The last ten years in many countries in central and eastern Europe and the Commonwealth of Independent States have been dispiriting. Transition has provided some grounds for optimism, but has been in many ways a social and moral disaster. Even where there is growth, this is not a reliable indicator of economic or social health, since it is everywhere and always based on sharp rises in inequality and real, intense misery and poverty. People have gained greater political freedom, but they have paid a heavy price. In the drive to create free-market economies with targeting of benefits and privatization of previous state functions, the human costs have been dramatic.

Inequality, income poverty, human poverty

The rapid rise in unemployment and the fall in the real value of wages and pensions has led to an explosion of inequality and plunged millions of people into poverty.

The most common way of expressing inequality is through the Gini coefficient: for any country this number lies between 0 (absolute equality) and 1 (one person gets everything). Prior to the transition, the societies in this region were relatively egalitarian. Over the period 1987-88 to 1993 most became more unequal. In Bulgaria, the Czech Republic, Estonia, Kyrgyzstan and the Russian Federation the Gini coefficient increased by 40% or more.

One result is a sharp rise in income poverty. If we use an income-poverty line of $4 per day (in 1990 purchasing power dollars), in the region as a whole the number of people living in income poverty rose between 1988 and 1994 from 4% to 32% - or from 14 million to 119 million people. Even in relatively successful Poland, more than 20% of the population lives in poverty.

The transformation of the planned economies took place during a high tide of neoliberal ideology. Reform policies often called for shrinking the government, on the assumption that the right size for all states was "small" and that the world was converging towards it. Many transition governments cut back their role not only in those areas that were distinctive of planned economies but also in the areas of government responsibility widely accepted in advanced market economies. Externally imposed macroeconomic conditions could often be met only by massive cuts in expenditure on such essential human development-connected activities as health, education and programmes to aid ethnic minorities.

The approach during the first transition decade ignored the interdependence of the economy and polity and imposed high human costs. Expectations of salvation by foreign direct investment were often used to argue for temporary cutbacks in the role of the state. Modern economic history shows, however, that at least in large countries foreign investment generally follows rather than leads successful development, coming after a country has proven itself competitive. Orthodox policies have systematically neglected some of the key factors that eventually attract serious long-term foreign investors: a skilled work force, an efficient infrastructure, an independent and reliable judiciary, impartial law enforcement, transparent and accountable government institutions, and most of all a healthy and well educated population. In orthodox programmes these are often mentioned in passing, but rarely accepted as legitimate and necessary funding priorities.

The tragic paradox is that many reform programmes during the first transition decade dismantled exactly those parts of the state administrative apparatus needed to monitor and steer a modern market economy. Many countries allowed the capacities of central government to decline to the point where they could no longer enforce the conditions required for a healthy market system to operate.

Instead of the desired free market conditions, organized crime and corruption emerged and became rampant. The focus on economic liberalization and macroeconomic reform resulted in increased inequality, unemployment, impoverishment, insecurity, vulnerability to social risks (such as crime, drug abuse and alcoholism), and marginalization of individuals, communities and regions. It weakened the capacity of government to act in a socially compensatory way. Even worse for the prospects of economic success, impoverished and delegitimized governments find it increasingly difficult to pursue the kind of effective microeconomic policies (industrial support and regional development strategies) that are essential features of successful development.

The orthodox policies associated with the "Washington consensus" have failed over the last 10 years to produce the desired outcomes in transition economies and elsewhere. This places the central role of the state back on the reform agenda, making clear that the state must play an active role in bringing about a successful transition. A search has now begun for a modified free-market model that recognizes the important role of the state and pays more attention to social equity.

Decentralization - a way out?

Planned economies were hyper-centralized. Thus it has been assumed that decentralization is a core feature of the move to a "normal society". It is often argued that lower-level governments are better able to carry out the functions of government in ways that meet the immediate needs of citizens.

Decentralizing economic decision-making through a mixture of privatization, commercialization of state-owned enterprises, and new enterprise formation has moved much activity outside direct government control. But invigorating local government has proved exceedingly difficult. Sharp reductions in available resources have left decentralization without the financial support required if it is really to work. Central government structures in the region have been so weakened that they are unable to build up the capacity of local government. The hope that local and regional governments could pick up the pieces left by collapsing national state administrations was natural, but reflexive enthusiasm must now give way to careful consideration of the elements necessary for decentralization to succeed.

