Colloquium 1995 Panel III : Privatisation and Industrial Restructuring

Russia's Military-Industrial Complex: Privatisation and the Emerging New Owners Leonid Kosals A free-market culture is slowly emerging in Russia's military-industrial complex (MIC). To date the government has been careful to keep overall control: three-quarters of the MIC are still in state hands despite the privatisation programme. But a new managerial attitude is emerging, reports Dr. Leonid Kosals. And this new breed of managers comes not a minute too soon, as this industry is in desperate need of a firm hand to help its companies develop and innovate. Today's big question is whether the governments will actually allow the MIC companies to follow this path to restructuring and conversion. Dr. Kosals is a Senior Researcher at the Institute for Population Studies, Russian Academy of Sciences, Moscow.

Goal of Paper and Information Used The goal of this paper is to provide an answer to the questions 1) whether new owners are emerging in Russia's military-industrial complex (MIC) and 2) if the process of creating new owners has been started, what stage this process is at. To do this we must account for the changes in the problems which enterprises are facing during today's radical economic reforms in Russia. The information used in this paper includes data from four sociological surveys carried out by the author, together with Prof. R. Ryvkina between 1992 and 1995. Survey I was conducted in January 1992 at the start of the radical transition. Some 312 directors of defence enterprises were polled in all main regions of Russia. We focused on the problems which directors faced and their plans to restructure their enterprises. Survey II (July 1994) included the opinions of 11 experts on the directions of changes in different parts of the MIC. We revealed whether there was some stabilisation in defence industries or it was only the decay of the enterprises during 1994. Among the experts were the specialists of the State Committee for the Defence Industries, and the League for Assistance to the Defence Enterprises, as well as the directors of the biggest military enterprises. Survey III (June-December 1994) was carried out by mail with the support and participation of the League for Assistance to the Defence Enterprises. Eighty-five directors of the military enterprises in different regions were polled (216 questionnaires were sent out). The aim of the survey was to analyse directors' changes of attitude related to market reform at the enterprise level, and particularly their opinion about privatisation. Survey IV, was also conducted with the support and participation of the League for the Assistance to the Defence Enterprises in May 1995. Fifty directors gave answers to the questionnaire about government policy in the MIC, as well as about the problems and prospects of the military enterprises. None of these studies was representative in the strict statistical sense. The samples were provided by experts because of the secrecy of statistical information concerning the MIC, and the difficulties of managing large-scale investigations of the subjects in question. However, according to competent experts, we have managed to grasp the main problems of defence enterprises because the surveys embraced a large number of organisations belonging to different branches of the MIC, situated both in the centre and in outlying regions, with both relatively good and bad economic positions. The methodology for these surveys was created by the author together with Professor R. Ryvkina. All possible errors and inaccuracies are the responsibility of the author.

Troubles of Defence Enterprises: From Central Planning to Market System All enterprises involved in the central planning system in the former USSR were faced with specific problems. The most important among them was the total dependence of enterprises on the ministries and the shortage of material resources. In contrast with managers in a market economy, Soviet directors had no serious financial troubles, nor problems with high taxes, marketing, competitiveness, quality of production, or survival of the enterprises. In order to know whether defence enterprises are involved in the market reforms, we compared the problems which enterprises were faced with in 1992 and 1994. During Surveys I and III we asked the question: "What are the main problems preventing the efficient operation of your enterprise?". (1) The distribution of the answers is detailed in Table I. Table I Main Obstacles to Operation of the Defence Enterprises in 1992 and 1994 (director's evaluations, percent - (2)) Problems of the defence enterprises 1992 1994 percent Ranking percent Ranking Breaking of the traditional business links between enterprises 80 1 25 6 Shortage of the material resources 44 2 0 11 Instability of economic policy, frequent changes of decisions 23 3 39 4 Too high taxes 22 4-5 77 1 Social tension in the enterprise 22 4-5 14 8 Decline of military procurements from the Government 18 6 60 2 Lack of guarantees for the sales 7 7 32 5 New problems (or old ones which became important under the transition to market economy), specified in 1994 percent Ranking Financial troubles 59 3 Old equipment 17 7 Overdue payments 12 9 Troubles of privatisation 1 10

