Privatisation in Russia - a successful experiment on the way to a market economy?

CONTENTS

1. Introduction

2. Conceptual Basics of the Privatisation process
2.1 Aims and tasks of privatisation
2.2 Different strategies of putting privatisation into action
2.3 Consequences for ownership
2.4 Special features of the Russian case

3. The course of privatisation in Russia
3.1 The Privatisation Program
3.2 Privatisation in its practical implementation

4. Underestimated difficulties in achieving the aims
4.1 Cultural values
4.2 Information deficits
4.3 The role of crime
4.4 Management initiative and incentives for restructuring
4.5 Incentives for restructuring on the part of workers

5. Summary and conclusion

BIBLIOGRAPHY

1.Introduction

When ‘privatisation’ became the word of the day in Russia, most policymakers and external observers made a number of rather simplistic assumptions, which gradually became hard to maintain. The very concept of privatisation was taken over from the West, referring to a transfer of state to private ownership. This move was expected to pave the way from a ‘command’ to a ‘market’ economy. However, the experience of privatisation in a post-socialist reality soon began to reveal its bewildering complexity and proved that most of the assumptions underlying the initial approach were inadequate.

What were the initial aims and tasks of privatisation? How could they theoretically be realized, and which particularities of the Russian economy were thereby taken into account?

The first part of this paper will attempt to answer these questions by focusing on the privatisation of large- and medium-size companies^[1] until the end of voucher privatisation in 1994. It was during this immediate transition period, when all the political, economic, and technical problems of implementing market orientated reforms in a society shaped by communism coalesced on the issue of how to achieve a successful privatisation of such enterprises. With these basics in mind, the second part will explore the implementation and course of the reform process until 1994. Part three will describe the practical obstacles, which the planners had not sufficiently taken into account. From there, the last part will summarize and conclude to what extent the first outcome of privatisation had achieved the initial aims.

2.Conceptual Basics of the Privatisation process

In order to understand the privatisation process and its obstacles in Russia, it is necessary to have a basic understanding of the economic logic behind this fundamental reform in the transition from a command to a market economy. The following paragraph will therefore introduce the theoretical ideas and methods of privatisation.

2.1 Aims and tasks of privatisation

The transfer of ownership from the state into private hand has several aims. In the former communist states, the major function of privatisation was the creation of incentives for a more efficient use of resources and the stimulation of entrepreneurial initiative in order to pave the way for a growing, innovative and competitive economy. Privatisation should also help to lower transaction costs and uncertainty. In Western societies all these aims are achieved almost automatically when ownership rights pass into private hands. However, in the case of Russia, as in fact in all former communist societies, two main tasks had to be put into action for these effects of a free market to set in: depoliticization, and the creation of a new institutional structure of corporate governance (adequate controlling- and management structures of an enterprise), favourable to the process of rapid revitalization and reorientation of the Russian economy.

Firstly, depoliticization was necessary because an economic transformation was impossible without a political one. Depoliticising economic decisions had to go along with establishing private ownership in order to separate political and economic power. This was especially crucial in post-socialist states where politics and economics used to be closely interlinked. One might argue that price liberalisation should suffice to deprive politicians of the ability to allocate goods and thereby to regulate production processes. Nevertheless, as long as politicians remain owners of enterprises the policy of a firm will not be determined by the market but with a view on politics.^[2] The danger is that politicians would keep certain scopes for rent-seeking activities and interference in the autonomy of firms, while managers would continue to seek first and foremost for subsidies, tax breaks, cheap credits or protective measures, whereas market orientation only came second. Privatisation should limit this possibility of political influence on entrepreneurial decisions, and should induce managers to orientate their strategies on the laws of the free market.^[3]

In the long term, depoliticization of the economy is also linked to macroeconomic stability. Russia’s reformers expected that divestment would reduce the state’s financial obligations to enterprises, many of which were inefficient, and thus help to lower the budget deficit while hardening budget constraints. By establishing individual property rights, privatisation should ensure that enterprise owners, managers and workers became responsible for the performance of their enterprise and not the government. In the short term, selling state property to investors – which was the planners’ initial idea – would also help control spiralling budget deficits by bringing in revenue.^[4]

But more than just depoliticization was needed to create efficient ownership. The absence of direct state ownership alone is no guarantee against the rent-seeking behaviour of special interests and for the state’s withdrawal from ordinary economic decisions. Roman Frydman and Andrzej Rapaczynski additionally emphasized liberalisation and the importance of putting through a powerful constituency in the economic sphere. The rights of economic actors vis-à-vis the state have to be clearly defined and must be able to be put through.^[5]

The second task, establishing efficient corporate governance structures, is the precondition for restructuring enterprises. These structures can help to give rise to new interests, which would not favour a policy of massive state support, but which would rather be opposed to state intervention. Their formation, however, is not an inevitable consequence of privatisation either. Apart from general politico-economic and institutional conditions (e.g. laws on disclosure, codified general accounting procedures, and institutions governing the payment of dividends) the privatisation strategy chosen is a decisive factor here.^[6]

2.2 Different strategies of putting privatisation into action

Confronted with the often conflicting interests of several economic actors (e.g. the state bureaucracy, directors of state enterprises, employees and the general public), all claiming their “just” share of privatisation, the reformers had to decide on a compromise strategy which would evade a struggle for distribution between these groups. The basic questions, which inevitably arise in this context, are whether to sell the productive capacities or to distribute them for free, and consequently to whom.

