Entrepreneurship and the Role of Government in Post-Socialist Economies: the Challenge of Institutionalisation Professor David Smallbone Small Business Research Centre Kingston University Kingston Hill Kingston upon Thames, KT2 7LB, UK (Tel: +44(0)20 8547 7218; fax: +44(0)20 8547 7218; Email: [email protected]) Professor Friederike Welter University of Siegen (Germany) and the Telia Sonera Institute at the Stockholm School of Economics in Riga (Latvia) (Tel. +49271740-2844, Fax +49271740-2279, E-mail: [email protected])

Abstract Former socialist economies provide a potentially rich context in which to examine the relationship between government policies and entrepreneurial behaviour. The main aim of this paper is to assess the role of government in relation to entrepreneurship development in economies, where, until the 1990s, private business activity was for the most part illegal. Experience over the last 20 years has shown that the most challenging aspect of the reform process has been institutional change, which explains the decision to focus on this aspect in this paper. By including evidence drawn from both Central and East European countries that are now members of the EU as well as states of the former Soviet Union, the paper will analyse both enabling and constraining influences of government, and its role in relation to institutional change.

1. Introduction Although entrepreneurship and small business researchers have been concerned with the policy implications of their research for many years, there is evidence of increasing interest in policy issues, evidenced by the recent publication of a number of books on entrepreneurship policy (e.g. Audretsch et al., 2007; Hart et al., 2003; Lundström and Stevenson, 2005) and two special issues of international journals forthcoming1. At the same time, the emphasis in these publications is on entrepreneurship policy in mature market economies, where policy makers have considerable accumulated experience and the policy environment has evolved 1

In the International Small Business Journal a special issue on entrepreneurship policy and in Entrepreneurship Theory and Practice one on government policy and entrepreneurial activity.

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over many years. This contrasts with post-socialist economies in Central and Eastern Europe and the former Soviet Union, where in many cases, private business activity was illegal prior to the 1990s. In view of the enormity of the challenge this represented to policy makers, postsocialist economies provide potentially rich ground for researchers interested in investigating the relationship between government policy and actions and entrepreneurial behaviour.

As entrepreneurship is increasingly recognised as a global phenomenon (reflected, for example, in the growing number of countries joining the GEM project), it is important that entrepreneurship researchers acknowledge the heterogeneity of environmental conditions, outcomes and behaviours associated with entrepreneurship (Davidsson, 20003). Whilst entrepreneurship results from the creativity, drive and skills of individuals (and groups of individuals), government is a key influence on the external conditions in which entrepreneurship occurs, influencing both the extent to which it develops and the form that it takes. In this context, it is argued that government policies and actions are a key element in the social embeddedness of entrepreneurship and, in some transition environments, a dominant influence.

At the same time, it must be recognised that almost 20 years after the process of market reforms began, there is sufficient differentiation of experience between former centrally planned economies, to question the legitimacy of treating them as a single group (Smallbone and Welter, 2001). Whilst sharing a common heritage in central planning, considerable differences can be identified between CEECs that are now members of the EU, and which are best described as ‘emerging market economies’; and former Soviet republics where the process of market reform is partial and in some cases has stalled completely. Although the latter may be reasonably described as ‘transition economies’, use of the term can be

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questioned, if taken to mean the process of reform is ongoing, since in some countries, this is not the case.

The challenge facing post-socialist economies at the start of the reform process was to create a policy context in which new businesses could be created and grow, as part of a shift of the means of production from public to private ownership. As a result, any assessment of the role of policy in this regard needs to adopt a broadly based view of what constitutes public policy. This is because a wide range of government policies and actions can impact on entrepreneurship and small firms; not just those that are targeted in this way, since some of the influence of government on entrepreneurship and small businesses may be inadvertent. As a consequence, it is more appropriate to think in terms of the influence of government policies and actions on entrepreneurship and SMEs, than more narrowly in terms of ‘entrepreneurship’ or ‘SME’ policy.

