Private sector and poverty reduction

The Private Sector and Poverty ReductionScholarship, policy advising, and programming concerningprivate sector development in transition economies oftenreflects the view that ‘If the horse gets enough oats, some willeventually pass through to the sparrows’. Ensuring that privateentrepreneurship directly contributes to pro-poor economicgrowth has too rarely been at the centre of attention. This isregrettable, since–despite the many successes of privatizationin the former Soviet Union, the new EU member states, and theWestern Balkans–many questions about the linkages betweenprivate sector development and poverty reduction in theseregions remain unresolved. In most of these countries, thenumbers of operating private companies relative to the popu-lation remain quite small compared to OECD levels. Privatesectors in much of the Western Balkans and the former SovietUnion are dominated by microenterprises, most of whichoperate on a subsistence basis in the informal sector. Strongmiddle-sized companies, or larger enterprises that have adopt-ed good practices of corporate governance and corporatesocial responsibility, are few and far between.

These questions are particularly important for developmentagencies, for whom strengthening the pro-poor character ofeconomic growth by helping market mechanisms to betterserve the needs of the poor, are increasingly a priority. Thisissue of Development and Transition examines the currentstate of the region’s private sector, and how developmentagencies can strengthen its pro-poor characteristics, in fivebroad areas: (1) microfinance; (2) countercyclical financialinstruments; (3) corporate social responsibility (CSR); (4) infor-mality; and (5) the evolving relationships between the private,state, and non-governmental sectors.

The issue begins with a debate between Milford Bateman andGrzegorz Galusek on the effectiveness of post-communist

microfinance. This ‘point/counterpoint’ discussion is followedby Tom Thorogood’s case study analysing guarantee funds inSerbia–a study that shows some strengths and weaknesses ofmicrofinance in practice. These articles are followed by JuliaKorosteleva’s macrofinancial analysis of GDP-indexed bonds,which suggests that greater private trading of these instru-ments could reduce the threat of currency crises that can beparticularly hard on the poor in emerging markets.

Some observers have suggested that the travails of transitionare leading to a reassertion of state ownership and control inRussia and some other CIS countries. However, David Woodruffexplains how in the Russian economy this trend is driven in largepart by the commercial ambitions of parastatal companies,rather than by policies of re-nationalization. Alena Ledeneva’sand Eugene Nivorozhkin’s survey of ‘informal’ business practicesin Russia, and Vyacheslav Toporov’s analysis of ‘one-stop shops’in Ukraine, show how heavy-handed state regulation, and asso-ciated rent-seeking opportunities, continue to burden privatesector development. Geoffrey Prewitt’s analysis of social enter-prises in the region strikes a similar note, emphasising the barri-ers to social entrepreneurship posed by ill-advised regulatoryframeworks. However, Jessica Allina-Pisano’s study of postcom-munist land privatization suggests that prospects for povertyreduction in rural areas are only loosely connected to landreform policies. The issue concludes with Peter Serenyi wonder-ing whether CSR in the region will be able to move beyond itscurrently marginal role.

This issue suggests that ‘blanket’ reforms such as generic SMEsupport, commercially oriented microfinance, and the liberal-ization of business environments, are too often pursued with-out paying proper attention to local and global conditionsand post-communist legacies. But it also suggests that thereare many areas in which, by giving the market a push, devel-opment actors can strengthen the private sector’s ability toreduce poverty.

James Hughes and Ben Slay

JULY 2007

Published by the United Nations Development Programme and the London School of Economics and Political Science

www.developmentandtransition.net

A l b a n i a A r m e n i a A z e r b a i j a n B e l a r u s B o s n i a a n d H e r z e g o v i n a B u l g a r i a C r o a t i a C y p r u s C z e c h R e p u b l i c F Y R M a c e d o n i a G e o r g i a H u n g a r y K a z a k h s t a n K o s o v o ( S e r b i a ) K y r g y z s t a nL a t v i a L i t h u a n i a M a l t a M o l d o v a M o n t e n e g r o P o l a n d R o m a n i a R u s s i a n F e d e r a t i o n S e r b i a S l o v a k i a S l o v e n i a T a j i k i s t a n T u r k e y T u r k m e n i s t a n U k r a i n e U z b e k i s t a n

7DEVELOPMENTTRANSITION&

Undermining Sustainable Developmentwith Commercial Microfinance in Southeast Europe Milford Bateman 2

‘Commercial’ Microfinance: Too Much, or Not Enough? Grzegorz Galusek 4

Guarantee Funds and Job Creation in Serbia Tom Thorogood 7

Countercyclical Financial Instruments:Prospects for Transition Economies Julia Korosteleva 9

The Expansion of State Ownership in Russia: Cause for Concern? David M. Woodruff 11

Informal Practices in the Russian Private Sector Alena Ledeneva and Eugene Nivorozhkin 13

‘One-Stop-Shop‘ Reforms in Ukraine: Do They Work? Vyacheslav Toporov 14

Towards a ‘Fourth Sector’? Social Enterprisesas a New Hybrid for Employment Generation Geoffrey D. Prewitt 17

Approaches to Agricultural Privatization inCentral and Eastern Europe and the CIS Jessica Allina-Pisano 19

Corporate Social Responsibility and Post-Communist Business: From State Paternalism to Enlightened Self-Interest? Peter Serenyi 22

Undermining SustainableDevelopment withCommercial Microfinance in Southeast Europe

Milford Bateman

The October 2006 award of the Nobel Peace Prize joint-ly to Bangladesh’s Grameen Bank and to Dr. MohammadYunus, Grameen’s founder, is the latest turn in a decadeof media hype surrounding microfinance. As is wellknown, the Grameen Bank model was discovered by theinternational community in the 1980s, and thereaftergradually deployed within developing countries toaddress issues of poverty and under-development. Theascendance of the neoliberal project from the early1990s onwards then led to crucial commercializingmodifications of the basic Grameen Bank approach,resulting in the now dominant ‘new wave’ commercialmicrofinance model, led by microfinance institutionsdesigned to operate as independent, commercially ori-ented, financially self-sustaining entities. These ‘newwave’ commercial microfinance institutions, it is said,avoid the need for constant international and govern-ment financial support while still extending microcred-its to many poor individuals and communities.

The commercial microfinance mirageThe ‘new wave’ commercial microfinance model arrivedin Southeast Europe in the early 1990s, and is todaywidely seen as one of the most successful donor inter-ventions in the region. Indeed, such is the presumedpositive impact of Bosnia and Herzegovina’s new micro-

finance sector that the country is now often described asthe ‘best practice’ example that all developing and tran-sition states should carefully follow, particularly otherpost-conflict countries.

However, many of the alleged developmental benefitsof the commercial microfinance model in SoutheastEurope, and by extension in many other countries, are amirage. Very little solid evidence has emerged to con-firm that commercial microfinance has facilitated sus-tainable economic and social development–as opposedto some largely temporary impacts involving a luckyfew, well-publicized microenterprises. In fact, far moreevidence is emerging to suggest that commercial micro-finance may well have undermined, if not largelydestroyed, prospects for sustainable socio-economicdevelopment trajectories in the region.

The informal sector serves as the final destination ofalmost all microenterprises supported by microfinance.It is fundamentally wrong to assume that the informalsector has unlimited abilities to elastically expand andabsorb all new microenterprises. New informal microen-terprises do not raise the total volume of business somuch as redistribute or subdivide it between new andexisting microenterprises. Globalization-driven condi-tions of an unlimited labour supply and dramaticallyreduced formal sector (especially public sector) employ-ment opportunities have combined to ‘saturate’economies with informal-sector microenterprisesalmost everywhere. As the UN’s 2003 ‘Challenge of theSlums’ report emphasized,1 this ‘saturation’ trend hasproduced recognizable declines in incomes and wagesin many developing countries, trapped within increas-ingly dominant urban slums. There is very little evidenceto support Hernando de Soto’s idea that an ever-expanding informal sector can serve as the decisive

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DEVELOPMENT &TRANSITION

The Microfinance Debate: An Opening ThoughtIn 2006 Muhammad Yunus and the financial institution he founded, Grameen Bank, won the Nobel Peace Prizefor their pioneering work in extending microcredits to the poor. In his acceptance speech, Dr. Yunus made thefollowing observation, which serves as a fitting way to open our point/counterpoint on microfinance:

"Poverty is created because we built our theoretical framework on assumptions which under-estimate humancapacity, by designing concepts, which are too narrow (such as the concept of business, credit-worthiness, entre-preneurship, employment) or developing institutions, which remain half-done (such as financial institutions,where the poor are left out). Poverty is caused by the failure at the conceptual level, rather than any lack of capa-bility on the part of people".

Muhammad Yunus, Oslo, 10 December 2006.

‘agency’ factor to precipitate an eventual sustainablegrowth and development trajectory.

This ‘saturation’ phenomenon is increasingly becomingthe norm in Southeast Europe. Many sectors areincreasingly under pressure from an influx of newentrants, all desperate to survive in conditions of flatdemand. Obvious examples include the retail sector,cross-border trade, simple services, cafes and localtransport (e.g., taxis). One reflection of ‘saturation’ is thehigh rate of microenterprise exit emerging almosteverywhere in the region. For example, the WorldBank’s 2005 evaluation of its Local Initiatives Project(LIP) microfinance programme in Bosnia and Herzegov-ina found that 30 percent of the microenterprises sur-veyed in 2002 had failed after just two years.2 Usingpanel household survey data for 2001-2004, WorldBank researchers estimated that around half of the indi-viduals in Bosnia and Herzegovina starting a newmicroenterprise in 2002 and 2003 closed their newbusiness within one year of its establishment.3

Commercial microfinance institutions in SoutheastEurope have been more than willing to supportmicroenterprises operating well below minimum effi-cient scale, and thus with little realistic chance of long-run survival. In a desperate attempt to survive, most ofthese microenterprises are forced into hyper self-exploitation – accepting ultra-low earnings, long hours,and so on – while others, as noted above, simply col-lapse. Many microfinance institutions are more thanwilling to do this because ultimately unsustainable

microenterprises are nevertheless very often able torepay their microcredit in the time allowed. Thesemicrofinance institutions are more interested in theirown survival even if this is achieved through construct-ing local microenterprise structures with very little realfuture – a ‘house of cards’. Examples of this trend can befound in Croatia, where many patently unsustainable‘micro-farms’ were established in the dairy sector thanksto microfinance support–many of which were only ableto survive thanks to the Croatian government’s subsi-dies available for ‘three-cow-and-above’ farms.

