Panel III :

and Industrial

The Privatisation Phase of Industrial Restructuring

Michael Kaser

Privatisation in the West took place within a detailed legislative framework and a free-market culture. Professor Michael Kaser confirms that Central and Eastern Europe's transition is quite the opposite. The direct costs are measurable - paying for restructuring, recapitalising banks, and absorbing old debts. The indirect costs are harder to quantify, but they reflect the chaotic environment in which the reformers have to operate. Their aim, according to one economist, is 'a normal Western market economy'. The problem is that they must create one in a world where literally everything is for sale.

Professor Kaser is working at the Institute of German Studies, University of Birmingham, UK.

Political Factors in Restructuring

Sir John Hicks, the first British Nobel Laureate in Economics, identified the competitive market as the principal institutional contributor to economic development and contrasted it with the only two other mechanisms for the exchange economy - a customary economy (with complete "belowness") and a command economy (with complete "aboveness"). (1) He was following through an earlier insight (2) that a price mechanism was not a created institution, but an inherent characteristic of an exchange economy.

Among command economies of the past, he cited that of the Mongol Empire of Genghis Khan and his successors, which significantly affected the medieval Russian economic system. (3) The Soviet-type command economy is the only system of modern times in which the nationalisation of productive assets was aimed at the elimination of political and economic competition. Governments of market economies in wartime, and totalitarian regimes have imposed all-embracing controls over the employment of such assets; those governments applied coercion and asset confiscation to enforce their control, but they did not arrogate to themselves the entirety of ownership: the facility of private ownership was not withdrawn.

When political competition replaced the monopoly of a Party oligarchy in the revolutions of 1989-92 and competitive allocation was sought for the factors of production, the choice was inevitably for private ownership of a substantial part of productive assets. Legislatures and executives undertaking that systemic transformation based their privatisation programmes both upon an economic case - to enhance domestic efficiency and external compatibility with trade and factor flows with established market economies - and upon the political case - to build a mass constituency of owners whose stake would dissuade them from surrendering it in any systemic reversal.

The participation of political objectives in government-directed ownership change has of course also been evident in most Western industrial economies, as phrases such as "rolling back the state" and "a property-owning democracy" testified during the 1980s and since. But everywhere, markets were operational within a detailed legislative frame and a pervasive "market culture". By contrast, the privatisation of post-communist governments took place as both political and economic systems were in flux.

This paper seeks to offer a comparative assessment of the progress of privatisation of 30 economies in transition. Three of these are constituents of a contemporary state (the Eastern Länder of Germany and two republics of Yugoslavia4); 21 are states created by the break-up of federations (15 from the Soviet Union, four others from Yugoslavia and two from Czechoslovakia) and only six continue integrally from communist times (Albania, Bulgaria, Hungary, Mongolia, Poland and Romania). In the majority of transition countries, therefore, the political centre-periphery relationship thus altered on the eve of, or during, the reshaping of the economic centre-periphery relationship, and each reform was radical. Taken in conjunction with personnel changes throughout the political and administrative hierarchy, a fast pace of political readjustment has accompanied the rapid transfer of productive-asset ownership.

The speed of political change has nevertheless been moderated in three ways.

  1. First, virtually no changes have taken place in regional and local boundaries, other than in the former GDR which was required to establish Land governments to obtain unification with the Federal Republic.

  2. Secondly, the previously ruling communist parties have reformed themselves as social-democratic parties: in five states, after a break in opposition, they have re-entered coalition governments (Bulgaria, Hungary, Lithuania, Poland and Slovakia) and in one (Mongolia) they have remained the government throughout.

  3. Thirdly, in 11 countries leadership by the president has tended towards the authoritarian, with the result that economic policies may be implemented without too scrupulous a regard for dissent: this is the case in varying degrees in the five states of Central Asia (Turkmenistan the most and Kyrgyzstan the least); of the Caucasus (Azerbaijan more than Armenia and Georgia); Albania, Romania and Serbia.

