Ba-2130106-R.S.Hunter

1

A Government’s Key to Unlocking a Successful
Entrepreneurial Business Environment
-
As Identified through an Analysis of the Lithuanian
Transition Context
Renée Hunter
S2130106
Bachelor’s Thesis
International Relations and International Organisation
University of Groningen
2014/2015
The International Political Economy of Eastern Europe and Central Asia, taught by
Prof. dr. H.W. Hoen
Abstract
Entrepreneurship is a concept that contributes a lot to the development and growth of
economies. This thesis describes different definitions of the concept and their
implications for further understanding of economics. William Baumol’s definition of
productive entrepreneurship is used, which places great emphasis on the institutional
structure that determines the rewards for entrepreneurship in an economy. There are
different ways in which a government can influence the institutional structure; the
most important ways being regulations, the taxation system and well-defined property
rights. This thesis aims to contribute to the understanding of which of these is most
important in encouraging a blossoming entrepreneurial environment in an economy.
Based on the transition from communism to capitalism in Lithuania, the different
actions undertaken by the government and the resulting levels of entrepreneurship, it
is concluded that a swift and comprehensive restructuring of taxation in favour of
SMEs is most important.

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DECLARATION BY CANDIDATE
I hereby declare that this thesis, “A Government’s Key to Unlocking a Successful
Entrepreneurial Business Environment – As Identified Through an Analysis of the
Lithuanian Transition Contex”, is my own work and my own effort and that it has not
been accepted anywhere else for the award of any other degree or diploma.
Where sources of information have been used, they have been acknowledged.
Name Renée Suzanne Hunter
Signature
Date December 19, 2014

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Table of contents
Abstract
.....................................................................................................................................................
1

DECLARATION BY CANDIDATE
.............................................................................................
2

Table of contents
...................................................................................................................................
3

List of figures
..........................................................................................................................................
5

Abbreviations/Acronyms
....................................................................................................................
6

Introduction
.............................................................................................................................................
7

Outline
..................................................................................................................................................
8

Relevance
............................................................................................................................................
9

1. An Introduction into Entrepreneurship
..................................................................................
10

1.1 Definitions
................................................................................................................................
10

1.2 Outcomes and Incentives
.....................................................................................................
12

1.3 Definition to Be Used in this Thesis
................................................................................
14

2. Entrepreneurship in an Institutional Context
.......................................................................
15

2.1 It’s All About the Rewards
.................................................................................................
15

2.2 What Are institutions?
..........................................................................................................
17

2.2.1 Informal Institutions
.....................................................................................................
18

2.2.2 Formal Institutions
........................................................................................................
20

3. The Most Influential Formal Institutions
..............................................................................
22

4. Lithuania
...........................................................................................................................................
26

4.1 A Brief Introduction into Lithuania
.................................................................................
27

4.2 Undertaken Courses of Action
...........................................................................................
28

4.2.1 Lithuanian Government
...............................................................................................
29

4.2.2 European Bank for Reconstruction and Development
......................................
33

4.2.3 Various Lithuanian Strategic Documents
..............................................................
35

4.2.4 Additional Sources
........................................................................................................
37

4.3 Extent to Which the Results Correspond to the Taken Courses of Action
.........
38

4.3.1 Barriers to Doing Business
.........................................................................................
38

4.3.2 Ease of Doing Business
...............................................................................................
40

4.3.3 SME Prevalence
.............................................................................................................
41

4.3.4 Corruption
........................................................................................................................
42

4.4 Conclusion
................................................................................................................................
44

5. Conclusion
.......................................................................................................................................
47

References
............................................................................................................................................
49

Annex 1 Policy guidelines as set forth in Fostering Entrepreneurship
...........................
54

4

Annex 2 Country-Specific Details on Lithuania in Ease of Doing Business Reports,
2004-2015
.............................................................................................................................................
56

Annex 3 Combined Data on Ease of Doing Business in Lithuania, 2004-2015
...........
61

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List of figures
Table Page Title
1 9 Main definitions of the concept of entrepreneurship
2 9 Main characteristics included in the definitions of entrepreneurship
3 32 Strategic Priorities of the EBRD in Lithuania
4 34 Initiatives towards Entrepreneurship as Mentioned in various
Lithuanian Strategic Documents (roughly 2002-2012)
5 38 Barriers to Doing Business as Mentioned by Lithuanian Entrepreneurs
6 39 Summary of the Most Important Rankings of World Bank Ease of
Doing Business Reports for Lithuania
7 41 Number of SMEs in Lithuania
8 42 Lithuanian Ranking on the Corruption Perception Index
9 43 Size of the Lithuanian Shadow Economy as % of GDP

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Abbreviations/Acronyms
BEEPS Business Environment and Enterprise Performance Survey
CEE Central and Eastern Europe
CPI Corruption Perception Index
EBRD European Bank for Reconstruction and Development
FSU former Soviet Union
GDP gross domestic product
IIDSF Ignalina International Decommissioning Support Fund
IPR intellectual property rights
NSA Nuclear Safety Account
OECD Organisation for Economic Cooperation and Development
SME small and medium-sized enterprises

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Introduction
Privatisation was but one element of the transition. It is well recognised that
the process of entrepreneurship is a critical facet of a market economy since it
affects innovation, job creation, and economic growth. 1
In addition to fulfilling the economic functions [such as innovation, job
creation, and economic growth], entrepreneurship may contribute to the
creation and evolution of a nascent market end accompanying institutions as
well as to public understanding of what constitutes a market economy2
.
As is well known, an important part of economic transition consists of
privatisation. For a market economy to function well, it is vital that the influence of
the government on the economy is reverted to a minimum. From this, it flows
naturally that it is good to have as much private ownership in the economy as
possible. Private enterprises are believed to be more efficient, more competitive, and
will therefore help GDP in an economy to grow, among other things.3
Not only the fact that firms are privately owned is of importance in economic
transition; also the characteristics of the specific owners of those enterprises are of
value. It is believed that certain types of firm-owners (innovative entrepreneurs of
small and medium-sized enterprises (SMEs) in particular) have a strong positive
effect on the economic growth of a country.4
In the words of Schumpeter, one of the
most eminent scholars in the field of entrepreneurship – it is not population growth or
capital accumulation that helps us understand the economy, since they are “grey,

1
OECD, Fostering Entrepreneurship (Paris: OECD, 1998), 269-270.
2
Ibid.
3
Anders Åslund, Why Capitalism Was Built: The Transformation of Central and Eastern Europe,
Russia, the Caucasus and Central Asia, 2nd
ed (Cambridge: Cambridge University Press, 2013): 9.
4
Among others:
Anders Åslund (2013): 9.
OECD (1998): 11.
Saul Estrin and Tomasz Mickiewicz, “Entrepreneurship in Transition Economise: The Role of
Institutions and Generational Change”, Institute for the Study of Labor, discussion paper no. 4805,
2010, 3.
Tomi Ovaska and Russell S. Sobel, “Entrepreneurship in Post-Socialist Economies”, Journal of Private
Enterprise 21 (2005): 8.
M.B. Neace, “Entrepreneurship in Emerging Economies: Creating Trust, Social Capital, and Civil
Society”, The ANNALS of the American Academy of Political and Social Science 565, no. 1 (1999):
149.
C.M. van Praag, “Determinants of Successful Entrepreneurship”, (PhD thesis: FEB: Amsterdam
School of Economics Research Institute, 1997): 11.

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derivative phenomena”. 5
Rather, it is “enterprise, innovation and economic
leadership, the vibrant colours that introduce qualitative transformation in its most
fundamental terms – the doing of things that have never been done before.”6
Not only does entrepreneurship through its natural characteristics influence
privatisation (it is privatisation, in a sense), it is the institutional environment that
encourages entrepreneurship that ultimately becomes the most important determinant
of growth in an economy.7
Naturally, this is something to be strived for. How to go
about this course towards increased levels of entrepreneurship? That is something this
thesis will attempt to make clear in the following chapters.
Outline
The main understanding this thesis wants to contribute to is the way in which
governments can successfully encourage productive entrepreneurship, as understood
by Baumol, through adaptations to the formal institutional framework within which
entrepreneurs operate. Since entrepreneurship has such a profound effect on the
development of an economy, it is very important that policymakers understand what
they can do to encourage it. Through fostering an entrepreneurial environment in a
developing economy, that economy can, as it were, from the inside out sustainably
develop itself, which is infinitely better than having external and temporary help from
outside to develop such an economy – “the entrepreneur and entrepreneurship should
take centre stage in any effort to explain long-term economic development.”8
Naturally, this is too big an endeavour to take on in a thesis of this limited size
and scope. Therefore, the main question to be answered in this thesis is as follows:
Which are the most important adaptations that a government can make to the
institutional framework within which entrepreneurs operate, in order to
successfully encourage productive entrepreneurship, as understood by
Baumol, as illustrated by developments in Lithuania during the years from
independence until today?
The reader will be guided towards the answer to this question in a logical
manner, starting with an exploration of the concept of entrepreneurship in the first
chapter. The second chapter will move on by explaining the concept of the above-
mentioned institutional framework, and the ways in which it can influence the
prevalence of entrepreneurship in an economy. The third chapter will strip down the
concept of the relevant institutional framework to a few points that are useable in an
analysis in order to answer the question. The fourth chapter will apply the information
from the first three to the transition process in the Republic of Lithuania, in order to
see what the government has done, how successful it was, and to finally answer the
main question.

