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Making markets: A comparative study of postcommunist

managerial strategies in Central Europe

LAWRENCE P. KING

Yale University

The transition from ``socialism'' to ` capitalism'' was ^ apart from being

the de¢ning phenomenon of the late twentieth century ^ an unprec-

edented natural experiment in societal transformation and organiza-

tional restructuring. Before the revolutions, the economies in Eastern

Europe were almost entirely state owned and centrally planned; today

the property of most postcommunist countries is predominantly in

private hands and is market integrated. According to neo-classical

``transition economics,'' as articulated by the leading economists study-

ing the transition as well as the World Bank and other International

Financial Institutions, the creation of private property and the freeing

of markets should have created enterprise restructuring leading torapid growth at the national level after a brief period of ``readjustment.''

It has been more than ten years since the transition was launched in

most postcommunist societies, but the neo-classical economists' pre-

diction seems to have come to pass in only a minority of the post-

communist countries, most notably in Central Eastern Europe and

Estonia. In most of the postcommunist world, there has been no real

recovery. Rather, a human disaster on a previously unimaginable scale

has ensued. This article seeks to explain under what conditions the

expectations of neo-classical economics will be realized. It argues that

the creation of private property and the existence of a market environ-

ment in itself does not produce an e¤cient economic system. Successdepends on who the owners are and how they are created.

This article builds on the insights of the New Economic Sociology,

which sees the economy as structurally embedded in networks of social

relations that collectively make up the social structure.1 Speci¢cally,

in this article, I argue that the more the economic actors that own

and control post-communist economic organizations are embedded in

Theory and Society 30: 493^538, 2001.

ß 2001 Kluwer Academic Publishers. Printed in the Netherlands.

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political and ¢nancial clientelistic networks, the less successful the

transition from the planned to the market economy will be. Therefore,

the key to a successful transition is to control the nature of the net-

works in which ¢rms are embedded. Privatization policy should be

formulated to discourage the activation of networks linking managers

of ¢rms to individuals in the state or ¢nancial institutions.

This article investigates the process of transition by identifying various

managerial strategies needed to survive the transition or to trans-

form socialist era enterprises to operate in a market or quasi-market

environment. The result of these strategies is di¡erent governance

structures (understood as patterns of ownership and control) in post-communist enterprises. These di¡erent governance structures are more

or less likely to contribute to e¡ective ¢rm restructuring. Therefore, the

aggregation of these strategies on the country level (resulting in the

prevalence of di¡erent governance structures in di¡erent countries) will

have a major e¡ect on national long-run macro-economic perform-

ance. The selection of di¡erent strategies in di¡erent countries, in turn,

depends on a country's: (1) political and ¢nancial networks, (2) inher-

ited legal-institutional structure, (3) privatization policy, (4) strength of

democratic institutions, and (5) attractiveness to potential foreign direct

investors.

The remainder of this article is divided into seven parts. The ¢rst

section reviews the theory advanced by neo-classical economists

regarding how to conduct the transition from a Soviet-style economy

to a market capitalist economy.The second section provides a typology

of managerial strategies used to survive the transition or restructure

organizations. The third section discusses each managerial strategy's

e¡ects on economic e¤ciency and growth. The fourth section provides

several case studies that illustrate these processes. The ¢fth section

discusses factors contributing to the selection of certain strategies

over others, and how these factors vary throughout the postcommunist

world. The sixth section o¡ers a conceptualization of the di¡erences

among types of emergent postcommunist capitalism. It argues thatthe postcommunist countries are experiencing a process of economic

divergence toward two distinct forms of capitalism. A small group of

countries are undergoing a process of dependent capitalist develop-

ment, and a much bigger group of countries (with the vast majority of

the combined total population) are undergoing a process of economic

`ìnvolution'' or `ùnderdevelopment.'' The conclusion discusses the

theoretical and policy implication of these ¢ndings.

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Neo-classical economics and the transition

The creation of capitalist economies in the postcommunist societies

was carried out under the intellectual leadership of the West's top

neo-classical economists (most prominently housed at the now closed

Harvard Institute for International Development under the direction

of Je¡rey Sachs). Market forces, not a developmental state, were meant

to guide the restructuring of the postcommunist economies. Neo-

classical academics and experts argued that by allowing the market

to allocate resources, a new and e¤cient set of organizations would

replace the deformed ine¤cient state-owned enterprises inherited from

socialism. In turn, this would bring economic growth.2 The intellec-tual and political leadership of the transition, negatively conditioned to

state involvement in the economy during the socialist period, embraced

this view.3

The neo-liberal inspired ``big-bang'' or ` shock-therapy'' policies of the

¢rst postcommunist governments ^ stabilization, liberalization and

privatization ^ were intended to allow `è¤ciency'' considerations to

shape the organizations of the new capitalist economies. As such, they

explicitly shared the neo-classical assumption of atomized, rational,

maximizing actors without ``chronic information problems.'' 4 Once the

incentive structure was correct, and markets were allowed to function,

everything else would follow. The neo-classical theory of enterprise

restructuring at the beginning of the transition was quite simple: ``Pri-

vate ownership would ensure pro¢t-oriented corporate governance,

while liberalization of trade and prices would set free the competitive

market forces that reward pro¢table activities. Firms would have

therefore both internal and external incentives to restructure.'' While

`àt ¢rst, overall growth will su¡er from the weakness of new, coordi-

nating market mechanisms. It will then, however, pick up as repressed

sectors and activities expand, in response to lifting of constraints.''5 As

a result, growth in postcommunist society will follow a J-curve. Once

the transition to capitalism is achieved and actors have time to adjust

to the new incentive structure, growth will accelerate.6

This formula, it was asserted, would quickly create ` normal'' economies

as found in Europe and America.7 By allowing the ` Invisible Hand'' of

the market to do its job, Eastern Europe would quickly catch-up with

the West, or as Sachs put it, experience a ` democratically based rise in

living standards.''8 With the market providing information and the

correct incentive structure in place, the postcommunist countries

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would undergo successful globalization and begin to catch up to the

West. ` At the base of all of this transformation [is] .. . the idea . . . that

the postcommunist world has the potential to grow more rapidly than

the develop[ed]9 world and thereby to narrow the gap in living stand-

ards, if they harmonize institutions and join their economies to the global

economic system.''10 With local prices equal to ``world market prices''

and a liberalized trade regime, private actors in each country will

utilize the country's ``comparative advantage,'' thereby contributing to

the wealth of the nation.

In contrast, this article argues that the ``transition'' to a private market

economy ^ under the intellectual leadership of neo-classical econo-mists ^ did not ineluctably result in the restructuring of ¢rms in the

direction of greater e¤ciency. Indeed, any e¤ciency gains were a by-

product of the strategic action undertaken by career-driven socialist

era managers embededed in networks of social relations. These man-

agers acted personally to survive the transition or restructure their

¢rms to allow them to survive in the new market or quasi-market

environment. This strategic action of managers was largely responsible

for the transformation of the governance structures of the ¢rms in the

postcommunist environment. The way in which governance structures

were transformed, in turn, has a large impact on the performance of

¢rms. The performance of individual ¢rms, when aggregated, deter-

mines the overall performance of the economy. Thus, the strategic

action of socialist era managers determines whether the transition

from socialism to capitalism will be successful.