Commercial microfinance has also ‘crowded out’ poten-tially sustainable microenterprises wanting to deployrelatively advanced technologies, skills, and productand process innovations. Southeast European countriesin the early 1990s had significant endowments of tech-nologies, skills and industrial expertise, which couldhave provided obvious ‘entry points’ for technology-intensive micro- and small enterprises. Many potentialmicro-entrepreneurs came forward from the mostadvanced sectors and companies with ideas for estab-lishing sustainable microenterprises. However, many ofthese potential micro-entrepreneurs simply could notdeal with the standard commercial microfinance busi-ness model–high interest rates and short repaymentperiods–and most quickly abandoned their ideas.Potential entrepreneurs were instead forced to establishsimpler businesses, such as in retail trade. The ‘deindus-trialization’ that characterized economic developmentin the region was therefore consolidated with the helpof commercial microfinance. This represents a hugeopportunity cost for a region that once boasted a highdegree of technological sophistication.

Microfinance and local development need not gotogetherInter-enterprise connections are now understood to bea crucial determinant of a local economy’s ultimate sus-tainability and progress. When many enterprises areengaged in activities that make use of technology, inno-vation, skills, coordination and planning, managerialcompetences and so on, a local economy can graduallyadvance and prosper in a sustainable manner. But suchbeneficial grass-roots dynamics cannot arise if the localeconomy is dominated by microenterprises with littleneed, ability, or wish to cooperate. While commercialmicrofinance in Southeast Europe has clearly producedsignificant numbers of new microenterprises, the over-whelming majority of these companies is unable toforge the efficiency-enhancing horizontal (‘proto-indus-trial districts’) and vertical (sub-contracting) connectionsthat are crucial to establishing a sustainable develop-ment trajectory.

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A patently unsustainable micro-farm?

Many of the early microenterprises in Southeast Europewere always going to prefer to enter into simple shuttletrading operations if they could, as these sectors are themainstay of microfinance operations across the world.However, the subsequent entry of many microenterpris-es into such operations helped generate the surge inimports (many EU-subsidized) that arrived in SoutheastEurope after 1990, and in Bosnia and Herzegovina afterpeace was concluded in late 1995. In Kosovo after 1999,the main microfinance institution – ProCredit Bank –was very heavily engaged in supporting trade-basedmicroenterprises, quickly becoming the most profitablemicrofinance bank in Europe.4 However, by first monop-olizing and then channelling both international donorfunds and local savings overwhelmingly back into sim-ple trade-based microenterprises, commercial microfi-nance created a most unsuitable foundation for sustain-able development and growth.

Finally, the rapid rise of commercial microfinance hascontributed to the steep declines in social capital levelsexperienced since 1990. Recasting individual survival as afunction of individual entrepreneurial success can under-mine the bonds of solidarity, shared experience, and trustthat often exist within poor communities. This is a truism.Recasting community development and support activi-ties as commercial operations – a central operating prin-ciple of commercial microfinance – can also dissolve localsolidarity, interpersonal communication, volunteerism,trust-based interactions, and goodwill. Operating in theinformal sector is itself associated with a diminution ofsocial capital, not least since most informal microenter-prises do not need to develop the trust-based linkageswith government and other enterprises that typicallyunderpin legitimate business operations and ethics.

Commercial microfinance: An ‘anti-developmentintervention’?It has yet to be shown that commercial microfinance isassociated with sustainable economic and social

development, or sustainable poverty reduction, inSoutheast Europe. Microfinance has instead under-mined most local economic and social developmenttriggers, such as cumulative and coordinated invest-ments, capturing economics of scale and scope, tech-nological innovation, inculcating social capital, orincorporating technical skills and knowledge. Com-mercial microfinance therefore amounts to what theformer World Bank economist David Ellerman hascalled an ‘anti-development intervention’ – an inter-vention that, like bad medicine, produces some mod-est short-run pain relief (quick poverty reduction for alucky few), but in the longer run undermines prospectsfor a sustainable recovery and eventually leads to‘death’ (to the chances of sustainable economic andsocial development). In light of this, current efforts bythe US-based MicroCredit Summit, growing numbersof commercial banks, and some high-profile charitablefoundations, to effectively ‘flood’ developing and tran-sition countries with microfinance can only be lookedupon with real concern.

Milford Bateman is an independent consultant andVisiting Professor of Economics at the University ofPula, Croatia. He has been a regular consultant toUNDP on poverty reduction and local economic devel-opment issues in Southeast Europe and elsewhere. DrBateman’s most recent published output on microfi-nance can be found in the edited book by ThomasDichter and Malcolm Harper entitled What’s Wrongwith Microfinance?, to be published in July 2007 byPractical Action Publishers.

1 UN Human Settlements Programme (2003). The Challenge of the Slums. London andSterling, VA: UN-Habitat and Earthscan.

2 Dunn, E. (2005) Impact of Microcredit on Clients in Bosnia and Herzegovina. WashingtonDC: Impact LLC.

3 Kunt, A. D, Leora Klapper and Georgios A. Panos (2007). The Origins of Self-Employment,Development Research Group. Washington DC: World Bank.

4 See The Economist, 14 September 2002.

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‘Commercial’Microfinance: TooMuch, or Not Enough?

Grzegorz Galusek

During the 1990s, large numbers of microfinance insti-tutions (MFIs) were set up across Eastern Europe, witha mandate to foster microenterprise development and

address rapidly spreading poverty. These MFIs had bythe end of 2005 served over 4 million active clients,predominantly low-income families and microenter-prises that would not otherwise have had access tofinancial services. By now, most of these MFIs can beconsidered a success, for they have moved fromreliance on donor funding towards sustainability,serving low-income clients and gradually integratingwith the formal financial sector. As the data in Chart 1below show, MFIs have grown particularly rapidlysince 2000.

Chart 1: Numbers of sustainable1 NGO MFIs inEastern Europe and the CIS

Source: Annual Mapping Study Survey of the MicrofinanceCentre for Central and Eastern Europe and the Newly Inde-pendent States. Microfinance Centre, Warsaw.

Microfinance in Eastern Europe and the CISWhile transition has brought opportunities to manybusiness-savvy people, for others it has meant a seriousdecline in living standards. In the 1990s, poverty levelsincreased dramatically in most of the region. Unem-ployment, resulting from enterprise restructuring andweak economic growth, was a key driver of risingpoverty rates. Many of the ‘new poor’ had enjoyedsecure jobs before the transition; they possessedimportant educational and skill levels, but had inade-quate business skills. Self-employment or work in fami-ly or individually owned businesses became importantsurvival strategies for those facing lay-offs from ineffi-cient state factories, restructuring, or budget cuts.

In developed market economies, sound, deep financialsectors are a precondition for private sector develop-ment. But in the transition realities of the 1990s, finan-cial sector instability and restructuring often precludedfinancing small- and medium-sized enterprise (SME)growth, while financing for microenterprises hardlyexisted at all. In addition to serving as a poverty reduc-tion tool, microfinance emerged to fill these gaps in thedemand for financial services.

How is microfinance organized in Eastern Europeand the CIS?The organizational characteristics of microfinance inEastern Europe and the CIS are quite diverse, embody-ing four different models:

• Greenfield microfinance banks. These were set up inthe late 1990s as a way of leapfrogging traditional MFI

development models, which emphasize building insti-tutional capacity in a non-bank, credit-only MFI andthen transforming it into a more complex legal struc-ture (often a bank). Such transformations are oftennecessary to access non-subsidized financing to sup-port the MFI’s growth, or to diversify its product offer-ing. As full-service banks (with banking licenses), theycan offer a wide range of financial products. So far, 17such banks are operating in Eastern Europe and theCIS, predominantly in the Balkans. These banks areenjoying rapid growth in their loan portfolios andclient bases. As the data in Table 1 below show, theaverage microfinance bank at the end of 2005 wasservicing more than 36,000 clients.

• Down-scaling banks. In this model, donors or gov-ernments offer mainstream commercial banks creditlines and technical assistance to provide financialservices to microenterprises. This model was devel-oped in Latin America by the Inter-American Devel-opment Bank and later adapted by the EBRD to theEastern Europe and CIS region, particularly in Russiaand Central Asia. But while this assistance hasstrengthened the banking system, providing greatertransparency and improved lending practices, thebanks have not yet reached large numbers of low-income clients.

• Credit unions are the most common MFI in EasternEurope and the CIS, growing rapidly since the early1990s. In most countries they offer credit and savingsservices (predominantly for consumption purposes) totheir members; as the data in Table 1 below show, theaverage loan size is around $1,700. But while countriessuch as Poland, Ukraine, and Romania have developedrobust financial cooperative sectors, in Central Asiathese institutions tend to be much weaker.

• NGO MFIs have been important providers of microfi-nance since the early 1990s. The NGO label may besomewhat misleading: most of these MFIs function asspecialized, sustainable financial intermediaries bal-ancing social and commercial goals. Many haveevolved from NGOs into more advanced commercialforms, to allow for faster growth. Most of these MFIsprovide credit to low-income micro-entrepreneurs;target groups include women, Roma communities,and rural households. This model is a particularlyimportant source of finance for micro-entrepreneurs:as the data in Table 1 show, the average NGO MFI loanin the region is around $1,100.

Most NGO MFIs offer financial services on marketprinciples to the target group determined by their

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mission, balancing commercial and social goals. Insome cases they offer (or link with providers of) busi-ness development services,2 in order to stimulatebusiness growth through building microenterprisecapacity for better marketing, information technolo-gy, and management. However, many MFIs workaccording to purely commercial principles irrespec-tive of their legal status or original mandate; socialand developmental outcomes are taken for granted.This often results from the market pressures to scaleup or transform.

The donor community may be partly to blame forencouraging (in the past) MFI business models thatfocus solely on financial performance. However, inrecent years there have been many calls for a strongerfocus on the ‘double bottom line’–providing informa-tion on social impact as well as financial performance.Many developmental organizations have sought tominimize the risk of mission drift. Social performancemanagement has for example become one of the pri-ority areas for the Microfinance Center (MFC) in War-saw: the MFC’s quality audit tool and strategic man-agement toolkit provide a menu of practical methodsthat can help translate MFIs’ social goals into their dailyoperations.

No single MFI institution can be regarded as universallysuperior. National legal and regulatory environmentsshould therefore be flexible enough to accommodate avariety of different institutional arrangements, in orderto ensure that different vulnerable groups are offeredthe financial services that most closely correspond totheir needs. This is not always recognized by policy mak-ers in some East European and CIS countries, where theprovision of microfinance services through some ofthese MFIs is illegal.

Significant market gaps are still presentWhile access to SME finance (including for high-endmicroenterprises) has been improving, financial servicesfor low-income households remain an urgent develop-ment issue. According to demand studies conducted bythe MFC, only 1 percent of low-income households havea bank account in Georgia, 16 percent in Azerbaijan, 17percent in Ukraine, 22 percent in Romania, and 67 per-cent in Poland.3 In many East European and CIS coun-tries, most low-income people have limited or no oppor-tunities to protect themselves against financial risks orbenefit from the formal financial sector.

