Reassessing Privatization in Eastern Europe
This paper looks at how far privatization has advanced in the former communist countries in Europe, how privatization has been achieved, and the issue of how privatization has affected the efficiency of firms -- i.e., firm restructuring. The discussion is based on a partial review of the literature during the last two years.How far has privatization advanced?
Estimates vary. One reason is that privatization is defined differently across analyses. For example, in its World Development Report 1996 (WDR96), From Plan To Market, the World Bank uses the term privatization to mean divestiture by the state of enterprises, land, or other assets. The term is not meant to include just any action that moves an enterprise in the direction of private ownership. This would suggest a reference to actions that, at least, transfer controlling stakes in a company from the state to the private sector. In contrast, in their assessment of privatization in industry, Anderson, Djankov and Pohl define a privatized firm as one with more than one third of its shares transferred to private investors.
In any case, by all accounts the extent of privatization in the former communist economies surpasses any precedent. To use a benchmark, Nellis points out that from 1980 to 1991 some 6,800 firms were privatized in the nontransition economies of the world. In contrast, in 15 transition countries of Central and Eastern Europe, as well as in the former Soviet Union, more than 45,300 medium size and large firms had been privatized by 1994. Of course, to that number one would have to add the privatizations that have taken place since then, bearing in mind that in some countries the process of privatization has accelerated. Moreover, the number of small businesses privatized ranges in the hundreds of thousands.
The result of privatization in these countries is that, in many, almost all of the small firms are in the private sector, while a majority of medium and large enterprises are also under private sector control. Thus, for six Central and Eastern European countries, the WDR96 indicates that the number of large and medium enterprises in state hands ranged from 4 percent in Estonia to 54 percent in Poland. It would seem that, in the typical country, some 30 percent of the enterprises were still state-controlled toward the middle of 1995.
Another way of addressing the issue of the extent of privatization in these economies is by measuring the contribution to GDP and employment of the private sector. In this regard, it is noteworthy that in the Czech Republic, Hungary, Poland, and the Slovak Republic, the private sector accounted for more than 50 percent of the GDP and employment in 1995. The changes relative to 1989 are shown in table 1.
Source: Borish and Noel (1997).
Now, while these changes are dramatic, as advanced above, they do not necessarily reflect the impact of transferring firms from the public to the private sector. The situation varies among the countries. Accordingly, in the Czech Republic, where privatization was accomplished relatively fast, the impact of privatizing state-owned firms may have been a main factor. In contrast, in the other three countries, especially in Poland, where privatization took place at a slower pace, the importance of the private sector mainly reflects the creation of new private firms.
A second noteworthy point is that a significant amount of privatization has yet to occur. Thus, state ownership is still important in industry (especially in natural monopoly industries), in much of finance, agriculture, and real estate -- both commercial and housing.
What have been the main approaches to privatization? What are the prevalent views regarding their specific impact on privatization objectives?
Although three main methods have been used in privatizing medium size and large firms, the importance of specific privatization methods has differed across countries. Moreover, to assess impact one has to take into account the objectives behind privatization. In general, these have been:
Nonetheless, it is pertinent to underline, that "increased efficiency" is by far the most relevant objective. In a way, all the others contribute to it or, as in the case of raising government revenues, are affected by how well increased overall efficiency in the economy is achieved. The three main methods for privatizing large and medium size enterprises have been:
The reference being to persons or entities who are neither employees, managers, or relatives of employees or managers, of the enterprises to be privatized. Sales may be: negotiated enterprise-by-enterprise (Hungary has made extensive use of this approach); by multi-enterprise tender whereby several enterprises are offered for sale as a single package (used by Estonia, Germany, and Latvia, for example); or through a public offering of shares (has been used in Poland and in Hungary).
In principle, direct sales to outsiders improves corporate governance, helps increase access to new capital and skills, and raises government revenues. The disadvantage has been that, due to difficulty in evaluating firms, negotiation, and follow up, it is a slower costly process, and may be perceived as unfair, as not everybody can enter into the negotiations. In fact, because of these factors, coupled with lack of domestic capital, and reluctance to sell to foreigners, it has been relatively little used.
The countries which have made most use of this method are: Germany, Hungary, and Estonia. On the other hand, relying on initial public offerings has not been an effective tool due to the underdevelopment of stock exchanges.
