Government-led industrial restructuring in transition economies: The role of information, incentives and legal setting (Bulgaria, China, Hungary, Romania)

After more than a decade of industrial reform initiatives, the economic performance of transition countries remains uneven. While some countries experienced rapid growth, a majority continues to suffer from depressed output levels and high structural unemployment. The dominant role of the public sector in the economy also remains an issue, in spite of the recent increase in the private sector's contribution to employment and output. Transition countries also differ in their ability to adopt the institutional and legal setting in line with other reform initiatives to move towards a market based economic system. In Part I, an analytical framework is developed, based on the literature on regulation under asymmetric information. As such, it contributes to the growing body of research, looking at the role of informational problems in the context of state-owned enterprise (SOE) restructuring. The model treats the implementation of an investment policy by the government for enterprise specific reforms as a contracting problem, analyzing distortions generated by asymmetric information between SOEs and the government. The feasible mechanisms to differentiate productive SOEs that have a higher chance of undertaking successful restructuring from unproductive ones are discussed. The arguments are made in relation to transition economies; however the model's implications are quite general and could be applied to any economy where the policy debate regarding restructuring declining industries is still unresolved. The model in particular sheds light to the complementary role of different reform initiatives in areas ranging from bankruptcy, corporate governance to performance-based pay and social safety nets. The theory section is complemented by individual country surveys in Part II, tracking legal developments in a representative set of transition economies. Four transition countries with divergent reform outcomes are selected: Bulgaria, China, Hungary and Romania. A comparative database of laws is assembled for each country in three areas, highlighted in Part I: organizing transfer of ownership and control of public commercial assets (privatization), coordinating firm default (bankruptcy); and improving wage structure and social protection (labor market). A legal system's capacity for adaptation and innovation is argued to contribute to the success of the structural reform as much as its enforcement capacity. Inconsistent application of laws, ad hoc regulations, unclear definitions of contractual obligations, among others are identified as factors contributing to transaction costs, and hampering investment levels and growth in transition economies. Part II also puts emphasis on the complementarity across legal reforms in determining the success of industrial re-structuring.