PRIVATIZATION IN NACC COUNTRIES
Defence Industry Experiences and Policies
and Related Experiences in Other Fields
    
COLLOQUIUM 1994 ********* COLLOQUE 1994

PRIVATISATION DANS LES PAYS DU CCNA
Experiences et politiques des industries de defense
et experiences comparables dans d'autres secteurs

Colloquium
29-30 June, 1 July 1994
Brussels
---------------------------------------------------------

PROBLEMS AND PROSPECTS FOR PRIVATIZATION IN
POST-COMMUNIST COUNTRIES

Salvatore Zecchini

     The fact that privatisation of state-owned
entreprises - in both the East and West - has become a
priority for governments is not a historical coincidence,
says Salvatore Zecchini. Governments are now realising
that privatization is a powerful instrument to help them
revive economic growth. Privatization is not the main
solution to problems affecting the defence industry.
But it can be an important component of a multifaceted
strategy. In the face of conflicting pressures, it is
likely that privatization in the next five years will
continue to be a gradual process and not the
determinant factor behind the expansion of the private
sector.

Salvatore Zecchini is Assistant Secretary-General of
the OECD in Paris, and Director of the Centre for
Co-operation with the Economies in Transition.

     It is not a casual coincidence of history if, in this
decade, privatisation stands high on the political and
economic agenda of both several OECD countries and all
the post-communist countries. It is rather the result
of a fundamental conclusion drawn by governments in
both areas, i.e. that privatisation is a major
instrument to realise important welfare gains for the
country as a whole because it revives economic
initiative and promotes innovation and higher
productivity, all factors that lead to sustained
economic growth. A concurrent consideration common to
both OECD countries and post-communist countries is
that privatisation can help the government to generate
resources or to save resources for the purpose of
reducing budget deficits. 
     Not only in ultimate goals but also in the
privatisation methods there are similarities as both
country groups are privatising similar categories of
public assets, i.e. land, manufacturing enterprises,
financial institutions and individual production
facilities. In spite of these similarities,
privatisation in the CEECs and NIS is in many respects
a process and a problem different from that which can
currently be seen in the OECD area. It is not just a
difference in the absolute and relative scale of this
operation since the CEECs and NIS have to privatise the
bulk of their productive assets. There are other more
important differences.
     The economic backdrop against which privatisation has
been taking place is much more difficult than in the
OECD area as all the reforming economies have
experienced a deep reduction in the level of economic
activity, living standards and savings. In addition,
they have had to pursue a much more diversified set of
privatisation objectives than merely disposing of
public assets at the best price. They also lacked an
institutional, legal and financial infrastructure that
could ease the ownership transfer, protect private
ownership and promote entrepreneurship. Last but not
least, privatisation had to be carried out in a context
of scarcity of domestic private capital and severe
shortage of entrepreneurship and management skills.
     All these differences make it doubtful whether these
economies can duplicate or draw many useful lessons
from the recent privatisation experience of OECD
countries. To deal with the unusual aspects of their
privatisation problems, the CEECs and NIS have had to
do a fair amount of experimentation, to draw on each
other's experience, and to carefully blend foreign
technical expertise with their own assessment of the
internal constraints to privatisation. But in one area
that is essential to support privatisation and in which
these countries have to take measures which are not
needed in the OECD countries, their action has been
below their possibilities. This area is the rapid
reform of the legal and institutional system which
presides over the carrying-out of economic activities.
     Instead of continuing to dwell on a comparative
analysis of the privatisation issues, I will
concentrate my remarks on the state of privatisation in
the CEECs and NIS, on the main problems which hamper
privatisation, with a specific attention to the defence
industry, and on the prospects for the next few years. 
     At the beginning of the transformation process,
privatisation, together with economic liberalisation,
was hailed by governments and people as the driving
force to accelerate the change of the economic system
and to inject dynamism into these lagging economies. In
fact, after 3 or 4 years this expectation has not
materialised in any of these countries in spite of the
considerable planning effort.
     In the last three years, it is the rapid output
expansion in the private enterprise sector that has
been the main factor to reverse or to slow down the
general economic decline. In Poland, Hungary and the
Czech Republic the private sector already contributes
more than half to GDP formation. Such an expansion,
however, has not critically depended on the pace and
extent of enterprise privatisation. For instance,
Poland has privatised only about 20% of its public
firms and Hungary only 1/3 in terms of asset value. The
disposal of individual or relatively small production
assets outside enterprise privatisation has instead
been important to allow many private entrepreneurs to
build a minimum of capital base rapidly. 
