World Bank Discussion Papers

Awakening the1Market

Viet Nam's EconomicTransition

D. M. Leipziger

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(Continued on the inside back cover.)

1 5 7 1a31 World Bank Discussion Papers

Awakening theMlarket

Viet Nam's EconomicTransition

D. M. Leipziger

The World BankWashington, D.C.

Copyright C 1992The Intemational Bank for Reconstructionand Development/THE 'WORLD BANK1818 H Street, N.W.Washington, D.C. 20433, U.S.A.

All rights reservedManufactured in the United States of AmericaFirst printing March 1992

Discussion Papers present results of country analysis or research that is circulated to encourage discussionand comment within the development community. To present these results with the least possible delay, thetypescript of this paper has not been prepared in accordance with the procedures appropriate to formalprinted texts, and the World Bank accepts no responsibility for errors.

The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) andshould not be attributed in any manner to the World Bank, to its affiliated organizations, or to members ofits Board of Executive Directors or the countries they represent. The World Bank does not guarantee theaccuracy of the data included in this publication and accepts no responsibility whatsoever for anyconsequence of their use. Any nmaps that accompany the text have been prepared solely for the convenienceof readers; the designations and presentation of material in them do not imply the expression of any opinionwhatsoever on the part of the World Bank, its affiliates, or its Board or member countries concerning thelegal status of any country, territory, city, or area or of the authorities thereof or concerning the delimnitationof its boundaries or its national affiliation.

The material in this publication is copyrighted. Requests for pernnission to reproduce portions of it shouldbe sent to the Office of the Publisher at the address shown in the copyright notice above. The World Bankencourages dissemination of its work and will nornnally give permission promptly and, when thereproduction is for noncommercial purposes, without asking a fee. Pernnission to photocopy portions forclassroom use is not required, though notification of such use having been made will be appreciated.

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ISSN: 0259-210X

D. M. Leipziger is lead economist in the World Bank's East Asia and Pacific Regional Office, CountryDepartment I.

Library of Congress Cataloging-in-Publication Data

Leipziger, Danny M.Awakening the market: Viet Nam's economic transition / D.M.

Leipziger.p. cm. - (World Bank discussion papers; 157)

Includes bibliographical references.ISBN 0-8213-208741. Vietnam-Economic policy. 2. Vietnam-Economic conditions.

3. Mixed economy-Vietnam. I. Tide. II. Series.HC444.L45 1992338.9597-dc2O 92-8002

CIP

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ABSTRACT

Viet Nam embarked on an ambitious program of economictransformation, beginning in 1989 with widespread price, exchange rate,and interest rate reform coupled with a cutting loose of state enterprisesfrom fiscal subsidy. Initial responses were very favorable, particularlyin agriculture; but a combination of external events including a precipi-tous drop in Soviet aid served to weaken macro balances. Nonetheless,Viet Nam is vigorously pursuing its transformation to a socialist marketeconomy.

This essay considers the basic issues facing transitionalsocialist economies, including price reforms, enterprise and financialsector reforms, and institutional changes relating to the role ofgovernment. Using Viet Nam as the case in point, it identifies the keyconstraints facing governments seeking to move rapidly to the marketsystem. Although Viet Nam is only in its third year of reform, it hasachieved a number of successes, prominent among which are almost completeprice decontrol and a flexible exchange rate. The essay addresses anumber of specific concerns facing Viet Nam, a country of some 65 millionpeople with an average per capita income of less than $200. Among theseare the links between enterprise and banking reform, issues ofdecentralization, industrial policy, changes in ownership and privatesector development, and issues of social justice.

The objectives of this paper are to: (i) inform a broadreadership about the bold economic reform program being undertaken withoutinternational assistance in Viet Nam; (ii) to identify for the authoritieskey bottlenecks and future issues to be addressed; (iii) to contrast wherepossible this experiment vis-a-vis reform programs in other countries; and(iv) to begin the process of generalizing lessons from these cases so asto better understand the transformation process itself.

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ACKNOWLEDGEMENT

Thanks are due to the following individuals for helpfulcomments without implicating them in the final product: David Dollar,Bernard Funck, Homi Kharas, John Nellis, Klaus Lorch, Mark Sundberg, VinodThomas, Michael Ward, and Shahid Yusuf, and to Yvonne Manu for technicalassistance.

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FOREWORD

Viet Nam's transition from a centrally planned to a socialist marketeconomy has been both swift and effective. Spurred by the demonstrated successof its East Asian neighbors, Viet Nam has begun the process of outward-orienteddevelopment. It continues to face considerable obstacles, however, in the formof an acute shortage of capital, weak institutions, and costly vestiges of thepast system.

This essay by Danny Leipziger, who has been involved on the Bank'sside with Viet Nam since our re-involvement in 1989, serves two useful purposes:first, it puts the Vietnamese case in perspective vis-a-vis the socialisttransition more generally and second, it charts a path for future Vietnamesereforms, drawing out the linkages among various aspects of reform. It is thusa major contribution to our thinking on the subject.

Callisto MadavoDirector

East Asia and Pacific Dept. I

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Table of Contents

Page No.

INTRODUCTION .... . . . . . . .. 1

I. THE FIRST BOLD STEPS. 3

Price Reform. 3

Consequences of Price Reform . . . . . . . . . . . 7Financial Sector Issues . . . . . . . . . . . . . . 9

Private Sector Development . . . . . . . . . . . . 10

Distribution Effects . . . . . . . . . . . . . . . 11State of the Macroeconomy . . . . . . . . . . . . . 12

II. CONSOLIDATION OF REFORMS . . . . . . . . . . . . . . . 16

Enterprise and Banking Reform . . . . . . . . . . . 16Encouraging Entrepreneurship . . . . . . . . . . . 18Decentralization .20.

III. A NEW ROLE FOR THE STATE . . . . . . . . . . . . . . . 22

Changes in Ownership . . . . . . . . . . . . . . . 22Industrial Policy .26Social Safety Net .28The Social Compact . . . . . . . . . . . . . . . . 30

Footnotes .32

Bibliography . . 35

INTRODUCTION

The number of countries abandoning central planning in favor ofmarket economics is growing. While it is difficult to present clear rulesthat should govern these difficult transitions, it is useful to collectexperiences in order to form broad characterizations of this process,provide guidance on the principles to be followed, and alert policymakersto the pitfalls to be expected. This paper attempts to do that, t'rawingprimarily on the current economic reform process in Viet Nam. Develop-ments in Viet Nam provide important initial lessons on post-socialisttransition in a very low income developing country and interestingparallels to similar processes in higher-income countries of EasternEurope. Since the reform process is still underway, however, it is toosoon to declare victory.

The Vietnamese reforms of 1989-91 followed an earlier half-hearted attempt at reform, which was largely unsuccessful, except perhapsfor the fact that it may have whetted the appetite of the reform-minded.The entire r.eform process is known as "doi moi" or economic "renovation. IThe failure of partial liberalization, documented by Drabek (1990) forViet Nam and Kornai (1990) more generally, is potentially instructive toother socialist economies (such as Myanmar, North Korea or Cuba) that mayat some point be tempted to partially reform in hopes of gaining someadvantages of the market without actually relinquishing centralizedcontrol.

Evidence demonstrates, for example, that partial foreignexchange retention schemes, such as those introduced in Myanmar (Burma)in 1989-90, at a time when the official exchange rate was overvalued bya factor of ten, did little to realign prices or to reduce the large-scaleresource misallocations which pervade the state enterprise sector. Severeprice distortions, such as still exist in Myanmar or the Soviet Union,serve only to nourish black markets, deprive central governments of muchneeded tax and tariff revenues, and validate Gresham's Law. In the end,currency recalls, which were inflicted on the Burmese economy withsurprising regularity and which were initiated in the USSR in early 1991,are the outward signs of policy desperation on the part of thosepolicymakers unalterably opposed to reforms. These examples of thefailure of partial reforms reinforce the view that full liberalization,particularly of prices, is indispensable for reforms to take hold andproduce significant production responses.

In contrast to these efforts to retain the status-quo, the boldreform programs of Poland, Hungary, Czechoslovakia, Laos, and Viet Nambear witness to the logic of embracing the market, although the diffi-culties of transition cannot be underestimated. Indeed, nationalgovernments can learn from households, which in many ways will already befollowing market principles. The economics of hoarding,l/ black marketeconomics, and the actions of farmers, traders and speculators alike all

-2-

speak to the rationality of economic decision-making, even in irrationaleconomic environments. It is, therefore, only a matter of time(admittedly three-quarters of a century in the case of the Soviet Union)before national policies align themselves with household behavior.

The abandonment of socialist economic thinking, by which forthis purpose is meant central planning and price administration, is noteasy to carry ou.t. Indeed, some of the fundamental issues which arecritical for success are the speed with which market economic principlescan be adopted, the consequences of those radical reforms, and thesequencing of reforms. Although the question of sequencing is open tojudgment rather than theoretical principles, we pose a possible transitionsequence primarily as an organizing approach.2/ This sequence and someof the ensuing policy burdens to be faced by the authorities are reflectedin Figure 1. This proposed sequence also provides the structure for theessay, which is divided into three parts: the initial steps, theconsolidation period, and a new role for the state. These form thebackdrop for our discussion of Vietnamese reforms.

Figure 1: TRANSITION SEQUENCE AND CONSEQUENCES

PRICE REFORM ENTERPRISE REFORM OWNERSHIPBANKING REFORM REFORM

Reform LEGAL REFORM REGULATORYMeasure REFORM

-11 11 ~~~~~~~~~~~~~~~~~~~t ime

Slow implementation Lack of instrumentsPublic mono olesI Weak institutionsEntrenched ur-au- Provincialism I

Policy cracyIIburdensll

Larger fiscal deficit Firm closuresLabor redundancy Bank decapitalization Greater incomeTemporary input Safety net demands disparitiesshortages Shortage of working Asset valuation

capital problemsPossible foreign

domination

-3-

PART 1: THE FIRST BOLD STEPS

Price Reform

The indispensable first step to meaningful reform is widespreadprice reform which essentially leaves very few administered prices in theeconomy. In the case of Viet Nam not more than a dozen prices remainedcontrolled after the price reforms of 1989. In Poland's "big bang"reforms, only the price of energy and labor were left administered.Similarly in Laos, only a handful of "strategic goods" were still subjectto price controls after the reforms. Although the case of China's pricereform is much more deliberate, the direction has been towards marketpricing, especially since 1980. It is difficult to argue in light of theallocative costs involved for anything less than an aggressive program ofprice liberalization.

