Privatization appears to have swept the field and won the day.1 More than 100 countries on every continent have privatized some or most of their state-owned companies in every sector of infrastructure, manufacturing, and services. An estimated 75,000 medium and large firms worldwide, including many in Central and Eastern Europe (CEE) and in the Baltics, Russia, and other countries of the former Soviet Union (BRO), have been divested, along with hundreds of thousands of small business units. Proceeds generated from these efforts are estimated at more than $735 billion (Privatisation International, 1998).2 Every country (including Cambodia, China, India, Laos, Russia, and Vietnam) that still retains a significant number of publicly owned firms is privatizing some or most of its firms (except Cuba and the Democratic People’s Republic of Korea).

Privatization Wins the Day

Privatization appears to have swept the field and won the day.1 More than 100 countries on every continent have privatized some or most of their state-owned companies in every sector of infrastructure, manufacturing, and services. An estimated 75,000 medium and large firms worldwide, including many in Central and Eastern Europe (CEE) and in the Baltics, Russia, and other countries of the former Soviet Union (BRO), have been divested, along with hundreds of thousands of small business units. Proceeds generated from these efforts are estimated at more than $735 billion (Privatisation International, 1998).2 Every country (including Cambodia, China, India, Laos, Russia, and Vietnam) that still retains a significant number of publicly owned firms is privatizing some or most of its firms (except Cuba and the Democratic People’s Republic of Korea).

One telling measure of privatization’s success is that the process has not been reversed: To date, only a small number of privatized firms have been renationalized, and where this happened (for example, in Chile and the Czech Republic a state-owned or state-dominated bank converted bad debt to equity), the instrument has usually been indirect and the period of renewed state ownership temporary.

What have been the operational results of this massive shift of ownership? Megginson and Netter (1998), in summing up their recent extensive survey of the empirical record on the financial and operating results of privatization efforts worldwide, state:

The evidence is now conclusive that privately-owned firms outperform SOEs [state-owned enterprises] … empirical evidence clearly shows that privatization significantly (often dramatically) improves the operating and financial performance of divested firms. (From the Abstract)

Much of the positive privatization experience reviewed in Megginson and Netter is drawn from Organization for Economic Cooperation and Development (OECD) countries. Although privatization started in industrialized market economies, it spread widely, and recent assessments of the results in non-OECD settings are also generally positive. For example, Boubakri and Cosset (1998) review the before- and -after performances of 79 privatized firms in 21 developing countries—mostly middle income, but including Bangladesh, Jamaica, Nigeria, Pakistan, and the Philippines. They conclude that on average the firms in their sample significantly increased their profitability, operating efficiency, capital investment spending, output, and employment and showed a decline in leverage and an increase in dividends. Havrylyshyn and McGettigan (2000), in their survey of the literature on privatization in the transition economies of CEE and former Soviet Union, found that private owners generally outperformed state-owned firms.

The multicountry surveys are supported by the positive findings of a growing number of country case studies. For example, a review by Kattab (1998) of the postprivatization performance of 28 divested firms in Egypt reveals increased sales (71 percent of the sample), increased earnings (68 percent), increased average salary per worker (96 percent), and a decline in both short- and long-term debt (82 percent).3 A 1997 study by La Porta and Lopez-de-Silanes4 of 218 cases of privatization in Mexico found, on average, a 24 percentage point increase in the ratio of operating income to sales. The study documents increases in profitability and output and substantial declines in unit costs and employment levels (although the blue-collar workers who retained their jobs received large salary increases). Seven of the 10 large loss-making manufacturing firms privatized in Bangladesh returned to profitability, showing increases in output, sales, capacity utilization and labor productivity, and declining unit costs (Dowlah, 1996). Much more along these lines could be presented. The fact is that almost every rigorous study comparing pre- and postprivatization operation indicates, on average, sizable performance improvement.5

Or Does It?

And yet, despite the ubiquity of divestiture,6 despite the assessment by investment bankers that privatization’s success has been indisputable,7 and despite the large and growing evidence from a variety of settings showing that privatization tends to improve firm-level performance, doubts remain and are growing. Indeed, suspicions and concerns about privatization, driven under by the liberalizing pressures of the 1980s and early 1990s, are resurfacing to a point of revisionism. These doubts are reflected

  • in the concerns of observers dissatisfied with the analytical rigor of the theory and the empirical studies supporting privatization;

  • in the arguments of opponents of privatization, who believe that privatization is not the right social solution, at least not for all firms or in all economies;

  • by fears that although privatization, even if beneficial for shareholders and the selling state, has not proven beneficial for society as a whole, or at least for significant groups of the poor and powerless actors in society; and

  • by the concerns of many whose previous acceptance of divestiture has been shaken by recent events in Russia and some of the other transition economies.

This study reviews the accomplishments and shortcomings of privatization in transition economies—where the scope and pace of privatization have been larger than elsewhere and expectations great, and where significant problems have surfaced. The study looks into where performance in transition economies has been unsatisfactory and why and discusses what governments, and those who assist them, should do about turning this experience around. The study’s principal findings are as follows:

  • Privatization generally proved its worth in the CEE and Baltic states.

  • However, too much was expected and promised of privatization in institutionally weak transition economies, particularly in countries of the former Soviet Union.

  • For seemingly excellent reasons, the emphasis was usually on massive, speedy transactions with substantial ownership stakes awarded to “insider” stakeholders. The reasoning was that the links between the enterprises and the state needed to be cut quickly to create a mass of private property owners, and the only way to do this was by offering substantial ownership stakes to workers and managers in the firms being privatized. If these powerful insiders were not rewarded, and quickly, they would block indefinitely the privatization—and transition—process.

  • In the transition states closest to Western markets, there is some evidence that this approach has been successful.

  • But the farther east the country, the more evident is the neglect of the supporting institutional frameworks required to promote financial discipline, competition, and freedom (and promotion) of entry of new businesses.

  • And in those instances, the speedy, massive, insider-oriented forms of privatization have generally failed to lead to the restructuring needed to enable firms to survive and thrive in competitive market operations.

Despite the severity of this indictment, there is little reason to think that had these firms remained in public ownership, their restructuring performance would have been better. The fact is that states that botch privatization also botch public ownership of enterprises. Overall, privatization has delivered remarkably well in many settings, especially when contrasted to a realistic set of alternatives instead of some theoretical ideal.

Thus, although this study agrees that the methods of privatization have to be altered and improved, and that much more attention needs to be paid to supporting institutions, it argues against renationalization or a search for other ways to make state ownership efficient and effective. The key unanswered question is how to go about correcting and improving privatization in institutionally weak settings.

Privatization and Its Detractors

Privatization’s detractors base their views on several arguments. A long-standing one is that competition and market structure are as, if not more, important than ownership in determining efficiency outcomes at the firm level. An updated empirical testing of this view comes from Pankaj Tandon (1995), who, on the basis of a 1994 literature survey, argues:

There are many cases where privatization has not led to efficiency improvement; these are generally associated with situations where the degree of competition has remained unchanged before and after privatization. … There are of course many cases where privatization appears to have “resulted” in efficiency improvement; in most of these cases, however, the privatization appears to have been contemporaneous with deregulation or other types of competition-enhancing measures (pp. 329–30).8

Tandon finds most consistent with the evidence the conclusion that it is the level of competition, not ownership, that best determines efficiency outcomes. He acknowledges that private owners have the right incentives to promote efficiency, and in line with modern amendments to neoclassical theory, he believes that government owners are likely to mismanage principal-agent issues more than private owners. He nonetheless preaches caution: In a competitive market “there exist mechanisms that could enable a public enterprise to operate as efficiently … as its private cousins. But if a market is monopolized, privatization by itself will not guarantee efficiency” (Tandon, 1995, p. 32).

Tandon’s view is that (1) if government owners enhance competitive forces or use management methods and incentives similar to those used in the private sector, they should be able to produce efficient behavior and outcomes, and (2) ex post perceived positive results attributed to ownership change may actually be due to increased competition. The implication is that many of the conclusions of the proponents of privatization may be more ideological than scientific, and insufficiently judicious about alternative ways of achieving objectives without changing ownership and about the possible negative effects of poor privatization.

“Selection bias” is another methodological criticism of privatization. The idea is straightforward: Improved performance in privatized firms does not necessarily show that private owners are better; rather the improvements may indicate that it is the better firms that are privatized. This criticism has particularly troubled studies of privatization in transition economies—economies characterized by thousands of transactions, a general tendency to reward insiders (who might have good information on the firm’s prospects), and a lack of constraints on insider trading.9

In the transition economies the evidence supporting privatization has come from CEE, in particular, from two studies. The first, by Roman Frydman and others (1997), examines performance to mid-1994, and the second, by Gerhard Pohl and others (1997), examines the experience to the end of 1995.10 A reasonable question is whether the highly positive findings from these relatively early days have been sustained. As shown by the case of the Czech Republic in the next section, the answer may be no.

The evidence shows that the returns to privatization diminish as we move eastward. Some examples:

  • A 1998 survey by Djankov and Kreacic of 92 state- and privately owned firms in the Republic of Georgia concluded that it was not private ownership but rather competition and financial discipline that was associated with the restructuring in Georgia—or at least with what restructuring that could be discerned.