Even when national governments decentralize responsibilities, they retain important policy and supervisory roles. They must create or maintain the "enabling conditions" that allow local government units or non-governmental organizations to take on more responsibilities, while allowing them large areas of real control. Resources and capabilities must be transferred to, or built up at, or allowed to emerge within, the local level to permit real use of the formal powers provided by decentralization. "Capabilities" go far beyond the accounting and information technology skills of local government employees; they include the mobilization of civil society forces in a give-and-take with local political and administrative authorities.

A health crisis that is not self-healing

Intensified human poverty in many countries in the region has led to a crisis in nutrition and health.

Millions of families are unable to feed themselves properly. A recent study indicates that in Poland 60% of children suffer from some kind of malnutrition. One of the most visible symptoms is "stunting" in young children caused by protein-calorie malnutrition. In Russia between 1992 and 1994 the percentage of children under two who were stunted rose from 9% to 15%.

Poor diet also leads to shortages of micro-nutrients: calcium, vitamin B, and especially iron (anaemia). In Ukraine between 1990 and 1995 the percentage of pregnant women with anaemia rose from 11% to 34%. Malnourished mothers are more likely to give birth to underweight children. In most countries in the region the number of children with low birth-weight has grown.

Poor nutrition means lower resistance to disease; and the same poverty that has caused the nutritional crisis means that even low-cost healthcare interventions are difficult to finance. In some countries of the former Soviet Union diseases such as diphtheria that are easily controlled by immunization are now reaching epidemic levels. Tuberculosis and even polio have reappeared. Sexually transmitted diseases and HIV/Aids are also on the rise.

In the Russian Federation male life expectancy fell between 1980 and 1995 by more than four years and is now only slightly over 60 - nearly ten years less than in China. Many early deaths are from coronary heart disease and other diseases that are exacerbated by smoking and alcoholism. But insecurity is also leading to suicide. In the Baltic states and the Russian Federation the male suicide rate is more than three times higher than in the European Union. Typically the rate is four or five time higher for men than for women, who have proved more resilient. Indeed women's life expectancy has generally risen.

The result is an increasing sex imbalance: compared with what would be expected in a normal population, there are now 5.9 million "missing men" in the Russian Federation and 9.7 million in the whole region.

The growth in poverty hits women in other ways. The closing of health clinics and the deterioration in care for the elderly means that many women have to spend more time at home - caring for family members, as well as providing goods that can no longer be bought (sewing, cultivating family plots, etc.). Women suffer more from domestic violence: housing shortages may force even legally separated couples to go on living together. They are more likely than before to be victims of violent crime, including rape.

The increase in human insecurity has also had a striking effect on birth rates. People who are uncertain about the future are reluctant to commit themselves to marriage and can afford fewer children. Between 1980 and 1995, birth rates in central and eastern Europe fell by between 21% and 38%; in the Baltic states they fell by one-third and in the Commonwealth of Independent States they fell by between 8% and 44%. Except for Croatia, the "total fertility rate" (the number of children born to the average woman in her lifetime) has fallen throughout the region.

The decrease in birth rates has generally been greatest in the countries where average income has dropped most steeply. The fall in births and the rise in deaths are causing the population of some countries to decline. This trend has been intensified by migration, with many people moving from one country to another in search of work, or leaving in large numbers for countries in the West.

There are many ways in which local government, working with civil society organizations, could tackle these problems effectively. All but the last of them are amenable to low technology, high-organizational-mobilization remedies.

In all of the currently advanced European and North American countries the concept of public health, with visiting health workers networks, use of primary and secondary educational institutions as contact mechanisms and a focus on maternal and child health, was already widespread in the early 20th century. These public health approaches, along with quarantine, played a central role in the large mortality decline and general health improvement that took place even before modern scientific medicine began to have a widespread effect (around the time of World War II).

Pre-reform China also demonstrates that simple, comprehensive, low-cost and well-organized public health measures can make an enormous contribution to the wellbeing of the population. Indeed, a fundamental lesson from public health policy worldwide is that a few, carefully targeted initiatives - maternal and child healthcare, vaccination, and quarantine - can bring about a major decline in mortality and general improvement in the wellbeing of the population.

Given the extent to which the health crisis in transition countries appears to be the result of collapsing routine and preventative care combined with sharply increased self-destructive population behaviour, low-cost local health mobilization programmes should be possible even where the healthcare system remains formally nationally controlled and highly centralized.

