/ 6 14p Viewpoint The World Bank FPD Note No. 24 October 1994 Russian Privatization: An Impressive Record John Nellis and Ira Lieberman Russia 'sprivatization record is impres- * persuade the most important "insid- sive and unique. Participants at a June er" stakeholders who might have 1994 World Bank conference on the opposed privatization-workers and subject concluded that it was irrevers- managers-to take part in the pro- ible, that the next stage ofprivatiza- tion-selling remaining shares andW firmns for cash through auctions and World Bank Group conference tenders-must be expedited. and that on privatization and the private sector in Russia developing capital and securities mar- kets and making business real estate The conference, held on June 20-21, tradable should get top priority. This 1994, brought together key decisionmak- Note reviews the privatization achieve- ers and advisors in the Russian privatiza- ments of Russian reformers over the past tion process, including: threeyears, discusses emerging second- - Anatoly Chubais, Russian Deputy tier privatization and post-privatization Prime Minister; *Maxim Boyco, Chief Executive Officer issues and summarizes the key themes of the Russian Privatization Center in the paperspresented at the World - Andrei Shleifer, Harvard University, Bank-sponsored conference. Advisor to the Russian privatization agency (GKI); Impressive by any standard * Jonathan Hay, Advisor to GKI; -Andrei Volgin, Director of the Derzha- Privatization is the one bright spot in va Investment Fund, Moscow; the generally bleak Russian economic * Charbel Ackerman, Advisor to the GKI; landscape. Starting from an acutely . Joseph Blasi, Rutgers University, Advi- difficult position' in November 1991, a sor to the GKI and the Russian Priva- small, determined, and often belea- tization Center; * Leroy Jones, Boston University, Advi- guered group of Russian reformers- sor to GKI. with some important external sup- The papers presented at this conference port2-has been able to: will be available in a forthcoming World devise and implement, in the face Bank publication, Russia: Creating Private of strong resistance, a "corporatiza- Enterprises and Efficient Markets, edited tion" program that has turned about by Ira Lieberman and John Nellis, with Enna Karlova, Joyita Mukherjee, and half of Russian state-owned enter- Suhail Rahuja. prises into joint stock companies; Private Sector Development Department D J Vice Presidency for Finance and Private Sector Development cess by offering them shares in the firms in which The mass privatization program of the former Czech- they work for free or at a low price; oslovakia, which transferred 1,491 firms into private * conceive and implement a voucher program giving ownership in 1992 and 1993-with a "second wave" 144 million participating Russians a chance to be- coming in both successor states that will touch an come, along with insiders, owners of enterprises; * create a national voucher auction system covering more than 85 regions, with 750 bid reception centers; privatization conference key conclusions * facilitate the creation of some 600 private invest- ment funds that compete for vouchers and con- 1. Russia's voucher-led mass privatization program, without vert them to diversified shareholdings in newly precedent in size and speed, is a major success. Why? privatized enterprises. Because the links between the enterprises and the state have been severely frayed, if not yet totally cut, and a By the end of June 1994, mass of property owners-who, presumably, will sup- * between 12,000 and 1,000 medium-size and port further reform-has been created. The first and * between 12,000 and 14,000 medium-size and overarching goal of the process, to make reform irrevers- large enterprises had been transferred to private ible, seems to have been achieved. Initial inquiries into ownership; the behavior of firms after sale reveal that restructuring 9 this set of firms employed more than 14 million is under way, as evidenced by product diversification, people, or about half of those employed in Rus- labor shedding, and change of top management. 2. The next stage of privatization will entail selling the sia's industrial sector; remaining shares and the remaining thousands of enter- * about 40 million Russian citizens owned shares in prises for cash, through auctions and tenders. The gov- privatized firms or investment funds. ernment proposes that a substantial amount of the cash so generated remain in the firm, to finance needed These achievements were made in the absence of restructuring. To increase the attractiveness of firms to consensus on the desirability, scope, and pace of investors, the real estate on which the company sits must be clearly tradable and clearly included in the liberalizing reform in general, and of privatization in deal. This approach will address essential needs of particular, and without what would normally be newly privatized firms, but will necessarily be slower considered the requisite administrative and financial than transfer through voucher auctions. And it has resources to implement, monitor, and enforce a already provoked vehement opposition from regional privatization program of this magnitude. Yet it was governments and municipalities, which see the new approach as a threat to their lucrative control over local done. The only potentially comparable privatization real estate. In mid-July 1994, the Russian Parliament experiences are those of the former East Germany rejected the proposed second-phase program, but it and the former Czechoslovakia. was promptly promulgated by a presidential decree. 