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Xavier Richet
To cite this article: Xavier Richet (1993) Transition towards the market in Eastern Europe:
Privatisation, industrial restructuring and entrepreneurship, Communist Economies and Economic
Transformation, 5:2, 229-243, DOI: 10.1080/14631379308427755
Article views: 9
XAVIER RICHET
The transformation process which has been taking place in Central and Eastern
Europe (CEE) for more than three years is a historical phenomenon which is still
giving rise to many questions about the duration, rhythm and scope of these
transformations, and about how financial capacity and managerial resources may be
harnessed to modify the structure of these economies and create durable market
conditions.
Considerable attention has been paid in recent years to questions such as how to
articulate and order macro- and microecönomic measures, whether to focus on
macroeconomic stabilisation or other measures, and how to privatise public assets.
The difficulties caused by massive privatisation, brutal recession and rapid
growth in unemployment have led to questions on some aspects of current transfor-
mations, particularly on the microecönomic aspect of the transition, the link between
privatisation and industrial reorganisation, and finally the capacity of these
economies to generate managerial skills rapidly, in order to manage newly privatised
firms. The role of the state in industry must also be defined, by comparison with
alternative models where public authorities intervene.
Prof. X. Richet, ROSES-CNRS, University of Paris I, 90 rue de Tolbiac, 75013 Paris, France.
This article is based on current research being carried out in several Central and East European
countries, financed by the French Ministry of Research and Technology. Several of the points
studied in this article were discussed with researchers from ROSES, and with researchers and
people involved in privatisation in Bulgaria and Hungary. The ideas developed here were also
discused with A. Gelb and I. J. Singh, of the World Bank, Saul Estrin, from the London Business
School, and S. Gomulka, of the London School of Economics. However, I take entire respon-
sibility for the judgements and possible errors in this article.
230 Xavier Kicket
retail trade sector, as against 11.7% in Ireland, 9.1% in the Netherlands and 7.3% in
France (Kharas, 1991). It has been calculated that, on average, the CEE countries and
the ex-USSR used twice as much energy and 2.5 times as much steel to produce one
unit of GDP compared with the average Western European market economy
(Winiecki, 1988). The absence of a financial system, the reliance on administered
prices and the subsidy policy have helped to build up the distortion and to limit the
impact of incentives to allocate resources more rationally. In Hungary, bureaucratic
redistribution reached a level where the total of subsidies equalled the profit made by
firms (Kornai & Matits, 1986). Thus firms achieving a high performance were
penalised to prolong the life of the most inefficient ones. In Czechoslovakia,
subsidies in 1988 represented 13.5% of GDP.
Labour productivity
1970-80 0.4 5.2 0.5 0.9 6.0 5.1 4.3
1980-87 2.7 3.8 3.7 2.3 2.5 2.1 3.4
Capital productivity
1970-80 -1.1 0.0 -2.8 -1.6 -0.5 -0.2 -2.0
1980-87 -3.3 -0.9 -2.3 -1.6 -3.8 -2.5 -2.2
Source: World Bank, Socialist Economies Reform Unit Data, 1990.
The private sector, more or less tolerated in most cases, encouraged in others
(Hungary, Poland), developed only slightly, hampered as it was by bureaucratic
regulations. Private activity developed only in sectors in which the scarcities were
relatively high (services, building), and where entry was difficult to halt. While these
activities stimulated the entrepreneurial spirit of some, they remained relatively
marginal. They only represent 14% of GDP in Hungary and Poland, 9% in Bulgaria,
3.1% in Czechoslovakia, and 2.5% in Romania in 1989. In fact, a two-tier structure
developed, and the growth of private activities had virtually no influence on the
behaviour of firms in the state sector, which enjoyed monopolistic positions.
The new democratic governments have inherited this industrial structure, which
they have undertaken to transform rapidly in the years to come, by adopting various
measures (Bornstein, 1992).