Simple programmes organized locally to deal with health and nutrition issues would be ideal ways to revive local civil society and the spirit of voluntary contribution to the general welfare. Local public health initiatives need not contradict national policy; indeed, a national-level initiative could call on local government and local non-governmental organizations to revive screening for childhood vaccination, various diseases, malnutrition, etc. Local maternal and infant nutrition programmes could be organized without great cost. Dozens of issues wait to be addressed: screening for and monitoring of high blood pressure and diabetes; helping the elderly with sight and hearing problems; identifying early signs of alcoholism and depression; winterizing apartments; cleaning up hazardous sites; and other such tasks. Public information campaigns about sexually transmitted diseases, safe sexual behaviour and HIV/Aids are badly needed in many countries of the region. Latin American experience shows that local government can be effective in exactly this area.

Effective social protection

In most countries in the region, one of the biggest causes of social deprivation has been the reduction in social protection in the 1990s due to government delays in paying social transfers and in adjusting the value of benefits in the face of inflation. Access to social security is no longer considered a universal right. The trend to means-tested and other selective, "targeted" forms of income transfer has been the most powerful theme of social policy throughout the region, and has been strongly encouraged by international organizations. This poses the most immediate challenge to rethinking the role of the state in social policy.

The minimum wage still plays an important role in most of these countries. If it is to be a guide to wages in general, it must be brought closer to the average wage. And if it is to be used to determine social transfers such as family benefits, then it must rise to some reasonable approximation of subsistence income. It is in many cases far from being close to either the average wage or subsistence income.

In effect, the minimum wage has been turned from a source of basic income security into a mechanism of destitution. In many transition countries, people are entitled to social assistance if their income falls below the statutory minimum wage, but since in most cases this wage level is set below subsistence, many people who are genuinely poor lack entitlement to benefits. In the Russian Federation, for example, the minimum wage in 1997-98 was just 8% of the average wage; in Kyrgyzstan in 1997 it was 13% of average state-sector wages, and in Armenia it was 11%.

Despite the growth in poverty and human insecurity, governments are still under pressure to cut public expenditure. For the next few years, this would be unwise - for both economic and social reasons. Especially in countries where inflation is already below 10%, further cuts could stifle economic growth. And if human development really is a priority, governments need to increase public spending. This requires a stronger public administration that can gather revenues efficiently and use them well.

Unemployment benefits have long needed reform. In most countries, conditions for entitlement have been tightened, periods of entitlement have been shortened, and benefits have declined both absolutely and relative to average incomes, while the average length of unemployment has risen. Many workers are trapped in jobs where they have been paid little or nothing for months. If they quit, they are likely to lose entitlement to severance pay, enterprise-connected social services and housing, as well as unemployment benefits; at the same time, employers have little incentive to dismiss redundant workers because of the obligation to pay severance. The result is concealed unemployment. If most of those actually unemployed do not register (as in Belarus, Russia, Ukraine and Moldova), but a high proportion of those who do register receive benefits, it may seem that the system is working, but even here the picture can be worrying. While in Russia the percentage of registered unemployed in receipt of benefits rose from 64% in 1992 to 90% in 1996, in other countries it fell.

Substantial problems have been created by shifting essential benefits and services from universal coverage to selectivity and targeting. Many countries have tried to reduce costs by limiting benefits to the very poorest. Such means-tested schemes are rarely effective in reaching the intended beneficiaries and invariably involve large administrative costs. In addition, governments have been wrongly advised to privatize many of their social services: effectively, this has meant abandoning state responsibility for basic welfare provision.

Consumer subsidies were pervasive in the old regimes and mostly universal in character (with some special supplements). In many countries they have been phased out. Some countries have attempted to subsidize certain basic goods selectively, however, for groups of the population deemed to be especially vulnerable or poor.

Selective and means-tested schemes for social protection are inherently flawed. International evidence demonstrates that only a modest proportion of those in need actually receive the benefits in question, while a high share of actual expenditure goes to administration and monitoring the application of the benefits [Goodin et al. 1999]. "Categorical targeting" approaches that make payments to all within a certain category (child, single parent, etc.) are much less costly and intrusive to administer, build solidarity, and directly combat social exclusion.

