Chapter IV.2 Enterprise Reform
- International Monetary Fund
- Published Date:
- December 1991
Reform of the structure, ownership, organization, and management of the USSR’s industrial enterprise sector is a fundamental aspect of the transition to a market system. The transfer of responsibility for production and marketing decisions from the central planning bureaucracy to the individual enterprise managers is expected to make better use of the latter’s technical expertise and initiative and lead to greater efficiency in resource use, faster technological progress, more rapid output growth, and improved product quality. To achieve these objectives, however, the simple devolution of authority over enterprise activities must be accompanied by major changes in manager and worker incentives; the legal and regulatory framework in which enterprises function; the manner in which enterprises interrelate with one another and the communications and transport networks that bring them together as buyers and sellers of products; the sources, terms, and mechanisms of enterprise finance; the structure of enterprise ownership, internal control, and administration; the skills which managers bring to their complex tasks; and the manner in which the society at large manages and finances housing, social insurance, and other social expenditures currently assumed by state enterprises.
After a brief overview of the industrial structure and pattern of ownership in the USSR, this chapter focuses on several interrelated aspects of industrial enterprise reform: the commercialization and privatization of enterprises, the demonopolization of industry, enforcement of a hard budget constraint, and the management of enterprises destined to remain, at least for the foreseeable future, under state ownership.
2. CURRENT STATUS AND TRENDS
The total number of industrial enterprises in the USSR has changed little since 1970, actually falling slightly from just over 49,000 to under 47,000 through 1987 (Table IV.2.1). The average size of enterprises, as measured by the number of employees, has grown in virtually all sectors, however (Tables IV.2.2-IV.2.5), and is significantly larger than found in Western industrial countries. Moreover, the share of the largest industrial enterprises in value-added has been growing over the past couple of decades; in contrast, for example, to the United States, where smaller enterprises have been increasing their share in recent years.
|Chemistry & petrochemistry||1,107||1,043||1,079||1,072|
|Timber, woodworking, pulp and paper industries||6,568||5,330||5,457||5,547|
|Construction materials industry||4,755||3,905||3,940||4,336|
|Chemistry & petrochemistry||1,418||1,850||1,856|
|Timber, woodworking, pulp and paper industries||429||563||489|
|Construction materials industry||421||563||530|
|Up to 100||11,821||607||27.3||1.8|
|Industries||Up to 100|
|(Thousands of employees)|
|Motorcar and bearing||0.4||18.4||32.4||504.3||739.0||1,294.4|
|Motorcar and bearing||—||1.5||2.5||39.0||57.0||100.0|
Enterprises up to 5,000 employees.
Enterprises up to 5,000 employees.
|Industries||Up to 100|
|(Number of enterprises)|
|Motorcar and bearing||7||59||44||136||22||268|
|Motorcar and bearing||2.6||22.0||16.4||50.8||8.2||100.0|
Enterprises up to 5,000 employees.
Enterprises up to 5,000 employees.
a. The state enterprise sector
State ownership remains the dominant form of enterprise ownership in the USSR, currently accounting for about 84 percent of the work force, 87 percent of national income, and 89 percent of fixed productive capital. Within the state industrial sector, as a result of the transfer of ownership rights in light industry and agroindustry, the share of republican and locally owned enterprises has grown in recent years, accounting for about 35 percent of sector output in the first half of 1990.
Industrial production in most sectors tends to be highly concentrated in one or a few enterprises. For example, in almost two-thirds of the 38 product groups included under sledge-press machines, the largest enterprise accounted for 75 percent or more of total production in 1988, and the same was true for 60 percent of the 38 product lines included in the tractor and agricultural machinery industry (Table IV.2.6). These data actually understate the degree of concentration; when broken down to greater levels of product specificity, there is commonly only one producer in the entire country. For 87 percent of the 5,885 products included in the machine-building sector, a single producer accounts for all deliveries to the State Supply Commission (Gossnab) (Table IV.2.7). A similar picture emerges from disaggregated Goskomstat data, which indicate that some 30-40 percent of Soviet industrial output is composed of goods produced on single sites. For example, single factories produce 100 percent of sewing machines, 97 percent of trolley buses, 100 percent of coking equipment, and so on (Table IV.2.8).
|Branches||Share of Product Groups|
included in Bracket
|Oil & chemical machines||12.4||18.8||68.8||16|
|Construction & roadbuilding machines||16.7||58.3||25.0||12|
|Motor cars & bearings||22.7||22.7||54.6||22|
|Tractors & agricultural machines||60.5||15.8||23.7||38|
|Machines for livestock farming and|
|Chemistry and timber industry||6.5||6.5||87.0||31|
|In all branches||36.6||24.1||39.2||344|
|Production of Products in Bracket (in percent of total)|
|Sewing machines||Shveinaia Association Podolsk||100|
|Automatic washing machines||Electrobytpribor Factory, Kirov||90|
|Trolley buses||Uritsky Factory, Engels||97|
|Forklift trucks||Autopogruzhchik Association, Kharkov||87|
|Diesel locomotives||Industrial Association, Voroshilovgrad||95|
|Electric locomotives and trains||Electric Locomotive Plant, Novocherkassk||70|
|Tram rails||Integrated Steel Works, Kuznetsk||100|
|Reinforced steel||Krivoi-Rog-stal, Krivoi Rog||55|
|Concrete mixers||Integrated Mill, Tuva Works||93|
|Road-building cranes||Sverdlovsk Plant, Sverdlovsk||75|
|Locomotive cranes||Engineering Plant, Kirov||100|
|Oil, chemicals and chemical engineering|
|Polypropylene||Neftkhimichesky Combine, Perm||73|
|Deep-oil-well sucker rods||Ochesk Engineering Plant, Ochesk||87|
|Sucker-rod pumps||Dzherzhinsky Engineering Plant, Baku||100|
|Hosts for coal mines||City Coal Machinery Plant, Donetsk||100|
|Coking equipment||Kopeisk Engineering Plant, Chelyabinsk||100|
|Hydraulic turbines||Metallurgical Works, Leningrad; Turbines Plant, Kharkov; Pipe Building Factory, Syzran||100|
|Steam turbines||Metallurgical Works, Leningrad; Turbines Plant, Kharkov; Turbo-Motor Plant, Sverdlovsk||95|
|Electrolytic tin plate||Magnitogorsk & Karaganda||100|
|Rolled stainless-steel||Pipe factors, Nikopol and Pervouralsk||96|
|Color-photography paper||Positive Film, Leningrad and Positive Film, Pereslavl||100|
|Freezers||Freezers Association and Plants, Kishinev and Krasnoyarsk||100|
Even where more than one enterprise exists, the national aggregates hide a high degree of regional monopoly power that is protected by generally poor communications and transportation and by administered marketing channels which, in turn, are insulated from one another by ministerial lines of responsibility. Moreover, the industrial branch ministries tend to view the enterprises under their control as merely cogs of the same wheel, thereby assuring that their activities are coordinated rather than competitive, and allocating and transferring resources among them in complex cross-subsidization. Factories under the same ministry produce all of the USSR’s hydraulic turbines, electrolytic tin plate, freezers, and so on.
