Chapter 2: Output Collapse, Reallocation, Restructuring, Market Selection

1. Chapter 2: Output Collapse, Reallocation, Restructuring, Market Selection

2. The evolution of GDP (1991-2000)

3. Causes of Output Collapse:1) Statistical Artefact Output collapse sharp, unexpected, faced by all countries most economists expected an increase in production  important to understand • Causes • Statitistical Artifact • official pre-transition statistics overestimated • imperfect measures of new small firm production • pre-transition prices vs electricity prices

4. 2) Aggregate Demand, Price Liberalisation and Stabilisation • Output decline coincided with price liberalisation • Stabilisation policies • Excess fall in aggregate demand • Not enough to explain such fall in output • Look at supply side explanations

5. 3) Monopoly versus Competition • Monopoly theory (Li, 1999): • Planned economy: few large firms, prices and quantity set by planner • Without central planner and without competition and competition policy  monopolies and chains of monopolies  output contraction

6. 4) Imperfections of Markets • Credit market imperfections: • Firms needed credit but difficult to obtain (high interest rates) contraction of firm production (Calvo and Coricelli, 1992) • But also higher credit to clients and SBCs • Labour market frictions: • Workers have to move from old to new firms  search costs mean time unemployment and output fall (Atkeson and Kehoe, 1996) • Real product wages did not change while consumption wage did (Blanchard, 1997)

7. 4) Imperfections of Markets (cont.) • Cut in subsidies too fast? unemployment from state firms  increase taxes to pay unemployment benefits higher taxes restrict output growth unemployment (Aghion and Blanchard, 1994) • Inefficient rent-grabbing and rent-seeking behaviour • Example: size and number of bribes to open and run a business

8. 5) Reorganisation • Systemic changes  existing information osolete  takes time to build new information stock  output is low at first – explains output of new firms. • New firms wish to try new technology  process of trial and error until achievement when output increases (Atkeson and Kehoe, 1997) • Firms have to replace old technology and complete adoption of new technology takes time (Sussman and Zeira, 1994)

9. 6) Trade • CMEA trade collapse (Rodrik, 1994) • Almost total collapse of trade • Disorganisation • Shortage of inputs? • Relevant for some countries e.g Hungary

10. Reallocation • Reallocation in the production process • Liberalisation plus Removal of state subsidies and legal restrictions to entry • moving from output maximization to profit maximization and cost minimisation • reallocation of labour and capital • from state firms producing low quality goods to new private firms producing new goods, among sectors Thus state firms decreased employment and output. Questions: Why so deeply and why did private firms not compensate the decrease? Disorganisation

11. Central Plan vs Market

12. 7) Disorganisation effects of liberalisation • Reallocation does not occur instantaneously. • There are frictions. What are these and what is the impact on the optimal speed of reallocation? • Which instruments can affect the speed of reallocation? • subsidy cuts ? • enterprise closures? • -information? • Look at decisions of individual firms

13. 7a) Information and Bargaining Problems • Transition = systemic change (Blanchard and Kremer, 1997) • production in planned economy: • one buyer and one supplier • centra planner making sure all produced to avoid disruption of production • liberalisation free to choose from many buyers and suppliers

14. 7a) Information and Bargaining Problems (cont.) • while true in the West, in transition economies only few suppliers and buyers but no planner! Markets could not do the job overnight. • Suppliers feel they have more opportunities in the private sector nevertheless • Lack of information on suppliers and their prices take it or leave it offer with potentially no agreement = bargaining failure • Also short term relationships rather than long term ones • Plus potential close down of state firms • Consequence: disruption! Higher the longer the supply chain. Some cases sarted before transition.

15. 7b) Search frictions and investment specificity • firms have to find long-term partners to invest  search and find or no investment •  disruption: fall in investment and in the eplacement of capital (Roland and Verdier, 1997)

16. 8) Initial Conditions • Geographical location • Historical proximity • FDI • Ethnical conflict and/or war • Industry structure and firm size • Political stability, commitment, momentum • Inflation, Monetary and Fiscal policies • Aggregate demand help explain differences across countries

17. Disorganisation • Disorganisation involves • Coordination mechanisms disintegrate • Breaking production and trading links • Disorganisation exacerbated by continuing control of the government over the economy • Multiplier effect of trade on output

18. Empirical Evidence of Disorganisation: Ukraine

19. Konings and Walsh, 1999 • Dataset • 300 Ukrainian firms • 50% of the traditional pre-transition firms • 50% of the de novo only private firms • Manufacturing, trade, and services • Most are privatised = 46% (mean size=452 workers=large) negative employment growth 12% • 9% are SOEs (mean size=598 workers=large) idem • 45% de novo firms (mean size=29 workers=small) positive employment growth 10%

20. Konings and Walsh, 1999 • Privatised + SOEs = “traditional firms” group • Survived first years of transition • Have market demand • Restructuring and reallocation costs relative small  no exit • De novo group • Perceived that could do well • How did disorganisation limit their growth in terms of employment and productivity?