     As the private sector could not afford large
investment outlays, it has developed in
low-capital-intensity activities in which it could use
relatively small production facilities or assets,
previously in public hands, in a new enterprise context in
which it could achieve sharp productivity gains.
     If in many segments of the services sector private
enterprises are predominant in number and output and if
the share of services in national output has risen
sharply in all reforming economies at the expense
mostly of industry's share, this is also due to the
flow of relatively small public assets into private
hands, while major assets and enterprises have remained
in the public domain.  
     Of course, within this general picture of the role of
privatisation, important differences exist. Progress in
privatisation has been very uneven in terms of both
countries and types of assets. Among the CEECs, the
Czech Republic has progressed more than the other
countries with more than 60% of public enterprisesÕ
assets already privatised or in the process of being
privatised in the on-going second wave of voucher
privatisation. Russia has been the most rapid country
in privatisation: about 40% of large enterprises and
more than half of small enterprises have changed hands
in less than two years. Estonia and Lithuania have also
advanced considerably in ÒlargeÓ and ÒsmallÓ
privatisation. Ukraine and other NIS are instead
lagging behind, still remaining at the beginning of
this process. 
     The so-called "small privatisation", namely the one
involving small firms operating in retail trade,
catering services, transport and small construction
businesses as well as small production units, is very
advanced if not already completed in some countries.
Furthermore, in Poland and Hungary, privatisation (de
jure or de facto) of production assets as opposed to
entire enterprises has been quite important, accounting
for about half of privatised production assets. This
has been performed, for instance, through
"liquidation", whereby production assets are
transferred to new entrepreneurs while the old public
firm disappears and its liabilities are taken over by
the public sector. Considerable delays instead
characterise privatisation of large firms, with the
exception of the Czech Republic and Russia which are
the only countries that have made substantial progress
in this respect. 
     The ownership change has not affected all economic
sectors to the same extent. Heavy industries,
utilities, energy, major transport firms and major
chemical industries have so far largely escaped
privatisation for reasons that cannot be related to the
notion that potential market failures justify retaining
these firms under direct public control.
     To this effect, several countries have instead used
the argument of the strategic nature of these industries
or sectors; they have not considered the possibility of
obtaining more efficient enterprises through
privatisation coupled with a new model of industry
regulation. Only lately there has been a change in
attitude in Hungary, Poland and the Czech republic.
They have privatised or are privatising public
utilities, such as power generation, telecommunications
and water supply. This can be explained with the
increasing pressure on these governments to generate
additional resources for the public budget and to
improve the quality of these services and management.
Banks and other financial institutions have been
privatised to a very limited extent, particularly
because they require extensive support by the
government due to the insolvency of many of their
debtors belonging to the public enterprise sector. 
     With the exception of Poland where agriculture was
not nationalised under the previous regime, agricultural
land is still to a large extent under public or
old-co-operative ownership. Problems in partition of
land and in some countries the unsettled question of
restitution to original owners are adding to the
delays. In those countries in which agricultural land
ownership has been transferred to peasants or
co-operatives, the impact on production has been
generally negative so far, because the new private
farmers have not been able to acquire needed farm
equipment and inputs, and to develop models of farm
enterprise which are a viable alternative to the old
co-operatives. In spite of being relatively easier to
implement, privatisation of housing is far from
complete because of delays in reforming rent level
determination and house purchase financing. The only
exception is Hungary where a favourable financing
scheme has accelerated this privatisation. 
     Overall, a large number of public assets are now in
private hands in CEECs and Russia, but in spite of the
considerable amount of preparatory work which has been
done in most post-communist countries, the bulk of
industrial, banking and large-scale enterprises has
still to be privatised. Only the Czech Republic and
Russia seem seriously determined to press ahead for the
completion of this process in a short period. As to the
other countries, it is not clear whether they will
overcome the many obstacles encountered in this process
and what will be the share of public ownership in the
enterprise sector at the end of this decade and its
importance for the development of these economies. At
this juncture in the transformation of the
post-communist economies what are the main problems
hampering progress in privatisation? 