  • A study of 50 medium and large privatized enterprises in Armenia noted that only three of the set had generated any new investment post-sale. For most of the others, the prognosis was for continuing decline and ultimate bankruptcy (CEPRA, 1997).11

  • A 1999 study on Mongolia concludes that partially state-owned firms perform better than privatized companies (Anderson, Lee, and Murrell).

  • Early surveys in Russia indicated few discernible differences in performance between state- and privately owned firms12 or modest positive differences in the privatized firms (Estrin and Earle, 1997).

  • Barberis and others (1996), one of the few studies of the Russian experience that clearly shows positive restructuring with privatization, dealt with small shops, most of which had been privatized for only a few months when the assessment survey was conducted between June 1992 and August 1993.13

  • Djankov (1998b), in examining enterprise survey data from 1997 and 1998 for 960 privatized manufacturing companies in Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russia, and Ukraine, found that most restructuring had occurred in the small number of firms in which foreigners had acquired significant ownership. Managerial owners had a mixed performance record, and both outside local investors and worker-owners seemed to have produced little restructuring.

In other words, the most likely forms of private ownership were those least likely to promote active restructuring. Even in Central Europe, Poland’s experience, which is one of comparatively slow and cautious privatization,14 combined with robust and sustained growth, has cast doubt on the necessity of privatization as a key element in the process of transition.15

The Rise and Fall of Russia

Russia’s privatization experience has come in for particular criticism. The voucher-led mass privatization program of 1992–94 transferred ownership of more than 15,000 firms, primarily to insiders. At the end of the exercise, managers and workers combined controlled about two-thirds of the shares in the average privatized firm. The program’s designers had tried to avoid insider dominance, but the financial mechanisms that might have prevented this outcome were swept away by the near hyperinflation prevailing at the time. Still, the mass privatization program had taken place without major claim of fraud, and by fall 1994, hopes were modestly high that

  • financial discipline and perceived self-interest would start to force secondary trading in the insider-dominated companies and introduce outside ownership; and

  • transparent and sound but nonvoucher methods would be used to privatize the half, or more, of industries still in state hands.

Several factors combined to prevent the proper unfolding of this process. First, insiders in the newly privatized firms generally feared loss of control. For most workers the case was one of “better the devil we know” (the existing management) than a cost-cutting, perhaps job-slashing, outsider. In turn, many of the old managers-turned-owners found it easier to lobby the state for assistance than to set the firm on the path to competitive performance. Second, the financial and physical condition of many of the firms were too unattractive for outsider investors. Third, the institutional underpinnings were weak and safe-guards—thus incentives—inadequate for transparent secondary trading, thus further discouraging outsiders. Fourth, the various Russian governments failed to put in place the required set of supporting policies and institutions that might have channeled enterprise activity to productive ends (such as a hard budget constraint, reasonable taxes and services, and mechanisms to permit and encourage new business entrants). Fifth, institutionalized property rights (indeed, a consensus on the economic rules of exchange) were generally absent. For the firms transferred in the mass privatization program, this mixture blocked the taking of the essential second step to opening the ownership of privatized firms to external investors and owners who would bring needed capital, market access, managerial know-how, and a bottom-line mentality to privatized companies (Nellis, 1994, p. 2).16

And worse was to come: A donor-led effort to persuade the Russian government to sell at least a few large firms by transparent, credible case-by-case methods expended considerable effort but led nowhere. Much of the second wave of privatization, which took place after 1994 (for cash and investment promises), in particular the “loans-for-shares” scheme, turned into fraudulent shambles—a situation pointed out by the strongest supporters of, and contributors to, the first mass phase of Russian privatization. The second phase

was non-transparent … involved clear conflicts of interest … created collusion … involved a non-level playing field, excluding foreign investors and banks not favored by the government. In two years the Russian privatization program has moved from the outstanding accomplishments of the MPP to the point where the program is now widely regarded as collusive and corrupt, failing to meet any of its stated objectives (Lieberman and Veimetra, 1996, p. 738).

Others go further, arguing that the entire Russian privatization program, including the voucher-led mass effort, has been the principal cause of the country’s economic decline. They argue that the program emphasized swift ownership change before (or instead of) the building of market-supported institutions. And without these supportive underpinnings (a basic capital market framework, minimal shareholder information and protection systems, enforceable contracts, a modicum level of capacity and probity in the supervision of the public sector) and without breaking up the huge monopolistic or oligopolistic producers in order to stimulate internal competition, the voucher program left the mass of new shareholders powerless to counteract the manipulations of the well-placed managers and their supporters in the financial community. Thus, a program that was supposed to distribute ownership and launch enterprises on a positive restructuring path became instead a transfer of productive resources from the state to a fortunate few, who—unconstrained by tradition, effective laws, or countervailing powers—stripped the assets from the firms instead of taking actions to renew growth and create jobs—actions that might have justified such a transfer.

Over time, the lack of turnaround, the continuing steep fall in output, the concentration of wealth, the demise of probity, the resistance to standard case-by-case methods, the deepening malaise, and the increasingly common anecdotes that only state-owned firms have resisted criminalization,17 combined to persuade many presumably predisposed observers to reject not only the notorious loans-for-shares scheme, but almost all of the Russian privatization approach. Thus Kenneth Arrow18 calls Russian privatization “a predictable economic disaster,” arguing that it should have been easy to foresee poor outcomes, given Russia’s institutional weakness and high inflation in 1992–95. Jeffrey Sachs19 says he now favors Russia renationalizing the natural resource firms wrongly privatized earlier. Simon Commander (1998) argues that Russian insider privatization has sanctioned a low investment—low productivity equilibrium, and as such has contributed greatly to Russia’s fiscal impasse. Many Russian economists and a few Western colleagues have concluded that the entire privatization approach in Russia was wrong, that it should have been preceded (not accompanied) by institution building, and that the proper way forward is to strengthen the structures of the state.20 These critics, in particular, stress the need to recreate or reinforce mechanisms to supervise and assist state-owned firms. One suggestion is to use a state-owned holding company, which supposedly would manage assets rationally and prepare firms for a smooth transition to competitive market operations (Alexandr, 1998). The views on privatization are so negative that a fair number of members of the federal legislature (the Duma) have urged that the huge tax arrears owed to the federal government by privatized firms be transformed into equity, which would effect a massive renationalization of industrial assets.

Difficulties in the Czech Republic

The limited expectations of privatization were perhaps reasonable in Russia, given the unfavorable factors against it: the length and intensity of the nonmarket approach, the unfavorable economic and structural conditions existing at the moment transition was launched, and the magnitude of the parallel political and institutional collapse. But in the Czech Republic, conditions and history made it reasonable not only to hope but to claim that the dramatic mass privatization program of 1992–95 would fully and permanently cut the links between the state and the divested enterprises and set the privatized firms on the road to unassisted competition in both domestic and foreign markets.

First signs were very encouraging. By 1995, Czech privatizers had divested more than 1,800 firms in two waves of exchanges for vouchers, sold a group of high-potential firms to strategic investors, and transferred to previous owners or municipalities a mass of other assets.21 By 1996, then Prime Minister Vaclav Klaus was able to claim that transition had more or less been completed and that henceforth the Czech Republic should be viewed as an ordinary European country undergoing ordinary economic and political problems. All indicators appeared to confirm this view: The Czech Republic was enjoying comparatively low inflation, low unemployment, rapid rise in the private sector’s share of GDP, high rates of investment and export growth to countries in the European Union, and a resumption of GDP growth starting in 1993 and peaking at 6.4 percent in 1995.

But at the end of 1995, the Czech GDP growth rate fell, and it fell again in 1996 and 1997 when it reached 1 percent. In 1998 results were starkly negative, with an annual GDP contraction of about 2 percent; projected growth in 1999 was zero or slightly positive. Thus the Czech economy was officially in recession—in contrast to 4–5 percent expansion in neighboring countries.

Many reasons account for the economic slide, including a mini-recession in Germany (now the Czech Republic’s largest trading partner) and some financial mismanagement at the end of 1995 and early 1996. Nonetheless, an increasingly large amount of the blame is being placed on the way privatization was carried out.

A 1998 OECD report states the argument: The Czech voucher approach to privatization produced ownership structures that impeded efficient corporate governance and restructuring. The crux of the problem was that insufficiently regulated privatization investment funds ended up owning large or controlling stakes in many firms privatized by vouchers, as citizens diversified risk by investing their coupon points in these funds. But most of the large funds were owned by the major domestic banks—banks in which the Czech state retained a controlling or even majority stake. The results, say the critics, were predictable:

  • Investment funds tended to overlook poor performance in firms, because pulling the plug would force the fund’s bank owners to write down the resources lent to these firms.

  • The state-influenced, weakly managed, and inexperienced banks tended to extend credit to high-risk, privatized firms with poor potential (whether or not they were owned by subsidiary funds), and to continually roll over credits rather than push firms into bankruptcy.

  • The bankruptcy framework itself was weak and the process lengthy, further reducing financial market discipline.