5
Stan Metcalfe, “J.A. Schumpeter and the Theory of Economic Evolution (One Hundred Years beyond
the Theory of Economic Development)” (Papers on Economics and Evolution #1213, Max Planck
Institute of Economics, 2012), 2.
6
Ibid., 2-3
7
Randall G. Holcombe, “Entrepreneurship and Economic Growth”, Quarterly Journal of Austrian
Economics 1, no. 2 (1997): 45-62.
8
Gunnar Eliasson and Magnus Henrekson, “William J. Baumol: An Entreprenuerial Economist on the
Economics of Entrepreneurship”, Small Business Economics 23 (2004): 6.

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Relevance
As explained above, a more thorough understanding of entrepreneurship could
lead to an infinitely more thorough understanding of long-term economic
development, and maybe even contribute to a revolution in economic aid to
developing economies. Up until now, literature on entrepreneurship has generally
been limited to theoretical discussions of the impact of entrepreneurship. A practical
application of the theory is something new to the body of research on it, which is what
this thesis will do through the policy-oriented discussion in the fourth chapter.
Moreover, with the discussion on the institutional framework in the second chapter,
this thesis will combine the neoclassical economic concept of entrepreneurship with
the institutional economic concept of the institutional framework, in the true inter-
disciplinary spirit of International Relations.
The following description by Baumol captures the essence of the relevance
and aim of this thesis well, which is why it will now be the conclusion for this
introduction:
The basic proposition, if sustained by the evidence, has an important
implication for growth policy. The notion that our productivity problems
reside in ‘the spirit of entrepreneurship’ that waxes and wanes for
unexplained reasons is a counsel for despair, for it gives no guidance on how
to reawaken that spirit once it has lagged. If that is the task assigned to
policymakers, they are destitute: they have no means of knowing how to carry
it out. But is what is required is the adjustment of rules of the game to induce
a more felicitous allocation of entrepreneurial resources, then the
policymaker’s task is less formidable, and it is certainly not hopeless. The
prevailing rules that affect the allocation of entrepreneurial activity can be
observed, described, and, with luck, modified and improved, as will be
illustrated here.9

9
William J. Baumol, “Entrepreneurship: Productive, Unproductive and Destructive”, The Journal of
Political Economy 98, no. 5, part 1 (1990): 894.

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1. An Introduction into Entrepreneurship
1.1 Definitions
Entrepreneurship is not a new concept. Many authors have explored it, and
many different definitions have been given to the concept. Tables 1 and 2 provide
summaries of the most important definitions that literature has provided us with.
Table 1: Main Definitions of the Concept of Entrepreneurship
Year Economist Entrepreneurial role
Classical Era
1755 R. Cantillon Introduced the term: Entrepreneur
ER as speculator
1800 J.B. Say ER as coordinator
Early Neoclassical Era
1890 A. Marshall ER as coordinator, innovator, arbitrageur
1907 F.B. Hawley ER as owner of output (uncertainty bearer)
1911 J. Schumpeter ER as innovator
1921 F. Knight ER as responsible decision maker in an uncertain
environment
1925 F. Edgeworth ER as coordinator
Mature Neoclassical Era
1925 M. Dobb ER as innovator
1927 C. Tuttle ER as responsible owner in an uncertain
environment
Modern Neoclassical Era
1973 I. Kirzner ER as arbitrageur and ‘alert to profitable
opportunities’
1982 M. Casson ER coordination of scarce resources under
uncertainty
1993 W. Baumol ER innovator and manager influenced by
existing incentive structure
Source: Ruta Aidis, “Entrepreneurship and Economic Transition”, (Discussion Paper, Tinbergen
Institute, Faculty of Economics and Econometrics, University of Amsterdam, 2003), 3.
Table 2: Main Characteristics Included in the Definitions of Entrepreneurship
Period Risktaker Arbitrageur Capitalist Manager Innovator
Cantillon 1680-1734 +++ ++ + 0 0
Say 1767-1832 ++ 0 - +++ ++
Marshall 1842-1924 + ++ +++ +++ 0
Menger 1840-1921 - + - ++ 0
Knight 1885-1972 +++ 0 - - +
Schumpeter 1883-1950 - + - - +++
Kirzner 1930 - +++ +++ - 0 0
Source: C.M. van Praag, “Determinants of Successful Entrepreneurship”, PhD thesis, FEB:
Amsterdam School of Economics Research Institute, 1997: 11.
Note: The meaning of the symbols used to summarise the function aspects is:
- : aspect explicitly excluded
0 : aspect not included
+ : aspect implicitly included
++ : aspect explicitly included
+++ : aspect is essential to the theory

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What is interesting to note is the different roles and tasks that are attributed to
the entrepreneur. It is not so much that the understanding of the concept has evolved
and grown in a certain direction over time, but rather that different economists have
truly different understandings of what an entrepreneur in fact should be or do.
One can roughly divide the summarised definitions into two categories; those
that look at what entrepreneurs have, and those that look how entrepreneurs act.
One strand of entrepreneurial definition is based on the fact that entrepreneurs
are self-employed, own a firm, or are the manager of the firm (they have the lead, or
have the ownership, to stick with the ownership terminology). The economists from
Table 1 falling under this strand are Say, Marshall, Hawley, Knight (to some extent),
Edgeworth, Tuttle, Casson, and Baumol.
The other strand looks more at the specific behaviour that an entrepreneur
exhibits. For instance, an entrepreneur is someone that takes risks in order to acquire
more wealth, profits, or other type of rewards. Or an entrepreneur is someone that
innovates, be it by inventing a completely new product or technique; by entering a
new market; using a new combination of techniques in a new market; or any other
way of innovation. The focus here is not on whether or not the entrepreneur is in
charge of a firm or project, or is the owner of the firm or even the output or profits of
the innovative or risky venture.
Needless to say, the two strands often overlap, and it often happens that it is
the manager that determines new innovative paths for a firm to take. Or it is the owner
of a bulk of resources that makes the strategic risk assessment to determine what to do
with them. However, according to the second strand of entrepreneurial theory, an
entrepreneur might just as well be an employee deep within a firm that identifies a
new technique. Or, taking the example further; one might even exit the economic
realm and see a car owner devising a new, more efficient system of carpooling with
her colleagues as an entrepreneur. The economists that fall roughly into the second
strand of conceptualisation are Marshall, Schumpeter, Knight to some extent, Dobb,
Tuttle to some extent, Kirzner, Casson, and Baumol.
This overlapping of concepts and definitions is something that has been noted
frequently in the literature. In response to this, a concept has been developed, named
‘innovative entrepreneurship’.10
This concept incorporates the two strands, and it
makes the concept of entrepreneurship more intuitive, in a sense. While all definitions
mentioned in the tables are indeed correct, and can be understood conceptually,
ultimately, what jumps to mind when talking about an ‘entrepreneur’ is the owner of a
private business that comes up with new products and ideas, or attempts to approach
the market in a new way, so as to make as much profit as possible.
Defining exactly what falls under ‘entrepreneurship’ is very important in order
to facilitate further research. The different definitions of entrepreneurship lead to
different factors and variables of research. For instance, when one takes an
entrepreneur to mean ‘innovator’, it becomes more important to take into account the
number of patent applications in an economy. On the other hand, when
entrepreneurship is taken to mean ‘self-employed person’, or ‘firm owner’; the
numbers measuring those two factors become the data of importance.

10
Among others:
William J. Baumol, “Small Firms, Large Enterprises, Productivity Growth and Wages”, Journal of
Policy Modelling 30, issue 4 (2008): 583.

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SMEs are a variable that work either way. There are more SMEs that are
innovative than large companies (even though large companies will always produce
more innovations in absolute terms, as they simply have more resources).11
Moreover,
most start-ups, which are owned by new business owners, are SMEs. So regardless of
whether one takes entrepreneurship to refer to the ownership of a company, the fact
that one is self-employed, or the innovative activities undertaken, it is useful to look
at data on SMEs.
Finally, it is important to recognise these differing definitions and
understandings of entrepreneurship, in order to better understand the collection of
literature on the topic. Not all works on entrepreneurship are as clear and definitive
about the exact type of entrepreneurship under consideration, and one needs to be able
to deduce what is understood by ‘entrepreneurship’ in that specific work in order to
not draw wrong conclusions from the information presented. This can be an easy
mistake to make as many concepts are used interchangeably – as can be seen by the
discussion of the concept above.
1.2 Outcomes and Incentives
Following the previous discussion into what an entrepreneur is, a step further
into the concept is to look at the effect of entrepreneurs on society and the economy
as a whole.
Before going into detail about the effects of entrepreneurship on society, it is
important to understand that these different outcomes do not necessarily say anything
about the goal of the entrepreneur. Overall, the assumption is that entrepreneurs
pursue their own best interests, which they do in different ways or roles (as outlined
above). It is not to be assumed that certain entrepreneurs are more ‘selfish’ or perhaps
more altruistic in their endeavours than others. The assumption is that entrepreneurs
are economic and strategic persons, and therefore make the most strategically
beneficial decisions.
An interesting account of this from the perspective of social psychology is
given by McClelland. His book explains how entrepreneurs are not motivated by a
desire for money, but rather by a desire for achievement. What exactly is seen as an
achievement obviously differs per individual; “the n-achiever is not an individualist
and does not depend for his success on private enterprise”, and so, working in, for
instance, government, can give just as much ‘entrepreneurial satisfaction’.12
Again, however, a definitional barrier has been hit. If one assumes that all
rational, achievement-oriented behaviour can be entrepreneurial, and it can take place
in different groups and with different types and amounts of resources… What does
one look at then in an economic context? Or, more to the point – how can one
distinguish those types of entrepreneurial activities that are of importance in the
context of transition economics, and specifically development or transition
economics?
This question is addressed and answered by Baumol, in his widely cited article
“Entrepreneurship: Productive, unproductive and destructive”. 13
It is seen as a very

11
OECD, SMEs, Entrepreneurship and Innovation (Paris: OECD, 2010): 5.
12
D.C. McClelland, The Achieving Society (Princeton: D. Van Nostrand Company, Inc., 1961): 292-
300.
13
William J. Baumol (1990).

