Institutional Reform Progress to Date and Remaining Challenges in South Eastern Europe

As shown in chapter 1's review of the economic trends in South Eastern Europe (SEE), output recovery and integration of the region into the world markets have been insufficient for sustainable growth. A successful transition process hinges on a well-functioning institutional environment for investment that safeguards property rights and contracts, supports dayto-day business transactions, creates jobs, accelerates poverty reduction, and helps integrate the region into the world economy.

To assess the progress of institutional reform and to highlight the remaining challenges, we present in this chapter an overview assessment of each of the four core issues that will be analyzed in detail in the book: competition, regulated infrastructure utilities, corporate ownership, and resolution of commercial disputes.

The chapter is organized as follows. First, we review in the aggregate the state of market institutions that influence the business environment in the eight countries that are the focus of this study (the SEE8). Next, we present a more disaggregated analysis of the institutional impediments and the reform progress to date of the eight governments in each of the four policy areas. The last section sets the stage for the in-depth comparative analyses in chapters 3 to 6.

Aggregate Assessment of the Business Environment in SEE

The snapshot analysis of the business environment in SEE based on the two European Bank for Reconstruction and Development (EBRD)-World Bank Business Environment and Enterprise Performance Surveys (BEEPS1 and BEEPS2) suggests that the 2002 investment climate in the region has improved in comparison with the climate in 1999. Figure 2.1 presents how the surveyed SEE8 enterprises perceived in 1999 and 2002 the relative importance of policy-related problems in each of the four thematic areas described above. The responses of the enterprises are averaged by country and are normalized on a scale from 1 to 4, with 4 representing the most severe obstacle. The chosen graphical representation is particularly effective because it allows us to capture (a) intertemporal variations in the perceptions of the surveyed firms, (b) changes across and within countries with respect to each policy issue, and (c) the severity of the problems in the four areas of the study.

[NOT INCLUDE FIGURE 2.1]

As figure 2.1 shows, access to regulated infrastructure utilities has significantly improved in the eight countries.1 Nonetheless, remnants from the old system, such as inefficient pricing, cross-subsidies, and lack of competition on the utilities market, have caused bottlenecks for the development of the private sector and have discouraged investment in SEE. Moreover, for countries such as Albania, access to regulated utilities still represents one of the major obstacles hindering expansion and growth of enterprises.

One striking observation from figure 2.1 is that, almost universally, corporate governance problems and access to financing remain rated among the most prevalent obstacles throughout the region. In the area of corporate governance, implementation of international accounting standards and financial audits has been the weakest in FYR Macedonia, Romania, and Serbia and Montenegro. This finding reflects a low level of transparency in privatization and a high level of state interference in FYR Macedonia and Serbia and Montenegro. For Romania, the finding is related to the low number of enterprises to adopt independent financial audits before 2003. A change in legislation at the beginning of 2003 required all companies listed on the Romanian stock exchange to adopt local accounting standards that are based on international accounting standards (IAS). Enterprises in Bulgaria and Moldova experience more obstacles in obtaining access to financing than the other countries in the region do. Financial regulation has been stringent with respect to bank lending in Bulgaria, especially after the crash of the banking sector in early 1997, and banks generally use more conservative methods in making loans now than they did during the period of lax lending before the crisis.

The business disputes data in figure 2.1 indicate that the judicial systems in the SEE8 have only slightly improved from 1999 to 2002. The region's weak institutional and governance capacity, including its inability to enforce its laws and regulations, is widely recognized. As the competition indicator in figure 2.1 shows, barriers to entry are also perceived as a major obstacle to business development in the SEE8. The problem is most pronounced in Albania and Moldova. There is limited cross-country variation in the area of exit barriers in the eight countries in 2002. The presence of subsidies and arrears has gradually declined since 1999, most likely because of an improved institutional environment, which includes the enforcement of bankruptcy and liquidation.

Figure 2.2, wh...

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