  • The lack of prudential regulation and enforcement mechanisms in the capital markets opened the door to a variety of highly dubious, and some overtly illegal, actions that enriched fund managers at the expense of minority shareholders and harmed the health of the firm, for example, by allowing fund managers to load firms with debt, then lift the cash and vanish, leaving the firm saddled with debts it had not used for restructuring.

Because of these experiences, many have concluded that the Czech firms privatized through vouchers did not sufficiently restructure where investment funds had the controlling stakes.22 And although the proximate and most visible determinants of inadequate restructuring lie in the glaring weaknesses of the capital and financial markets, the voucher privatization method is viewed as the underlying cause. The emphasis of the method on speed, neglect of institutional issues, such as the weak legal and regulatory framework, and atomization of ownership helped to undermine its success. David Ellerman (1998) is the most outspoken critic of the Czech scheme. He argues that the negative outcomes were predictable given the separation of ownership from control. Moreover, the funds themselves lacked stable ownership, and the broader economy provided few institutional mechanisms to instill decent corporate governance in either the funds or the firms. The natural result was a “two-sided grab-fest by fund managers and enterprise managers” accompanied by “drift, stagnation and decapitalization of the privatized industrial sector …” (Ellerman, 1998, p. 11).23

Other Transition Economies

Similar concerns have been raised in some of the other transition economies. Many officials and observers, particularly in the smaller and more geographically isolated transition countries, cautiously agree to privatization in general but argue against rapid and mass privatization. Those from Albania, Mongolia, and countries of the former Soviet Union are particularly skeptical, for the following reasons. First, they see few positive outcomes from privatization in Russia. And since they consider their industrial assets and business environments to be similar to those in Russia, they believe they cannot avoid the same problems.

Second, they fear that the countries lack the administrative and legal mechanisms needed to transform rapacious grasping into tolerable and productive attempts at acquisition. Third, many aspects of the economies of countries that were once part of the former Soviet Union are still under the influence of Russian supply, transport, energy, and sometimes criminal networks. Fourth, some of the countries that tried mass privatization schemes, such as Albania, Kazakhstan, Mongolia, and Moldova, concluded that they gained little from this effort. They found that dispersing ownership among the inexperienced population has not improved governance of firm managers. Too often, firm managers remained unchanged, failed to restructure their firms, and remained largely unaccountable for their actions. Leaders in Uzbekistan, for example, are increasingly convinced of the correctness of their neighbor’s policies of general gradualism and of their opposition to handing over firms to owners lacking in financial strength and expertise. These experiences are claimed to justify, to necessitate, a slower, more cautious, more evolutionary, and more government-led path to ownership transfer.24

In light of all this, it is not surprising that in some post-Soviet countries—especially those in which the political transition entailed less of a break with the past than in Russia and where the inherited state structure maintained some cohesion and effectiveness—a Chinese-style approach to enterprise reform and ownership change is considered the proper model to follow.25 The overall Chinese record of high and sustained growth, largely without a shift to formal private ownership, poses a stark contrast to the generally poorer transition performance elsewhere. Moreover, the approach is the subject of encouraging comments from a number of Western economists. For example, Joseph Stiglitz (1998) states that the Chinese experience shows that an economy might achieve more effective growth by focusing first on competition, leaving privatization until later. Thomas Rawski (1997), whose overall conclusion is that economists overstate the importance of ownership, states:

The generally negative evaluation of state enterprise performance is overdone … China’s state industry has increased output, productivity, and exports … the upper tier of state firms is not far removed from international market standards … The main source of SOE financial problems lies in their history, not their ownership … (Without politically imposed financial burdens) SOE profitability may equal or exceed the financial performance of China’s highly touted collective factories … the productivity performance of state industry may match or surpass the accomplishments of the collective sector … (p. 14).

The attack on privatization could be expanded in severalways: for example, by noting the insufficiency of analytical work on the macro-economic and fiscal impact of privatization; by pointing out that the “fiscal space” justification for privatization (that is, governments should cease pouring resources into inefficient and badly managed state-owned firms; instead, they should sell them and concentrate resources and action on those socially needed activities that only governments can and should undertake) states a hope, not a known reality. However, very little is known in emerging markets or the transition economies about how the proceeds of privatization are actually applied.26 And given the nature of the political and administrative systems in many of these settings, doubts are warranted about transition governments’ abilities to collect and allocate wisely the sums generated through privatization.

Political Economy Aspects of the Question

What are the political economy aspects of privatization—the issue of who in transition society wins and loses from transactions? As noted, a good part of the criticism of privatization in Russia and the Czech Republic stems from the widespread perception that reform in general and privatization in particular have yielded benefits to the very few at the expense of many—for example, the Czech workers in Ellerman’s (1998) “decapitalized and stagnant” privatized firms; and the voucher investors in the two countries who were led to believe their investments would yield an income stream and a capital gain, neither of which materialized for most.

To date, no study of transition countries has examined these issues in the rigorous manner pioneered by Galal and colleagues’ 1994 study, Welfare Consequences of Selling Public Enterprises, which studied the gains and losses of sellers, buyers, workers, consumers, and competitors. Indeed, very little empirical work of any sort has yet appeared on the question of privatization’s effects on income distribution in transition settings (or elsewhere). Analysts have begun to produce some oblique and tantalizing hints about the relation between privatization and incomes. For example, Garner and Terrell (1998) looked at movements in income distribution in the Czech Republic and Slovakia through 1993. They concluded that income inequality had risen much less than was claimed in the World Bank’s 1996 World Development Report. They also predicted more inequality in these countries as the returns from asset distribution are realized.

Newell and Socha (1998) looked at the related issue of privatization’s impact on wage distribution in Poland. They concluded that private sector workers typically earned less than their state-sector counterparts after privatization, and the gap was widening; but they also noted that after controlling for experience, tenure, and workplace size, their research showed a small positive private sector premium. Not much can be made of these beginnings, and more work is needed on the subject.27

A common allegation is that women in transition countries bear a higher percentage of the costs of privatization than do men. In one of the only studies to examine this issue, Sewall (1997) argues that privatization in Hungary was triply costly to women, because women formed a disproportionately higher percentage of those laid off by new owners, privatization often involved the closing of the firm’s social services—canteens, clinics, day-care centers—so crucial to female participation in the workforce, and women formed almost the entire workforce in these social service units. Although Sewall’s study is one in a single country, the findings can reasonably be expected to apply to many other transition countries.

Privatization is often assumed to inevitably and automatically result in increased unemployment; but the relationship between employment and privatization in transition countries is not straightforward. For example, the Czech Republic privatized rapidly but maintained a low unemployment rate (a remarkable 3 percent) through 1997. The low rate was at first taken as a sign of the Czech reformers’ success but was later revealed as too good, as an indication that the needed level of corporate restructuring was not taking place in the privatized firms. The recent steep rise in Czech unemployment (7 percent and climbing at the end of 1998) came about even as the pace of privatization had slowed to almost a halt. Something of the same phenomenon has taken place in Russia: that is, mass and rapid privatization, but a relatively small increase in the official unemployment rate. (Although masses of people are officially employed, they are working part time, or not at all, but are kept on the books, or are not being paid.)

In Poland and Hungary, in contrast, privatization started and progressed much more slowly, and neither country followed a “mass” approach. Yet official unemployment grew rapidly in both countries, reaching 16.7 percent in Poland in 1993–94 (down to 9.6 percent in 1998), and 14.1 percent in Hungary in 1993 (falling to 10.8 at the end of 1996). The conclusion must be that employment levels are as much a function of the scope and pace of overall economic restructuring as they are of ownership.

A Summation of the Critique

The perception of many citizens, analysts, and some leaders in transition settings—especially those in the BRO countries—as well some knowledgeable external observers, is close to the following:

In far too many privatization transactions and in far too many transition countries, mass and rapid privatization has turned over mediocre assets to large numbers of people who have neither the skills nor the financial resources to run them well. Most high-quality assets have in one way or another (sometimes by “spontaneous privatization” that preceded official schemes, sometimes by manipulation of the voucher schemes, and perhaps most often in the nonvoucher second phase or in secondary trading) gone to the resourceful, agile, and politically well-connected few. In many instances where ordinary citizens managed to obtain and hold minority blocks of shares in the high-quality firms, the shareholders have been induced to turn over their shares to others at modest prices, or they have seen, without warning or explanation, the value of their minority shares fall to nothing.

These occurrences are particularly prevalent in countries where the post-transition state structures are weak and fractured. This allows significant parts of government to become captured by groups whose major objective is to use the state to legitimatize or mask their acquisition of wealth. (Poor outcomes also can occur when strong governments fail to create a modicum of prudential regulation for financial and capital markets.) The international financial institutions must bear some of the responsibility for the poor outcomes, since they often insisted on the primacy of economic policy (or they followed uncritically the lead of intensely committed reformers). They requested and required transition governments to privatize rapidly and extensively, assuming that private ownership by itself would provide sufficient incentives to shareholders to monitor managerial behavior and push firms to good performance. Competitive policies and institutional safeguards could follow at a later date. The immediate need was to create a basic constituency of property owners. The key assumption was that to build capitalism, one needed capitalists, lots of them, and fast.

