That East European governments have made only slow progress in dealing with the large loss-making state-owned enterprises (SOEs) inherited from socialism should come as no surprise to those familiar with recent UK and Mexican experience of implementing enterprise reform on a much smaller scale. In Discussion Paper No. 898, Research Fellow Sweder van Wijnbergen argues that gradualism offers no solution, since governments in the region would probably be no better able to deal with loss-making SOEs slowly. The extreme laissez-faire alternative of wholesale bankruptcy proceedings would also be unnecessarily destructive: for economies in transition, enterprises' past and current losses may reflect distorted incentives rather than bad management or outright insolvency; the capacity of the law-courts is very limited; and bankruptcy codes exhibit a strong bias towards liquidation rather than restructuring. He proposes instead that an SOE's major private creditor should take the lead in initiating its restructuring and designing a new, viable capital structure, since lead banks are better placed than governments to assess firms' long-term viability.

Van Wijnbergen describes Poland's recent launch of a wholesale clean-up of loss-making SOEs along these lines and dismisses arguments that domestic banks lack the necessary skills for two reasons. First, the record of state involvement in large-scale enterprises under socialism and the well-documented history of regulatory capture in the West indicate that governments' skills are certainly no better; and the chances of successful restructuring increase with the influence of future vis-à-vis past owners, since it is inextricably linked with privatization. Second, in many countries the performance of a sub-set of commercial banks is improving rapidly. Assigning such a role to commercial banks makes financial sector reform commensurately more urgent, however, since enterprise and bank reform must proceed simultaneously if either is to have any chance of success. The progress of Poland's financial and enterprise reform to date suggests that its decentralized approach to loss-making SOEs holds much more promise than the government-oriented approaches pursued elsewhere.

On the Role of Banks in Enterprise Restructuring: the Polish Example
Sweder van Wijnbergen

Discussion Paper No. 898, February 1994 (IM)