Towards 1994, defence enterprises had found themselves in a new socio-economic environment, facing new problems, while many traditional obstacles of the Soviet system had disappeared. Financial difficulties were growing - they occupied the third rank in 1994, while directors did not even mention them in 1992 among the list of important problems. Moreover, the financial restrictions became the key factor in relations between enterprises and government: high taxation was the main problem, according to the directors. As for the shortage of material resources (one of the major problems in the Soviet economy) - this problem was not mentioned by the directors at all (see Table I). It is interesting that the main obstacle in 1992 - breaking of traditional business links between enterprises - does not matter now. It means the defence enterprises have almost adapted to the economic consequences of the decay of the USSR. There were serious changes in the economic attitude and behaviour of the directors. Many of them have assumed responsibility for their enterprise. One such director told us during the interviews (Survey II): "The main point is to rely only on my own strength. I know nobody can help us. And I don't expect any assistance - either financial or administrative". Judging from this comment, we can see that real market reforms have started in Russia: enterprises have been operated apart from the state and the market mentality is starting to emerge among the people. (3) However, all this is not enough for forming a stable and productive market economy. It is necessary for the efficient owners (who are concerned with long-term prosperity) to gain control of the enterprises.

Ownership Structure of Defence Enterprises The emergence of the owners was set in motion before the government privatisation programme. This process was determined by many factors operating from the 1980s: the adoption of market-oriented laws (the USSR Law of Cooperation, the USSR Law of the Enterprise, etc.), the policy of "glasnost"; the downgrading of ideology; the breaking of the Communist Party's monopoly of political power; and the radical economic changes (liberalisation of prices, liberalisation of the foreign trade), etc. In general all these measures created the conditions for some ambitious managers to operate as de facto owners. (4) Now that Russia has some experience in transition, it is obvious that it will take many years for efficient owners to emerge. First of all, this is because many competitors want to get hold of the former "socialist property". Among them are directors, state officials (federal and local authorities), labour, Russian and foreign entrepreneurs, banks and others. As a result of this competition a clear structure of ownership is emerging, where each owner occupies his own place and has a fixed share of capital. This structure is the indicator of the distribution of property rights determining the enterprise's productivity. Therefore, we must consider the problem of the single owner, but we have to discuss the problem of a structure of ownership including many agents. The pace of privatisation is slower in the MIC than in other industries: according to the evaluation of D. Vasiliev, the Deputy Chairmen of State Committee for Property (Goskomimushestvo'), 70 percent of enterprises were privatised in Russia by the middle of 1994, (5) but only 53 percent of the MIC (Survey III). Also, half of them were privatised with the different restrictions established by government ("golden share" providing the right of veto by the state, etc.) aimed at preserving state control. Thus, the government had control of the activity of the establishments among all defence enterprises in 1994. In spite of this, new owners are still emerging in the MIC. Therefore, it is necessary to reveal the real structure of ownership in defence enterprises. We investigated this during Survey III by putting the following question to directors: "If you establish the value of your enterprise as 100 percent, what are the shares of the different owners?" There was a list of the potential owners and the director had to specify the share of the each owner in percent. The distribution of shares is shown in Table II (6, 7): Table II The owners: percent State foundation for property 24 Labour 49 Directors 5 Foundations for investment 8 Private enterprises 7 Russian business people 4 Banks 2 Foreign investors 1 Total 100 Thus, according to directors' evaluations the biggest of the owners is labour, holding approximately half of the property. The second largest owner is the state, controlling a quarter of the capital of defence enterprises. Other owners (Russian and foreign business people, banks, etc.) have the remainder. Privatisation as an administrative and legal procedure was a relatively short-term action. To know its real results we must investigate the socio-economic consequences of privatisation at the level of the enterprise, in other words, study the changes in management, investment activity, financial position, etc.

We asked the directors about these changes (see Table III). Table III Director's Evaluations of the Consequences of Privatisation in Enterprises (percent) Spheres of enterprise's operation Position is Total better worse not changed Freedom of operation 64 0 36 100 Attitudes to labour of personnel 11 20 69 100 Wages 11 18 71 100 Financial position 2 43 55 100 Size of production 7 45 48 100 Quality of production 5 11 84 100 Implementation of new technologies 9 26 65 100 Adoption of new products 49 21 30 100 Conflicts 16 26 58 100 Investment activity 11 25 64 100 Relations with Ministry 7 16 77 100