Pension reform remains one of the focal points of social policy. The zeal with which privatization and funded schemes have been urged to replace pay-as-you-go state pensions should be tempered by concern about the implications for low-income earners and for income distribution. Considerable pressure has been exerted on governments to adopt variants of the Chilean pension system, which allows for various "tiers of entitlement", with a "first pillar" of public provision of a minimum benefit, an obligatory "second pillar" based on contributions from those who are employed and a "third pillar" based on voluntary contributions to private funds.

Such schemes are known to erode the role of state-guaranteed social protection, to be very expensive to administer and to generate additional inequalities. Those with long-term, well-paid employment stand to benefit, but the poor and vulnerable, who rely on more irregular or informal forms of employment, are disadvantaged. The effects on the health of the "first pillar" (the public pension) need to be carefully assessed before cash-short governments are encouraged to adopt this expensive and socially divisive palliative [Orsagh and Stiglitz 1999 and Barr 2000].

If conventional economic arguments for pension reform of the kind generally advocated cannot stand the light of day, what motive can there be for such strong lobbying? The answer, I think, is an ideologically driven and often explicitly stated desire to destroy a solidarity-based concept of social life and citizens' co-responsibility. Nothing more. Inspection of the background of key advocates does little to dispel this suspicion.

In many transition countries social security has not taken a large share of national income and the levels of protection have commonly been lower than in many countries elsewhere. While some restructuring of social policy financing and provision is required, principles of universalism should be preserved and reinforced to help ensure social integration, reduce poverty and inequality, and strengthen community. The core of the welfare system should be a subsistence income that permits everyone to survive with dignity and respect. This can be achieved by setting realistic minimum wages, which in many countries have fallen to desperately low levels.

Better environmental performance

The Environmental Action Programme (EAP) for central and eastern Europe endorsed by the Lucerne ministerial conference in April 1993 has been a blueprint for environmental policy reform in the region. It made reducing threats to human health one of the most important criteria in setting priorities. To solve the most urgent environmental problems cost-effectively and efficiently, it recommended a mix of policy tools, institutional strengthening, and carefully selected and well-prepared investment.

The region inherited the environmental problems of a centralized planned economy: the economies of the former Soviet bloc were resource-intensive, making especially inefficient and polluting use of energy in goods production. The same economies, however, made highly efficient use of centralized environmental strategies such as co-generation and central district heating, comprehensive resource recycling, emphasis on mass transit, household-level waste separation, and standard-size reusable bottles and containers.

Transition sharply cut production-based pollution, due largely to a sharp decline in goods production; but heating and resource reuse systems also decayed or were abandoned and buses and trains were partially replaced by cars. Many of the abandoned functions or approaches were fully modern, reflecting current environmental policy and practice in the most advanced market economies, but they were associated with the old regime and often treated as a badge of backwardness.

In some countries environmental conditions are well documented, in other countries they are less well known. Pollution varies widely across the region, which includes large areas of undisturbed nature with unique wildlife as well as ecological disaster zones. High rates of pollution are noticeable in northern Bohemia, south-west Poland, the Black Sea and the Danube river basin.

The previous system used a top-down, command-driven approach to environmental policy and lacked flexibility. During the 1970s and 1980s most countries in the region developed institutions, laws and policy instruments to limit or reduce environmental degradation. Implementation and enforcement remained weak, however, and these measures had little impact.

Decision-makers generally put production goals before environmental objectives. Public authorities were often unable to monitor and regulate activities for which they were formally responsible. In many cases the same authority was both the source of pollution and responsible for preventing it. Civil society was seldom able to influence policy-making.

The transition to democracy and a market economy offered the countries of the region the opportunity to reconstruct their environmental policies and management systems fundamentally.

Part of the EAP deals with building better institutions for environmental policy-making and management. Local and regional agencies are primarily responsible for implementation, monitoring and enforcement, while national authorities are responsible for coordination and setting overall policy. The driving forces behind this change include declining public budgets, pressures to reduce central administrative functions in favour of regional and local government, policies to promote greater democracy, and the application of ecological criteria to land use planning. Through decentralized decision-making, environmental actions can be tailored to specific needs. In recent legislation many countries in the region have moved in this direction, giving local government new and broader environmental responsibilities in the following areas: air quality; air pollution; water quality and water supply; managing waste water and providing adequate supplies of clean drinking water; waste management; land-use planning; and protecting and managing green areas.

