The transition economies of South Eastern Europe (SEE) are often cited as a setting where the business environment is one of the main obstacles to higher levels of internal and foreign investment and to higher growth rates. Compared with the more successful economies of Central Europe and the Baltics, the Balkan countries have, so far, proceeded at a slower pace in transforming their economies and have been beset with civil strife and war conflicts.1 Generally, investment and growth rates recorded in the eight South Eastern European countries that constitute the sample of this study (SEE8) have been lower than in their Central European and Baltic counterparts.
After the resolution of the Kosovo conflict in 1999 and after the change in the regime in Serbia and Montenegro in 2000, the regional economies stabilized. Newly elected governments have been making efforts to improve the business climate and attract inward investment. The purpose of this chapter is to analyze the quality of the investment climate in the Balkans from the perspective of commercial dispute resolution. Obviously, the institutions that (a) promote certainty and confidence when a firm transacts with other firms and (b) serve to enforce contracts (such as the courts, business networks, private protection firms, and government) are a crucial facet of the investment climate and are worthy of special attention.
A spectrum of institutions support contractual compliance and enforcement. Courts are the main institution enforcing contracts and resolving business disputes. Business disputes are inherent in business transactions. In a complex economy involving many buyers and sellers as well as complex goods and transactions, firms necessarily undertake risks in dealing with new clients and suppliers, and face potential disputes with them. Without efficient courts and the expectation that courts will uphold their contractual rights and obligations, firms will be less willing to deal with new clients and suppliers, and fewer transactions willPage 280 take place. Reliable and efficient courts encourage new business relationships because new partners do not fear being cheated. In addition, good courts help businesses undertake more complex business transactions and help them produce more sophisticated goods and services by allowing for complex contracts to be written and by encouraging specific investments. Furthermore, courts play an important role in securing social peace.
Despite these functions, companies in many countries seldom use courts.2 Why does this pattern occur? What are the alternatives to contract enforcement outside the courts? Other institutions also serve to enforce contracts and reduce the uncertainty a firm faces when engaged in transactions with other firms. These institutions include both formal and informal mechanisms of enforcement, such as social networks, business associations, or public information channels to help firms decide with whom to do business and under what conditions. In general, contract enforcement mechanisms could be divided into (a) personal relationships based on trust, (b) self-enforcement through repeated transactions, (c) third-party enforcement based on reputation, (d) private enforcement, (e) administrative government intervention, and (f) court enforcement (litigation). Although each of these mechanisms could potentially serve the same purpose, some are inefficient because either they exclude new clients (for instance, the first mechanism listed, which promotes commercially transacting with only known, repeated customers) or they structure transactions with a goal to avoid business disputes (for example, requiring prepayment). Other mechanisms, such as business associations, have been shown to be seldom used.
Although much criticism has been voiced about the use of private protection firms (the Russian rackets) as a substitute for corrupt and inefficient court justice, anecdotal evidence suggests that they are also widely used in the Balkans. However, a detailed and systematic analysis of firms' enforcement strategies does not support this view. Furthermore, those firms providing private protection services for contractual enforcement are fraught with their own inefficiencies.
Efficient contract enforcement is fast, fair, and affordable. However, there is a tradeoff between speed and fairness: fast procedures may forgo a certain degree of fairness. Finally, court enforcement must be cheap relative to the value of the dispute; otherwise it will not be used.
This chapter will describe how firms choose to structure their transactions and resolve their contractual disputes with other firms in the SEE8. Our starting point is that (a) courts allow for complex exchange to take place and (b) relational contracting and third-party mechanisms of enforcement generate inefficiencies. First, to describe how SEE8 firms avoid disputes, we use detailed business case studies conducted by the World Bank in 2002 in each of the eight countries. In addition, we usePage 281 data from the two European Bank for Reconstruction and Development (EBRD)-World Bank Business Environment and Enterprise Performance Surveys (BEEPS1 and BEEPS2), conducted in 1999 and 2002. The surveys covered more than 6,000 firms in 26 transition economies (EBRD and World Bank 1999, 2002).
Next, we describe the informal, out-of-court ways to achieve settlement of business disputes. Third, we focus on court enforcement of contracts. We explore what determines the use of the courts in resolving commercial disputes. We describe how formal, fast, and costly the enforcement of commercial debt contracts in each of these countries is, and we compare our findings with those for the other transition economies. We argue that firms tend to use the court system when it is less formal, less expensive, and faster in resolving disputes. Available legal survey data (about the exact procedures creditors must go through to collect a debt claim of 50 percent of the country's gross national income per capita, what their legal costs would be, and how long the first-instance process would take) enabled us to identify weaknesses in the functioning of the courts and to propose recommendations for court reform.
Before we proceed with the analysis of contract enforcement, let us first look at how firms in the sample countries perceive their legal systems. Figure 6.1 compares the confidence in the legal system by surveyed firms located in the SEE8 in 1999 and 2002. The data come from firm managers' answers to the BEEPS questionnaire in 1999 and 2002. All the countries of our sample participated in the 2002 BEEPS; in 1999, firms from Serbia and Montenegro did not take part in the survey. Figure 6.1 evaluates to what extent firm managers agree or disagree with the following statement: "I am confident that the legal system will uphold my contract and property rights in business disputes." Firms are given an answer scale from 1 to 6, corresponding to various degrees of disagreement or agreement with the above statement, with higher values indicating a higher degree of agreement. The measures reported in the figure are country averages across all firms that responded to this question, regardless of whether the firm had or had not used the courts in past business disputes.
The results suggest that, in 1999, surveyed firms in Bosnia and Herzegovina and in Croatia felt most confident about their country's legal system, whereas Moldovan firms had the least confidence in their country's legal system. In 2002, firms in Serbia and Montenegro displayed the highest confidence on average, with Moldovan firms again scoring lowest on their confidence in the legal system. Importantly, the trend in confidence between 1999 and 2002 is predominantly downward. Average confidence in the legal system was lower in 2002 than it was in 1999 in Albania, Bosnia and Herzegovina, Bulgaria, and Croatia; confidencePage 282 stayed at approximately the same level in the former Yugoslav Republic of Macedonia and marginally improved in Romania and Moldova.
[NOT INCLUDE FIGURE 6.1]
This finding is consistent with other current studies of the business environment in this region, including a recent World Bank study (Gray, Hellman, and Ryterman 2004). This study, using data from the BEEPS questionnaires for 1999 and 2002, establishes that, in most South Eastern European countries, corruption measures have worsened over that period. For example, within the group of transition economies, corruption is perceived by business managers to be most problematic in SEE and the Commonwealth of Independent States (CIS). Perceptions of corruption stayed relatively constant at high rates in Albania, Bosnia and Herzegovina, Bulgaria, FYR...