Panel III :

and Industrial

Successes and Failures:
Privatisation in the Transition Economies

Peter Rutland

The solution to Eastern Europe's transition problems lies in implementing the Western economic policy 'trinity' of liberalisation, stabilisation, and privatisation. The first two were relatively easy because governments simply had to stop doing things - controlling prices, and spending money. The third was more difficult, yet it had become an important criterion for measuring the success of economic reform. The key to its success, says Peter Rutland, is strong leadership, good administration, and a clear timetable. They have been a qualified success, he thinks. But the benefits could take years to come through.

Dr. Rutland is Assistant Director (Research) of the Open Media Research Institute, Prague.

Western observers very quickly adopted an agreed framework for analysing the transition from state socialism in Eastern Europe. This framework was essentially teleological in nature. It was assumed that there was a definite model towards which the former socialist countries were headed. In the economic sphere, this was to be a capitalist market economy, to be reached through the speedy unleashing of market forces. There was widespread agreement among Western economists that what was required was the policy troika of liberalisation (lifting controls and allowing market-clearing prices to emerge), stabilisation (eliminating inflation and establishing convertible currencies) and privatisation (the transfer of assets to new owners). (1)

These standard formulae, derived from the principles of neoclassical economics, received a welcome audience in the West. The confidence with which Western economists advanced these prescriptions was comforting to Western governments and financial institutions. It seemed to impose order and predictability on the chaos of the disintegrating economies and political systems of Eastern Europe.

As with the economic prognosis, so it was with the political system. The common assumption was that these countries would all move towards Western-style electoral democracy, again on the premise that there was, broadly speaking, a single model which could be emulated.

Note that both in the economic and political spheres the received wisdom was strongly teleological in nature. It was assumed that we knew where these countries were headed, and that their destination was more or less a single model of social organisation. Behind this assumption there stands a still deeper and less explicit premise: the supposition that, as national economies become more integrated into the global economy, they must necessarily become more alike.

As with the expansion of the European Union, it is expected that integration must take the form of the addition of increasingly homogeneous units. While some degree of homogeneity is obviously a precondition to international economic cooperation, global experience over the past 30 years (the success of the East Asian economies, for example) suggests that strong elements of heterogeneity will persist even as countries increase their level of international economic cooperation.

If challenged, Western experts would admit that yes, of course, there are differences between Anglo-American and German forms of corporate governance; or that yes, there were important distinctions between presidential and parliamentary forms of democracy. However, it was implicitly assumed that these were of minor importance, not significant enough to alter one's overall perception of the transition process.

For East European economies, this meant that they were expected to pursue a single model of economic transition - and would be assessed in terms of their relative success or failure in pursuing that goal. The East European countries were held up against an abstract model of marketisation and democratisation which few (if any) can actually be expected to realise. This approach carries the danger of engendering frustration among the leaders and peoples of Eastern Europe - a feeling which may be turning into resentment towards the Western countries which are categorising them as "failures" in the transition process.

Beyond the Rhetoric of Transition

As other presenters at this conference have noted, the countries of Central and Eastern Europe have found it very difficult to implement successfully the policies needed to stabilise their economies and introduce market institutions. Five years into the transition process, only half a dozen of the 27 countries in the region can be deemed to be "succeeding". In the remaining countries, one can detect some positive signs, but these are offset by persistent problems. In general, all countries have made considerable progress in liberalising their economies - lifting price controls, removing restrictions on private enterprise, and opening up foreign trade.

Most countries have also made brave efforts to stabilise their economies, by cutting government spending and tolerating a fall in real wages. However, this has usually not been enough to bring the rate of inflation down into single figures. Even in Poland and Hungary, inflation continues at 20-30 percent a year, and the foreign debt overhang remains a troublesome problem. The third aspect of the policy package - privatisation - has seen even more mixed results. While most countries have seen a boom in private retailing and services, the bulk of manufacturing industry remains in the hands of the state. (On this, see the paper in this volume by Michael Kaser.)