Decentralization is, however, a mixed blessing. Local governments throughout the region are acquiring administrative responsibilities without adequate power to raise revenues or adequate staffing and training. Central funding has been drastically reduced and most local authorities are now dependent on the limited funds that they can raise locally. This financial pressure sometimes results in the overexploitation of natural resources. Another danger is policy fragmentation, when decentralization makes it impossible to take environmental action on the scale required.

Economic events affect environmental policy by influencing the revenues countries are able to generate for environmental projects and the additional funds that they are able to attract. In the early 1990s countries in central and eastern Europe experienced less profound damage to their economies than the CIS states and made a quicker recovery. On the whole, they have been better able to use market-based mechanisms to promote environmental management. They have also raised the prices of natural resources to reflect world market prices, so they have a strong incentive to use these resources efficiently.

Economic stabilization in Hungary has led to the growth of a commercial market for municipal loans. These loans have been used to upgrade water treatment facilities, improving water quality - and also improving air quality through reduced fuel consumption. Loans to improve central district heating systems or to switch from coal to gas-fired heating have also improved air quality.

In Poland, a well-publicized debt-for-nature swap in 1992 led to the creation of Ekofundusz (ecological foundation). Ekofundusz obtained more than $130 million in the first six years and expects more than $400 million in additional funding by 2010. These funds are used for projects to reduce greenhouse gas emissions, transboundary air pollution and pollution flowing into the Baltic Sea, while improving waste management and protection of biodiversity. The fund covers up to 30% of the cost of projects proposed by municipal authorities.

Unfortunately Ekofundusz is an exception, and lack of revenue has meant an acute shortage of resources for environmental programmes elsewhere in the region. Municipalities must provide subsidies for commodities such as heat, but their ability to generate revenue in a climate of non-payment is low. As a result, municipalities in Russia and other CIS countries find it hard to raise money for investment projects. Where the economy is poor or the currency is not convertible, there is almost no access to credit through the commercial banking sector. Other sources of financing have also been hindered by general macroeconomic difficulties; the fledgling municipal bond market in Russia, for example, was paralysed by the devaluation of the rouble in 1998.

The availability of extra-budgetary revenue for local environmental investment has also affected progress in the two major sub-regions. In general, the central and eastern European countries have maintained sufficient infrastructure at the federal and regional levels to enforce environmental regulations. Enforcement generates revenue through fines, which can then be used to support environmental projects. This type of revolving fund for environmental projects now exists in Poland, the Czech Republic, Hungary, and Slovenia.

The opposite has occurred in many CIS countries. Environmental laws in the newly independent states remain some of the strictest in the world, but they are still not enforced. In some cases, fines are set so low that polluters are better off paying the fines and ignoring the laws. In other cases, governments simply lack the resources or the political will to prosecute polluters. As a result, the amount of internal revenue available for environmental projects is limited.

Ten central and eastern European countries have signed association agreements with the European Union and started negotiations for full membership. Accession will require the transposition, implementation and enforcement of EU legislation (the acquis communautaire) in the candidate countries. This means creating appropriate institutions, developing policies with country-specific solutions and mobilizing funding for their implementation. Since local governments are the main authorities responsible for implementing environmental legislation and play the role of competent authority in many EU directives and regulations, accession will have a significant impact on local government in candidate countries. Cities will need to make sure that air and water quality meets EU requirements and that waste management is properly carried out. Sewerage systems and waste water treatment plants will have to be built or upgraded and the efficiency of energy services and waste management will have to be improved.

The new comprehensive EU legislative framework on air quality places increasing pressure on local authorities to respect strict legal limits so that ambient air quality is improved. Similar legislation on noise abatement may follow, requiring local authorities to measure, monitor and, where appropriate, reduce noise in urban areas. It is essential that local authorities are actively involved in the EU approximation process, but this can be only achieved through continuous dialogue with national and regional environment agencies.

The important role of local government in accession can be a driving force for further decentralization, consistent with the EU principle of subsidiarity. Recent surveys showed that few local governments in the accession countries are prepared for these assignments. In some cases they are even not aware of the upcoming changes. Further decentralization of responsibilities will require strengthening the financial position of local government and extensive capacity-building, including both technical assistance and training.

Environmental initiatives that could be taken locally range from public information campaigns about energy use and measures encouraging elementary changes in usage patterns to direct efforts to transform the "production processes" of municipal enterprises and departments. Experience elsewhere indicates that large savings can be made from simple inspection and correction of burners and other equipment, in what are called "energy housekeeping" inspections. The psychology of energy waste that formed over a long time in an environment of abundant low-cost energy has still not been overcome; so many simple steps have not been taken in public education and awareness.

