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Joseph E. Stiglitz
Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia
University, was Chairman of President Bill Clintons Council of Economic Advisers and served
as Senior Vice President and Chief Economist of the World Bank. His most recent book, coauthored with Bruce Greenwald, read more

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JUN 25, 2001 0

Serbias Advantages in Coming Late

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On June 29th, donor countries will meet to discuss aid to the former Yugoslavia. The talking will
be tough, particularly on the issue of extradition of indicted war criminals to the International
Tribunal in the Hague. Such talk, however, must not be allowed to obscure a clear-eyed
assessment of what Serbia really must do in order to get back on its feet economically.
Serbia is the last ex-Communist country to begin a transition to a market economy. Although it is
impossible to compensate Serbias people for a wasted, brutal decade, there are advantages in
reforming late: Serbs can learn from the mistakes of others.

Joseph Schumpeter, the great Austrian economist, described the dynamics of a market economy
as creative destruction : new innovations replace old devices; new firms drive old ones out of
business. The postcommunist transition, too, involves creative destruction: new institutions, new
ways of organizing economic, social, and political relations should replace old, discredited ones.
But destruction makes sense only if something is created to take its place. Destroying jobs is not
a virtue in its own right; it is a virtue only if new and better jobs are created. High productivity
jobs, however, require entrepreneurship and capital, and from the outset the transition countries
lacked both, as well as the institutions that support them.
Every society possesses latent entrepreneurs, but to energize them banks are needed so that their
new businesses can be funded. In too many postcommunist countries, real banks not those that
lend money to governments or finance deficit-ridden state enterprises, but banks that foster new
enterprises with credits and advice were absent.
Moreover, the type of disciplined, practical lending that entrepreneurs need cannot exist if real
interest rates are too high. In America and Europe, moderate real interest rates of 5% or less are
often viewed as dampening economic activity. So how can real entrepreneurship emerge when
real interest rates are soaring, which is what happened in the transition countries?
Beyond watching real interest rates and banks carefully, Serbs should also beware the siren song
of rapid privatization. Privatization was supposed to increase efficiency and lower prices. In
many cases, it did neither. Privatization had little impact on growth in countries that did not
require good corporate governance within privatized firms. Where monopolies were privatized
before competition and regulatory policies were in place, privatized firms grossly exploited
consumers.
In some countries (say, the Czech Republic) where privatization was accompanied by the
continuation of government-managed banks, privatization offered a new way to siphon public
money into private hands. Lacking democratic safeguards, the temptation was irresistible.
The efficiencies that come with privatization are usually seen prior to privatization; they occur as
soon as hard budget constraints when companies have fixed budgets without state handouts
are imposed. Czech bank socialism lacked hard budget constraints. Semi-state owned banks
kept funneling money to firms on government directions. Even when the environment is
favorable with democratic checks and working institutions privatization and deregulation still
can go wrong. Witness Britains privatized railways and Californias electricity industry.
A more fundamental question also needs to be asked: in the postcommunist countries, which
individuals could afford to buy privatized firms? Where was their capital to come from? The
answer, sadly, turned out to be that people with friends in the state banking system secured the
funds to buy privatized enterprises at discount prices.
Voucher privatization seemed to offer an alternative form of peoples capitalism. But voucher
privatization dispersed shares widely, and to succeed, equity markets with wide share ownership

need strong protections for investors. In the Czech Republic, which pioneered this method, the
holding companies that were supposed to provide oversight instead helped insiders tunnel out
assets. A few people became wealthy, everyone else felt cheated. In addition, capital markets
failed to help enterprises restructure. Of course, successful privatization did occur: Hungary sold
firms to foreign investors, Poland and Slovenia privatized gradually. But these were rare.
Three lessons emerge from the postcommunist transition:
- insisting on speed, on rapid privatization, is disastrous. Countries that lagged behind at first,
like Hungary, Poland and Slovenia, are now the leaders;
- incentives matter. If the wrong incentives are in place, Russian and Czech-style asset stripping
will follow;
- privatization works only if it is part of a broader transition strategy that emphasizes job creation
and creates legal and other institutions needed to underpin a market economy.
Some economists naively thought that once assets were privatized, new owners would demand
the rule of law. Obviously, they didnt know history. John D. Rockefeller did not demand the
anti-trust laws of the late 19th centurys; Bill Gates isnt demanding a competition policy today.
Oligarchs prefer crony capitalism and kleptocracy to the rule of law. Historically, the middle
classes demanded the rule of law, but the postcommunist transition silenced the middle classes
by impoverishing them.
Despite the pain of the past decade, the prognosis going forward remains bleak. Across Eastern
Europe and the former Soviet Union there is a profound lack of confidence in the market
economy, even a lack of confidence in democratic processes so undermined by corruption.
If Serbia absorbs these hard lessons its transition will be smoother than in the countries that
pursued shock therapy. It should seek a balanced role between government and the private
sector, as well as balance economic efficiency with a concern for social justice.

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