Perhaps the most worrying feature of the transition is the deep and persistent fall in GDP. (2) In his presentation to the NATO conference, Professor Michael Ellman offered a list of five countries which appeared to have turned the corner of the "transformation recession", and experienced positive growth in 1994 (Slovenia, Albania, Czech Republic, Poland and Estonia). Optimists would wish to add other countries to the list of success stories, arguing that the fall in officially-reported GDP overstates the extent of recession, because of the expansion of the informal sector. While it is true that the unreported economy has boomed, there have been few systematic efforts to estimate its rate of growth. Its expansion is unlikely to have been sufficient to offset the 40-50 percent drop in official GDP. (Bear in mind also that there was already an informal sector before 1989.)

Five years into the transition, then, few countries in the region can claim the mantle of success. And yet the standard approach to the transition economies is to judge them in terms of success and failure. Analysts anxiously monitor their performance to see who is furthest down the path towards a market economy, and typically draw up scorecard of who is ahead and who is falling behind. This orientation towards success has two deleterious side effects.

First, countries which are showing few signs of progress are told that they must be patient, and are reassured that eventually they will reach their goal. This advice is unlikely to be very convincing for much longer. Five years into the transition, people's patience seems to be wearing thin; as is evidenced by the victory of social-democratic governments in the second round of free elections, in every country save the Czech Republic.

Western observers will have to acknowledge the fact that for some of these countries the transition process has effectively ended, and they must develop new categories to analyse the politics and economics of countries which seem to be "frozen" in transition. This implies that rather than targeting assistance and policy advice on measures to speed up the pace of transition, the West should be more focused on trying to shore up the status quo, to preserve those elements of the economy and civil society which are functioning effectively and provide a bulwark against social entropy.

Western policy for some of these countries may have to start thinking more about stopping a slide back into anarchy and despair, rather than a blinkered focus on the necessity of transition to a brighter future. The West cannot afford to allow large parts of the eastern half of the European continent to slip into a living tableau of "Waiting for Godot."

The second negative consequence of the success orientation of Western analysis is the temptation to analyse events in each country in terms of their progress towards democracy and a market economy. It is particularly pernicious to draw up a scorecard ranking the various countries in terms of the speed of transition they have attained. Observers zero in on a handful of easily-monitored indicators, and keenly report who is ahead in currency convertibility or reducing budget deficits, while Eastern governments anxiously await their latest bond rating from Standard & Poors.

Such an approach is undesirable because it encourages politicians to think in terms of abstract and universal models rather than trying to tailor solutions to local problems. It also plays into the long standing rivalries and tensions between the countries of the region. Repeatedly through their unhappy history they have found themselves competing for attention and favours from the West. On occasion this has caused them to prematurely embrace Western philosophies and alliances, while simultaneously failing to cooperate with their Eastern neighbours. Western states wittingly or unwittingly pick favourites among the Eastern countries, and play out their own rivalries with other Western states on a continental scale. This happened in the 1920s and 1930s, and it seems to be happening again.

Unlike in earlier periods, however, this situation is unlikely to produce sharply negative consequences. There are no attractive alternative ideologies to liberal democracy, and it is hard to imagine communism or fascism taking root in the region once again. However, the fate of Yugoslavia should serve as a sobering reminder of the need to carefully study the situation inside each country in its own terms, rather than holding them up in comparison to abstract models of marketisation and democratisation.

How to Account for Success?

Let us assume for the sake of argument that the success/failure paradigm is a viable approach to the study of the economies in transition. How, within the framework of this approach, can one explain the differing outcomes in differing countries? In particular, can one attribute success to the adoption of correct economic policies? It is our contention here that it is extraordinarily difficult to come up with a systematic and empirically grounded explanation of the relative success and failure of the economies in transition. And to the extent that a pattern can be discerned, it is just as plausible to argue that the policy package adopted by a country's political leaders is not as decisive a variable as is often assumed. Rather, exogenous or circumstantial factors, such as the starting position of the country when it entered the transition process, may be more important in accounting for differences in final outcome.

What features are shared by the five countries identified by Professor Ellman as the most successful transition economies to date (Slovenia, Albania, Czech Republic, Poland and Estonia)? It would be hard to argue that they had all adopted similar policy packages. Each country seems to have implemented a range of measures which differ both from each other and from IMF orthodoxy. Some were able to adopt and maintain wage controls, others were not. Some have carried out a mass privatisation programme, others have not. Admittedly, they have all made progress towards currency convertibility and stabilisation, but the measures adopted have varied from country to country (a currency board in Estonia, a crawling peg in Poland, strict monetary and fiscal policy in the Czech Republic), and inflation in several of them (such as Estonia and Poland) remains obstinately high.