The tendency toward huge scale and extreme concentration reflects, in large part, the preferences of central planners, whose abilities to process information and enforce directives depends on keeping the number of entities they deal with as small as possible. While such monopoly power may not be of great concern in a system of central allocation and administrative pricing, the dangers inherent in this degree of market concentration for the transition to a market system are evident. Moreover, it is likely that in many sectors the current sizes of enterprises significantly exceed optimum scales in terms of costs of operation.
At the same time that bureaucratic imperatives have led to extreme concentration of production at above-optimum scales, other forces have led, within the huge enterprises, to uneconomic vertical integration of production, in which enterprises strive to meet their own input needs at suboptimal scales of production. Principal factors contributing to this phenomenon are the unreliability of input supply, resulting from the increasingly inefficient centrally administered supply system, the lack of an efficient wholesale market, and breakdowns in the transport system; and the vertical organization and jealously guarded self-interests of the branch ministries responsible for the enterprises.1
With the coming into force of the Law on Enterprises in 1988, state enterprise managers were given somewhat greater autonomy in production decisions, with a system of state orders—covering less than total output capacity—replacing the old mandatory production and delivery targets. State orders still accounted for about 75 percent of total production in 1990, however, and 90 percent or more for some industrial branches. More significant has been the enterprises’ greater control over financial resources, created by a sharp decline in the profits remitted to the state budget and increased fungibility allowed for retained earnings. The resulting increase in enterprise liquidity more than offset the contraction of bank credit (Chapter II.2) and permitted, among other things, a rapid increase in wages and social expenditures.2
b. Nonstate forms of enterprise
Since 1988, the Soviet economy has seen the accelerating proliferation of new enterprise forms, including cooperatives, leasing arrangements, and newly defined small enterprises. Though not exactly private (see section 3), these enterprises operate with substantial independence from the state planning and allocation system, and managers have enjoyed greater freedom in production, pricing, wages, and employment decisions. By October 1990, there were approximately 215,000 cooperative enterprises, employing an estimated 5.2 million people, and accounting for some 5-10 percent of GDP, and for just under 2 percent of fixed productive capital.3 Some 39 percent of cooperative enterprises in 1990 were in the manufacturing and construction sectors and accounted for about 49 percent of total cooperative output. The most rapidly growing sector of cooperative activity in the course of 1990 was construction. In contrast, the number of cooperatives in trade, restaurants, and other consumer services declined significantly, possibly reflecting a deterioration in public attitudes and growing governmental restrictions (see below).
Many cooperatives have been formed out of whole plants or work units in existing state enterprises. They often operate on the basis of leasing arrangements within the parent state enterprise. Goskomstat reported that some 170,000 cooperatives were operating in this fashion (in all sectors) during the first half of 1990. Some 1,900 free-standing industrial enterprises were reportedly operating under leasing arrangements during the same period (a more than 10-fold increase since 1988), enjoying a growth of output of more than 4 percent over the previous year, compared to a decline of 0.6 percent for the industry as a whole.4
The Government’s attitude to the growth of the cooperative sector has been ambivalent. As noted, the cooperatives have enjoyed greater freedom than state enterprises and, at first, also benefitted from a lower rate of taxation. Some restrictions were placed on their fields of activity, however, beginning in late 1988,5 and taxes and the prices at which they could obtain inputs were sharply raised. Cooperatives are also more dependent than state enterprises on the “gray” markets for their inputs, and find access to sites and public services more difficult. Under the tax reform set to take effect on January 1, 1991, cooperatives were to be given equal tax treatment with state enterprises. Popular attitudes toward cooperatives (particularly those engaged in retail operations) are frequently negative. They are widely characterized as criminal, or at best antisocial, diverting supplies from the official marketing channels and taking advantage of scarcities to charge exorbitant prices and make large profits.
Finally, about 1.2 percent of the nation’s fixed productive assets are in the hands of private individuals. Individual ownership is still highly concentrated, however, in peasant agriculture. In the industrial sector, it is limited to small-scale artisan activities that require no employed labor. Although the decree on small businesses issued by the Supreme Soviet in mid-1990 appears to permit enterprise ownership by individuals, it is too early to know how it will be interpreted in practice.
3. THE COMMERCIALIZATION AND PRIVATIZATION OF ENTERPRISES
In a system of free markets and private ownership, neither the state nor anyone else bears a responsibility for protecting owners against losses resulting from their enterprise activities. To a considerable degree, therefore, the owners’ present and future welfare depend on the success of the enterprise. They thus have a direct personal interest in assuring that enterprise capital is used efficiently and is properly maintained, and that new capital acquisitions will similarly be directed to profitable uses. And they are further impelled by competitive pressures to stay up to date technologically, replacing machinery and restructuring plant and operations as needed to improve product quality and minimize production costs.
