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 ---------------------------------------------------------- CONVERSION AND PRIVATIZATION OF DEFENCE ENTERPRISES IN RUSSIA Keith Bush Conversion is hard in the West. In Russia, the problems are even more formidable. The tradition of creating state monopolies in defence production goes back to Tsarist days. Now the hothouse doors are open, and Russia's cosseted defence plants are having to pay market prices for raw materials and market wages for skilled workers. And with no more Warsaw Pact partners, she also has to make all her own weapons. Small wonder that there has been little enthusiasm to date for conversion, says Keith Bush. Things are moving - but a change in the political climate could uproot the whole process. Keith Bush is a Senior Associate at the Centre for Strategic Studies in Washington. During his professional career, he has acquired wide-ranging experience as an analyst of the Soviet economy. The conversion/ diversification of defense industries in the West will be difficult enough, but the problems facing the former Soviet Union and Eastern Europe in this area look even more formidable. In Russia the thrust of conversion will be via privatization. Formal voucher privatization has proceeded rapidly throughout the economy, but questions remain for privatized defense plants in respect of the remaining degree of state control and the amount of operational autonomy left with the enterprises. The conversion/diversification of defense industries to the production of civilian goods and services presents appreciable problems in any developed society, but the challenge to the military-industrial complexes of the former Soviet Union and in Eastern Europe appears to be even more formidable than in the West. The American experience has been typical of the starting point of most Western attempts to retool their military-industrial complexes. Defense firms have traditionally been geared toward working for one single customer, in the shape of the Department of Defense, that sets the price, pays much or most of the bill upfront, and then provides new infusions of cash as each specified phase of the project is completed. The factories have been accustomed to long production runs and lengthy lead times. In many instances they have been the sole suppliers of a given piece of military hardware or have been able to arrive at comfortable market-sharing arrangements. For reasons of national security, they have generally been sheltered from foreign competition. The prices paid for their products have often been a secondary consideration, provided that they meet stringent quality and performance standards.(1) Defense plants in Russia, in other former Soviet republics, and in Eastern Europe start from much the same kind of operational environment, but are confronted by additional obstacles. Traditionally, the defense industry in prerevolutionary Russia and in the former USSR was a state monopoly, though with some competition organized among design bureaus to stimulate alternative designs of new systems. The prices of their material inputs were kept artificially low, but now they must reckon with inputs priced at or near world levels. They rarely had to meet the full burden of depreciation, premises, and research and development costs out of their operating budgets. They have lost their privileged status that guaranteed them access to the highest available levels of personnel and technology and priority in respect of supplies. To a much greater extent than in the West, many of them are located in one-company towns and cities, where virtually the entire population is dependent on the plant, and no alternative employment is within commuting distance. Unemployment exchanges are nonexistent or function poorly. The housing market is in its infancy, and much of the available living space is in fact company housing. For the above reasons, labour mobility has tended to be much lower than in the West. Nevertheless, there has been a considerable outflow of skilled workers from the military-industrial complex during the past few years, owing in large part to the prolongation of wage controls in the complex after such controls had broken down in most other sectors, starting in 1989, combined with sharp cuts in state defense procurements. Most of those who voted with their feet were presumably the younger workers residing in large cities. Factories have typically provided a whole range of infrastructural services -such as clinics, kindergartens, creches, vacation resorts, canteens, and even farms - for which local authorities are reluctant or unable to assume responsibility. Unlike their Western counterparts, most of them have no marketing experience or expertise. And the defense industries in these countries have been isolated to a far greater degree from manufacturers of civilian products and lacked feedback in both directions. The Progress of Privatization Throughout the Economy ---------------------------------------------------- After the launch of the conversion program in December 1988, in the USSR and then in Russia, several blueprints were drawn up and much debate ensued over how to proceed with the conversion of the military-industrial complex, but little progress on the ground was evident until 1993. In the wake of such traumatic events as a prolonged economic recession, savage cuts in state procurements of military hardware, a sharp fall in arms exports for convertible currencies, and tardiness in accepting the precept of Charles Dickens's Mr. Micawber that budgetary outgoings should approximately match budgetary income, defense manufacturers were finally persuaded that conversion must proceed in earnest and that the process would not be financed primarily by outright grants or soft credits out of the federal budget. Instead, plants would have to generate the necessary capital