Of some 11 indicators, positive changes (column 1) were noted only in two cases: directors mentioned the increase of freedom of operation and rise of adoption of new products (64 percent and 49 percent, respectively). In other fields the situation is the same or worse. According to the directors' estimations, the worst changes are in finance and size of production: 43 percent and 45 percent, respectively, among them cited the negative effect of privatisation. In general, the negative evaluations of privatisation dominated the positive ones, though in most spheres there are no significant changes (answers saying "no changes" are the most frequent). Does this mean that one can identify the directors of defence enterprises as the enemies of privatisation? According to our investigations it does not. For example, answering the question "In your opinion, was the privatisation of your enterprise necessary?" (Survey III) 58 percent gave a positive response and only one-third of respondents said that privatisation was not needed for their establishment (10 percent couldn't give an answer). In informal interviews most of the directors said that it is impossible to refuse privatisation in the current position of Russia's MIC. In spite of negative short-term consequences, privatisation gives the directors the opportunity to become owners and to boost the enterprises. Finally, the comparative analysis of the position of state and privatised enterprises demonstrates that economic indicators without privatisation would clearly be worse (Table IV, data of Survey III). The investment activity in privatised enterprises is higher and overdue payments are lower than in state enterprises. The directors know this (though the difference between these two kinds of enterprise is not great). Therefore they estimate privatisation as a lesser of possible evils. This opinion does not depend on the ideological values of the directors - even those who are opposed to the line of the president and the government share this view. Privatisation has had contradictory results as a reflection of the contradiction in its position within Russian society. On the one hand, privatisation had to take place in former conditions of social and political stability. Therefore it had to follow to the traditional Soviet values, such as collectivism, social equality and justice, which are still widespread in Russian society now. On the other hand, the direct goal of privatisation is to create an economy with private property rights, which is oriented towards the criterion of economic efficiency. The current stage of privatisation is a compromise between these two opposite tasks. This compromise shows itself as a replacement of state ownership by labour property. This action provoked only nominal ownership, and although the property was separate from the state, efficient owners have not yet emerged. The greatest parcel of the shares cannot concentrate real control over enterprises in the hands of labour - although the government cannot control the enterprises either. Meantime, labour and the state have the opportunity to stop the initiatives of directors and outsiders in important questions. In our opinion directors and outsiders perhaps could become efficient owners of most enterprises if they have much more capital than now.

What Are the Perspectives? Privatisation in Russia is not yet complete. It will take years for efficient owners to emerge in the MIC. Probably there will be two stages in this process. Stage 1. Redistribution of property into the hands of those who can keep business competitive in a market economy. This stage can go in two directions. The first direction is the purchase by business people of the shares held now by the workforce. The second one is the sale of shares currently held by the state. Stage II. Institutionalisation of the owners. The key problem here is social acceptance of the new owners. It is impossible to fix property rights while the greater part of society will not accept them as owners. Without this, they will not have the security needed for the long-term motivation to invest and to innovate, in spite of the fact that they would have the legal property rights. The duration of stage 1 might be a relatively short period (perhaps 3-5 years), but the social acceptance of the owners will take much longer, 8-10 and even more years, perhaps. This is because the Russian population is now sceptical about the effects of privatisation. Moreover, public opinion is opposed to the privatisation of large industrial enterprises at the moment. According to the results of a poll conducted by the Russian Centre for Public Opinion Research in April-May of 1995, out of 2,000 adults in the sample, only 8 percent said there had been positive results when asked about consequences of privatisation. Thirty percent mentioned that the results were equally positive and negative, and 40 percent of people asserted that privatisation has only negative sides (22 percent did not know). The more disappointing picture is in the answers of people to the question of whether to keep large enterprises in state ownership: 74 percent of the adults polled think that they should be kept under state control and only 11 percent support their privatisation (20 percent do not know). Negative public opinion about the results of privatisation and particularly opposition towards a genuine separation of the large industrial enterprises from the state, will significantly slow down the process of finding efficient owners for the MIC. What are the perspectives of the defence enterprises in such a social context? To know this, in May 1995, we asked in Survey IV the question: "In your opinion, what is the future of your enterprise?" and received the following answers: Future of enterprises expected by directors: % Expansion of production, increase of profits, hiring of labour force 16 Conservation of the current position 25 Slow down of production, losses, lay-offs 52 Bankruptcy 5 Do not know 2