The potential demand for microfinance services couldbe quite dramatic, however. A micro-credit demandstudy conducted in 2006 in Poland for the EuropeanInvestment Fund showed that there were 2 million actu-al (14 percent) and potential (86 percent) low-incomeclients who would benefit from micro-loans in Polandalone. Only a tiny fraction of the existing microenter-

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Table 1: MFI lending in Eastern Europe and the CIS

Data as of 31 December 2005. Source: 2005 State of the Microfinance Industry in Eastern Europe and Central Asia,Pytkowska J., Microfinance Centre for Central and Eastern Europe and the Newly Independent States (MFC), 2006.

Numbers Numbers of MFIs: Borrowers Overall MFI Average MFI loan:of MFIs: Lenders Borrowers per MFI loan portfolio portfolio size

Credit unions 5,499 2,684,800 488 $4,571,774,743 $831,383 $1,703

Microfinance banks 17 619,948 36,468 $2,038,139,329 $119,890,549 $3,288

Downscaling banks 47 187,064 3,980 $980,827,165 $20,868,663 $5,243

NGOs 164 650,915 3,969 $707,462,935 $4,313,798 $1,087

Regional totals 5,727 4,142,727 723 $8,298,204,172 $1,448,962 $2,003

A $2,000 loan helped this shopkeeper expand her business in Bulgaria

Photo courtesy of the Microfinance Centre

Guarantee Funds andJob Creation in Serbia

Tom Thorogood

Despite high GDP growth, which has averaged 6.5 per-cent annually since 2003, unemployment rates continueto be alarmingly high in Serbia: the national averageremains over 20 percent, and some regional rates aremuch higher. Unemployment rates could increase fur-ther in the near future as the remaining socially ownedcompanies are privatized or go into liquidation proceed-

ings. Support for the creation and expansion of small-and medium-sized enterprises (SMEs) is widely recog-nized as one of the most effective forms of job creation.This article explains how guarantee funds can helpaddress the liquidity constraints that often hamper SMEdevelopment, via the example of a UNDP guaranteefund introduced as a pilot project in South Serbia.

The South Serbia Guarantee FundThe high costs of, and inadequate access to, financeare frequently listed as important constraints on SMEdevelopment–particularly in less-developed regionssuch as South Serbia. In mid-2004, as part of its support

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prise market is currently served by formal financial insti-tutions. The situation is probably even more dramatic inthe region’s poorer countries. The study highlightedinadequate financial products for low-income house-holds, low financial literacy of potential clients, and theirmistrust of formal financial institutions, as key barriers totransforming potential into effective demand for micro-finance services.

ConclusionsWhile the data point to rapid growth of microfinance inEastern Europe and the CIS, they also demonstrate thefailure of MFIs in this region to reach low-income groupson a large scale. This underscores the importance of non-financial services (including basic financial education) inhelping the poor to absorb and manage family andmicroenterprise finance, to properly use financial servic-

es, and to develop business skills. These market gaps cre-ate opportunities for designing microfinance strategiesand products to respond to these unmet needs. Thismeans combining existing microfinance knowledge andexperience with new technologies and private capital tocreate the new business models needed to reach morepoor people. It also requires policies to level the playingfield for different institutional models, and strengthenincentives for private sector investment in microfinance.

Grzegorz Galusek is Executive Director of the Microfi-nance Centre, Warsaw, Poland.

1 ‘Sustainable’ refers to MFIs whose operating incomes equal or exceed their operatingexpenses.

2 Examples include such MFIs as Zene za Zene in Bosnia and Herzegovina, Microinvest inMoldova, Kamurj in Armenia, and Stedonica Opportunity Bank in Serbia.

3 Matul M., M. Rataj (2006). Microcredit Market Development in Poland. Warsaw: TheMicrofinance Centre.

Source: 2005 State of the Microfinance Industry in Eastern Europe and Central Asia, Pytkowska J. Microfinance Centrefor Central and Eastern Europe and the Newly Independent States (MFC), 2006.

Figure 3: Cumulative growth in active borrowers by institutional type

Figure 4: Total number of active borrowersby institutional type and sub-region

for economic development in this region,1 UNDP’sSouth Serbia Municipal Improvement and RecoveryProgramme established a guarantee fund. While cred-its of up to €5,000 had been available for small busi-nesses and in excess of €100,000 were available forlarge companies, many SMEs struggled to obtain loansin the €10,000 – €50,000 range, due to the absence ofloan collateral. Not only do banks in Serbia oftenrequest 200 percent collateral for a loan of this size, butmost property and land holdings–particularly thoseoutside Belgrade–are not registered in the land cadas-tre, so that title of ownership cannot be used as a guar-antee. Even when property is accepted as collateral,banks often put a low value on it.

The guarantee fund has sought to fill this gap by provid-ing guarantees to creditworthy SMEs in South Serbiathrough a public sector institution established for thispurpose. The fund itself was established by the region’slargest municipality, Leskovac, which has provided$20,000 annually to cover the fund’s running costs andanother $40,000 to guarantee loans for activities in itsjurisdiction. Most of the guarantee fund’s lending capi-tal (some $240,000) has been provided by the Norwe-gian Government via UNDP.

SMEs that have been offered loans can apply to theguarantee fund for up to 50 percent of the collateralneeded. Loan guarantees are serviced via contracts withthree of Serbia’s largest banks: Komercijalna Banka, YUBanka, and Agrobanka. The value of the guarantee,which is initially deposited in the bank, is graduallyreturned to the fund as the loan is repaid, thus givingthe fund a ‘revolving’ character. SMEs supported by thefund must be assessed as creditworthy both by the bankand the guarantee fund.

Some 27 loans, worth some $555,000 and creating 114jobs, have to date been supported by guarantees fromthe fund worth some $278,000. The types of businessessupported include small-scale wood processors, bak-eries, sweets producers, meat processors, dairies, andvarious service-sector enterprises. Credits for activitiesor businesses involved in trading, alcohol, or gamblingare not supported by the fund, and start-up loans areavoided. As the associated risk levels fell, the banksengaged in this programme reduced their interest ratesto 8.5-9 percent – well below the 12-16 percent ratesSerbian banks typically charge for SME loans.

Lessons LearnedThe results of an independent evaluation of the guaran-tee fund conducted in October 2006 pointed to a num-

ber of conclusions. On the positive side, the fund hasimproved SME access to credit and increased employ-ment by supporting private banks in their core businessareas. Not surprisingly, the demand for loan guaranteeshas far exceeded the supply: fund data indicate thatonly 27 guarantees were provided out of a total of 500applicants during 2004-2006. While prospects for thetake-up of these guarantees were initially constrainedby the conservative lending posture of Serbia’s banks,these attitudes underwent a profound change as thebanks began to appreciate the benefits of this scheme.In this sense, the guarantee fund may have helpeddeepen Serbia’s financial system.

The evaluation also noted some weaknesses in theguarantee fund. As a pilot programme, its initial geo-graphical coverage was far too ambitious; it wouldhave been better to initially focus on one or a cluster ofmunicipalities. Likewise, more thought should havebeen given to the institution managing the fund. Intransition economies, public sector institutions oftenhave difficulties offering efficient, apolitical manage-ment of this type of financial activity. At the very least,more specialized expertise should have been

employed in the design phase of the fund. As a result,the management of the guarantees issued has notalways been as tight as it could be. Allegations con-cerning excessively long grace periods in the repay-ment of some loans, and uses of funds for purposesother than those specified in the loan contracts, havebeen raised. So have questions about whether some ofthe borrowers tapping the guarantee fund would havebeen able to provide the collateral needed withoutaccess to this scheme.

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Bakery equipment purchased with support from the guarantee fund

CountercyclicalFinancial Instruments:Prospects for TransitionEconomies

Julia Korosteleva

High levels of public debt and its risk profile–particular-ly the prevalence of short-term and foreign currency-denominated debt–are widely viewed as primary indica-tors of vulnerability to international financial crises.These factors helped trigger Russia’s financial crisis in1998, as well as a series of high-profile debt defaultsacross ‘emerging market’ economies, including Argenti-na and Turkey in 2001, and Uruguay in 2002. The highsocial costs of these crises underscore the importance ofimproving sovereign debt structures and introducingcountercyclical market-based financial instrumentswhich, along with sound macroeconomic policies, couldhelp reduce the vulnerability of emerging economies toexternal shocks. GDP-indexed bonds (GIBs) and othercontingency-linked debt instruments could help makepublic debt structures more sustainable, reduce the risksof currency crises, and yield substantial benefits in eco-nomic performance.

Why countercyclical financial instruments?Debt instruments that are indexed to real economic vari-ables such as GDP and exports, or their determinants (e.g.

natural disasters, commodity prices, or changes in totalimports purchased by key trading countries) can provideconsiderable insurance benefits. These instruments canbe seen as comprising bond and insurance contract ele-ments, with payments contingent on the performance ofthese real variables. The issuance of bonds whose nomi-nal values or coupon payments are linked to commodityprices seems sensible for countries with a poorly diversi-fied export structure where a few products dominate.

Commodity-linked bonds could benefit transitioneconomies like Azerbaijan, Kazakhstan, and Russia,whose development prospects in general–and fiscal andexternal positions in particular–can be quite sensitive toterms-of-trade movements. Similarly, hedging againstshocks to prices of key imports, notably gas and oil, couldbe very important for such small open economies asBelarus and Moldova. Disaster insurance contracts wouldbe beneficial to small countries that are vulnerable tonatural catastrophes like Georgia or Tajikistan, for whomthe cumulative damage from various natural disastersreached 70 and 58 percent of GDP respectively in 1975-2002 (Borensztein et al. 2004). Larger and more diversi-fied economies could benefit from greater use of hedg-ing against macroeconomic fluctuations by linking thenominal values of their debt to GDP growth trends.

To the extent that they allow investors to share thereturns and risks of economic upturns and downturns,GIBs resemble equity-like instruments. When bondreturns are linked to GDP growth in the issuing country,its debt burden is reduced in the event of adverse

JULY 2007 | issue 7

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In addition to collateral on bank loans, guarantees canbe provided directly through suppliers of equipmentand machinery. More broadly, other financial productscould be developed to meet the needs of the SME sec-tor. Such products that have been created in neighbour-ing countries (e.g., guarantee funds to support equip-ment purchases in Macedonia) could be adapted to Ser-bia. These problems suggest that the capital availableunder the guarantee fund has not always been used inthe most efficient manner. Selecting a stronger institu-tion to manage the fund, and putting in a more effectiveoversight framework, could have avoided some of theseproblems.

ConclusionDespite these difficulties, it is clear that credits provid-ed to SMEs in South Serbia have helped generateincome and employment in this important region,2

where unemployment is such a chronic problem and

very few initiatives can show tangible results inaddressing it. Still, further support should be condi-tional on changes in the management arrangements,in order to increase the efficiency with which the guar-antees and their associated credits are deployed.Finally, for this initiative to make a real difference, con-siderably more funds should be available to guaranteeloans, somewhere in the range of €2 to €3 million, thusaffording many more applicants access to this serviceand making a significant impact upon employment inthe region.

Tom Thorogood is Programme Manager for the Munici-pal Improvement and Revival Programme Phase II inSouth Serbia.