themselves after privatization(2). Since the freeing of most wholesale and retail prices in January 1992, the privatization program in Russia has been the most important facet of President Boris YeltsinŐs economic reform. In its pace and scope, it has far exceeded comparable processes in both West and East. Although formal voucher privatization started only in October 1992, by the end of March 1994 most of the economy had been formally destatized. Anatolii Chubais, the deputy prime minister in charge of privatization and the chairman of the State Committee for the Management of State Property (GKI), was able to present an impressive balance sheet at a news conference on 23 March. Some 15,000 large industrial enterprises and more than 80,000 small enterprises -70% of the total- had been turned into joint-stock companies. Chubais declared that more than half of the gross domestic product was now being produced outside the state sector(3). It is probably true to say that privatization in Russia is now irreversible. Opinion polls regularly show a majority of the population in favour of the program, and even its most outspoken opponents do not advocate its cancellation or any attempt at renationalization. Yet what we have seen during the past eighteen months has been the formal destatization of much of the economy. There is much to the charge put forward by the reform economist and current presidential hopeful Grigorii Yavlinsky: "What has happened so far is not privatization, it is collectivization, which puts the workers and managers in charge of enterprises. Their interest is in increasing wages, not investment. This is a new problem created by this style of management"4". His point is taken by some of Chubais's advisers, who concede that "workers and managers often end up with more than 70% of the shares of the privatized companies" and that concessions to the managers of privatized plants have been "simply enormous"(5). The criteria for the success or failure of the program must surely be whether privatization has changed the way in which the plants operate and are managed. Maksim Boycko, the head of the Privatization Center, claimed that more than half of the privatized firms had already altered their product mix -although he did not spell out to what degree- and had introduced incentive-based wages. At the first 215 meetings of shareholders, according to Boycko, the incumbent managers were removed from twenty-nine factories(6). Critics are less sanguine and claim that little has changed, apart from the formal deeds of ownership. Most managers remain in place, little headway has been made in reducing widespread overmanning, and many plants appear to survive on soft credits. But it is early days yet, and major shifts in direction can hardly be expected only a few months after the outset of formal privatization; especially as many facets of the operational environment remain untouched. It is probably true to say that the command economy in Russia has been dismantled but has yet to be replaced by the mechanisms, the nuts and bolts, of the market. As Chubais himself admitted, the whole concept of privatization could come to nought without the implementation of broader macroeconomic reforms and the establishment of a reliable financial system with a functioning capital market(7). At the time of writing, despite the best of intentions and a multitude of promises, no really hard budget constraints have been introduced for plants in the state sector or for most, if not all, of those that have been formally corporatized or even privatized. Only a handful of enterprises have been declared bankrupt, and it was not until March 1994 that the government started listing candidates for bankruptcy proceedings(8). And to judge from a recent interview with the head of the Federal Administration for Insolvency Cases(9), prompt action in this regard should not be expected. The official rate of unemployment is still about 1%, and even the true unemployment ratio of, say, 6-8% by no means corresponds with a drop of over 40% in gross domestic product since 1990. The establishment of functioning anti-monopoly legislation is a lengthy business in any economy, and it has hardly got off the ground in Russia. Import competition is unknown in many sectors, and protectionism has been heightened by the raising of import tariffs as of 15 March 1994. The level of foreign investment in the Russian economy remains low -a total of perhaps $7-8 billion at the end of 1993(10) - which is understandable, given the maze of conflicting legislation and the lack of property rights and stable institutions guaranteeing contracts, not to mention the wholly unpredictable system and punitive levels of taxation. Indeed, what Seagram's manager in Kiev said of Ukraine is true of most, if not all, of the former Soviet republics: "It is now impossible to do business in Ukraine legally and make a profit"(11). Conversion via Privatization ---------------------------- By the end of 1994 about 1,500 of the roughly 2,000 major defense plants in Russia are due to have been formally privatized(12). How will they fare in comparison with the other privatized factories in the remaining sectors of Russian industry? What are their strengths and weaknesses? The good news is that the products of defense enterprises in the former Soviet Union have long been virtually the only fabricated goods that have been able -nay, obliged- to compete on the world market. These enterprises' workforces and technologies were selected from the best available in the country. Many of them should presumably therefore represent an attractive prospect for domestic and foreign investment funds. Their premises and equipment are, generally speaking, superior to those found in civilian industry. Their social infrastructural amenities tend also to be better than those at their civilian industrial counterparts. Until fairly