Ownership of the means of production in the USSR is formally vested in the people as a whole. In the name of the people, the state, through its various agencies and ministries at different governmental levels, has exercised the basic rights of enterprise ownership, making production and pricing decisions and determining how the capital stock would be used, maintained, and augmented. Nevertheless, fundamental aspects of ownership have been missing for those who have exercised these rights: especially, the ability to buy and sell enterprise assets and a related personal stake in the long-term value of those assets. Soviet planners have placed the principal emphasis on maximizing immediate physical production, with little concern for the waste of capital and other inputs this might entail. Competition has not been present to encourage innovation; indeed, the time needed to install new equipment and teach the new worker skills required by changing technology may often have been considered by managers to be too costly in terms of short-term production losses.
b. Government plans for privatization
The Soviet authorities have clearly identified the ownership problem as lying at the heart of the unsatisfactory performance of Soviet enterprises in terms of productive efficiency, product quality, and general technological backwardness. As a consequence, the presidential guidelines for economic reform call for the “denationalization and demonopolization of the economy and the development of enterprise and competition.” As commonly used, “denationalization” (sometimes translated as “destatization” or “commercialization”) means establishing an enterprise as a financially and managerially autonomous entity. As stated in the guidelines, “Not only are they autonomous in their activity, but they are also economically responsible for the results of this activity—in terms of both current income and their own property.”
For a large enterprise, as described in the guidelines, commercialization would typically be carried out first through converting the enterprise to a joint stock company while still under public ownership. As proposed, ownership would initially pass to state property funds, which would act as holding companies. Privatization through the sale of shares is seen as a subsequent step for most medium and large commercialized enterprises, but the need for commercialization would apply equally to those enterprises that are expected to remain in the public sector. Smaller enterprises, on the other hand, could be quickly privatized without going through the intermediate stage.
While details of commercialization programs are to be worked out by the union and republican governments in their respective areas of ownership—a discussion complicated by intergovernmental disputes over enterprise ownership—the guidelines propose that outright privatization begin immediately in such activities as trade, restaurants, consumer services, repair shops, construction, and small enterprises generally. The commercialization of large and medium-sized enterprises is also to begin right away. Eventually, it is expected that most of the production and service sectors of the economy will have been transferred to private ownership.
c. The process of spontaneous privatization
While plans and measures to implement these guidelines are being debated at all levels of government, the process of privatization has already effectively begun with the rapid proliferation described above of cooperative enterprises, leasing arrangements, and other devices by which ownership rights are being devolved to managers and workers of state enterprises. Although the legal basis for property rights in these new enterprise forms remains unclear (see Chapter IV.7), the trend seems unlikely to be reversed, and the challenge will be for those working to reform the legal/regulatory framework to catch up and normalize the process now in train.
Many enterprises have already been hived off from existing state enterprises precisely in order to gain the greater degree of managerial freedom that these new organizational forms make possible. There is some evidence, albeit anecdotal, that greater managerial freedom and responsibility has resulted in marked increases in the physical efficiency and quality of production in these enterprises.6
These positive observations must be tempered, however, in two important respects. First, so long as the price signals to which these enterprises are responding remain severely distorted, resources, even though being used more efficiently in physical terms, still may be guided to the wrong uses from the point of view of overall economic efficiency. Private entrepreneurs responding to wrong price signals do not necessarily ensure better results than central planners. Moreover, the dual price system now established for state and nonstate enterprises has led predictably to the diversion of inputs and retail merchandise from the state enterprises and stores to the cooperatives and other nonstate modes of operation, where they are sold at the higher uncontrolled prices.7 The apparent profitability of the new enterprises may thus derive, in part, from their ability to take advantage of administered price distortions rather than from superior economic performance.
Second, while many of the rights of ownership have been effectively conferred on the new enterprise managers, neither they nor those who employ them are able to derive any benefit, through sale, from the growth of enterprise value. Moreover, they still do not bear the risks of losses that would also attach to full private ownership. With the important exception of those cooperative enterprises that have been started with members’ own resources, many enterprises under the new modes of organization are starting with state-owned capital, for which they have paid little or nothing out of their own pockets, and which they have no right to sell. As a consequence, the managers of many of these enterprises appear focused on short-term gain, with relatively little attention being given to safeguarding and enhancing the long-term viability of the enterprise and the value of its assets. Indeed, their incentive may be to appropriate and decapitalize those assets.
The appropriation of enterprise assets is taking place already, in essentially two ways. The first is the outright transfer of assets from the state to one of the new modes noted above.8 The other occurs in cooperative units that remain within a larger state enterprise. Such cooperatives use state-owned equipment in their operations, for which the host enterprise typically charges a rent. Formally, the host enterprise provides inputs only for the output that it buys from the cooperative. In fact, however, the cooperative may be using the capital stock (and sometimes variable inputs, too) free of charge to produce for sale or barter in the market. The proceeds of these extra sales are then paid out to the managers and workers in higher wages and salaries.9
Even enterprises that are still formally state-owned are subject to this process. In some cases, for example, several state enterprises have been converted to joint stock ownership, and then they have jointly established a bank which has purchased the shares. Although the state remains the owner of all the enterprises in theory, it is unclear in practice who should or does supervise them. The practical result appears to be that power has been concentrated in the enterprise managers, who, at no cost to themselves, are able to use the enterprise assets to pursue their own economic goals, but who also have little or no incentive to protect and enhance the value of those assets.
In short, the spontaneous de facto privatization of enterprises has already begun, but no personal interest is being created in the maintenance and enhancement of enterprise assets. Moreover, the risks of ownership remain with the state. It is consequently urgent that a clear law of private property be put in place, providing owners with the right to buy and sell productive assets and guaranteeing them against arbitrary and uncompensated expropriation of their property rights and assets, while setting out in companion laws on contracts and bankruptcy the responsibilities and material risks that ownership in a market system also confers. Only in this way, along with thoroughgoing price reform, can successful transition to the market be completed and individual decisions disciplined to correspond to the broader public interest in efficient market-responsive decisions at the enterprise level.
