Start-Ups and Transition

How fast transition should occur and how fast privatization and/or entry should take place in formerly socialist economies has been widely debated by economists. The field evidence on start-ups is mixed, with fragmentary data indicating that the performance of start-ups varies widely across countries. The evidence suggests that two vastly different equilibria are emerging in transition economies: a high development equilibrium and a low development equilibrium. In the high development equilibrium start-ups supply higher quality goods than transforming SOEs, aggregate supplies are ample and start-ups are a growth engine. This contrasts with the low development equilibrium in which start-ups provide lower quality goods and the overall supply of goods is lower. In this paper, we develop a dynamic model which explains how features of the transition can push an economy to either the high or low development equilibrium in the long run. We concentrate on the speed with which bureaucratic interference in the economy is eliminated and the speed with which entry by private firms occurs. Our central conclusion is that delayed entry by start-ups can substantially increase the likelihood of the high development outcome, especially when bureaucratic interference is persistent. Our result captures how this interference, while transitory, can have a negative long run impact and underlines the importance of government polices to encourage entrepreneurship, such as subsidies and tax breaks