Which strategies are pursued by these managers depends to a signi¢-

cant extent on ¢ve factors: the inherited legal-institutional structure,

the existing networks of political and ¢nancial power at the time of the

transition, the privatization policies adopted by the postcommunist

government, the strength of democratic institutions (including the

freedom of the press), and the level of interest in the local economy by

foreign direct investors. These factors are in turn related to the balance

of power within the post-communist power elite at the beginning of thetransition process. Those countries in which the communist era politi-

cal-bureaucratic elite dominate in the postcommunist period will have

the least successful transitions.

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The typology of managerial strategies of transition

This study uses Hungary and the former Czechoslovakia and Slovenia

as a sample frame to study the di¡erent ways in which governance

structures have been transformed. What justi¢es studying ¢rms in

these countries and not others? The postcommunist countries in Cen-

tral Europe have the best chance of having a successful transition to

capitalism and ``joining'' the European capitalist system. They are both

literally and ¢guratively the closest to Western Europe. Prior to the

institutionalization of the Communist system they had the most capi-

talist development; and now they have the greatest opportunity for

international economic cooperation. Furthermore, they have pursuedeconomic policies favored by Western powers and Western capital.

That is, their governments consistently rank highest on indexes of

``liberalization'' or ``transition indicators'' ^ and therefore ``market re-

forms'' should have the most opportunity to restructure organizations

in these economies.11 Thus, we investigate cases where the neo-classi-

cal dynamic has the most chance of being found. If reality diverges

from the neo-classical model to a signi¢cant extent in these cases, what

chance does the model have of providing much guidance to under-

standing Uzbekistan or Russia?

The managerial strategies of transition identi¢ed in this article were

derived inductively from the case study data.12 They can be analytically

distinguished by the types of alliances socialist-era managers must

create to pursue them. These alliances are forged between managers

and a) state elites; b) ¢nancial sector elites; c) other managers; and

d) foreign ¢rms. The actual strategies employed in real cases often

involve combinations of the strategies identi¢ed in this article. These

strategies are thus the constituent moves that alone or in combination

make up the micro-methods that have been employed to ``make capi-

talism'' in Hungary and the former Czechoslovakia.13

Political capitalism

Political capitalism is made possible when individuals ``privatize'' state

power. That is, they use clientelistic ties to people with political power

or bureaucratic authority to create new ¢rms, in£uence ¢rm restructur-

ing, or in£uence ¢rm survival.14 Thus, the restructuring of organizations

can be heavily dependent on the existence of clientelistic networks

between enterprise managers and state managers. Actors use their ties

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to incumbents in positions of political authority for two purposes: ¢rst,

to demand the sale of shares of a company to themselves or a client;

second, to procure large and lucrative contracts or cheap loans from

the state. They then return some pro¢ts to their political patrons, who

use it to further their political careers or simply accumulate wealth in a

sultanic fashion.

Financial clientelism

Another strategy to transform organizations in Eastern Europe in-

volves drawing on clientelistic connections to sources of ¢nance inorder to privatize or restructure companies. This di¡ers from political

capitalism because these loans are obtained clientelistically yet without

the use of political networks.

Auto-cross-ownership

The previously discussed managerial strategies all involve alliances

with non-managers in the state or ¢nancial institutions. A strategy

relying primarily on alliances with managers in other (related) ¢rms,

is auto-cross-ownership. Managers, using their positional power, in-

stitutionally purchase other companies in a strategy of reciprocal

cross-institutional ownership. These ties of cross-ownership are rein-

forced through interlocks on Boards of Directors and Supervisory

Boards.15 The primary resources used by managers employing this

strategy are the personal relationships with managers at other ¢rms

forged during the socialist period, and their company's internal cash

reserves or access to ¢nance.

Ultimate control rests with the top managers of these ¢rms, with a

network of power emanating from the Boards of Directors and the

Supervisory Boards of the biggest companies in the group. The result-

ing governance structure of these ¢rms is both ``private'' (to the extentthat they are not owned by any organs of the state, even indirectly) and

``self-owned.'' This ``network of ¢rms'' resemble Japanese Kiretsu or

Korean Chaebol . U.S. banks also have high levels of cross-ownership.

The unique feature of the auto-cross-owned company is that there are

no people or extended families with ownership rights standing behind

the inter-enterprise ownership as in the advanced capitalist countries.16

This is an ownership form that consists of a non-state owned ¢rm

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without any signi¢cant ``natural individuals'' as shareholders. It is thus

` auto'' cross-ownership, unlike other examples of cross-ownership.

They not only own each other, but they also collectively own themselves.

This goes beyond the managerialist claim that di¡use ownership by

individual shareholders creates a situation in which managers control

the corporation. There are no people or families that are signi¢cant

shareholders. The shareholders are the companies in the group.17

Satellite ¢r ms

Unlike the previous strategies, managers pursuing satellite strategiesdo not need to forge alliances with any actors outside of their ¢rms.

To use this strategy, managers can capitalize on the fact that they have

the only really good information about the enterprises they run and

the enterprises' immediate environments. By forging an alliance with

other managers in the ¢rm, managers create parasitical ` satellite''

companies. This strategy involves the appropriation of ``property'' and

``wealth'' broadly conceived from state-owned enterprises (or recently

privatized companies) via satellite ¢rms created and owned by man-

agers.18 Managers create side businesses in the form of ` satellites''

revolving around their company. Satellites di¡er in their duration and

scope. Short-term satellites serve as mechanisms for ``privatizing'' the

¢nancial assets of ¢rms. The key to the successful use of this strategy

consists in controlling both ends of the transaction. Managers make

contracts between satellite ¢rms they have established and their own

companies to pay themselves for ¢ctional services such as ` consulting''

and ``presentations.'' This requires an alliance with at least some other

managers who know what is going on and are probably engaging in the

same activity.

Parasitic satellites can exist for far longer than these short-term satel-

lites, and operate on a much larger scale. Managers of ¢rms form

``satellite corporations'' around the old state owned or privatized ¢rms.

Like short-term satellites, these ¢rms are created during a period inwhich there is no e¡ective controlling owner. Unlike the short-term

parasitic satellites, they are typically of a much larger scale and may

have much greater longevity. These ¢rms are sometimes subsidiaries of

the ``mother'' company, sometimes privately owned. Whichever situa-

tion exists, the pro¢t is taken by their managers. Managers employing

this strategy pro¢t by utilizing networks formed in the socialist period,

and almost certainly must provide some kind of kick-back to establish

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themselves as either an intermediary company with the right to sell to

the old company after taking a large portion of the pro¢t margin, or as

a company that sells to the old company's customers.

Clone companies

Clone companies require the same alliances and the same use of

insider information as parasitic satellite strategies. While this strategy

could be pursued by a single manager, typically a group of managers

forms a private company that is a duplicate or ``clone'' of their old

division (or part of a division) of the state owned enterprise in whichthey formerly worked. The employees of the old enterprise provide the

initial labor for the new enterprise.