There is also a political concern in the present process. In addition to the public’s general perception of cooperative activity as profiteering, many resent what they see as the privileged access of certain individuals to the ownership rights being conferred on the managers of the new enterprise forms. It is widely believed in the USSR that many of those acquiring economic power in the new enterprises, and in the process taking ownership of state assets, are members of the traditional Communist Party elite, the nomenklatura, who are exploiting their rank and insider information. Another line of popular belief is that many of the new entrepreneurs are essentially criminals, emerging from the underworld of black marketeers and speculators. This negative public image could generate a serious backlash and impede the transition to free markets. The process of privatization clearly needs to be normalized and made more transparent, with access open to all willing to risk their own resources in the process.
d. The pros and cons of rapid privatization10
The presidential guidelines advocate divestiture of the state’s ownership rights over the nation’s enterprises. They do not, however, set out a clear program or time frame for transforming enterprise ownership, and questions of speed and sequencing continue to be a matter of debate.
Early privatization, in particular, raises several problems. In the first place, it is difficult to estimate the value of enterprises, when relative prices are still unsettled, and their future prospects remain unclear. In any event, the value of the state’s productive assets far exceeds the savings available in the private sector to pay for them. Even in the case of small enterprises, provision will be needed for buyers to pay in installments. Commercialization and privatization in the industrial sector is complicated further by the large and frequently indivisible nature of the assets involved, the high degrees of market concentration, oversizing of plants, and uneconomic vertical integration of production. Two possible consequences of rapid privatization, therefore, are that assets would be acquired at far below their actual values, providing a windfall to buyers, and/or that asset ownership might become concentrated in the hands of the few individuals who have the money or political connections to acquire it.
While receipts from the sale of state assets could help to reduce the monetary overhang and provide important revenues to the government during a period when fiscal consolidation is crucial, rapid privatization of larger enterprises might require some giveaway of the assets concerned. The resulting widely scattered ownership of individual enterprises, moreover, would be unlikely to result in effective monitoring and control of enterprise managers. It is further argued that persons or entities receiving ownership rights over productive assets at low cost to themselves might feel less of a stake in assuring the efficient use of those assets. Finally, the privatization of enterprises prior to their internal restructuring and the restructuring of the industries in which they operate would confer undesirable monopoly power and profits on some parties, while running the danger of saddling others with hopeless loss-makers.
On the other hand, while rapid privatization of shares in the larger enterprises might reduce cash proceeds to the state, it would also permit a wider distribution of assets seen as belonging to all the people. The problem of enterprise control could be reduced by first transferring the ownership of enterprises to property funds or holding companies, whose shares would then be distributed to the public. This is not very different from what is suggested for commercialized, but non-privatized enterprises. The holding company, either directly or through a board of directors, would exercise ownership control over its enterprises. Moreover, the stake which most new asset owners would see in the future income streams and sales value of the assets could be more important than the purchase price of the assets in providing appropriate incentives. At the same time, the greater the share of the savings that new owners transferred to the government in exchange for the assets, the less they would have available to make the needed investments in enterprise restructuring and modernization, something they are likely to do more efficiently than the government.
The case for more gradual commercialization assumes that the performance of the state enterprises can be improved, or even maintained at their present levels, during the course of a slower transition. Given that poor enterprise performance has, to a considerable extent, been the result of undefined ownership, it is doubtful that such an assumption would hold. Until and unless interest in the efficient use and value of capital becomes imbedded in enterprise decision-making, the nation’s capital stock will continue to be wasted and dissipated. By the same token, clear ownership and property rights must accompany rational prices to achieve the desired demonopolization and efficient restructuring of industry. It is argued below that enterprise managers, acting in response to market signals, can do a major part of the job of demonopolization more efficiently than would be done by officials in ministries. However, enterprise ownership must already have passed to persons or organizations that have stakes in the use of its assets. The rapid “spontaneous privatization” process that is already under way also points up the need for a quick regularization and completion of ownership reform.
The proposed middle stage of commercialization of state enterprises under the aegis of state property funds should offer a distinct improvement over the present ministerial control of enterprises. Efforts in other countries to place state enterprises under a hard budget constraint and to subject them to market discipline, however, have not always worked out well in practice. It has been found to be very difficult to insulate state enterprise management from political pressures and the noneconomic objectives of governments. Thus, it is recommended that the authorities consider an even more rapid privatization process than the various reform programs and the presidential guidelines have proposed.
e. The manner and terms of privatization
A mixed approach to privatization is recommended, which may vary by type of activity and size of enterprise, as well as according to the preferences of the different republics. Specifically, it is suggested that small enterprises be privatized rapidly through outright sale to individuals, cooperatives, or other bodies willing and able to acquire them and to accept the risks of entrepreneurial activity. The privatization of larger enterprises will necessarily take longer and could proceed along essentially two paths: (i) the direct sale or leasing of divisible product lines, stages of production, or service activities to individuals, cooperatives, etc.; and (ii) conversion into joint stock companies under the initial ownership of state property funds created for the purpose, with privatization proceeding through the market sale of shares to individuals, nonbank financial institutions, and other enterprises and organizations, either directly or through mutual funds. The sale of shares to banks should not, however, be encouraged both because equity investments, except in strictly limited amounts, represent greater risk than banks ought normally to take on, and because of the inherent conflict of interest that could lead banks to lend excessively to enterprises in which they hold an ownership interest.