3. A fundamental contribution of the mass privatization In Germany, the Treuhandanstalt succeeded in put- program has been its capacity to reveal the need for, ting more than 10,000 enterprises into private and to spur, reform in other aspects of the economy. ting more tan 10,000 eterprises ito privateLegal reforms, land privatization, protection of share- hands between 1991 and 1994. This achievement holder and creditor rights, social safety net reforms and cannot and should not be minimized. Nonetheless, the closely related issue of how to dispose of ancillary German privatization was a case of integrating a or social assets of firms-the need for reform in all formerly socialist economy into a functioning- these areas is acute, and considerable activity is under indeed flourishing-market economy, an exercise way. However, a recurring theme in the conference, on that dfferssharpl fromthe toal trnsitio thatwhich there was universal agreement, was that the top that differs sharply from the total transition that priority was the development of capital and securities Russia confronted. In Germany, an irreproducible markets. This is seen as critical to assist investors in combination of West German legal and administra- acquiring property and protecting savings, and to ad- tive institutions, West German managers, and West dress the need for improved corporate governance in German money eased many of the problems of the privatized firms. that integration. 2 additional 1,300 firms-is the best, perhaps the only, All in all, the obstacles to Russian privatization were comparator to the Russian privatization program. more numerous and more daunting than those en- Once again, the Czech and Slovak privatization pro- countered in Germany and Czechoslovakia, or in- grams are remarkable achievements. Indeed, a few deed in any other country that has seriously em- Czechs have suggested that their method was the barked on the process. In Russia, because of these "right way" to privatize since, in contrast to the Rus- different initial conditions, the period of "extraordi- sian approach, it gave no special inducements to nary politics"4 was both shorter-lived and less in- insiders. Outsiders-extemal investors and invest- tense than in other economies in transition. This ment funds-played a major ownership and gover- point must be grasped, both to comprehend how nance role from the outset; and some Czech practi- truly impressive Russian privatization results have tioners and external observers now criticize Russia been and to understand why the Russian process for not having followed the same course. has unfolded as it has, with the defining characteris- tic being the provision of financial rewards or equity Without disputing the impressive Czechoslovakian stakes to all the actors and agencies involved. Had achievements, it has to be stressed that Russia em- the Russian reformers attempted to follow the barked on privatization in circumstances very differ- Czechoslovak route of centralized administration of ent from those of the former Czechoslovakia. First, the process, and had they tried to treat enterprise precommunist Russia in 1917 was markedly different insiders as potential purchasers like any other, the from precommunist Czechoslovakia in 1948; it was likelihood is high that very little privatization would less industrialized and less capitalist. Second, the have taken place. length of the communist period in Russia was almost double that in Czechoslovakia, so in Russia collectiv- What happens next... ist approaches and habits had more time to take root The Russian privatization team thus opted for the and become deeply ingrained. Third, and paradoxi- method that they judged would yield results-and cally, Czechoslovakia "benefited" from an absence of they got them. But as a consequence, the results reform communism; that is, unlike Hungary, Poland, were tentative and partial. The transfer of ownership and, to some extent, Russia, Czechoslovakia main- basically to insiders was a striking step, but only a tained basically intact the central planning system first step-which must now be followed by equally until the very end. The successor governments thus essential second steps opening ownership of priva- have not had to debate the scope and pace of liber- tized firms to external investors and owners. These alizing reform with entrenched, decentralized stake- steps will, it is hoped, bring needed capital, market holders such as the Solidarity movement in Poland, access, managerial know-how, and a bottom-line the workers' councils in Hungary, or the relatively mentality to privatized companies. External investors empowered enterprise managers, cooperative mem- should complete the restructuring of firms begun by bers, and leaseholders created in perestroika Russia. the transfer of ownership. A significant percentage The Czechoslovak successor regime in 1990 was less of restructured firms would then become profitable constrained by decentralizing forces than almost all and nationally and internationally competitive; and of the other successor regimes in Eastern and Central Russia would be well launched on the process of Europe-circumstances of which Vaclav Klaus and growth and