     Clearly, privatisation has not been hindered by the
particular approach followed by these countries. After
the initial professions of faith in one or the other
approach, these governments have soon come to recognise
that to deal with the complex reality of public firms
dismissal it is necessary to use all available methods.
All countries are currently resorting to a multiplicity
of approaches, although there are differences among
countries as to the choice of the predominant approach.
     Mass privatisation, i.e. the unrequited transfer of
ownership to the population at large, has either been
adopted or is being considered by all countries. This
is the only instrument that can accelerate the pace of
privatisation because it does not discriminate among
sections of the population in terms of who would
benefit. Moreover, it avoids the difficulty raised by
the capital requirement for the acquisition of
ownership or the difficulties of having to restructure
a firm before it is sold.  
     Therefore, it is not surprising that privatisation
has progressed rapidly in those countries in which this
method has been applied more extensively. The Czech
Republic and Russia, which are the front-runners in
privatisation, have transferred more than half of the
book value of privatised firms through mass
privatisation vouchers. Hungary, which has had
difficulties in making privatisation advance, has
recently introduced generous credit facilities for the
purchase of firms by its population in order to obtain
some of the benefits stemming from mass privatisation.
Through this approach it can quicken the pace of
ownership transfer. 
     It is evident that the public sector of these
countries is not in a position to carry out a
reorganisation or operational restructuring of its firms
to make them competitive in the market place. These
governments even lack the means to implement a financial
restructuring aimed at helping the firm to achieve a
balanced capital structure by reducing its excess leverage
(i.e. eliminating its debt overhang). The public owner can
instead be expected to "corporatise" its firms, and to
break up large firms. Apart from these tasks,
restructuring is to be obtained by private
entrepreneurs once ownership has been transferred to
their hands. Management contracts are just an
approximation to this result. Poland is the country
that more than any other has been engaged in
pre-privatisation reorganisation, but this has been
possible only for a relatively small number of firms.
Extending this approach to the rest of large
enterprises would imply a significant protraction of
privatisation. 
     Management or employee buy-outs are the second most
used instrument for privatisation. They have been
linked to voucher schemes for mass privatisation or
sales under preferential conditions. Both options have
been widely applied in Russia, Poland and Lithuania on
the request of the enterprises themselves. 
     Trade sales, i.e. the sale of firms to strategic
investors through public tenders, closed tenders,
direct sales, or various forms of auctions, are more
difficult to implement than other methods because they
require extensive preparation of the sale, a measure of
restructuring of the enterprise to be privatised, and
adequate financial support. Among the reforming
countries, Hungary is the one which has chosen to rely
mostly on this method as it accounts for about 3/4 of
privatised firms by book value. As long as it followed
only this approach Hungary made relatively slow
progress in privatisation. 
     If the approach to privatisation is not at present
the main problem in making progress, other factors
constitute impediments. First, the initial enthusiasm
and social and political pressures for privatisation
are fading away in several countries, including Hungary
and Poland. Political consensus is lacking because of
the persistent fear of adverse social consequences of
post-privatisation restructuring.
     Two consequences have been a source of particular
concern:
a) the radical change that privatisation induces in the
distribution of wealth;  this represents a major shock
for societies used to decades of "egalitarianism";
b) the restructuring of the labour force and social
services provided by the privatised firm which tends to
eliminate the job and social guarantees of the old
regime.
     In the face of these concerns, governments tend to
link privatisation to the fulfilment of a multitude of
objectives other than achieving efficiency gains. These
include distributing public assets to all the
population since all have contributed to their
build-up, creating new employment opportunities or
limiting job destruction, obtaining guarantees of
development of the firm's capital, favouring new
entrepreneurs, and maximising proceeds.
     These aims are not mutually compatible, and cannot be
achieved by privatisation alone, even if the approach
is diversified into alternative methods that are
applied to different portions of public assets. To the
extent that governments have not been able to establish
an order of priority between conflicting aims, a
compromise has been the necessary outcome and the
easiest compromise of all was initially to delay the
process. Of course, delays are not a viable solution as
they lead to a deterioration of assets, abuse through
mismanagement or misappropriation, and eventually to
liquidation of firms.
     Thus, after the initial stage, mass privatisation
became the main solution to political and social
impediments. But this is not the best solution for the
economy because the development of these economies
demands a certain degree of concentration of enterprise
ownership in the hands of entrepreneurs who are fully
committed to steer the course of their enterprises.