Clearly crucial in this process is the exchange rate, whichshould be devalued to its market rate. A strong case can be made for aslight over-devaluation, however painful to government, to indicate theseriousness of the reform movement and to restore some confidence in the:Local currency. The experiences of Viet Nam as well as other transitioneconomies such as Poland and Laos in which foreign currencies were widelyused as both stores of values and price yardsticks, show that anoverdevaluation coupled with real positive interest rates can halt theerosion in value of local currency vis-a-vis alternative means ofexchange. Devaluation-cum-positive real rates will obviously only workin an environment of strict monetary control. Without it, individualsLong accustomed to over-valued exchange rates and hyper-inflation will notbe persuaded to switch to domestic currency. On the other hand, onceexpectations are reversed, and currency substitution occurs, the centralgovernment can gain from the increased level of deposits, and can, withinLimits, borrow form the domestic banking system to help finance its fiscaldeficit.

The evidence from the dramatic Vietnamese devaluation andinterest rate reform in the spring of 1989 is instructive. Figure 2ashows the prevailing real interest rate and the size of monetary depositsin banking for the months following the initial reforms. Dong depositsare seen to respond very quickly to new monetary circumstances asdepositors rushed to take advantage of real positive yields. Alsostriking is the decline depicted in Figure 2b in the price of gold, theother store of value traditionally used in Vietnamese as well as othersocieties, showing the extent to which currency substitution actuallyoccurred. This program of monetary reform, undertaken in Viet Nam underthe watchful eye of the IMF, provided the linchpin for stabilization. Ingeneral, stabilization programs often falter because of the inability ofthe financial system to fuel the resource shifts from import-substitutionto export industries and the political unacceptability of the loss of jobs

Figure 2aReal interest rates and savings deposits trends

Per cent Billions of dong

20 3'°°°

....... . .... ............. ....... ......... v212 00010

1,'''''''' AbtS 0000

-10 1 ., i,1 1,000

-20 k ";;;; ; 0

1/86 1/87 1/88 1/89 1/90 1/91

Year

(Interest rates are real monthly rates and deposits are billion dong)

Dd dep rate *+- Time dep rate * Deposits

Figure 2bTrends in market gold prices: 1/86 - 3/91

(Dong per ounce)

Millions4

3 - - - - - - - -- - - - - - - ........ ..

2. . CGold price (Hanoi)

01/86 1/87 1/88 1/89 1/90 1/91

Year

-6-

which accompany them.3/ In the socialist transition context, there maybe a greater one-time public acceptance of large resource shifts, but theaccompanying credit crunch and fiscal strains may ultimately undermine thereform efforts. This certainly characterizes the current situation inViet Nam as seen in Figure 2a in the shift back towards negative realdeposit rates and the flattering of deposits during 1990.

"Freeing up prices" provides productive units with the impetusto immediately shift their economic decisions to the new price structure.In a way it validates their previously covert behavior. Farmers candishoard to take advantage of new higher prices for agriculture, andprovided that some security of land tenure exists, they can select cropsmixes to maximize returns to the land. The extent of the supply responsecan be quite significant provided that entry barriers are also eliminated.In Viet Nam, where food shortages led people to flee the country and whererice had to be imported through 1988, agricultural reforms--both pricereform and the fifteen year, transferable lease given to the familyfarmer--were instrumental in making the country a net rice exporter in1989 and indeed the third largest rice exporter worldwide. Whilefavorable weather undoubtedly helped, one tends to find a large and rapidsupply response in crop agriculture, provided that access to inputs,particularly fertilizer, can be maintained.

While market prices may very well already have prevailed in theinformal trade sector, price reform in the industrial sector, largelystate-owned, produces the most severe repercussions. Allowing firms todetermine their own prices and subjecting those to the market testdisorients state enterprises used to receiving specified inputs atadministered prices and delivering products according to plan atartificial and often irrelevant prices. The shock to the economy islarger the more industrialized is the country and the greater the existinglevel of distortions in resource allocation prior to reforms. It isreported by Sheng (1990) that the level of subsidies to enterprisesreached 15 percent of GDP in Hungary and 20 percent in Poland in the late1980s. By abandoning "the plan," the reforming country accepts the factthat many enterprises will for a time produce unwanted products as theyrealign their output and seek new markets. Ultimately, however, firmswill either have to adjust or begin to fail. The consequences of failureare reported increases in overt unemployment of 5-10 percent in Viet Namand Poland and other Eastern European countries.4/

Despite the high cost of "shock treatment," the alternative ofpartial price reform or partial elimination of subsidies is quiteunappealing, since it delays the inevitable, continues the hemorrhagingof public funds, and delays the redeployment of resources which is neededfor reforms to ultimately succeed. In other words, the distorted segmentof the economy continues to siphon off funds needed in the reformed partsof the economy under a partial reform scenario. Most importantly,continued subsidization raises the specter in the minds of managers thatthe reforms can be circumvented. Wide-ranging versus incomplete pricereform can be contrasted in the cases of Viet Nam and China. In theformer, no more than a dozen prices remained controlled after reforms(included some natural monopoly prices), while in the latter, much more

- 7 -

widespread price-fixing has occurred.5/ Of course, comparisons arefEraught with difficulties, especially since China was able, like Korea andTaiwan in previous decades, to obtain timely and significants sums offoreign capital. Viet Nam by comparison continues to be economicallyisolated by the international community, despite its reforms begun almostthree years ago.

It should be noted that "shock therapy' to the industrial sectoris much more costly in countries, such as Poland, where this term tookprominence, with large industrial sectors, employing sizeable workforces,with limited ability to adapt their product lines to a new system ofprices. The losses are not necessarily, indeed not at all, a reason todelay or dilute the reforms, but they do indicate the need for large dosesof external financing, especially to cover some of the social adjustmentcosts and provide critically needed imports. During this period, it ispossible for living standards (as normally measured) to fall, although thepre-reform data is probably quite misleading due to supply shortages, poorquality services, and the effects of hyperinflation. Growth rates arealso normally underestimated in the early years of reform due todifficulties of properly comparing production before and after priceliberalization. The experience in Viet Nam is that despite someemployment setbacks, the stabilization program which halted hyperinflation(viz., average annual inflation fell from 400 percent in 1988 to 35percent in 1989) effectively raised real incomes in rural areas.Urbanites fared less well. Unfortunately, however, lapses in macromanagement in 1990 combined with an abrupt withdrawal of Soviet assistancerekindled inflation. Despite reportedly small positive per capita incomegains registered in 1990, growth has been sluggish and the continued needto curtail expenditures may limit further growth.

The political acceptability of drops in per capita income isquestionable, particularly in fledgling democracies, such as Poland. Yetthey may be unavoidable, especially if the industrial sector is large andcharacterized generally by loss-making state enterprises. The onlyoptions are dissolution, which, because of its employment effects, has notbeen widely chosen by reformers or large wage cuts, which is alsopolitically difficult to carry out. One channel which should beencouraged to absorb displaced workers, and to give signals to flounderingstate enterprises, is to sanction and indeed encourage private enterpriseactivity as quickly as possible in as broad a range of activities aspossible, but indispensably in trade and services. This has begun in VietNam, but its pace is too deliberate. Free internal trade should beencouraged to erode the power of provincial monopolies and subjectenterprises to competition, domestic and gradually external.

Consequences of Price Reform

The detailed consequences of price reforms is seen in countrystudies, such as those prepared by the World Bank, but one clear lessonof these experiences is that price reform works. The evidence is ample,not only from East Asia, but also from Eastern Europe. Its speed varies,influenced by the characteristics of markets as well as by the overall

economic environment in which reforms take place. Favorable results areevident as firms abandon unprofitable product lines and, for example,begin using the:Lr truck fleets to become transport service providers, orredirect their output to high-return export markets rather than barterarrangements predicated on physical delivery of quotas and the tradedemands of COMECON as it existed prior to 1990. Against these gains mustbe considered the stresses borne by the economy as it shifts to a systemof market prices. Areas to be examined include fiscal finances, financialintermediation, employment, income distribution, and private sectordevelopment. The vantage point is the recent Vietnamese reform program.

A general observation from the Vietnamese experience is thatprice reform may initially weaken the fiscal situation of the transformingeconomy. Although there can be substantial gains in expenditure savingsas direct subsidies to state-owned enterprises are eliminated, the reverseflow of transfers normally expected as mandatory payments to the centralgovernment in the socialist framework (be they labelled depreciationpayments for capital assets, dividends from enterprises, or the equivalentof taxes) will also fall. At the same time demands on the national budgetwill rise as enterprises attempt to shed labor and government tries tomaintain social service delivery.

In the case of Viet Nam, it is reported that transfers fromstate enterprises to the central government fell from 9.2 percent of GDPin 1987 to 2.6 percent in 1991. While subsidies amounting to 4.9 percentof GDP in 19137 were eliminated, the net budgetary loss vis-a-visenterprises ovier the period was 1.5 percent of GDP. Overall, fiscalrevenue fell from 12.2 percent of GDP to 7.6 percent in 1991, and when theincrease in oil revenues is excluded, the loss is even greater.6/Unfortunately, in the case of Viet Nam, this initial phase of reform alsocoincided with a sharp reduction in foreign assistance, from the USSR inparticular, so that domestic financing of the fiscal deficit by the StateBank increased considerably, and was equal to about 80 percent of thedeficit in 1989-90. The ensuing difficulties of macroeconomic managementthreatened to undo much of the gain of initial exchange rate and monetaryreform, highlighting the importance of macro-stabilization policies as theanchor of transitional reform. Prudent management of public finances iscentral to the success of price reforms because firms and householdsalready face 'considerable price shifts and the onslaught of generalizedinflation merely compounds their confusion.