But capitalism requires much more than private property. It functions because of the widespread acceptance and enforcement of fundamental rules and safeguards that make the outcomes of economic exchange secure, predictable, and of reasonably widespread benefit. Where such rules and safeguards, such institutions, are absent, not only fairness and equity suffer, but performance of firms suffer as well, because in an institutional vacuum the chances are high that no one in a privatized firm is interested in maintaining the long-run health of the assets.

Too many supervising state officials become interested mainly in extracting rents and selling licenses, permissions, and protection to the firm, rather than enforcing policy. Even when the state retains a significant minority share of the firm and representation on the firm’s board of directors (as is common in many transition countries), the representatives are often looking more for perks, payoffs, and protection of bureaucratic interests than ways to boost shareholder value. Faced with voiceless shareholders and a rapacious or ineffective state that makes believing in the sanctity of property rights difficult (and inflicts punishing tax and interest rates), the manager of a firm may conclude that promoting shareholder value is impossible or not worthwhile. The easier course of action is to lobby the state for assistance or to strip assets and walk away. The former can often be arranged with the collusion and blessing of supposedly supervisory government officials or private bankers or fund managers. Workers, shareholders or not, are caught in the maelstrom, searching for stability and safety, and hoping only to keep their jobs. The other mechanisms of corporate governance—financial and capital markets, the economic and financial press, the insolvency/bankruptcy regimes—are too weak or embryonic to provide countermeasures.

In such circumstances, privatization is more likely to lead to stagnation and decapitalization than to improved financial results and enhanced efficiency.

Can the Problems Be Corrected?

This conclusion is a substantial indictment of privatization, sufficient to establish that at least in some institutionally weak settings the promise of privatization has remained unfulfilled and mistakes have been made. But is the evidence sufficient to condemn the concept? The answer is no.

The Defense

The first counterpoint to the arguments against privatization is the large volume of rigorous studies cited earlier. These studies, conducted in a wide variety of sectoral, geographical, and income settings, show that firms tend to perform much better after privatization than before, as measured by a number of financial and operational efficiency indices at the firm level. A smaller amount of evidence—mainly from several middle- and high-income economies—also show welfare improvements from privatization.

The question is whether we can expect similar positive results in transition settings. Country conditions matter. Several studies indicate that the lower a country’s income, the less dramatic or speedy will be the results of privatization and the more likely that the process could go wrong.28 As noted earlier, countries in CEE—closer geographically, historically, and culturally to Western commercial traditions and markets—have generally privatized more swiftly and with much better results than their more Eastern counterparts. (A more optimistic interpretation would be that the positive results of privatization are taking much longer to show in most of the countries of the former Soviet Union than in the CEE or Baltic states.) Important differences—not only in location and history, but also in institutional density and capacity and adherence to the rule of law—distinguish these countries from those of the former Soviet Union. These factors affect the type of privatization policies and approaches chosen and the ways in which the choices are implemented and the financial and economic outcomes obtained.29 But these caveats do not contradict the main point: The mass of empirical evidence indicates that privatization, when correctly conducted, produces positive benefits. For transition countries, the question is not whether to privatize but how to privatize better.

This conclusion is not accepted by all. Given the difficulties already elaborated, and drawing on the general criticism of Tandon (1995), many argue that the best course of action for transition economies, especially in the former Soviet Union, is to further postpone privatization until competitive forces and an enabling institutional framework are in place. And, as noted, some analysts call for the renationalization of some of the firms already divested, with the intention of managing them in the public interest, through greater state involvement. The more liberal of these critics add that some or all of the renationalized firms could be sold again in the future, when firm and market conditions have improved and investors are offering better prices. Response to this line of reasoning is threefold.

In some transition settings, privatization produces clear benefits

The first and easy point to make is that a return to statism would be blatantly nonsensical in the CEE and Baltic states. In those regions, the trials of the Czech approach notwithstanding, evidence strongly suggests that privatized firms generally and significantly outperform state-owned companies. Two studies (Frydman and others, 1997, and Pohl and others, 1997) presented strong evidence of the superior performance of privatized firms, particularly in the Czech Republic, Hungary, and Poland. Looking at a variety of performance indicators to the end of 1995, Pohl and his colleagues (1997) found that in 6,300 firms in seven countries privatization was the key to restructuring, because divested firms registered much higher rates of productivity growth, investment, and positive operating cash flows than the state-owned enterprises in the sample. The study also concluded that all forms and methods of privatization (except those that gave ownership to workers) produced the same positive results, a disputed issue to which we shall return.

In this study, the highest percentage of strongly performing privatized firms are found in the maligned Czech Republic. Pohl30 states that an updating of the database shows this still to be the case at the end of 1997 (although performance by Hungarian firms was by then about as good as that of the Czechs).

Frydman and colleagues (1997) reviewed the effects of privatization on corporate performance in a sample of 188 Czech, Hungarian, and Polish firms (half privatized, half state-owned) covering the years 1990 through 1994. The authors found that private ownership in their sample (except for cases where workers became owners) significantly improved the key aspects of corporate performance, particularly revenue generation. Moreover, the privatized firms laid off relatively few employees in the early days of transition and increased employment more than state firms did. Indeed, the authors argue that “privatization is the dominant employment strategy in transition”(p. 30). The study31 also found no selection bias present. Rather, it found just the opposite: Where insiders had obtained the better firms, they had tended to manage them badly, whereas outsiders had tended to get below-average firms but had turned them around, as measured by later revenue performance.

Papp and others (1998) reviewed Hungary’s privatization efforts and found that they were far from faultless. They had failed to increase significantly either income to the seller or competitive forces (but Hungary has also earned more than $8 billion from privatization sales, more than any other transition country in CEE and the former Soviet Union). Still, the overall conclusion of Papp and his coauthors was as follows:

Privatization has led to better asset management and corporate governance; to greater efficiency in production, restructuring and modernization of older enterprises; to the production of new and improved products; and to a greater export orientation (p. 339).

Simonetti, Rojec, and Rems (1999) looked at the relationship between financial and operating performance and ownership form in Slovenia. Because of the Yugoslav heritage of the “social capital” concept, ownership is a particularly tangled issue in Slovenia. The authors examined six ownership categories: private firms (but not privatized), foreign-owned firms, firms whose majority shares were sold to insiders, firms whose majority shares were sold to external buyers, nonprivatized (socially owned) firms, and state firms (mainly public utilities). The authors’ sample of 1,902 firms represents about three-fourths of Slovenia’s industrial assets, sales, and employment during 1994–96. The result is that, although few in number, foreign-owned firms are doing the best, averaging a respectable 5.4 percent return on equity during this period, compared with 3.9 for private firms, –0.03 for internally privatized firms, 1.2 for externally privatized firms, –4.6 for nonprivatized firms, and –0.60 for the state firms. When we add profit margin:

Foreign and private companies remain much better than companies from other ownership categories, followed by internal and external companies with positive figures, while non-privatized and state companies are pretty much under water (Simonetti, Rojec, and Rems, 1999, p. 2).

Although the performance of the Slovenian privatized firms is hardly outstanding, they are doing much better than the nonprivatized companies from the same sectors. The latter are the poorest performers by almost every measure. This last is an important point: The standard against which privatized firms should be measured is the performance of the nonprivatized sector from which the privatized firms were drawn, and not some theoretical ideal.

Djankov and Pohl (1998), who examined the performance of large privatized firms in Slovakia, found generally improved performance, even though most of the firms had been turned over to the old managers (the very insiders whose ownership so often was hypothesized to account for poor performance elsewhere).

Much indirect evidence suggests that liberalizing reforms, in general, and privatization, in particular, produce good results. Estonia privatized the bulk of its enterprises quickly, mostly to external investors, and in a minority of cases it used vouchers, but always to divest a minority of shares (see Nellis, 1996). The country returned to positive GDP growth rapidly and sustained it. Estonia is the only transition country to register double-digit growth rates and continued to grow at a high rate despite the world and Russian crises. Haltiwanger and Vodopevic (1998), analyzing the effects of Estonian reform on labor, found that in the early days following the separation from the Soviet Union, layoffs increased dramatically, but later in transition, hires and job creation surged. The layoffs tended to take place in large manufacturing and state-owned firms, whereas job creation took place in smaller, service-oriented private companies. “These results suggest that Estonia’s liberal and radical reforms enabled huge worker and job reallocations without producing massive unemployment” (from the Abstract). Much of the job creation came about in new entry firms, but the privatized companies contributed to the growth as well. Thus, a fair amount of evidence suggests that privatization in the CEE and Baltic states works and that the portrait of privatization drawn earlier is overly negative and critical, at least in this part of the transition world.

Renationalization is unlikely to work

The second part of the response is that renationalization would be a desperate measure and highly likely to fail, particularly in those countries of the former Soviet Union where it is most likely to be espoused. At first glance, the idea of renationalization certainly has appeal: Select some or all of the most egregiously misprivatized firms and put them back in the portfolio of the state; then sell them again, but this time do it correctly. Correctly, presumably, would mean the following:

  • Sell the enterprises in an open, transparent manner, with valuation procedures that conform to international standards of practice.