    The concentration of political power led the Vice-President of the European Bank for Reconstruction and Development, Ron Freeman, publicly to observe while in Uzbekistan that the Bank can accept and keep as members ("countries of operation") only those countries which adhere to "the fundamental principles of multi-party democracy". (5)

    One political development which is the result of privatisation is the enhanced influence of enterprise management in local administration. Under the command economy, state enterprise directors were subordinate to an "industrial ministry" in the capital city and deployed their efforts to obtain and fulfil "easy" material and financial plans (within the "cosy relations" Kornai so aptly described (6)), and regional and local authorities were almost wholly dependent on centralised finance.

    Lateral contact was largely informal, with factory chiefs associated within the local nomenklatura, although some "dual subordination" existed in budget-financed institutions. The mutual relationships after privatisation are much more specific: enterprises generate local tax revenue, profoundly affect local employment and have discarded many of their social-support functions for local authorities to re-establish as best they can. In Russia, in particular, the influence of local management on local government is both ways: a "Council of Directors" (7) exerts pressure on local councils and the latter often have shares in local enterprises.

    Such economic restructuring as has taken place has in general happened later than the political reshaping just described, and has followed privatisation (but partly and substantially preceded it in Germany). Some salient features of the changes are noted in a concluding section, but less comprehensively in this paper than with respect to privatisation. (8)

The Privatisation of Non-Farm Assets

Once the policy of asset divestment had been adopted, electorates, parliaments and governments had to choose the recipients of property. Political considerations were taken into account in three ways. The first was to offer restitution or compensation to previous owners. Termed "re-privatisation" (as ZatkalíkováÝ describes it in this volume), the process was especially directed towards households; corporate and institutional owners other than churches and charities were usually excluded.

Land and residential property is in process of restitution in the Eastern Lander of Germany, Albania, (9) Bulgaria, the Czech and Slovak Republics, (10) Estonia, Latvia, Lithuania, the former Yugoslav Republic of Macedonia, Poland, Romania and Slovenia. Hungary, by contrast, offered only compensation, but this was in the form of vouchers which could be traded or exchanged for shares in privatised equity or housing. The second was to allow the staff of the enterprise to select the mode of privatisation (or in one republic, Serbia, re-nationalisation).

In describing such "decentralised implementation", Rutland, in this volume, cites it as "privatising the privatisation process". The third, and most significant, was to give free, or virtually free, vouchers to citizens to buy equity in state enterprises and in some cases housing. Among the voucher schemes used, or planned, the denomination in most was money, but in a few it was points. (11) The idea of vouchers originated in Poland (12) but the initial schemes were launched in Czechoslovakia and Mongolia.

Nine governments decided against free vouchers, but all 30 states initiated privatisation with some disposal of small state entities - shops, personal service units and artisan workshops - usually by auction, but often by a procedure which allowed existing employees to take over. (13) There is a quasi-voucher scheme in Hungary in interest-free loans for the purchase of shares; its privatisation had originally been on a case-by-case basis but from May 1995, it has been much extended - receipts amounting to $1.2 billion are expected in the first year.

Four governments are selling on the model of Western privatisations - the Treuhand in the new German Lander, and Estonia which emulated its practice, Azerbaijan (after the post-coup government reversed its predecessor's voucher scheme), and Uzbekistan. In Tajikistan, civil unrest has precluded an overall scheme but much of the state sector which actually operates is run locally.

Macedonia has similarly allowed small firms to drift into private hands, but by mid-1995, nearly 300 larger ones should have been transferred. Because the Yugoslav Federal Assembly has not yet enacted a law on privatisation, it fell to the Montenegrin and Serbian legislatures to authorise ownership change: under the series of laws since 1951 on worker self-management, it is the staff who have been choosing and a substantial proportion have opted to become state property. (14) Croatia also inherited worker self-management, but its law (of 1991) merely formalised such property rights as joint-stock companies, leaving them to sell shares as they chose.