In such a perspective, direct intervention designed to increase small firm’s access to finance, for example, may appear insignificant alongside the role of government in shaping the regulatory environment for private business; and/or influencing the value placed on enterprise and entrepreneurship in the society at large, through the actions of government representatives and officials. This is partly because the experience of the transition period has been that an implementation gap typically exists between policy pronouncements and actions. However, an emphasis on the role of government broadly defined is also due to the important role of institutional development, which involves not just market institutions, such as banks, other financial intermediaries, consultants and training organisations, but also public sector regulatory bodies of different sorts, together with market oriented behaviour on the part of such institutions.

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The evidence from the transition period suggests that establishing an appropriate and effective institutionalisation of entrepreneurship policy is one of the main preconditions for productive entrepreneurship to be developed and sustained. Key roles for the state in this regard are to remove unnecessary obstacles to enterprise creation; establish a facilitating environment for private sector development; and to contribute to the development of appropriate institutions that operate to facilitate private sector development, not to prevent or to milk it, with punitive taxation and continual changes to the ground rules to which business must operate. The effective institutionalisation of SME policy involves different forms of partnership between national and regional authorities, as well as between government at different levels and various private sector bodies. A key priority in this respect is to establish the mechanisms for effective dialogue between the state and entrepreneurs. Thus a key aspect of effective institutionalisation of policy is effective co-ordination between the various institutions involved, both formal and informal.

In this context, the rest of the paper focuses on four key and interrelated themes:

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Challenges involved in creating an institutional framework with the orientation and capacity to facilitate entrepreneurship development;

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the regional dimensions of institutionalisation and entrepreneurship policies;

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dialogue and governance issues, which present enormous challenges in a situation where there is no recent tradition of self-governing organisations;

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and regulation, in a context where the role of the state in relation to business needs to be redefined.

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In discussing each theme, examples are presented from countries at different stages of market reform, in order to bring out the role of government as both an enabling and constraining influence.

The data used in the paper are drawn from a number of empirically based investigations of entrepreneurship in which the authors have been involved since the mid 1990s, in countries that include Poland, the Baltic States, Russia, Belarus, Ukraine, Uzbekistan and Moldova. Most of these studies include both survey and case study evidence that will be selectively drawn upon to examine the role of government and institutions at different stages of market reform, the processes involved in the institutionalisation of policies for entrepreneurship and the effect of this on entrepreneurial behaviour.

2. Developing an Institutional Framework to Facilitate Entrepreneurship Analysis of the experience of entrepreneurship development in post-socialist economies over the last 20 years emphasises both the important role of institutions and the challenges involved in creating an enabling institutional environment. Where the institutional environment is seriously deficient, the number of private firms remains small and those that do operate are forced to adapt in ways that can result in significant resources being allocated to non-productive activity.

2.1 Institutional deficiencies as persistent problem: The example of the newly independent states (NIS) The constraining influence of institutional deficiencies on entrepreneurship development which is a major impediment to entrepreneurship development in many post Soviet transition economies, may be illustrated with reference to Belarus, where the operating environment for

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business is currently one of the most hostile in the world, based on an assessment by the European Bank for Reconstruction and Development (EBRD, 2005). Since the early 1990s, the overall economic environment in Belarus has constrained both the creation and subsequent development of small businesses, because of the combined effect of multiple exchange rates, import/export restrictions; poor access to loans and the crisis in the late 1990s caused by the collapse of the Russian rouble. Although government claims to support small enterprises through the creation of an appropriate legal environment for business activity; the provision of soft loans; and the establishment of an advisory infrastructure, in practice, few positive policy actions have been consistently implemented and credit lines are not fully established. In short, an ‘implementation gap’ can be said to exist with respect to so-called ‘small business policy’ in Belarus, which is a phenomenon previously reported in other postsocialist economies (Smallbone et al., 1999). A typical reason for this is a failure to allocate a budget to support policy pronouncements, often reflecting a lack of political commitment to private sector development, as well as deficient policy processes.