Hence, a second stage of ownership adjustment is
necessary after privatisation and this requires well
functioning capital markets. 
     Nevertheless, as a second-best solution, mass
privatisation is the easiest approach, and at the
present juncture a number of lagging countries are
moving in this direction. They are actually forced to
privatise because there is less room in their budgets
to sustain the cost of supporting public enterprises
and past delays in privatisation have not led, as
expected, to lower hardship for people and easier
recovery for these economies. Even under these
conditions, progress will depend on the capacity of
governments to develop cost-effective social policies
to smooth the enterprise restructuring process. 
In this respect, two conditions must be fulfilled:
a) that the level of economic activity starts rising
again;
b) that an active labour market policy is developed. 
     The second major problem is represented by the
inadequacies of the institutional and financial
framework of the economy and of privatisation itself.
At the institutional level, the transfer of ownership
is still taking place in a context in which property
rights are not adequately protected and private
enterprises operate in an uncertain legal and
regulatory environment.  
     Enforcement of contractual obligations is doubtful
and costly, while the hold of the old bureaucracy over
economic activities is still pervasive. At the
financial level, privatised enterprises face
difficulties in meeting their financing requirements
and in diversifying their capital sources in order to
correct their currently-high financial leverage. Credit
allocation by banks is still distorted in favour of
firms holding public guarantees.
     The possibility of reducing enterprises' debt ratio
through debt/equity swaps with the creditor banks is
limited because of the weak capital base of most banks.
Financial markets are still at an early stage of
development and are dominated by the financial
instruments issued by the government. The general
attitude of these countries has been to give priority
to solving industrial crises on a case-by-case basis.
Less emphasis has been placed on improving rapidly the
economic environment, in easing rigidities on the
employment of labour force, and in developing
competitive markets for products and factors of
production. 
     Under these framework conditions, it is difficult to
expect that privatised enterprises can become
competitive soon and that privatisation can bring about
an early renewal of these economies. 
     Linked to this problem is a third one, i.e. the
failure of privatisation in all the post-communist
countries to attract large flows of foreign capital.
Although there have been some restrictions or
discriminations against foreign investors for the purpose
of preventing a sell-off to foreigners, these measures do
not seem to have constituted a major disincentive. 
     For instance, even in the case of Hungary, which is
the largest recipient of FDI, only one third of foreign
capital has been invested in the purchase of public
firms, while the largest part has been oriented towards
the establishment of "greenfield" enterprises. In fact,
the same rigidities in capital and labour use that
depress the profitability of domestic investment in
public firms, discourage foreign participation in
privatisation. Since these firms, like the others, need
foreign capital and know-how to gain competitiveness
and profitability, the government should consider what
support to give to potential foreign investors in order
to partly offset the disincentive stemming from these
rigidities. In so doing, they would not discriminate
against domestic investors because the latter already
benefit from mass privatisation free of charge and
other preferences.
     A fourth problem is represented by the shortage of
entrepreneurs. These countries have at their disposal a
substantial number of good managers of production
processes but have also a shortfall of entrepreneurs,
i.e. people that are able to launch new production
initiatives and manage business risk. The transfer of
ownership into private hands does not lead, on its own,
to a rapid conversion of good production managers into
good entrepreneurs who are capable of maximising the
value of their enterprise within the constraints of a
competitive market economy. Therefore, to ensure that
privatisation leads to development of viable
enterprises, it has to be coupled with a government
action aimed at promoting entrepreneurship on an
economy-wide scale. 
     A fifth problem concerns the uneven quality of the
enterprises which have still to be privatised. In the
initial phase governments have disposed mostly of the
firms which are in better conditions and can attract
investors' attention. As privatisation advances, what
are on offer are the less attractive firms and demand
for them by private investors might be lacking. In this
case governments are faced with the choice between
liquidation and restructuring before privatisation.
     Both options are costly and difficult to implement
since they involve either dealing with the resulting
unemployment and liability settlement, which also
affects banks' solvency, or planning and implementing a
business-oriented restructuring. Hence, with progress
in privatisation, its interdependence with progress in
other policies, such as industrial, social and
financial policies, becomes critical for making further
headway.      
     Privatisation of defence industries raises a number
of problems that leave little in common with the general
issue of privatisation. The difficulties in the defence
sector derive basically from a shift in the composition
of the demand in the economy: military procurement has
been cut back sharply in a short period and government
subventions to military industries have been curtailed.