integration into the global economy. his reform team have made the most.3 In addition, Russia is a far more complex country than was Such is the hope-but much stands in the way. A Czechoslovakia, with some 150 million people number of critical issues and questions emerge: spread across a vast territory of 88 regions, autono- * Insiders fear that the restructuring brought about mous republics, and major municipalities. The Mos- by extemal investors will cost them their jobs; cow oblastalone is larger than the Czech Republic they thus do their best to prevent or limit sales of and Hungary combined. large blocks of shares to external investors. What 3 are the mechanisms by which secondary share es?And what parallel reforms are required in the trading, leading to restructuring, will be amplified financial sector and capital market development to and entrenched? support these actions? * The voucher scheme expired on July 31, 1994; the * Important as privatization is, it is only a part of the present political configuration will not, apparently, transition process, alongside new entrants and tolerate a second voucher issue. However, be- greenfield investments. What does the nonpriva- tween 10,000 and 12,000 enterprises remain un- tizedprivate sector look like, and how, if at all, do its corporatized, unprivatized, and lacking the vouch- activities differfrom those of theprivatized sector? er mechanism to spur their divestiture. What will happen to this important set offirms?At whatpace The new book based on papers presented at the will cash sales (tenders or auctions) proceed, and World Bank conference addresses these questions who will ensure the transparency of the process? and issues-in sections entitled Privatization, Capital * Small-scale privatization in Russia is impressive in Market Development, Corporate Governance and absolute terms (with some 85,000 small business Restructuring, and The Emerging Private Sector: units divested), but lags relative to similar programs Constraints and Regulations. in, for example, Poland, Hungary, Estonia, and the Czech Republic, where a much larger percentage of In the sense that the reformers did not simply face the privatization of the entire small-scale base has been divested. Small- a mass of state-owned enterprises, but also had to deal with the scale privatization schools both new owners and "quasi-private" entities created during the late perestroika period. See consumers in market economics, and has proved John Nellis, Improving the Performance of Soviet Enterpses (World Bank Discussion Paper 118, Washington, DC, 1991). critical in job creation, essential to the absorption of 2 From the G-7 countries (through bilateral programs), the EBRD, the surplus labor flowing out of the large-enterprise World Bank Group, and the European Union. Equally important, the sector. Why has Russia performed comparatively Russian privatization team knew how to put these external resources to effective use. poorly in small-scale privatization, and what does it 3 One potentially massive set of decentralizing factors that existed in mean for the economic future of the country? 1990-the federal nature of the state and the tensions between the • Twelve to fourteen thousand medium-size and Czech and Slovak territories-has, of course, been resolved by the large fims are nw in prvate hans. But fw be- ,dissolution of the federation. large firms are now in private hands. But few be- 4 The phrase is from Leszek Balcerowicz and Alan Gelb, "Macropolicies lieve that their future operations will be left entire- in Transition to a Market Economy: A Three-Year Perspective," a paper ly to determination by pure market forces, espe- presented at the World Bank's Annual Bank Conference on Develop- cially since at present the Russian variant of the ment Economics, Washington, DC, April 1994. The authors argue that a period of "extraordinary politics" occurred in a number of Eastern market deviates so sharply from the textbook and Central European countries when the old communist elites were model. Privatized firms urgently require technical discredited, but "modern" interest groups were few, fragmented, and assistance (to help in the preparation of business unorganized. This allowed reforming technocrats to take command, greatly raising the "probability that difficult, notmally controversial, plans and restructuring); credit to finance working economic policy measures will be accepted" (p. 11). The period lasts, capital, trade, and investments; and equity injec- say the authors, for one or two years, and then "politics as usual" tions to provide both long-term money and active tends to regain supremacy. governance. How can these needs be met without reintroducing into businesses the heavy hand of John Nellis and Ira Lieberman are both managers in the Private Sector the state? Who willfund and provide these resourc- Development Department This series is published to share ideas and invite discussion. It covers financial and private sector development as well as industry and energy. The views expressed are those of the authors and are not intended to represent an official statement of Bank policy or strategy. ® Printed on recycled paper. Comments are welcome. Please call the FPD Note line to leave a message: 202-458-1111; or contact Suzanne Smith, editor, Room G8105, The World Bank, 1818 H Street, NW, Washington, DC 20433, or Internet address ssmith@worldbank.org. 4