In terms of institutionalisation, in such transition countries with slow, or little, progress with market reforms, the legal framework is still one of the main barriers to the development of small business and entrepreneurship. Creating an adequate legal framework involves laws relating to property, bankruptcy, contracts, commercial activities, taxes, but it also involves developing an institutional framework with the capacity to implement it, with major implications for staffing. In practice, specialised economic courts; a private legal profession and effective enforcement mechanisms are lacking for the most part. In addition, there is a lack of adequate personnel in government administration, because of low public sector salaries combined with a lack of education and training opportunities. Frequent changes in tax regulations and other commercial laws require a constant adjustment of knowledge by

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small business managers (and/or a need to pay advisers to help them remain compliant), as well as by those in government administration. All of this results in time lags, uncertainty and arbitrariness in decision making on the part of public officials, with regards to law enforcement, which is not helped by a typical lack of specificity in the drafting of laws. Fundamentally, these institutional deficiencies reflect a lack of political commitment to facilitate private enterprise development. Belarus may currently be one of the worst examples, but the issues identified above exist to varying degrees in most of the other former Soviet republics (apart from the Baltic States, which are now part of the EU).

Empirical evidence suggests that in such conditions, entrepreneurs often cope with an inadequate institutional framework through ‘evasion’ strategies, which include combining legal and informal production; setting up a ‘fictitious’ enterprise; and cash payments to employees, which are undeclared to the tax authorities (Welter and Smallbone, 2003). A further example is diversification into unrelated activities, which may be seen as a necessary strategy for generating revenue in an environment that is both resource and demand deficient. But it is also as an attractive development path for successful entrepreneurs, who are keen to avoid being noticed as too successful, because of the unwarranted attention this can attract from officials and representatives of the KGB.

In this context, it is also hardly surprising that the number of privately owned enterprises in such countries remains small. In Belarus it amounts to approximately 33,000 registered small enterprises by the end of 2005, that is in a country of approximately 10m people (Ministry of Statistics and Analysis of the Republic of Belarus, 2006), accounting for modest levels of employment (about 456,000 in 2005). Even if the 228,000 registered individual entrepreneurs are added, the level of entrepreneurship per head in Belarus is below that of most other NIS,

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including Russia, Ukraine and Moldova. Moreover, the authoritarian nature of the regime severely limits the scope for informal unregistered activity to exist. In the assessment of the World Bank (2003), the level of development of private businesses in Belarus lags behind all neighbouring countries.

2.2. Building institutional capacity: The example of Central and Eastern Europe and the Baltic States In all former socialist countries, the starting point for private sector development was the administrative and legal reforms that made it possible for private companies to exist alongside SOEs. This applied in Belarus and former Soviet republics, as well as in CEECs that are now members of the EU. However, in the latter case, the dynamic growth of entrepreneurship after 1990 generated considerable demand for institutional change, focusing on developing a legal infrastructure appropriate to market conditions and the creation of commodity, capital and labour markets.

Institutional capacity building has proved to be the most challenging aspect of the reform process in all transition economies and one that is central to the continued development of entrepreneurial capacity in these countries, because of its potential impact on transaction costs. However, in CEECs that are now part of the EU, the process of Accession has contributed to institutional and policy development, driven partly by the need for Accession countries to meet the conditions for entry laid down by the EU, and partly by the desire to have the institutional conditions in place that would enable new members to successfully access EU Structural Funds to facilitate restructuring. This can be illustrated with reference to Estonia, which is a country where considerable progress has been made in terms of institutional development, in contrast with Belarus.

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Following independence in 1991, government policy in Estonia has been underpinned by a free market philosophy and a commitment to the institutionalisation of private ownership and market reforms. Rapid privatisation meant that by the end of 1996, most large enterprises had been sold, with attention then turning to the utilities, such as energy, telecommunications, railways and ports. Since 1991, Estonia has also had a liberal trade policy in which trade barriers and tariffs have been largely abolished, leading to a growth in exports, on the one hand, and to an inflow of duty free imports, on the other. It has also contributed to Estonia’s success in attracting foreign investment, which has been an important enabling factor contributing to the success of its economic reforms and the structural transformation of the economy. As a result, on most indicators of market reform, Estonia scores highly in comparison with other Central and Eastern European countries and former Soviet republics. For example, based on EBRD assessment, by 2005, 80% of GDP was contributed by the private sector (EBRD, 2006).

