inexperienced in evaluating enterprise performance.

This argument is supported in the article by John C. Coffee who finds that the preconditions for the successful operation of a German form of banking system do not exist in the Czech Republic. Similarly, Herbert Baer and Cheryl Gray examine the role of external creditors in Hungary and Poland and conclude that weaknesses in the banking system itself, including inadequate managers and state control, limit the usefulness of the banking system as a control device.

Frydman, Katharina Pistor and Rapaczynski indicate that the desire of institutional investors in Russia to promote industrial restructuring has been resisted by enterprise insiders. The theme of insider ownership is extensively analysed in the second volume where John Earle and Saul Estrin argue that the textbook advantages of outsider ownership may be less effective in transition economies where shares are widely dispersed and the legal system is frequently incapable of enforcing shareholders' rights. Furthermore, external owners who do not bear the social costs of large-scale redundancies may make decisions that are socially inefficient.

Andrei Shleifer and Dmitry Vasiliev suggest that managers in transition economies have little incentive to restructure enterprises unless they own equity in the enterprises, but that managerial ownership should be limited to 5-10 per cent of the stock. Joseph Blasi and Andrei Shleifer demonstrate that managers had kept majority ownership and control out of the hands of outsiders in 63 per cent of Russian firms surveyed at the end of 1994. Although there is some evidence that blocks of shareholders have been accumulating a larger stake in enterprises, they argue that this process needs to be accelerated and the position of blockholders on boards of management must be strengthened to provide an effective system of corporate governance.

On a positive note, Charles Sabel and Jane Prokop demonstrate that insider-owners in enterprises in the Sverdlovsk region had shown considerable willingness and ability to experiment once workers had been guaranteed job security during the period of experimentation and had been convinced of the need for radical measures to avoid bankruptcy.

The two volumes will be of interest to specialists and students of transition economies and also to those concerned with the wider problems of corporate governance. Both volumes are self- contained. Readers who are interested in the peculiar challenges created for Russia and eastern Europe by the predominance of management and employee buy-outs in the early stages of privatisation will find the articles in volume two of especial interest.

Alan Smith is reader in economic and social studies of eastern Europe, School of Slavonic and East European Studies, University of London.