(1) Direct sale
In the service sectors, the Government’s proposal to sell assets through open and well publicized auctions is commendable and should proceed as quickly as possible. The idea that buyers should be allowed to make payment in installments to permit both rapid sale and a wide and equitable distribution of the assets is equally sensible. Particularly important will be the privatization of transportation, storage, and distribution services, where assets—e.g., trucks, warehouses, retail shops—are easily sold off one by one, and where the existing commercial monopolies can therefore be rapidly broken up. Sales proceeds would go to the Government and could be used to pay off any debts of the enterprises whose assets were sold, and to recapitalize the banks.
With respect to larger enterprises having multiple product lines, or whose production processes are divisible, the process of sale or leasing of discrete parts of enterprises that is already taking place should be further encouraged. The sellers or lessors could be either the newly formed joint stock companies or, in advance of the completion of conversion, existing state enterprises. Sale would be by open and well publicized auctions and would require a significant equity downpayment by the new owners, equivalent, say, to 15 percent or more of the purchase price, allowing them to finance the remainder with interest at normal terms.
Monthly lease payments could also be established by auction or, alternatively, made equal to an estimated straight-line depreciation of the value of the assets, plus a negotiated return to the lessor, and the life of a lease would be based on the expected life of the covered assets. While leases were in effect, the original assets would be held as collateral by the lessor. No new state or lessor investment would be made in the leased enterprise; any replacement or new investment would be the responsibility of, and would be owned by, the lessees, who would also be responsible for arranging its financing without state subsidy or guarantee.
Lessees would be free to organize their enterprise as they see fit—joint stock company, cooperative, individual proprietorship, etc.—and to alter their product lines and methods of production. It should also be possible for lessees to sell lease contracts to other individuals or organizations, subject to antimonopoly laws and regulations. Otherwise, lease holders would lose their interest in protecting the value of the leased assets. At the end of a lease contract, if structured as suggested above, the value of the original assets would have been entirely depreciated, and any new assets would be fully owned by the lessee. Enterprises that became unprofitable, either during or after the life of the lease, whether because of mismanagement or changing market conditions, would be allowed to fail.
To ensure against arbitrary and opportunistic behavior in the valuation of assets, it might be desirable to establish a review procedure for sales and leasing contracts, vested in an independent government agency answerable to the union or republican parliaments. To avoid undue delays in the privatization process, as has occurred in other countries undergoing similar reforms, the review should be limited to questionable cases. These could be brought to light by a requirement that all such arrangements be publicized in the newspapers, identifying the sellers and buyers, or lessors and lessees, the assets covered by the contracts, and the terms of the sale or lease.
Large enterprises with indivisible production processes, or otherwise not amenable to leasing, would operate as joint stock companies. Shares might be distributed and held in two ways. A large (but less than controlling) proportion of enterprise shares could be distributed free of charge (or at very low cost) to all Soviet citizens (or citizens within the jurisdictions of the governmental levels determined to hold ownership rights over the respective enterprises).11 To assure equity, given the great uncertainty about share values at the beginning of the reform process, the distribution could take place either as shares in an asset pool—in effect, a mutual fund—or as vouchers entitling the holder to later purchase of shares in the stock market. Such a distribution could serve to widen both the sense of individual participation in the reform and the ownership interest in improved enterprise performance.
A controlling interest in these shares of the large state enterprises would need to be held initially by state holding companies (state property funds) that were independent of the line agencies or regulatory authorities of government and charged with supervising the entities under their control as commercial, market-oriented enterprises, and with husbanding the long-term value of their assets. Prior to the development of an active equities market, such concentration of control would continue to be necessary to ensure that managers respond to owners’ interests.
Enterprises should be accorded no preferential treatment from the state by virtue of their public ownership. Moreover, to encourage competition, enterprises producing the same goods or close substitutes should not be owned by the same holding company. Dividends on shares held by the holding companies would flow to the state budget. To avoid owner/agent conflict of interest prior to the privatization of share ownership and the creation of an efficient equities market, dividend payments could be specified in advance as a fixed percentage of after-tax profits.
Over time, as financial savings and markets grow, state property funds would sell their shares to individual and institutional investors, including mutual funds, pension funds and insurance companies. Some shares could be transferred to national or republican pension funds to provide them with an initial capital base. Alternatively, or in addition to selling off holdings one by one, holding companies could, in effect, convert themselves into mutual funds, selling shares in their respective portfolios. An intention to do this should be written into their charters, including a statement of intentions regarding the period over which the assets would be sold or the holding company itself would be privatized.
Another option, attractive for its absorption of part of the monetary overhang, might be the advance purchase of shares in the form of indexed government bonds, the proceeds of which could be used after 2-3 years to buy the shares of enterprises and/or mutual funds (Chapter II.3).
(4) Other issues
The presidential guidelines propose that priority in the buying of property and shares be given to labor collectives, and that their members be accorded various forms of financial assistance to help them become owners. The experience of labor-managed enterprises in other countries, however, has been disappointing. Workers in control of enterprises have tended to concentrate on the maximization of their own incomes with a relatively short-term time horizon, limiting the employment of new workers and decapitalizing the assets of the enterprise over time. It is recommended, therefore, that substantially less than a controlling ownership be distributed on a preferential basis to an enterprise’s own workers, and that the shares be distributed to workers on an individual, rather than collective, basis. Workers would thus enjoy the same ownership rights as other shareholders, including the right to sell their shares (as well as to acquire new shares) in the market.
Another issue concerns the treatment of the debts of existing enterprises. Should these be assumed by the new owners? As a general principle, debts in excess of a firm’s assets should be written down and not passed on as a burden to the new owners.12 In the case of leased assets, the debt liability would remain (along with asset ownership) with the lessor, but the related debt service would be included in the lease payment.
f. Imposing a hard budget constraint
Enterprises, whatever their ownership, only respond to market signals and to the pressures of competition if the owners and managers are truly held responsible for the financial results of their decisions. Market discipline is obviously undercut when there is a “soft budget constraint”, i.e., when losses are covered by transfers from other enterprises, the state budget, or automatic credits from the financial system. The imposition of a “hard budget constraint” means making enterprises financially independent of these sources of assured financing. Financial autonomy needs, of course, to be accompanied by managerial autonomy that permits enterprises to adjust to changing constraints and opportunities, i.e., to adjust prices, outputs, employment and other inputs in response to the signals given by the market. The importance of a hard budget constraint, in turn, highlights the urgency of rapidly eliminating existing price distortions. Otherwise, it could have the undesirable result of making many relatively efficient enterprises financially inviable, while encouraging the expansion of enterprises made profitable only by virtue of the distorted prices.