During the initial phase of transition, government was responsible for administrative and legal reforms, which made it possible for privately owned enterprises to develop, although for a time the continuous nature of these changes contributed to an unstable and uncertain business environment. It also took some time to completely revise the tax system, which meant that the development of small private enterprises was initially constrained by the remains of a tax regime inherited from the Soviet period. At the same time, during the 1990s, direct support measures to support small business development in Estonia were noticeable by their absence, with the role of government best characterised as one of limited intervention, focusing instead on establishing the framework conditions to facilitate productive, private enterprise development.

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The development of an appropriate institutional framework is an important part of the process of market reform. In general, the institutionalisation of business support includes the development of institutions on three levels: macro-, meso- and micro-level (Welter, 1997). At the macro level, responsibility for enterprise support in Estonia has been rationalised under the Ministry of Economic Affairs, with the aim of making more effective use of the resources available for enterprise support. This contrasts with the situation prior to 2000, when a total of five Ministries were involved in enterprise support directly or indirectly. Alongside a rationalisation of agencies and of responsibilities between Ministries, there have also been developments in the policy process, including the publication of a national policy document for SME development (Estonian Ministry of Economic Affairs, 2002), which represents a significant step forward in strategic thinking, with related measures and responsibilities for implementation. A particularly noteworthy step was linking strategic policy objectives to specific action plans, tied into the budgetary process, since this helps in overcoming the implementation gap that was previously referred to as a common feature of (small business) policy in a post-socialist context.

Considerable progress has also been made in developing the institutional framework for enterprise development at the meso level. This includes the banking system, which, now largely under foreign ownership has developed a range of financial products similar to those available to enterprises in a mature market economy. It also includes a number of unions, associations and chambers, established by special interest groups, mainly on the basis of voluntary membership. Some of these, such as the Chamber of Trade and Commerce and specialised sector-based organisations have been the main source of support for businesses, particularly with regard to the process of exploiting foreign markets. In 2000, the public

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business support infrastructure in Estonia was rationalised into two organisations, in an attempt to make it more efficient, transparent and accessible: Kredex, the Credit and Export Guarantee Fund, and Enterprise Estonia, which has responsibility for implementing public business support measures.

At the micro-level, institutional development has focused on the development of a network of business development centres that originated with foreign donor funding in the 1990s. Previous evaluation had identified a number of weaknesses in the donor-financed network, including poor relationships with local authorities and other relevant institutions (such as banks), and limited impact within local business networks. Other problems identified included the ongoing dependence of these centres on subsidies, the poor advertising of their services, and the fact that their activities had been mainly limited to dealing with start-ups (Bateman, 2000), leaving established businesses not well provided for. As a result, the business support network has been the subject of reform, both to improve the quality and effectiveness of services delivered to small businesses but also to improve the administration, management and cost effectiveness of the support institutions.

3. The Regional Dimension Within post-socialist countries, the development of entrepreneurship varies considerably between regions and localities (Smallbone et al., 2001), as it does in most mature market economies (e.g. Reynolds et al., 1994). This draws attention to the role of regional and local governments and their communities in economic development (Commission of the European Communities, 2001b) and the potential importance of ‘bottom-up initiatives’, which may create the most effective milieu for entrepreneurship development. It means that there is a need for institutional capacity building at the local and regional, as well as at the national

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level, if the contribution of entrepreneurship to local/regional development in new member states of the EU is to increase. In some countries (e.g. Estonia), the issue is associated with a need for a reform of local government structures, which have neither the capacity or resources to effectively engage in regional policy, and a strengthening of the role and experience of local authorities in local economic development. However, there is also a need to examine the influence of ‘soft’ factors (i.e. informal institutions in North’s understanding, North, 1990), such as the level of involvement of local entrepreneurs in the process, and the skills and capacities of local government in this area.