  • Involve internationally recognized professional financial and transaction advisers; fully disclose all relevant information to all bidders, with no restrictions on the number or nationality of these bidders.

  • After the sale, pose no restrictions on the buyer to maintain the same line of business, the same number of employees, and so on.

But only a few transition governments outside CEE (or even within) can reasonably be expected to undertake this process and handle it well. Only a few have the capacity to prevent the assets stripping in state-owned companies or the technical and political capability and willingness to divest firms according to this set of procedures. As Shirley (1999) has shown, the irony is that countries with the administrative skills and political capacity to run state-owned firms effectively and efficiently are usually the same countries that can privatize well. Conversely, the forces and conditions that lead governments to botch privatization are the same that prevent decent management of state-owned enterprises. Shirley’s point is significant—not only with regard to renationalization but also in response to the concerns of Tandon and Stiglitz that competition more so than ownership determines outcome efficiency. Her point is that few governments have the luxury of choosing between enhancing competition or changing ownership. Her findings reveal that it is a mistake “to think of privatization as totally distinct from reform of enterprises under continued state ownership. Rather the two demand similar, politically costly reforms and tend to succeed or fail together” (p. 28).32

Shirley’s recommended course of action for countries clearly not ready for major reform (a category that includes some if not many of the countries of the former Soviet Union) is to build the foundation for reform:

by reducing fiscal deficits to increase pressures for SOE reform by making the burden of SOE deficits explicit; easing trade restrictions to strengthen exporters who can become a constituency for SOE reform when SOE inefficiencies harm their ability to compete in global markets; removing barriers to entry since new entrants can also be a voice for reform; eliminating regulatory and policy obstacles to new job creation (such as restrictions on firing or taxes or subsidies that encourage employers to substitute capital for labor) and uncoupling SOE jobs and social services such as education or health care to encourage labor mobility (p. 30).

These steps might be sufficient to launch reform in a mixed economy in which state-owned enterprises account for a fifth or less of GDP. But these measures are unlikely to turn the tide in institutionally weak transition economies, except perhaps in the very long run. In the latter, the problem is not revealing the costs and inefficiencies of the state enterprises, but rather establishing the basic rules to enable any form of ownership to be efficient. Moreover, in transition countries the remaining state-owned enterprises are only part of the problem; the equal or greater question is what to do about misprivatized firms—a question the Shirley measures would only obliquely address. Djankov (1998a and b) provides evidence suggesting that many transition governments will find restructuring firms under state ownership difficult. In this case study, Djankov examines Romanian efforts to isolate a set of large, financially troubled companies in order to determine what is required for their recovery and sale or closure. Djankov presents data showing that none of the intentions of the isolation program were fulfilled. Moreover, the program may have delayed restructuring by not imposing hardened budget constraints on loss-making enterprises. He concludes that transition governments should “privatize rapidly, and not attempt to restructure enterprises prior to privatization” (p. 10).

The conclusion: Renationalization is not the alternative; rather, governments must find ways to privatize correctly and to set and enforce performance standards on those already privatized. The critical question, of course, is how.

What’s wrong with caution?

The third part of the response is much more intricate. Even if one accepts the notion that renationalization is unlikely to work, one could still make an argument against further rapid privatization. The reasoning is that in institutionally weak and politically fractured transition countries, long removed from or never fully integrated into the Western commercial tradition, governments should halt privatization of the remaining portfolio (majority or minority stakes) and shift their efforts to (1) strengthening market-supporting institutions (mainly public but some private as well), with the goal of channeling present “wild east” commercial activity into socially productive and acceptable modes, and (2) imposing discipline on and competition in the remaining public enterprises, accompanied or followed by staged, incremental shifts in ownership patterns, in a more or less evolutionary, Chinese-style manner.33

Once again, the idea has a prima facie appeal and one that other governments, such as Vietnam, have tried to follow, with some early success.34 But again, the solution assumes the existence of a desired end state at which it is aiming—an effective state mechanism and institutional framework.

The paradox is that those countries that had largely rejected the communist state and political systems but that possessed little or nothing of a capitalist past to anchor them are having considerable trouble moving in an orderly manner to the market system. And ironically, the once planned Asian economies that have avoided political transition but have maintained enough administrative competence and political legitimacy to allow them to discipline the most blatant forms of theft and corruption have so far best combined the move to market principles and tactics with sustained growth, but without formal privatization. By this reasoning the Soviet Union might have successfully adopted such an evolutionary strategy in, say, the 1960s or early 1970s, but by the time the attempt was made by Gorbachev in the late 1980s, state power and legitimacy had sunk so low that the attempt failed.35

A second and powerful part of the explanation for the inapplicability of the Chinese approach is that China’s economy was structurally very different from that of Russia and other countries of the former Soviet Union. China embarked on its form of transition at a time when agriculture accounted for more than 70 percent of GDP, and industry only 15 percent; the corresponding figures in Russia were 13 and 42 percent (World Bank, 1996). The courage and vision of Chinese policymakers who launched and sustained the liberalizing reforms should be acknowledged. But we must also recognize that shifting resources from agriculture to nontraditional forms of industry was a different, more manageable task than restructuring an industrial base that produced almost nothing for private needs. It is thus not surprising that attempts in the CEE or BRO to find a slower and less painful move to the market without much privatization have also proven ineffective: for example, in Ukraine, Romania, Bulgaria (prior to the 1997 elections), and Belarus.36 During the long periods of nonprivatization in these countries, many state-owned enterprises had their assets stripped; when privatization eventually comes, there will probably be little left to transfer.

The overall assessment appears bleak: Privatize incorrectly and the result will not be increased production, job creation, and increased incomes, but rather stagnation and decapitalization. But keeping enterprises in the hands of a weak and venal state is likely to lead to a similar end. In both instances the evident long-term solution is to build the administrative and policymaking and enforcing capacities of the government. And to this end there are questions that need satisfactory and operationally viable answers, for example: What precisely must governments do in this regard to produce a public service with the public interest in mind, and how precisely do they go about doing it? What is the role of external assistance in this process, and how long will it take to effect reasonable progress? Can anything be done in the shorter term? Several transition governments have tried to compensate for managerial deficiencies by contracting out much or all of the privatization process to agents and advisers. For example, at the beginning of its privatization program the government of Estonia relied heavily on German technical assistance from the Treuhandanstalt, obtaining not simply expertise but an entire approach, which was applied with great success. The Bulgarian Privatization Agency has turned over to privatization agents and transaction advisers (PATAs) much of the responsibility for the sale of about 30 large firms and has pooled batches of smaller firms and contracted the sale of these firms to private actors;37 results are starting to flow in.

The government of Uzbekistan has resolved to privatize 30 of its largest firms, delegating major responsibility to international financial advisers in every step of the process. Romanian officials have expressed an intent to follow a similar procedure for more than 200 of the largest firms remaining in state hands. These efforts go beyond the common tactic of employing experienced consultants to assist a national privatization agency; they turn over significant decision making power to the agents employed in order to circumvent the constraining political process and to find technical solutions to perceived political and institutional difficulties.

But it is neither possible nor desirable to eliminate entirely the role of the sovereign. Worldwide experience has shown that it is imperative that representatives of the body politic ultimately approve and ratify, and be seen to ratify, the privatization recommendations of technical advisers and agents. If this is not done, there will be no political counterweight to offset the claims and allegations of opponents.

Technicians and politicians often differ on what constitutes an appropriate or acceptable transaction. In good circumstances, such as in Estonia, a spirit of compromise prevails. For example, German advisers strongly opposed the use of vouchers because they considered them harmful to corporate governance and revenue generation, whereas the political authorities needed a mechanism to garner public support for a contentious program. Both sides eventually agreed on a scheme whereby a minority of shares (and only in some firms) was exchanged for vouchers, after a core investor had taken a controlling majority stake. In Russia, on the other hand, an effort to construct a case-by-case privatization program, with intensive use of private sector financial advisers, has not produced the anticipated results, because Russian authorities have been reluctant to turn over to the agents anything other than accounting and valuation exercises. The Bulgarian PATA program has produced some results and promises more, but not without significant strains and disputes between the agents and the supervising government officials over the extent of the agents’ decision making powers. It took four years of difficult negotiations for the various Polish governments to put together their mass privatization program, which in effect hands over to private agents (organized in National Investment Funds) the task of taking some 500 larger firms to market—but it is now producing good results. The point is that contracting out is an option worth considering, but it is far from a generalized or speedy solution. And as always the effectiveness of the effort depends heavily on the existence of a modicum of governmental will and capacity.

  • Based on the experience with privatization in Poland, Romania, Russia, and Uzbekistan, Itzhak Goldberg argues for what he terms “reprivatization.”38 According to Goldberg, the principal obstacle to progressive restructuring in privatized firms in Russia and elsewhere is the excessive concentration of ownership in the hands of insiders who lack the means and incentives to lead the firms forward.39 Accepting the futility of renationalization, Goldberg argues instead for increasing the capital in privatized firms, and then diluting the stake of insiders by selling the resulting shares to external investors. His list of steps (in addition to the capital increase) required to bring about this opening to real owners includes strengthening mechanisms that allow owners to select managers, improving labor mobility, strengthening disclosure and audit, and strengthening the rights of shareholders.