The main advantage is that it is faster and relatively easy to do. However, on the downside, by and large, it is not regarded as leading to better corporate governance, increase in new capital, skills or government revenues.
Another disadvantage is that it entails an element of arbitrariness and unfairness -- a worker loses or gains depending on whether he happens to be in a "bad" or "good" firm. Moreover, use of this method may block further reforms if insiders prevent access to ownership by outsiders (who would bring new capital and skills) or the latter are reluctant to invest (because of insider control).
While these are the prevailing perceptions regarding insiders buyout, the empirical record, nonetheless, is non-conclusive. For instance, Anderson, Djankov and Pohl analyzed the impact of privatization on firm restructuring in seven Central and Eastern European countries. They used several measures of restructuring, but their main measures were labor and total factor productivity. The essence of their approach is that they regressed these variables on government policies that included different methods to privatize. Surprisingly, they found that the impact on firm restructuring did not differ significantly across privatization methods.
One should note that, the other most frequently approach used, "equal access" voucher programs (see below), may de facto become management-employee buyouts, if managers, employees, and their families use the vouchers and other resources to buy stakes in their own companies (as in Lithuania). A fortiori, voucher programs which give preferential access to managers and employees are also de facto insider buyouts - -Russia is an example.
While the literature on privatization processes in the former socialist countries is extensive and growing, empirical analyses of the impact of privatization on the economy and on the privatized firms tend to be too limited or sketchy. The reasons are several.
First, privatization processes in these countries have taken place along a broader process of policy reforms including, for example, liberalization of prices and interest rates, change in trade policies, and fiscal and monetary reform. One consequence is that it is extremely difficult to distinguish between the effects of privatization and of the new policies.
Second, most of the existing analyses are based on data collected around 1994 or earlier. As mass privatization really started in most of these countries not earlier than 1991 or 1992, the span of time between privatization and data collection was probably too short for capturing the impact of privatization on firms restructuring and, even harder, on the economy overall.
Third, when privatization has been accomplished through sales to outsiders -- as in traditional privatizations in other countries -- the firms might have undergone some restructuring prior to the change in ownership. As a consequence, some of the changes in performance might be due to the pre-privatization restructuring rather than to the privatization itself.
Fourth, comparisons of performance between privatized and enterprises still in state hands may suffer from selectivity bias in that the better or worse performing firms might have been chosen for privatization. A related aspect is that the state might have decided to keep a set of firms to shore them up prior to allowing them to compete in the market.
Finally, many of these studies have to rely on financial or accounting data provided by the firms themselves. As in these countries generally accepted accounting principles (used in market economies) are not applied, supervisory and regulatory institutions (such as the ones involved in financial markets) are not well developed, and even in Western countries, many types of accounting data are manipulable by management, the study results may be suspect.
Nonetheless, as can be gathered from prior comments, advances have been made in attempting to isolate the effects of ownership changes from the public to the private sector. One such attempt is by Frydman et al.
These authors focus on a sample of medium-sized companies in the Czech Republic, Hungary, and Poland which underwent privatization without having undergone any special pre-privatization preparations. Their data is for the period 1990 to mid-1994.
Frydman et al. compare the performance between state and privatized firms, not addressing the issue of differences in performance between any of these firms and new firms. Moreover, they try to avoid selection-bias issues by evaluating the pre-privatization performance of privatized firms relative to state firms and establish that, originally, there was no difference between them. In addition, to identify the effect of ownership changes, they evaluate the post-privatization performance of privatized firms, again relative to state firms.
After using multivariate analysis to control for other factors than change in ownership, the authors conclude that:
Except for worker ownership, private ownership dramatically improves the most essential aspects of corporate performance. They measure performance, primarily, by enterprise revenues, and argue that the effect of privatization results, mainly, from entrepreneurial efforts to stem revenue losses and generate revenue increases.
Ownership changes tended to result in the removal of rather obvious inherited cost inefficiencies.
Privatized firms are also more successful at moderating employment losses.
Outsider-owned firms perform better than insider-owned firms on most performance measures. However, while the effects of manager-ownership are ambiguous, passing ownership to employees seemed to result in no advantage over state-ownership.