The Government’s intention, as outlined in the presidential guidelines and agreed in all the major reform proposals—to put a halt to budget subsidies to enterprises, to force the restructuring of enterprises that can thereby be made financially viable, and to liquidate chronic loss-makers—is commendable. Consistent with this objective and equally worthy of support is the intended reform of the financial system, which is also to be put on a self-sustaining, commercial basis (see Chapter IV.5). Of concern in this regard, however, is the current tendency of branch ministries and groups of enterprises to establish commercial and cooperative banks. If these are used as vehicles for relaxing the hard budget constraint on loss-making enterprises, it will jeopardize both enterprise reform and the soundness of the banking system.
The guidelines correctly state that time will be required by many enterprises to adjust to the new economic conditions, and it is proposed to create union and republican stabilization funds, with independent administrations, to provide financial support of different kinds to properly evaluated and justified restructuring efforts. Such assistance can help avoid unnecessary declines in employment and output, but there is also a risk that such special financing arrangements could channel resources to noneconomic and nonviable uses and become a substitute for, rather than a complement to, the needed restructuring. Consequently, these funds should be allocated according to rigorous economic criteria. Moreover, as the stabilization funds are to be financed from budgetary resources, macro-economic stabilization objectives will limit the resources available for restructuring programs. As indicated in the guidelines, foreign investors can play an important role in the restructuring of Soviet enterprises. They would only be willing to do so, however, under a regime of clear ownership rights, and would do so efficiently only in a context of rational prices. This is yet an additional reason why substantial price reform and commercialization should be among the first steps of the reform process.
Finally, it is important that the imposition of hard budget constraints on enterprises be accompanied by the elimination of existing differentials in the tax treatment of enterprises in accordance with their size, branch, mode of organization, or other factors. Competition in a market system should take place on as level a “playing field” as possible.
The existing system of enterprise accounting will need to be revised to meet the requirements of a market economy. The publication of financial accounts, incorporating a proper valuation of assets and liabilities, should begin at an early stage in the transition. These should be audited (externally as well as internally) and should aim to present a full and fair view of the financial position of an enterprise or bank, for the information of shareholders, creditors and those entrusted with supervisory authority. Such accounts would also provide some of the information necessary to allow managers to evaluate performance and take key decisions, for instance on investment. The necessary changes to the present accounting regulations would be relatively straightforward. Western technical assistance could, however, be of use here as well as in the training of accountants and auditors to implement the new system.
4. INDUSTRIAL RESTRUCTURING AND DEMONOPOLIZATION
As noted earlier, production in most branches of Soviet industry is highly concentrated, with a large number of important products being produced by a single factory, and the production of other goods produced under cartel arrangements centered in the industrial branch ministries. While convenient for central planning purposes, this tendency to huge scale and extreme concentration is intolerable in a market economy. Thus, the emphasis given by the guidelines and other reform plans to the demonopolization of Soviet industry, as a prerequisite to efficient market operations, is fully warranted.
To ensure that enterprise owners and managers are motivated to reduce costs, raise quality, and satisfy the needs of their customers, their freedom in a market economy to make production decisions must be matched by buyers’ freedom to choose among competing products and producers. The possibility of enterprise failure, if customers are not satisfied, places a firmer discipline on enterprise performance than the administrative commands of planners. Currently, however, the development of competition in the USSR is hampered by a myriad of laws and regulations that prevent the entry of new enterprises into the market, branch ministries that act to cartelize the enterprises under their authority, credit and input allocation systems that favor existing state enterprises, and by poor communications and transportation as well as by administrative trade barriers being set up between regions. If the transition to a market economy is to succeed, these barriers to competition must be dismantled, and the Government must act vigorously to encourage trade rather than to thwart it.
a. Introduction and maintenance of competitive markets
Governments in market economies have an important responsibility for promoting and protecting competitive market conditions, and the Soviet authorities should act quickly to introduce an effective framework of antimonopoly laws and regulations along with the institutions to enforce them. Given the high degree of concentration and vertical integration of Soviet industry, the behavior of dominant enterprises must be strictly regulated to prevent them from impeding the emergence and growth of competing firms. Effective powers must be provided to the anti-monopoly agency to restructure the dominant firms where feasible. The agency’s powers in this regard must apply to both private and state enterprises.
Where competition already exists, the legal and regulatory framework should ensure the freedom of new enterprises to enter an industry, prevent collusion among enterprises, and discourage predatory behavior that might lead to the monopolization of an industry (see Chapter IV.7). Artificial barriers to entry, such as so-called profile restrictions, should be abolished to permit existing firms to seek out new opportunities wherever they may exist. The control of ministries over enterprise activity should be eliminated. In this regard, the current tendency, encouraged by some branch ministries and local governments, for enterprises to join in large associations and conglomerate “concerns,” is a step in the wrong direction. There is a very delicate balance to be maintained between the legitimate freedom of association to formulate and defend group interests and the cartelization and exertion of economic power to the detriment of competition and the public. Interregional trade barriers, such as have recently been imposed by some republican and local governments, must also be avoided; and the various enterprise forms should be put on an equal footing in all aspects of government regulation, taxation, and access to public services.
The investigative and enforcement powers of the antimonopoly agency, as expressed in the existing draft legislation, need to be substantially strengthened. To this end, the possibility of substantial fines and criminal penalties should be added for both failure to cooperate with investigations and substantive violations. Given the complex economic analysis required to identify many practices as anticompetitive, it is advisable that a specialized competition tribunal be established to hear private actions or appeals from agency decisions, rather than the normal court or arbitrazh systems (see Chapter IV.7).