232 Xavier Richet
Transformation of Ownership Rights and Barriers to Privatisation
The transition to a market first of all implies the existence of actors capable of
influencing the market, that is, persons or institutions entitled to ownership rights
associated with the holding and use of assets. Several factors are favourable to
privatisation (Neuberger, 1992; Richet 1991):
(a) the arrival in power of liberal and conservative political majorities favours the
adoption of privatisation measures, all the more so as they imply a perhaps
romantic conception of a market economy (the notion of the smallholding which
existed in these countries before socialist industrialisation);
(b) the opportunity to drain the population's financial resources into the purchase of
state assets offers a way of mopping up excess money;
(c) a market economy requires the participation of actors with property entitlement
if it is to function properly. Furthermore, the market seems the best way to
apportion resources and coordinate economic activity in a decentralised environ-
ment;
(d) privatisation would create an irreversible situation by swiftly changing owner-
ship ratios;
(e) privatisation would reduce the power of the old and the new bureaucracies over
industry,2 and reduce the control of the new bureaucrats over state assets;3
(f) privatisation would compensate for state disinvolvement by stimulating swift
development of market mechanisms.
Another problem is the choice of privatisation techniques. While the final objective
is the same, the new governments in the CEE countries have opted for three forms
of privatisation, which could be divided into two types, internal and external
privatisation (Table 4).
In the first, state assets are distributed among the population. This is the simplest
technique and apparently the fairest. This is what is being applied, with some
difficulty, in Czechoslovakia. Citizens buy vouchers which give them the right to buy
shares through auctions organised by the government, or they can sell the vouchers
to investment funds (more than 430 in Czechoslovakia at the time of writing). At the
Privatisation, Restructuring and Entrepreneurship 233
moment, this technique of privatisation is causing a certain amount of speculation.
The difference between the nominal value of the vouchers and the potential value of
the shares in firms is considerable. Once the firms are sold, the scope for speculation
will diminish greatly and the profitability of the firms will be less than speculative
gains, so shareholders may well lose interest. Nevertheless, the positive aspect is that
the numerous investment funds which have spontaneously been set up will play the
role of a real principal, facilitating both restructuring and control of acquired firms.
Another technique, chosen and applied in Poland, consists in constituting a
capital market very quickly by creating financial institutions ex nihilo, which will
then manage the former state property. The highly sophisticated plan established by
the Polish government provides for the creation of a certain number of institutions,
which will receive the state assets and then act as if on capital markets; creating
pension funds, unit trust funds, banks, employee incentive funds, and sales or
distribution to company officers. The goal is to privatise state assets on a massive
scale by internal and external privatisation.
Several criticisms could be made of these two processes, even though they have
the advantage of being irreversible in effect, by rapidly reaching a critical mass. The
first criticism is that the system is very precarious. It assumes that those receiving the
assets (private persons or institutions) will behave as true actors on the market, and
will provide sufficient incentive for firms to improve their efficiency. This approach
ignores the fact that economic agents such as the government, managers and
households in post-socialist economies are in the great majority of instances averse
to taking risks, and will not necessarily manage their assets in optimum fashion; on
the contrary, many might be tempted to seek gilt-edged securities and flee financial
investment. Another criticism is that the value of state firm assets is low, and so
future profitability is doubtful.
Because most of industry is obsolescent, the governments want to shuffle off
responsibility by giving a poisoned chalice to the citizens, leaving them to restructure
industry. In this case, according to partisans of this strategy for disengaging the
government, the nomenklatura would have less opportunity to take control through
spontaneous privatisation.4
A third approach, that of the Hungarians, is to sell firms directly to internal and
external operators. The advantage of this strategy is that management is in the hands
of operators with industrial experience. Here again, criticisms can be made. It is a
slow process; time is needed to find buyers and evaluate assets where no reliable
accounting system is available. It can lead to a particular type of 'crowding out':
potentially profitable firms will be sold first, and as the number of potentially
saleable firms diminishes, the government agency for state ownership will find itself
with virtually unsellable assets. This hypothesis is being confirmed by the slow rate
at which state firms and small units are being privatised. In practice, it is mostly a
combination of the three approaches that can be observed, in varying degrees in the
three countries most engaged in the privatisation process, Hungary, Poland and
Czechoslovakia.