To the question, How can new shares be issued without the cooperation of existing owners? the answer is that the Russian government, for one, could easily bring about a capital increase in many firms. As noted, most privatized firms are heavily in arrears on their tax payments. Moreover, government has retained a minority stake in the majority of privatized firms. A conversion of tax debt to equity would provide the government with a substantial set of shares to sell. In many cases the addition to capital, when added to the retained shares, would be large enough to provide a purchaser with a controlling stake.

This proposal is both a long-term and a partial solution (in the sense that only some firms will attract core investors). Moreover, the political and institutional deficiencies elaborated above deeply affect the likelihood that a government would undertake such corrective measures or that it would succeed in implementing them even if it made a sincere effort to do so. The suggestion is that the reforming elements in the transition governments, and the international assistance community (the international financial institutions, the European Community, the bilateral donors) abandon speed as a priority and shift their efforts to a necessarily slower and less dramatic form of case-by-case or tender privatization. This approach would aim at creating, from the bottom up, the climate in which monied, core, competent investors could take over the currently stagnant, decapitalized firms.

Overall, despite the many and evident obstacles hindering good privatization policy and practice, there seems to be no alternative, especially in institutionally weak transition countries, to a continuation of efforts to privatize. These new efforts may differ considerably from those of the recent past; and they may need to be less ambitious and accept a slower pace of implementation. But they need to continue.


So the answer is: Yes, it is time to rethink privatization, at least in those transition settings where history, geography, and politics have so readily channeled seemingly laudable economic policy into suboptimal outcomes. In Russia and elsewhere too much was promised of privatization, both by reformers who seemed at first to view ownership change as a sufficient condition to bring about a new liberal order and (less forgivably) by external advisers and aid providers, whose hopes for fast and relatively simple solutions may have clouded their judgment on whether the necessary supporting systems for privatization were in place, or how long it would take to put them in place and what was likely to happen in their absence.

But the admission of error should not be overdone. The fact remains that

  • Privatization is the right course of action when it can be carried out correctly. Recall that in a number of CEE countries the policy is an undoubted success, far superior to letting the firms remain in state hands.

  • In most countries and sectors around the world privatization yields great benefits at the firm level; it was not immediately obvious that some transition countries would differ from some of the low- to middle-income, institutionally weak, nontransition settings in which privatization has been successful. Early transition evidence showed a strong correlation between liberalization and stabilization and a return to growth.40 And it was thought privatization was an integral part of this reform package. The problems of the approach emerged later, in corrupt second-phase sales for cash, in the lack of restructuring in insider-dominated firms, in the unregulated actions of investment funds, and so on. Many critics voiced concerns about vouchers, but few anticipated how badly some of the post-voucher transactions would be conducted.

  • Those who say they had predicted the problem all along offer no viable alternative. For most transition countries, the alternative to privatization is not likely to be some Chinese-style combination of macroeconomic reform and unclear property rights. Because of the large differences in the political systems and starting conditions of these countries, such an approach would result in asset stripping and further stagnation under weak state supervision rather than high economic growth.

  • Complaints from inside the countries are more justified but must be examined carefully. Doubtless, many transition government officials opposed to privatization are expressing sincere convictions, based on the assessment that the policy is not working or is proving too costly. But just as clearly, some officials are benefiting greatly from the continued state involvement in firms, and in the close relation between government and business that provides many opportunities for rent seeking. Thus the assertions of these officials on the superiority of continued state involvement are suspect.

  • One must continually ask, What was and is the alternative to privatization? It is not clear that Russia would be better off today had it avoided mass privatization in 1992–94. Several other institutionally weak transition economies that eschewed, delayed, or approached privatization more cautiously have little to show for it: Belarus, Bulgaria, Romania, and Ukraine, for example (although in no case is privatization or its absence the whole of the explanation).

  • The radical reformers in then Czechoslovakia, Poland, Russia, and elsewhere insisted at the outset that speedy privatization was essential to create a constituency for transition to the market, to prevent further asset stripping, to sever the links between the enterprises and the state; and, most dramatically, to prevent the communists from returning.41 In retrospect, it appears that more time was available than was thought. The return of communism in its traditional format was not a realistic possibility (though the failure of reform may be increasing the prospect). It might have been possible to approach privatization in a more deliberate manner; the results might have been less insider ownership and domination, less resistance to external investors, more protection for minority shareholders, and so on. But recall again that countries that tried a slow approach have not made a go of it.

Armenian officials vigorously argue that despite the problems of their privatized firms, the absence of external purchasers, plus the need for speed, gave them no choice but to proceed with voucher privatization. Although they would prefer that a higher percentage of the privatized firms were turning around, they argue that even very weak private owners are better than state ownership. In state hands these firms today would be making strong claims on scarce public resources, threatening the whole of the hard-won reform program. The same argument could be made in other countries.

So, in sum:

  • Privatization remains the generally preferred course of action, but its short-term economic effectiveness and social acceptability depend on the existence of the institutional underpinnings of capitalism. Where these are present, privatization should and can go forward.

  • If these underpinnings are missing but the government is effectively addressing their construction or reinforcement, it might be better to delay privatization until this effort is bearing fruit: Hungary and Poland are cases in point.

  • The heart of the matter is in cases where government is unwilling or incapable of creating the supportive underpinnings. The evident long-term course of action here is to support measures enhancing will and capacity (assuming one knows what they are). Nonetheless, the reasonable short-term course of action is to push ahead with case-by-case and tender privatization along the lines espoused by Goldberg, in cooperation with the international assistance community, in hopes of producing success stories that will lead by example.

This chapter was first published by the International Finance Corporation as Discussion Paper No. 38. The author thanks Itzhak Goldberg and Simeon Djankov for a number of key suggestions and ideas. Valuable comments were also received from Igor Artemiev, Anders Åslund, Nick Barr, Harry Broadman, Constantjin Claessans, Simon Commander, Francois Ettori, Roman Frydman, Oleh Havrylyshyn, Gregory Jedrzejczak, Homi Kharas, Donal McGettigan, David Phillips, Robert Myers, Thomas O’Brien, Brian Pinto, and Lou Thompson. Remaining errors are the author’s.


In this chapter, privatization means the transfer of a majority of ownership equity from state to private hand.


Proceeds, however, are a partial and imperfect measure of privatization’s magnitude and importance, because thousands of firms have been privatized through voucher or give-away schemes.


Kattab provides no information on how this set of firms was selected for study from the 91 privatized firms in the country.


A summary of their longer article also appears in World Bank (1997).


Other studies showing positive results from privatization include Galal and others (1995), Shaikh and others (1996), and Newbery and Pollitt (1997). Articles demonstrating the superior efficiency performance of private versus public firms include Majumdar (1998) and Dewenter and Malatesta (1998).


Megginson and Netter (1998, p. 5) note that privatization moved “from novelty to global orthodoxy in the space of two decades.”


See Morse (1998). Richard Morse is Global Head of Industry at Dresdner Kleinwort Benson.


Tandon is one of the four authors of the justly celebrated Welfare Consequences of Selling Public Enterprises (Galal and others, 1995), generally regarded as one of the strongest pillars of the proprivatization argument. He specifically does not exclude his previous study from his conclusions.


But Havrylyshyn and McGettigan (2000) review three recent studies that attempt to take selection bias into account, and they still conclude that privatization is associated with better performance.


We return to these studies later in this chapter.


The firms in the sample had been privatized for slightly more than one year.


“… ownership changes are generally rather weakly associated with most indicators of performance, including sales, wages and employment,” Commander, Fan, and Schaffer (1996, p. 8). See also Chapter 7 in the same volume by Earle, Estrin, and Leshchenko (1996). The data in this study run to mid-1994.


The authors are aware of the limitations of their data set and did their best to focus on short-term, quickly visible restructuring measures.


Through 1996, about half of the Polish 1989 state-enterprise sector remained in government hands, including many of the largest firms (see Blaszczyk, 1996).


The issue is examined in Pinto and van Wijnbergen (1995). Hungary eschewed vouchers and mass privatization methods, but did divest the bulk of state-owned assets.


See also Blasi and others (1997, p. 122), which concludes that the needed postprivatization restructuring of Russian firms proved far more complex than was anticipated.


A Washington Post (1999, p. A16) story on the criminal takeover of coal mines in the Kuzbass Basin region of Russia asserts: “The most productive mines are still largely state-owned, and regional government officials serve on the boards of directors.”


Author’s notes of Arrow’s presentation at a World Bank seminar on What Went Wrong in Russia? Washington, D.C., October 26, 1998.


Author’s notes of Sach’s presentation by videoconference to the World Bank Institute’s Core Course on Privatization, Washington, D.C., November 2, 1998. Sachs is much more critical of the loans-for-shares scheme than of the Mass Privatization Program (MPP).


Three vocal critics of the Russian privatization approach are Nekipelov Alexandr, Stanislav Menshikov, and Oleg Bogomolov; Western economists associated with a “move more slowly; concentrate on institutions in advance of ownership change” include Michael In-triligator, Lance Taylor, Marshall Pomer, Kenneth Arrow, and Dorothy Rosenberg.