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important contribution to the study of entrepreneurship, as it so succinctly helps
understand and come to terms with the different definitions of entrepreneurship and
put them in a context that can be worked with.14
Whereas the previously introduced
definitions remain relatively ‘flat’, as they look at actions of individuals and their role
within individuals firms, Baumol introduces a whole new layer of meaning. Table 1
illustrates this, as it shows very clearly how Baumol is the first to include the idea of
incentives in his discussion of entrepreneurship. These incentives become crucial, as
they determine the so-called direction of entrepreneurial activities.
According to Baumol, there are three different kinds of entrepreneurship that
can be characterised as such according to the outcome they have for society as a
whole. The different types of entrepreneurship that Baumol identifies are productive,
unproductive, and destructive. “The basic hypothesis is that, while the total supply of
entrepreneurs varies among societies, the productive contribution of the society’s
entrepreneurial activities varies much more because of their allocation between
productive activities such as innovation and largely unproductive activities such as
rent seeking and organised crime.” 15
Baumol assumes that “the supply of
entrepreneurship, i.e., the application of entrepreneurial talent, is roughly a constant,
while its distribution between productive and unproductive or even destructive
activities is greatly affected by the social payoff structure.”16
The first concept, that of productive entrepreneurship, encompasses those
(innovative) entrepreneurial activities that add new value to an economy; that create
new jobs; that increase wealth and general well-being; that produce new products,
technologies or knowledge. This is the general, intuitive, positive view that currently
exists of entrepreneurial activities. Baumol has expanded this general view so as to
include such activities as innovations in rent-seeking procedures, such as the
“discovery of a previously unused legal gambit that is effective in diverting rents to
those who are first in exploiting it.”17
These newly included activities make it
possible to determine two new categories; namely unproductive and destructive
entrepreneurship.
Unproductive entrepreneurship encompasses those activities that are not
necessarily detrimental to the economy and society at large, but rather only benefit the
entrepreneur himself. They are rather ‘neutral’ in a sense, as their effect on the
economy is neither positive nor negative. What they do affect, however, is the
dedication of entrepreneurial talent and energy to productive entrepreneurship. In
Baumol’s own words: “Rent seeking, often via activities such as litigation and
takeovers, and tax evasion and avoidance efforts seem now to constitute the prime
threat to productive entrepreneurship.”18
This is because the total ‘supply’ of
entrepreneurial talent is presumed to be stable.
Finally, destructive entrepreneurship are those activities that “lead to a

14
OECD (2010): 35.
Aidis, “Entrepreneurship and Economic Transition”, (Discussion Paper, Tinbergen Institute, Faculty of
Economics and Econometrics, University of Amsterdam, 2003), 7.
15
William J. Baumol (1990): 893.
16
Gunnar Eliasson and Magnus Henrekson (2004): 5.
17
18

14

parasitical existence that is actually damaging to the economy.”19
Here, the benefits
that these activities bring to the entrepreneur are actually diverted from benefiting
others. Examples are certain military activities, which can be classified as
entrepreneurial, but destroy many lives and livelihoods of others.20
1.3 Definition to Be Used in this Thesis
From here on, when the term ‘entrepreneurship’ is used, what is meant with it
is the concept of productive, innovative entrepreneurship, as most often seen in SME
activities. Especially in the context of transition economies, this definition is useful,
as it gives a way of differentiating between those entrepreneurial activities that may
abound as a result of transition but do not add anything to the development and
growth of the economy as a whole (such as rent-seeking), and those that one would
ideally want in an economy, as they produce jobs, economic growth, innovation,
sustainable development, etcetera.

19
20

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2. Entrepreneurship in an Institutional Context
Now that an understanding of the concept of entrepreneurship has been given,
the connection with institutional economics will be made.
2.1 It’s All About the Rewards
The point of understanding more about entrepreneurship is of course
understanding how to be able to encourage more of it. There are two things that are
important in increasing the level of entrepreneurship in an economy. One the one
hand, one should make it interesting, rewarding in some or other way, enticing, if you
will, for people to become entrepreneurs. And on the other hand one needs to
diminish the risks involved in entrepreneurship as much as possible – “making it
easier for potential entrepreneurs to take the plunge.”21
As explained by Baumol, the entrepreneurs of a society are generally the
talented citizens. Whether they put their talent to use in productive, unproductive or
even destructive activities depends on the rewards that are awarded to the different
types of activities. This is precisely what is mentioned by Baumol in his theory of
entrepreneurship – “he assumes that the supply of entrepreneurship, i.e., the
application of entrepreneurial talent, is roughly a constant, while its distribution
between productive and unproductive or even destructive activities is greatly affected
by the social payoff structure” [emphasis added by author].22
It is also underlined by
other academics, such as North, Hall and Sobel, and Balkienė and Jagminas.23
An interesting article that gives considerable insight into the motivation of
entrepreneurs and the choices that they make in their career is “The Allocation of
Talent: Implications for Growth”, by Murphy, Shleifer and Vishny.24
As they explain,

21
OECD (1998): 23.
22
Gunnar Eliasson and Magnus Henrekson (2004): 5.
23
Among others:
-‐ Gunnar Eliasson and Magnus Henrekson (2004): 5.
-‐ William J. Baumol (1990): 894.
-‐ Ruta Aidis (2003): 70.
-‐ William J. Baumol (2008): 580.
-‐ Douglass C. North, Institutions, Institutional Change and Economic Performance
(Cambridge: Cambridge University Press, 1990): 9.
-‐ Kristina Balkienė and Jonas Jagminas, “Allusion to Public Policy: Innovative
Entrepreneurship”, Viešoji Politika Ir Administravimas (Public Policy and
Administration) 34 (2010): 42.
-‐ Joshua C. Hall and Russell S. Sobel, “Public Policy and Entrepreneurship”, Technical Report
06-0717 (The University of Kansas School of Business – Center for Applied Economics,
2006): 5.
24
Kevin M. Murphy, Andrei Shleifer and Robert W. Vishney, “The Allocation of Talent: Implications
for Growth”, Working Paper no. 3530, NBRR Working Paper Series (Cambridge MA: National Bureau
of Economic Research, 1990).

16

entrepreneurs are the talented people in any society. It hardly matters what they are
talented in – it suffices to say they are talented, active, see opportunities and, most
importantly, act upon them. The authors explain how these kinds of people are vital
for any economy and, especially, how their choice for different career paths are
greatly determinant of the success of any economy. They show and explain how
societies with a relatively higher number of lawyers grow significantly slower than
societies with a relatively higher number of engineers, since the latter produce new
output, products and value for a society, while the former only ‘move value around’,
if you will. In Baumol’s terms, lawyers are involved in unproductive
entrepreneurship, while engineers are involved in productive entrepreneurship.
The important thing to realise, then, is that a government wanting to
encourage the right choice for the talented people – the entrepreneur – has to make
sure the rewards for choosing productive entrepreneurship are higher than the rewards
for choosing unproductive or even destructive entrepreneurship.
So what is meant by ‘rewards’? What is that which drive entrepreneurs? As
mentioned earlier, entrepreneurs are taken to be rational actors, working towards
achieving something that is in their interest. “Technical progress, economic growth,
productivity, even efficiency have not been significant goals since the beginning of
time. So long as an acceptable life style could be maintained, however that was
defined, other values held the stage.”25
It is wrong to assume that enticing rewards
would only be of a pecuniary nature. They may also be more abstract, such as a more
positive or negative social image, for instance.26
The rewards for the different kinds of entrepreneurship are determined by the
so-called ‘rules of the game’.27
This is the entire environment within which the
entrepreneurial activities take place, and includes such widespread concepts as
taxation and infrastructure, but also culture and social structure. Or, in other words,
the rules of the game are all institutions in the economy of a country, both formal and
informal. It is just as well that these are the determinants, because “if differences in
‘entrepreneurial spirit’ are the source of differences in entrepreneurship levels
between areas, the public policy can do little to foster it. Fortunately, the evidence is
clear that entrepreneurship is an omnipresent feature of human nature. What differs
across areas is thus not the degree of underlying entrepreneurial spirit, but instead
how that spirit is channelled.”28
There are different ways to achieve the right rules of the game. The two
‘instruments’ most generally defined as focal points for policy in this are culture and
cultural attitudes, on the one hand, and the framework within which entrepreneurs
operate on the other. A third instrument that is sometimes placed under the umbrella
of the framework is that of government programmes. The similarity between the two
is the fact that both can be rather directly influenced by government policies. The

25
26
William J. Baumol (1990)
William J. Baumol, “Small Enterprises, Large Firms, Productivity Growth and Wages”, Journal of
Political Modelling 30, issue 4 (2008): 576.
27
28
Joshua C. Hall and Russell S. Sobel, “Public Policy and Entrepreneurship”, Technical Report 06-
0717 (The University of Kansas School of Business – Center for Applied Economics, 2006): 1.