The primary assets managers use is their detailed knowledge of their

¢rm and the ¢rm's internal and external networks. The old managers

take either a part of (or the entire), network of human capital of a

division (or a section of a division) of a state-owned enterprise and

establish a legally separate company. This company will have some or

all of the same personnel and will compete in the same line of business

as the old division. In this case what is ``privatized'' is the network of

accumulated human capital (made more valuable by existing as a net-

work of inter-dependent behavior) of a division of an enterprise. This

includes contacts with old business partners, both foreign and domestic.

Manager and employee buy-outs

A straight-forward alternative way to create domestic owners without

recourse to clientelistic networks and satellite companies involves the

execution of manager or employee buy-outs (MEBOs). This is a strat-

egy by which a network of managers ^ often with the cooperation of

workers ^ privatize the original state owned enterprise (or a division of

such an enterprise). This is typically accomplished by forming a limitedliability company that privatizes the original company, often on very

favorable terms. It seems that cheap management buy-outs may be

favored by governments as a way to prevent bankruptcies and save

jobs (and thus win electoral support).

Does the existence of employee buy-outs contradict the argument that

the structure of the new postcommunist capitalist economies primarily

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results from the strategic action of socialist era managers? Probably

not. Whether this practice takes the form of a manager and employee

buy-out or simply an employee buy-out, all commentators and re-

searchers report that in the vast majority of such ¢rms managers then

go on to dominate the new `èmployee-owners.'' First, the opportunity

to subscribe to shares is usually based on seniority and salary, which

favors management. If seniority is not the principal of share distribu-

tion, then salary is, which also favors management. Furthermore, the

di¡use ownership among employees, as well as managerial monopoli-

zation of information, further strengthens managers relative to work-

ers. Indeed, one study of seventeen employee owned ¢rms found that

employees ``with their generally low equity stakes, did not see them-selves as owners. As the proportion of their incomes made up by

dividends was insigni¢cant, the focus of employees' attention was on

receiving higher wages and keeping their jobs.''19

The case study data supported this view. The Chief Economists of the

Hungarian State Property Agency reported that it was ` common

knowledge'' that managers dominated employee buy-outs. Moreover,

in those case studies that experienced an insider buy-out, managers

tended to buy-up shares from employees until they had a controlling

percentage. This was the case in all ¢ve ¢rms studied in Slovenia ^

where the privatization law mandated that insiders receive 60 percent

of their ¢rms' shares.

Privatization by foreign capital

While all managerial strategies discussed so far involve managerial

alliances with other domestic actors, the most keenly anticipated

method of transforming governance structures relies on alliances with

foreign direct investors. Like the domestic-based strategies, foreign led

privatization also occurs (partially) as a result of managerial networks

and a reliance on the inside information of managers. There are a

number of ways in which foreign investors and local economic elites join forces. The most visible type of foreign capital penetration consists

of local managers assisting a multinational in the privatization of their

company. Managers employing this strategy seek to become members

of the upper management of a foreign multinational corporation that

privatizes a state-owned enterprise. Szelenyi refers to managers who

pursue this strategy as members of a ` comprador intelligentsia,''a term

that originated to describe the Chinese partners of British opium

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merchants and thus implies that one grows wealthy by assisting for-

eigners in gaining economic control and dominance of one's own

society.20

This is an attractive strategy for most managers, as the wealth and

prestige that go along with being a member of the management of a

foreign multinational are quite substantial. Managers are very rarely

¢red in this situation, and often earn extremely high salaries. It is

probable that in exchange for this treatment, some socialist managers

utilize their monopoly of knowledge about the ¢rm for the bene¢t of

their foreign partners. These managers may provide exclusive informa-

tion on a ¢rm's real capacities, or they may hide ¢rm assets from thestate so as to lower the price of privatization. However, managers do

not necessarily have to engage in any special or secretive behavior to

receive excellent treatment. MNCs will be generous toward managers

for a variety of reasons. High wages and job security can be used

preemptively to eliminate the incentive for opportunistic behavior by

managers before their control is ¢rmly established. Furthermore, given

the very limited markets for managerial talent in the postcommunist

environment, as well as the very low wage levels compared to what

expatriate managers would receive, there is little incentive for foreign

owners to behave di¡erently toward socialist era managers.

Joint-ventures

FDI does not only enter the postcommunist environment through

large scale privatization. There has been signi¢cant Green¢eld invest-

ment in some countries. The governance structures of these companies

are not that di¡erent from large-scale foreign led privatization.21 There

are also Joint Ventures, in which ownership is shared between domes-

tic owners and foreigners. Some of these are also not really di¡erent

from large-scale privatization ^ only the foreign partner doesn't want

to buy all the shares (for example, to save money by purchasing just a

controlling share). However, another variant of the Joint Venture isvery small scale and occurs when a manager pursues a clone company

strategy (as described above) with the participation of a foreign part-

ner. Typically, during the late socialist period the manager had estab-

lished a personal relationship (frequently a ``weak link'' to use Gran-

ovetter's term) with a representative of a foreign ¢rm who becomes an

investor in the Joint Venture.

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The relationship between managerial strategies and economic

e¤ciency and growth

The typology of managerial strategies describes various patterns of

action by which managers combine diverse resources to survive the

transition, and in the process transform the governance structure of

their enterprises. As such, postcommunist managers make postcom-

munist capitalism. Of course, they make it in circumstances not of

their own choosing, but inherited from the past. The question remains:

what type of capitalism has been made by this process?

The strategy of making capitalism through privatization by foreigndirect investment may create very di¡erent types of ¢rms. This strategy

can bring the most advanced business techniques and capital for mod-

ernization and expansion. As in the giant corporations of the United

States, the majority owners delegate the right to control the daily

activity of the ¢rm to managers, but retain the ultimate authority to

set strategy and run the business. Thus, the state-owned enterprise

privatized by the multinational ¢rm takes on the structure and func-

tions of the most advanced business form in the world. Such ¢rms will

usually contribute to development through the investment of resources

into technologically superior ¢rms, producing manufactured goods for

export to Western Europe. Not all of the restructuring created by

foreign privatization, however, will serve to ``close the gap'' between

postcommunist capitalism and the Western systems to which they

aspire.

Some of the foreign investment may take the form of ``market destroy-

ing'' behavior where foreign companies will merely purchase the dis-

tribution network of some enterprise and cease all local production.

By selling commodities produced extra-locally, national productive

capacity (both of the ¢nal goods and of domestically produced inter-

mediary goods) is destroyed.22 Or, foreigners can buy several compa-

nies in the same sector, creating new monopolies. Similarly, some

foreign investment will merely use Central European factories to dovery low value-added subcontracting for multinationals, such as in

clothing manufacturing. With this type of investment, the foreign ¢rm

does not transfer any technology. There were many ¢rms like this

among the case studies (especially in clothing, but also in electronics

and household chemicals). Many of these ¢rms also exclusively use

foreign produced inputs. It is not clear how this activity can lead to

economic development or ``catch up'' ^ and certainly is inferior to a

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solution that increases demand for domestically produced inputs or

generates investment into labor saving technology. Still, these ¢rms

can at least serve as a source of hard currency for the government and

wages for employees (and thus aggregate demand). Finally, to the

extent that foreign owned ¢rms of all varieties repatriate their pro¢ts,

this lowers the amount of pro¢ts that can be plowed back into the

productive capacity of the business. Despite these factors, on balance

FDI in the postcommunist environment seems far more bene¢cial

than harmful. This is the conclusion based on extensive case study

data from Central Eastern Europe as well as quantitative analysis.23

While there are many ways in which foreign owned ¢rms a¡ect the

domestic economy, the predominant overall e¡ect, empirically, is ex-tremely positive. This is the inescapable conclusion one draws when