1 Reference is to the 13 municipalities in South Serbia where UNDP implements theMunicipal Improvement and Revival Programme Phase II.

2 See ‘The South Serbia Programme: Lessons in Conflict Prevention and Recovery‘. Devel-opment and Transition. Issue 6. April 2007.

shocks and weak economic performance, and vice versa.For example, a country with an anticipated GDP growthrate of 4 percent that is paying interest on its standard(‘plain vanilla’) government bonds of 8 percent can con-sider issuing GIBs that would pay one percentage pointextra for each 1 percent above the baseline growth rate,and 1 percent less for every percentage point by whichreal GDP growth falls short of 4 percent. In years of eco-nomic slowdown with growth, say, equal to 2 percent,the issuing country would pay 6 percent (instead of 8percent on the non-indexed bond).1

Such indexation mechanisms work as automatic stabi-lizers, reducing the country’s debt-servicing costs–andthe possibility of default–during economic downturns(Borensztein and Mauro 2004). By increasing the ‘space’for countercyclical fiscal policy, GIBs can help keepdebt/GDP ratios relatively stable, thereby reducing thelikelihood of debt and currency crises. They can alsohelp restrain new spending during periods of highgrowth. Broader use of GIBs would reduce the need topursue contractionary macroeconomic policies duringperiods of slow growth, in order to maintain access tointernational financial markets or to IMF and World Bankfunding. This may improve the investment and businessclimates, enhancing prospects for economic growth andpoverty reduction.

Obstacles to the expansion of countercyclical debtinstrumentsDespite these benefits, GIBs have been used only spar-ingly in the region. So far, only Bosnia and Herzegovinaand Bulgaria have issued bonds containing an elementof GIBs as part of their Brady restructurings that includ-ed clauses providing higher coupon payments whenGDP growth reaches a certain threshold.2

A number of obstacles limit the spread of GIBs in theregion. These include:

• GDP measurement and moral hazard: The accuracyof GDP data, which is essential in determining thevalue of GIB coupon payments, is not always abovereproach in transition economies. Moreover, theauthorities may be tempted to misreport or revise theofficial figures, in order to reduce coupon paymentsduring economic upturns.

• Data revisions and lags in publication: Large revi-sions of GDP data for transition economies are notuncommon; significant over- or under-payment ofcoupon payments can result. Lags in data publicationand revisions could reverse the GIBs’ countercyclicaleffects.

• Complex pricing: Some investors may be reluctant topurchase GIBs because of difficulties in understandingtheir pricing. A well-established pricing model for GIBsshould be developed–possibly by the internationaldevelopment community.

• Illiquidity: Markets for new debt instruments are usu-ally illiquid, and the cost of their issuance is higherthan for standard bonds, whose large turnover canminimize transactions costs. The ensuing liquidity riskcould reduce GIBs’ attractiveness for investors.

• Callability: Many bonds are ‘callable’: they containclauses allowing the issuer to repurchase themwhen they reach a certain price. Making GIBscallable could allow governments to repurchasethem during periods of high economic growth, pre-venting investors from obtaining the anticipatedhigher coupon payments. In general terms, then,GIBs would have to be non-callable if they were tobe used extensively.

Many of these obstacles reflect the start-up costs asso-ciated with any market innovation, financial or other-wise. International development agencies like theWorld Bank, IMF, and the UN system–whose mandatesinclude promoting economic growth and reducingpoverty via better management of the global gover-nance architecture–could accelerate the expansion ofGIBs by underwriting some of the costs of their devel-opment.

ConclusionsTheir past vulnerability to currency and debt crises sug-gests that transition economies could benefit from theissuance of GIBs. However, GIBs are a rather specializedfinancial product; many transition economies are focus-ing instead on deepening the market for their ‘plain vanil-la’ bonds. Indeed, a number of the poorest CIS countriesdo not have sovereign credit ratings, effectively makingtheir ‘plain vanilla’ bonds–for which domestic markets arequite under-developed–too risky for most internationalinvestors. Thus, many transition economies which mightfind GIBs potentially beneficial are unable to issue themon the international markets at a reasonable cost.

However, in transition economies with relatively well-developed financial systems, there is scope for GIBs todevelop further. This is particularly important in light ofthe need for deeper domestic markets for long-term,local-currency instruments that could help make publicdebt structures less prone to crises. GIBs issued in localcurrency on domestic capital markets may appeal to insti-tutional investors, such as emerging hedge funds, insur-

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JULY 2007 | issue 7

11

The Expansion of StateOwnership in Russia:Cause for Concern?

David M. Woodruff

In the last five years, the weight of state-owned firms inthe Russian economy has expanded dramatically, lead-ing some observers to speak of a reversal of marketreforms. Such concerns are overstated. Neither thebehaviour of Russian state-owned enterprises (SOEs),nor the environment in which they operate, recalls thepre-reform era. Indeed, much of the SOEs’ expansionreflects the commercial, profit-driven ambitions of theirleaders rather than a coherent policy rationale. Thegovernment’s main challenge is not to ensure themicroeconomic efficiency of SOEs, but to make surethat the SOEs’ expansion drive does not threaten itsother priorities.

SOEs on a buying spreeAccording to researchers at Alfa-bank, in the middle of2003 the Russian state owned stock worth about 20percent of the capitalization of Russia’s stock market.By early 2007 the state’s share had risen to 35 percent(Grozovskii 2007). Much of the growth represented abuying spree by SOEs, especially oil company Rosneftand the natural gas monopolist Gazprom (OECD 2006,38). Among the largest acquisitions were major assetsconfiscated from the private oil company Yukos in lieuof tax debts, purchased by Rosneft, which thusbecame the country’s largest producer of crude oil.Gazprom, for its part, purchased the private oil com-

pany Sibneft for $13 billion in 2005. In 2006 it agreedto spend over $7 billion buying a share of the SakhalinII oil project from Royal Dutch Shell. In the bankingsector Vneshtorgbank has acquired private rivals.Defence firms in aviation and shipbuilding are consol-idating into large new conglomerates under stateownership. The state’s arms-export firm Rosoboronek-sport has taken control of assets in metallurgy andauto manufacturing.

Back to the USSR?Because privatization is so closely identified with eco-nomic reform, some observers have seen growingstate ownership as evidence of a reversal of reform.However, such judgments obscure the shifts under-way by implicitly associating contemporary SOEs withthe rickety enterprises of Soviet-era ministerialbureaucracies that Russia privatized in the 1990s.Russia’s SOEs operate on international capital mar-kets in ways that radically differ from the pre-privati-zation era. SOEs have borrowed huge sums on inter-national markets to fund their acquisitions; Rosnefttook on $22 billion of debt in early 2007 for the pur-chase of Yukos assets; Gazprom is seeking $12 billionin new financing for its entry into Sakahlin II andother purchases. Even though the majority of theirshares are held by the state, all major SOEs view stockmarket capitalization as a crucial measure of theirperformance. Gazprom has liberalized circulation ofits stock, unifying long-segregated foreign anddomestic markets; with a capitalization of over $220billion, it is now one of the world’s most valuablefirms. Rosneft, Vneshtorgbank, and Sberbank haveheld initial public offers for a portion of their shares.On taking over carmaker AvtoVAZ, Rosoboroneksport

ance companies, and pension funds. The latter in particu-lar are likely to have an interest in debt instruments thatcarry a relatively low default risk, and are either inflation-indexed or denominated in local currency. The mandato-ry-funded pension schemes that have emerged recentlyin many transition economies as the second pillar of pen-sion systems could in particular increase the demand forGIBs. Prospects for the more rapid expansion of trading inthese instruments would improve if international devel-opment agencies could help bear the risks of deepeningthese markets by underwriting some of their costs.

Julia Korosteleva is Lecturer in Business Economics atUniversity College, London.

1 This example assumes away additional costs often associated with GIBs, such as insur-ance premiums.

2 ‘Brady bonds’ (named after former US Treasury Secretary Nicholas Brady) are a securi-tized form of restructured public debt. They are a common component of sovereigndebt restructuring agreements in developing countries. In the cases of Bulgaria andBosnia and Herzegovina, these bonds were ‘callable’, so that instead of making addi-tional payments to their holders when GDP growth surpassed the threshold levels, theauthorities repurchased the bonds (Segal 2004).

References: - Borensztein, E. and P. Mauro (2004). ’The Case for GDP-

indexed Bonds’. Economic Policy, April: 165-216.- Borensztein, E., Chamon, M., Jeanne, O., Mauro, P. and

J. Zettelmeyer (2004). ’Sovereign Debt Structure for Cri-sis Prevention’. IMF Occasional Paper No. 237. IMF:Washington D.C.

- Segal, R. (2004). Bulgaria: The Balkans’ Other GDP-LinkedExternal Debt. London: Exotix Limited. http://newfinan-cialorder.com/Bulgaria_April_2004%5B1%5D.pdf.

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prioritized repackaging ownership to capture stockmarket returns.

Their capital market activities force a certain level oftransparency on the SOEs. They also invest a vocal con-stituency of profit-oriented lenders and minorityshareholders with the power to hold hostage SOEs’ability to raise finance. The eagerness of investors tolend money to and buy shares in SOEs may in part rep-resent rational herd behaviour aimed at cashing in ona booming market. But this eagerness also suggeststhat investors view the risks associated with state own-ership as insignificant.

Beyond raising general concerns about the microeco-nomic efficiency of SOEs, some observers have suggest-ed that the slowing growth in Russian oil productionsince 2004 reflects state expansion in the sector. Howev-er, rapid oil production gains in the prior years werelargely a one-off, short-term opportunity to use newtechnology to improve yields from mature fields discov-ered in the Soviet era. Gazprom and Rosneft seem to bemanaging their newly acquired oilfields no worse thanSibneft and Yukos did before them (Woodruff 2006).

Borrowing Up a StormIronically, SOE expansion is creating the greatest chal-lenges in areas where one might expect state ownershipto confer an advantage–fostering a coherent set of pri-orities and a long-term focus. SOEs’ massive foreign bor-rowing is a primary example. When these loans are con-verted into roubles, the money supply expands, con-tributing to Russia’s core macroeconomic dilemmas ofinflation and real exchange-rate appreciation. Borrow-ing has been especially intense recently. In the finalquarter of 2006, foreign indebtedness of state-ownedbanks and other firms grew by $13.9 billion, nearly 19percent. Capital inflows for 2006 reached a record $40billion, a figure that was nearly equalled in the first fivemonths of 2007 alone.

Russia’s Minister of Finance, Aleksei Kudrin, and othergovernment officials have called for a slowdown inSOEs’ foreign borrowing, and have pushed state firmsembarking on IPOs to seek capital from the rouble-hold-ing public instead of relying solely on new funds fromabroad. Macroeconomic factors limit how much incom-ing investment Russia can effectively absorb. The statemust thus regard international financing as a scarceresource, and take steps to ensure that it is directed inline with long-term development priorities. At themoment, however, SOEs are directing these scarceresources not to production projects, but to empire-building acquisitions, saddling themselves with large

debt burdens that could be a barrier to their subsequentdevelopment (Hubbard 1998).