17

difference between the two is that changes to the framework are more profound and
long-lasting, while government programmes aren’t quite as permanent and more
focused on a specific group. An example might be a specific subsidy, or information
dissemination on a certain topic. Government programmes, however many or big they
may be, cannot be used as substitutes for adaptations to the framework. They can be
used as support and as an addition to the other actions taken.29
The following section
from an OECD publication gives a good overview of what government programmes
are and can potentially achieve:
In complementing framework conditions, well-designed programmes to foster
entrepreneurship can, for example, encourage and maximise the benefits of
collaborative behaviour; increase the flow of information for financing
entrepreneurship; encourage awareness of entrepreneurship and improve
skills formation; and (…) add flexibility to policy when factors affecting
entrepreneurship are location-specific. Such programmes can be inexpensive,
as is the case, for example, with information dissemination on procedures for
establishing a business; publicly commending entrepreneurial efforts through
awards such as ‘most successful business of the year’, which make role
models more visible; and government support for programmes such as
business competitions in schools and universities which can help students to
get useful practical experience and give encouragement. Programmes of this
sort have the added virtue of not interfering with market incentives.30
Out of these instruments, it is important to focus on the framework first and
foremost, with the other two aspects to follow, since the framework forms the basis
and it is useless working against a system that is not functioning.31
However, the other
two dimensions are equally important at later stages.
When all of the above is translated into terms from within institutional
economics, the point is that the rewards to entrepreneurship are determined by both
the formal and informal institutions of an economy – “institutions (…) are a
particularly significant factor determining both the entry rate and the prospects of new
firm survival and growth.”32
A discussion will now follow in which is explained what these formal or
informal institutions are, and in what ways they potentially influence
entrepreneurship.
2.2 What Are institutions?
The fact that the rules of the game are vital for directing entrepreneurial talent
down the productive path brings us to the concept of institutionalism, or more
specifically: institutional economics. Institutional economics focuses on
understanding the role of the evolutionary process and the role of institutions in
shaping economic behaviour. Institutional economics emphasises a broader study of

29
OECD (1998): 24.
30
OECD (1998): 25.
31
OECD (1998): 12-13.
32
Saul Estrin and Martha Prevezer, “A Survey on Institutions and New Firm Entry: How and Why Do
Entry Rates Differ in Emerging Markets?”, Economic Systems 34, issue 3 (2010): 305.

18

institutions and views markets as a result of the complex interaction of these various
institutions (e.g., individuals, firms, states, social norms).
One author who has written a considerable deal about the concept of
institutions and their influence on economic performance, is Douglass North. He
makes the distinction between formal and informal institutions, and explains them as
follows:
Institutions are the humanly devised constraints that structure political,
economic and social interaction. They consist of both informal constraints
(sanctions, taboos, customs, traditions, and codes of conduct) and formal
rules (constitutions, laws, property rights).33 34
(…) Institutions provide the
incentive structure of an economy; as that structure evolves, it shapes the
direction of economic change towards growth, stagnation, or decline.35
Institutions are the rules of the game in a society or, more formally, are the
humanly devised constraints that shape human interaction.36
“Within North’s framework, organisations such as firms will adapt their
activities and strategies in accordance with the opportunities and limitations of formal
and informal institutions.”37
Institutions thus form the rules of the game in an
economy, and determine the rewards for different kinds of activities. Especially in
transition economies, there is a general lack of free market capitalistic institutions –
the earlier in the transition process the economy find itself, the greater this lack is.
Here again the importance of the presence of entrepreneurs can be emphasised, as “in
emerging economies bereft of civil infrastructure, entrepreneurs have the potential to
make significant contributions towards creating civil societies.”38
The following sections will explain how different kinds of institutions set the
rules of the game and can influence the direction and outcome for society of
entrepreneurial activity.
2.2.1 Informal Institutions
As explained above, informal institutions are, for instance, taboos, customs,
traditions, etcetera; in other words, culture. Culture is formed through complex
processes that do not easily let themselves be captured in mainstream economic
thinking. Nevertheless, it is more and more often realised that cultural factors do, in

33
Douglass C. North, “Institutions”, The Journal of Economic Perspectives 5, no. 1 (1991): 97.
34
Ruta Aidis, “Why Don’t We See More Small- and Medium-Sized Enterprises (SMEs) in
Lithuania?”, Working Paper No. 2002-038/2 (Tinbergen Institute, 2002): 5-6.
35
Douglass C. North (1991): 97.
36
Douglass C. North, Institutions, Economic Change and Economic Performance (Cambridge:
Cambridge University Press, 1990): 3.
37
Ruta Aidis (2002): 6.
38
M.B. Neace, “Entrepreneurship in Emergin Economies: Creating Trust, Social Capital, and Civil
Society,” The ANNALS of the American Academy of Political and Social Science 565, no. 1 (1999):
160.

19

fact, truly affect business activities. 39
Two examples that are especially interesting in
the transition context of Lithuania are the social image of entrepreneurs, and the
history of the country.
The image of entrepreneurs is important for their success and the attraction of
productive entrepreneurship – when productive entrepreneurship is “socially valuable
and valorised” over other activities, it is more rewarding.40
This is important to keep
in mind, since entrepreneurial activities that are performed in a society where there is
a lack of trust in entrepreneurs as people will most likely fail.41 42
Under communism,
private enterprise was both socially unacceptable (because it went against the state)
and by extension illegal, and it had been this way for decades.43
“Enterprise creation
on the part of individuals represents a significant change from past patterns of
behaviour under centrally planned economies in which private initiative was
illegal.”44 45
The informal institution of history is naturally strongly interlinked with that of
image, as it partly influences the ideas associated with entrepreneurs, especially in
post-socialist countries, since “the social context inherited from the former socialist
period appears to affect both the attitudes and behaviour of entrepreneurs and the
attitudes of society at large towards entrepreneurship.”46
And history is of course not
simply history, as its effects are ongoing and influence the present as well. Behaviour

39
OECD (1998): 13.
40
Marcus Dejardin, “Entrepreneurship and Growth: An Obvious Conjunction? An introductive Survey
to Specific Topics”, research undertaken for the Institute for Development Strategies (Faculty of
Economics and Social Sciences, University of Namur, 2000): 9-10.
41
M.B. Neace (1999): 149.
42
In “Entrepreneurship: Productive, Unproductive, and Destructive”, Baumol sketches the images of
entrepreneurs in different historic periods, and so convincingly explains why, even though they had the
technological capacity to do so, people rarely diverted their entrepreneurial talent to productive
activities. For instance, in early Roman times, high social rank came with wealth, but not with wealth
that had any productive origins, so to speak. Those at the top of society owned lands or were politically
active. Working your way up through trading or artisanal work, for instance, was something typically
done by former slaves, who had no social image to uphold in the first place. The reason for
technological innovations not being implemented on a larger scale was that, generally speaking, their
inventors belonged to the upper classes. Being learned and researching new innovative techniques was
socially accepted in those circles, but then putting in the work to actually produce the innovations and
make money out of it, and produce value with it, was not. Thus, talented Romans in the upper classes
diverted their activities to socially accepted activities, such as land-owning and politics, while those
that did not care so much for social image, or had no social image to begin with, did not have enough
means to actually become entrepreneurs on a great scale. The article also contains descriptions of this
image-effect in other regions and during other periods of time.
43
Tomi Ovaska and Russell S. Sobel, “Entrepreneurship in Post-Socialist Economies”, Journal of
Private Enterprise 21 (2005): 8.
44
OECD (1998): 269-270.
45
Of course, there is a vast array of other informal institutions that influence business activities.
However, these two have been chosen as most salient and important for this analysis. In addition, the
reader is pressed to keep in mind that especially with such informal institutions as culture, taboos,
etcetera, concepts are intertwined and interdependent and not nearly as clear-cut as is presented here.
46
David Smallbone and Friederike Welter, “The Distinctiveness of Entrepreneurship in Transition
Economies”, Small Business Economics 16 (2001): 249.

