Journal Issue

Former Yugoslav Republic of Macedonia: Enterprise profits hinge on private ownership and hard budget constraints

International Monetary Fund. External Relations Dept.
Published Date:
November 2003
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Before the iron curtain fell, most firms in Central and Eastern Europe and the Soviet Union either were owned by the state or were socially owned. Their behavior was driven by political and social considerations, such as achieving employment targets, rather than by profit-maximizing considerations. Changing the structure of incentives in which enterprises operate is a necessary condition for the successful transition to a market economy. This article, based on a Working Paper by Juan Zalduendo, Senior Economist in the IMF’s Policy Development and Review Department, examines the performance of firms in the former Yugoslav Republic (FYR) of Macedonia, comparing the performance of firms created following privatization (new firms) with that of firms that predated the transition (surviving or old firms).

When FYR Macedonia achieved independence in 1991, its enterprise sector was dominated by socially owned enterprises in which employees as a group were involved in all investment and employment decisions but individually had no ownership rights. Such firms accounted for about 85 percent of employment in that sector.

The prevalence of social (as opposed to state) ownership slowed the process of privatization, and, once privatization picked up in the mid-1990s, it allowed insiders to buy firms on generous payment terms. In the end, only 20 percent of firms were sold to strategic investors. Insider privatization often led to weak corporate governance, so that firms did not operate to maximize their value and failed to mobilize the resources, know-how, and trade links needed to modernize and expand production.

Despite the weaknesses of insider privatization, aggregate profitability indicators have improved since 1997, although they continue to lag behind those in other transition economies. Zalduendo attributes this improvement to success in dealing with large loss-makers; the closure of older, inefficient firms; and the entry of new, more dynamic ones—a process that market economies rely on to weed out poor performers and foster more efficient resource allocation. The evidence suggests, he says, that this entry and exit process has taken hold in FYR Macedonia: two-thirds of the firms that existed in 2000 started up after 1994, and about 60 percent of the firms in existence in 1994 had closed by the end of 2000.

But the performance of surviving firms remained below par (see table, this page). Their operating profits were lower than those of new firms, and labor productivity remained weak despite cuts in the workforce. This weak performance persisted despite progress in exposing firms to competition through market-based economic institutions. FYR Macedonia has low tariffs, few trade restrictions, and a market-based price system in which administered prices prevail in only a handful of sectors—features that normally compel firms to increase their efficiency.

Essentials of restructuring

Why was the performance of surviving firms unsatisfactory? Zalduendo examines how ownership structure, hard budget constraints, and market-based economic institutions affected enterprise restructuring in a representative sample of 823 surviving manufacturing firms that operated between 1994 (the year that preceded the acceleration of privatization) and 2000 (the last year for which enterprise level data are available).

Ownership structure emerged as an important determinant of improved profitability. Surviving firms that, by 2000, were privately owned maintained stable levels of operating profits throughout the 1990s, while socially owned and state-owned firms exhibited a decline in both profits and labor productivity during the same period. Firms with mixed ownership structures—privatized firms in which the state retained residual shares or held an ownership claim until full payment of sold shares had been completed—saw improved profitability after 1997, but their performance remained weak (see table, this page).

Although direct support to firms from the government budget declined during the 1990s, Zalduendo finds that budget constraints remained soft because the government tolerated arrears in wages, taxes, and social contributions. These arrears rose from 3 percent of GDP in 1994 to 4 percent of GDP in 1997 before declining in the late 1990s. The evidence shows that firms’ financial discipline improved when their budget constraints were hardened. FYR Macedonia has made progress on other fronts that affect budget constraints. Specifically, a new bankruptcy law was enacted in 2000, and private banks play an increasingly important role in the banking sector. The changes in the legal framework, if enforced and accompanied by improvements in bank lending practices, should compel poorly performing firms to tighten financial discipline.

The road ahead

Zalduendo’s conclusions are consistent with the literature on transition economies: private ownership, hard budget constraints, and market-based economic institutions improve enterprise performance. These findings make it clear that FYR Macedonia has much to gain from completing the transfer to private hands of the firms that remain under social ownership. In addition, the government should avoid softening budget constraints and continue to improve the functioning of market-based institutions. In this regard, nonforbearance of arrears and improvements in bank lending practices are needed. In particular, if the large number of surviving firms still under mixed ownership are to improve their performance, the authorities must fully enforce the new bankruptcy proceedings and consider mechanisms to harden the budget constraints that these enterprises face.

Copies of IMF Working Paper No. 03/136, “Enterprise Restructuring and Transition: Evidence from the Former Yugoslav Republic of Macedonia,” by Juan Zalduendo, are available for $15 from IMF Publication Services. The full text of the paper is also available online at

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