one is acquainted with a large number of domestic and foreign ¢rms in

the postcommunist world.24

Whereas the large-scale privatization by foreign capital creates the

most modern type of capitalist ¢rm, the resulting governance structure

from the clone strategy looks much like the small capitalist enterprise

of the period of ``competitive capitalism'' prior to the corporate revo-

lution of the late nineteenth century in which the owner also directly

manages the ¢rm. These clone companies are like small ¢rms else-

where. They have the advantages of tight ownership and control, and

strong linkages with the domestic economy. Their downside is that they

have very little access to investment capital. To compensate for this,

many bring in a foreign partner and form a Joint Venture. Once miss-

ing from the industrial structure under socialism, these small and

medium sized ¢rms are very important players in the postcommunist

economies. In time, these ¢rms ^ because they were forged by a

strategy relying only on alliances with other members of their ¢rms,

and did not involve opportunistic behavior ^ create market-dependent

actors who do not have clientelistic network relations with political or

¢nancial elites. These ¢rms should behave like the ¢rms in the neo-

classical model of transition. If provided with a supportive institution-

al environment (which in this case must be created primarily by thestate), such ¢rms can play an important role in restructuring the

economy from the ground up, as the most competitive among them

develop into large dynamic modern capitalist ¢rms.

Similar to clone-companies, MEBOs can play a positive role in creat-

ing small and medium enterprises with an identity of ownership and

control. This is the major virtue of MEBOs: the internalization of

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agent-principal externalities. In other words, MEBOs ensure that the

parasitic behavior of owners, managers and workers will be checked.

This is a massive advantage in the postcommunist environment, where

newly created domestic outside owners (who received the property

vastly below its book value, but who still have no money for restructur-

ing) often see asset-stripping as the most rational course of action.

And while it is true that MEBOs are less likely to layo¡ workers than

other domestically owned ¢rms, they actually have a major interest in

adopting labor-productivity enhancing production techniques: their

future livelihoods depend on it. The major drawback to MEBOs is

their general lack of capital for ¢rm restructuring ^ a problem that

can be (but generally is not) taken care of with cheap credits from adevelopment bank.

In direct contrast to MEBOs and clones are strategies involving the

creation of ` satellite'' ¢rms. These managerial strategies create gover-

nance structures that are both typically and not typically found in

Western capitalism. The funneling of funds or capital out of ¢rms

leaving liabilities does not necessarily result in unique governance

structures. To the extent that these activities take place only in a brief

time period, they can be seen as a mechanism for creating a class of

wealthy individuals. These individuals may or may not invest their

pilfered money into new, capitalist enterprises, a decision presumably

dependent on their structure of opportunities and their future expec-

tations. This type of activity can be interpreted as a kind of postcom-

munist ``primitive accumulation.'' When satellites are not one-shot

deals, when they involve the creation of more or less permanent satel-

lites, the resulting governance structure does not resemble the ¢rm

organization we expect to ¢nd in capitalist economies. In these cases

there is a radical separation of the right to sell property and the right to

control the enterprise and obtain its residual income. It is hard to

imagine this type of ¢rm openly existing in the advanced capitalist

core. And it is hard to imagine this type of governance not producing

deleterious economic consequences as resources £ow to personnel

(and thus to conspicuous consumption or foreign bank accounts) in-stead of investment in the enterprise.

As with the strategies involving the ` appropriation''of assets from state

owned enterprises through satellites, the use of clientelistic access to

¢nancial capital in itself does not result in the creation of ¢rms with

unique governance structures. This is merely another example of a

means of making capitalists, another modern version of the enclosures

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movement. In the nineteenth century, business groups in the United

States, as well as in England, Scotland, and Germany, had similar

types of arrangements.25 If ¢nancial capital continues to £ow to busi-

nesses based on personal connections, however, the developmental

consequences are unlikely to be favorable. There is no reason to expect

capital to £ow to dynamic or e¤cient sectors, so there will be not be an

optimal allocation of resources.

Similar to the clientelistic allocation of bank loans, when political

power is used to in£uence who wins a privatization bid, the resulting

business structure may not be very unusual. When actors utilize polit-

ical power or clientelistic access to ¢nance regularly to secure oppor-tunities for pro¢t or expand their businesses, and not just to privatize

¢rms or start new ¢rms, the resulting governance structure diverges

signi¢cantly from the ideal-type of modern capitalist enterprise. Inter-

enterprise relationships are not mediated by the market, but through

the state or clientelistic networks. Businesses do not prosper by adopt-

ing e¤cient practices and providing goods and services at a better cost

than those of their competitors, but by maximizing their political

muscle or their connections. If generalized across the system, this

practice can only have negative economic consequences in the long

run, for resources do not go to the e¤cient.26 If pervasive enough, it

becomes questionable whether this is even capitalism as it is currently

understood. It seems more accurate to call this ``patrimonial capital-

ism'' in which the relative separation of the political and the economic

spheres, typical of modern capitalism, does not exist.27

While the strategies elaborated above are not typically thought of as

``capitalist'' practices (with the exception of long-term parasitic strat-

egies) they are not unheard of in capitalist economies.What does seem

unique to the postcommunist world is the strategy to create auto-cross

ownership. In the enterprises relying on auto-cross-ownership, some

or all of the owners are essentially replaced by a managerial elite, close

to what the Western managerialist theorists such as Berle and Means

incorrectly thought was emerging in the United States.28

The develop-mental consequences of this type of governance structure seem, from

one perspective, bene¢cial. Auto-cross-ownership clearly reduces the

``market integration'' of ¢rms in these related sectors. This prevented

the destruction of many ¢rms devastated by the ``market shock'' of

liberalization exacerbated by the political dismantling of Comecon

trade. Rather than destroying ¢rms, this strategy creates a huge high-

tech multinational company, collectively subject to market discipline,

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with at least the potential to compete with Western multinationals.

Although such ¢rms are likely to be multiple monopolists and oligo-

polists, and although they may evade taxes, they do raise the possibility

of becoming world leaders in a dynamic sector of the global economy,

much as a number of Korean Chaebol have become.

Of course, from the neo-classical perspective, this strategy reinforces

inherited monopolies and protects managers from outside control cre-

ating massive liabilities likely to seriously distort incentives. Most

importantly, the existence of cross-ownership might dampen a ¢rm's

budget constraints, as failing ¢rms might not be allowed to go out of

business by the other ¢rms in the cross-ownership group. Thus, fromthis perspective, auto-cross ownership creates a deformed version of a

private enterprise unlikely to lead to the maximally e¤cient use of

resources. Only time will tell which of these predictions is more

accurate.

Selected case studies

The above descriptions of managerial strategies and resulting gover-

nance structures are best illustrated with a few examples from the case

study data. Space does not allow for examples of each strategy, but this

is not necessary. Instead, I discuss four examples that are theoretically

crucial. Three of these may be unfamiliar to Western social scientists:

political capitalism, ¢nancial clientelism, and auto-cross-ownership. A

case of foreign direct investment, because it is the single most impor-

tant type for fostering ¢rm restructuring, is also included. The most

important types that are left out are small and medium ¢rms created

by clone strategies and MEBOs; but these should be familiar to West-

ern readers and therefore less in need of illustration.