20

that was acceptable and normal during the Soviet years, but that is not conducive to
any kind of functioning market economy, is sometimes simply “carried over” from
the Soviet system.47
This can in turn have profound effects on the success of
implemented changes to the formal institutions, therefore it is always good to
‘remember where you come from’, so to speak.48
2.2.2 Formal Institutions
While informal institutions can have an impact on the rules of the game and
thus the rewards for certain types of entrepreneurship, it is the formal institutions that
will carry the most weight in the analysis in this thesis. This has on the one hand a
very practical reason, for it is considerably easier to measure the presence of formal
institutions than it is to measure informal institutions such as certain taboos. This
makes an analysis easier to conduct. Additionally, for the earlier-mentioned purposes
of this thesis (namely: shedding light on what governments can do to foster
productive entrepreneurship), it is indeed more important to take into account formal
institutions. These are the institutions that can directly be influenced by policies
implemented by government, and the applicable informal institutions will generally
follow, as influenced by the formal ones.
This is not to say that informal institutions are not important. As has been
shown in “A Survey on Institutions and New Firm Entry: How and Why Do Entry
Rates Differ in Emerging Markets”, informal institutions can both work with or
against formal institutions, and Fostering Entrepreneurship describes it quite
accurately as follows: “Some lines of thought suggest that in transition countries, the
long experience under a planned economic system (70 years in the case of Russia) has
shaped the norms and values of the citizens to such an extent that there is no longer an
entrepreneurial spirit. Research conducted more recently refutes this claim, and
underlines the fact that entrepreneurial ability exists in many different types of
societies, and that framework conditions are a principal determining factor.”49 50
However, informal institutions are slower to change than formal institutions, and a
positive change to the formal institutions might very likely help bring about positive
changes to informal institutions.51 52
In addition, the outcomes of a change in formal
institutions are more predictable, making them better and more reliable instruments
for policy. “The overall moral (…) is that we do not have to wait patiently for slow

47
48
On the other hand, it must be emphasised that the Soviet history did not affect market economic
endeavours in a solely negative way. In some cases, it was exactly the memory of what had been, and
the motivation to move away from that situation, that sparked the “sheer energy, relentless strategies,
and sometimes controversial practices” that characterises many entrepreneurs in post-socialist countries
(Source: Mike W. Peng and Stanislav V. Shekshnia, “How Entrepreneurs Create Wealth in Transition
Economies”, The Academy of Management Executive (1993-2005) 15, no. 1 (2001): 95).
49
OECD (1998): 270.
50
Saul Estrin and Martha Prevezer (2010): 305.
51
Ruta Aidis (2002: 24-25.
52

21

cultural change in order to find measures to redirect the flow of entrepreneurial
activity toward more productive goals.”53
Formal institutions shape the rules of the game in profoundly different way
than informal institutions do. With formal institutions, the point is to make it possible
for entrepreneurs to carry out their activities in a relatively profitable and risk-free
manner. In contrast, the point with informal institutions is to make it acceptable for
entrepreneurs to carry out their activities.

53
Ibid., 919.

22

3. The Most Influential Formal Institutions
While the previous chapter has explained the general concept of institutions
and the way in which they can have influence on entrepreneurship in an economy at
all, the current chapter will go deeper and prepare the reader for the analysis of the
Lithuanian situation in the last chapter. This chapter will look at the different formal
institutions that are in play more deeply, and will explain which are going to be
looked at in the analysis – and why. Whereas an allusion to these institutions has been
given in the previous chapter, this chapter will function as a justification for the
concepts used in the final analysis.
To reiterate what was concluded in the previous chapter; formal institutions
can encourage productive entrepreneurship through making those activities
rewarding and attractive. Then what exactly are those formal institutional frameworks
that might be conducive to entrepreneurship? An important underlying principle for
policies conducive to productive entrepreneurship is that of economic freedom. The
most important formal institutions are legislation and regulation allowing for private
economic activity, strong and well-defended property rights (both intellectual
property rights as physical property), a strong commercial banking system,
competition law (in other words; anti-monopoly regulations), control over strong
business ethics, bankruptcy laws and procedures, etcetera. “Elements of framework
conditions more specific to entrepreneurship include simple and inexpensive
procedures for licensing and registration, a non-prohibitive and transparent system of
taxation, as well as stable legislation and regulations.”54
The formal institutions that
are of greatest importance for successful productive entrepreneurship are summarised
succinctly as follows: “Several institutional characteristics are argued to affect
entrepreneurial endeavour: the quality of commercial code, the strength of legal
enforcement, administrative barriers to entry and to business activities, the prevalence
of extra-legal payments and a lack of market-supporting institutions.”55 56
The OECD publication Fostering Entrepreneurship gives a comprehensive set
of policy guidelines (as can be read completely in Annex 1).57
The main points
concerning the institutional framework are as follows:
-‐ to diminish barriers to competition (which includes providing adequate
protection of (intellectual) property)58
-‐ to ensure government regulations on financial institutions to not inhibit
the allocation of finances to the wrong sectors
-‐ to allow for flexible employment contracts

54
OECD (1998): 270.
55
Saul Estrin and Tomasz Mickiewicz, “Entrepreneurship in Transition Economies: The Role of
Institutions and Generational Change”, Discussion Paper No. 4805 (Institute for the Study of Labor,
2010: 6-7.
56
A complete overview of the policy guidelines with regards to fostering entrepreneurship as put forth
by the OECD can be found in Annex 1.
57
OECD (1998): 28-30.
58
This is not only encouraging for entrepreneurial activities, but also good for society as a whole.
Secure IPR secures the returns on investment in R&D, which is thus increased, and since research has
shown that social returns from R&D are higher than private returns, this is of great benefit to society as
a whole. (Source: OECD (1998): 67.)

23

-‐ to ensure that the costs of complying with government regulations are
as low and easy as possible
-‐ to ensure the tax system is transparent, compliance with it is
straightforward, and to ensure it is favourable to entrepreneurial
activities
-‐ to simplify the process of registering a new business
-‐ to review that bankruptcy legislation provides for an appropriate
balance between encouraging risk-taking and protecting creditors
-‐ to ensure social insurance provisions are beneficial to potential
entrepreneurs59 60
When comparing these to the most common barriers to entrepreneurship in
transition economies, as identified in the same publication, it is not difficult to see
points of comparison:61
-‐ macroeconomic instability
-‐ taxation
-‐ barriers to entry
-‐ insufficient legislation and implementation
-‐ finance issues
The final barrier to business mentioned in the list is ‘finance issues’.62
While it
is most definitely true that finances are very important for any business, and that a
lack of start-up capital is especially prevalent in transition economies, the analysis
will not take into account any programmes or policies geared towards greater
accessibility of finances. This has a few reasons. First of all, it is something that is
also greatly influenced by informal institutions, such as the general faith that investors
have in the business environment. When investors see an environment that is
conducive to business, they will be more willing to invest, making it less critical for
government to take on the burden of assisting potential entrepreneurs in financing

59
Needless to say, when taking into account any policy or framework guidelines whatsoever, there will
always be winners and losers. It is not to say that the suggested guidelines are in any way the recipe for
successful economic growth, rather that they are beneficial to encouraging entrepreneurship, a specific
contributing factor to economic growth.
60
(These points are largely reconfirmed by Joshua C. Hall and Russell S. Sobel (2006): 14)
“(…) reform-minded policymakers could:
-‐ reduce state corporate income taxes
-‐ reduce state personal income taxes
-‐ eliminate state turnover, business or occupation taxes
-‐ reform workers compensation through privatisation or tougher rule enforcement
-‐ reform medical malpractice
-‐ reform the judicial system to minimise the effect of politics and electoral pressures
-‐ eliminate state minimum and maximum price and wage limits and restrictions
-‐ engage constitutional limits on public land takings such as eminent domain
-‐ reduce occupational licensing requirements
-‐ reduce government employment and public ownership of resources (such as land
holdings), freeing these resources to be employed in the private sector
-‐ simplify the tax code to reduce the ability of (and incentives for) groups to lobby for
exemptions and credits
-‐ and, reduce the returns to lobbying through legislative reform that makes it more
difficult to pass pork-barrel legislation.”
61
OECD (1998): 277-282.
62
Ibid., 281.

24

their endeavours. On the other hand, policies of government focusing on accessibility
of finances can easily take on the form of a subsidy, and there are arguments to be
made for the inefficiency or even complete lack of success of financial contributions
by government to entrepreneurs. For instance, governments will most likely (and
rationally) select those businesses that they think will be most likely to succeed after
receiving the contribution. In the end, however, this means that most companies that
receive the contribution are those that would have been successful businesses without
the government contribution anyway, thus completely neutralising the effect of those
investments.
So if this important aspect influencing barriers to becoming a productive
entrepreneur will not be taken into account, which formal institutions will? The
formal institutions believed to be most important in creating the right rules of the
game are regulations as embodying the all-important and capitalist idea of ‘economic
freedom’, a tax system that is advantageous to entrepreneurs, and well-defined
property rights. These fit the previously given explanation of formal institutions
making it possible to participate in productive entrepreneurship in a profitable and
otherwise rewarding way.
Well-defined property rights are in fact at the basis of any kind of
privatisation. Privatisation made it possible for people in the post-socialist economies
to have private property, often for the first time in their lives. When it is not clear in
what way one can prohibit others to take possession of your property, it is naturally
significantly riskier to even purchase property. What use is property if one does not
have any certainty that it will remain in one’s possession? Similarly, what use is
inventing something when one does not have any certainty that others will not be able
to run away with the idea and start making profits with it?63
A tax system can be very effective in making an economy interesting or
uninteresting for enterprises, and it should not be surprising in what way.64
Small
enterprises have less financial leeway so feel the weight of taxes on their budget more
heavily than large enterprises, but, as mentioned in the first chapter, these are exactly
the enterprises that are important in terms of innovation and contributing to the
productive growth of an economy. Applying different tax rates and different types of
tax cuts for such small enterprises can considerably raise their potential for profit. As
a matter of fact, high taxes are also an incentive for unproductive entrepreneurship, as
it means there is more to be gained from tax collecting, or moving one’s activities to
the black market. 65
The final point as mentioned are ‘free’ regulations, which admittedly is a very
broad and vague concept. For the purpose of this analysis, it may include anything
from the procedures needed to start a business, and the flexibility afforded to
employers in hiring and firing employees, to the procedures to be followed when one
wants to eventually close a business. This might at first sight not seem like an all too
important process, but in fact it determines a lot in terms of risk. When it is unclear in
what way an entrepreneur will be able to ‘step out of the game’, once it becomes clear
that profits are not high enough, is works as a deterrent. In addition, it is important to
have other possibilities aside from filing for bankruptcy, when enterprises find
themselves in dire straits, as “only a small proportion of closing firms are bankrupt,