One major barrier to the entry of new industrial enterprises is the highly monopolized state supply system. As indicated above, the breakup and privatization of wholesale trade should be among the first priorities of economic reform. The establishment of a market for lease rights, permitting their ready purchase and sale between private parties, would also greatly facilitate freedom of entry and exit. The continuing desire of many local governments to maintain control over property leases runs counter to this requirement.13 Finally, a bankruptcy law is needed to provide for orderly restructuring or liquidation of failing enterprises in a way that provides transparent and reliable protection of the interests of owners and creditors.
b. Industrial restructuring
Some Soviet industries—such as steel and petrochemicals—appear significantly oversized, and the demand for their output at appropriate relative prices is likely to be far below present capacities (perhaps by as much as 50 percent). Such situations, on top of inefficient organization and backward and highly capital-intensive technologies, present special problems for privatization. In these cases, a more managed approach may be required, in which plans.are formulated for the overall restructuring and modernization of the industry—including the elimination of excess capacity, phasing of import liberalization, writing-off of assets and the retraining of workers—prior to the commercialization and privatization of the surviving assets.
In the course of reform efforts over the past several years, the Soviet authorities have expressed growing concern about the composition of industrial output, noting particularly the historical emphasis on heavy industry at the expense of consumer goods, and adopting the more recent objective of converting defense industries to non-military uses. Enterprises in the defense complex have been increasingly pushed through administrative measures into the production of consumer goods, usually alongside their normal operations, even though the two manufacturing processes may bear little relation to one another and offer no economies in the use of plant and equipment. It is virtually impossible to judge, however, what underlying comparative advantages the Soviet economy might enjoy in the industrial sector until domestic prices have been freed and a beginning is made to integrate it into the world economy.
c. Market forces for demonopolization and restructuring
Various state interventions notwithstanding, most industrial restructuring and demonopolization could occur in large measure as an outcome of the market process itself, rather than as an administered prerequisite to the introduction of market forces or the reform of ownership. Enterprise owners disciplined by market forces are generally in the best position to determine which lines of activity to shed and which to expand. The market itself can thus provide the pressures to eliminate inefficient vertical integration of production. It can also guide the expansion of consumer goods production, including, where efficient, the conversion of defense-related enterprises.
The removal of quantitative restrictions on imports, coupled with reasonable tariff levels, would put an effective ceiling on the ability of domestic enterprises, even where there is only one, to raise prices on tradable goods. This ceiling would be lowered as tariffs were reduced over time (see Chapter IV.3). Nevertheless, enterprises enjoying monopoly power could, as prices are freed, and to the limits set by import competition, be expected to exploit that power by raising their prices. Moreover, the pricing of nontradeable goods would not, by definition, be limited by competition from abroad. There would thus be a period in which monopolistic enterprises succeeded in garnering abnormally high profits. But it is precisely those higher profits which, in a market economy, would attract new entrants and provide the desired competition. Thus, in activities where new entry becomes relatively easy, demonopolization could be expected to take place over time as a result of market forces. In contrast, price controls and taxation of “excess profits” would discourage market entry. Consequently, by seeking to limit the benefits to the monopolist, such an approach might serve to perpetuate the monopoly.14
On the other hand, it must be acknowledged that, with the predominance of monopoly or oligopoly on both sides of most Soviet markets, and the absence of a commercial tradition, the lag in market response to opening opportunities might be considerably slower than in established market economies. Foreign investment could help in this respect.
5. THE MANAGEMENT OF STATE-OWNED ENTERPRISES
The establishment of financial discipline through imposition of a hard budget constraint is an essential first step in improving the management of state enterprises. At the same time, a central factor in the poor performance of Soviet state enterprises has been the absence of any stake, on the part of those making the fundamental decisions regarding the enterprises’ activities and policies, in the efficient use and future value of their capital assets. Once enterprises are converted into joint stock companies, the authorities will still have to face the question of how the need to represent the interests of owners in the assets of the enterprise is to be instilled into the public holders of enterprise shares and the enterprise managers that they employ.
The state property funds set up to hold and manage state shares in the enterprises not yet fully privatized must be charged with representing owner interests. The Government should clearly declare in this regard that the basic objective of these holding companies is to promote the current and long-term profitability of the enterprises under their control, subject to the discipline of competitive markets. The holding companies should not be able to cross-subsidize some enterprises with the profits of others or otherwise relax the hard budget constraints on any enterprises. Nor should they have the ability to prevent the entry or exit of enterprises, or to tilt public policies and the enforcement of regulations to give their enterprises a competitive advantage over others. While the management of the holding companies would make clear that the primary objectives of their enterprises were to maximize productive efficiency and profitability, consistent with protecting the value of enterprise assets, and would monitor and assess enterprise performance in this regard, they should not interfere in their daily management.15 In the interest of limiting owner losses, the holding companies would also see to the restructuring of enterprises, where this was desirable, the liquidation of chronic loss-makers in their portfolios and to the auctioning of remaining assets.
Given the complexity of supervising the activities of large numbers of enterprises in different sectors, it would be expected that the holding companies would exert their ownership rights through boards of directors. Board members would be appointed and held responsible for their performance by the holding companies. The composition of the boards should include technical experts in the fields of the enterprise’s activity as well as legal and financial experts. The boards would be directly responsible for setting enterprise policies, monitoring performance, and hiring, evaluating, rewarding, and, as necessary, dismissing enterprise managers. Enterprise managers, operating under the policies set by their respective boards of directors, would have full responsibility for the management of the enterprise, including the power to determine the organization of production; to set the offer price, quantity, and composition of output; to hire, reward, and dismiss workers; and to manage the enterprise’s finances.