An innovative programme in Turkmenistan uses small high-pressure pumps to raise the pressure in the water lines of individual apartment buildings. Once people come to believe water will be available when they need it, they can be convinced to stop long established practices such as always leaving faucets partly open (to retain suction or to be the first to get water when an empty system is refilled). Metering of building usage patterns (unconnected to billing for water use) is helpful in showing how much leakage or waste there is (small differences between peak hours and the middle of the night are a sign of great waste).

Acting on its own without national government or international donor support, the municipal government of Debrecen, Hungary reorganized and upgraded its "thermal utility" (its urban heat and hot water system). The result is a system that covers its real costs of operation, has almost no payments arrears and has improved local air quality. It is so successful that Debrecen is now selling consulting services to municipalities in Hungary and several other countries. Of course this is "exceptional management", but once such achievements occur in one place they can lead to wide emulation.

Municipalities can also make connections to the Global Environmental Facility (GEF), which focuses on energy efficiency as a path to reducing "greenhouse gas" emissions. In Bulgaria, GEF funded an NGO to improve energy efficiency in municipalities through pilot projects and awareness raising. Gabrovo is the key municipality for the pilot programme (www.eneffect.bg). In the Czech Republic, GEF gave $450,000 to an NGO to develop low-cost, energy-efficient public housing designs; municipalities pay for the construction (www.svn.cz). In Hungary, GEF provided $4.4 million to a government-owned non-profit Energiakozpont (energy centre) to support energy audits, feasibility studies, and awareness of energy efficiency issues in municipalities. The federal government is matching this money, and municipalities will cost-share the audits.

There is a great potential for municipalities to work with community-based organizations in mobilizing local groups to tackle energy and heat problems. The public could be invited, for example, to help in finding losses from the central district heating and domestic hot water systems. Such efforts could be particularly good avenues for active church engagement with local government.

A "Winter 2002" campaign could be organized to carry out a pre-winter inventory of glazing and heating connections in all apartment buildings in a city in order to reduce energy waste; this could be combined with screening for elderly, ill, or otherwise vulnerable citizens. Municipalities could help by collecting and preparing used, discarded glass and window frames for use in repairs to broken apartment or factory windows. Small greenhouse and cold-frame modules could be created at very low cost from materials that would otherwise end up in landfills. This is also a natural area in which local governments could nurture the growth of new micro and small enterprises, as is suggested below.

Collaboration between cities might be useful in applying for loan funds to repair or upgrade central district heating and co-generation systems. Often the same simple technology (automatic controls, measurement devices, boiler or filter replacements) is needed by many or most towns in a region or nation, but each project by itself is too small to qualify for available loan funds. A multi-city approach to regional or national government could offer significant economies in energy use and low purchase prices from "package" arrangements. Often, the bill for energy use must ultimately be paid at the regional level, so real savings would be welcome there.

This illustrates a problem that should not be a problem: routine old-technology solutions that are too small and "easy" to qualify for funding. This is an area where different initiatives are waiting to be tried, many with the potential to energize civil society.

Local economic revitalization

A hidden but central principle of conventional economic policy advice is the homogeneity of successful economic institutions. Modern economic history shows, however, that there have been and are a number of economic systems in which ownership and management arrangements are mixed together in unconventional ways, but that were or are nonetheless successful. Many of these "successful" systems live in a world far from free-market conditions (McIntyre 2000a).

Advanced market societies have vast experience of diverse institutional mixtures. This is most obvious in countries such as Italy, France and Taiwan that carried high levels of state-owned enterprise into the 1990s, in the last two countries often in leading, high technology sectors. Norway, Sweden and Finland provide a related Nordic variant that is similarly technically progressive. Industrial policy, in many different forms, has played a great role in both the countries where it is famous (eg, Japan, Korea and France) and those where it is not (eg, information technology in the United States and Finland).

A remarkable example of how municipalities can stimulate business without direct ownership is found in northern Italy, in the Emilia-Romagna region around Bologna, where more than 1,800 cooperatives employ 60,000 workers. Many of these small businesses export high-tech products that compete internationally. Over several decades the regional and local governments have creatively blended public-private partnerships with worker ownership to transform a once impoverished agricultural area into the fastest-growing part of Italy, with a per capita income ranking of 10th among the 122 official regions in the EU.