An example of political capitalism is the ¢rst private Slovak Cable

Television station, which began operations in 1995. I could tell this

company was peculiar even before the interview started. The o¤ceswere on the top £oor of a hotel, not an o¤ce building or an industrial

park. Co¡ee was served by a secretary dressed in what can politely be

called ``non-standard'' business attire, while two men left the o¤ce of

the CEO clothed in matching black leather out¢ts complete with cow-

boy boots, jackets, briefcases and sunglasses (worn inside). All in all, it

was a rather non business-like atmosphere ^ completely at odds with

the private TV station I visited in the Czech Republic. These trappings

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seemed to be the symbolic manifestations of the process of political

accumulation, where providing a life-style suitable to attracting ``men

at arms'' into the household/business unit, and appearing wealthy and

dangerous, is more important that appearing e¤cient and business-

like.29

This business, which at the time of the interview in June of 1996 had

233 employees and approximately 15 percent of the market, was owned

by a three person partnership ^ the CEO had 25 percent of the shares

and two others had 75 percent. The CEO, who spent his career in one

capacity or the other in o¤cial media, ran the ¢rm, and the other two

provided the money. According to an interview with a former memberof the Slovak parliament and a member of the ¢rst postcommunist

Czechoslovak government, the two partners were close associates of

Prime Minister Meciar, the dominant political ¢gure during Slovakia's

transition.

The TV station, in addition to its TV operations, had recently expanded

by creating a number of daughter companies. Only one of these com-

panies was related to TV (it buys and sells televised sporting events).

The other companies were a telemarketing company, an employment

agency, a string of ``7^11'' type cash and carry stores, and a real-estate

company. The business strategy, according to the CEO, was to become

independent of the media business, which, he emphasized, ``could be

quite unstable.'' This seemed an acknowledgment of the potential

instability of property rights when property is handed out on the basis

of political loyalty. At any rate, this strategy of wide diversi¢cation

seemed rather odd for a new TV station, which one would expect to be

occupied with the di¤cult tasks of starting broadcasting. The private

TV station in the Czech Republic that was studied had no such analo-

gous investments.30 Rather, as the interviewee implied, the owners of

the Slovak company seemed to be preparing for a rather hasty exit

from this market.

These investments were paid for with bank loans serviced at 8 percentinterest rates ^ just a little more than half the rate the other businesses

in the Slovak cases were able to secure. The interviewee, when asked

how he got such cheap loans, responded that he had to work very hard

to secure them, and managed to get foreign loans at much lower

interest rates than available on the domestic market. This is extremely

unlikely ^ none of the domestically owned ¢rms in the entire sample

used such loans. The reason, according to a Slovak bank president,

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was that any loan received in foreign currency had to be paid back in

foreign currency ^ and was thus subject to £uctuations in the relative

value of the currencies, which are unlikely to favor the weaker transi-

tion economies in the long run, because they are much more likely to

be prone to speculative attacks and the subsequent devaluation of their

currencies.

Thus, granting foreign credit to domestic ¢rms in postcommunist

Europe as a practical matter, at least through 1996, was almost always

done only when the loan applicant had a secure export market and

could thus earn hard currency. It is therefore likely that the interviewee

was lying about the source of his investment funds. According tothe aforementioned former member of parliament, this company was

given cheap loans from the state owned commercial bank. Further-

more, this interviewee reported, other companies were politically pres-

sured to advertise on this station. Not surprisingly, the station was

markedly pro-Meciar. Thus, the creation and activities of this ¢rm

seemed to be primarily determined by clientelistic access to political

power.

To the World Bank, the ¢rm just described would be considered an

example of the creation of new private property. At least in this case,

private property, which according to the neo-classical transition econ-

omists is presumably an index of e¤ciency and a market economy,

can be better understood as the use of political power through net-

working that had little to do with e¤ciency or free market trans-

actions. The long term macro-economic consequences should be

obvious. Resources are not £owing to the most e¤cient ¢rms as a

result of market competition, but toward agents able to use their

political networks to great advantage. Therefore, in such a system there

is no reason to expect that pro¢ts will be reinvested in the production

process, leading to increasing labor productivity and thus national

wealth. As this case study reveals, investment funds that were provided

by the state (but secured through personalistic networks), and which

could have gone to establishing a high-quality and competitive busi-ness, instead went to unrelated business activities in which the manage-

ment had no expertise. Indeed, because the current slate of large

property holders are dependent on their particular patron's political

position, not to use whatever pro¢ts one has to safeguard the political

position of the patron is irrational. Not to do so means that other

patron-client cliques may gain an advantage ^ threatening the con-

tinued ownership of the clients' property. This is the structure at the

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base of many pre-capitalist forms of economic organization, and par-

tially explains the relative superiority of what Weber would call ``mod-

ern economic capitalism'' to all previous forms of economic organiza-

tion.31

Very similar to the functioning of political capitalist strategies are

clientelistic ¢nancial strategies outside of political networks. An exam-

ple of this is GoldenGroup32 in the Czech Republic. This Financial

Holding Company was established in 1992 as a brokerage house and

did investment banking for three years at the time of the interview in

1996. The brokerage forms the heart of the company and it acquired

other ¢rms currently in the group. In the spring of 1995 this ¢rm waschanged into a holding company and listed among the top ten broker-

age houses and asset managers in the Czech Republic. It included one

of the most important investment funds for the second wave of voucher

privatization as well as two investment funds from the ¢rst wave.33

GoldenGroup owned an insurance company with 300,000 subscribers

as well. The total assets of the group in 1995 consisted of 10 billion

Crowns (about U.S. $333,000,000) worth of shares in over seventy

companies.

GoldenGroup was fully private ^ 99 percent of its shares were in the

hands of the top two managers ^ 94 percent with the 32-year-old CEO

and founder. The founder secured money for his ¢rm's expansion as a

result of cooperating with two banks. In one, GoldenGroup was the

majority owner, and in the other, GoldenGroup was a signi¢cant

shareholder. Using cash from these banks, the group grew rich as a

result of trading in securities and buying citizen vouchers during two

waves of privatization. The initial money used to purchase shares in the

group's two banks, according to the interviewee, came from the

owner/CEO's contacts made while working in two state majority

owned banks. GoldenGroup is an example of the creation of a new

private enterprise that has nothing to do with e¤ciency driven restruc-

turing and everything to do with clientelistic networks and access to

¢nance (ultimately dolled out by the state ^ as the state owned thebanks that issued the initial loans to the founder of GoldenGroup).34

The holding company GoldenGroup seemed problematic in terms of

e¤ciency considerations. GoldenGroup was owned by one very young

technocrat with links to the elites in ¢nancial institutions. This owner

had no experience in any of the ¢rms that were incorporated into the

holding company. Moreover, the actual holding company had only

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four members (counting the main owner and founder) and thus had an

extremely small capacity (if any) to monitor e¡ectively all the agents

(managers) in the privatized ¢rms incorporated in the holding com-

pany. This creates an environment ripe for the execution of parasitic

satellite strategies in the ¢rms in the group.

