At a lunchtime meeting on 8 December, Wendy Carlin and Colin Mayer presented results of recent research on the appropriate method for restructuring enterprises in Eastern Europe. Carlin is Lecturer in Economics at University College London and a Research Associate in CEPR's project on Economic Transformation in Eastern Europe. Mayer is Professor of Economics and Finance at the University of Warwick and Co-Director of CEPR's Applied Microeconomics programme. Their remarks were based on their article, `Restructuring Enterprises in Eastern Europe', in issue no. 15 of Economic Policy (see box). The meeting formed part of CEPR's research programme on Economic Transformation in Eastern Europe, supported by the Commission of the European Communities under its SPES and ACE programmes and by the Ford Foundation. The views expressed by the speakers are their own, however, not those of the above organizations nor of CEPR, which takes no institutional policy positions.

Carlin began by defining `restructuring' to include the splitting up of core businesses, addressing the problems of vertical and horizontal integration and the restructuring of firms' finances and production processes. The key issues were the stage at which restructuring should occur and who should organize it. The literature on ownership and vertical integration is a plausible basis for evaluating the alternative sequences of state and private-sector control currently operating in Eastern Europe, and thus the most effective method of restructuring. She distinguished between the case where private intermediaries are involved in restructuring before privatization, that where the state restructures its enterprises prior to their privatization, and the case where privatization takes place immediately, i.e. before restructuring.

Restructuring by both state and private institutions has made great progress in East Germany. The state has set employment, regional, industrial-structure and competition objectives and created an independent agency the Treuhand to oversee their implementation, together with restructuring and privatization. The Treuhand prepared `opening balance sheets' to determine enterprises' viability on the basis of the quality of management, the markets in which they were operating and their contacts with Western companies. Some 70% of former state firms survived this stage. The Treuhand then sought restructuring plans from their managements and set up supervisory boards to monitor their implementation. It adjusted their balance sheets (wrote off debts) and approached potential Western buyers, from which it sought further restructuring plans, showing preference for purchasers that intended to develop Eastern German enterprises. Where necessary it broke up firms, disposed of unprofitable activities and retained only segments of enterprises. While the total costs of the Treuhand's operations have been very high, much of this is attributable to the writing-off of debts and cleaning up the environment. The pure administrative costs amounted to some DM 1-2 billion.

Mayer emphasized the high rate of restructuring in Eastern Germany that resulted directly from this system. He stressed the initial role of Western expertise in supervisory boards, in the appropriate restructuring of enterprises and generating important contacts with Western markets. Conflicts of interest had arisen, however, as Western German firms sought to extract assets cheaply from Eastern German firms, with one motive for some purchasers being to restrict competition. Western German banks have been extremely reluctant to offer funds at their own risk; most equity finance has been offered to small companies, and mainly for management buy-outs. The stock market has also played only a minor role; only one company has so far been floated. There has nevertheless been a successful and gradual devolution of control from the government, which sets its own objectives, to the Treuhand, which is responsible for the management and restructuring of enterprises, to the individual supervisory boards, and finally to management.

Mayer maintained that the abundance of Western German administrative and managerial skills and sound public-sector finances clearly made a major contribution to the Eastern German transformation. Care must therefore be taken in drawing implications for the rest of Eastern Europe, which does not have these advantages and faces additional political obstacles. Mayer argued, however, that the East German case suggests several ways in which countries without adequate managerial and financial resources can devolve control gradually from government to the private sector and eventually to management. Current disenchantment with `spontaneous' privatization in other East European countries reflects an initial failure to provide sufficient control resulting from fears of too much centralization. This resulted in the transfer of ownership before restructuring, and may lead to more state involvement in the long term, for example to correct market failures such as monopoly. The failure is therefore institutional, reflecting inadequate managerial and financial resources in both private and public sectors. It may be corrected by concentrating resources initially in a small number of institutions and purchasing management and finance from the West. Mayer concluded that the ultimate constraint on the speed of transition of socialist into market economies is the West's willingness to provide these resources at prices the East can afford.