recently, the level of work discipline was also higher: in mid-1993 their representatives could claim that "compared with the overall chaos in the country, order, organization, and discipline have been preserved at defense industry enterprises"(13). This may no longer be the case. By March 1994 mutterings of discontent were getting louder, after months in which the economy-wide payments arrears crisis had affected defense plants also, and many employees had been working part-time or had been obliged to take unpaid leave. During the phase following voucher privatization, however, the defense plants in these countries will face some obstacles in common with all other factories. One troublesome issue is the legacy of decades of integration with other former Soviet republics and, to a lesser extent, with East European members of the now defunct Warsaw Pact. Thus, according to a deputy chairman of Roskomoboronprom, the umbrella organization in charge of Russia's defense industries, without inputs from other former Soviet republics Russia can produce only 17% of the military hardware it requires. It will therefore need to collaborate on defense output with them for at least another five to seven years(14). But this cooperation is imperilled by payments problems, breakdowns in supplies, and stoppages caused by fuel shortages. To date, the conversion effort in Russia has been propelled largely from the top down. And yet the political leadership, in the shape of Roskomoboronprom, has shown little enthusiasm for the privatization process(15). A similar distaste has been shown by the key defense official concerned with conversion, Deputy Defense Minister Andrei Kokoshin(16). The main problem for all these privatized companies -defense and civilian alike- will be to find independent sources of capital(17). The problem may be more acute in the case of defense plants, though, in that clarity has yet to be established on the degree of independence of these plants and how much of a controlling influence will be retained by the government. As Chubais put it: "Real sources of finance that could rescue enterprises exist, but will never agree to invest resources in state [defense] enterprises, because they do not know how such an enterprise will be managed, what belongs to them and what does not, to whom state property belongs - to the director, to the work force, to the State Committee for the Management of State property, or to the government"(18). Under the provisions of the presidential decree on the privatization and state regulation of the defense industry, which modified the terms for its privatization, in the case of those enterprises in which the state retains an ownership share, the government will retain a role in the appointment of executives. Moreover, the mechanism for floating the shares of defense enterprises will make it difficult for outsiders to gain a sizable ownership share(19). In a recent pronouncement, the deputy chairman of GKI in charge of privatizing defense plants said that, of the 850 eligible factories that had not been privatized by the end of February 1994, the state would retain a majority share in 150 of them for three years and would exercise veto powers over managerial decisions at 600 plants(20). Conclusion ---------- Although the necessity to down size the former Soviet Union's monstrous military-industrial complex has been evident and generally accepted for several years, Russia, which inherited about 80% of that complex, has taken only hesitant steps toward converting its defense industry. Not until 1993 was the decision taken to effect and finance this process by means of privatizing the bulk of the defense plants. Progress in the formal voucher privatization of these plants has been impressive in the past few months. A crucial requirement for the privatization process following the initial voucher phase will be the clarification of their executive autonomy and the demarcation of government control in key aspects of their management. Otherwise formal privatization is unlikely to bring the new and substantial investment that is necessary for effective conversion. The complete transition to some variant of a market economy in Russia, the other former Soviet republics, and Eastern Europe will take generations. Likewise, the conversion/diversification of their large military-industrial complexes -a vital component of the transition process- will require decades, even if reform elements survive in top government positions to maintain the momentum. A shift in regime in favour of a figure such as Russia's Liberal Democratic party leader Vladimir Zhirinovsky or former Vice President Aleksandr Rutskoi could stall or delay this forward movement; all bets would then be off. FOOTNOTES --------- 1 See The Economist, 2 April 1994. 2 Keith Bush, "Aspects of Military Conversion in Russia", RFE/RL Research Report, no. 14, 8 April 1994. 3 Ostankino Television, 23 March 1994. 4 Cited in The Economist, 12 March 1994. 5 Ibid. 6 The Washington Post, 31 March 1994. 7 The Wall Street Journal, 1 February 1994. 8 ITAR-TASS, 4 April 1994. 9 Novoye vremya, no. 2, January 1994. 10 The Wall Street Journal, 26 January 1994. 11 International Herald Tribune, 29-30 January 1994. 12 Interfax, 7 April 1994. 13 Delovye lyudi, August 1993, p. 26. 14 Interfax, 8 December 1993. 15 See Bush, "Aspects of Military Conversion....". 16 This was demonstrated most clearly in his interview with Rossiiskie vesti, 22 July 1993, but also in subsequent pronouncements. 17 Anatolii Chubais in The Wall Street Journal, 1 February 1994. 18 Ostankino Television, 3 February 1994. 19 Julian Cooper, "Transforming Russia's Defence Industrial Base", Survival, Winter 1993, p. 157. 20 Interfax, 28 February 1994. ---------------------------------------------------------- Copyright 1994 NATO All rights reserved. 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