At the same time demand for civilian goods has risen
but in a new context of markets open to competition and
of a decline of per-capita income levels for large
sections of the population.
     Other peculiar difficulties are the exclusive
dependence of the economy of certain regions on
military industries, the relatively high incidence of
laboratories and test facilities over total facilities,
the secrecy surrounding many technologies and the
coexistence within the military sector of a
considerable production of consumer goods and machine
tools. For instance, in the former Soviet Union, it is
estimated that more than half of consumer goods were
produced by the military-industrial complex. To assess
the role and problems of privatisation in dealing with
these difficulties the governments have, first, to
clarify the objectives to be pursued. 
     Thus, the first problem to be tackled is to decide
whether to pursue a reallocation of human and physical
capital as well as technologies towards other sectors
of the economy or other enterprises which are expanding
in the new market-based economic system, or to continue
investing in the military industries to produce the new
range of goods and services requested by the market. 
     Related to this problem is a second one pertaining to
the structure of ownership. The question is whether the
government should retain ownership of facilities
working for the market and aim at upgrading their
management, or should transfer ownership to the private
sector, being that more market- and business-oriented.
Likewise, as to defence-oriented production facilities,
the question is whether the national security concerns
could be addressed through other means than direct
government ownership of these facilities. In other
words, should the government be only on the demand side
of the economy, leaving the supply side for both
military and civilian goods exclusively in private
hands? Or should the government turn military
industries into conglomerate companies which own both
civilian and military-oriented companies and which can
use resources generated in one group of companies to
support the other. 
     Assuming that a certain portion of the current
defence industry has to be privatised, another question
emerges: whether to privatise individual assets, or
entire plants, or to extend privatisation to military
technology for the purpose of allowing their use in
non-military sectors. All these questions have to
receive an answer at the political level rather than at
the military one since these involve many
considerations which lie outside the military realm and
also concern the future structure and development of
the economy. From an economic point of view, it would
seem appropriate that all facilities working for the
market be transferred to the private sector because the
latter is in the best position to compete in the market
place. 
     It is not clear whether countries with a sizeable
defence industry, such as Russia, have moved in the
direction of drawing a clear demarcation line between
the core defence activities to be retained in the
public sector for security reasons and the other
activities which can be privatised. By the end of 1993
Russia had privatised more than 270 defence-related
enterprises and corporatised another 760. In the same
period it is estimated that more than 1.8 million
workers had left the defence sector. 
     In view of all these problems afflicting the defence
industry, it does not seem that privatisation per se is
the main solution. It is, however, an important
component of a strategy which starts with "unbundling"
the defence industry in to privatisable and
non-privatisable assets, then proceeds with privatising
all that is not related to ÒcoreÓ national security,
and eventually leads to a restructuring of privatised
enterprises by private entrepreneurs.  
     Enterprise restructuring is, nevertheless, a
difficult task since it requires converting military firms
to the logic and demands of the market. The experience of
the US after the World War II and that of other OECD
countries more recently shows that plant conversion
seldom succeeds because the military enterprise culture
does not encompass critical elements for being
successful in the market place, such as
cost-effectiveness, market analysis, financial
management and marketing. It has often been the case
that OECD countries, instead of converting or
privatising defence plants, have found it more
appropriate to liquidate these assets or to scrap them
outright. Recent surveys of Western investors also
confirm this conclusion as they indicate a clear
preference for establishing new plants in the reforming
economies rather than converting existing defence
plants. Hence, it seems that the reforming countries
should focus their response to the problems of their
defence industry in directions other than enterprise
privatisation. Specifically, they should aim at
creating an environment conducive to the creation of
new enterprises and new job opportunities. This has to
be supported by consistent social, credit and
labour-market policies directed to favour the
reallocation of production factors. For regions which
are particularly hit by defence expenditure cut-backs,
it is also necessary to resort to regional development
plans. 
     Leaving aside defence privatisation, what future can
be envisaged for the general privatisation process in the
next five years, starting from the present situation
and the many problems already mentioned? In the
countries that have made limited progress so far, an
acceleration of the pace of privatisation seems
unlikely unless a new high wave of mass privatisation
for free is launched. As for the others, mainly the
states of the former USSR who have lagged behind, an
acceleration is possible. The pace of privatisation
will likely depend on two conditions:
a) the stringency of the public budget constraint which
might deprive public firms of critical support; and
b) the pace of output recovery since a revival of
economic activities might ease the social costs of
privatisation. Overall, only in one or two countries,
such as the Czech Republic and Russia, enterprise
privatisation is expected to be completed by 1997.
