BUSINESS-GOVERNMENT RELATIONSHIP IN EUROPEAN POST-TRANSITION COUNTRIES: DO INNOVATORS GET THE WORSE END OF A STICK?

• Author: Botric, Valerija

1. Introduction

   According to the Global Competitiveness Report 2015-2016 (Schwab, 2015), only few European post-transition countries have reached the stage of innovation-driven economies. Those are: the Czech Republic, Estonia, Slovakia and Slovenia. The remaining European post-transition countries are efficiency driven (Albania, Bosnia and Herzegovina, Bulgaria, FYR Macedonia, Montenegro and Serbia) or in transition from efficiency driven to innovation driven (Croatia, Hungary, Latvia, Lithuania, Poland, Romania and Turkey) (Schwab, 2015). The evidence shows that these economies vary in their innovative performance but they generally lag behind developed European countries. The latest edition of Innovation Union Scoreboard (European Commission, 2015) reveals that the best performing post-transition country is Slovenia with the innovation performance close to the European Union (EU) average. This score categorizes Slovenia in group of innovation followers. Other post-transition countries are modest (Romania, Bulgaria and Latvia) or moderate innovators (Lithuania, Poland, Croatia, Slovakia, Hungary, Estonia).

   The transition process has entailed the evolution of different previously non-existent institutions governing everyday business activities. The institutional transformation created the opportunities for new entrepreneurs, but also implied regulating the newly established as well as existing markets in a novel way. Frequently drastic institutional changes created unfavorable environment for entrepreneurs and toughened the conditions for their survival (Ahlstrom and Bruton, 2010).

   Transition in European economies additionally complicated the relationship with regulations related to European enlargement process and the questions of government officials' capacities to ease the transformation of societies in efficient way. These processes resulted in an enormous number of regulations but also in the instability of the regulatory framework (Manda, 2010). As a result, Rodriguez-Pose and di Cataldo (2015) recently argued that the state of institutional quality significantly varies across European regions contributing to uneven spread of innovation performance.

   The main research question addressed in this paper is to determine how entrepreneurs in post transition economies perceive government activities. Special emphasis is put on the question whether innovative enterprises tend to perceive government more burdensome than other segments of the economy. To that end, we focus on three aspects of business-government relationship: tax administration, business licensing and courts. The main contribution of the present paper is to quantitatively analyze this issue for innovative and non-innovative firms. The identified differences can have important consequences for the future economic growth of the post-transition countries, due to the vital role of innovation in any economy.

   We focus on post-transition European countries relying on the assumption that due to the EU accession process they either went or are going through a similar institutional change process. In particular: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, FYR Macedonia, Hungary, Kosovo, Latvia, Lithuania, Poland, Romania, Serbia, Slovak Republic, Slovenia, and Turkey. The paper adopts the following structure: section 2 briefly summarizes the relevant literature, section 3 presents data sources, methodology and preliminary findings. Section 4 provides empirical results and discussion, and the last section brings conclusions.

2. Literature review

   The business environment influences the choices of firms to engage in innovation activities. The resulting innovative performance observed at the country level depends on the interplay between firms and institutions. The regulatory environment has the potential to support, but it can also hamper business creation, performance and growth. The importance of institutional development has long been incorporated in the global economic growth literature. The argument states that economies with stronger legal environment are able to develop financial systems that ensure stable financing of its entrepreneurs (Levine, 1998). Financing of innovative projects could be perceived even riskier by financial institutions. In such circumstances, institutional development that ensures credit protection has the ability to spur long-run economic growth. This has been recently confirmed by Marresch, Ferrando and Moro (2015) who claim that a firm which operates in a country with weak creditor protection and a low-quality judicial enforcement system can face a competitive disadvantage with respect to a firm located in a country with strong creditor protection and a high-quality judicial enforcement system.

