Saul Estrin

Privatisation plays a central role in transition economies. Indeed, if the share of public ownership is a measure of socialist control, then progress in transition is indicated by the growth in the private sector share. But because almost the entire industrial sector was in state hands under the communists, privatisation in transition was no small task. This condition forced innovation in privatisation methods, leading to the widespread use of “mass privatisation”- distributing state assets at a zero or nominal price. Privatisation was very successful, in the sense that the state sector was rolled back rapidly everywhere. The bigger questions, which are the subject of this article, are whether privatisation also enhanced company performance and improved economic growth - and, if not, whether this was because of the methods of privatisation used.

 

Privatisation Methods

Every country used a variety of privatisation methods. For example, small firms were usually sold to the highest bidder, and utilities were floated on stock markets. However, it was possible by the time the bulk of privatisation was completed in the late 1990s, to discern the predominant method used in each country (see EBRD Transition Report, 1998). Mass privatisation was the most common; nineteen of the 25 countries listed used it as either a primary or secondary method. Management Employee Buyouts (MEBOs) were also important, with nine countries using them as their primary method, and six more as their secondary. Most transition economies therefore eschewed conventional methods of privatisation by direct sale: only five countries, themselves among the most developed, used this as their primary method.

Privatisation Outcomes

Few countries contained a private sector of any significance in 1990, except for Hungary and Poland, where the private sector already represented over 30 per cent of GDP. This makes the growth in the private sector share during the 1990s, reported in Table 1, even more dramatic. In only five years, the private sector share was above 50 per cent in nine countries, though in eight countries in the Commonwealth of Independent States (CIS), it remained below 30 per cent. By 2002, the private sector in thirteen additional countries had reached at least 50 per cent of GDP; only Belarus and Turkmenistan still had private sector activity at 25 per cent of GDP. Thus the privatisation process was in most countries effective in transferring the bulk of economic activity from state to private hands in the space of hardly more than a decade.

The Impact of Privatisation on Firms

Summary studies (e.g. Djankov and Murrell, 2002) usually conclude that the impact of privatisation on company performance has been positive and significant, though not in every circumstance. Most also conclude that the effect of privatisation on company performance has been much greater in Central Europe than in the CIS.

Two factors are usually cited as influencing whether privatisation enhances company performance. The first is the nature and characteristics of the new private owners. When the new owners are foreign firms, the improvement in most performance measures is quite marked. There is also some evidence that privatisation to domestic private outsider owners improves performance, though it can be important for the ownership shares to be concentrated. However, there is hardly any evidence indicating that company performance is improved when firms are privatised to insiders, either managers or workers. This is probably because insiders exploit their control to resist (rather than promote) the changes required to make firms competitive in the market environment. Insider ownership was a fairly common phenomenon, especially in the CIS. This probably goes some way to explain the weaker economic performance in many of those countries, compared to, for example, Hungary, Poland and the Czech Republic, where foreign direct investment flows have been much greater.

The second factor is the institutional and business environment in which privatisation takes place. Privatisation underscores the importance of corporate governance, which depends on a competitive market environment and the enforcement of property rights. In countries where the legal system is not functioning effectively and businesses face high levels of corruption and weak financial discipline, private ownership may not be sufficient to improve performance.

It is often argued that these deficiencies of governance and institutions can be traced back to the methods of privatisation, in particular the widespread use of mass privatisation. This argument has been strengthened by country studies highlighting problems of weak governance, corruption and tunnelling in the Czech and Russian mass privatisation programmes.
The Impact of Privatisation on Growth

There have been relatively few studies on the impact of private sector development on growth. However, Bennett, Estrin and Urga (2005) find that private sector development enhances growth, using a panel data model for 26 transition economies, 1991-2003. This study finds that a 1 per cent increase in the share of the private sector in GDP is found to increase GDP growth by 0.18 percentage points.

Figure 1 plots the relationship between GDP growth rates (?GDP) and the private sector share of GDP (PRIVSECT) in all the transition economies over the period. It shows that the relationship is positive, though with a diminishing effect and with higher variances in growth rates when the private sector share is lower. In a regression also containing country and time specific fixed effects, the relationship (figures in parentheses are t-statistics) was found to be: ?GDP = -4.262 (-1.36) + 0.115 (1.73) PRIVSECT.

Bennett, Estrin and Urga (2005) also show that GDP growth in transition economies is driven by the same fundamental factors as in developed Western economies: employment growth, capital accumulation and improvements in human capital. They also find that only mass privatisation enhances growth in a statistically significant way. Sales of state owned firms and MEBOs do not accelerate the rate of growth. They link this to the speed with which mass privatisation allows firms to be removed from the state sector, and therefore for budget constraints to be hardened.

Conclusion

The most impressive feature of privatisation in transition economies has been the speed and scale at which it has occurred. The reforming governments of the late 1980s and early 1990s managed successfully to transfer the huge state owned sector into largely private hands in a time period of hardly more than a decade. Even so privatisation appears to have led to improved company performance, especially when the new owners are foreign or concentrated domestic ones. Privatisation has also apparently enhanced growth and provided governments with much needed revenues. Finally, while the micro-economic evidence appears to suggest that weak or perverse effects from privatisation may be associated with some methods of privatisation (in particular mass privatisation), our study demonstrates that this does not seem to have any appreciable influence on macroeconomic outcomes.

Table 1: Private sector share in GDP and employment in Europe and CIS, 1989-94
	In GDP			In Employment
	1991	1995	2002	1991	1995	2001
Albania	24	60	75	..	74	82
Armenia	..	45	70	29	49	..
Azerbaijan	..	25	60	..	43	..
Belarus	7	15	25	2	7	..
Bosnia and Herzegovina	..	..	45	..	..	..
Bulgaria	17	50	75	10	41	81
Croatia	25	40	60	22	48	..
Czech Republic	17	70	80	19	57	70
Estonia	18	65	80	11	..	..
FYR Macedonia	..	40	60	..	..	..
Georgia	27	30	65	25	..	..
Hungary	33	60	80	…	71	…
Kazakhstan	12	25	65	5	..	75
Kyrgyz Republic	..	40	65	..	69	79
Latvia	..	55	70	12	60	73
Lithuania	15	65	75	16	…	…
Moldova	..	30	50	36	..	..
Poland	45	60	75	51	61	72
Romania	24	45	65	34	51	75
Russia	10	55	70	5	..	..
Serbia and Montenegro	..	..	45	..	..	..
Slovak Republic	..	60	80	13	60	75
Slovenia	16	50	65	18	48	..
Tajikistan	..	25	50	..	53	63
Turkmenistan	..	15	25	..	..	..
Ukraine	8	45	65	..	..	..
Uzbekistan	..	30	45	..	..	..
Means	20	44	62
Sources: EBRD Transition Report 1999, 2003

Saul Estrin is a Professor of Economics and the Adecco Professor of Business and Society at London Business School. In August 2006 he will take up his new position as Convenor of the new Department of Management at the London School of Economics and Political Science.

References:

Bennett, J., Estrin, S. and Urga, G. (2005): Privatisation and Economic Growth in Transition Economies, forthcoming.

Djankov, S. and Murrell, P. (2002): ‘Enterprise Restructuring in Transition: A Qualitative Survey’. Journal of Economic Literature 40 (3): 739-793.

EBRD Transition Report (various years). European Bank for Reconstruction and Development, London.