Among voucher-issuing countries, Mongolia was a pioneer, giving uniform-value vouchers to all citizens of any age; Armenia and Turkmenistan similarly schedule them for all citizens, but allow a supplement for any purchase of shares in the employee's own enterprise. Ukrainian non-tradeable vouchers are of uniform value, but citizens are entitled to a supplement corresponding to the amount standing to their credit at the State Savings Bank when the Soviet rouble ceased to be legal tender, and accounts were frozen.

Moldova differentiated vouchers by the length of the recipient's employment in the country and Albania and Slovenia by the recipient's age. Bulgarian, Georgian, Latvian, Lithuanian and Romanian voucher privatisation began at various dates in 1995. (15) In the latter, uniform (non-tradeable) vouchers had been distributed in 1992, but because their face-value had been deeply eroded by inflation, a further allocation is being made with a higher value (equal to double the average wage). The Russian and Ukrainian schemes had envisaged deposits in escrow accounts in the State Savings Bank on which the beneficiary could draw only to buy equity in privatised firms, but, in the event, only Kyrgyzstan adopted this procedure.

Ninety percent of Russian tradeable vouchers distributed in 1992, also of a uniform value, were used in the allotted period (to July 1994) together with auction and cash purchases. Forty million shareholders were established in that first stage of large-scale privatisation. Military and dual-purpose industry was nevertheless largely excluded: Kosals, in this volume, notes that government control was maintained in three out of four such plants at the end of the first stage.

The second stage, for which money purchase is the sole channel, is intended to be concluded in 1995 and was foreseen as bringing nine trillion roubles ($1.8 billion) to the enterprises being sold (with a smaller payment to local and central government). However, a mere 50 billion roubles ($10 million) had been paid by the end of March 1995, largely because households had no more savings to spend (after the earlier "small" and first stage of the "large" privatisation) and because the corporate and banking sectors preferred to buy Treasury bills. These raised 5.7 trillion roubles in 1994 and should cover the bulk of the 1995 budget deficit of 32 trillion, (16) but to the evident detriment of privatisation in that second stage. The scheme allows some concessions to employees. (17)

The principal reason for denominating vouchers in "points" was to prevent them increasing the money supply and thence inflation. In the united Czechoslovakia, booklets of points were sold at a very low charge and were used in a first round of sell-offs. Ninety-six percent of the aggregate number of shares on offer were taken up. But whereas the Czech Republic maintained the procedure into a second round, Slovakia, after much political controversy, which ZatkalíkováÝ recounts in this volume, discontinued it in early July 1995.

Belarus graduated points on scales related to age, employment and social situation; it made provision for such vouchers to apply to half the state-enterprise equity to be privatised during 1994-97, but by late 1994 only 3 percent of state enterprises had been privatised. (18) Kazakhstan differentiated points by urban and rural residence, favouring the latter.

Most governments which issued vouchers permitted them to be traded, and all allowed them to be pooled in investment funds. In Poland, however, the 15 National Investment Funds into which citizens may invest their vouchers are the pillars of the scheme. Instituted as long ago as December 1993, the Fund management (consortia of Western and Polish financial companies) obtained their first state-enterprise controlling equity in July 1995. Of the 413 state enterprises accepting selection for this first round, 28 were offered at that time, and in a second phase it is hoped to persuade another 300 enterprises into the "pool".

The Funds get 60 percent of the state's equity; 15 percent is given gratis to employees, 15 percent is held for social uses or given to pensioners, and the residual 10 percent stays in government ownership. Although Funds may relinquish their holding before term, they are meant to hold their shares and manage the holdings efficiently for ten years. If they perform according to long-term gain, they can leave with 15 percent of the terminal value of the assets under management. In all voucher-issuing states, shares in investment funds could also be bought, but lack of regulation led to a number of fraudulent flotations, particularly in Georgia and Romania; as Glozheni records in this volume, Albanian legislation on investment funds is imminent.