Gazprom is the most important example. As gas con-sumption rises with economic growth, and as depositsin developed fields dwindle, the company will need tomake large investments in new fields. But Gazprom hasnot made these investments a priority. Instead, it hasraised capital to bring more assets under its control.Gazprom is presently poised to significantly widen itspresence in the power generation sector, where assetsare now being sold off as part of efforts to promote com-petition and attract investment. Despite objections fromthe state’s anti-monopoly organ, Gazprom is also likelyto win approval for the purchase of coal producer SUEK,which would leave it controlling nearly 40 percent of thecountry’s coal output. Thus, Gazprom’s acquisitionsthreaten to undermine the competitive logic of the intri-cately crafted electricity sector reform.

In other sectors, however, SOEs do not threaten toreduce competition (to the extent that it exists to beginwith). Banking has been dominated by state-ownedentities since the 1998 financial crisis, and acquisitionsby state banks do not significantly change the competi-tive balance in the sector. In automobile manufacturing,foreign companies are building significant new capaci-ty. Private companies will likely continue to play a cen-tral role in the production and refining of oil. Neverthe-less, in these sectors too, SOEs have concentrated onpurchasing existing assets rather than on new produc-tive investments.

ConclusionIn assessing the growth in state ownership of the Russ-ian economy, the key issue is not the precise percentageof assets owned by the state. Indeed, this is likely toshrink in the medium term. Even though many energy-system assets will wind up under the control ofGazprom, others will pass to the private sector. Heavilyleveraged SOEs are also likely to engage in additionalshare offerings to pay down their debts. This reversal,should it occur, would not resolve the major difficultiesrevealed in the SOE acquisition boom. Russia’s macro-economic situation limits the volume of foreign invest-ment it can accept without severe inflationary conse-quences. It needs to take steps to insure these funds aredirected not to reshuffling ownership, but to productiveinvestments for the long term.

So far, expanded state ownership has failed to accom-plish this urgent goal. This may cast a long shadow overprospects for converting Russia’s current economicboom into sustainable development, the benefits of

JULY 2007 | issue 7

13

Informal Practices in the Russian PrivateSector

Alena Ledeneva and Eugene Nivorozhkin

In the 1990s, Russia’s development emphasized reform-ing formal institutions. Yet the outcome of these reformsoften depended on informal practices that both opposedand contributed to formal structures. These informalpractices moderated some of the exigencies of transition,helping companies to exploit legal loopholes and opti-mize tax schemes. However, they also allowed companiesto engage in asset stripping, share dilution, and transferpricing, not to mention the limitation of shareholder vot-ing rights and the abuse of Russia’s insolvency laws. Whilethe Russian economy of today is much more stable andprosperous than it was 10 years ago, Russian businessescontinue to require a high degree of informality to ‘getthings done’. Informal practices persist because interper-sonal trust compensates for popular distrust of state andfinancial institutions.

Informality and Russia’s economic transitionInformality is commonly associated with corruption andthe absence of the rule of law; it is believed to subvertthe foundations of good governance and investor confi-dence. Informality certainly allows competent players ofinformal rules to bend the system to their advantage.What is rarely noticed, however, is that these practicesplayed a key role in transforming Soviet enterprises intoprivate businesses able to compete in a market environ-ment. For example, Adachi underscores the importanceof informal corporate governance practices in threemajor Russian companies–the oil company Yukos, Russ-ian Aluminium and Norilsk Nickel–in their struggle tosurvive, to deal with the disintegration of the Soviet eco-nomic system, and to compete and grow under post-Soviet constraints (Adachi 2005). In How Russia ReallyWorks (Ledeneva 2006), informal practices associatedwith barter, financial schemes, and alternative contract

enforcement mechanisms are shown to have bothadvanced business and strengthened the importance ofnon-market alliances, which are both competitive andanti-competitive.

While informal practices rapidly adapt to legal changesand make use of legal institutions, they also createobstacles to consolidating the rule of law. Although pri-marily benefiting certain groups, informality caters to awider set of economic needs and is implicitly endorsedby the state. The state itself is sometimes accused of ‘taxterrorism’ against business. Hainsworth and Tompson(2002) refer to ‘the informal fiscal system’ that reflectsofficial responses to short-term financial and politicalpressures. Part of the problem is the lack of clear, acces-sible, and consistent rules. Thus, contradictions in taxlegislation virtually guarantee a degree of informality,since officials must decide which rules to enforce andwhen. The tax organs sustain non-transparency bydevising enabling regulations that allow them to manip-ulate inconvenient legislation. Vested interests in stateagencies lead to informal ‘bargaining’ between taxpay-ers and officials at all levels. The formal rules of thegame–tax legislation, normative acts, ministerial instruc-tions–are important factors in these negotiations, butthey are not definitive.

which are broadly distributed across different regionsand social groups.

David M. Woodruff is Lecturer in Comparative Politics atthe London School of Economics.

References:- Grozovskii, B. (2007). ‘Glavnyi sobstvennik strany.’

Vedomosti, 13 February.

- OECD (2006). ‘Economic survey of the Russian Federa-tion 2006’.

- Hubbard, R. (1998). ‘Capital-market imperfections andinvestment’. Journal of Economic Literature 36, no. 1:193-225.

- Woodruff, Y. (2006). ‘Between State and Market’ in Fun-damentals of the Global Oil and Gas Industry (London:World Petroleum Council).

Firms often resort to paying in cash to avoid taxation

© Mikkel Ostergaard / PANOS PICTURES

14


‘One-Stop-Shop’Reforms in Ukraine: Do They Work?

Vyacheslav Toporov

Massive job destruction and the spread of povertyhave accompanied the transition from a socialist to a

market economy in Ukraine. While the post-1999 eco-nomic recovery has increased wages and productivity,it has not yet brought substantial improvements in jobcreation to reduce poverty. The poor endure longerperiods of unemployment, have more restricted accessto the labour market, and are overrepresented in sec-tors with high rates of underemployment such as agri-culture and construction. More rapid business forma-tion could alleviate these tensions by creating moreincome- and employment-generation opportunities.

The relationship between taxpayer and tax collector isnot normally based on negotiation, but in Russia, asHainsworth and Tompson indicate, ‘The bargained taxbill is no more a paradox than was the bargained plan‘.Unlike the use of black cash or bribery, many taxschemes are grounded in legal loopholes and can bemore properly described as tax avoidance than tax eva-sion. They exploit defects in the tax legislation which,according to some respondents, may have been leftthere on purpose. The centrality of law in such creativescheming, however, is a noticeable and positive devel-opment.

The key role of Russian banksRussian banks tend to play a dual role vis-à-vis the taxorgans–they are both taxpayers to, and agents of, thefiscal organs. Since a substantial share of tax revenuesis collected via the payments system, tax authoritiesrely heavily on banks not only to provide informationabout clients’ finances, but also to cooperate in taxcollection. This practice creates an incentive for firmsto conduct transactions in cash. However, the use ofblack-cash strategies by firms is limited, and typicallyrequires the banks’ help in obtaining large quantitiesof cash in violation of restrictions on the use of cashfor inter-company transactions. Hence, banks play acritical role in so-called ‘tax optimization’ strategies.

The centrality of banks in managing financial flowsand information, and in mediating between tax col-lectors and tax payers, allows them to create andexploit these profitable lines of business. Russia’sCentral Bank fell under intense scrutiny following themurder of Andrei Kozlov, its first Deputy Chairman, inSeptember 2006. There are widespread concerns thatCentral Bank decisions concerning small- and medi-um-sized banks are overly subjective and often polit-ically motivated.

Trust-based relationships are also the basis for insidertrading, which (given the few legal restrictions on it)

seems widespread on Russian financial markets. Whilethe law ‘On Securities Markets’ prohibits trading basedon ‘office information’, its definition is vague and penal-ties for its use are insufficient. The notion of ‘insiderinformation’ is not used, and the Federal Service forFinancial Markets (FSFM) has insufficient powers to dealwith it. A draft of the law on ‘insider information’ wasprepared by the FSFM in 2005; it remains under discus-sion. Whether its eventual enactment will reduce thescale of insider trading and price manipulation remainsto be seen.

It is often assumed that informal practices in Russian busi-ness are a Soviet phenomenon and thus are less commontoday. Our research and recent events in the banking sec-tor dispel this myth. Informal practices, in particular thoseassociated with discrete banking services, are reported tobe essential for business operations and indicative of theimportance of interpersonal trust in Russian business(Ledeneva 2006). The prime break with the Soviet pasthas taken place in relation to the poor. Informal practicesin today's Russia are much more exclusive and do notcater to their needs.

Alena Ledeneva is Reader in Russian Politics and Soci-ety, and Eugene Nivorozhkin is Lecturer in the Eco-nomics of Central and Eastern Europe, at UniversityCollege London.

References:- Adachi, Yuko. 2005. Informal Corporate Governance

Practices in Russia in the 1990s: The cases of Yukos Oil,Siberian (Russian) Aluminium, and Norilsk Nickel. PhDdissertation, University College London.

- Hainsworth, Richard and William Tompson, ‘Tax Policyand Tax Administration in Russia: The Case of the Bank-ing Sector’, Post-Communist Economies, Volume 14Issue 3, September 2002.

- Ledeneva, Alena (2006). How Russia Really Works: TheInformal Practices That Shaped the Post-Soviet Politicsand Business. Ithaca: Cornell University Press.

JULY 2007 | issue 7

15

In their efforts to improve the business environment,many governments are seeking to ensure better start-up conditions for companies, both by simplifying ini-tial registration procedures and by reforming subse-quent regulatory processes. In Ukraine, the authorities(supported by the World Bank and other internationaldonors) have focused mainly on simplifying businessregistration procedures, which take the form of a seriesof permissions and licensing decisions made by vari-ous general and sectoral regulatory agencies. Donorsgenerally prefer to focus on such changes as they arerelatively easy to measure and track for reporting pur-poses.

‘One-stop shops’ have a role to play . . .As in other transition economies, the ‘one-stop-shop’approach was chosen in Ukraine as a model for simplify-ing registration procedures. Following the Law ‘On StateRegistration of Legal Entities and Individual Entrepre-neurs’ adopted in 2003, one-stop shops were set up inmany Ukrainian municipalities. These measures put rep-resentatives of various state agencies in one location tobetter provide information about and accelerate busi-ness registration procedures, thereby reducing oppor-tunities for corruption associated with multiple, non-transparent contacts between entrepreneurs and stateagencies.