In spite of pressure from representatives of former owners, discussion on
restoring property nationalised by the former communist governments has not
yielded very extensive results. The problem of restoration seems insoluble, and,
indeed, unjust, both legally and economically. This is because it is impossible to
discount the value of property, and because no laws exist (properties nationalised by
the communist governments were then sold to individuals). Moreover, it is unjust
because some nationalisation and expropriation took place before the communists
234 Xavier Richet
arrived (Jews and German minorities were expropriated, and large estates and
industrial enterprises were nationalised before 1947-49), and the resulting national
income was collected in the name of the people by the planners. The Hungarian
solution has been financial compensation: former owners have received vouchers
with which to buy shares in privatised state enterprises. In Czechoslovakia, more
than 50 000 businesses have been restored to their former owners. Many claims
remain and a special fund, financed by the receipts from privatisation, has been set
up. It is probably in Bulgaria that the law on restoration of former owners' property
has been the most extended (Injova, 1992).
This review of privatisation policy and conception illustrates the different
approaches and shows how optimistic governments are about the swift accomplish-
ment of their programmes (Table 5). In Hungary, Poland and Czechoslovakia
privatisation of state-owned enterprises has proceeded relatively slowly in fact
(barely 10%), and the worst is certainly to come. Great Britain took some ten years
to privatise 10% of its productive capital; Hungary, at this rate will take several
decades. However, as some experts have pointed out, the value of state assets has
been considerably overestimated, and at the moment it is falling (Mihalyi, 1992).
Enterprise Restructuring
Some aspects of restructuring in enterprises can be mentioned (Singh, 1991):
(a) Changing the control structure. Firms which were in the charge of a branch
ministry must break the ties which linked them to the central power and separate
management from ownership, thus making management responsible to owners.
(b) Internal organisation of enterprises. State firms are characterised by the absence
of departments specialised in sales or in accounting. Management control is
virtually non-existent, and any information collected is for the ministry and not
for decision makers.
(c) Technological change. Despite many efforts to adapt technology, most plants are
obsolete, on average 12-15 years old. Moreover, plants were used for production
of goods for the CMEA market, and therefore quality and design standards were
generally lower than those in Western markets. To face international competi-
tion, most of these plants will need replacement, and the remainder will need
adapting. In some cases state-owned firms are up to Western standards, such as
the plastics industry in Poland and aviation in Czechoslovakia. Companies
created jointly with Western firms should enable technologies to be mastered. A
further difficulty is in positioning firms according to their technological skills
(Dubois, Koltay, Mako & Richet, 1990).
(d) Change in financial structure. One of the consequences of introducing a financial
system is that firms in these countries will be obliged to change their financial
structures in areas such as debt and inter-firm credits. Most state enterprises have
particularly high debts. In many cases the balance sheets will need to be pruned
by writing off part of the accumulated debts in order to improve financial
conditions. Budget constraints must be made more severe. At the same time,
firms with high economic potential should not be penalised by the inefficiency
of the old financial system.
(e) Change in managerial attitudes. The manager in a state firm is the equivalent of
a foreman in a capitalist firm, all things being equal. He knows how to
coordinate some production operations, but has no links with the sales depart-
ment, management, or the bank. Managers must therefore change their attitudes
and take account of market tendencies and evolution in demand; within the
enterprise, a system of incentives should be created, and management must be
supervised by owners far more effectively. At the moment, in most cases,
management skills are non-existent, and some time will be needed to improve
the situation. Cooperation with Western firms may, in this regard, contribute to
the transfer of management skills.