21. Table 1: ‘Aggregate’ Job Turnover and Net Employment Growth = early restructuring in Ukraine

22. Table 2: The Age Composition Equipment

23. Table 3: Gross Job Flows According to Ownership in 1996 “Traditional young equipment”: a) less negative employment growth than “traditional old equipment” and b) job turnover closer to de novo firms.

24. Table 4: Disorganization Indicator I

25. Table 5: Disorganization Indicator II Traditional firms have a more complex production.

26. Table 6: Structure of competition in the product and input market

27. Table 7: Frequency of dependence on imported inputs

28. Table 8: Frequency of financial Difficulties in 1996

29. Table 9: Evolution of productivity since 1995

30. Table 10: Dependent variable: Firm Level Employment growth in 1996

31. Table 11: Ordered Probit results, dependent variable: Evolution in Productivity: 1 = down, 2= the same and 3 = up

32. Conclusions • Small firms grew more in terms of employment and productivity • Lack of new investment / new equipment • constraints employment and productivity growth of traditional group (pre-transition firms) • The number of products = complexity of production • similarly especially traditional with old equipment

33. Conclusions • Better performance of de novo firms related to: • inputs imports • (also traditional with new equipment when looking at productivity ) • competition Disorganisation affects negatively firm performance

34. Restructuring • Production structure was distorted compared to market economies • Relative overdevelopment of heavy (e.g. military) industry vs underdevelopment of services • A bias toward few big firms and against small firms • High capital intensity but obsolete equipment • Low quality products • Labour and input hoarding

35. Table 1.1: Sectoral Allocation of Labour in OECD and CPEs (percentage shares)Source: OECD

36. Table 1.2 Distribution of Employment in Industry by Size of Firms (Percentage shares) Source: OECD. Data for West Germany, France and Italy are from 1987, for the GDR from 1988 and for the other countries from 1989.

37. Restructuring • With transition Need change of structure and organisation of production plus in most cases ownership • Reduce labour (especially low productivity labour and close down obsolete plants) • Change products and product quality • Change capital /equipment • Change managers  higher output, quality and productivity  also unemployment state sector and potentially overall although future recovery

38. Initial Restructuring Shedding off labour that does not directly contribute to the production process (social networks) Wage cuts in order to meet hard budget constraints Deep Restructuring Adoption of modern technologies Re-training of management and workers Replacing the inefficient production workers with the more efficient ones Modernisation of obsolete equipment Initial and Deep Restructuring

39. Obstacles to Deep Restructuring 1.Those whose jobs are at risk will oppose restructuring: • unskilled managers • workers at obsolete plants 2. Restructuring is likely to require large capital expenditures • capital equipment of state firms is obsolete • financing replacement from retained earnings difficult: no well-defined rights for future profits 3. Privatisation mode (e.g.insiders), lobbies, political commitment, unemployment compensation

40. What was predicted? • Job Destruction (JD) but no Job Creation (JC) in the state sector (SOEs). Did it happen like that? • Jobs moving from state-owned enterprises to privatised or private ones. Did they? • Jobs moving from declining sectors or regions to growing sectors or regions. Did they?

41. Evolution of Employment (1990-2000)

42. Faggio and Konings, 1999

43. Table 2: Description of the sample according to ownership types (1993, 1997). Note: (i) 1993 figures refer to 1994 for Romania and Bulgaria. (ii): the ownership classification is not available for Estonia

44. Table 3: Annual net and gross job flows for Bulgaria, Romania, Estonia and Poland (1993-1997)

45. Table 3 (cont.): Annual net and gross job flows for Slovenia (1993-1997)

46. Table 4: Annual average gross and net job flow rates according to ownership type 1994-1997

47. Table 5: Annual average gross and net job flow rates according to firm size, 1994-1997

48. Table 6: Fraction of excess job reallocation resulting from employment shifts between sectors (in %) Note: Sectors are classified according to the NACE Rev. 1, 1-digit classification

49. Table 7: Fraction of excess job reallocation resulting form employment shift between regions (in %) Note: Regions are classified according to the Eurostat Nomenclature in CECs (level 3): 28 countries in Bulgaria, 41 in Romania, 5 in Estonia, 49 in Poland and 12 in Slovenia.

50. Results • Average firm employment decreased over time • Poland-Estonia-Bulgaria-Romania- Slovenia • Size SOEs decreased • All countries all but for 3 years: JD>JC  neg. employment growth but JC>0 • Romania and Bulgaria always • Poland and Estonia JD=JC last year, similar to Belgium and UK respectively • Slovenia values are closer • Gross job reallocation: Estonia-Romania-Slovenia- Poland-Bulgaria