     For the others, privatisation will continue to be a
slow process, which might become hostage to social and
political compromises, and might be restricted to a
fraction of existing public enterprises. In contrast, a
rise in the demand for the purchase of public firms
could stem from the expected easing of the current
constraints represented by the weakness of the legal
and institutional framework of the economy, the
shortage of domestic capital and the limitations in
entrepreneurial skills. This is not, however,
sufficient to spur the authorities to accelerate
privatisation, unless significant benefits are
expected, such as significant revenue for the currently
strained public finances or considerable capital
in-flows for the balance of payments. 
     In the face of these conflicting pressures, it is
likely that in the next five years the development of
the private sector would have to rely more on new
entrepreneurial initiatives than on newly privatised
public enterprises.  
     Surprisingly, it might be the case that the
autonomous expansion of the private sector could offer a
window of opportunity for facilitating speedier
privatisation. By attracting labour currently employed in
public firms, the private sector could alleviate the
social impact of privatisation, and defuse its most
contentious aspects. The outcome could be to bring to
manageable proportions either the closing-down of public
firms or their radical restructuring for the purpose of
making them competitive. In other words, the problem of
privatisation could disappear since public firms could
either be liquidated and their production assets sold
if not written off, or they could be turned into viable
firms managed along business-oriented criteria and in
no need of privatisation. 
     Regardless of whatever scenario would become reality,
it is likely that in most of these countries the
economic system would evolve in the coming years into a
sort of "mixed capitalism", with private firms
co-existing and competing with an important sector made
out of firms owned by public authorities. In such a
context, the major concerns for the purpose of
attaining efficiency gains for the economy as a whole
are both to create the framework conditions for private
economic initiative to materialise and prosper, and to
ensure evenhanded treatment for private firms and
public ones so as not to distort competition. This
would imply the discontinuation of the many preferences
in financial and regulatory terms that public firms
have so far enjoyed. 
     Among the various forms of privatisation, free
ownership transfer and management or employee buy-out
at national prices will continue to prevail over trade
sales although the balance between them might shift
towards sales if considerable proceeds or employment or
investment guarantees will be provided by buyers
outside the firm. In any case, the initial ownership
transfer will be just the first phase of a process of
ownership restructuring which will continue after
privatisation. A new wave of ownership reshuffle is to
be expected in the next five years with the result of a
concentration of corporate governance in fewer hands
than at the moment of privatisation. 
     The wide diffusion of shares among the population
does not necessarily reflect people's desire to hold them
and to exercise the inherent ownership rights over the
way companies are managed. It is instead dictated by
the two needs of dealing with concerns over the
distribution of the accumulated social wealth and
implanting a new economic culture among people. In
spite of these needs, the reallocation of shares seems
inevitable in order to allow a mechanism of control
over and accountability of management to emerge in the
face of the current fragmentation of ownership. 
     Three components are crucial to this end:
a) investment funds or mutual funds;
b) secondary markets;
c) the banking system.
Investment funds and similar institutions are bound to
play a prominent role in controlling enterprises'
management as intended by the authorities in launching
mass privatisation. Building on these foundations,
their role could easily develop into providing equity
capital to new enterprises by attracting and mobilising
private savings. Their ability to monitor the state of
health of firms and their diversification of risks
offer clear advantages to investors over a direct
investment in enterprises' stocks. 
     Secondary markets for stocks and assets have begun to
develop in these countries as the principal mechanism
for adjusting the portfolio composition of investors
and to provide liquidity to share holders. Their
expansion has been hampered in some countries, such as
Russia, by temporary preclusions of subsequent
ownership transfers. With the progress in privatisation
and a wider diffusion of shares, pressure for the
abolition of these constraints will increase. A
significant development of secondary markets could
hence be envisaged. Such a development needs, however,
to be sustained by improvements in the regulatory
framework of markets and in the requirements for
transparency of information on enterprises and
financial institutions. 