The major difficulty of sustaining the integrity of exchange andmonetary reforms is the monetization of fiscal deficits. In economieswithout highly developed capital markets and a historical record of highinflation, it becomes difficult to finance increased public deficitswithout recourse to the printing of currency. While this dilemma is notunique to reforming socialist economies, it takes on added dimensions inthis context. For example, in the Laotian case, the price reform of 1987-88 included an abandonment of script (coupons for specified goods) inpublic sector compensation and major shifts in the velocity of moneycirculation which complicated monetary control (see World Bank, 1989).The importance of monetary control in reforming socialist economies hasbeen highlighted by Yenal (1989) and others, in particular as it is

-9-

affected by declining control of central authorities. The phenomenon ofmonetary decentralization at the expense of national policy objectives iswidespread in reforming socialist experiences, as seen in the printing ofcurrency by republics in Yugoslavia or the violation by provincial banksof monetary policy objectives in China and Laos. These policy indiscre-tions stem from a number of factors: first, the loss of power of centralgovernment institutions and second, the distress of the state enterprisesector and the serious shortage of capital which is the natural conse-quence of massive price reform. Whereas we will address directly theissue of decentralization later on, we now turn to the second consequenceof the initial steps of reform, the stress placed on the financial sector.In the literature, following Kornai, this has come to be called thehardening of the budget constraint giving way to the softening of thefinancial constraint.

Financial Sector Issues

Whether the financial sector is characterized by traditionalcommand economy mono-banking or by a reformed, two-tier separation of thecentral bank from commercial banking institutions, the shock of price andenterprise reforms is felt dramatically in the banking sector. Theinitial price reforms in Viet Nam revealed that many enterprises wereunprofitable. It is estimated that within a year of the initial reformsin Viet Nam, 30 percent of state enterprises were losing money, 40 percentwere able to break even (probably barely) and 30 percent were profitable.Therefore, 70 percent of bank borrowers were unlikely to be able toservice their existing debts. At the same time, enterprises desperatelyneed working capital to reorient production, upgrade equipment, andweather the revenue losses of now defunct plan contracts; however, as aconsequence of monetary reforms, interest rates to borrowers are high andpositive in real terms compared to previous highly subsidized rates. Andfor many, credit is unavailable at any price. In addition, previouscredit allocation systems based on plan priorities are seen to beanachronistic, yet no alternative mechanism or reliable data yet exist tojudge credit-risk. Managers never before accustomed to taking a directrole in credit allocation cannot do so effectively. Moreover, atprovincial and district levels, these individuals are often members of thelocal administrative apparatus, People's Committees or local governments,and thus unable or unwilling to act independently.

Once the facade of central planning is removed, the traditionalbanking sector is likely to be technically insolvent, and highly dependenton central bank financing, which is inimical to monetary controlobjectives. The banking system's liquidity crunch hampers the developmentof profitable activities and drives managers to seek creative solutions.Some are less desirable than others. Plant managers in China and EasternEurope, unable to obtain spare parts or working capital, have resorted tostripping their capital stocks. The financial stress in the economy inthe early stages of reform probably impacts most profoundly on the largegroup of possibly profitable enterprise, those marginally surviving butin need of cash infusions. It is at times politically more difficult todeny credit to large loss-makers, often enterprises with large work

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forces, large past investments of capital, or located in politicallypowerful regions of the country. This sapping of scarce capital servesto further weaken bank balance sheets, since much of this credit is stillprovided at preferential rates.7/

Despite severe capital shortages, however, new means arecontinually found to mobilize needed capital. In Ho Chi Minh City(formerly Saigon),, entrepreneurs have established relationships with otherEast Asian nations (usually the NICs which seek their own offshoreplatforms for labor-intensive exports) to secure the raw materials andmachinery needed to generate exports. Some state-owned enterprises havesought and received permission to become joint public-private shareholdingcompanies in order to act commercially, i.e., lease their land, tap localsavings held outside of the banking system, and enter into businesscontracts. Foreign direct investment is being encouraged throughout thecountry following passage of legislation, but implementation has beenslow. The first joint venture bank was recently opened to tap foreignsources of capital. This private sector entry into the public bankingsector follows a long-established Asian principle that you do not destroyold institutions, but rather you create new ones which quickly becomedominant.8/ Therefore, for a time, one can expect public and privateactors to co-exist in a number of subsectors, raising a separate set ofquestions about the levelness of the "playing field" facing the privatesector.9/

Private Sector Development

The strength of the supply response to price reform dependslargely on the adaptability of the private sector. The critical firststep in the reform sequence involves legalizing the private sector.Private enterprise enabling legislation has been proposed by theVietnamese authorities, and when combined with additional foreigninvestment laws, such as that passed by the Vietnamese in 1990, has servedto reassure private entrepreneurs and their foreign partners that theinitial administrative leniency was indeed to be codified.10/ The sameapproach was followed in Laos, where private activities were sanctionedin 1987. Of course, legislation only provides the framework which theauthorities can implement with either enthusiasm or reluctance. As seenby the example of the Peoples Committee of Ho Chi Minh City, thePrefecture of Vientiane in Laos, or the mercantalist provinces of China,those authorities wishing to attract private foreign investors can do soeffectively by implementing measures friendly to the private sector.11/

Rules for domestic business activities are crucial for foreigninvestors, who may not be convinced by Foreign Investment Laws, (such asthose decreed in Laos in 1987, in Myanmar in 1989 or in Viet Nam in 1987)unless they are matched by domestic company law reforms that enable jointventures with the private sector to be formed. Joint ventures with thepublic sector are possible for enclave projects--natural resourceextraction or hotels perhaps--but genuine cooperation with the foreignentrepreneur requires legal reform to define the rights of the localentrepreneur.12/

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The legalization of private enterprise activities also providesa number of salutary consequences for the industrial and service seactors.First it opens the door to efficiency gains by allowing competition indomestic markets. This is seen rapidly in the trade and service siectors.Second it provides an excellent vehicle for the repatriation of foreigncapital from abroad. Expatriate communities provide the quickest sourceof equity for private entrepreneurs, and given the extreme short-age ofworking capital, this flow is essential for private sector development.To facilitate this, the authorities must relax exchange controls, at least.for inward flows of capital. The authorities will need to use the mostbasic tax designs, possibly existing laws, to generate much-neededrevenue. Evidence from Viet Nam has shown, for example, that the havenof market economics, Ho Chi Minh City (HCMC) and its environs, account for67 percent of nationally collected activity-based 1990 tax revenuesdespite having only 20 percent of the country's population. It is alsoworth noting that HCMC transferred 75 percent of its revenue collectionsto the center.

If privatization of publicly-owned assets is on the agenda (andthere may be valid reasons, as discussed later, in the case of Viet Namto delay this very difficult and politically contentious process forlarge, capital-intensive enterprises), the priority should be seen to bedivestiture not revenue generation. Experience even from market economiessuch as Malaysia and the Philippines shows that troubled publiccorporations, often heavily indebted and with tainted balance sheets,cannot easily be sold. Government should seek to stem the tide ofhemorrhaging losses involving public monies and sell enterprises asquickly as possible. Even sales at rock-bottom prices (provided that ashare of future profits can be appropriated) are to be preferred, if theprivate sector takes the firm off public hands. Elaborate privatizationschemes have not worked and end up being quite costly for governments tomanage.13/

The importance of rapid private sector development can be seenin the recent growth performance in Viet Nam, where (family farm based)agriculture and the private sector growth is estimated to have producedthe bulk of growth since the full-fledged "doi moi" process began in 1989.The same phenomenon may be seen in Hungary and Poland, where the privatesector has provided the economy with its growth impetus. In China, greatdynamism has come from the cooperative and collectives sector, but,exporting has still required major private sector style marketing efforts.In Viet Nam, although statistics are weak,141 we do know that industrialoutput, particularly of the state enterprise sector, was negative in 1989,whereas growth of the private sector and growth in agriculture were themost dynamic sectors of the economy.

Distribution Effects

Of special concern to socialist governments undertaking thetransition to the market is the effect of those reforms on employment andlncome distribution, social objectives not easily sacrificed bypolicymakers. As already noted, employment in the state enterprise sector

- 12 -

is likely to suffer, although agricultural employment and private sectorand self-employment should rise as a partial fillip. In most developingcountries a return to the countryside is unusual, even if the terms-of-trade between agr:iculture and urban incomes favor the former and as theydid in Viet Nam when food prices rose. State enterprises employingredundant workers are financially unable to release them formally if, asis usually the case, a worker is entitled to severance pay, often onemonth per year of service. Far better for a plant manager to carry ahigher than needed complement, and to encourage partial or part-timeemployment, than to be faced with massive lump-sum payments. Henceworkers in many transition economies hold multiple employment. Often thepublic sector employment is more valuable for its benefits (health care,education allowance or housing subsidy) and its government connectionsthan for its salary. As a result, evidence points to relatively smallofficial lay-offs in the early phase of reforms.15/

Distribution issues are thorny and involve difficult measurementproblems. The rural-urban shifts already discussed many well provetransitory as the trade and service sectors develop.161 One concern inmaintaining public support for the reform agenda is excessive rentgeneration by either the new entrants into markets, such as exporters whogain access to credit, or monopolists, such as importers of a criticalcommodity like fertilizer, who gain "abnormal profits' through remainingimport licensing. The distinction between normal and abnormal profits isperhaps a trifle less clear in an economy undergoing massive economictransformation, however. That rents should be generated is inevitable.That they become permanent is not inevitable. It can be argued, however,that regulatory reform is not the most urgent priority, nor that it canbe addressed unt:il effective markets are created. Of course, clearmonopoly positioins are to be avoided, but the risks to entrepreneurshipin a post-socialist economy are large (viz., reversibility of policy isthe clearest riskc) and some excess profits should be permitted, perhapsto signal the alttractiveness of private sector activity and encourageentry, which by iLtself may render those rents transitory.17/