This very weak monitoring capacity not only creates ``bad agents''

but ``bad principals'' as well. All the Czech managers of production ¢rms

complained that the institutional owners that emerged as mediators in

the voucher privatization schemes were extremely poor owners. They

knew nothing about the ¢rms, made no attempt at aiding in the forma-

tion of a business strategy let alone its execution (i.e., using their ownnetwork connections to help the ¢rms), and were only interested in

pro¢ts as opposed to investments. As such, e¡ective ¢rm restructuring is

very di¤cult in these circumstances. One interviewee described board

meetings with representatives of investment funds in this way: `Ì give

them a bunch of stu¡ about the company they pretend to read, and

then they give me a bunch of stupid advice that I pretend to listen to.''

Another case from the Czech Republic, MegaChem, provides a

glimpse at the possibly uniquely postcommunist governance structure,

auto-cross-ownership. MegaChem group was the second largest enter-

prise in the Czech Republic in 1996, trailing only the state owned

electricity monopoly in terms of economic importance. Moreover, it

was one of the only Czech-based multinational corporations, with

subsidiaries in over twenty companies located around the world and

about 10,000 employees.

MegaChem was founded in 1948 as the state owned foreign trading

company with a legal monopoly on all imports and exports of chem-

ical, pharmaceutical, and petrochemical related products. In 1968, it ^

along with a number of other trading companies ^ was converted into

a ``corporatized'' ¢rm or a ``normal limited shareholding company.''

This meant that shares of MegaChem were formally owned by the

¢rms whose products they traded. Thus, MegaChem was owned bythe re¢neries, chemical ¢rms, and pharmaceutical ¢rms in Czechoslo-

vakia as well as the state foreign trade bank that made loans for

exports and imports. These ¢rms did not have to pay for these shares,

and in fact did not exercise any control rights. Like virtually all ¢rms in

Czechoslovakia, MegaChem was primarily controlled by a state min-

istry (engaged in a process of ``plan-bargaining'' with enterprise man-

agers) before the collapse of the Communist system.

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The ownership of MegaChem (who owned MegaChem, not what Meg-

aChem owned) remained almost unchanged from 1968 up through

1996. The same one hundred or so companies owned MegaChem. In

addition, about 4.5 percent of MegaChem's shares were owned by

employees (mostly managers received these shares to circumvent taxes

on excess wage increases). By 1994 MegaChem had gained controlling

shares of ownership of most of these owning ¢rms ^ creating the auto-

cross-owned holding company.

MegaChem's access to ¢nance and its considerable cash reserves drove

the reorganization of the chemical, pharmaceutical, and petrochemi-

cal sectors. After 1989, those companies that owned MegaChem wererequired to pay for the shares given to them in 1968 if they wished

to maintain ownership rights. Most ¢rms did not want to relinquish

these shares, creating a huge source of cash for MegaChem. Thus, the

inherited legal-institutional structure (and the way the laws were

interpreted) was crucial and should be understood as an essentially

contingent factor historically. However, the strategic choice of the

managers, given the inherited situation, was also causally implicated.

Many of these companies, once forced to trade through MegaChem in

the Communist period, now attempted to eliminate the middle-man

and do their own marketing and distribution to take advantage of the

new liberalized market environment. They almost all failed, and the

plan back¢red.

The cost of establishing their own marketing and distribution net-

works proved to be much higher than many ¢rms expected. ``Making

markets'' was not as easy as neo-classical economists suggested.

According to Sachs, ``Markets spring up as soon as central planning

bureaucrats vacate the ¢eld.''35 This simply was not the case. These

additional costs, combined with the severe decline in demand resulting

from the ``transformational recession'' that rocked Czechoslovakia

after the destruction of the Comecon trading block, created major

problems for most ¢rms in these sectors. The President of MegaChem

USA (a wholly owned subsidiary of MegaChem based in the New Yorkarea) worked for one such company until 1993. He said his company,

like many in the sector, borrowed money from MegaChem equal to the

value of their capital stock. Then, when the privatization process be-

gan, MegaChem made a debt-for-equity swap and acquired ownership

of the company. In this way, MegaChem acquired a controlling interest

in many ¢rms in the sector. According to the interviewees, it succeeded

in acquiring over 50 percent of shares in most cases. In those compa-

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nies in which it did not own over 50 percent of the shares, it could still

exercise control by collaborating with other shareholders. In particu-

lar, according to several members of the Board of Directors and the

Supervisory Board, MegaChem had a working arrangement with a

large private institutional investor that would vote with MegaChem to

insure MegaChem's control of these companies in return for Mega-

Chem's help in other sectors.

In June 1994, MegaChem formed a holding company, MegaChem

Group, with ownership in over sixty di¡erent ¢rms. The old Mega-

Chem became just one company (albeit the largest and most impor-

tant) in this group. While most of the ¢rms in this group were theprivatized ¢rms in the petrochemical, chemical, and pharmaceutical

industries, the group also owned an airline, hotel, printing company,

several professional sports teams, and signi¢cant banks, pension

funds, and investment funds. These investment funds themselves

owned shares in some of the companies in this group, further strength-

ening MegaChem's control.

Firms in the MegaChem group used interlocking board member-

ships to reinforce the ties of ownership. For example, the chairman

of the Board of Directors of the largest Czech-based pharmaceu-

tical producer, which was one of the largest owners of MegaChem,

was the Chairman of the Supervisory Board of MegaChem, just as

the chairman of the Board of Directors of MegaChem Group was

the Chairman of the Supervisory Board of that pharmaceutical com-

pany.

Thus, MegaChem privatized its own owners, a process once referred to

in the Czech parliament as ``privatization by incest.'' MegaChem was a

self-owned holding company with many subsidiaries, cooperating with

each other to maximize pro¢ts. The companies within this network of

¢rms were controlled by the top management of the holding company

and the major ¢rms in the group. According to the interviewees and

the Annual Report, the individual ¢rms coordinated their activitiesand gave preferential treatment to ¢rms within the group when select-

ing business partners. If one of the ¢rms delivered overpriced or

inferior goods, however, it could be replaced with a ¢rm outside of the

group. More importantly from the perspective of budget-constraints,

the interviewees all claimed that, after a few years, any ¢rms in the

group that were not pro¢table would be allowed to go bankrupt.

Finally, according to a rather frank admission by a member of the

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poultry vaccine manufacturing capacity from the United States to

Hungary. Thus they enjoyed labor costs less than one-tenth the level in

the United States, but were able to turn out commodities of equal

quality. Soon Sano¢ made Budapest the center of all biologicals for

the MNC.

Of course, to enable this transformation, Sano¢ made huge invest-

ments into Sano¢-Phyaxia. It invested 48 million Forints in 1991, 62

million in 1992, 88 million in 1993, 190 million in 1994, 120 million in

1995, 162 million in 1996, 412 million in 1997, 676 million in 1998 and

688 million planned for 1999. Much of this went into research and

development, which increased by 300 percent from 1991 to 1997. AllR&D for biologicals for Sano¢ are now done in Budapest. While by

1997 they had 25 percent of the Hungarian market, this was a very

small portion of their sales. Central and Eastern Europe accounted for

only 12 percent of their turnover, the Far East with 6 percent, South

Africa and the Middle East with 21 percent, and, most importantly,

the European Union with 61 percent. Their revenues leapt from 685

million Forints in 1993 to 3393 million Forints in 1998. This is the type

of enterprise ^ by making massive investments in technology and

R&D and by providing access to a global distribution network ^ that

will lead the postcommunist countries to the core of the world division

of labor, if indeed they are to reach that ultimate goal.

