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newly private firms "created barriers for some newcomers who were without these connections" (Webster, 1993a: 9). In the New Independent States, firms that were offshoots of old state enterprises or had been established by local governments had preferential access to state resources (Jones, 1992:81-82). In contrast, start-ups formed after the reforms of 1988 were often forced to engage in bribery to obtain necessary goods or credit. Preliminary evidence suggests that in many sectors, market allocation has replaced bureaucratic allocation more rapidly in Central and Eastern Europe than in Russia.14 This suggests that the speed of development of input and credit markets is an important predictor of the long-run efficiency of emerging industries.

Berkowitz and Cooper (1997) analyze the speed at which bureaucratic control over credit and input markets affects the performance of start-ups and overall sectoral efficiency. They develop a dynamic model of an industry in transition in which a restructured state-owned enterprise competes with a start-up. Firms compete in quality and quantity in a differentiated duopoly. The model starts with a pretransition phase in which the state-owned enterprise is regulated by planners. At the beginning of the transition, restructuring is immediately effective, and the enterprise is forced to behave like a firm in a market economy. At the same time, a start-up that is more efficient than the state-owned enterprise is allowed to enter the market. These two firms repeatedly compete in a differentiated oligopoly.15 Initially, credit and input markets are underdeveloped and controlled by bureaucrats. These conditions increase the entrant's costs in the early rounds of competition. Over time, bureaucratic allocation is phased out, and the start-up and former state-owned enterprise have equal access to inputs and credits.

As long as costs are not too asymmetric, the underlying static model has two rankable equilibria in the long run when bureaucratic discrimination against the start-up no longer exists. In either equilibrium, there is strict product differentiation. In the efficient equilibrium, the low-cost start-up takes on the high-quality role, while in the inefficient equilibrium, the high-cost former state-owned enterprise takes on the high-quality role. Aggregate supply, product differentiation, and consumer surplus, as well as individual firm profits, are higher in the efficient equilibrium. The long-run efficiency of the transformed industry depends on which Nash equilibrium is selected.

The solution to the equilibrium selection problem is motivated by the lack of information and experience facing both transformed state-owned enterprises and start-ups at the beginning of the transition in Central and Eastern


See de Melo and Ofer (1994), Webster (1993a,b), Webster and Charap (1994), Webster and Swanson (1993), and Zemplinerova and Stibal (1995).


Start-ups are frequently more efficient because their managers are often drawn from the elite of the labor force in terms of education and job experience (de Melo and Ofer, 1994:9). Restructured state-owned enterprises may have higher costs because they are often forced to hire redundant labor and provide inexpensive social services to their employees.

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