State of the Macroeconomy

Evidence from socialist reform experiments shows that additionalstrain is borne by the macroeconomy as the initial steps of price reformproceed. A major weakness, as postulated in Figure 3, of price reform inits initial stage is the prospect of it worsening the fiscal situation.Expenditures may be reduced as subsidies are eliminated--and the case forsuch a withdrawa:L of support is compelling if firms are to adjust to a newsystem of input and output prices--but other expenditures will grow, suchas social welfare expenses; temporary budgetary support for the usuallyailing banking sector; and capital investments, often needed in infra-structure to spur foreign investment. In the recent case of Yugoslavreforms, for instance, widespread banking sector losses associated withenterprise supports cost the central bank to monetize the equivalent of9 percent of GDP., In the case of Viet Nam, to accommodate both the fiscalimpact of reforms and the abrupt pullout of the Soviets, the authoritieswere forced to ctut capital expenditure to 2-3 percent of GDP and virtually

- 13 -

Floure 9' Financing the Deficit in Viet Nam

20

16- . ... ............ I. ...... .Capital Expgnditure

Prim ary 1 2 -. ...= _<................. ......... ......... .... ............. .Figcal

Del oitI so., OP) 8 l- -V __|

4 .. . ... . ......... .......... ...

0-Source of

Flnancing

Deficli -4 ...................... ........... .............................. ................. _._. I of GDP)

-81986 1987 1988 1989 1990 1991

- Current Expend. -I- Total Revenue Tax Revenue

9 Total Expend. Foreign Aid Overall Deficit

- 14 -

eliminate Operations and Maintenance expenses. Revenues in Figure 3 aredepicted as falling rapidly during initial reforms since tax revenuesdwindle. In time, these recover, as the private sector becomes moreprofitable, it activities more monitorable, and its taxes morecollectible.18/

The lower panel of Figure 3 shows the possible means offinancing the fiscal deficit, including to varying degrees, reliance onforeign savings, domestic borrowing from the banking sector (since debtinstruments are unlikely to be marketable for some time), and the creationof money. The latter, going beyond the small amount of seignorage thatis permissible, poses perhaps the greatest threat to early reforms. Itcan of course be limited by a greater availability of foreign assistancewhich can be used for budgetary support; however, recent experience inViet Nam indicates that foreign financing is unlikely to be available insufficient quantity to fill the larger ex ante fiscal deficit. The shocktherapies of both Laos and Viet Nam involved rising deficits and excessivemoney creation.19/

This classic economic management problem of monetized deficits,ensuing inflation, and ultimate depreciation of the currency works atcross purposes with the reforms themselves. In order to maintain themomentum of savings mobilization, an especially difficult goal whenemployment is threatened and incomes are falling, interest rates must beraised. This exacerbates the distress of the cash-poor state enterprises.Public spending must be cut, usually beginning with capital expenditures.But this serves to dissuade foreign investors. Large-scale debtrescheduling, such as in the case of Poland, becomes indispensable, sincedebt service is often one of the largest budgetary items. In cases wherethe major creditors are the East bloc themselves, such as is the case forViet Nam, debts are often in rubles of unclear value since the debts werecontracted at highly distorted "transferable ruble" exchange rates and theUSSR reportedly wished to be repaid at those prices, even though the rublehas now been devalued de facto by a large margin.20/

During the initial stage of reforms, it can be argued, the bulkof financing to ease the adjustment strain and still maintain the momentumof reform must come from the international community. Table I shows thereliance of reforming socialist economies in 1990 on major sources offunding, the International Monetary Fund, Paris Club rescheduling, andbilateral and multilateral assistance flows. As can be seen, EasternEurope and Laos have been rather well funded, although the capitalrequirements of the farmer are also enormous, while Viet Nam has beenunfunded. In the absence of large infusions of external capital, thereform programs; are likely to fail. (Hence the discussion surrounding theSoviet Union, the so-called "Grand Bargain"). While there is noobligation certainly on the part of the West to finance reforms (althoughthe reform process can both produce a budgetary gain in the West via lowerdefense spending and ultimately create new markets), it would be naive toexpect the market to replace Marx successfully without significantexternal assistance. Indeed, the momentum of reform must be maintainedby stabilizing the macroeconomic environment, attracting external capital,and moving on 1:o the next stage of reforms, a period of consolidation.

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Table 1: FUNDING THE REFORM PROCESS

Poland Bulgaria Romania Viet Nam Laos

(In percentage of total imports)

World Bank 2.6 5.3 4.9 -- 12.5IMF 3.3 10.7 13.1 -- 5.4Other Bilateral and MultilateralO.7 16.0 18.0 6.2 33.5Debt Relief /a 33.1 24.0 -- -- --

Total Official Capital 39.7 53.4 36.1 6.2 51.4

/a Paris Club and London Club.

Source: World Bank staff estimate.

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PART If: CONSOLIDATION OF REFORMS

Enterprise and 13anking Reform

The second major phase in the sequence of reforms proposed inFigure 1 focuses on enterprise and banking reform. It takes as given theestablishment oE a legal framework which enables individual and firms tomake rational, market-based economic decisions. The proposition isadvanced that enterprise and banking reform should be pursued simul-taneously. The reasoning is as follows. Enterprise reform in the absenceof banking reform will not allow viable firms to gain access to necessarycredit and wilL not penalize unviable enterprises engaged in distressfinancing. Conversely, banking reform without significant enterprisereform will not yield a superior allocations of capital because enter-prises, unfettered by market discipline, will engage in short-termexpedient behavior, such as asset stripping, excessive wage bonuses toavoid paying profits taxes, and off-balance sheet transactions whichprevent lenders from providing working capital to enterprises on soundcommercial criteria. This is the stage of reforms now confronting VietNam.

For bcth banking and enterprise reform to go forward requiresfirst and foremost a baseline examination of the balance sheets of bothfirms and banks. In socialist economies, most banks, long used todirected lending, have portfolio of non-performing loans which exceedtheir capitalization. It would be unwise to consider banking recapitali-zation before a thorough investigation of their financial position hasbeen undertaken. Since the bulk of bank portfolios consists of loans topublic enterprises, the urgency of assessing state enterprises 'viability"is clear. Basic audits are essential, and are best performed by competentautonomous agencies to maintain objectivity and insulate the process fromdomestic political forces. Failure to provide financial oversight tostate enterprises the result in serious management and ultimately thecollapse of even potentially viable enterprises.

At the outset, the question of who should receive credit needs tobe addressed since it will take some time to fix the banking sector andsome guiding principles are preferable to the status-quo. Related to thatis the question of how much time should be given for an enterprise toresurrect itself? Furthermore, what should be done with those stateenterprises unable under market circumstances to reach profitability. Onecriterion which can be used for credit allocation in a severely capitalconstrained economy is the ability to generate foreign exchange earningsquickly. The advantages of favoring exporters are as follows: first,exports are being measured by international prices gauge to their competi-tiveness,21/ and in an immature market economy, domestic prices are aflawed guide to profitability; second, earning foreign exchange is in andof itself critical for the reforming economy in its early stage becauseof a shortage cf imports and domestic savings and the need for the economyto shift resources quickly from the non-tradable to tradable sector; and

- 17 -

third, the economy will via exporting increase its access to foreignentrepreneurship, technology, market information, and ultimately externalcapital, so that the returns to investments in exporting as an activityexceed the firm's internalized returns. This is the strategy adoptedimplicitly by the Vietnamese authorities and it explains their focus atleast in the southern part of the country; however, to date it has notbecome as central a policy as it was in the early history of Korea andTaiwan, for example.221

In judging the appropriate time needed for rationalization orretrenchment of an enterprise, one may advise a rather arbitrary andbrutal rule of thumb. If an enterprise cannot reach a break-even pointon an operating expense basis in one year, it is highly likely that itwill never reach this point, coming as it does from a command-economyenvironment. This assertion is open to refutation of course in manyspecific cases.23/ Nevertheless, an enterprise which cannot cover thecost of its inputs is providing negative value added to the economy andharsh measures are in order to release those resources so employed to morerewarding economic activities. Experiences from Eastern Europe showclearly that gradual rehabilitation of firms is extremely costly andyields only limited success. Indeed according to Kharas (1991) even inPoland, where reform incentives are strongest, large enterprises haveresisted reforms and privatization has had few takers, with only five suchdeals completed by 1990.

What is most likely to keep uneconomic enterprises afloat isaccess to subsidized working capital. In Viet Nam, for example,budgetarily provided working capital ("van lu dong"), provided at belowmarket interest rates to some state enterprises, was in 1990 the majormeans of support of loss-making enterprises. These subsidized credits arein essence transfers which will most likely never be repaid and merely thedelay the inevitable. For this reason, cutting off support to thoseenterprises that are loss-making is prudent policy. A hard budgetconstraint (viz. fiscal austerity) cannot be enforced without a hardfinancial budget constraint as well.

In the area of financial sector reform, one of the central issueswhich arises is how to deal with the non-performing assets of the bankingsystem, especially once the enterprise closures or failures haveformalized the loss. Sheng (1990) refers to these actions as damagecontrol and loss allocation. A few options, technically differentperhaps, exist for the latter, but in the end it is the national govern-ment that will carry the loss. Banks can segregate these assets ortransfer them to the central bank or to a separate trust. The key stepis transparency. The second key is their transfer as soon as possible tothe national financial accounts, rather than letting those losses fall onthe central bank. The latter is the expedient solution used in Korea, thePhilippines and elsewhere, but it damages central bank profitability andcan confuse monetary policy. Most importantly, it deludes policymakersinto thinking that they are dealing with a monetary phenomenon when it isreally a fiscal burden. In some countries, like Yugoslavia in the late1980s these losses were very large and placed a significant burden oneconomic management.