     Apart from secondary markets, stock exchange markets
could become an important instrument for privatisation
by the end of this decade. So far only a small number
of firms have been sold in the markets (15% of total
book value privatised in Hungary and a lower percentage
in Poland). As these markets mature, it can be expected
that the number of public offerings of stocks will
rise. This will concern both entire companies' stocks
and minority stakes retained by governments after the
initial privatisation. This trend is already evident:
Hungary plans to sell large companies through the
Budapest Stock Exchange and the Czech National Property
Fund is selling shares retained after the first wave of
voucher privatisation. 
     Despite its current weakness, the banking system is
also essential in supporting both privatisation and
post-privatisation. Its role will strengthen to the
extent that banks are directly involved in the
restructuring of the liabilities of the enterprises to
be privatised. A certain number of debt/equity swaps
will take place and the increasing presence of stocks
among banks' assets will heavily influence the
operational profile of the banking system: the model of
"universal bank" might become the predominant one.
Banks will also fulfil the essential function of
supplying liquidity to investors and stock market
participants. Without such support, secondary markets
can hardly develop into efficient instruments for
resources allocation and would remain rather
unpredictable, with discontinuous patterns in price
evolution.  
     As regards the role of foreign capital, there are now
very few elements that might lead to an increasing
interest of foreign companies in participating in
privatisation, given several internal or operational
constraints that accompany privatisation. The
participation of foreign investors might instead rise
in the post-privatisation reallocation of ownership,
but this would demand major improvements in the
performance of stock markets and financial
intermediaries, such as investment funds. 
     Finally, two considerations on the expected benefits
of privatisation. Welfare gains for the economy as a whole
do not stem simply from privatisation but from its
combination with competition. So far there has been
limited support for demonopolisation prior to
privatisation, particularly among those interested in
acquiring public firms or that have already acquired
them. Nor has liberalisation of foreign trade, profit
regulations and competition laws been adequate to
reduce the market power of monopolists. In the absence
of demonopolisation authorities might refrain from
relinquishing their ownership of de-facto monopolist
firms. This does not seem the appropriate response
because privatisation of predominant market suppliers
might bring about higher efficiency gains than in the
opposite case if it is accompanied by more stringent
regulations aimed at reducing the market power of major
domestic suppliers and by incentives for new
competitors to enter the market. At any rate, the
commitments taken by several CEECs and NIS to lower
further their trade barriers in the next few years,
particularly vis-a-vis European companies, is bound to
make their markets much more competitive than at
present by the end of this decade. 
     As to the impact on public finances, privatisation is
not likely to generate large revenues for the budget,
assuming the prevalence of methods other than trade
sales. Some relief for public expenditure might however
derive from the disposal or liquidation of firms,
provided that the consequent social costs and social
expenditures are not substantial. If some large
enterprises are retained in the public sector for
several years a hidden burden would remain in the
budget. This will prompt the authorities to restructure
these enterprises and to establish objective criteria
for the accountability of management. Hungary, Poland
and Romania are already considering entering into
contracts with management groups to conduct operational
restructuring and manage these enterprises. Such
contracts, which include ownership incentives, might
expand in the near future and prove successful in
rehabilitating enterprises.  
     In conclusion, it has to be stressed that in a market
economy, privately owned firms generally outperform
public firms in cost-effectiveness, efficiency and
competitiveness. Hence, in order to raise public
welfare in the "mixed-capitalism" that will
characterise these economies for at least this decade,
privatisation has to remain a constant objective of
governments and should continue to be pursued in spite
of the difficulties. 
     In this respect, the main challenge for these
governments is not just to achieve a successful
restructuring of firms still kept under public
ownership but to be able to recognise when the time has
come for these firms to be privatised. If these
governments fail in taking a timely decision in this
sense, they will likely fall into the old trap of
inefficiencies and subsidies. In other words, they will
show that they have not learned enough from the
experience of OECD countries that after decades of
complacency are now forced by their economic ills to
push privatisation through. 
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Copyright 1994 NATO

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First edition 1994
ISBN 92-845-0079-6

This is the latest in a series bringing together papers
presented at the NATO colloquia organised by the NATO
Economics Directorate and Office of Information and
Press on economic issues in the former USSR and Central
and East European countries. For further information
please write to the Director, Office of Information and
Press, 1110 Brussels, Belgium.

The articles contained in this volume represent the
views of the authors and do not necessarily reflect the
official opinion or policy of member governments or
NATO.