236 Xavier Richet
Industry Restructuring
Industries also need restructuring with regard to three factors: size and economies of
scale, numbers, and competition within the industry.
1989 1990 1991* 1989 1990 1991* 1989 1990 1991* 1989 1990 1991* 1989 1990 1991*
Growth of GDP (%) 0.5 -12.0 -3.7 1.0 -1.1 - 1 6 -7.9 -10.5 - 1 3 -0.2 -4.3
Industrial production (%) -0.5 -23.3 - 1 2 0.8 -3.7 - 2 3 -2.1 -19.8 - 2 2 -2.5 -5.0 -19 2.2 -14.1 -27
Exports ($ bn) 15.6 18.6 18.6 14.3 13.5 13.7 6.1 3.5 3.2 10.9 10.8 11.4 7.9 6.4 6.1
Imports ($ bn) 17.4 14.7 18.8 17.1 19.0 16.5 3.8 5.2 3.9 12.4 12.6 11.3 10.0 8.9 6.5. 5
Inflation rate (%) 251.0 553.4 70.3 1.4 10.0 58.0 l.l 27.0 160.0 17.0 29.0 35.0 9.8 64.0 470.0
Unemployment rate (%) 0.3 6.1 11.5 0.0 1.0 6.6 0.0 0.0 4.8 0.5 1.7 8.3 0.0 1.6 10.7
Trade balance ($ bn) -1.8 3.9 -0.2 -2.8 -5.5 -2.8 2.3 -1.7 0.7 -1.5 -1.8 -0.1 -2.1 -2.5 -0.4
o
Exchange rate 1439 9500 13485 15.0 18.2 29.0 14.5 34.7 198 59.1 63.2 80.5 0.86 2.15 18.6
3
SX
Source: The Economist, 21 September 1991; OECD; UN-ECE; National Accounts.
xtrepreneursh
Note: * Third quarter.
to
238 Xavier Richet
through imports has soared for state enterprises which once held monopolies on their
domestic markets.
The implementation of these measures did not result in a J-shaped curve at
microeconomic level (Brada & King, 1991). The effect of the J-curve at this level
may be observed in increased output volume and increased well-being.
Because there is enormous distortion in the financial markets and the labour
market, adjustment costs resulting from modification of relative prices were much
higher than anticipated. On the capital markets, banking and financial infrastructures
are virtually non-existent, and gaps in the law have meant that there is little private
investment. The labour market lacks mobility because industrial structures are
extremely rigid. Another reason is that too much importance is attached to stabilising
measures, which are not seen in the context of sectoral and microeconomic measures.
State firms have attempted to avoid macroeconomic regulations, with all their
disparities, by using inter-firm credit, thus limiting the effects of monetary con-
straints.
The institutional reforms concerning ownership rights and privatisation have led
to modifications in the forms of ownership. Thus entrepreneurial capitalism in the
shape of small enterprises has begun to emerge, and public assets have begun, to a
smaller degree, to be privatised. In the latter case, it must be emphasised that
progress is slow (Table 7).
(a) Assets would be kept under control. Mass privatisation by distributing and
selling assets to the public would lead to managerial control because ownership
would be too fragmentary.5
(b) Western experience shows that enterprises which disinvest first restructure their
assets in order to increase their value. At the moment, the value of assets to be
privatised is steadily depreciating owing to high opportunity costs.
(c) The financial holding companies which would have greater expertise than the
specialised agencies such as Agencies for State Property, which are entrusted
with privatisation. The latter are small units of necessarily bounded rationality.6
Alongside a financial strategy, holding companies could develop industrial
strategies by seeking to encourage synergies between the firms in their portfolio,
or with firms under other holding companies' control. They could gradually
privatise themselves by selling their own shares on the stock exchange. One
disadvantage to this model is that it is difficult to see what type of principal
240 Xavier Richet
could be used to control holding companies in the absence of strict monetary and
financial policies.