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Encouraging Entrepreneurship

Enabling legislation for private enterprise activity and entryinto previously restricted areas of production and trade is needed forserious state enterprise reform. Those entities must feel pressured toundertake drastic measures or face elimination. Table 2 indicates thekind of legislation implemented by transitional socialist economies inEast Asia in thie early stages of their reform agendas. Of course, thepassage of legislation does not bring about reform. Many other impedi-ments remain, paramount among them the speed and seriousness with whichlegislation is implemented by the authorities. Legalizing privateactivities is an important step, but the telling statistics may be theactual registration of new firms as well as the percentage of suchapprovals granted and their sectoral composition. Legalizing additionalprivate restaurants in Hanoi is noteworthy, but legalizing a joint venturetourism company which would compete with the local government-ownedtourist monopoly would be more significant. The second criticalconstraint to the implementation of legislative intent is access to creditin which the issue of financial sector reform comes to the fore onceagain. Although clearly a second-best alternative, it may be worthconsidering indicative targets for private sector lending, recognizing,as in the case of Korea, that intervention in the allocation of credit,while effective, is not cost-free in terms of financial sectordevelopment.24/ Nevertheless, in order to effectively promote privateenterprise, these kinds of interventions should be sanctioned in caseslike Viet Nam.

Table 2: INSTITUTIONAL REFORMS IN ASIA

Reform Year 1 Year 2 Year 3

Eliminate price setting LaosViet Nam

Legalize private entrepreneurship Viet Nam

Separate central bank fromretail banking Viet Nam

Laos

Joint stock company legislation Viet Nam

Foreign investment law LaosViet NamMyanmar

- 19 -

The issue of entrepreneurial development is clearly related tothe speed with which the government withdraws from directly productive andservice activities. Experience in Poland, for example, has shown thatsmall state-owned shops can be quickly privatized, as seen by the factthat almost half of them were transferred to private hands in 1990.Similar programs are now under way in Czechoslovakia and Hungary.Removing barriers to entry is essential to allow private sector develop-ment, but importantly also to promote greater efficiency in the publicsector entities operating in any particular economy activity. One methodof boosting private investor confidence, and quickly revitalizing privateenterprise, is to allow the return of expatriate entrepreneurs (althoughthis is not without legal and political risks to the authorities).

Smoothly functioning product markets require well functioningfactor markets, which do not usually exist in transforming economies.Labor markets need to be deregulated to allow wage differentiation withrespect to skill and productivity levels, increased labor mobility, andgreater downward wage flexibility. This is typically easier to achievein smaller enterprises. In large state enterprises, labor policy is oftenthe major obstacle to privatization and new arrangements need to benegotiated with labor unions. Kharas (1991) pinpoints wage control as thekey factor in both establishing the competitiveness of privatized firms(and efficiency of public sector firms) and endorses excessive wage taxlegislation as introduced in Czechoslovakia. Creating new and responsibleboards of directors is a strong step in the direction of more independentmanagement of enterprises. Also of concern are capital markets. Creditmarkets suffer from the rigidities previously described which limit thegrowth of the private sector as private entrepreneurs are usually last onthe queue for credit. A case can be made to allocate a minimum fixedpercentage of credit for use by the private sector, as a second-bestintervention to handle a market distortion.25/

The encouragement of entrepreneurship is central to maintainingthe momentum of reform. This raises an important issue of the"stewardship of the reform process itself." Who manages reforms? Itrequires tremendous political clout, a sense of policy direction, and theability to implement. Most reform experiences have tended to use supra-ministerial bodies--Councils of Ministers, Coordination Councils orIndependent Reform Commissions-- essentially to circumvent the vestedinterest of line ministries. Many obsolete ministries and governmentbodies need to be abolished entirely. Price Commissions, formerly chargedwith setting and administering prices, are prime examples. Planningministries clearly need to be reformed. Civil Service reform moregenerally is also typically central to the process, as the rolls arebloated with unneeded and poorly trained bureaucrats in many m:inistries.The problem is that all central apparatus' cannot and should not beabandoned; indeed, some new agencies (such as regulatory authorities) needto be created and others (such as welfare ministries) may need to bestrengthened, albeit with a "market-friendly" orientation.

There are strong needs for government action in the process ofreform. Striking among them are requirements for financial auditing andbanking supervision, economic monitoring and planning, and macroeconomic

- 20 -

management. Impediments to the establishment of strong institutions inthese and other areas are (a) lack of qualified personnel, (b) areluctance to see strong central institutions re-emerge, and (c) a poorknowledge base on which to make decisions. For these reasons, initialpolicy impetus may rest with independent units, such as the Council ofMinisters in Viet Nam, which reports directly to the Prime Minister;however, eventually a new implementing apparatus will have to beestablished to JEollow through on reforms. Thus, institution rebuildingis a clear priority.

Decentralization

For both banking and enterprise reform to succeed a priority isto shift both production and credit decisions away from local politicalstructures. The experience of China and Laos has shown that nationalgoals can be sacrificed by local (provincial) People's Committees orGovernors who maintain a strong grip on local enterprises, credit alloca-tion decisions, and tax and tariff collections. In Laos, only 6 percentof customs duties collected nationwide finds its way into nationalcoffers. At the same time, local branches of the State Bank havejeopardized monetary control objectives by exceeding by a wide margincredit ceilings. In China, as Yenal (1989) has pointed out, thedecentralized power of the provinces caused a rupture in macroeconomicmanagement in the late 1980s. In Viet Nam, the leadership of Ho Chi MinhCity attempted to avoid centralized control of its financial marketdevelopment. It therefore sanctioned local credit cooperatives, but alsofailed to regulate them, and ultimately called on the State Bank of VietNam and Ministry of Finance in Hanoi to foot the bill when these creditinstitutions failed. The tension between central and decentralizedadministrations is a key feature of post-central planning environments.Decentralization offers possible efficiency gains, but also reducesmacroeconomic control and a substitutes lower level bureaucraticinterference for central control in economic decision-making.

Decentralization of public decision-making and control is adebatable proposition in the development literature and in public financemore generally (see Bird, 1978), and it usually leads to distributionalproblems with the center and the periphery vying for shares of the centralrevenue pie. This can be complicated if provinces control the amountsthey transfer to the centers. In reforming socialist economies, there isa strong tendency when central control is relinquished to seedecentralized control emerge. At times this can be beneficial, if localadministrations assist the movement to the market and are export-oriented.This is certainly the case with the southern export-oriented provinces ofChina and as noted previously the reality in Viet Nam today, where HCMCis the dynamic, market-driven part of the country. It is less benign ifdecentralization takes the form of an inward-looking strategy, protectingloss-making enterprises, erecting internal protection to the trade ofgoods and services. The latter has also happened in China, where rawmaterials are not made available to neighboring provinces and whereinternal trade taxes are imposed to protect local industry fromcompetition.

- 21 -

It is for this reason that a power vacuum should not be allowedto form at the center, even if it means a slower than desired lpace ofpolicy of devolution from the center. It may take time to convincefederal bureaucrats to alter past policies, but it is shortsighted toemasculate central authority. It is the central authorities who mustagree to policy reform packages with entities such as the IMF and WorldBank, and it is central ministries which are charged with the design andprioritization of public investment programs and their financing. One ofthe ironies of most decentralization experiences is that empowered localadministrations tend to demand more from the center in terms ofinfrastructure and services, but are at the same time less willing totransfer revenue to the center or allow national priorities to overridelocal vested interest.

How this dilemma is resolved is of course a matter forpolicymakers and the political process to sort out, but some lessonsemerge rather strongly. Decentralized credit decisions must be madewithin overall resource envelops. This implies clear monetary oversightfrom the center. As a practical matter it means that managers need to beaccountable to the central administrative structure in areas such ascentral banking and outlays from the national budget. This may requirerctation of personnel and frequent audits. The function performed by the(US) General Accounting Office or the French Inspecteurs des Finance givethe central government the information on which to judge performance oflocal governmental authorities. Fiscal revenues must be allocated in linewith service delivery responsibilities, with a clear preference for thecentralization of revenue collection and explicit revenue sharing ratherthan the "collect and keep principle" favored by strong decentralizedunits. A central auditing function is particularly needed for effectivemonitoring of state enterprises, for example, something totally lackingirn many transition economies at present, including Viet Nam. And mostimportantly, the central authorities must have sufficient instruments andmeans of conducting econojmic management.

A distinction must be drawn, however, between central oversightin microeconomic (as opposed to macroeconomic) areas and control in thoseareas. Decentralization of authority can have significant benefits andcan promote the transition process, if there is a clear consensus betweenthe center and the periphery on the proper course of action. Althoughtransitional socialist economies will need to design their owninstitutional framework, it is often useful to borrow the essence of suchstructures from successful developing countries. In that spirit, theEconomic Planning Board used so successfully in Korea is a possible modelfor countries like Viet Nam, which need a planning, investment, andcoordination apparatus (provided that the staff can be hand-picked andbuilt around those who understand market economics). These institutionalrequirements are necessary for the final stage of reforms and set thefuture course of the relationship between economic agents and the state.

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PART 111. A NEW ROLE FOR THE STATE

All economic systems establish early on what is the role of thestate. The model for most European transition economies is a kind ofregulated market development, with the ultimate aim being socialdemocratic market economies, epitomized by Western Europe. In East Asia,China has followed an iconoclastic course, and Laos and Viet Nam have beenclear to separate economic competition from political reform. Thisdistinction between the demise of Marxist-Leninist dogma in Eastern Europefrom the mere demise of Marx in East Asia reveals itself first in theeconomic sphere in the speed with which ownership changes are pursued.Ownership changes, the establishment of an industrial and regulatorypolicy framework, and the shape of the social safety net are the finalaspects of reform which this essay attempts to treat.