However, as of the end of 1998, much remained to be privatized in the Czech Republic: majority or controlling stakes in three of the four major banks, parts or all of infrastructure firms, a number of large industrial concerns. Taken together, the state retained 40 large firms classed as “strategic,” and had minority stakes in more than 325 nonstrategic commercial and industrial concerns. Tellingly, the Czech state still retains significant ownership interest in 9 of the 10 largest firms in the country.


Weiss and Nikitin (1997, p. 21) looked at financial performance in a set of Czech firms. They concluded that while “ownership concentration in hands other than funds has a major (and positive) effect on performance,” there is “no evidence of a positive effect of ownership shares by funds on the performance of operating companies.” Pavel Mertlik (Minister of Economy in the Social Democrat government that came to power in 1998) argued much the same point (see Mertlik, 1998, pp. 103–22).


Pistor and Spicer (1997) were also critical, concluding that funds generally have been unable to enhance the value of their holdings because of the import of “the initial design problems in mass privatization—asymmetric information and imperfect property rights …” (from the Summary).


It has to be pointed out, however, that many proponents of this line are benefiting from the substantial rents produced by a system of heavy government involvement in the economy.


For an assessment of the various approaches on enterprise performance and reform in use and under consideration by the Chinese, see Broadman (1995). For a discussion of the competing and hotly debated interpretations of the results of Chinese reforms short of privatization, see Sachs and Woo (1997), especially pp. 18–31, “The SOE Sector Under Reform.”


Since this writing, Davis and others (2000) have conducted a study to examine the macro-economic and systemic fiscal impacts of privatization, among other issues.


The Europe and Central Asia region of the World Bank is commissioning a study on this topic.


See, for example, Boubakri and Cosset (1998).


This has long been recognized. Kikeri, Nellis, and Shirley (1992) concluded that the two key factors determining privatization outcomes were the nature of the market into which the firm was being divested—competitive or noncompetitive—and country conditions. The latter refers to a country’s overall macroeconomic policy framework and capacity to regulate. “In unfavorable country settings, where the existing private sector is small, capital markets are thin, and the interest of external investors is limited, the sale of enterprises even in competitive sectors may be more difficult”(pp. 4–5).


Communication from Gerhard Pohl, August 1998.


The methodological rigor of this study is exemplary, but the sample size is small, the firms are medium size (perhaps larger firms are more difficult to turn around?), and the data somewhat dated.


Shirley made related points in her earlier work (see Shirley, 1998).


In essence, this is the approach long recommended by Intriligator and others (1995, pp. 10–11); see also my response in the same issue (Nellis, 1995).


At least for a time. But even before the East Asia crisis, investor enthusiasm for Vietnam was waning, for reasons of both policy and interfering practices. Moreover, Vietnam has not experimented as broadly or boldly as China with ownership models. At the end of 1998 fewer than 50 small and medium-size firms had been “equitized,” the Vietnamese term for divesting ownership to firm insiders. (See Amin and Webster, 1998.)


This reasoning is similar to that found in Sachs and Woo (1994, pp. 102–45).


With its regulated prices and minimal privatization of medium and large firms, Belarus is an anomaly both in terms of policy and outcomes so far. Outside observers argue that Belarus’s relative stability in terms of output and job maintenance is fragile, heavily dependent on the volatile Russian market, and thus potentially unsustainable. The fact remains that at the moment the unemployment rate in Belarus is lower and the wage arrears much less than in Russia or Ukraine.


See p. 9 of Alexieva and others (1998) for a description of the approach.


This phrase and notion, and many of the ideas in the following paragraphs, were provided by Itzhak Goldberg, of the World Bank, in several written communications in December 1998 and January 1999.


In contrast to the view of Pohl and others (1997) that all forms of privatization, to insiders or outsiders alike (other than to workers alone), result in positive outcomes, Goldberg’s is the increasingly accepted view. See Frydman and others (1997). See also Aghion and Blanchard (1998, p. 88), who state “outsider ownership is a necessary, although not a sufficient condition for deep restructuring and there is little evidence of strategic restructuring in firms without outsider ownership …”


See World Bank (1996), which presents the evidence for these points in the Introduction and in Chapters 1 and 3.


The most tightly reasoned argument along these lines is found in the writings of three economists deeply involved in the Russian privatization program: Maxim Boycko, Andrei Shleifer, and Robert Vishny. See in particular Boycko, Shleifer, and Vishny (1995).


  • Aghion, Philippe, and Olivier Blanchard, 1998, “On Privatization Methods in Eastern Europe and Their implications,” Economics of Transition, Vol. 6 (No. 1), p. 88.

    • Search Google Scholar
    • Export Citation
  • Alexandr, Nekipelov, 1998, “On the Nature of Russian Economic Catastrophe and Possible Approaches to Dealing with It,” unpublished paper presented at the Second Boston Seminar on Economic Globalization, October, pp. 1617,

    • Search Google Scholar
    • Export Citation
  • Alexieva, N., J. Nellis, T. O’Brien, and Lada Stoyanova, 1998, “A Review of Bulgarian Privatisation,” paper for the seminar on Bulgaria—Enterprise Privatization: Progress and Issues, Paris, OECD.

    • Search Google Scholar
    • Export Citation
  • Amin, Reza, and Leila Webster, 1998, “Equitization of State Enterprises in Vietnam: A Progress Report,” Mekong Project Development Facility, Hanoi, Vietnam.

    • Search Google Scholar
    • Export Citation
  • Anderson, James, H. Young Lee, and Peter Murrell, 1999, “Do Competition and Ownership Affect Enterprise Efficiency in the Absence of Market Institutions? Evidence after Privatization in Mongolia,” Working Paper, Department of Economics and IRIS Center (College Park: University of Maryland).

    • Search Google Scholar
    • Export Citation
  • Barberis, Nicholas, Maxim Boycko, Andrei Shleifer, Natalia Tsukanova, 1996, “How Does Privatization Work? Evidence from Russian Shops,” Journal of Political Economy,Vol. 104 (No. 4), pp. 76490,

    • Search Google Scholar
    • Export Citation
  • Blasi, Joseph, Maya Kroumova, and Douglas Kruse, 1997, Kremlin Capitalism: Privatizing the Russian Economy (Ithaca: Cornell University Press).

    • Search Google Scholar
    • Export Citation
  • Blaszczyk, Barbara, 1996, “Privatization and Ownership Transformation in Poland,” in Privatization in Post-communist Countries, 2 Volumes, ed. by B. Blaszczyk and Richard Woodward (Warsaw: Center for Social and Economic Research).

    • Search Google Scholar
    • Export Citation
  • Boubakri, Narjess, and Jean-Claude Cosset, 1998, “The Financial and Operating Performance of Newly Privatized Firms: Evidence from Developing Countries,” Journal of Finance, Vol. 53 (June), pp. 1081110,

    • Search Google Scholar
    • Export Citation
  • Boubakri, Thesia, 1998, “A Gini Decomposition Analysis of Inequality in the Czech and Slovak Republics During the Transition,” Economics of Transition, Vol. 6 (No. 1), p. 41.

    • Search Google Scholar
    • Export Citation
  • Boycko, Maxim, Andrei Shleifer, and Robert Vishny, 1995, Privatizing Russia (Cambridge: MIT Press).

  • Broadman, Harry, 1995, Meeting the Challenge of Chinese Enterprise Reform, World Bank Discussion Paper No. 283 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Center for Economic Policy Research and Analysis (CEPRA), 1997, “Mass Privatization of Enterprises in the Republic of Armenia: An Early Assessment” (unpublished, Washington: U.S. Agency for International Development).

    • Search Google Scholar
    • Export Citation
  • Commander, Simon, 1998, “Russia: What Is To Be Done?” EDI Forum, Vol. 3 (No. 2), pp. 78,

  • Commander, Simon, Qimiao Fan, and Mark Schaffer, eds. 1996, Enterprise Restructuring and Economic Policy in Russia, EDI Development Series (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Davis, Jeffrey, Rolando Ossowski, Thomas Richardson, and Steven Barnett, 2000, Fiscal and Macroeconomic Impact of Privatization, IMF Occasional Paper No. 194 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Dewenter, Kathryn, and Paul Malatesta, 1998, “State-Owned and Privately-Owned Firms: An Empirical Analysis of Profitability, Leverage, and Labor Intensity,” Working Paper (Seattle: University of Washington).

    • Search Google Scholar
    • Export Citation
  • Djankov, Simeon, 1998a, “Enterprise Isolation Programs in Transition Economies,” Policy Research Working Paper No. 1952 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Djankov, Simeon, 1998b, “Ownership Structure and Enterprise Restructuring in Six Newly Independent States” (unpublished, Washington: World Bank), pp. 23,

    • Search Google Scholar
    • Export Citation
  • Djankov, Simeon, and Gerhard Pohl, 1998, “The Restructuring of Large Firms in the Slovak Republic,” Economics of Transition, Vol. 6 (No. 1), pp. 6785,

    • Search Google Scholar
    • Export Citation
  • Djankov, Simeon, and Vladimir Kreacic, 1998, “Restructuring of Manufacturing Enterprises in Georgia: Four Case Studies and a Survey” (unpublished, Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Dowlah, C.A.F., 1996, “Privatization Experience in Bangladesh, 1991–1996” (unpublished, Washington: World Bank).