The main advantages of a free allocation through vouchers are twofold. First, it can be implemented relatively quickly because one avoids a lengthy process of evaluating the approximate value of assets in state firms.^[7] Secondly, it eliminates the problem of domestic capital shortage or the reluctance of foreign investors to enter. On the other hand, handing out shares for free is connected with the disadvantage of neither bringing in urgently needed capital nor concepts for restructuring or new management ideas in order to increase the efficiency of firms. Moreover, free shares might not motivate their holders to manage their affairs efficiently and to develop a certain appreciation for the former state property.

However, the alternative option of selling state property would have excluded wide sections of Russia’s population, most of which did not have sufficient savings at their disposal. Only a limited fraction of the people could have afforded to buy shares - mainly members of the old nomenklatura and those who had made a fortune on the black market. The unfair outcome of such an option would have discredited privatisation from its very beginning, and was therefore unacceptable.

The second question, concerning the allocation would be the choice between insiders (directors and employees) and outsiders (the wide Russian population and foreign investors).

On the one hand, the first option of a pure insider privatisation contradicted considerations on justice for two reasons. First, there was no reason why those who happened to work in factories should have received more than those working in public services or agriculture. The second reason went in the opposite direction. Under insider ownership, workers get claims that would be highly correlated with their other source of income. In case of bankrupt firms, workers would not have only lost their jobs but also ended up with useless pieces of paper.^[8]

On the other hand, some advisers warned against the danger of insiders blocking or complicating the privatisation process if they were not sufficiently awarded property rights. In this context it was feared that they could hinder restructuring or even use their access to firms’ assets in order to sell or evacuate those parts which were still of use in order to leave nothing but a torso to the new owners.^[9]

The second option, in form of a free distribution to the public at large would have solved most of the legitimacy problems associated with selective giveaways and the sales model. In the East European context, a giveaway model needed no special justifications, because the whole society had paid a very heavy price for the construction of the national industry in the years of communist rule.^[10] The main problem with the second option, whether in form of a free distribution to the public at large or of selling shares to outsiders, is to ensure that the new owners can exercise sufficient control over the management of the privatised enterprises. Otherwise no change in the status quo can be accomplished and the firm will not be restructured.

Obviously, the reformers had to find an acceptable compromise formula to solve these two crucial questions.

2.3 Consequences for ownership

Private ownership and competition should have helped to alter Russia’s distorted industrial structure, which was highly monopolised, and neither oriented on costs nor on demand, but rather the result of political decisions. There are, however, divergent interests of different private owners, according to their relationship to the enterprise. Frydman and Rapaczynski predicted that:

“If the state withdraws from its ownership position and leaves in its place a structure in which the insiders remain in effective control of the formally privatised enterprises, while at the same time their incentives are not radically altered, it is likely that they will continue to pursue policies and strategies designed to force the government into a new system of political enterprise governance [...].”^[11]

One attempt to alter these insider incentives was the option of a management buy out in which managers become owners and get a share in profits. Standard economic theory predicts that this should create bigger incentives for restructuring. However, it was doubtful whether such putatively successful Western concepts could simply be applied to post Soviet conditions, which were completely different in nature and might have also shown unanticipated reactions.

[...]

^[1] The privatisation of small enterprises, such as shops and service establishments was comparatively simple. It mainly allowed managers to become owners, which was probably both easier and more efficient than bringing in outside investors.

^[2] See Siehl, E. (1998), p. 76.

^[3] See Frydman, R./Rapaczynski, A. (1994), p. 142.

^[4] See Nelson, L. D./Kuzes, I. Y. (1995), p. 125.

^[5] See Frydman, R./Rapaczynski, A. (1994), p. 143

^[6] Ibid, pp. 143-144.

^[7] See Frydman, R./Rapaczynski, A. (1994), p. 16 ff.

^[8] See Blanchard/Layard (1991), p. 34.

^[9] See Kordasch, S. (1997), p. 127 ff..

^[10] See Frydman, R./Rapaczynski, A. (1994), pp. 26-27.

^[11] Frydman, R./Rapaczynski,A. (1994), pp. 143-144.