Privatization

1
Privatization Structural Reform

• Igor Lukashin
• ECN 365 /IBS 394 Lecture
• August 5, 1998

2
Privatization Definitions

• Legal transfer of property rights from the state
  to private agents (narrow)
• Measures contributing to the destatisation of
  economic activity
• Private property need not mean full ownership
  (l-t leases)
• Creation of entirely new enterprises

Your father finally learned the new economic
policy
3
The Aims of Privatization

• Political considerations Taking property from
  the state,creating a new class of capitalists
• Equity considerations Property return to former
  owners
• Efficiency reasons Would only work if theres a
  market environment
• Financial generating revenues for the state
• Instrument of stabilization monetary overhang
  elimination

4
The Aims of Privatization Harsh Realities

• Fiscal potential not viable, privatization is
  costly.
• East Germanys Treuhand debts to revenues ratio
  61
• Fees to foreign accountants expenditures of
  privatization agencies
• Giveaway costs minimized, but receipts are nil
• Equity dominant in Poland
• workers get preferred share
• Czechoslovakia Political aims
• take property from communist management voucher
  privatization

5
The Mechanisms of Privatization

• Creation of private enterprises Street Sales
  Human Capital
• Consulting, private teaching, engineering,
  computer services
• Legal support for small-scale privatization
• Trade services, construction
• Large-scale privatization
• Free or quasi-free asset distribution management
  governance problems
• How to turn into efficient firms? How to manage
  state sector along market methods?

Learn to swim! Market
6
The Institutional Framework

• The Government supervises
• Ownership rights given to privatization
  agencies/funds
• Transformed into joint-stock companies before
  privatizing
• Valuation of enterprises
• Liquidation
• Restructuring or recapitalising
• Industrial restructuring
• Financial restructuring
• Bankruptcy procedures
• Writing off bad debts

7
Privatization with the Help of Foreign Capital

• Creation of legal framework
• Ambivalent attitudes
• Hoped to attract FC
• Need to address nationalistic feelings, e.g. land
  ownership
• Foreign investment - large share of proceeds, but
  no more than 10-15 of total capital
• FC - contradicting objectives with domestic
  policy
• Lobbying for increased tariffs on competing
  goods favorable exchange rate changes
• Benefits problems to foreigners

8
Sales of Assets to Domestic Capitalists

• Tantamount to FC family ties
• Lack of domestic capital
• Free distribution
• Privatization through non-cash bids
• Reorganizing into joint-stock company
• allocation of shares to creditors
• Non-cash bid by a new management team
• Stock market?
• Public offerings lack transparency Narrow
• HH stock market gambling

9
Mass Privatization Schemes

• Distribution of vouchers to be converted into
  shares in operating companies
• Distribution of shares in investment funds or
  holding companies that in turn have shares in
  companies
• Russia everyone got a 10,000 rubles worth
  privatization voucher, tradable in cash or
  securities 3 variants of privatization
• Variant 1 25 free non-voting shares for
  employees
• Variant 2 51 shares at 1.7 book value on
  01/01/92 (gift - high inflation) option
• Variant 3 20 to group of employees _at_ book
  20 more if successful restructuring

10
Mass Privatization Schemes Reasons

• The quickest way (takes time if technical
  constraints and political obstacles interfere,
  e.g. Poland)
• Politically appealing massive gift to the
  electoral constituency
• Appeared as an irreversible commitment to
  capitalism
• What Russian doesnt like fast price decline of
  the stock bought by his neighbor? )

11
Spontaneous Privatization

• Nomenklatura turned owners of their enterprises
• Splitting up state companies
• Transfer of crown jewels into joint-stock
  companies
• Leaving the unprofitable parts to the state
• Enterprise-initiated
• Submit Privatization Plans
• Cant exclude insider info
• Is spontaneous privatization bad?
• Asset-stripping versus effective management

12
The Lasting Difficulties of Privatization

• The speed and sequencing
• Prices or privatization?
• All-encompassing reform package preannounced with
  a set schedule
• The restitution problem
• Cash or securities? Who should be compensated?
• The benefits to be extended to former employees
• Looked upon with suspicion, tantamount to
  spontaneous privatization
• The special case of privatization in agriculture

13
The Outcome of Privatization Who Controls the
Enterprises?

• Share of privatized sector
• overall production
• employment
• Management of private sector
• Small vs Large scale units
• Already privatized
• Preparing for Privatization
• State-owned in medium term
• Corporate governance
• principal/agent problems
• Acting governance by the insiders
• Did you come to tell me you quit? No, to buy
  the enterprise!

14
Other Areas of Structural Transformation

• Demonopolization
• Dual industrial structure, foreign-owned big
  business, rest -domestic
• Creation of modern financial and tax structure
• Cushioning the impact of stabilization and
  structural transformation
• What is the role of state in the emerging
  markets?
• What should be its industrial policy?

15
The Banking and Financial Sector Reform

• Monobank two-tier banking system
• to support stabilization program
• to provide finance to the economy
• to facilitate privatization enterprise control
• CB quantitative credit tightening
• high inter-enterprise indebtedness, large payment
  and tax arrears
• banks cant exert pressure on bad debtors -
  reluctant to show non-performing loans
• adverse-selection effect too high domestic
  interest rates
• US-UK vs German-Japanese model

Tomorrow youre going to hold up a bank - prison
is on the verge of bankruptcy!
16
The Tax Reform

• Part of structural transformation, critical to
  the stabilization program
• The new tax system should
• Provide resources to the budget
• Be transparent as simple as possible
• Not too heavy to avoid entrepreneurial
  disincentives
• Mixed results tax evasion
• VAT - less painful for the public than income tax
• Less easy to evade
• Not easy to monitor
• Slow to implement, train administration

There are thousands of ways to evade taxes
Mines the most effective!
17
Building a New Social Safety Net

• Main problem Pension system
• New Poor Inflation eroded their already low
  pensions
• Social expenditures- budget financed
• Need to balance budget - cut in spending
• Private insurance schemes - not realistic

18
Creating a New Legal System

• Old code not suitable for the new market
  environment
• Some of the normal market activities - a serious
  crime under old laws
• Need to create new legislation for economic
  situations not possible before
• Provides foundations for basic decision-making
  property laws, constitution, government restraints

Due and speedy process
19
Is an Industrial Policy Necessary?

• State involvement in long-term strategic
  development of a given activity
• Tariffs increased to protect nascent
  industries
• Restructuring, shutting down bankrupts, pursuing
  anti-monopoly policy
• Agricultural policy
• Profits appropriated by retail distribution
• had to pay higher taxes
• Lobby for protection subsidies

20
Will the Transition Ever End?
Bulk of changes went through A new system has
taken shape Uneven income distribution Proper
incentives in place Definitely on the way to
market
Look, the dollar is going to go up by 20 points!
Boris issuing more and more decrees Should really
stop discretionary legislation for better
predictability
21
Thank You for the Wonderful Second Summer Session

• Difficult course
• Fresh instructor
• Unfamiliar, strange, eerie material
• Killer tests
• Challenging presentations
• Constant video surveillance
• Soviet jokes - not funny
• Unintelligible Russian accent
• Obscure Russian Songs
• Inaudible video
• And youre still here! Whats wrong with you???
  )