Changes in Ownership

Although a great deal can be accomplished in the initial stagesof reform by realigning prices and removing subsidies, there are veryfundamental differences in economic and financial strategies between thosefirm owned by the state and those owned by individuals. In the end, thequestion must be asked: who represents the interest of state capital?Managers seeking to maximize short-term profits, maintain labor peace, orfollow their own objective function do not necessarily pursue optimallong-term strategies.26/ Managers, or labor and management in cases wherecooperative arrangements exists, tend to pursue biased strategies whenthey ignore capital's contribution to output, and fail to worry aboutdepreciation, returns to capital, and ultimately new levels of investment.Indeed, it is considerably easier to avoid this potential conflict andcede private ownership in an array of economic activities not governed bynatural monopolies. This cannot occur overnight, however, so that one isstill faced with two problems: (a) how to change ownership and (b).howto manage those enterprises remaining for either the short or long-run inthe public domain.

Privatization is a popular notion that has been actively pursuedin Eastern Europe and even in more remote place like Laos. Its benefitsare clear: aligning ownership and management, removing a public sectorheadache from government, facilitating the mobilization of domestic andforeign investment in firms, and promoting competition. If so clearlybeneficial, then why is it not a panacea for all transition economies?The first reason is that these transactions are difficult, especially forlarger enterprises, because of the valuation problem. The state does notwant to give away firms, although in many cases the firm's value isneither transparent nor large. Firms have often already beendecapitalized. In other cases, the firm's debts are so extensive that thestate has to cleanse the balance sheet before selling. Taking thesemeasures into account means in many cases that the real profit fromenterprise sales is small. The second difficulty to wholesale privatiza-tion is the lack of buyers. There are related equity concerns that thosewith special access to funds (either domestic of foreign) will gain unfairadvantage in sales of enterprises. Auction methods are often used to

- 23 -

increase transparency, but in cases like Laos, where the population is ascant 4 million and per capita income is $180, the range of bidders willbe limited. Third, and more relevant for larger enterprises is the issueof unemployment of the labor force. For privatization to succeed the newowner must have control over the labor force, but this puts a largeresidual social burden on the authorities. Privatization can work and isuseful, but takes time and only deals with a part of the enterpriseproblem.27/

Other approaches to the problem of state enterprises are:(i) liquidation, (ii) the establishment of holding companies, or(iii) better public sector management. The former is politicallydifficult, but has been done in some provinces in Viet Nam on a smallscale and in Hungary. Liquidation still involves major issues ofvaluation of existing assets and, more importantly, liabilities. Thereare thorny issues of competing claims on liquidated enterprises, many ofwhich are defunct in a financial sense. Liquidation can take on differentmeanings in different market contexts. In Poland it has come to meanbankruptcy and a change in legal structure to joint shareholdingcompanies. In Viet Nam, the "Liquidation Board" of Ho Chi Minh City(established in 1991) has taken over enterprises (to partly prevent assetstripping) and has sold enterprises to the private sector, interestinglywithout using the proceeds to repay any enterprise debts.

The second alternative, the creation of holding companies, atleast for larger enterprises, as experimented with by Italy decades ago,is designed to remove state enterprises from the control of individualministries and to facilitate baseline financial accounting on a consistentbasis. This approach has been used in Hungary where a State PropertyAgency was created to act as a holding company for state enterprises.While a potentially useful first step towards ultimate privatization, theholding company may take on a life of its own. It may end up as adepository for many insolvent firms, which is then saddled with extensivelegal hurdles to disposing of firms, with the result that sales areinfrequent and ultimately the liabilities of the holding company may needto be transferred to the central government. Of course, in developedcountries, these kinds of workouts and divestitures are handled throughthe banking sector, but governments often finance the bailout orrestructuring in the end.28/

A significantly different approach is state enterprise reformwithout changing ownership. This can be pursued for large enterpriseprovided government is willing to institute strict, objective, andmonitorable management criteria. The best documented system of publicsector management is the Korean Performance Evaluation System, which wasapplied to such industrial giants as POSCO (the Republic of Korea's steelcompany) and KEPCO (the Korean Electric Power Company) .29/ The companieswere managed independently and achieved or surpassed efficiency andmanagement standards of the private sector. This approach, therefore,provides a viable alternative to changes in ownership, although itsapplicability is limited in the early socialist transformation stage dueto the general weakness of institutions.

_ 24 -

As with most other aspects of the post-socialist reform program,one can argue for either rapid change or gradualism. Whereas the issueis relatively clear in the area of price reform, for example, ownershipchange is a more politicized issue where solutions can vary. The need todeal with effective ownership (at least on a long-term lease basis) isclear for agriculture, and the desirability of selling small enterprisesis also clearcut from an efficiency point of view. The speed with whichlarger enterprises should be privatized is partly a political decision,but also partly a function of how reversible are enterprise losses and whothe potential new owners might be. The clear priority for government isto stem enterprise losses, realizing that sunk costs are unrecoverable.This often leads to experimentation. In some contexts, such as Hungaryleasing arrangements have been effective, while in others partialprivatization is potentially viable. Setting up joint stock companies isone such half-way house.30/ The issuance of stock vouchers to the publicis another, but may be mostly symbolic.

Surprisingly for East Asia, the paragon of market-led growth, thestate enterprise sector is not small.31/ Its efficiency varies, but manyfirms are profitable and well managed. One could argue that naturalmonopolies (i.e., electricity, water, and telecommunication) should beginas public sector activities. A weaker but still plausible argument canalso be made for resource industries (i.e., oil, gas, treecrops). Tradingand processing activities should be devolved to the private sector.Manufacturing activities should be largely private and should in no casebe controlled by central line ministries. Some services can be state-owned for the critical reform period, but competition needs to beencouraged by licensing alternative providers of service. In these areas,Viet Nam still has far to go. The slow speed of enterprise reform,particularly in t:he north, can in part be ascribed to the politicaldifficulty of coming to grips with the ownership issue. This has been theexperience of China (see Box).

One difficult area is how to deal with provincially or locallyowned and managed public enterprises. Privatizing in the context oflocally-controlled enterprises may be tantamount to ceding a localmonopoly to the politically powerful. The issue of provincial autonomyhas become a problem in China, and early indications from Laos are thatdecentralization has strengthened considerably the power of provincialpower-brokers. In these circumstances, the practical choices may betemporary continuation of central government ownership over enterprises,hopefully with a change in management and operations, or provincialgovernment reforms. Neither option is appealing. In Poland, for example,trying to make agricultural exports competitive in fields like dairy isbeing hindered not by the production of milk, but rather by theinefficiency of locally controlled dairy processing enterprises; in thesecircumstances, the reform program is being stalled by inefficiencies whichcould be reversed by ownership change.

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Box: The Case of China

A number of accounts relate the somewhat unique case of thePeople's Republic of China (PRC) to reform and liberalization (see I.J. Singh, 1991 for example). China has completed a decade of rapidgrowth, averaging close to 10 percent in real GDP gains. Its pace ofreform has been deliberate and some could say its actions incomplete.The major differences between the PRC approach and that of the EasternEuropean experiments are: (i) the incomplete nature of price reform,where China continues to sanction some price administration, (ii) theabsence in the Chinese case of large-scale privatization schemes, and(iii) the adoption of partial trade liberalization, with aggressiveexport promotion being coupled with imports protection. Much of thedifference in approach can be ascribed to the political structures inplace in China versus Eastern Europe with resulting differences on theissue of private ownership, for example. As important, perhaps, isthe question of size. The options confronting a giant economy likeChina differ from those confronting Hungary, with respect toindustrial strategy. Hungary sees itself as part and parcel of theEEC trading system, whereas China has a huge domestic market to serve.

The common element in all reform experiments has been theearly emphasis on agricultural reforms. The second common element hasbeen the importance of stimulating exports. The third noticeablefeature has been the general inability, or in the case of China,disinclination, to directly privatize public enterprises. Viet Namhas followed the first lesson and has aggressively liberalizedagriculture, with remarkable success, viz., exporting more than 1.5m. tons of rice in 1989 and 1990. It is beginning to promote exportsmore intensively, although not in the most efficient manner as yet,since licensing of trading companies prevents free entry and creditis difficult to obtain. On enterprise reform, the Vietnamese have yetto pick a course, although the Chinese go-slow approach may haveintrinsic appeal. The Vietnamese authorities cannot fail to consider,however, that 40 percent of China's state enterprises are reportedlylosing money and that it took a decade before China declared its firstenterprise bankrupt. The possible advantages of the Polish approachto more aggressive privatization -- at least formation of joint stockcompanies and selection of independent boards of directors -- may beconsidered, and would be more consistent with Viet Nam's commitmentto reforms and its very limited resources.

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Industrial Policy

The issue of the "proper" role of the state in the area ofindustrial policy (IP) is both contentious and complex, and the literatureis replete with views on the topic.32/ The issue for developing countriesis usually couched in the context of how interventionist governmentsshould be, with the examples of Japan, Korea, and Taiwan touted as casesof successful intervention. The stellar performer among newlyindustrialized countries, Korea, has been alternately seen as a paradigmof free market economics or a testament to enlightened but far-reachingdistortionary economics, depending on the observer. Against this back-ground, generalizations are risky. Nevertheless, it is fair to say that(a) neutral industrial policies are hard to find, if for no other reasonthan the fact that IP includes the total incentive package facing industryas result of exchange rate, trade, credit, technology, and labor policies;(b) if a bias is to exist, it should for a developing country(particularly in the early stages of growth) be in favor of exports;(c) general or functional interventions are to be preferred to selectiveor industry-specific interventions; (d) industry-specific interventions,particularly affecting relative factor prices, are risky and can leavelong-term scars on an economy, and (e) as important as is the overallincentive regime, industrial relations between industry and the state arealso crucial for successful industrial development.33/

What then can be said about IP as it affects transformingsocialist economies? The most obvious statement is that having just begunthe process of removing government from the market, it would recidivistto reintroduce it in another guise. Second, one of the major factorswhich made some forms of intervention successful, at least in Korea, wasthe strength of the bureaucracy (and its research affiliates) and therelationship of government to industry associations and ultimatelybusiness itself. These prerequisites are currently lacking in Viet Nam,and most other transition economies. The implementation channels arefragile, business is weak, and institutions are nascent. It is thereforesimply too early to consider whether an activist IP is warranted orpotentially beneficial.