The socialist model of economic development was a centralised one in which local and regional government had little responsibility for, or powers to influence, economic development. In countries, such as Belarus, little has changed in this respect, thereby limiting the scope for regional development programmes. This may be illustrated with reference to border regions, where cross border co-operation involving institutions and enterprises might help to stimulate economic development, although a lack of powers and resources at the regional level limits the scope for exploiting this potential. At the same time, previous studies have identified some local/regional variation in the attitudes of local government towards business in Belarus, which is reflected in the behaviour of licensing officials and other employees, influenced by the guidelines laid down by the local mayor. As far as entrepreneurs are concerned, the local institutional environment was more ‘user-friendly’ in the capital than in the peripheral region. In other words, a centralised government structure does not preclude some variation in the behaviour of government organisations at a local level. It is at the local level where small firms typically come into direct contact with the various officials representing government, which in view of the room for discretion in

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interpreting laws and regulations on the part of those responsible for implementing them, increases the scope for spatial variations (Smallbone et al., 2001).

However, the institutional ‘hole’ at the regional level, which is typical in post-socialist economies, may be illustrated with reference to Romania, where one of the current policy priorities (as it is in other new member states of the EU) is to increase the competiveness of the SME sector, through innovation and a greater emphasis on non-price competitive advantages. However, addressing this issue satisfactorily, only partly depends on the attitudes and behaviours of entrepreneurs; it also has major implications for policy and institutional change. This is because innovation in SMEs does not occur in isolation, relying instead on external inputs from the regional and national innovation systems, which include public research institutions, technology transfer organisations, education institutions, the legal, institutional and policy framework, as well enterprises.

In a post-socialist context, it can be argued that the ‘soft’ elements of an innovation system gain particular importance because the ‘socialist heritage’ influences the current institutional frame for innovation as well as public attitudes and the general understanding of what constitutes innovation. In the Soviet period, in-house research in firms played only a minor role in innovation (Paasi, 2000) and industrial research was mainly carried out in research institutions of branch ministries. Even in countries that are at an advanced stage of transformation (e.g. Poland), the proportion of R&D expenditure spent at the firm level is much lower than in more established EU countries (Smallbone et al., 2001).

In this context, the creation of more market-oriented innovation systems in Romania presents a number of challenges. The fundamental problems are the weak link between R&D and

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production; the lack of any tradition of market driven research; and the low level of involvement of universities in developing links with businesses. Another problem is that socialist innovation systems used a narrow definition of innovation, focusing on technology. An additional issue is the effect of resource constraints, since some research institutions have been closed during the transition period due to a lack of finance, leaving researchers without paid employment.

Another key institutional barrier at regional level, as far as SMEs are concerned, is the absence of regional innovation systems, which means that support for innovation tends to be overly focused on the Bucharest region. The problem is compounded by the absence of a regional tier of government to facilitate the development of innovation systems at the regional level. It is true that the European Commission has encouraged the establishment of Regional Development Agencies to enable Structural Funds to be distributed, but in practice these are little more than administrative offices because of a lack of embeddedness in the country’s governance structure. The nature and extent of development of regional innovation systems is particularly important in raising the innovative performance of SMEs. One particular form of regional innovation system is represented by regional clusters of innovative firms, which result from networking between companies and also between companies and intermediary institutions. More generally, there is substantial research evidence showing the importance of local and regional linkages for SMEs in stimulating and facilitating innovation (Asheim et al., 2003).

Whilst research on innovative milieus emphasises the local and regional embeddedness of innovations in terms of trust, tacit local/regional knowledge, learning processes and informal interactions, spatial innovation systems also reflect the formal institutional settings and the inherent division of labour between enterprises and institutions, in short: the innovation systems. Clearly, then, one of the central reasons why a regional dimension to innovation systems and

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innovation policy is important is that some innovation activity in SMEs is territorially based , which means that innovation can be stimulated by co-operation between local players and place specific resources. At the same time, the role of local inputs into innovation processes varies between types of SME, based on their sources of competitive strength.

These institutional challenges also raises questions concerning the respective responsibilities of authorities at different levels; the co-ordination of national and regional support programmes; the establishment of appropriate lines of demarcation of responsibility; and the need to take steps to avoid unnecessary layers of bureaucracy and duplication of effort. There may also be a need to build institutional capacity at the regional and local levels, which may be dependent on a wider process of institutional reform.