Nearly 200 one-stop shops have been established inUkraine, often at the initiative of the local authorities.Statistical data indicate that their introduction cut theduration of standard registration procedures nearly inhalf, from 38 to 20 working days. However, survey datacollected by the International Finance Corporation (IFC)show no significant changes in the costs or efficient pro-vision of information to entrepreneurs.1 Entrepreneursin 2006 continued to identify regulatory pressures, cor-ruption, and unstable legislation as key causes ofUkraine’s unfavourable business climate. Other surveydata2 indicate that 72 percent of top managers believethat ‘friendly relationships’ with civil servants are neces-sary to be successful in business. Transparency Interna-tional’s Corruption Perceptions Index persistently placesUkraine among the countries where perceptions of cor-ruption are greatest.3 While unofficial payments to civilservants (as measured by Transparency International) in2006 constituted 3.4 percent of companies’ sales vol-umes, smaller businesses faced higher official and unof-ficial payments.

. . . but are not the whole storyThese data underscore how business formation inUkraine–as in other transition (and some developed)economies–is constrained by factors that are notlinked to registration and licensing, and therefore can-

One-stop shops are supposed to help small businesses like this emblem maker

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not be cured by one-stop-shop reforms. In addition,one-stop shops in Ukraine have weak legal powersand are generally advisory in nature. Because theyoften do not provide detailed information, one-stopshops are sometimes incapable of advising on theexact procedures of individual agencies. Frequentchanges in the secondary legislation and enablingregulations needed to implement Ukraine’s basic legalframework, particularly concerning licenses and per-mits, continue to offer significant rent-seeking oppor-tunities to local officials.

Mutual distrust continues to pervade relationsbetween business and regulatory agencies in Ukraine.Since registering a company requires obtaining signif-icant numbers of permits and licences, both entrepre-neurs and regulators know that frequent controls, ver-ifications, and inspections can follow registration.Smaller companies in particular fear the ‘costs of expo-sure’ that come with registration. As a result, largenumbers of businesses eschew legalization to avoidboth formal registration costs and further pressuresfrom regulatory bodies. Faced with the challenges ofregulating entrepreneurs with at least one foot in theinformal sector, state agencies seek to maintain exten-sive controls over businesses, without considering theoverall burden imposed on entrepreneurs in this way.This is particularly the case in countries in which thecommunist nomenklatura has preserved key positionsin the state administration.

In Ukraine, matters are further complicated by the par-tial decentralization of economic administration, whichgives the local administration substantial de factoautonomy in setting the commercial ‘rules of the game’.Regulatory authority is therefore dispersed across multi-ple national and sub-national laws in an inconsistent,often contradictory fashion. Moreover, the introductionof permit-issuing one-stop shops was partially compro-mised by the reluctance of certain government bodiesto bring their regulations into compliance with the legalframeworks upon which these reforms are based. Statis-tics show that the volume of legislation adopted hasbeen increasing each year (see figure 1), often at ratesexceeding the monitoring and compliance capacities ofentrepreneurs and civil servants.

ConclusionTo address these problems, UNDP’s Crimea Integrationand Development Programme supported the estab-lishment of one-stop shops in all Crimean districts, andis now focusing on supplementary measures to helprealize the promise of these reforms. These includedeveloping a comprehensive review of current regula-

tions pertaining to business licenses and permits, anaudit of institutional capacities in key state and localgovernment agencies, advocacy for the ‘secondarylegislation’ needed to limit the discretion of line min-istries and other regulatory agencies in these areas,improved adjudication of commercial disputes, andthe creation of a web portal providing comprehensiveinformation on business registration procedures inCrimea.

Since barriers to the creation and expansion of newbusinesses go well beyond registration issues, the sig-nificance of one-stop shops in Ukraine should not beexaggerated. Broader approaches to improving thebusiness environment are needed at all stages, not onlyat registration. Improvements in administrative andregulatory transparency could improve inter-sectoralunderstanding of the big picture, and promote bettertop-down and grass-roots control over law making andimplementation. Measures to strengthen the judiciary’sability to resolve commercial and regulatory disputescan significantly contribute to this transparency.Stronger technical and human capacities of both regu-latory bodies and one-stop shops themselves couldreduce incidences of misinterpretation of legal acts,and make their contribution to any business promotionsystem more valuable.

Vyacheslav Toporov is Communications Associate forthe UNDP Crimea Integration and Development Pro-gramme.

1 Business Environment in Ukraine 2004, December 2004. International Finance Corpora-tion. (http://www.ifc.org/ifcext/uspp.nsf/Content/PMSurveysRU). See especially thesection on company registration.

2 ‘Quarterly Enterprise Survey’. Institute for Economic Research and Policy Consulting,October 2006. http://www.ier.kiev.ua.

3 See, for example, Transparency International’s ‘Corruption Perceptions Index’ (2004).

Figure 1

Source: Ukrainian electronic legal database Liga.

Upward trends in the number of legal acts regulating business activity

+2,600

+2,900

+3,100

+3,500

+4,200

2000 2001 2002 2003 2004

JULY 2007 | issue 7

17

Towards a ‘FourthSector’? SocialEnterprises as a NewHybrid for EmploymentGeneration

Geoffrey D. Prewitt

Social enterprises are receiving increased attention asinstitutions promoting employment and social inclu-sion. They entered the European development dis-course in the early 1990s as an attempt to describe theorganizations found inthe porous boundaries ofthe voluntary sector (civilsociety) and the privatesector (the market). Likecivil society organiza-tions (CSOs), social enter-prises do not enjoy pre-cise, universally accepteddefinitions, legal or oth-erwise. Social enterprisesmay be cooperatives,associations, founda-tions, mutual benefit andvoluntary organizations, charities, and other not-for-profit or limited-profit distribution entities that tend tofocus on general interest social services and work inte-gration measures, often promoting local developmentin disadvantaged regions.

A new way forward?Voluntary sector institutions during the last 30 yearshave acquired a central role in addressing poverty,unemployment, service delivery, and other social prob-lems.1 Social enterprises have become a relevant actor innew welfare systems and employment strategies incountries ranging from Mexico to New Zealand, butmost notably in the EU-15 countries. Experience fromthese countries demonstrates that social enterprises canhelp reduce poverty by:

• Improving access to basic public services (social, edu-cational, health, etc.) for local communities, includingfor those who are unable to pay;

• Supporting local economic development in depressedcommunities;

• Helping to integrate vulnerable groups (ethnic minori-ties, single women, people with disabilities) into thelabour force; and

• Generating employment in the provision of theseservices.

While a number of countries have passed legislation tosupport the expansion of social enterprise activities,2 thecountries of Central and Eastern Europe and the Com-monwealth of Independent States (CIS) have been slowto do so. CSOs in these countries often function as tradi-tional development non-governmental organizations(NGOs), providing social welfare and humanitarian assis-tance, particularly in post-conflict areas. Few CSOs inthese countries have an explicit mandate to address crit-

ical employment issues,particularly with respectto such vulnerable/mar-ginalized groups asyouth, ex-combatants,the displaced, or thelong-term unemployed.In a region with signifi-cant unemploymentrates, it is surprising thatmore CSOs are notengaged in this area,focusing instead onshort-term ‘bandage’

interventions. In many cases, this leaves CSOs at themercy of donor trends and the imperatives of mobilizingexternal resources. In contrast, by engaging in econom-ic activities through social enterprises, CSOs could gen-erate their own revenue.

Impediments to social entrepreneurship in transi-tion economiesSocial enterprises have yet to emerge in large numbersin the countries of Central and Eastern Europe and theCIS. Although the new EU member states–particularlythe Czech Republic, Hungary, Poland, and Slovakia–haveembraced them, further East there is much less recogni-tion of the potential benefits of social enterprises. Rea-sons for this include:

• Difficulties in obtaining data on the numbers of theseorganizations, or their sectoral and employment pro-files;

• Unfavourable legal frameworks (in Macedonia, not-for-profit organizations are not permitted to engagein economic activities);

What is a ‘social enterprise’?

A common definition of social enterprise is, ‘Any pri-vate activity conducted in the public interest, organ-ized with an entrepreneurial strategy but whosemain purpose is not the maximization of profit butthe attainment of certain economic and social goals,and which has a capacity for bringing innovativesolutions to the problems of social exclusion andunemployment’ (OECD, 1999).

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• Non-transparent and unstable public support (includ-ing subsidization policies) for social enterprises, partic-ularly in light of the non-trivial resource requirementsassociated with starting up social enterprise activities;

• Inadequate appreciation of the actual and potentialbenefits of social enterprise activities (particularly interms of employment creation) by national and localauthorities, as well as by the private sector; and

• Weak interest in or lack of understanding of ‘socialentrepreneurship’ in many CSOs.

Removing barriers to social entrepreneurshipThe expansion of social entrepreneurship can be seen asa structural dynamic common to countries with differ-ing social welfare regimes, legal frameworks, and levelsof economic development. This evolution reflects aneed for solutions that combine entrepreneurship withthe pursuit of social aims, and which benefit from multi-ple funding sources (public funding, commercialincome, volunteer labour, donations, etc.). Unfortunate-ly, legal frameworks in CIS countries often seek to intro-duce firewalls between economic and social activities.Not-for-profits must therefore create subsidiary compa-

nies whose activities (if conducted lawfully) are liable tocommercial taxation. This discrimination against socialentrepreneurship acts as a major brake on the expan-sion of not-for-profit activities. On the other hand, thereis always a risk that commercial companies may seek to‘redefine’ themselves as social enterprises in order toreduce or avoid taxes. Therefore, the blurring of eco-nomic and social activities can be abused and requirescareful regulation.

Addressing these constraints requires new approachesto entrepreneurship, in order to create more legal andfiscal space for commercial activities conducted by thenot-for-profit sector. Clarifying the legal definition of the‘public interest’ served by social enterprises–with a par-ticular emphasis on service provision for local economicdevelopment–may also be necessary. Regular assess-ments of social enterprise activities and mandates areimportant to ensure accountability and reduce the like-lihood that commercial interests are not pursued underthe cloak of not-for-profit status. The legal relationshipsbetween social enterprises and the public sphere shouldlikewise be redefined, in order to facilitate the outsourc-ing of social service delivery to social enterprises. Asconcerns relationships with the private sector, move-

Workers team up to rebuild houses in the Skenderaj/Srbica municipality of Kosovo © Hazir Reka

JULY 2007 | issue 7

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Agricultural Privatizationin Central and EasternEurope and the CIS

Jessica Allina-Pisano

Governments in Central and Eastern Europe and theCommonwealth of Independent States (CIS) have pur-sued a variety of agricultural privatization policies dur-ing the post-socialist period. The central stated aims ofprivatization were relatively uniform across the region:greater efficiency through improved labour incentiveslinked to private ownership, and the creation of a ruralmiddle class with a stake in democratic governanceand political stability. Socialist-era collective farmswere restructured or dismantled, and farm assetsparceled out to members of former collectives. Somecountries, such as Romania and then Czechoslovakia,applied one policy in privatizing collective farms andanother for state farms while others, like Bulgaria andUkraine, did not.