Even in the United States, widely thought to be committed to classical purely private solutions, there are many alternative modes of ownership: 47,000 cooperatives; 6,300 municipally-owned enterprises; 2,500 employee stock ownership plan (ESOP) companies in which employees own a majority of the shares (including some very large companies); and a myriad of "non-profit" entities that by themselves constitute 6.5 per cent of the US economy (Shuman 1998). Sub-national governments often play a role in supporting the successful functioning of these entities.

The lesson to be learned by transition economies from these examples is that in a variety of national contexts working arrangements were developed which allowed the successful coexistence within the same economic space of very different forms of organization and ownership.

In many transition economies there are "incompletely privatized" entities in large numbers and varying sizes. Legal questions about the initial privatization, the death of owners, artificial and real economic crises and other factors have placed the problems and often the assets of many of these previously state-owned enterprises in the hands of local governments [McIntyre 2000b]. What to do next?

Ellerman points out that there is an alternative to the generally disastrous voucher privatization which could have supported growth of the crucial small and medium sized enterprise sector in all CIS countries [Ellerman 2000]. He calls this alternative "Polish leasing", although the same "lease buy-out" approach was developed during the perestroika period in the Soviet Union. The method was organizationally perfected both in the indigenous cases during the 1980s and then in the pre-voucher period (1991) pilot lease-buyout programme supported by the European Bank for Reconstruction and Development. Ellerman argues that this would have provided a better path to the market. He quotes the American jurist, Bernard Black, who is the principal author of the Russian corporate law codes:

It is ironic that the Russian Communists of a decade ago, knowing that central planning was a dead end but not fully trusting markets either, likely built through enterprise leasing a better means for enterprises to manage the transition to privatization and a market economy than the privatize-now approach that western advisors later promoted and Russian reformers enthusiastically seized on. The Russians who blame western advice for destroying their economy are not entirely wrong [Black, Kraakman and Tarassova 1999].

This homegrown privatization method (lease buyouts or enterprise leasing) was more or less equivalent to one of the most successful of the eastern European privatization programmes, the "Polish leasing" approach. According to Ellerman, this promising and extremely popular USSR-period approach was

...abolished by the reformers with the full approval and indeed insistence of the western advisors. Thus the reformers and their western counterparts not only pushed Russia along a disastrous path but deliberately blocked an alternative indigenous path that showed great promise elsewhere (eg, Polish leasing and Chinese TVEs) (Ellerman 2000).

This approach is in effect the sale of an enterprise to its workers and/or managers, as well as other local stakeholders, with payments made over time out of future sales proceeds. Former World Bank chief economist Joseph Stiglitz has proposed exactly this approach, specifically linking it to the current institutional dead-end in many countries in the region, and calling for "privatization to stakeholders" (Stiglitz 1999). This concept has wide potential application in the countries of the region as an approach to redeeming failed past or failing future privatizations.

Local economic development initiatives

In Budapest the city government was able to resist pressure from the national government for rapid and extensive privatization of city services, but successfully reorganized and improved the performance of those functions it retained. It was also able to prevent abandonment of construction of a fourth subway line. This type of transportation infrastructure has major human development effects because it directly allows commuting, job-seeking and health and social service access by low income citizens.

In Moscow the city government has carried out its own economic development policy, organizing orderly small enterprise privatization (including active support programmes, credit access and other measures) and blocking the national large-enterprise privatization initiative - directly taking control of several very large enterprises to protect employment and municipal tax revenue. It buys and sells billions of dollars of foodstuffs each year, using a self-financing revolving fund, to guarantee adequate supplies and prevent price manipulation. It carries out a multi-region food supply programme, subsidizing investment in agriculture and food processing in surrounding oblasts, as well as guaranteeing market access.

Moscow is a wealthy city, drawing tax revenues from the headquarters of firms that produce in other parts of Russia, but its active engagement with economic development policy and income support (which includes 100% supplementary payments to national pensions for all city residents) reflects not just money, but good urban management.

Enterprise revitalization

A new programme to revitalize enterprises in Russia is an example of how to mobilize local economic development based on small and medium-sized enterprises (SMEs).

This World Bank Institute programme is working with the Federation Council and Duma, the Russian Union of Employee-Owned Enterprises and the Academy of Self-Management to improve management and performance by piloting the application of high performance management techniques and teamwork methods, paying particular attention to new and "mixed" types of enterprise.