Even if one was willing to argue that one could detect a strong convergence in the policies adopted by these countries, this would beg the question of why those particular countries adopted the requisite package of policies. It should be emphasised that most observers merely assume that because their economies seem to be succeeding, this must be because the countries adopted the necessary policies.

One must pose the chicken-and-egg question: it may be that an improvement in economic performance caused by extraneous factors made it possible for the governments to adopt something resembling orthodox policies. As far as this author is aware, this point about the similarity of policies among the "successful" countries has yet to be shown through a thorough comparative study. Inferring from evidence of success that the country must therefore have adopted the correct policies is an ex post rationalisation rather than an explanation. There is a hint here of the "ants on a log" syndrome. (Ronald Reagan once compared the US Congress to 600 ants on a log, each thinking that it was steering it down the river.)

The key feature in explaining these countries' success would appear to be that they are all adjacent to Western markets. This makes it relatively easy for them to benefit from a rapid increase in cross-border trade and tourism. It also means that it is at least conceivable that they could be invited to join the European Union at some not-too-distant point in the future. One can add that with the exception of Poland all of them are small in size. This means that a given quantity of Western aid goes further than in a country the size of Ukraine, and it means that the impact on the European Union of greater access to Western markets will be relatively modest. (To reiterate, this is less true of Poland - the absorption of her farm sector into the Common Agricultural Policy would be a very costly exercise.)

The point is that for reasons of geography the economic prospects for these countries, short-term and long-term, are more rosy that for larger countries located further to the East, for whom access to the European Union is only conceivable after the first wave of countries have gained entry. Even this tentative explanation has to deal with exceptions, however. Hungary and Croatia are both small countries with a common border with an EU member, yet for various additional reasons their economies have failed to stabilise sufficiently to make it onto the Ellman list.

Does this argument over how to explain success really matter? Well, it is not purely an academic dispute. Western aid and trade has been tied to the assumption that the crucial variable is government policy. Some governments are rewarded for adopting the correct policies, and others punished for failing to do so. Moreover, the debate over transition has come increasingly to be dominated by a horse-race mentality: looking for which countries are ahead and which are falling behind.

How to Explain the Successful Privatisation Programmes?

Privatisation has proved to be the most difficult of all the policies to adopt. (3) Effective implementation of a programme of mass privatisation has in practice been confined to a handful of countries (East Germany, Czech Republic, Russia). In all these cases, the leaders opted for a swift and fairly simple privatisation scheme, where speed took precedence over questions of equity and fairness (about which political debate can go on ad infinitum).

However, the more one looks at this question, the more complex it becomes. It is instructive simply to draw up a list of all the factors which could possibly have an important influence on the success of the privatisation process. An evaluation of the relative success of Russia, East Germany and the Czech Republic in implementing a mass privatisation programme would have to consider some or all of the following elements: (4)

Economic factors

  • A stable, convertible currency.
  • A stable or growing GDP.
  • A boom in exports, generating cash for needed imports.
  • Modest unemployment, to avoid social tension.
  • The introduction of effective bankruptcy procedures, to accelerate restructuring.

Political factors

  • The emergence of a cohesive, technically competent team of top administrators.
  • Support from strong political leadership.
  • Conjunctural factors (a window of opportunity).
  • Public support for the programme.
  • Consensus among political and economic elites in favour of the programme.

Administrative factors

  • General bureaucratic capacity (efficient, non-corrupt civil servants).
  • The laying down of a strict timetable.
  • Existence of a clear and reliable legal structure to adjudicate disputes and monitor implementation.
  • The creation of a separate specialised bureaucracy tasked with designing and implementing the programme.
  • Support from international agencies.
  • A decentralised process to minimise opposition while maximising administrative capacity.

Note the multiplicity of factors that could be involved. One can draw three broad conclusions about the relative influence of these factors from the countries where mass privatisation was quickly implemented (Czech Republic, Russia and East Germany).