The conditions favoring the selection of di¡erent managerial

strategies

Since the causal argument is that certain managerial strategies pro-

duce developmentally bene¢cial governance structures while others

produce the opposite, understanding why one managerial strategy is

selected over another becomes the key to understanding why the tran-

sition process was successful in some countries and not others.

The most deleterious strategies were political capitalism and ¢nancialclientelism. Taking political capitalism ¢rst, clearly where democratic

structures are strongest, and in particular where a free press is ¢rmly

entrenched, this strategy will be less prevalent. A transparent political

system (in which the mass of the citizenry can ¢nd out what is going

on, and hold political actors accountable for their actions electorally)

will limit this process. Similarly, the reproduction of the old political

elite creates more potential network ties that can be mobilized for

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clientelistic strategies.Where the technocracy (managers) and dissident

intellectuals defeated the political bureaucracy during the transition

from socialism, and a circulation of elites occurs, there will be fewer

bureaucrats in o¤ce with well developed network ties to enterprise

managers. This process will remain more limited.38 In other words: in

the countries where the Communist Party abandoned communism as a

result of external pressures, or loss of external backing from Moscow,

we ¢nd the greatest amount of political capitalism.39

The prevalence of this strategy is also in£uenced by government policy.

There are more opportunities for political capitalism when privatiza-

tion relies on the free distribution of shares to citizens (so called``voucher'' privatization) as opposed to the direct sale of state assets to

strategic investors with public tenders (typically foreign ¢rms or indi-

viduals).Voucher privatization means that shares are essentially given

away to a large number of owners (all adult citizens) with virtually no

capacity to monitor ¢rm managers and without access to new markets,

managerial skill, or investment capital. Under such a situation, it is

more likely that over time individuals will emerge who are able to use

their networks with government o¤cials in state-owned banks and

other government institutions to receive capital. This will enable them

to establish one or more investment funds to purchase these vouchers,

thereby gaining control of large amounts of property.Vouchers will not

be more conducive to political capitalism than direct sales, however, if

the direct sales are done behind closed doors. This practice provides

ample room for the placement of the clients of politicians or bureau-

crats into positions of ownership.

Like political capitalism, ¢nancial clientalism is employed only by the

lucky few with connections to those who run or in£uence postcom-

munist ¢nancial institutions. There is, in fact, a great a¤nity between

¢nancial clientelism and political capitalism. At the upper ends of

¢nancial clientelism, political in£uence is almost necessarily utilized

because the state ultimately foots the bill. Thus, those factors that

favor political capitalism also favor the employment of ¢nancial clien-telistic managerial strategies. This is particularly true for privatization

policy. Voucher privatization creates a great deal of space for ¢nancial

clientelism, as banks and other ¢nancials create investment companies

and funds that become involved in centralizing the extreme dispersion

of shares created by their free distribution to citizens.

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Auto-cross-ownership is a strategy that seems quite historically con-

tingent. It is greatly facilitated by a peculiar legal-institutional struc-

ture. In particular, when a company is formally owned by many small-

er companies this strategy become a real possibility. Such an owner-

ship pattern is probably a purely contingent historical outcome ^ but

one that was fairly widespread in the case of socialist-era monopoly

trading companies (at least in Czechoslovakia after reforms in 1968

and 1969). In addition, the large company must have a substantial

amount of money, or access to the resources of ¢nancial institutions,

in order to purchase the owning companies. This is also an outcome

that is contingent on the fortunes of ¢rms in particular sectors or the

personal connections of top managers with bank managers. And of course, this type of ownership must be `àllowed'' by national govern-

ments ^ as the government approves all privatization plans. The polit-

ical power of managers of large enterprises would in all likelihood

contribute to such government policies.

While auto-cross-ownership creates the largest post-privatization eco-

nomic unit, satellite strategies create some of the smallest. Managers

employ satellite strategies in a period of radical uncertainty prior to

privatization, or in the absence of e¡ective monitoring following a

privatization. The self-seeking nature of humans emphasized by prin-

cipal-agent theory40 seems to £ourish in this situation. In essence, the

` agents'' are left unsupervised and unmonitored. Voucher privatization

schemes will contribute to this type of activity by creating owners with

little to no monitoring capacity. Confronted by the ``transformational

recession,'' lack of strong ownership makes it almost impossible to

restructure and survive. Under these conditions, it may be that no

realistic managerial strategy will successfully transform the enter-

prises, and that rational managers would therefore seek to secure their

own future through the establishment of satellite companies. Given

that citizen-owners have no monitoring capacity, and that investment

companies, like GoldenGroup, have very little monitoring capacity (or

expertise at portfolio management), such self-serving behavior is only to

be expected by those who believe in rational utility maximizing actors.

As ubiquitous as the satellite companies in the postcommunist world

are clone companies. This managerial strategy is very widespread

throughout the postcommunist world and is facilitated by price and

trade deregulation and the elimination of legal barriers to small busi-

ness entry. However, this strategy is limited to relatively low capital

intensive sectors, unless clientelistic access to ¢nance is also secured.

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Even more dependent on government policy are Management and

Employee Buy-Outs. MEBOs are regulated by laws governing the price

of shares and the eligibility of shareholders. Furthermore, governments

typically allow ¢rms to pay for their privatization out of future earn-

ings or make special credits available to such ¢rms (typically at neg-

ative real interest rates). If these favorable credit policies are not in

place, then only very small ¢rms with little capital equipment will be

able to be privatized through MEBOs due to lack of funds. MEBOs are

also facilitated by the legal-institutional legacy of the communist

period. The legal forms of employee or cooperative ownership, which

were not very meaningful during socialism, suddenly took on enor-

mous importance in terms of the formal ownership of the shares of these companies in the postcommunist environment. Of course, net-

works of political power will also be important: both labor and man-

agement will have an interest in lobbying for such a privatization

policy. Foreign actors can also be important in this regard. In the

extreme, they can lobby and exert pressure on the local state both

directly and through IFIs (international ¢nancial institutions) and

other avenues to block the privatization of large enterprises exclusively

through management and employee ownership. This seems to be the

case in several key sectors of the Hungarian economy.41

The most developmentally bene¢cial strategies are, unfortunately,

dependent on actors outside the postcommunist world. Large-scale

privatization through FDI provides the overwhelming advantages of

investment capital and advanced technology from the West as well as

access to Western markets. The key to selecting this strategy involves

having a buyer, a situation that exists only if the ¢rm has some poten-

tial for successful restructuring. Such potential usually stems from a

production process that can create commodities that have an interna-

tional market.