4. Governance Issues The term ‘governance’ is a very versatile one, referring to the exercise of power in both a corporate and a state context, although the emphasis in this paper is on the latter interpretation. It embraces actions by executive bodies, assemblies (such as national parliaments) and judicial bodies, although governance extends beyond government to include, for example, the capacities of businesses, community groups and academic institutions (Hart, 2003). Since governance is concerned with the rules, procedures and practices affecting how power is exercised, it embraces both formal and informal institutions (in the Douglass North sense, see North, 1990, 2005), as well as their legitimacy and effectiveness, which can have important implications for the development of entrepreneurship.

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In countries such as Estonia, the path to EU Accession has highlighted issues of governance, as part of an attempt to improve the effectiveness and legitimacy of institutions at an EU level. This is reflected in the EU’s White Paper on European Governance, which included participation as one of five key principles underpinning good governance. The others were openness; accountability; and effectiveness of institutions; and coherence between policies and actions, as well as between policies (European Commission, 2001a). The participation principle draws attention to the nature and extent of the dialogue and co-operation between the state and representatives of entrepreneurs, at different stages of the policy process, from conception to implementation. In mature market economies, self-governing, self-regulating organisations act as professional intermediaries in the process of dialogue between government and entrepreneurs, in order to ensure that the interests of businesses are taken into account in the decision making of public authorities at different levels. Whilst Chambers of Commerce existed in the former Soviet republics during the socialist period, supposedly to represent the interests of business, they were effectively arms of the state, dominated as they were by large state-owned companies (OECD, 1996). As a consequence, Central and Eastern European countries have lacked a recent tradition and experience of self governing organisations, which has represented a particular challenge, as far as building institutional capacity during the Accession period is concerned.

Institutional capacity includes the ability to lobby effectively, which is a function that did not exist during the socialist period. This weakness may be demonstrated with reference to consultations leading up to EU Accession, which included employer’s organisations in the consultation process. However, having a place at the consultation table does not necessarily lead to active involvement in and contribution to the process; and in Poland, for example, social partners were criticised for their lack of familiarity with procedural aspects of

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preparations for negotiations; as well as insufficient knowledge about integration processes and negotiations connected with them. Differences in the level of knowledge between government and non-governmental organisations seriously limit the possibility of conducting consultations based on partnership principles.

Unlike new member states of the EU, such as Estonia and Poland, where there have been significant developments with respect to the openness of public institutions, participation by entrepreneurs in policy formulation, and the accountability of public institutions, the situation in Belarus in these respects, as example for transition economies with slow reforms, is far from encouraging. In this case, the state continues to play a dominant role in the economy, with the majority of enterprises and banks still under state control. From a governance perspective, many economic activities are regulated by Presidential decrees, which often contradict existing laws (EBRD, 2007). Regulations often take the form of so-called ‘recommendations’ by government, such as lending rates for banks (both state-owned and private) and recommended price levels. Such interference by the state is reminiscent of the Soviet period, when authoritarian control by the state over the economy was the norm. In addition, poorly specified legislation which leaves to much discretion in the hands of the (poorly paid) officials responsible for their implementation is fertile ground for corruption.

Not surprisingly therefore, in a recent IFC survey of enterprises in the country, the three most commonly reported obstacles business development (i.e. administrative procedures (72% of respondents); attitudes of civil servants to private business (67%); and (ironically) activities undertaken by local authorities to create favourable conditions for private enterprise (57%)) all referred to aspects of the exercising of state power, which in Belarus are outside the influence of entrepreneurs (IFC, 2007). From a governance perspective, the points to stress

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are that the behaviour of public institutions is far from open, with the power of the state absolute, reflected in the use of Presidential decrees and an apparent arbitrariness in their application. This is part of a wider absence of accountability, with poorly defined roles of public institutions involved in regulating and influencing private business activity; and a frequent lack of connection between policy pronouncements and actions by the state, particularly with respect to financial support measures.

5. Improving Regulation A key policy issue, which can be used as a litmus test for the effectiveness of the wider system of policy development and governance with respect to entrepreneurship, concerns the effect of administrative and regulatory barriers on the establishment and subsequent development of enterprises. One of the key roles of government policy in a market-based system is to create an enabling environment for entrepreneurship, thereby make an effective contribution to generating employment and economic development. At the same time, the state also has an important regulatory function to ensure that business operates within rules that seek to balance the need to encourage and promote enterprise with a need to protect wider social interests and the public good. Establishing an appropriate balance between the creation of an enabling environment for business and ensuring that business operates within rules established to protect wider social interests and the public good, has been the subject of considerable debate in mature market economies, with some divergence of views (Bannock and Peacock, 1989; Harris, 2002; Storey, 1994). However, in a post-socialist context, establishing an appropriate balance is doubly difficult because of the lack of any tradition of the state as a regulator of business activity.