The Russian legislation under the first stage allowed state enterprise personnel to choose among three variants and one of these assured 51 percent of the shares to be allotted to them: it is not surprising that nearly four-fifths of enterprises selected this path to "insider" control. (19) In the second stage, the government has ruled out sale of its controlling holdings in many major companies (the gas and telecommunications monopolies and the biggest oil concerns) and has passed management control in others to a consortium of large banks against a very large loan to reduce other provision for the public borrowing requirement.


In Poland and ex-Yugoslavia, collectivisation was never imposed; Bulgarian and Hungarian co-operative farms were at the most liberal extreme and the Albanian form of quasi-state collectives were the most repressive. The privatisation of farmland is virtually complete in Central and Eastern Europe and the Baltic States (with some exclusions of entitlement of foreigners to ownership).

Complications have been inserted by legislatures into some procedures - restitution to former owners (as noted above) and leasing rather than outright ownership. Many difficulties have been experienced in the demarcation of properties where an official survey was not maintained on a property basis or was contested. These problems were at their worst in Albania, but were also manifest in Bulgaria and Romania (where a law is in course of enactment to permit the private ownership of land, including by foreigners). The situation in the many Bulgarian and Slovak co-operative farms which continue by their members' wish is complicated by absentee-ownership.

In some countries, notably Russia, Ukraine, Belarus, the Central Asian states, Bulgaria and Slovakia, collective and state farms have remained largely as before. A complex series of reasons accounts for members' unwillingness to establish themselves as independent farmers. Among these in Russia is the strength of conservative elements (from the village nomenklatura up to the Agrarian Party in the Duma and the "agricultural lobby" in the government, led by Deputy Premier Aleksandr Zaveryukha) and the difficulties individual farmers face in obtaining supplies, finance for investment and marketing outlets free of corruption and crime.

There are similar conservative interests in the other predominantly Slav states, but whereas President Leonid Kuchma decreed Ukrainian private land ownership soon after he took office (though progress is slow on implementation), President Aleksandr Lukashenka remains cautious and only leasehold is yet permitted in Belarus. Elsewhere in the Commonwealth of Independent States (CIS), change to private land ownership has been most comprehensive in Armenia, but is also under way in Kazakhstan, Kyrgyzstan, Moldova and Uzbekistan. Georgia, Tajikistan and Turkmenistan, however, only permit leasehold, and Azerbaijan has not yet taken any measures.


Privatisation is usually the first phase of "restructuring". It constitutes a legitimisation of the political and economic system, and it fosters a more efficient use, and a decentralised mobilisation, of resources. It involves both measures which enterprises normally take in market economies as costs and sales conditions and prospects change, and those which are indicated (though not necessarily implemented) by the systemic change itself. The introduction of a market and especially the liberalisation of incomes and prices evokes effects and responses in both spheres.

A difference between the "normal" and the "extraordinary" is that the role of the state is much greater in the second than in the first. This is partly because the state is divesting itself of microeconomic functions and must therefore undertake a specific regulatory function, and partly because the state possesses more funds and more powers to implement change than a private corporation (particularly if inflation and/or recession have weakened the financial, investment and managerial potential of the latter). The state has, as in all circumstances, a duty to execute policies conducive to macroeconomic stability and development and to facilitate (and/or to protect from) external economic transactions.

Among the measures which restructuring has been applying in East and Central Europe and in the post-communist Asian states are:

  • The "unbundling" of groups unsuited to, or undesirable for, a market economy. Large combines were especially favoured by planning bodies and communist leaderships as a reaction to the short-lived experiments in managerial devolution of the mid-1960s; monopolies were established under the auspices of Comecon or as national protection and by search for the economies of scale within quasi-autarkies; most state enterprises undertook social-support functions.