Thus, most of the directors polled see the future of their enterprises negatively: more than half among them think that its position will be worse. However, there is a group of optimists expecting the expansion of their organisations. A similar group of optimists was found in other investigations. For example, in Survey III we revealed that there were 13 percent of enterprises where the socio-economic position was relatively good, according to the directors' evaluations. These establishments could overcome one of the main diseases in the Russian economy - reversing the decline of production. Only 9 percent were in a position to do this, but the expansion of production was 31 percent monthly in 1994 (in comparison with 1993), while the production in other enterprises declined by 27 percent. The enterprises with a relatively good position had much better sales, 23 percent among them had more orders than they could meet (among others those were only 2 percent). The other organisations in good shape could engage 2/3 of their productive capacities and only 29 percent among them were to cut production of some articles (in contrast with 46 percent and 72 percent, respectively, between establishments with severe problems). When we make the analysis of enterprises in relatively good condition, we mean only relative prosperity, because under the current situation in the Russian economy and society there are no completely healthy organisations. Forty-seven percent of these establishments are near bankruptcy, and 41 percent are in no danger (12 percent do not know). But among the others, 68 percent are afraid of bankruptcy, and only 17 percent are not afraid (15 percent do not know). Thus, there is a group of enterprises in the Russian MIC which could start to adapt to the market. Although these organisations have all the same ailments as the Russian economy has, they want to use the economic freedom to develop production, to innovate and to embark on conversion. Therefore, the government first has to carry out a policy directed at this group of enterprises to create favourable conditions for their expansion.

The processes of distribution and redistribution of the former socialist property have latent and even criminal forms in Russia. It is not obvious what the final state of privatisation and the structure of ownership will be in the near future, nor what will be the influence of privatisation on Russian society. The traditional sociological instruments used in this paper have their own limitations and cannot provide the analysis of many latent outcomes and results of privatisation. The defence enterprises in Russia usually include many units for social services; these enterprises influence the lives of more than 10 million people (8). Therefore, it is necessary to add to, and to correct, the conclusions in this paper, analysing the consequences of privatisation for different social groups and taking into account possible prolonged socio-economic and political factors stimulating privatisation in the Russian MIC, and the obstacles preventing it. Footnotes Directors had to choose from a given list of problems. These problems were revealed during the informal interviews with the directors. Since the problem of the dependence on the ministries already did not disturb the directors seriously in 1992, this problem was dropped from the list. Since the respondents could choose more than one item the sum is not equal to 100 percent To know more details about adoption of the defence enterprises to market see: A. Izyumov, L. Kosals, R. Ryvkina. The Russian Military-Industrial Complex: The Shock of Independence. In: The New Economy, Vol. 6, No 1, Issue # 25, Winter 1995, pp. 10-11. The process of privatisation in the MIC was partly spontaneous as in other sectors of the Russian economy. See the analysis of spontaneous privatisation in the MIC in: I. Filatotchev, T. Buck & M. Wright. The Military-industrial Complex of the Former USSR: Asset or Liability? In: Communist Economies & Economic Transformation, Vol. 5, No. 2, 1993, p. 198 Izvestiya, 29 June 1994 There are some data that privatisation in the MIC has not moved more slowly than in other sectors. See: C. Gaddy. Economic Performance and Policies in the Defence Industrial Regions of Russia. Paper prepared for the Workshop on Russian Economic Reform sponsored by the Center for International Security and Arms Control, Stanford University, 22-23 November, 1993, p.10. This result was obtained concerning the regional level. As for the level of enterprise there are many obstacles to privatisation in the defence sector - very large size of enterprises, many establishments for the social services under them, etc., which particularly prevent privatisation. To compare these data with the results of the polls among the directors in other industries, see, for example, scientific report: L. Kosals, R. Ryvkina. The Owners of the Russian Industrial Enterprises: the Analysis of Director's Opinions and Expert's Evaluations. Moscow, International Centre for Research into Economic Transformation, 1994, pp. 8. This report based on the poll of 426 directors of industrial enterprises in different branches, located in all main regions of Russia and carried out by the Russian Center for Public Opinion Research in 1994. The structure of the ownership revealed by this poll was very similar to the one presented above. The difference between the two structures of ownership is that in other industries the share of labour is a little bit greater than in the MIC, but the share of the state is less. As J. Cooper argued: "They (defence enterprises - L.K.) are not simply production units, but social institutions, often central to the existence of local communities and even whole towns. Yet it is highly unlikely that all will be viable in the new conditions. Closures will be needed and large enterprises may have no choice but to break up, parts separating out as independent companies. Indeed, the latter process has started with privatisation. In these circumstances the generation of alternative employment will be essential." (J. Cooper. The Conversion of the Former Soviet Defence Industry. London, Royal Institute of International Affairs, 1993, p. 38).