The first priority of a reforming socialist economy is to exportthis goal not only produces scarce foreign exchange, but also orients theeconomy towards a system of market prices at a time when domestic marketsare in their early stages. There is ample time later on for considerationof market complexities a la Krugman, 1987, 1989; Dixit, 1987; and Branderand Spencer, 1984. The first priority of IP is to set the incentivestructure in such a way that it promotes exports--the incentive regimeshould at least. exhibit 'the modest pro-export bias' reported for Koreain the 1960s and early 1970s.34/ International prices will provide themost reliable guide to domestic resource allocation.

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Some would argue that this kind of neo-classical approach, isanachronistic, and that the economic development of Korea proves thatdeliberately "getting the prices wrong" can alter a country's naturalcomparative advantage and foster rapid growth.35/ This approach isprobably wrong in most cases; but it is most certainly the incorrectpolicy prescription for a transition economy. As in most developingeconomies, capital is scarce and often locked-in to the poor allocativechoices of the past. Although the private sector offers better returns(even on a risk-adjusted basis) than the public sector, it usually cannotavail itself of working, let alone investment capital. Under thesecircumstances, it is counterproductive for government to take a positionon the leading sectors of the economy or even worse the leading firms,especially for a country at the low-end of the industrialization spectrum.It is far better for government to use its influence to see capitalchanneled to export activities than to waste its efforts at possiblydamaging IP interventions at the early stages of transformation.36/

To facilitate export growth, the authorities need to maintain arealistic and competitive exchange rate and allow exporters to operatefreely i.e., without licensing restrictions) and rely as much as possibleon duty drawback schemes,37/ or in their absence, on a simply administeredtariff. One danger that has become evident in the Vietnamese case is theattempt by government to promote exports using old instruments and poorly-designed policies. It is reported that Viet Nam's Export Decree 96Promulgated in 1991 provides tax exemptions and indirect export subsidiesto "licensed" trading companies and exporters. This restriction onexporters undermines some of the effectiveness of previous reforms, andwhere added to the shortage of capital substantially limits the prospectsof exporters. In other contexts where the initial stages of reform haveproven successful, and prices are realigned and the banking system isbeginning to be function on a more commercial basis, there is merit inestablishing a new export bank whose major purpose is to intermediateforeign assistance to exporters.

Deeply interwoven in the role of the state discussion is theissue of regulation.38/ Government should be keen to promote competitionvia, inter alia, trade liberalization, anti-trust actions to foster entry,and the breakup of existing monopolies. In the latter regard, Anti-Monopoly Offices (such as that operating in Poland) have a very formidablejob in Eastern Europe. An interesting issue in Eastern Europe is whetherthe transitional socialist economies opt for the U.S. or the continentalapproach to anti-trust. Audretsch (1989) dichotomizes these approaches,whereby in the U.S. monopolistic behavior is in and of itself a publicpolicy 'bad,' whereas in Europe only the abuse of dominant market poweris illegal. As a general proposition, one may argue that transitioneconomies may be better off exposed to a stronger strain ofcompetition.39/

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Moving the state from a directly commanding role in the economyto a regulatory one is the most difficult transition to manage.Essentially, one wants to move from a system where industrial risk wassocialized and moral hazard behavior was rampant to one in whichgovernment intervenes very infrequently, and where risk is borne byentrepreneurs. This is a very difficult transition and it should beviewed as movement along a spectrum rather than an on-off policy. Thereis ample evidence that publicly-owned firms exposed to the market mayengage in expedient, and long-run inefficient behavior. Therefore, it ismore than likely that government agencies will need to actively intervenein the public interest to prod public enterprises towards betterperformance and to help map out restructuring strategies. Theseindustrial restructuring issues share common features with normalrationalization problems described for declining industries in moreadvanced countries, yet the urgency of these actions is obviously greaterin reforming socialist economies and the weakness of institutions makessolutions more difficult to design.

Social Safety Net

One positive aspect of well-intentioned socialist economies hasbeen their preoccupation with the equitable delivery of essential socialservices--health, education, and family planning. Evidence from Viet Nam,for instance, shows a remarkable pattern of social indicators, despite itslow level of development. Using the UNDP's Human Development Index, forexample, Viet Nam is ranked near the median at 56th out of 130 countries,while it ranked close to the bottom (16th poorest country in the world)on the basis of income.40/ Only China and Sri Lanka had similardisparities between social indices and income (see HDR 1990). The basicposition of Viet Nam as of 1988 in a number of areas is reported in Table3, along with comparable data from Korea for 1965. The comparison isinstructive as a measure of Viet Nam's potential, especially since VietNam's state of human capital, as measured by health and educationindicators, is far higher than would normally be expected of a very low-income country.

The major social sector difficulty facing transitional socialisteconomies is that the social sectors will progressively be starved ofbudgetary funds, if, as has been the case in Viet Nam, the fiscal crisiswhich follows the reform program comes to pass. (The problem will beacute even if user fees and stricter means testing become morewidespread.) The risk then is that social development will suffer duringthe reform period. Indeed, as enterprises are given incentives tomaximize profits and seek market-tests for their performance, they willper force be fulfilling less of a social function. Given this trend, thestate will need to redefine its role. Unfortunately, given the budgetconstraints on 'both firms and governments, the outcome is likely to beless coverage of health, pension, and unemployment benefits. The distri-bution of income will probably become more skewed as greater wagedifferentiation occurs, and returns to capital are increasingly capturedby private entrepreneurs.

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Table 3: COMPARISON OF VIET NAM (1989) WITH KOREA (1985)

Viet Nam (1989) Korea (1965)

Population density (per sq km) 194 291Population growth rate (X) 2.10 2.65Crude birth rate (per 1,000) 31 35Crude death rate (per 1,000) 8 11Age dependency ratio (X) 88 87

Life expectancy 81 57Infant mortality (per 1,000) 68 6ePopulation per physician ('000) 2.85 2.70Per capita calorie intake (cal/day) 2,025 2,255Per capita protein intake (g/day) 39 57Primary school enrollment (X) 100 100Secondary school enrolIment (%) 3S 40

GNP per capita (current USS) 109 106GNP per capita (1988 constant USS) 109 394Composition of GDP (%)

Agriculture 40.0 a 38.0Industry 30.0 a 24.7Services 30.0 °L 37.2

Savings/GDP (%) 5.1 7.4Investment/GDP (X) 10.0 15.0

Composition of labor force (%)Agriculture 71.9 58.8Industry 15.7 13.2Services 12.4 28.2

Exports/GDP (X) 10.3 9.5Imports/GDP (X) 19.7 1S.9Trade balance/GDP (X) -9.S -6.4Manufacturing exports/total exports (X) 28.0 82.3Foreign debt/GDP (X) 101.8 22.8/bDebt service/exports 24.0 21.0O

Length of paved road(km per 1,000 vehicles) 71 39

Railway (km per 1,000 population) 0.04 0.17Electricity production per capita (kWh) 108.5 113.2

La Estimated.Lb 1970.

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Efficiency gains provide the most likely means for improvementsin the public provision of social services. It is likely, however, thatthe coverage will be significantly reduced and that greater reliance willbe placed on private provision of many of these services, such as healthand even education. The largest challenges exist on the areas ofunemployment and pensions. While government will continue to shoulderexisting pension liabilities, most of these are deferred liabilities.They can be further extended by increasing the retirement age andpartially funded by providing share ownership in privatized firms topension plans, as has been proposed in Poland. Unemployment coverage isalso a variable liability depending on labor laws and practices. In low-income countries where pension systems are rather underdeveloped, this isobviously less of a burden on public sector coffers.

Whereas changes in the distribution of income are to be expected,one danger to be avoided is large shifts in the distribution of wealth.Certain productive assets, once privatized, can increase rapidly in value,and others (such as housing) can gain value rapidly due to high inflation.While there is no reason to begrudge owners these gains (provided theassets were legally obtained), there is every reason to expect capitalgains to be taxed at a rate commensurate with the lower range of incometaxes, and for wage income and interest income to be treated fairlyconsistently. Transition periods are prime times for new wealth to becreated. Thus, governments must be vigilant to see that market economicsdoes not become synonymous with rampant rent creation, a risk nowparticularly acute in the Soviet Union. Even while regulatory processesare in flux, effective taxation of private gains must be pursued.41/ Thisis an important element in maintaining a social consensus in favor ofreforms.

The Social Compact

The basic premises of post-socialist reform programs are firstthat the economy will perform better under a market regime than it didunder central command, and second that improved performance will translateinto measurable improvements in consumption and living standards. Ofcourse, it is difficult to predict what the precise potential growth pathfor a socialist transition economy is likely to be. As an illustrativeexercise, Leipziger and Manu (1992) attempt to build on the Korea-Viet Namcomparison and recalculate the "norms' exercise, which had previously beenundertaken by Chenery and Syrquin (1975), for a cross-section of countriesusing 1980 as the base year. Using Korea-style growth rates, admittedlyoptimistic, a country like Viet Nam would overshoot the "norms"--essentially indicators associated with average performance at each levelof per capita income--only by the year 2008 for both investment andmanufacturing as proportion of GDP. The point is that even withoutstanding performance, the industrialization of Viet Nam is a long-termgoal to be pursued over the next two decades. (Obviously, much of EasternEurope, starting from a stronger industrial base, will succeed morequickly.)

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The issue that arises is how the authorities can maintain acohesive economic policy for that length of time, essentially deferringrapid consumption gains for the future. That rapid gains are achievablein the new market environment is certainly to be believed. That theachievement of these potential gains will rely on the relationshipsestablished between the economic agents in the economy and the governmentis one of the key lessons of the Asian development experience.42/ Thesocial compact for transition economies is in one sense based on thesimple notion that in the first instance government will be providing theindividual less but allowing him to produce and keep more. However, inthe early stages of reform, government must bear losses of various kinds,the funding of which is highly dependent on foreign assistance. As thereforms take hold, the public must contribute by way of taxes to pay offpublic sector obligations and begin to replace foreign savings withdomestic savings. Again rapid gains depend on a deferral of consumption.