This strategy diverges from the transformation procedures in CEE countries such as
Hungary and Poland, where state enterprises have built up cross-control patterns.
Because state enterprises, in changing their legal status, redistribute ownership rights
without necessarily selling assets to private operators (Mihalyi, 1992), one part
remains in state hands, another in those of local authorities, and the remainder in
employees' ownership. Transformation is on the same lines as the redistribution of
activities. In the end, it is the taxpayer who pays for the transformation. In fact, the
forms of ownership are changed with no notable alteration in the state's control,
since it remains the major shareholder. In Hungary and Poland, recent data show that
citizens only bought a small percentage of state assets (a mere 12.5% in Hungary in
1991). This strategy also enables the state to maintain its prerogatives and favours
the development of managerial control which is still strongly risk-adverse.
minimum efficient size for firms which are to be split up and privatised, notably
fanning and industrial cooperatives. There again, the French experience in restructur-
ing state-owned groups in 1984-86 could be used as an example.
A further aspect of industrial policy is financing of firms and access to capital
such as loans with interest rate subsidies, and budget subsidies, and adopting tax
incentive and protectionist measures. Some products close to final consumption
could be protected in order to maintain employment, exchange rate policy could
favour exports, and finally, certain industries could continue to receive operating
subsidies; at the same time, the government should recapitalise enterprises with high
growth potential. Implementation of CEE industrial policies raises some problems,
however:
(a) such action recalls previous interventionist practices on the part of centralised
authorities which have influenced most sectors of activity in the past;
(b) it is difficult to determine priority sectors and to select the appropriate instru-
ments;
(c) bureaucratic forms of management might be perpetuated, thus delaying structural
adjustment supposedly because industry needs to be protected and employment
maintained;
(d) the high level of investment needed;
(e) the weakness of present governments and the lack of competence (state decision
makers with bounded rationality) in implementing these choices.
Conclusion
Every road leads to Rome. The economies in Central and Eastern Europe have
moved into a transition period at varying speeds, some preferring shock therapy,
others a more gradual approach. They are nevertheless confronted with the same
difficulties—considerable disparity between stabilisation and adjustment, and the
slow rate at which enterprises in the state sector are changing. Governments have no
clear vision of the industrial strategies to be followed, and think that privatisation
alone will be enough to ensure structural adjustment and transformation into market
economies. The process of trial and error will be long, and will cost more than
anticipated; but the experience gained by the actors in today's transformations should
enable them to choose the most effective organisation model.
Notes
1. It is interesting to note that the directors of Volkswagen did not modify the management
of Skoda when they took it over, whereas in other countries and in other sectors, Western
acquirers have been led to change the top management in enterprises newly taken over.
2. Cases where state assets are totally taken over by the former nomenklatura are relatively
limited. However, nomination of new bureaucrats to executive posts in industry is likely
to perpetuate bureaucratic interference in different forms.
3. The creation of financial holding companies to manage state assets could facilitate this type
of control.
4. By underestimating the value of assets and assigning them to puppet companies. On a first
view, this type of acquistion seems likely to be limited in scope (Mihalyi, 1992).
5. Managerial control, as a first step, would be a second best and if free entry and exit on
markets exists, this could facilitate subsequent take-over and lead to a better control.
6. An exception must be made of the Treuhandanstalt in the former East Germany, which
242 Xavier Richet
operates in a market environment. It is a much bigger institution in terms of workforce
(3000 persons), resources (from West Germany) and skills (the directors come from West
German industry). (Cf. Carlin, 1992)
7. The industrial choices of CEE governments are somewhat contradictory. On the one hand,
they seek to demonopolise the economy by splitting up big enterprises to adapt them to
their markets, and on the other, foreign acquirers wish to maintain the monopoly positions
of the firms which they have taken control of, such as Volkswagen-Skoda in Czechoslo-
vakia, and Schlumberger-Ganz-Meter and Ansaldo-Villamosagi in Hungary.
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