   Researchers have documented that there are large differences in the quality of institutions among countries and composite indices have been developed to measure different aspects of institutional development (World Bank Governance Indicators --Kaufmann, Kraay and Mastruzzi (2009); Polity IV dataset--Jaggers and Marshall (2000)). Although it could be argued that transition economies aspiring to join the EU had to adapt by acquiring the same institutional features prescribed by the acqui, studies have shown that adopting high quality laws cannot substitute for weak judiciary enforcement (Pistor, Raiser and Gelfer, 2000). EU regulations have, in some cases, encouraged innovation and entrepreneurship but there is also evidence of their less favorable effects (Pelkmans and Renda, 2014).

   A cursory overview of the World Bank Doing Business 2016 indicators shows that bureaucratic and regulatory frameworks in European post-transition countries in many aspects create unfavorable environment for entrepreneurs. Although some economies have reached better ranking positions in some of the indicators, the overall ease of doing business ranking for most of these countries is not satisfactory as most of them are well away from the most efficient economies, with exceptions of FYR Macedonia, Estonia and Lithuania that are ranked among the top 20.

   Government relationship with innovative enterprises is more frequently analyzed with respect to different support mechanisms and their effectiveness on the innovative firms (Afcha, 2012; Lach, 2002; Almus and Czarniteki, 2003). It is generally believed that government activities are aimed at stimulating innovation activities. The policy instruments designed by government encourage innovation success (Aschhoff and Sofka, 2009). Even some regulatory actions are thought to stimulate innovation activities, which is frequently emphasized in the literature on eco-innovation determinants (Horbach, Rammer and Rennings, 2012; Demirel and Kesidou, 2011; Kesidou and Demirel, 2012; Costantini and Mazzanti, 2012).

   Unlike that stream of literature, in this paper we aim to explore how regulatory and institutional frameworks affect business activities of firms (especially innovating firms). The current state of business environment in these countries is such that we can hypothesize the potentially negative effects of government activities on business/ innovation activities. We hope to contribute to the discussion why some transition economies lag in their innovative performance. The argument is related to the issue of competitiveness, where one of the basic requirements for competitiveness at the national level incorporates institutions, infrastructure, macroeconomic environment, health and primary education of the population (Schwab, 2014). Reforms that enable improvement of these features of an economy create initial positive preconditions for enterprises to compete on the international market. For countries where the business environment is weak, large reforms are often necessary (Klapper and Love, 2011).

   When considering specific obstacles which the government activity might impose on entrepreneurs, corruption has occupied a large segment of the literature, in particular the literature on transition economies. When formal institutions do not function properly, business owners and managers tend to rely more on personal networks (Puffer and McCarthy, 2011). As transition countries mostly struggle with corruption and similar problems, one could expect that entry regulation might serve to resolve these issues. However, entry regulations, which in general increase costs and reduce creation of new firms, do not help to reduce illegal behavior in developing countries struggling with corruption (Klapper, Laeven and Rajan, 2006). The distinct effect on innovative enterprises has been explained by Shleifer and Vishny (1993) who argue that innovators are more likely to engage in acquiring novel equipment, opening new premises, importing or introducing new category of products to the market. Since these activities are also unprecedented to government officials, the space is opened for creative interpretations of specific laws and procedures. This has been documented by Ayyagari, Demiguc-Kunt and Maksimovic (2014) who have found that innovating firms pay more bribes than non-innovators in 57 analyzed countries. The additional burden put on innovative firms has been greater in countries with more bureaucratic regulation and weaker governance. However, authors argue that this does not imply that innovative firms receive better quality public services or engage more frequently in other illegal activities such as tax evasion.

   Some studies have found that entrepreneurs are more likely to thrive in countries with low regulatory burdens (Klapper, Love and Randall, 2014). Yet, the relationship is not straightforward, since in addition to over-regulation, under-regulation of economic relationships can exist. Oxley and Yeung (2001) argue that the development of new sectors and entrance of new firms in a sector can be hampered due to a weak rule of law. This can be extended to innovation performance if...