In most countries in the region, rural populations andtheir representatives responded to agricultural privati-zation policies with opposition and, in some cases, overtresistance. This led, in almost all cases, to substantialfluctuations in both policy design and implementationduring the 1990s. That reform should have encounteredsome societal resistance is not surprising: both majorapproaches to privatization (restitution and distribu-tion) threatened entrenched power structures in the

countryside by moving land and farm assets into privateownership.

Countries in Central and Eastern Europe pursued landprivatization through restitution programmes thatgranted land directly to its former owners or, as in thecase of Hungary, indirectly through compensationvouchers to be used at auction. The latter approach, asVerdery (2003) has observed, privileged rural develop-ment over the restoration of previous land tenurearrangements. Restitution was to reshape not only thecountryside, but also the nation: in many cases, realloca-tion of property reinforced post-World War II decisionsaimed at ethnic homogenization and nation-building.

In contrast, the CIS countries privatized land by distrib-uting shares to those who had worked on collective andstate farms during the last decades of socialism, withoutregard to pre-socialist patterns of land tenure and own-ership. This apparently less contentious approach nev-ertheless generated or heightened social conflicts, asrural populations contested the boundaries of the com-munity to be included in distribution and, on manyfarms, members refused to allow the allotment of landand labour assets.

The implementation of both land restitution and distri-bution policies has generally moved more slowly thananticipated, as farm directors resisted decollectivizationand as contentious cases passed through the courts.Furthermore, rural people across the region faced com-mon disincentives to acquiring land: the absence ofaffordable credit and machinery, and low prices on agri-

ment from charitable donations towards more collabo-rative approaches should be promoted, particularly incountries with welfare-to-work schemes or quota sys-tems for disadvantaged workers. International actorscould facilitate the dissemination of good practices,both in terms of helping to reform legal frameworks anddescribing the social enterprises that have thrived inthose legal contexts.

What next for social enterprises in the region?Since social enterprises are only now consolidating theirposition in OECD countries, their maturation in transi-tion economies may still be some years away. Morerobust efforts to ensure an appropriate environment forsocial enterprises–in terms of enhancing cooperativeownership, supporting the development of entrepre-neurial skills in the voluntary sector, and increasingawareness of different actors (including international

ones) about the significance of social enterprises–areparticularly important. For social enterprises to realizetheir full potential, attention must be given both to thelarger policy arena and to the organizational structuresthemselves. This will require addressing negative, his-torical associations with ‘collective’ action, as well asbroadening the scope, legal parameters, and definitionsof voluntary activities. In order for social enterprises torealize their full potential, attention must be given bothto the larger policy arena and to the organizationalstructures themselves.

Geoffrey D. Prewitt is Poverty Reduction and Civil Soci-ety Adviser for UNDP’s Bratislava Regional Centre.

1 As noted, for example, in Social Enterprises, OECD, 1999; and The Emergence of SocialEnterprise, Carlo Borzaga and Jacques Defourny (eds.), 2001.

2 For example, Italy’s Law on Social Cooperatives (1991) and Belgium’s Social PurposeCompany legislation (1995).

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cultural commodities made leaving collectives an unat-tractive prospect. The social services–health care, edu-cation, other services–provided by collective and statefarms under socialism were also powerful incentives forrural people to remain on large-scale farms.

The valuation and distribution of non-land assetsproved difficult for farms across the region, and in mostCIS countries, non-land assets were never allocated tomembers of collectives. Typically, assets of former col-lectives were to be divided among their membersaccording to a formula that reflected some combinationof wage levels under socialism and the number of yearsthat people had worked for the collective. However, theeconomic instability of the early 1990s, with attendantinflation and currency crises, required the repeatedrevaluation of farm assets. On most agricultural enter-prises, this was a task that directors had neither the incli-nation nor resources to undertake.

Ultimately, the ‘privatization’ of non-land farm assetsdid take place, but not under the rubric of reform poli-cy. Across the region, members of collective farmsspontaneously dismantled agricultural infrastructurefor resale and informally appropriated machinery andother farm assets. This practice, observed in a variety of

national contexts, was the product not only of social-ist-era attitudes towards collective property (‘every-thing around me is the collective farm’s, everythingaround me is mine’), but also of more recent transfor-mations: changing attitudes towards property amidstpolitical and economic transition, receding state con-trol and surveillance of rural areas, and short-termincentives to appropriate common property beforeone’s neighbours did. Many rural people believed thattheir labour under socialism entitled them to a share offarm assets: if farm directors and politicians would notensure that they had it, some decided they would takeit for themselves–just as elites had done under indus-trial privatization.

Land tenure outcomesMany factors complicate the task of accurately assessingprivatization outcomes in the post-socialist countryside.In most cases, states' resources for data gathering inrural areas are inadequate. Those involved in designingand overseeing privatization policies have good reasonto emphasize or exaggerate reform successes, whileproducers continue to face tax incentives that encour-age the underreporting of harvests, profits, and machin-ery acquisition. Across the region, variation in reportedoutcomes sometimes reflects differences in how

A ruined state farm and flour factory near Barbele, Latvia © Jan Banning / PANOS PICTURES

JULY 2007 | issue 7

21

researchers collect information, rather than actual differ-ences on the ground.

Still, there is general agreement that agricultural privati-zation has produced a bifurcated set of land tenure out-comes across Central and Eastern Europe and the CIS:land consolidation in some areas, and excessive frag-mentation in others. This bifurcation is not due to differ-ing policy approaches, as consolidation and retention oflarge-scale agriculture occurred under both restitutionand distribution programmes. Rather, the different out-comes reflect variation in the size of land plots, croptypes, and the response of local elites to reform policy.

In much of the region, agricultural privatization resultedin the preservation of large-scale farms, as rural peoplestayed in collectives or formed cooperatives as a hedgeagainst risk (Meurs 2001), and as local business and stateelites worked together to maintain large-scale agricul-ture (Allina-Pisano 2004). These enterprises operate onthe basis of leasing relationships, and former collectivesare often able to collect monopoly rents. In many cases,these large-scale farms are less modernized and relymore on human and animal labour than did their social-ist predecessors.

Where the size of land allotments under privatizationwas relatively small (a hectare or less) and thereforemanageable for household production, and whererecent traditions of cultivation favoured fruits and veg-etables over industrial crops and grain, rural people hadmore incentive to claim land, and there was more defacto distribution. In such cases, including the Balticstates and countries in the Caucasus, as well as Moldovaand Kyrgyzstan, the first 10 years of reform resulted inthe allocation of small land share plots and fragmentedland tenure systems.

In either case, however, the paper record of agricultur-al privatization reflects only ownership patterns andmay obscure patterns of land use (Allina-Pisano 2007).For example, apparent land fragmentation has oftenbeen accompanied by informal leasing arrangementsthat have in recent years led to land consolidation.Conversely, large-scale farms frequently subcontractwork to smaller organizational units within the enter-prise.

Prospects for sustainable developmentThere is thus no clear association between privatiza-tion approaches and resulting land use patterns.Instead, the greatest variation in both responses to andoutcomes of land privatization appears to exist at thelocal level, differing from farm to farm and from village

to village (Allina-Pisano 2007, Verdery 2003). This typeof variation, in which the skills, connections, and otherresources of individual farm directors and other localelites are more likely to determine the health of a farmthan the details of reform policy, is explained in part bythe nearly uniformly disadvantageous economic envi-ronment.

Agricultural subsidy regimes and protectionism in theEuropean Union and North America, as well as lowerlabour costs in China and Africa, make it difficult forfarmers in Central and Eastern Europe and the CIS tomake a profit from sustainable agriculture. Large-scalefarms are under increasing pressure to engage inunsustainable practices: to lease land for serial cultiva-tion of nitrogen-leaching cash crops, to withhold leasepayments or salaries from rural people, etc. New EUmember states in the region will not have full access tothe EU’s CAP benefits for some time; in the meantime,commercial agriculture will continue to be fraughtwith risk.

Meanwhile, small-scale agriculture is likely to continueto be viable only where off-farm income sources (e.g.,remittances) can sustain rural households. If the socialistpast was marked by inefficient large-scale agriculturalenterprises that informally supported household pro-duction, the post-socialist present is characterized bymore fragmented land tenure systems, in which ruralcommunities have greater freedom to pursue small-scale production, but take on greater labour burdens,and greater risk, in doing so. Without reform of subsidyregimes in the West, post-socialist countries are likely tosee a growing role for large-scale leasing enterprises,with narrow profit margins and fewer and fewer bene-fits for rural people.

Jessica Allina-Pisano is Associate Professor in the Schoolof Political Studies, University of Ottawa.

References:- Allina-Pisano, J. (2004) ‘Sub Rosa Resistance and the

Politics of Economic Reform: Land Redistribution inPost-Soviet Ukraine,’ World Politics 56:4, 554-581.

- Allina-Pisano, J. (2007) The Post-Soviet Potemkin Village:Politics and Property Rights in the Black Earth. Cam-bridge: Cambridge University Press (forthcoming).

- Meurs, M. (2001) The Evolution of Agrarian Institutions: A Comparative Study of Post-Socialist Hungary and Bul-garia. Ann Arbor: University of Michigan Press.

- Verdery, K. (2003) The Vanishing Hectare: Property andValue in Postsocialist Transylvania. Ithaca: CornellUniversity Press.

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Corporate SocialResponsibility and Post-Communist Business:From State Paternalism toEnlightened Self-Interest?

Peter Serenyi

The voluntary integration of social and environmentalconcerns into commercial operations–‘corporate socialresponsibility’ or ‘CSR’–is not a new trend in the West.Often encouraged by the watchdog efforts of consumergroups, companies in many western countries havebeen spending money on responsible business prac-tices for years, often because they see it as important fortheir reputation and image. What is new, however, isthat firms are starting to recognize–and some studiesare beginning to show–that CSR can boost a company’sprofits. By reducing the usage of energy and otherinputs, firms can promote environmental sustainabilityas well as reduce costs. Firms are increasingly aware thatbetter working conditions for employees can helpreduce turnover and absenteeism.1 Financial institutionsare increasingly integrating CSR criteria into investmentdecisions, creating new financial opportunities for com-panies that embrace CSR principles.

In post-communist countries, the notion that compa-nies have a social role to play is not new. Under socialismstate-owned companies built and maintained social,cultural, sporting, housing, and recreational facilities,and provided hot water at subsidized rates for localcommunities, without commercial cost-benefit analysis.These activities were part of the communist ideology ofguaranteed welfare and social protection; they were notdriven by factors of economic efficiency.

