The transition paths from plan to market have varied markedly across countries. Central and Eastern European and Baltic countries, which opted for fast and deep reforms including transformation of their business environments, rapidly narrowed the productivity gap with advanced economies. In contrast, in countries of the Commonwealth of Independent States, which embarked on reforms later and with less depth, the productivity gap remains large. Whereas the literature has focused mainly on empirical studies, this paper develops a dynamic search model of firm start-ups that reflects these trends. The model shows that an enabling business climate contributes to start-ups of highly productive firms at an earlier stage of transition, underscoring the importance of early reforms. The role of the state sector as an employer during transition rises in countries where reforming the business environment is particularly costly.