  • Earle, John, Saul Estrin, and Larisa Leshchenko, 1996, “Ownership Structures, Patterns of Control, and Enterprise Behavior in Russia,” in Enterprise Restructuring and Economic Policy in Russia, ed. by Simon Commander, Qimiao Fan, and Mark Schaffer (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Ellerman, David, 1998, “Voucher Privatization and Investment Funds: An Institutional Analysis,” World Bank Working Paper No. 1924 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Estrin, Saul, and John Earle, 1997, “After Voucher Privatization: The Structure of Corporate Ownership on Russian Manufacturing Industry,” Center for Economic Policy and Research Discussion Paper No. 1736 (London: CEPR).

    • Search Google Scholar
    • Export Citation
  • Frydman, Roman, Cheryl W. Gray, Marek Hessel, and Andrzej Rapaczynski, 1999, “The Limits of Discipline: Ownership and Hard Budget Constraints in the Transition Economies,” Transition Economics Series No. 5 (Vienna: Institute of Advanced Studies).

    • Search Google Scholar
    • Export Citation
  • Frydman, Roman, Cheryl W. Gray, Marek Hessel, and Andrzej Rapaczynski,, 1997, Private Ownership and Corporate Performance: Some Lessons from Transition Economies, World Bank Policy Research Working Paper No. 1830 (Washington, World Bank).

    • Search Google Scholar
    • Export Citation
  • Galal, Ahmed, and others, 1995, Welfare Consequences of Selling Public Enterprises (Washington: Oxford University Press).

  • Garner, Thesia, and Katherine Terrell, 1998, “A Gini Decomposition Analysis of Inequality in the Czech and Slovak Republics During the Transition,” Economics of Transition, Vol. 6 (No. 1), p. 41.

    • Search Google Scholar
    • Export Citation
  • Haltiwanger, John, and Milan Vodopevic, 1998, “Gross Worker and Job Flows in a Transition Economy: An Analysis of Estonia,” paper presented at the World Bank seminar on Poverty, Household Economics, and Rural Development (unpublished, Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Havrylyshyn, Oleh, and Donal McGettigan, 2000, “Privatization in Transition Countries,” Post Soviet Affairs, Vol. 16, No. 3.

  • Intriligator, Michael, Robert McIntyre, Marshall Pomer, Dorothy Rosenberg, and Lance Taylor, 1995, “Checklist for Action in the Russian Economy,” Transition, Vol. 6 (September–October), pp. 1011,

    • Search Google Scholar
    • Export Citation
  • Kattab, Mokhtar 1998, “Constraints of Privatization in the Egyptian Experience,” paper delivered at the conference on Public-Private Partnerships in the Middle East and North Africa Region, Marrakech, September.

    • Search Google Scholar
    • Export Citation
  • Kikeri, Sunita, John Nellis, and Mary Shirley, eds., 1992, Privatization: The Lessons of Experience (Washington: World Bank).

  • La Porta, Rafael, and Florencio Lopez-de-Silanes, 1997, “The Benefits of Privatization: Evidence from Mexico,” National Bureau of Economic Research Working Paper No. 6215 (Cambridge, Massachusetts: NBER).

    • Search Google Scholar
    • Export Citation
  • Lieberman, Ira, and Rogi Veimetra, 1996, “The Rush for State Shares in the ‘Klondyke’ of Wild East Capitalism: Loans-for-Shares Transactions in Russia,” The George Washington Journal of International Law and Economics Vol. 29 (No. 3), p. 738.

    • Search Google Scholar
    • Export Citation
  • Majumdar, Sumit, 1998, “Assessing Comparative Efficiency of the State-owned, Mixed, and Private Sectors in Indian Industry,” Public Choice, Vol. 96 (July), pp. 124,

    • Search Google Scholar
    • Export Citation
  • Megginson, William L., and Jeff Netter, 1998, “From State to Market: A Survey of Empirical Studies on Privatization,” paper presented to the Global Equity Markets Conference (unpublished, Paris), December.

    • Search Google Scholar
    • Export Citation
  • Mertlik, Pavel, 1998, “Czech Privatization: From Public Ownership to Public Ownership in Five Years?” in Privatization in Post-Communist Countries, Vol. 1, ed. by B. Blaszczyk and Richard Woodward (Warsaw: Center for Social and Economic Research).

    • Search Google Scholar
    • Export Citation
  • Morse, Richard, 1998, “The Paradox of Privatisation,” Privatisation International, No. 123 (December), p. 6.

  • Nellis, John, 1994, “Introduction,” in Russia: Creating Private Enterprises and Efficient Markets, ed. by Ira Lieberman and John Nellis (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Nellis, John, 1995, “The Dangers of Dirigisme,” Transition, Vol. 6, (September–October), pp. 1113,

  • Nellis, John, 1996, “Finding Real Owners: Lessons from Estonia’s Privatization Program,” Viewpoint No. 66 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Newbery, David, and Michael G. Pollitt, 1997, “The Restructuring and Privatization of the U.K. Electricity Supply—Was It Worth It?” in The Private Sector in Infrastructure: Strategy, Regulation, and Risk (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Newell, Andrew, and Mieczyslaw Socha, 1998, “Wage Distribution in Poland: The Roles of Privatization and International Trade, 1992–96,” Economics of Transition, Vol. 6 (No.1), p. 47.

    • Search Google Scholar
    • Export Citation
  • Organization for Economic Cooperation and Development (OECD), 1998, Czech Republic (Paris: OECD).

  • Papp, Anita, Millard Long, Mihaly Kopanyi, and Peter Mihalyi, 1998, “Privatization: Restructuring Property Rights in Hungary,” in Public Finance Reform During the Transition: The Experience of Hungary, ed. by Lajos Bokros and Jean-Jacques Dethier (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Pinto, Brian, and Sweder van Wijnbergen, 1995, “Ownership and Corporate Control in Poland: Why State Firms Defied the Odds,” CEPR Discussion Paper No. 1273 (London: Centre for Economic Policy Research).

    • Search Google Scholar
    • Export Citation
  • Pistor, Katharina, and Andrew Spicer, 1997, “Investment Funds in Mass Privatization: Lessons from Russia and the Czech Republic,” Viewpoint, No. 110 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Pohl, Gerhard, Robert E. Anderson, Stijn Claessens, and Simeon Djankov, 1997, Privatization and Restructuring in Central and Eastern Europe-Evidence and Policy Options, World Bank Technical Paper No. 368 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Privatisation International, 1998, No. 123 (December), p. 4.

  • Rawski, Thomas, 1997, “China and the Idea of Economic Reform,” paper prepared for the Symposium on China’s Gradualism Reconsidered (unpublished, Yokohama, Japan).

    • Search Google Scholar
    • Export Citation
  • Sachs, Jeffrey, and Wing Thye Woo, 1994, “Structural Factors in the Economic Reforms of China, Eastern Europe and the Former Soviet Union, Economic Policy, Vol. 9 (April), pp. 10245,

    • Search Google Scholar
    • Export Citation
  • Sachs, Jeffrey, and Wing Thye Woo, 1997, “Understanding China’s Economic Performance,” HIID Development Discussion Paper No. 575 (Cambridge, Massachusetts: Harvard University), pp. 1831,

    • Search Google Scholar
    • Export Citation
  • Sewall, Rebecca, 1997, “Gender Impact of Privatization,” paper delivered to the World Bank Group on NGO Dialogue on Privatization, October 21–22 (unpublished, Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Shaikh, Hafeez, and others, 1996, Argentina Privatization Program: A Review of Five Cases (Washington: World Bank).

  • Shirley, Mary, 1998, “Why Performance Contracts for State-Owned Enterprises Haven’t Worked,” Viewpoint, No. 150 (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Shirley, Mary, 1999, “Bureaucrats in Business: The Roles of Privatization Versus Corporatization in State-Owned Enterprise Reform,” World Development, Vol. 27 (January), 11536,

    • Search Google Scholar
    • Export Citation
  • Simonetti, Marko, Matija Rojec, and Marko Rems, 1999, “Enterprise Sector Restructuring and EU Accession of Slovenia” (unpublished, Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Stiglitz, Joseph, 1998, “Knowledge for Development: Economic Science, Economic Policy and Economic Advice,” paper given at the Annual Bank Conference on Development Economics (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • Tandon, Pankaj, 1995, “Welfare Effects of Privatization: Some Evidence from Mexico,” Boston University International Law Journal, Vol. 13 (No. 2), pp. 32930,

    • Search Google Scholar
    • Export Citation
  • Weiss, A., and G. Nikitin, 1997, “Performance of Czech Companies by Ownership Structure” (unpublished, Boston: Massachusetts: Boston University).

    • Search Google Scholar
    • Export Citation
  • World Bank, 1996, “From Plan to Market,” in World Development Report (New York: Oxford University Press).

  • World Bank, 1997, Viewpoint, No. 117 (Washington: World Bank).