The striking differences in the size distribution of firms and industrial concentration within industries between Europe's market and formerly socialist economies reflect the incorporation of small- and medium-sized firms into large enterprises under socialism. In Discussion Paper No. 664, Research Fellow David Newbery and Paul Kattuman use a model with new firm entry in which proportional rates of firm growth are random to demonstrate that the remarkably consistent pattern of firm size distribution in the market economies across industries, time and countries may be attributed to the operation of powerful market forces. In Soviet-type economies, in contrast, planning requires the centre to receive information from and send instructions to individual enterprises, so their total number in each industry must be small to be manageable.

Newbery and Kattuman note that this concentration is preserved and enhanced by restrictions on competitive entry: the absence of independent sources of finance and the ban on hiring labour. Public choice theory suggests that the transaction costs that inhibit coalition formation are smaller for producers than for consumers (relative to the benefits such coalitions may bring). Reduced competition among enterprises and bilateral bargaining with a government lacking reliable, unbiased information therefore result in the observed inefficiency and stagnation. South Korea and Taiwan also have rather concentrated industrial structures, in which large enterprises received state subsidies, but these have been contingent on export performance, which provides an objective, non-manipulable test of competitiveness.

Newbery and Kattuman maintain that Eastern Europe's large enterprises must be dismantled to stop them using their bargaining power to demand continued state subsidies. They recommend breaking up the enterprises into their component `establishments', defined as autonomous units that keep accounts, to provide a well-defined starting-point, decentralize control and create incentives to improve lower-level management. This would also facilitate small firms' entry into intermediate production, reduce concentration in product markets and hence increase competition, force banks to assess creditworthiness more carefully and redress the balance in their bargaining power with large enterprises, as well as mitigating the inexorable pressure for protectionism to ailing producers in the future.

Newbery and Kattuman investigate the implications of this policy using 1985 UK and Polish data on the size distributions of both enterprises and establishments. They find that such a reform would ensure significant progress towards a size distribution of the type found in the market economies, but it remains to be demonstrated whether such a scheme would be practical or politically feasible.

Market Concentration and Competition in Eastern Europe
David M Newbery and Paul Kattuman