It draws on the experience of the UN Development Programme in Ukraine, which began in 1994. This focuses on the role of local self-governing entities (mostly municipalities) in stimulating local SMEs by training SME operators and local government officials; developing public-private programmes to support investment in the enterprises; and creating innovative forms of credit support - including the use of municipal property as collateral for loans to local SMEs.

These new municipal credit mobilization techniques address the crucial problem of small and medium-sized enterprises - lack of access to credit on "reasonable, non-criminal terms". Churches and church groups might well play a role in this in many transition economies.

Many false hopes have been built on the assumption that, once market economy conditions are introduced, small enterprises will develop automatically and will dynamize the system. While SMEs are a potentially dynamic force in revitalizing local economies and reducing poverty, they seldom are cumulatively successful (at more than subsistence levels) without active institution-building and support from outside. The United Nations University/WIDER research project on SMEs in the transition economies strongly underlines these points, concluding that local authorities would be wise to follow the practice of regional and local authorities in western countries in adopting a local industrial policy (McIntye 2001).

A healthy relationship with the surrounding state-owned and previously state-owned enterprises is crucial if SMEs are to move beyond providing services and small-scale retailing. Local government can stimulate constructive interaction between the large and small entities, improving the flexibility and competitive position of both.

Local government can also support the "unpacking" of bankrupt or unprofitable large enterprises in ways that salvage as many smaller production units and employment places as possible. The experience of the World Bank ARIA programme in Moldova shows that the physical and human resources of financially nonviable large enterprises are a valuable source of "start-up" capital that, with the aid of technical assistance and local government support, can be reconfigured into viable smaller enterprises. The Russian enterprise revitalization programme mentioned above also has a promising new technique of operating and reorganizing formally "bankrupt" entities under municipal protection.

Equally promising are efforts to trigger local saving-investment cycles, based on the visible use of local savings to fund effective local projects. It is necessary to explore different approaches to establishing local SME infrastructure and institutional support, emphasizing formation of credit cooperatives and considering establishment of municipal or local church-based credit guarantees for small enterprise loans.

The local enterprise revitalization approach has strong advantages of credibility, low cost, and a high probability of establishing cumulative local learning circles. It builds capacity and reduces dependence on external consultants. It can be used in situations of extreme government budgetary stringency. And it offers potentially powerful positive examples in an environment where direct copying of western models has often proved unsuccessful.

Reviving the state, reasserting rights of citizenship

A few countries in the region have seen modest economic growth in the transition period, but even this success has limitations. Economic growth does not matter much if people are dying from preventable diseases because the healthcare system is stripped of funds and hospitals lack essential medicines or supplies. Competitive exchange rates that make a country's products cheaper are not enough to sustain an export-led strategy if corruption is prevalent and revenues are stolen in "capital flight". Fiscal reforms are not successful if taxes cannot be collected and the economy comes to depend heavily on various forms of barter.

A major problem with the economic policies advocated for the transition period is that they have been based on minimizing the role of the state. Because of the protracted and complex nature of the transition, it is now clear that the responsibilities of the state need to increase rather than decrease. The state should be activist and intervene in critical areas where market forces cannot ensure an efficient allocation of resources or where access to basic assets and opportunities for people's livelihoods is inequitable.

Governments can delegate some activities to commercial or non-governmental organizations, but they still bear the ultimate responsibility. This needs to be discharged through a new kind of state, responsive and transparent and open to widespread public participation - one that serves the wishes of the majority while protecting the interests of minorities.

Experience has demonstrated the importance of maintaining a viable state in achieving sustainable and equitable growth. In the rush to dismantle "socialist" systems many countries have undermined the ability of their states to underpin market economies. The state plays a central part in modern market economies in maintaining economic stability, regulating the markets, and ensuring essential social services. The overwhelming social transformations progressing in the region require a large role for governments, not small; more investment in the public sector, not less; putting in place a set of rules and regulations and an impartial legal system, not fast deregulation; improving provision of social services, not their abandonment.

The future of the region will depend on activist states that can help unleash the creative potential of their citizens. These states can and should be revived democratic states in both spirit and practice, especially at the local level.

Dr Robert McIntyre is senior researcher at the Institute for International Economic and Political Studies, Russian Academy of Sciences, Moscow.

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