Implicit in this reorganization of enterprise ownership, control, and management is a dramatic change in the roles and responsibilities of the existing branch ministries. Indeed, it is expected that most of these ministries would disappear, as some already have. One possibility would be to consolidate them into a single Ministry of Industry, whose functions would include the formulation and monitoring of the government’s overall industrial policies and study of sectoral policy issues. It would not become involved, however, in the control or management of enterprises.
6. THE TRAINING OF ENTERPRISE MANAGERS
The shortage of trained and experienced managers is likely to be one of the most serious bottlenecks to rapid improvement in enterprise performance. Many higher-level enterprise personnel are production engineers and technicians, who tend to be more familiar with production processes and design than with their enterprise’s finances or the needs of its customers. Financial directors of state enterprises typically know the details of enterprise balance sheets but little of the performance analysis and cash and risk management techniques required of managers of market-based enterprises. Individual managers vary widely in their willingness to take initiative in the uncertain and rapidly evolving Soviet environment, partly, it seems, depending on the signals being received from their respective ministries.
A large number of training programs of varying quality have sprung up in recent years in the USSR, ranging from short courses on how to attract joint venture partners to full management curricula, including marketing, advertising, cost control, quality control, and other elements of management long removed from the principal concerns of Soviet enterprise managers. Some of these programs are being carried out in collaboration with foreign educational institutions. Such contacts should be encouraged and expanded. Thus far, however, these programs appear to be aimed primarily at top managers—chief executive officers and their closest deputies. Enormous needs at the middle and lower managerial ranks remain largely untreated. Most of this training will have to be provided, as in Western enterprises, within the enterprise itself. Training and orientation to their new roles will also be needed by the many individuals who will be expected to sit on enterprise boards of directors.
Management training obviously offers one useful focus of external assistance. Programs now under way in several East European countries might offer useful examples of how to attract and achieve maximum benefits from such assistance. The authorities might also consider, on a pilot basis, the use of fixed-term management contracts, under which experienced foreign managers (perhaps retired from Western firms) could be brought in to reorient the operations of selected enterprises and to train their successors.
Thus, wages and salaries rose an estimated 12 percent in 1990, despite falling industrial output.
This compares to under 14,000 cooperative enterprises, employing 156,000 workers in 1987. Of the 5.2 million persons employed by cooperatives in 1990, approximately 65 percent were cooperative members, and the remaining 35 percent were hired employees.
It is not clear whether this difference is real or simply a statistical result of the reclassification of economic entities. Other sources report that some 12,500 leasing arrangements have thus far been officially registered.
For example, cooperatives were prohibited from wholesale trade, natural resource exploitation, and the sale of medical supplies and works of art.
One example, a manufacturer of gears and reducers, was converted to operation under a leasing arrangement in order to avoid closure because of the poor quality of its output. The firm was also making substantial financial losses at the time of its conversion. Under the new arrangement, the labor force continued at the same level, but the number of managers was cut by 25 percent. The firm achieved a 50 percent improvement in productivity (in physical terms) during the first year. While output prices remained the same, the enterprise succeeded in negotiating lower prices from suppliers. Now profitable, the enterprise has sold off some of its older equipment, raised wages, and is investing in new equipment. According to present plans, by the end of the lease period (12 years), the firm will have re-equipped its entire plant. The managers intend eventually to convert the firm into a joint stock enterprise and to privatize it formally.
Under present regulations, cooperatives and other enterprises outside the state supply system are supposed to pay market prices for their inputs too, but it is widely reported that illegal diversion frequently takes place. With prices in the market often several multiples of state-controlled prices, such diversions are inevitable.
In one case, an enterprise was allowed to lease the assets of the enterprise and, through equity investments and technical assistance, build an association of enterprises, many of which resulted from other leasing arrangements or employee buyouts of state enterprises and their conversion to cooperative form. The central holding company derives a substantial income flow from these enterprises. As of August 1990, the association encompassed numerous enterprises of various forms in activities as diverse as banking, construction machinery, transport, tourism, and publishing. The terms on which the associated enterprises had acquired their assets from the state were unclear; they apparently brought no outstanding debt with them. Also unclear was the legal status of the original mother enterprise and the residual claim, if any, of the state on its assets.
One enterprise, formerly producing consumer goods as a small unit in a larger state enterprise, was converted into a cooperative, using space and equipment leased from the parent company. Based on its success, the entire plant is now being divided up into a family of cooperatives and small enterprises with only an association at headquarters continuing to function formally as a state enterprise. In this way, the individual production units are able to escape from wage controls and other bureaucratic interventions, while the association as a whole retains its access to the state supply system and to long-term credit.
Free distribution is consistent with the proposition that state enterprise assets are owned by all the people, on behalf of which the government acts as agent. A small proportion of each enterprise’s shares could be distributed preferentially to workers in the enterprise.
Implications of this debt write down for the financial sector are discussed in Chapter IV.5. As suggested above, part of the proceeds of the sale of government assets could be used to recapitalize the banking system. To stretch out the impact on the state budget, the government could take over the service of part of the enterprise debt (at the new, higher level of interest rates) rather than writing it off.
Governments do have a responsibility to regulate the location and nature of industrial activities for a variety of public purposes, such as preservation of the environment and avoidance of public health hazards. Thus, all market economies impose zoning restrictions, health regulations, etc. Where possible, however, these are best done through general laws and regulations with penalties on offenders, rather than through the detailed ex ante review of all proposals, giving arbitrary authority to government agencies to delay and stop property transfers.
High profitability may also be the initial result of and reward for introducing a new product or method of production. The proposed tax on monopoly profits, if it wrongly identifies the sources of unusual profits, could thus weaken the incentive for innovation.
As indicated in the presidential guidelines, the social responsibilities of enterprises would be progressively shifted to the Government at its various levels. To the extent that state enterprises continue to be charged with the execution of social programs, these should be paid for from the government budget rather than the after-tax profits of the enterprises.