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Regulation covers “the full range of legal instruments and decisions through which governments establish conditions on the behaviour of citizens or enterprises” (OECD, 1998). Compliance with regulations and other statutory requirements involves a cost for business, which includes the opportunity costs with respect to the resources devoted to compliance, as well as any direct money costs. As a result, minimising the regulatory burden on business to the level that is necessary for the protection of the public good is a key element in government policy designed to encourage entrepreneurship and private sector development. Regulations that are overly burdensome, complex or impractical may reduce business competitiveness by contributing to higher administrative and compliance costs, as well as to a diminution of the rule of law when non-compliance becomes rife.

In this regard, the foundation of the rule of law is based on a mutual respect for the legitimacy of regulation by both government and citizens. Rather than viewing regulations as tools by which government directs its citizens, they may be seen as a means of limiting the power of the state by closely defining it. Such a view is based on a democratic principle of “co-operation” between government and its citizens, rather than an “authoritarian” style of regulation, which transition economies have experienced in the past. It should also be noted that regulations are part of a wider regulatory system that includes processes and institutions through which regulations are developed, enforced and adjudicated. Apart from the regulations themselves, the regulatory system includes processes of public consultation, communication and updating.

At the same time, it may be argued that individual businesses may benefit from regulatory intervention in some instances, as well as being burdened by it in others. An appropriate and effectively implemented framework of property rights and contract law can both enable and

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constrain business activity. As a result, in a report that is otherwise critical of the regulation of business by governments, the World Bank (2005) praises countries that have strengthened regulations regarding the protection of property rights, contract enforcement and the protection of investments.

Although the issue of regulatory burdens can affect the development of all businesses, it can be a particular barrier during the start-up period, when entrepreneurs face many other demands on their time, in a context where time and money resources can be particularly scarce. All this affects transaction costs, which in turn can have implications for competitiveness, both domestically and internationally.

With respect to regulatory reform, again there are huge differences between transition countries, with Belarus lagging behind other CIS countries. This is reflected in the expectations placed on the state registration agency, whose responsibilities for newly established businesses result in officials seeking to avoid future problems for themselves by demanding as many documents as possible from new entrepreneurs (Lyah and Pinigin, 2003). In addition, the State Control Committee, with its sweeping powers to control prices, contracts, salaries and other aspects of business activity is unique to Belarus. Rather than providing encouragement and support for entrepreneurship, in practice, the government in Belarus appears to make life very difficult for entrepreneurs through administrative barriers and regulatory interference. This is reflected in procedures and practices that involve the use of overly complex forms and requirements; an excessive number of forms and regulatory requirements; and frequent changes in forms and requirements. As a consequence, it is reported that a Belarusian company is obliged to obtain four to five times as many licences as companies in other CIS, with an average of 30 days to secure a single licence. On top of this

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they have to deal with certification, on average 8.4 times a year, rising to 12.1 for businesses in transportation and communication and 10.9 in trade and public catering (Rakova, 2003). Another example concerns the procedures for levying and reporting taxes, where profits tax is said to be regulated by 150 legal documents, income tax by 100, and property tax by 50 and VAT by 180.

Excessive regulations and procedures is one aspect, but so too is the contradiction between different pieces of legislation that often exists. A highly imperfect regulatory environment also breeds corruption because of the conflicting provision and instability of legislation; the overly broad brief of state agencies, which places a premium on ministerial rather than public interest; the plethora of controlling agencies with extensive competencies; an excessive number of poorly regulated procedures; a guiding principle for state agencies that everything is forbidden unless explicitly allowed; low awareness of legal issues on the part of both individual citizens and state officials; and an absence of a detailed procedure for the imposition of economic sanctions, which leads to violation of the principle that “the punishment should fit the crime” (Zhuk, 2002). The latter gives state bureaucrats considerable scope to employ arbitrary action and abuse.