The important prerequisite for this strategy is that all playersin the game must accept the rules and believe in the ultimate outcome.Fortunately, the past experience of socialist economies is so dismal thatthe credibility of reforms does prima facie exist. The dynamic marketsof the world, of which East Asia is a striking example, offer the prospectof rapid growth and relatively rapid industrial transformation. Thechallenge to the reforms is to see that these popular expectations arefEulfilled.

- 32 -

FOOTNOTES

1/ See Bhagwal:i (1974), Chadha (1991) et. al.

2/ For earlier efforts, see work by Gelb and Gray (1990), and the WDR

(1991).

3/ See WeintrEub and Cline (1991), Nelson (1989), and Easterly andSchmidt-Hebbel (1991) on stabilization experience.

4/ See Dollar (1991) and Kharas (1991)

5/ The Chinese situation has been aided and abetted by interprovincialtrade restrictions which serve to create provincial monopolies.

6/ The same cannot be said for some Eastern European economies likePoland, where reforms may have aided the budget situation asdomestic taxes collected on extractive and other export industriessold at depreciated exchange rates helped the budget.

7/ In Viet Nara in 1990, there were at least seven interest rates forborrowers, ranging from 1.5 percent month to 4.5 percent per month,depending on the "priority' of the sector.

8/ A good example of this approach was the creation in the early 1980sof a new class of financial intermediaries in Korea, the non-bankfinancial institutions, which effectively competed with commercialbanks, and forced a realignment of function in the financial sector.

9/ For a review of banking issues in transitional socialist economies,see Sheng (1990).

10/ The initial Foreign Investment Law was passed in 1987 andimplemented in 1988; however, certain features (such as definitionsof joint venrture, legal capital requirements, and guarantees of fairtreatment) needed to be reexamined and thus an additional 1990 FDILaw was recently enacted.

11/ Some would argue, as in the case of Laos, that these overtures tothe private sector were too generous. See Funck (1991).

12/ As noted by Velic (1991), without clear property right legislationor commercial law, the impact of the FDI Law (Dec. 1987),Implementing Decree (Jan. 1988), and the establishment of the StateCommittee for Cooperation and Investment (March 1989) may be limitedin the case of Viet Nam.

13/ See Hinds (1990) on the experience of Eastern Europe.

- 33 -

141 Of course, the severe limitations of socialist national incomeaccounting concepts (Net Material Product Systems) and the greatdifficulty in measuring newly-emerging private sector activity posechallenge to those attempting to monitor economic activity.

15/ See Kharas (1991) on Poland.

16/ Indeed it is the rare country that actively monitors the rural-urbanincome differentials, although Korea was known to do in the 1960sand 1970s. See Leipziger and Petri (1989).

17/ It can be argued that the creation of new wealth has long-lastingeffects on the distribution of ownership and wealth in a society, asfor example, the creation of the jaebols in Korea. See Leipzigeret. al. (1992).

L81 One of the greatest challenges facing policymakers in socialisttransition economies is to generate sufficient taxes to keep macro-economic stability without stifling the incipient private sector.This requires a well-designed tax system and the cooperation oflocal administrators, who are the only ones who can monitor thegrowth of new economic activity. Fortunately, coming from a usuallystern central command economy, entrepreneurs are unlikely to want torisk losing the right of free-market activity, so that Ministries ofFinance should not let tax evasion take hold as it has in manydeveloping countries.

19/ See Funck (1991) on Laos and Dollar (1991) on Viet Nam.

201 Viet Nam's outstanding debt to the Soviet Union is reportedly 10billion rubles, equivalent to $7 billion (at the transferable rubleexchange rate of TR 1.5 = $1.00) or 70 percent of 1989 GNP.

21/ Assuming inputs are not artificially subsidized.

221 See Wade (1990).

:23/ I am reminded in this instance of an admonition from a now retiredDirector of the Western Hemisphere Department of the IMF who saidthe optimal length of any country's adjustment program was one year.

24/ See Leipziger (1988), Cho (1988) and Nam (1991).

25/ This form of intervention is unquestionably controversial as havebeen all credit reservation schemes, especially those favoringagriculture. They are not preferable to fixing the initial capitalmarket distortions in the banking sector which discriminate againstcertain borrowers, but may prove to be expedient.

26/ The same of course can be said of capitalist managers who are agentsrather than principals and who through actions like mergers andacquisitions (aimed at maximizing size) have often damaged firms atthe expense of their owners.

- 34 -

271 See Hinds (1990).

281 See Reich (1985).

29/ See Kim (1986), Song (1988), and Shirley (1989).

30/ A case can be made for banks to obtain shares in enterprises in lieuof unpaid debts, and provided bank management can be made moreautonomous, it has possibilities for providing ownership incentives(i.e., representing the interest of capital) on enterprise boards.

31/ See Shirley and Nellis. (1991).

32/ See, forc example, Wade (1990), Leipziger (1988), Caves (1985),Krugman (1989), and WDR (1991) for a sampling.

331 See Wade (1990), Zysman and Tyson (1983), and Leipziger and Petri(1988).

34/ See Westphal (1978).

35/ See, for example, Amsden (1989).

36/ Of course there are exceptions, such as in negotiating tradeconcessions or accessing restricted (e.g. EEC) market, wheregovernment intervention is required.

37/ Fully operational duty drawback schemes, while desirable, requiredetailed production information and a strong system ofimplementation. See Y. Rhee (1984).

38/ For a fuller discussion of the former, see Wade (1990), while thelatter iS covered in part by Audretsch (1989).

39/ Kharas (1991) argues in the case of Eastern Europe that an excessivefocus on competition will reduce the attractiveness of domesticfirms to foreign investors.

40/ The Human Development Index, like its Physical Quality of Life(PQLI) precursor pioneered at the Overseas Development Council is acomposite of a number of indicators, in this case indices of lifeexpectancy, literacy, and purchasing power-adjusted GDP per capita.

41/ Since corruption is a major feature of any planned system due tounmet demand, care must be taken to avoid a continuation of thesepractices in the market milieu. The two instruments needed arestrong competitive pressures and transparent, enforceable regulatorypowers.

42/ See Wade (1990).

- 35 -

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24 New Indutial RoadSingapoe 1953

Recent World Bank Discussion Papers (continued)

No. 127 Using Indigenous Knowledge in Agricultural Development. D. Michael Warren

No. 128 Research on Imrgation and Drainage Technologies: Fifteen Years of World Bank Experience. Raed Safadi andHerve Plusquellec

No. 129 Rent Control in Developing Countries. Stephen Malpezzi and Gwendolyn Ball

No. 130 Pattems of Direct Foreign Investment in China. Zafar Shah Khan

No. 131 A New View of Economic Growth: Four Lectures. Maurice FG. Scott

N o. 132 Adjusting Educational Policies: Conserving Resources While Raising School Quality. Bruce Fuller and Aklilu Habte,editors

N o. 133 Letting Girls Learn: Promising Approaches in Pnrmary and Secondary Education. Barbara Herz, K. Subbarao,Masooma Habib, and Laura Raney

No. 134 Forest Economics and Policy Analysis: An Overview. William F. Hyde and David H. Newman, with a contributionby Roger A. Sedjo

No. 135 A Strategyfor Fisheries Development. Eduardo Loayza, in collaboration with Lucian M. Sprague

No. 136 Strengthening Public Service Accountability: A Conceptual Framework. Samuel Paul

No. 137 Deferred Cost Recoveryfor Higher Education: Student Loan Programs in Developing Countries. Douglas Albrechtand Adrian Ziderman

No. 138 Coal Pricing in China: Issues and Reform Strategy. Yves Albouy

No. 139 Portfolio Performance of Selected Social Security Institutes in Latin America. Carmelo Mesa-Lago

No. 140 Social Security and Prospectsfor Equity in Latin America. Carmelo Mesa-Lago

Nro. 141 China's Foreign Trade and Comparative Advantage: Prospects, Problems, and Policy Implications. AlexanderJ. Yeats

Nro. 142 Restructuring Socialist Industry: Poland's Experience in 1990. Homi J. Kharas

No. 143 China: Industrial Policiesfor an Economy in Transition. Inderjit Singh

No. 144 Reforming Prices: The Experience of China, Hungary, and Poland. Anand Rajaram

No. 145 Developing Mongolia. Shahid Yusuf and Shahidjaved Burki

No. 146 Sino-Japanese Economic Relationships: Trade, Direct Investment, and Future Strategy. Shuichi Ono

No. 147 The Effects of Economic Policies on African Agriculture: From Past Harm to Future Hope. William K. Jaeger

No. 148 The Sectoral Foundations of China's Development. Shahidjaved Burki and Shahid Yusuf, editors

No. 149 The Consulting Profession in Developing Countries: A Strategyfor Development. Syed S. Kirmaniand Warren C. Baum

No. 150 Successful Rural Finance Institutions. Jacob Yaron

No. 151 Transport Development in Southem China. Clell G. Harral, editor, and Peter Cook and Edward Holland,principal contributors

No. 152 The Urban Environment and Population Relocation. Michael M. Cernea

No. 153 Funding Mechanismsfor Higher Education: Financingfor Stability, Efficiency, and Responsiveness. Douglas Albrechtand Adrian Ziderman

No. 154 Eamings, Occupational Choice, and Mobility in Segmented Labor Markets of India. Shahidur R. Khandker

No. 155 Managing Extemal Debt in Developing Countries: Proceedings of aJoint Seminar,Jeddah, May 1990. Thomas M.Klein, editor

No. 156 Developing Agricultural Extensionfor Women Farmers. Katrine A. Saito and Daphne Spurling

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