When privatization began in the 1990s, many firmsdivested themselves of these social obligations in orderto stay afloat in the market economy. This focus on corebusiness activities often created feelings of nostalgia andresentment among people whose access to social servic-es was being scaled back. When combined with popularviews equating privatization with corruption and insiderdeals, these divestitures further reduced popular trust inpost-communist companies and their managers. RecentUNDP surveys for Croatia and Hungary reported thatmany people don’t trust the new capitalists. Accordingto data published in 2004, more than half of Polesbelieve that private businesspeople don’t obey the law.2

The (slow) rise of CSR in transition countriesIn contrast to state paternalism, CSR is about the devel-opment of the communities, markets, and humanresources on which a company’s long-term prospectsdepend. It reflects a forward-looking ‘enlightened self-interest’ approach by companies looking for partner-ships with other stakeholders to find solutions to com-mon problems. In contrast to the West (where civil socie-ty groups spurred companies to adopt CSR principles), inthe post-socialist world, the first big CSR push came fromforeign investors seeking to align their business practicesin Eastern Europe with CSR principles at home. EU acces-sion processes also helped catalyze post-communistCSR, by encouraging local companies to distinguishthemselves as progressive and able to compete on themore brand-conscious, consumer-driven–and oftenmore socially aware–single market. Some local NGOs arestarting to push companies to go beyond what isrequired by law to promote social and environmentalgoals. And some business leaders see the pursuit of CSRas a way of strengthening popular trust in post-commu-nist companies.

CSR is supported by the United Nations, both regionallyand globally. The Global Compact was founded in 2000by former Secretary-General Kofi Annan as a voluntaryalliance of businesses that agree to follow 10 core CSRprinciples in such areas as human rights, environmentalprotection, labour standards and anti-corruption. Withover 3,200 member companies, the Global Compact hasbecome the world’s largest CSR initiative. In the Europeand CIS region, national networks exist in Armenia,Belarus, Bosnia and Herzegovina, Bulgaria, Croatia,Georgia, Hungary, Lithuania, Northern Cyprus, Macedo-nia, Moldova, Poland, Russian Federation, Turkey, andUkraine. These networks help companies to exchangeideas on how best to implement CSR principles, and tobetter support development programming.

Coca-Cola’s ‘Every Drop Matters’ regional water partner-ship with UNDP highlights recent developments in thisarea. Since for Coca-Cola clean water is a key input forvirtually all its products, sustainable water resourcemanagement is a key business objective. One joint proj-ect in Croatia has mobilized local communities to regu-larly clean local rivers by ‘adopting’ them.3 Microsoft,which is providing software and curricula to telecentresaround the region, is working with UNDP in Bulgaria toprovide computing and Internet facilities to tens ofthousands of beneficiaries. It is also working to strength-en IT skills of disadvantaged Roma communities in Hun-gary, the disabled in Poland and the Czech Republic,and youth in Slovenia, to bolster their employmentprospects.

JULY 2007 | issue 7

23

Multinationals are also introducing CSR principles tothe region via supply chain management. For exam-ple, the British retail chain Tesco has offered its suppli-ers the chance to sell on the UK market if they can fol-low stringent social and environmental principles.Danisco Sugar in Lithuania employs supply chainmanagement techniques to ensure that social, envi-ronmental, ethical and quality standards are beingmet by its suppliers.

Human resource development is another focus areafor CSR in the region. SVIK, a Slovak textile company,has invested in a local trade school in order to increasethe number of skilled Roma workers on which thecompany can draw. Today, Roma employees–most ofwhom were trained in this trade school–comprise onethird of SVIK’s workforce. Kurt Zrt, a medium-sizeddata recovery company in Hungary, has sponsoredtechnical education programmes for disadvantagedyouth, as part of efforts to ensure adequate supplies ofskilled workers.

Large Russian companies–including those in which thestate retains important ownership stakes–are also show-ing strong interest in CSR. The aluminum maker Rusal isspending $10 million a year to run grant programmesthat support the environment, worker health and safety,and the communities in which the company operates.Other Russian companies such as gas giant Gazpromand electricity provider UES are demonstrating theirinterest in CSR, in part so they can access Western capi-tal. Going beyond what is required by law is importantfor western markets, which have shown more skepti-cism towards Russian business practices. Pursuing CSRhas served to lower financing costs and risk premiumsfor Russian companies.4

Firms in Russia are not the only ones who need toimprove public perceptions of their business practices.Charges of corporate social irresponsibility have beenlevied against prominent western multinationals,including Coca-Cola and Tesco. In 2006, six states inIndia announced partial or complete bans on Coca-Colaproducts after claims that the drinks contained harmfulpesticides. Tesco has been criticized for building onhighly contested greenfield sites, and for underminingthe livelihood of small traders. For these (and other) rea-sons, critics perceive CSR initiatives as being merely win-dow dressing to distract attention from harmful corpo-rate behaviour.

More questions than answersThe fundamental question for development practition-ers is whether CSR helps to reduce poverty. Unfortu-nately, its newness in the post-communist region pre-cludes definitive answers to this question. It is clear thatlong-term thinking–a cornerstone of corporate socialresponsibility–gets short shrift in many local companies,which are fighting for survival, struggling to pay salaries,and fending off the tax office. UNDP research on CSR inPoland strongly suggests that large numbers of compa-nies will not become interested in CSR until their cus-tomers start to value it. However, UNDP CSR studies con-ducted in Croatia, Hungary, Lithuania, Poland, and Slo-vakia do suggest that CSR initiatives can have a signifi-cant impact on poverty and social exclusion.

Prodded by foreign investment, multilateral organiza-tions, and local leaders, CSR has a fighting chanceamong larger companies in the region. As distinct fromthe West, where the chief drivers of CSR have been con-sumers and civil-society groups, the chief proponents ofCSR in Central and Eastern Europe and the CIS remainforeign investors and large indigenous companies. Thereal question now is how to spur consumers and civilsociety groups to replicate the role they play in theWest, in pushing companies to pursue more responsiblebusiness practices.

Peter Serenyi, Communications Associate for UNDP’sBratislava Regional Centre, is managing editor of Devel-opment and Transition.

1 Competitive Social Responsibility: Uncovering the Economic Rationale for Corporate SocialResponsibility among Danish Small- and Medium-Sized Enterprises. Working paper pre-pared by Mark Kramer, Marc Pfitzer, and Paul Lee. FSG Social Impact Advisors and theCenter for Business and Government, John F. Kennedy School of Government, HarvardUniversity, July 2005.

2 Beata Roguska, ‘The Owner, Employer, and Citizen: Reconstructing the Image of Entre-preneurs’, in The Economic Awareness of Polish Society and the Image of Business, ed. L.Kolarska-Bobinska. Warsaw: The Institute of Public Affairs, 2004, p. 103-131.

3 See http://www.undp.hr/show.jsp?shownewsrepcat=71660&page=51980&showsin-gle=68444.

4 Stephen Schmida, ‘A Russian Twist on Responsibility.’ The Moscow Times. 31 January 2005.

Microsoft is helping people with disabilities gain high-tech job skills inthe Czech Republic

Photo courtesy of Microsoft

The International Media Forum on Corporate SocialResponsibility will be held in Kyiv, Ukraine on 12-13 July.The Forum, organized by the UN’s Global Compact in part-nership with Expert magazine and Mobile Telecommunica-tions System, will focus on the role of the media in promot-ing, challenging, and implementing corporate socialresponsibility (CSR). To register for the event please sendan email to [email protected].

The MDG Forum on North and Central Asia will be heldin Bishkek, Kyrgyzstan on 19-20 July. This event will focuson progress made towards achieving the MillenniumDevelopment Goals (MDGs) in Central Asia and the Cauca-sus. Participants will also discuss water and land manage-ment, pro-poor growth through regional cooperation, andMDG data and monitoring. The event is being organized bythe United Nations Economic and Social Commission forAsia and the Pacific (UNESCAP), the United Nations Devel-opment Programme (UNDP), and the Asian DevelopmentBank (ADB). For more information please contact JacekCukrowski ([email protected]).

World Water Week will take place in Stockholm, Swedenon 12-17 August. This is a key annual event for experts andorganizations working in the field of water governance.This year’s focus is ‘Striving for Sustainability in a ChangingWorld’. For more information please contact Juerg Stau-denmann ([email protected]).

Building Capacity to Measure and Foster the Progress ofSocieties: The role of Evidence-based Policy-Making. Thisevent, to be held on 26 September 2007 in Moscow, willbring together representatives of multilaterals, non-govern-mental organizations, and the media to discuss how to bringstatistics, policy makers, and societies closer together. Theorganizers are: the International Programming Evaluation

Network (IPEN), the State University – Higher School of Eco-nomics, the Organization for Economic Cooperation andDevelopment (OECD), the United Nations Children’s Fund(UNICEF), the United Nations Economic Commission forEurope (UNECE), and the United Nations Development Pro-gramme (UNDP). For more information please contactJaroslav Kling ([email protected]).

The forum entitled, Business Reputation: Responsibility,Transparency, Sustainability, will be held at the Presi-dent Hotel in Moscow on 5 October 2007. The RussianUnion of Industrialists and Entrepreneurs is organizing theevent together with UNDP-Russia and the Global CompactOffice. Participants will include Russian companies andinternational organizations that are working on issues ofsustainable development and socially responsible enter-prise. For more information please contact Asel Abdurah-manova ([email protected]) or Larissa Zelen-ina ([email protected]).

The sixth ministerial meeting Environment for Europewill take place in Belgrade, Serbia on 10-12 October 2007.The meeting will follow up on the last ministerial held inKyiv, Ukraine in 2003. In attendance will be ministers of theEnvironment, Foreign Affairs, Finance and other sectors todiscuss the progress of the official environmental strategyfor the countries of Eastern Europe, the Caucasus, CentralAsia, as well as the Balkan region. For more informationplease contact Viktoria Zimm ([email protected]).

The 39th National Convention of the American Associa-tion for the Advancement of Slavic Studies (AAASS) willbe held at the Marriott Hotel in New Orleans, Louisiana on15-18 November. This national forum makes possible abroad exchange of information and ideas, stimulating fur-ther work and sustaining the intellectual vitality of SlavicStudies. For all issues relating to the AAASS National Con-vention, please contact: Wendy Walker, AAASS ConventionCoordinator ([email protected]).

Forthcoming issues of Development and Transitionwill focus on:

Gender issues in the region (November 2007)

The Environment in Europe and the CIS (April 2008)

The editors welcome contributions. If you wish tosubmit an article please follow the guidelines atwww.developmentandtransition.net.

JOB OPENINGUNDP’s Bratislava Regional Centre is currently lookingto fill the position of Regional Practice Leader (Democ-ratic Governance Practice). For more information pleasevisit http://europeandcis.undp.org/?menu=p_jobs.

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Tel: +421 2 59337 111Fax: +421 2 59337 450www.undp.org/europeandcis

Development & Transition is published by the United NationsDevelopment Programme and the London School of Economicsand Political Science. The ideas expressed here do not necessarilyreflect the views or policies of either organization. www.developmentandtransition.net

Editor: James Hughes: [email protected] Executive Editor: BenSlay Deputy Editor: Gwendolyn Sasse Managing Editor: PeterSerenyi Marketing and Production Coordinator: Denisa PapayovaAdvisory Board: Nicholas Barr, Willem Buiter (Chair), StanislavGomulka, Mary Kaldor, Dominic Lieven, Margot Light, Kate Mortimer

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