63
This refers of course to IPR.
64
OECD (1998): 280.
65

25

and most firm closures do not involve losses to creditors. Nevertheless, policies that
restrict the scope for enterprises to restructure or close down completely diminish the
ability of an economy to adjust quickly and discourage entrepreneurs from starting
up.”66
This introduction into the different institutions that a government intent on
encouraging productive entrepreneurship should focus on will be the basis on which
the following chapter is based. It will look at the different developments during the
transition of Lithuania, and on that basis identify to what extent the different
government actions have been successful. This will finally lead to the answer to the
main research question as posed in the introduction of the thesis:
Which are the most important adaptations that a government can make to the
institutional framework within which entrepreneurs operate, in order to
successfully encourage productive entrepreneurship, as understood by
Baumol, as illustrated by developments in Lithuania during the years from
independence until today?

66
OECD (1998): 22-23.

26

4. Lithuania
In the previous chapters, the groundwork has been laid for the coming analysis
of entrepreneurship in Lithuania. The first chapter explained the concept of
entrepreneurship and its differing outcomes; the second chapter provided an
additional theoretical layer by adding the institutional economic way of thinking to
the concept of entrepreneurship; and the third chapter then outlined the translation of
the previously provided theoretical concepts to practical courses of action for
government. An important distinction to keep in mind is that between government
programmes, and the creation of certain institutions and what one may do in order to
increase the presence of entrepreneurship in an economy.
As explained in the previous chapter, the institutional frameworks that are
believed to be most basic in their importance for laying the groundwork for further
encouragement, if you will, are loose regulations (embodying the all-important and
capitalist idea of ‘economic freedom’), a tax system that is advantageous for
entrepreneurs, and well-defined property rights. These form the basis of other
frameworks, government programmes and finally cultural attitudes in an economy,
and are therefore considered to be the first priority in embarking on such a mission. In
this chapter, an analysis will be made in order to determine if these institutional
frameworks are indeed those that are of greatest importance to the entrepreneurs
themselves. In other words – can we indeed see that these frameworks influence the
(perceived) barriers to business, and do they influence the prevalence of
entrepreneurship in the economy?
The answer to this question will be determined by the current chapter. The
analysis will be based on Lithuania, which has been chosen due to its unique
transition process, which combines elements found both in CEE countries and FSU
countries.67
For instance, Lithuania had been part of the Soviet Union, and in that
way had known a strict communist economy for close to half a century. This meant
Lithuania had further to come in terms of transition than, for instance, Hungary. But
half a century of communism, on the other hand, is also quite short, when compared,
for example, to Russia’s seventy years. There was still a memory, however slight, of
an entrepreneurial spirit – they “cherished a petty bourgeois ideal of peasants,
craftsmen, and shopkeepers that represented the normality of the interwar period ,
when they had enjoyed independence. They lived for [the] slogan ‘Small is beautiful’,
and they wanted to revive their old beautiful world of smallness.”68
This, in contrast,
means that it was relatively easier for Lithuania to return to a business environment
conducive to entrepreneurs. Also, Lithuania and the rest of the Baltic States quite
early on aligned themselves with the European Union, and the steps taken in order to
eventually join the Union had a profound effect on the subsequent transition process.
Lithuania, however, is not the epitome of the successful Baltic Transition that Estonia
is.
All in all, the Lithuanian situation contained elements from all different kinds
of transition processes. This means that analysing aspects of the Lithuanian transition
cannot be done through the often-used ‘clichés’ of equating fast and effective
transition and business development with the influence of the European Union, and

67
68
Anders Åslund (2013): 187-188.

27

slow transition and rigid transformation by old Communist-style managers with the
history of the Soviet Union.
The chapter will then be structured as follows. First of all, a sketch will be
given of the current situation of the Lithuanian business environment. Following this,
attention will be paid to the actions of the Lithuanian government in terms of creating
the above-mentioned basic institutional frameworks of flexible regulations and
advantageous tax system.69 70
Subsequently, the results of these actions will be
checked by considering data on the extent of the Lithuanian business environment and
opinions of active entrepreneurs, most notably on what they consider to be the most
prominent barriers to business in their country. Data that will additionally be taken
into account are statistics about the size of the shadow economy and corruption in
Lithuania. Following the idea that the supply of entrepreneurial spirit remains
constant, an increase in corruption or activities in the shadow economy will be taken
to mean that it has become less rewarding (and thus attractive) to take part in
productive entrepreneurial activities.
The sources used to base the analysis on will be taken from a broad base of
reports by large international organisations, by Lithuanian national organisations and
from large-scale researches in which interviews and surveys have been conducted
with entrepreneurs. Some interpretational liberty is taken with some of the data and
statistics, since data is not always available for years in consecutive order, or the
statistics gathered do not concern the exact same topics. This is a statistical
conundrum that is relatively common with research on transition economies, which is
why this is not considered to be too big of an issue here.
The combination of the actions taken by the Lithuanian government and the
extent to which they are reflected in the resulting business environment will finally
allow the conclusion of this thesis to come into being. It is this analysis of real-life
data in light of the previously introduced theories that will provide the practical,
policy-oriented conclusion that this thesis aims to give.
4.1 A Brief Introduction into Lithuania
As alluded to previously, Lithuania became a part of the Soviet Union during
the final stages of the Second World War, in 1944. Before that, it had long been part
of the Polish-Lithuanian Commonwealth, until independence was declared in 1918.
Independence from the Soviet Union was declared in 1990, and almost immediately
the decision was made to realign with the rest of the European continent, in an
attempt to ‘return to Europe’, and right from the start the long-term goal was to
become a member state. This was achieved in 2004, along with a large number of
other Eastern European countries.

69
As mentioned above, well-defined property rights are also, and for obvious reasons at that,
considered to be crucial for a blossoming entrepreneurial environment in a country. However, due to
size constraints and the fact that information on IPR in Lithuania is scarce, the choice has been made to
focus on regulations and taxation. As will become clear, that is quite enough to occupy oneself with!
70
The attentive reader may have noticed that the ‘innovative’ aspect of innovative productive
entrepreneurship is not represented in these. This is due to constraints in terms of research size.
Moreover, the policy road towards encouraging innovation is generally quite different from
encouraging entrepreneurship, which focuses, for example, a lot more on the connection with
universities and research institutes than only SMEs and entrepreneurs. This is a side-track that will be
left for other research.

28

A Lithuanian private sector had already begun developing as early as 1985,
which is when Soviet Law allowed for cooperatives to be set up. The Enterprise Law
of 1990 specified different types of enterprises, and from independence on, the
number of private enterprises has been rising steadily.71
Lithuania is consistently portrayed as a steady democracy, committed to
multiparty democracy and with a strong judicial system that is truly independent.
Elections at all levels are assessed as free, fair and competitive. Moreover, it is
consistently described as a successful transition country that has managed to quickly
and comprehensively take in the acquis communautaire of the European Union.72
Prices and trade were liberalised early on, enterprises were privatised quickly, and the
financial sector was gradually and successfully strengthened. However, the fact that
Lithuania lagged behind in terms of income per capita remained an issue, as it had
ramifications for the amount of capital available for investment and savings.73
Additionally, Lithuania was hit more than averagely harshly by the financial crisis of
2008, “like no other member state” of the European Union.74
Last but not least,
corruption remains a problem, influencing the levels of trust that the public have in
the holders of power.75 76 77
4.2 Undertaken Courses of Action
The following sub-section identifies the different courses of action undertaken
by the Lithuanian government throughout the transition period in order to encourage
an entrepreneurial environment. Readers are requested to bear in mind that no
evaluation of the different activities will be given yet – that is to be left for the
subsequent sub-section.

71
World Bank, Lithuania: The Transition To A Market Economy (Washington DC: World Bank,
1993): 92.
72
EBRD, “Strategy for Lithuania: Summary, 1994-95”, 1994.
EBRD, “EBRD Strategy for Lithuania 1996-97: A Summary”, litstrat.doc 3/6/97, 1996.
EBRD, “Document of the European Bank for Reconstruction and Development. Strategy for Lithuania.
As Approved by the Board of Directors on 9 March 2004”, 2004.
As Approved by the Board of Directors at Its Meeting on 23 March 2006”, 2006.
As Approved by the Board of Directors at Its Meeting on 22 September 2009”, 2009.
As Approved by the Board of Directors at Its Meeting on 13 November 2012”, 2012.
73
EBRD (2004): 1.
74
Inga Blaziene, “Anticipating and Managing Restructuring Lithuania”, national background paper as
used in a national seminar for the International Training Centre, A.R.E.N.A.S VC/2008/0667 (2009): 5.
75
EBRD (2004): 2.
76
EBRD (2006): 16.
77
EBRD (2009): 3.

