Enterprise Isolation Programs in Transition Economies

Abstract

Poor results from the isolation program for financially distressed firms in Romania suggest that enterprise restructuring under government auspices does not work - that transition economies should privatize rapidly, without attempting first to restructure enterprises. How should countries in transition to market economies handle the losses of large loss-making enterprises? Over the past six years several governments in transition economies have implemented isolation programs that combine features of reorganization under bankruptcy (as in industrial countries) with severance payments for employees and assistance with labor deployment. Djankov analyzes isolation programs for financially distressed firms in transition economies based on empirical evidence from Romania, the program that had the greatest coverage. The results indicate that Romania's isolation program fulfilled none of its intentions. Despite substantial costs, it neither delivered tangible improvements in operational performance nor improved the process of privatization or liquidation of large loss-making enterprises. Worse still, the program may have delayed restructuring by not imposing hard budget constraints. Firms included in the program faced softer budget constraints than their counterparts outside the program. Loss makers were not selected through objective criteria, and the agency in charge was not sheltered from political pressure in enforcing hard budget constraints. Djankov therefore questions the feasibility of creating special programs for enterprise restructuring under government auspices, with government agencies choosing beneficiaries and deciding on the scope of activity. His conclusion supports the insistence of international donor organizations that governments in transition economies privatize rapidly, without attempting first to restructure enterprises. This paper - a product of the Economic Policy Unit, Finance, Private Sector, and Infrastructure Network - is part of a larger effort in the network to study transition economies. The study was funded by the Bank's Research Support Budget under the research project Enterprise Restructuring in Bulgaria and Romania (RPO 681-96).