  • Following any break-up, new organisational forms are required: an important development characterising Russia is the "financial-industrial" group. A recent study by a Russian economist lists the pros and cons of the policy embraced since December 1993, by the Russian State Committee for Industrial Policy (Goskomprom) to foster these, subject to two binding conditions, viz., that no participating corporation should be admitted if its equity were more than 25 percent in state hands and that no financial institution should own more that 10 percent of the shares in a participating corporation or invest more than 10 percent of its assets in participating corporations. There are a number of conditions the relaxation of which requires approval by the relevant government regulatory body, such as the Anti-Monopoly Commission. (20) The danger perceived is that some such groups are motivated by survival through mutual protection and preferential subsidisation rather than by the gain of competitiveness or of foreign participation.

  • Capitalisation in many forms includes particularly the recapitalisation of banks (both state-owned and private) and clearing the accumulation of bad debts from enterprise balance sheets. A very substantial literature exists on this topic. Inter-enterprise indebtedness remains substantial in all CIS member-states and in Albania, Bulgaria, the former Yugoslav Republic of Macedonia and Romania. Hungary, Latvia and Lithuania have a special problem because their bankruptcy laws (of 1993, 1991 and 1992 respectively) do not impose a requirement that companies with overdue liabilities should cease trading.

    Nation-wide loan-restructuring among enterprises and banks was largely completed in Poland in 1994. The clearance of non-performing debt and the laying of sound regulatory regimes have been carried out in Croatia, Czechoslovakia, Estonia (but only after a banking crisis in 1992), Hungary, Latvia, Poland and Slovenia, but remain to be fully developed in most other states. New capital formation is also required for implementing decisions on market forecasts (see below) and may be provided by foreign investment by direct implantation, as portfolio purchase or the flotation of new shares.

  • Management may be changed, for those more capable of directing an enterprise (often in a new size and shape) under the new conditions. The dominance of "insider" shareholding (in particular Russia and Mongolia) may weaken such flexibility.

  • "Resizing" the workforce may not always, but usually does, mean redundancy. The growth of the private sector to absorb those laid off reduces the need for a state "social safety net". State funding for the externalities of training and continuing education is required to reskill the labour force.

  • The reassessment by the restructured firms, their management and their workforce of new prospects for costs, sales and investment includes change in marketing and advertising methods and openness to the development of foreign markets.

  • Environmental repair and protection is a significant area for restructuring because of the prevalence of output priority in the previously-supply-driven plan systems. As Feshbach points out in this volume, private owners of former state enterprises are unlikely to have funds both for new investment and for environmental repair, and foreign investors would be deterred by the cost of such repair or even by an unwillingness to live in heavily polluted areas. Another issue is the division of such costs between the state (either as previous owner or for the common good) and the post-privatisation owner.

  • There is, finally, the very broad consideration of adjustment to market-based regulatory, prudential and conventional legislation and practice. Again, there is a substantial literature on the necessary infrastructure and the process of monitoring change in it.

The direct costs of privatisation are being experienced under three headings - expenditure on the privatisation process; financial and physical restructuring; and subsidisation, including recapitalisation of banks and the absorption of inter-enterprise bad debts. Indirect costs are emerging because of inadequate legislation on titles and their exchange, poor regulatory procedures and criminality; standards are far from acceptable where a contract killing is cheaper than settlement of a debt, or where a majority of banks do not reach legal reserve ratios or are party to capital flight or money-laundering. Restructuring ends when the aim is achieved (in the words of the architect of the Polish economic transition, Leszek Balcerowicz, a few days after taking office in September 1989) of "a normal, Western market economy".


  1. Hicks (1969, p. 21); see also his reply to critiques in Hicks (1977, pp. 181-4).

  2. Hicks (1960, p. 707).

  3. Kaser (1978, p. 426).

  4. Montenegro and Serbia, which have separate privatisation programmes in the absence of any Federal legislation.

  5. Cited in Financial Times, 31 May 1995.

  6. Kornai (1992) and earlier works.

  7. In historical perspective, the council (sovet direktorov) descends from the merchants' hundred (kupecheskaya sotnya) of medieval Russian towns and the Petrine guild (gild'iya) (Kaser 1978, pp. 426, 448).