29

4.2.1 Lithuanian Government
The EBRD has published a number of strategic documents concerning its
approach towards different transition countries, including Lithuania. These documents
also make mention of the different activities undertaken by the government and the
extent to which these have been successful. In this analysis, therefore, these
documents can be used as a source from which to gather information on the courses of
action of the Lithuanian government. Not only do the documents explain directly
what has been done, it is also quite inconceivable that the EBRD would work in
complete opposite directions as the government, or be able to do its work without
some effort from the Lithuanian government in the same areas. Conversely, for non-
Lithuanian speakers it is considerably difficult to access (especially older)
government documents, as they have hardly been translated. Documents from
organisations such as the EBRD have consistently been published in English, making
them very accessible.
Unfortunately, these documents aren’t as detailed as one would wish them to
be. This is only natural, as their main purpose is of course not to exactly document the
actions undertaken by the government. However, they do convey the most important
and summarised points. Therefore, these documents may be used in this section to
identify what government has done.
Throughout the documents, mention is made of the positive progress made by
the Lithuanian government. By 2004, it is reaffirmed that the Lithuanian government
has made considerable progress through structural reforms, early liberalisation, rapid
privatisation, etcetera. 78
Moreover it is mentioned that the government is reform-
minded; all comments pointing towards a successful transition in the European
Union.79
The exact steps will be dealt with in chronological order below, divided per
theme.
4.2.1.1 Regulations
In 2001, changes in legislation were made that improved the processes of
enterprise restructuring and bankruptcy law. 80 81
The laws adopted were the Law on
Enterprise Restructuring, the Enterprise Bankruptcy Law and the Law on Natural
Person Bankruptcy.
‘Enterprise restructuring’ refers to “the totality of procedures established by
Law on Restructuring which aim to maintain and develop the activities of an
enterprise, settle its debts and avert bankruptcy through securing assistance of the
creditors of the enterprise and application of economic, technical, organisational and
other measures.”82 83
The amended version of this law provides for an alternative to

78
EBRD (2004): 1.
79
EBRD (2004): 9.
80
EBRD (2004): 2.
81
EBRD (2004): 11.
82
Ieva Baranauskaite, “Key Insolvency Laws in Lithuania – An Overview”, accessed on December 12,
2014,
http://www.insol.org/emailer/Oct_2013_downloads?Key%20insolvency%20Laws_Lithuania.pdf.

30

bankruptcy when enterprises are temporarily in financial difficulty. Instead of filing
for bankruptcy, under this law, enterprises have recourse to, amongst other things,
deferred payments, debt relief, debt reduction, etcetera. This naturally makes business
considerably less risky and more attractive.84
The Bankruptcy Law stipulates under what circumstances debtors and
creditors may file for bankruptcy, protects creditors, and states that a bankruptcy
procedure may not last over a year.85
In the 2001 amended version, the definition of
‘bankruptcy’ as used in the law was adapted, to make the process more accessible.86
The EBRD states that, based on its Legal Indicator Survey, by 2002 the body
of commercial law in Lithuania is to be deemed supportive of investment and
commercial activity.87
And in 2003 the EBRD’s Corporate Governance Sector
Assessment Project assessed Lithuania to have high compliance with its existing
commercial laws, as compared to the OECD average, which is again affirmed by the
2009 report.88 89
However, in the same year, compliance with the insolvency laws is
considered to be very low, and it is “one of the least extensive insolvency laws in the
EBRD’s countries of operations.”90
The issues with these laws are, for instance, that
they don’t go into effect until debts are at least three months overdue, and that in the
assessment they fail to take into account complete balance sheets of businesses.91
In
2004, the effectiveness of the insolvency laws was measured, and they appeared, in
practice, to lack considerably in effectiveness. This was particularly due to the fact
that the procedures were not accessible enough.92 93
This general sentiment is
reaffirmed in the 2009 report (“enforcement rules and procedures could be
improved”), but the wording is considerably weaker, giving the impression that over
five years, the situation has rather improved.94
Mention of this collective of processes is made in 2012 again, with the report
indicating that progress was made in establishing which cases have to be taken to
court; setting a shorter time limit on the process; relieving the court of its obligation to
individually notify all stakeholders; and setting shorter time limits on creditors for

83
In other words, enterprise restructuring means that any legal aspect of the enterprise may be
restructured (be it the legal form, ownership, operational structure, etcetera). The main reason for this

may be maximising profit, or a major turning point such as a bankruptcy, merger, buyout, etcetera.
84
EBRD (2004): 31.
85
Ieva Baranauskaite.
86
EBRD (2004): 31.
87
Ibid.
88
Ibid., 33.
89
EBRD (2009): 15.
90
EBRD (2006): 49.
91
EBRD (2006): 50.
92
EBRD (2006): 50-51.
93
Especially, they were deemed too complex and time-consuming to start.
94
EBRD (2009): 15.

31

actually notifying the courts of their claims.95
This is an improvement over the
previous forms of legislation, where claims would not be dealt with until they were at
least three months old. All in all, the insolvency laws are taken to be above average
for transition economies.96
4.2.1.2 Tax Administration
The EBRD reports do not mention nearly everything that has been done in this
account. As of 2004, the EBRD mentions this as an area still needing great
improvement, and in 2010 the flat rate corporate tax was reduced.97 98
This was done
in order to create a more level playing field as a response to concerns by private
investors over governance and the informal sector, according to the 2012 EBRD
report. The reduction meant tax on profit went from 20% to 15%.99
4.2.1.3 Registering Businesses
Progress in this area is continuously mentioned. However, the message
continues to be that more work needs to be done.100
In 2012, the report mentions
progress made in the process of starting a business, through enabling online
registration for certain companies (limited liability companies) and elimination
notarisation requirement for certain documents. This has naturally led to a reduction
of start-up time and costs, which is, of course, positive, but has not been enough for
Lithuania to catch up in terms of ranking – it still being ranked only 107 out of 185.101
Later on in the report, the progress is determined not to be enough, as “starting a
business, licensing, employment legislation and investor protection are still seen to be
particularly burdensome.”102
4.2.1.4 Innovation
Promoting innovation (an important part of entrepreneurship, as explained in
earlier chapters) is not a policy area that has received a lot of attention. The first
mention that one can find of it is only in the 2012 EBRD strategy document, which in
turn quotes the National Reform Programme as emphasising “the need to raise
competitiveness”, which is does through targeting “technology-intensive production
through stimulating research and development”.103

95
EBRD (2012): 10.
96
EBRD (2012): 11.
97
EBRD (2004): 12.
98
EBRD (2012): 9.
99
Further below, in information from different sources, we shall see that this was not the first tax
reduction.
100
EBRD (2004): 11.
101
EBRD (2012): 10.
102
EBRD (2012): 25.
103
EBRD (2012): 2.

32

4.2.1.5 Corruption
Continuous mention is made of progress in this field, however, it also seems to
never be enough.104
In 2004, for instance, the EBRD states that “Lithuania has taken
significant steps to combat corruption through the adoption of a national anti-
corruption action plan and creation of independent monitoring and enforcement
mechanisms.”105
By 2006, the situations is described as “lower than in most transition
countries, [but] still relatively high compared to standard developed market
economies.”106
It appears that corruption has become more of an issue in recent years,
as illustrated by the following section:
…there has long been a close relationship among business, financial and
political elites in Lithuania, with individuals often crossing over from one
sphere of public life to another. This close relationship between the political
and business elite has at times raised concerns about possible informal
constraints or influences on the independence of certain elected officials, and
a number of high-profile political leaders have resigned or been dismissed as
a result of corruption…107
This has obviously not gone by unnoticed; as “in the light of ongoing concerns
by private investors over governance issues and competition from the informal sector
by the government has sought to ensure a more level playing field.”108
The coalition
formed in 2012, however, involved some parties that had been accused of corruption
in the past, which led it to become more of an issue again.109
4.2.1.6 Conclusion
Based on the EBRD strategy reports taken into account, the following steps have been
undertaken by the Lithuanian government:
-‐ The judicial framework concerning insolvency has been adapted and
continuously improved, the highlight being the great adaptation of three
insolvency laws in 2001. An issue, although diminishing, remains
accessibility of the procedures, and the limited size of the laws.
-‐ Commercial law in Lithuania has been steadily improved and compliance
is regarded as high.
-‐ As of 2010, the flat rate corporate tax has been decreased (from 20% to
15%). However, taxes remain a barrier to doing business.
-‐ Truly considerable steps have been taken in the process of registering a
business.
-‐ Fostering innovation through whichever means has not been a priority.

104
EBRD (2004): 11.
105
EBRD (2004): 12.
106
EBRD (2006): 16.
107
EBRD (2012): 10.
108
EBRD (2012): 9.
109
EBRD (2012): 7.