First, economic factors may be less decisive than was initially supposed by many Western observers. In all three countries privatisation was implemented despite the fact that the fall in GDP had not stabilised. In neither Russia nor the Czech Republic has bankruptcy legislation played a very important role, nor has unemployment risen to significant levels. Russia even managed to carry out its programme in the midst of continuing high inflation.

Second, all three countries' privatisation programmes share some common features at the level of administrative design. In each of these countries the programme was implemented in a decentralised manner, and a lot of responsibility for proposing restructuring schemes was delegated to the level of the enterprise. Either the current managers or rival would-be owners were obliged to draw up privatisation projects, which would then be approved by a central clearing house. Another distinctive feature was that in all three countries a special new government agency was created to monitor the process.

This agency was given a specific and narrow mandate, and from the outset the assumption was that it would wind itself up once the assets in the programme had been shifted into new ownership. This meant that the bureaucrats in charge of privatisation had clear instructions to move the process forward as quickly as possible. Countries which tried to involve existing bureaucratic agencies do not seem to have been able to inaugurate programmes capable of transferring a large volume of assets in a short period of time.

As far as the politics of transition are concerned, there were two competing schools of thought as to how best to tackle the problem of political opposition to reform. The central paradox facing the reformers in 1989-91 was that the potential beneficiaries of reform (future capitalists and future generations of consumers) did not currently exist as organised social actors: they had a hypothetical existence, and were dispersed through society.

On the other hand, those who would bear the costs of transition (such as pensioners, farmers, and workers and managers in heavy industry) were already present, were aware that they would be among the losers, and in some cases were well-organised and with a strong political voice. How could one overcome this political imbalance between the diffuse winners and the all-too-specific losers?

There were two schools of thought on this question. The "window of opportunity" philosophy, as represented by former Polish Finance Minister Leszek Balcerowicz, argued that the government must move as quickly as possible: while the old elites are disoriented by the collapse of communism, and while the new government enjoys a honeymoon of democratic legitimacy. The coalition building school argued that compromises must be made in order to neutralise potential adversaries (by offering them side payments) and unite potential beneficiaries by welding them into a coalition actively supporting the reforms. This would necessarily be a protracted process, in contrast to the lighting strike advocated by the window of opportunity school.

The window of opportunity strategy seems to have worked fairly well with regard to liberalisation and stabilisation. These were relatively simple policies whose basic features were well-known from the experience of other countries. They could both be introduced quickly since they involved doing less of something (regulating prices or spending money, respectively). Privatisation was a rather different proposition, since this required doing something positive creating a mechanism for transferring a massive volume of industrial assets into the hands of new owners.

In each country which adopted mass privatisation, steps had to be taken to neutralise potential opponents and to create a political constituency in favour of change. In East Germany this was done through a generous social policy and a commitment to raise Eastern wages to Western levels: a policy which is costing Germany in excess of $100 billion a year in subsidies.

In both Russia and the Czech Republic a crucial component of privatisation was the distribution of vouchers to the general population. This gave the people at large the hope (cynics would say the illusion) that they might personally gain from the programme. More subtly, one can argue that the voucher programmes created uncertainty about who would finally emerge as the new owners of the privatised firms. It was realised that the shares distributed to the general public would not stay in their hands for long, but would be bought up by mutual funds, businessmen, banks and the like.

But the programme did not try to closely regulate the secondary market in shares, and did not predetermine who would emerge as the new owners. This uncertainty was politically useful, since it gave the government a degree of "plausible deniability". In the event that ownership gravitated into the hands of foreigners or unsavoury native businessmen, they could argue that this was not their intent, but that it was the product of the autonomous decisions of individual citizens, selling their shares to the highest bidder. Also, uncertainty over the outcome of the whole process may have encouraged potential opponents of privatisation (for example, incumbent managers) to adopt a wait-and-see attitude, since it might turn out that they will benefit from the scheme.

Lessons Learned

The preceding section argued that it is very difficult to come up with convincing explanations for why some countries appear to be succeeding in transition to a market economy. The main conclusion to be drawn from this is that one must be cautious about making success criteria the pivotal factor in determining one's attitude towards the political and economic situation of a given country.

