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Institutions, economic liberalization and firm growth: evidence from European transition economies

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This article investigates the determinants of firm growth using a dataset matching firm-level data with country indicators of access to external finance, governance, and economic liberalization in ten European transition countries over the period 1996–2011. We find that the quality of state rebuilding after the collapse of communism matters. First, country governance adds something above the impact of a change in variables that proxy for access the external finance. Second, the results also show that economic liberalization has no direct effect on firm growth. Instead, its impact operates through country governance. The countries that benefit the most in terms of firm growth are those with higher than average country governance indicators.

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  1. Among a few exceptions, see e.g. McKinnon (1991). He discusses the importance of institution building before economic liberalization and privatization.

  2. See e.g. Johnson et al. (2002) who study the effects of property rights protection and credit markets development on firm investment in five transition countries.

  3. Sales growth is the most commonly used measure of firm growth in the literature (Delmar et al. 2003). Studies on the determinants of firm growth in transition countries mainly focus on firm characteristics like age, size, and industry affiliation but the effects of country reforms have received little empirical research. Among a few exceptions see e.g. Giannetti and Ongena (2009) who study the effects of foreign bank entry on firm growth in 14 transition countries.

  4. Section 2 provides discussion. See also for a unified methodology of studying both issues at a country level Hausmann et al. (2008).

  5. Most studies follow law and finance literature and examine mainly legal system.

  6. Studies of economic liberalization in transition countries are mainly macro-studies, and most examine the effects on economic growth in early transition (for a review of earlier studies see e.g. Heybay and Murrell 1999).

  7. See for studies on firm growth e.g. Demirguc-Kunt and Maksimovic (1998); Guiso et al. (2004); see also for macro-studies on economic growth King and Levine (1993) and Acemoglu and Johnson (2005).

  8. See e.g. Besley (1995) and Johnson et al. (2002), see for recent studies on the link between the judicial efficiency and entrepreneurship e.g. Ippoliti et al. (submitted) and Posada-García and Mora-Sanguinetti (2015), see also for the effects of property rights protection and freedom from corruption on entrepreneurial activity e.g. Audretsch (2015).

  9. See e.g. La Porta et al. (1997, 1999, 2000), see for transition countries e.g. Pistor et al. (2000).

  10. See for the effects of economic freedom e.g. Berggren (2003), Doucouliagos and Ulubasoglu (2006), Bergh and Karlsson (2010), Justesen, (2008), Mogens and Coll (2012), see for a survey de Haan et al. (2006), see for transition countries Peev and Mueller (2012), for the link between economic freedom and the institutional path dependency Facchini (2013).

  11. See for country studies e.g. Hyytinen et al. (2003) on Blazy et al. (2012) on France. See for recent research on the relationship between stock market upswings (downswings) and financial market regulation e.g. Lohse and Thomann (2015).

  12. Data on protection of creditor rights are not available on yearly basis. Thus, we did not use them in our study over the period 2006–2011.

  13. Studies using Orbis database adopt similar approach in their sample design, see e.g. Bertrand et al. (2007); Giannetti and Ongena (2009).

  14. Very small and young firms in European transition countries hardly rely on bank financing (Bonin and Wachtel 2003).

  15. Full definitions are in Beach and Kane (2008).

  16. For a recent discussion on firm growth measures see e.g. Daunfeldt et al. (2013).

  17. See e.g. Bonin et al. (2008) on banking in Eastern Europe.

  18. Slovenia is the only country with a low level of foreign bank presence (see Table 2).

  19. See e.g. Heybay and Murrell (1999), Godoy and Stiglitz (2006).

  20. Bekaert et al. (2005).

  21. The results for sales growth are similar (but generally with lower R2 s) to those for assets growth.


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We would like to thank to Dennis Mueller, Gunnar Eliasson, Adjit Singh, the two anonymous referees and the participants at the Swedish Entrepreneurship Forum on Regulations, Entrepreneurship and Firm Dynamics in Stockholm for their helpful comments on the preliminary version of the paper.

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Correspondence to Evgeni Peev.

Appendix: List of variables

Appendix: List of variables

1.1 Firm-level data

  • Assets growth—ln (total assetst/total assetst−1)

  • Sales growth—ln (salest/salest−1)

  • Total assets—total assets in th USD

  • ln(emp)—log of number of employees

1.2 Country Finance

  • creditpriv—domestic credit to private sector (in per cent of GDP). Ratio of total outstanding bank credit to private sector at end-of-year, including households and enterprises, to GDP.

  • Source: EBRD survey of central banks.

  • badloans—(in per cent of total loans). Ratio of non-performing loans to total loans. Non-performing loans include sub-standard, doubtful and loss classification categories of loans, but excludes loans transferred to a state rehabilitation agency or consolidation bank, end-of-year.

  • Source: EBRD survey of central banks.

  • forbank—asset share of foreign-owned banks (in per cent). Share of total bank sector assets in banks with foreign ownership exceeding 50 per cent, end-of-year.

  • Source: EBRD survey of central banks.

  • us_rate—real interest rate in the US (in per cent). Real interest rate is the lending interest rate adjusted for inflation as measured by the GDP deflator. Source: IMF

1.3 Country governance indicators

We use four of the Worldwide Governance Indicators: government effectiveness, regulatory effectiveness, rule of law, and control of corruption. The indicators are constructed using unobserved components methodology and are measured in units ranging from −2.5 to +2.5, with higher values corresponding to better governance (Kaufmann et al. 2012). The four governance indicators are defined below:

  • Government Effectiveness—measuring perceptions of the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to such policies.

  • Regulatory Quality—measuring perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development.

  • Rule of Law—measuring perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence.

  • Control of Corruption—measuring perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as “capture” of the state by elites and private interests.

1.4 Economic liberalization

Heritage Foundation measures several aspects of economic freedom in 183 countries. The indexes are based on a scale of 0 to 100, with 100 being the highest level of economic freedom. We briefly define the five indexes of economic freedom used in this study below.

  • Business freedom is the ability to create, operate, and close an enterprise quickly and easily.

  • Trade freedom is a composite measure of the absence of tariff and non-tariff barriers that affect imports and exports of goods and services.

  • Monetary freedom combines measures of price stability and price controls.

  • Investment freedom is an assessment of the free flow of capital, especially foreign capital.

  • Financial freedom is a measure of banking security as well as independence from government control.

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Peev, E. Institutions, economic liberalization and firm growth: evidence from European transition economies. Eur J Law Econ 40, 149–174 (2015).

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