33

-‐ Corruption remains an issue, of which government is also actively aware,
as can be seen from the fact that it has been addressed directly through
for instance changes in the tax system.
4.2.2 European Bank for Reconstruction and Development
The EBRD has published a number of strategic documents concerning its
approach towards different transition countries, including Lithuania. These documents
naturally concern the priorities for the EBRD in certain time periods, but also provide
background information as to the development in terms of transition, and thus form an
excellent source of information about the development of the business environment in
Lithuania, that is additionally quite comprehensive.
An overview of the principal objectives of the EBRD, as defined in the used
documents, is given in Table 3.
Table 3: Strategic Priorities of the EBRD in Lithuania
Year Strategic priorities of the EBRD
1994 Private enterprise development (supporting needs of emerging private sector
and SMEs)
Strengthening financial sector (particularly for assistance of SMEs)
Rationalising energy use, security of supply and nuclear safety
Improvements of critical infrastructure (focus on private sector development,
commercialisation and trade, and environmental rehabilitation)
1996 Strengthening the banking sector
Overcoming the lack of medium-term to long-term capital
Strengthening the post-privatisation process
Attracting increasing levels of foreign direct investment
Transfer of know-how at the enterprise level
Upgrading key infrastructure, with particular emphasis on the energy sector, as well as
privatisation of and/or private sector participation in infrastructure
2002 Strengthening of cooperation with municipalities (especially in infrastructure sectors), in
addition to improving municipal finances
Maintaining an active policy dialogue to assist in legislative changes
Participating in larger industrial transactions
Supporting projects that enhance cooperation with neighbouring countries
Expanding the volume and spectrum of funding instruments for SMEs through
local financial institutions
Supporting restructuring, commercialisation and participation by the private
sector in infrastructure
Actively administering the NSA and IIDSF
2004 Continuing prudent macroeconomic policies and increases in domestic savings
Press authorities to improve the tax administration, streamlining business
registration and simplifying the cumbersome legal framework
Completing the privatisation process, restructuring some large local companies
and improve corporate governance standards
Enhancing the support for SMEs
Promoting commercialisation and private sector financing, and improving
regulatory frameworks
Restructuring and commercialisation of the energy sector
Reforming of the inadequately targeted an expensive social safety net
2006 Supporting the upgrade of state transport infrastructure and municipal infrastructure, while
actively promoting energy efficiency and the use of renewable energy
Providing intermediate capital to companies with projects requiring extensive restructuring or

34

corporate governance support
Supporting privatisation of remaining partially state-owned enterprises
Continuing to work on intermediate financing for SMEs
Encouraging the development of local capital markets
Supporting the enterprise sector in meeting the EU environmental requirements
2009 Further strengthening the stability of the financial system
Strengthening measures to counteract the effects of the crisis on the real sectors
Ensuring security of energy supply
Improving long-term competitiveness
Modernising municipal and environmental infrastructure
2012 Supporting investments in renewable energy and energy efficiency
Improving the competitiveness of the export sector
Supporting the strengthening of local banks
Conducting policy dialogue
Source: Author
Based on: EBRD (1994); EBRD (1996); EBRD (2004); EBRD (2006); EBRD (2009); and
EBRD (2012).
Note: The strategic priorities for 2002 were mentioned in the strategic document of 2004.
Note: Not all mentioned priorities are of importance in this analysis. For purposes of
increased overview, those points that are of importance have been presented in a
bigger font than those of lesser importance.
As one can see, a lot of attention is paid to financing (as is in line with the lack
of national capital) and supporting SMEs. Further reading of the texts of the
documents reveals that most of the support given to SMEs by the EBRD consists of
financial support, as is seen in the following section:
The EBRD strategy will continue to rely substantially on financial
intermediaries to reach SMEs, which account for a substantial number of
enterprises in Lithuania. The [European] Bank [for Reconstruction and
Development] may seek to reach the smaller companies by establishing a
small regional capitalisation investment fund (on a regional basis) to target
companies which are now out of reach for the existing investment funds.110
The [EBRD] will also support the development of SMEs. Since these
companies are quite small, the [EBRD] can hope to achieve this primarily
through operations in the financial sector and through equity funds.111
What comes to mind when reading the documents, is that the financial
investments cannot have had the desired effect; since each year, focus on finance is
reaffirmed. What also becomes visible is the fact that those EBRD priorities that are
of importance for this analysis on SMEs become less frequent in later years, with
2004 seeming to be a tipping point. Speculatively, one can say that this means that the
situation for SMEs in Lithuania has improved over the years. This assumption is
strengthened by the 2009 report directly mentioning that “the business environment is
among the best in the region”.112
Moreover, by 2012 the EBRD directly mentions that
“Lithuania is an advanced transition country”, which is why “the EBRD’s activities at

110
EBRD (1996): 2.
111
EBRD (2004): 18.
112
EBRD (2009): 3.

35

present are limited and will remain focused on a small number of priorities, in line
with the expected graduation of the country by the end of the current EBRD medium-
term strategy period in 2015.”113
4.2.3 Various Lithuanian Strategic Documents
Table 4 gives an overview of the priorities in entrepreneurship areas for the
Lithuanian government, and the extent to which they correspond with priorities as
identified by the European Union.
Table 4: Initiatives towards Entrepreneurship as Mentioned in Various
Lithuanian Strategic Documents (roughly 2002 – 2012)
Source: Kristina Balkiene and Jonas Jagminas, “Up-To-Date Awareness of Entrepreneurship

113
EBRD (2012): 3.

36

Policy: Focus on Innovation”, Viešoji Politika Ir Administravimas (Public Policy and
Administration) 34 (2010): 512-513.
Note: The policy documents referred to by the abbreviated titles are:
-‐ “The State’s Long-term Development Strategy”,
http://www3.lrs.lt/pls/inter3/_dokpaieksa.showdoc_l?p_id=193888.
-‐ “Description of Strategic Directions of Small and Medium-Business Development to the
Year 2008”, http://www3.lrs.lt/pls/inter3/dokpaieska.showdoc_ bin?p_id=264150.
-‐ “The National Programme for Youth Entrepreneurship Education and Promotion for the
Year 2008-2012”, http://www3.lrs.lt/pls/inter3/dokpaieska. showdoc_bin?p_id=358099.
-‐ “National Lisbon Strategy Implementation Programme for 2008-2010”,
http://www3.lrs.lt/ pls/inter3/dokpaieska.showdoc_l?p_id=329187&p_query=&p_tr2=.
-‐ “Government programme of Republic of Lithuania”,
http://www3.lrs.lt/pls/inter3/dokpaieska.showdoc_bin?p_ id=333778.
-‐ “Lithuanian Innovation Strategy for the Year 2010-2010”, http://www.
ukmin.lt/lt/veikla/veiklos_sritys/ino/LIS_ENG.doc.
-‐ “Priorities of the Government of the Republic of Lithuania for the Year 2011”,
http://www3.lrs.lt/pls/inter3/dokpaieska. showdoc_bin?p_id=383409.
-‐ “National Reform Programme of Lithuania, 2011”, http://ec.europa.
eu/economy_finance/sgp/pdf/20_scps/2011/01_programme/lt_2011-04-29_nrp_en.pdf.
Note: The abbreviated titles in the top row represent various Lithuanian policy documents,
and the left-most column represents priorities as defined by the European Union. The
pluses in the corresponding cells show which EU priorities are mentioned by the
different Lithuanian documents.
Note: The European priorities by which the national strategic documents are measured are
gathered by the authors from the following documents:
-‐ “ Communication from the Commission of 7 April 1998 on Fostering Entrepreneurship in
Europe: priorities for the future”,
http://ec.europa.eu/enterprise/policies/sme/documents/index_en.htm.
-‐ “Presidency Conclusions. Lisbon European Council, 23 and 24 March 2000”,
http://www.consilium.europa.eu/ueDocs/cms_Data/docs/pressData/en/ ec/00100-
r1.en0.htm.
-‐ “Working together for growth and jobs. Integrated guidelines for growth and jobs (2005–
08). European Commission”, http://ec.europa.eu/archives/
growthandjobs/pdf/integrated_guidelines_en.pdf.
-‐ “Proposal for a Community Lisbon Programme 2008–2010. Commission of the European
Communities, COM(2007) 804 final”, http://eur-lex.europa.eu/
LexUriServ/LexUriServ.do?uri=COM:2007:0804:FIN:EN:PDF.
-‐ “ The European Charter for Small Enterprises. European Council, 19-20 June 2000”,
http://ec.europa.eu/enterprise/policies/sme/documents/charter/ index_en.htm.
-‐ “ Green Paper: Entrepreneurship in Europe. Commission of the European Communities.
COM(2003) 27 final”, http://europa.eu/documentation/official-docs/green-
papers/index_en.htm#2002.
-‐ “Action Plan: The European Agenda For Entrepreneurship. Commission of the European
Communities. COM(2004) 70 final”, http://eur-lex.
europa.eu/smartapi/cgi/sga_doc?smartapi!celexplus!prod!DocNumber&lg=en&type_
doc=COMfinal&an_doc=2004&nu_doc=70.
-‐ “Implementing the Community Lisbon Programme—Modern SME Policy for Growth
and Employment”, http://ec.europa.eu/enterprise/policies/sme/documents/sba/index_
en.htm.

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