With regard to privatisation in particular, it is worth reiterating that the complex process of industrial restructuring is not synonymous with privatisation. Closing factories, shedding labour, and investing in new industries with good future prospects are difficult decisions which will not necessarily be solved by the simple transfer of assets from state into private hands. Restructuring begins before privatisation takes place (as state-owned firms are weaned off subsidies and are thus forced to accept "hard budget constraints").

And most of the real struggles over restructuring will occur after privatisation, and will spread over many years. The mere act of transfer of ownership is but one step in this process, and one should beware of exaggerating its importance in the search for signs of positive developments in the transition economies. Also, one should not forget that exposure to market competition (domestic and international) is likely to be far more important in promoting efficiency than the specific question of the pattern of ownership of industrial assets.

Many commentators at this conference have underlined the fact that the countries of the region are politically and economically distinct and should not be subsumed into a "one size fits all" transition model. Many countries of the region have strayed from the preordained transition path, or at least are falling badly behind, and each faces a unique configuration of problems. Successful integration with the global economy in general, and the European Union in particular, clearly does presupposes a certain degree of homogeneity from its component parts.

The record of the past five years in Eastern Europe suggests that heterogeneity continues to be the order of the day. Indeed, in some respects the region's diversity is greater than it was in the socialist period, when the Soviet Union tried (largely unsuccessfully) to impose a degree of uniformity. But the more difficulties these countries encounter in the transition to the market, the more diverse they will become, since problems and calamities tend to emphasise uniqueness. As Tolstoy says at the beginning of Anna Karenina, "Happy families are all alike, but every unhappy family is unhappy in its own way."

From this record of diversity Professor Michael Kaser drew the conclusion that one must call upon the state to step forward and take measures necessary to adapt to the particular problems of the country in question. However, just because each country has a different set of problems, and because each country has its own state apparatus, it does not follow that the state is best-placed to deal with the divergence from the ideal transition path.

One can agree that in most countries the market transition model has failed to bring about the necessary restructuring of large sectors of heavy industry, and has failed to halt the precipitous fall in GDP and living standards.

But just because spontaneous market processes have failed thus far does not mean that the state will be capable of doing a better job. The mere fact that the state is specific to each country does not mean that the national state is capable of dealing with its problems. The evidence of the past 40 years of socialist economics suggests just the opposite - that the state is likely to do an even worse job. If one looks at specific sectors of state activity (such as health care or the education system), one finds that because of budgetary constraints, poor political leadership and general social dislocation, the post-1989 state is performing less effectively than its socialist predecessor. This does not augur well for their ability to mount an effective industrial restructuring policy.

Thus it is still possible to argue that the state that governs least governs best, and that there will be no easy solutions to the economic plight of the ailing transition economies. Non-state actors such as international governmental agencies, international private business and domestic private business, may be more effective at tackling these problems than the national state.


  1. For a sample of the transition literature, see S. Islam and M. Mandelbaum (eds) Making Markets (New York: Council on Foreign Relations, 1993); L. Csaba The Capitalist Revolution in Eastern Europe (London: Elgar 1994); J. Sachs Poland's Jump to the Market Economy (Cambridge Mass.: MIT Press, 1994).

  2. G. Kolodko, 'From recession to growth in post-communist economies', Communist and Post-Communist Studies, vol. 26, pp. 123-43, January 1993.

  3. On the general progress of privatisation programmes, see the series of studies from the Central European University, such as: J. Earle, R. Frydman and A. Rapaczynski (eds), Privatisation in the Transition to a Market Economy (New York: St. Martins, 1993); and R. Frydman and A. Rapaczynski, Privatisation in Eastern Europe: Is the State Withering Away? (London: Central European University Press, 1994).

  4. P. Rutland, 'Thatcherism, Czech style: Organized labor and the transition to capitalism in the Czech Republic', Telos, winter 1992-93, no. 94, pp. 103-29; P. Rutland, 'Privatization in Russia: two steps forward, one step back?', Europe/Asia Studies, vol. 46, no.7, 1994, pp. 110-32; J. Roesler, 'Privatization in East Germany', Europe/Asia Studies, vol. 46, no. 3, 1994, pp. 505-518.

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