In contrast, regulatory reform has become a priority issue for entrepreneurship policy in postsocialist economies that are now part of the EU. During the last decade, the management of regulation has become a priority of EU institutions, reflected in the drive for better regulation. The issue is especially important in the case of the EU’s new member countries, where a particular challenge has been the need to simplify legislation, whilst, at the same time, adopting the “acquis communautaire”, as a condition of EU membership. The main focus of the simplification process is the reduction of the time and cost of registration and licensing,

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with “one-stop shops for administrative procedures a welcome development” (Commission of the European Communities, 2001: 23). At the same time, there are still unresolved questions, such as what consultation mechanisms could help governments to ‘think small first’; and what are the most cost-effective ways of informing the business community of changes in legislation.

Evidence drawn from a largescale survey of SMEs in Estonia, undertaken in 2002, shows that although Estonia is significantly better than Belarus in terms of regulatory improvements, it still has some way to go to achieve the standards of mature market economies in Europe. For example, in the survey, businesses set up during or after 2000 were asked to assess how long the initial registration and licensing procedures had taken. In a majority of cases (55%), these procedures were reported to have taken less than 1 month, with a further 31% reporting the process took between 1-2 months. At the same time, in 9% of cases, respondents reported experiencing delays of more than 2 months.

6. Conclusions Since the 1990s, the countries of Central and Eastern Europe and the former Soviet Union have embarked on a transformation of their entire political and economic systems, the scale of which is unprecedented in recent history. The shift from central planning to market based economies has involved much more than economic change. Adapting the role of the state in the economy (and society) has been a major part of the challenge, since the process of market reform requires a fundamental change in the role, type and behaviour of public institutions, as well as the establishment of new forms of governance. This reflects a need for a more fundamental shift in the role of the state in the economy, as government replaces its roles as planner of resource allocation and price setter, owner and financier of enterprise activity

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through subsidies and transfers, with a role as regulator and facilitator of private enterprise activity, with all that involves. Not surprisingly, the experience in this regard has varied considerably between countries, as the contrasting examples referred to in the paper demonstrate, despite the fact that these countries share a common socialist heritage.

The contrasting experience described in the paper reflects differences in the level of commitment to market reforms, as well as in the knowledge and resources available to the state to implement what is required. For countries from Central and Eastern Europe that have recently joined the EU, the process of Accession gave added impetus to the ongoing process of market reform, including access to funds to assist with the ongoing restructuring, during both the pre- and post-Accession periods (Smallbone and Rogut, 2005). By contrast, in Belarus and many other NIS, the process of market reform has stalled, essentially because of a lack of recognition and commitment on the part of the state to create the conditions to enable entrepreneurs to fulfil their role as generators of wealth and drivers of economic development. In such conditions, private businesses exist despite the policies and actions of government, although the extent of productive entrepreneurship is limited and the behaviour of entrepreneurs necessarily shaped by institutional deficiencies (Smallbone and Welter, 2006).

The experience of these former centrally planned economies during the last 20 years must be included in any attempt to asses the role the state plays in influencing the development of entrepreneurship. From a theoretical perspective, it is important that our concepts and analysis embrace entrepreneurship in a wide range of operating environments, rather than narrowly focusing on entrepreneurship in a mature market context. Empirical assessment of the role of government in countries such as those featured in this paper underlines the

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importance of taking a broadly based view of what constitutes ‘policy’ in this regard. This is because so-called ‘small business’ or ‘entrepreneurship’ policies either do not exist, or exist but are not implemented, or are implemented but affect so few businesses that they may be considered marginal to the entrepreneurship that develops. By contrast, policies related to taxation and the regulatory environment, and the behaviour of the institutions responsible for implementing them, affect most businesses to some degree. Whilst the point is not specific to post-socialist countries, the existence of major institutional deficiencies in countries such as Belarus draws attention to framework conditions that are largely determined by the state, which are largely taken for granted in mature market environments. This in itself is an important reason why a full assessment of the role of the state in relation to entrepreneurship needs to embrace a wide range of political and economic contexts, including those featured here.

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