A Mechanism Design for the Firm Performance Analysis of Transition Economies

Abstract

Ever since the Soviet Union collapsed in 1991, transition countries have adopted the market economy system. However, some of these countries are currently more tied in reciprocal economic relationships with European Union members, the pro-EU group, while[ others continue to maintain pre-existing ties, the pro-Russia group. The purpose of this paper is set to tackle how firms perform differently across two groups both theoretically and empirically. In particular, a game model is first developed to evaluate if an ex-communist country networking effect persists. Second, if it has resulted in deterioration of the firm performance of the pro-Russia group compared to that of the pro-EU group, and third if a networking effect is able to enhance the firm performance of the pro-Russia group. The predictions of the model are tested empirically with two regression models controlling for the size effect of the firms within the transitional economies. Because long-lasting political ties with Russia in CEE countries can generate endogeneity, a 2SLS estimation using a secondary data is attempted for testing some propositions. The dataset is collected from the Business Environment and Enterprise Performance Survey jointly constructed by the World Bank and the European Bank for Reconstruction and Development. The empirical results have two important findings based on the secondary data. First, in terms of innovative capability and input-output efficiency, firms in the pro-EU group outperform those in the pro-Russia group. Second, the networking effect can compensate for firm performance in the pro-Russia group even though firm efficiency is lower than the pro-EU group. The findings of the paper suggest two kinds of business strategies. First, between transitional economies and pro-Russian countries, the former is a better place for making investments as the former can request to pay higher embedded costs. Second, the networking effect of pro-Russian countries cannot be discounted. Indirect exports based on a mutual long-term relationship across pro-Russian countries while pivoting on Russia are a non-negligible factor.