Also, they find that privatization funds do as well at restructuring privatized firms as other outside owners. (This finding contrasts with the conclusions of Pistor and Spicer who argue that in both the Czech Republic and Russia privatization funds have not met expectations because: fund shares are selling at a discount, which suggests that the funds have not been able to increase the value of their holdings or fail to share any gains with investors; they have not contributed much to the development of capital markets.)
Perhaps more surprisingly, they find that foreign investors provide less of an advantage than usually assumed. In other words, their impact is not significantly different from that of major domestic outsiders.
A different approach is used in another ongoing study on the impact of Russian privatization. Saul and Estrin analyze the ownership structure that emerged from that process using information from a July 1994 sample survey of over 400 state and privately owned manufacturing companies.
They document the large fraction of shares transferred to insiders and also analyze the holdings of the state. In the study, Saul and Estrin distinguish among the following categories: the state, workers, managers, and different types of outside investors. Among other points, through multivariate techniques, they also explore the implications of alternative privatization methods for ownership structure and the effects of ownership structure on enterprise performance (measured by labor productivity).
They find that, while it is true that privatization in Russia has benefited mostly insiders, outsider shareholders may wield more clout than generally thought. The reasons are : outsiders are unequally distributed across companies and, in a significant fraction of firms, their stakes are much higher than average; outsiders tend to invest in somewhat larger companies which raises the proportion of capital they may influence; non-voting shares limit the control rights of inside and state shareholders; that citizens ultimately placed a relatively large fraction of vouchers with Investment Funds and that, as the 10 percent limit on fund ownership in any one company is not being enforced, outsiders holding concentrated blocks of shares may have some measure of control over insiders.
Regarding links between enterprise performance and ownership, Earle and Estrin find evidence of systematic effects of private ownership on restructuring and on labor productivity. Their results indicate that, among private owners, managers have the most consistently positive and statistically significant impact on performance; however, they also find a weaker, but still positive, impact of ownership by investment funds on the same variables.
Interestingly, their results based on ordinary least squares indicate that other types of private owners - - workers, banks, domestic firms, foreign investors - - do not lead to a performance superior to that under state ownership. Their results based on instrumental variable techniques, however, show much larger effects of outside ownership on performance, and greater effects of institutional ownership (relative to the OLS results).
In Hungary a recent study found that new firms adjust their labor forces faster to demand changes. Privatized firms acted as new firms after one or two years. Surveys in Poland (1993) and in Russia (1994) indicate that new private firms generate higher profits than state firms. In Poland and in Slovenia the results showed that privatized firms did better than state firms. However, the conclusions are not strong because they may just reflect the fact that the better state firms were privatized.
Other results (as in the work by Earle and Estrin mentioned above) suggest that performance depends on how the privatization was made. Outside owners in Russia and Ukraine who had bought their small businesses through competitive auction invested more and performed better than inside owners who had obtained their firms free or nearly free.
What is one to make of all this? As had been pointed out in the WDR96 it probably is too early for clear conclusions. Some (growing) evidence indicates that the impact of privatization has been positive and significant. However, other analyses suggest that the jury is still out.In conclusion
In spite of the vast literature on privatization in transition economies, the previous sections are indicative of the tentativeness of the basic conclusions reached through empirical research. There still is a long way to go in terms of ascertaining the impacts of different approaches to privatization and what the effects on the economies have been. Probably the situation could not be different.
As mentioned before, most available analyses are based on data collected through 1994, a relatively short period after privatization gained momentum in the main transition countries. Moreover, except for Poland and Albania which experienced average annual growth rates of real GDP of some 2.4 and 1.4 percent respectively, for 1990-1995, the average growth rates for all other transition countries in Europe for the same period were negative. Such context makes it the more difficult to detect aggregate impacts on the economies resulting from privatization.
In contrast, annual rates of growth have been predominantly positive for the last two years. Given that in many of these countries a significant fraction of GDP originates in the private sector, one may conjecture that the effects of privatization may be more clearly traceable with more recent data. In that light, one initial suggestion is for studies that concentrate on case studies of individual firms in specific countries, in addition to aggregate or sector studies. Such case studies are likely to be more telling on such aspects as: the links between different privatization methods and firm restructuring; the role of financial markets; and the nexus between firm performance and ownership concentration.
While more tentative, the following other suggestions seem also warranted.
At the time this paper was written, the above conclusions seemed relevant for countries that have yet to start a real transition to capitalist economy. Cuba is an example.