  8. This is because the present writer had in recent research compiled more comparative information on privatisation than on restructuring (Kaser 1995a; 1995b).

  9. A form of co-ownership was instituted by a 1993 law where non-agricultural land had already been privatised (EBRD, 1994, p. 16). Glozheni, in this volume, notes the legal disputes raised by the restitution of farmland.

  10. Industrial property was also included in the restitution law of 1990 for the united Czechoslovakia, and church property in a Slovak law of 1993.

  11. The descriptions of schemes follow EBRD 1994, 1995, and ECE 1995; IMF Economic Reviews; and documents on East Germany, Mongolia and Yugoslavia.

  12. Frydman and Rapaczynski 1994, p. x.

  13. For a comparison of 'small privatization' in Russia with the Czech Republic, Hungary and Poland, see Friebel, 1995, and in the latter three Earle et al., 1994.

  14. Petrovic 1994.

  15. As only 434 enterprises were concerned, there are approximately 2,200 shareholders per (rather small) enterprise; data from Mongolian Chamber of Commerce and Industry, 1995, p. 8.

  16. The Financial Times, 12 June 1995, commented: 'In contrast to Russia's infamously ramshackle equity market, the market for government bonds has won acclaim for its sound trading and settlement arrangements.'

  17. For the three variants, see Kaser 1995, pp. 17-18.

  18. EBRD 1995, p.53.

  19. This short paper is not the place for a full discussion; see particularly Birn, Jones and Weisskopf 1994, pp. 272-6; Kaser 1995, pp. 40-4 and Young and Reynolds, 1994, pp. 39-40.

  20. Starodubrovskaya 1995, p. 11.


  • Birn, A., Jones, D. and Weisskopf, T. (1994), 'Privatization in the Former Soviet Union and the new Russia', in Estrin, 1994, pp. 252-78.
  • EBRD (1994), Transition Report 1994, London, EBRD.
  • EBRD (1995), Transition Report Update, London, EBRD.
  • Earle, J. S., Frydman, R., Rapaczynski, A. and Turkewitz, J. (1994), Small Privatization: The Transformation of Retail Trade and Consumer Services in the Czech Republic, Hungary and Poland, Central European University Press, Budapest.
  • ECE (1995), Economic Survey of Europe in 1994-1995, New York and Geneva, United Nations.
  • Estrin. S. (ed.) (1994), Privatization in Central and Eastern Europe, London, Longman.
  • Friebel, G. (1995), 'Organisational Issues of Trade and Services Privatization in Russia', Economic Systems, 19 (March), pp. 25-58.
  • Hicks, J. R. (1960), 'Linear Theory', Economic Journal, 70, pp. 671-709.
  • Hicks, J. R. (1969), A Theory of Economic History, Oxford, Clarendon Press.
  • Hicks, J. R. (1977), Economic Perspectives, Oxford, Clarendon Press.
  • Kaser, M. C. (1978), 'Russian Entrepreneurship' in Cambridge Economic History of Europe, VII, Cambridge, Cambridge University Press.
  • Kaser, M. C. (1995a), Privatization in the CIS, London Royal Institute of International Affairs.
  • Kaser, M. C. (1995b), The Central Asian Economies after Independence, 2nd edn, Washington, the Brookings Institution (forthcoming, revision of 1st edn, London 1992, in Allison, R. (ed.), Political and Economic Challenges in Post-Soviet Central Asia and the Transcaucasus).
  • Kornai, J. (1992), The Socialist System, Oxford, Oxford University Press. Mongolian Chamber of Commerce and Industry (1995), Review of the Mongolian Economy in 1994, Ulaanbaatar.
  • Starodubrovskaya, I. (1995), 'Financial-Industrial Groups: Illusions and Reality', Communist Economies and Economic Transformation, 7 (March).
  • Young, P. and Reynolds, P. (1994), The Amnesia of Reform: A Review of Post-Communist Privatization, London, Adam Smith Institute.

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