What then accounts for the presence of such potential foreign investors

in the economy as a whole? One possible variable is the policy regime

regulating foreign investment, which can range from barring FDIacross the board to granting huge tax concessions to foreign investors

or even providing foreign investors with protection in the domestic

market. However, most FDI will depend on a host of other conditions,

such as geographical proximity to advanced capitalist economies, the

existence of an expatriate diaspora with capital willing to invest in

the home country, the size of the local market, its valuable natural

resources, its infrastructure, its human capital base (including lan-

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guage capacity), its wage levels, the general business climate, and per-

haps its cultural similarity to the country of the potential investor. The

fact that increasingly FDI-friendly policies throughout the developing

world in the 1980s and 1990s have not led to signi¢cantly elevated

levels of FDI (excluding China ^ which does not even have capital

account convertability) should caution against placing too much hope

on pro-FDI policy as a means of securing FDI £ows.42 It is probable

that anti-FDI policies can be very e¡ective in keeping (or pushing) FDI

out, but pro-FDI policies are very ine¡ective in pulling FDI in. Beyond

the establishment of equal protection for foreign ownership, there is

not that much the postcommunist government can do to secure large

FDI £ows. To the extent that FDI is crucial to the outcome of thetransition, that outcome is determined by actors external to postcom-

munist society.

For the small scale Joint Ventures, the inherited structure of personal

connections, or networks, will have a crucial role. In those socialist

countries that experimented with markets, managers will have had

more opportunities to develop network ties to individuals with access

to capital to invest in the postcommunist economy. Thus, Hungary's

extensive period of market reforms, and external opening and travel to

the West starting with the New Economic Mechanism in 1968, meant

that Hungarian managers had many ties to Western businessmen,

which were mobilized for the creation of the small JVs. As a result,

many of the small and medium ¢rms in Hungary were formed in this

way.43

Toward a theory of postcommunist divergence

Not all strategies are found in equal frequency in all countries. Auto-

cross ownership was found only in the Czech Republic. MegaChem

was the second largest company in the country, and several other well-

known industrial giants took this form. Similarly, there was far more

¢nancial clientelism among the Czech cases. In Hungary there wasmore large-scale privatization via foreign direct investment as well as

small JVs up through 1998,44 and greater reliance on political connec-

tions in Slovakia. While these di¡erences are impressionistic because

they are not based on a random sample of ¢rms, it strongly suggests

that managers have pursued strategies in di¡erent proportions in each

country, producing various mixes of governance structures, and thus,

when aggregated, dissimilar capitalist systems.

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It is probable that the transition from socialism to capitalism, although

made by a multitude of managerial strategies of transition at the

micro-level, creating a variety of governance structures, will more or

less congeal into di¡erent ` types'' of postcommunist economic re-

gimes, or, types of capitalism. We would expect that di¡erent types of

capitalism will produce di¡erent patterns of not only long-term eco-

nomic growth, but of political cleavages and dynamics as well. It seems

that there are at least two likely axes upon which the postcommunist

economies can be divided.

On one axis is the extent of economic activity in£uenced by political

power (political capitalism). In some countries, this strategy may behegemonic (say in Russia or Bulgaria, where vast portions of the na-

tional wealth have been distributed in this way). The most important

resource in these societies is political power, and the most important

network ties link political patrons and their business owning clients.

On the other end of the axis are societies with relatively little political

capitalism. In these societies, political capitalism exists (as it does

everywhere) but it is a scandal, can be punished, and is thus much

more limited. An example is the Czech Republic, where Klaus's gov-

ernment fell because of a fairly small scandal of trading privatization

decisions for campaign donations (5-6 million Crowns ^ about

160,000 to 200,000 U.S. dollars).

On another axis lies the extent of foreign capital's involvement in the

transition. In these countries there will occur a process of dependent

development, in which foreign capital plays an increasing role in shap-

ing the postcommunist economy.45 It is de¢nitely capitalism, but it is

also de¢nitely dependent ^ dependent on foreign demand and the

decisions of foreign owned multinationals over the rate of investment

and linkages with the rest of the economy. In these economies the most

important resources for local economic actors are ties to multinational

companies.

On the other end of the spectrum are those societies in which mana-gerial strategies that create local ownership predominate. These might

be complicated institutional ownership arrangements (like Mega-

Chem), strategies that rely on clientelistic access to ¢nancial or politi-

cal power, or strategies that rely on management and employee buy-

outs. Thus, at one end are economies extremely tied to foreign direct

investment (most prominently Hungary and now the Czech Republic

and Estonia, but also Poland, Slovenia and Slovakia to a lesser extent).

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At the other end, countries have almost no foreign direct investment

(such as Russia and the Ukraine). These countries may still be depend-

ent (on external aid or raw material exports), but this dependence is

not based on foreign ownership, and thus has a di¡erent dynamic.

They are not dependent on the decisions of foreign-based MNCs over

the repatriation of pro¢ts, investment decisions, and purchasing deci-

sions. As a result, they may have more autonomy from global actors.

However, such countries will not bene¢t nearly as much from invest-

ment capital or technology transfer, and will be much more vulnerable

to losing their markets in the capitalist core. Thus, FDI has the poten-

tial to bring dynamic capitalist accumulation to the domestic econo-

my, and as such can lead to ` catch-up'' with the West. It is possible thedomestic equivalents like MegaChem can do the same, but it is far

from clear whether this is so. To the extent that domestic ownership

forms are operating in a neoliberal policy environment (free trade,

¢scal austerity, and no industrial policy), they are unlikely to be inter-

nationally competitive with the ¢rms of the advanced core.

Figure 1 should be understood as a heuristic device for placing some

countries on these axes. This table uses foreign direct investment per

capita as a measure of ``dependence.'' As a rough proxy for political

capitalism, it uses an index of ``state capture'' provided by the World

Bank. This index measures ``the extent to which businesses have been

a¡ected by the sale of government decisions and policies to private

interests.''46 The yearly average of the change in real GDP from 1994 to

1998 is provided in parentheses as an indicator of each economy's

dynamism.

Clearly there is a more dynamic version of postcommunist capitalism

present in the countries in the lower right hand corner of the ¢gure,

and a stagnant (or to use Burawoy's language an `ìnvolutionary'') style

of patrimonial capitalism in the upper left corner. For those postcom-

munist countries located in the upper left corner, we can expect that ^

in addition to much worse macroeconomic performance ^ national

politics will be dominated by warring groups of patrons and clients,struggling over the possession of property. Democracy will be much

weaker in these societies, as the importance of staying in o¤ce when

property is distributed (and thus protected) by political patrons pro-

vides a great incentive for ¢xing elections and manipulating the media

to this end.

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The countries listed in the bottom right corner will have much higher

levels of economic growth. They may well move from the ` semi-

periphery'' to the ``core'' over the next three or four decades if they

continue to export manufactured goods to Western Europe. Thus, they

may undergo the same movement that such countries as Finland,

Spain, and Portugal experienced since the 1950s. The political system

will converge with the political systems of the advanced capitalist core.

Because property rights are not subject to renegotiation every timenew politicians take o¤ce, businesses can rely on Western style lobby-

ing and campaign contributions to deal with political elites. While

many ¢rms will engage in political capitalism (as is the case even in

the West), many ¢rms will be able to ignore politics when conducting

business. Thus, a relative separation of the political and the economic

sphere can emerge.

Figure 1. Two axes of postcommunist capitalism and economic performance.

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There will probably be a movement over time toward the ``poles'' in the

bottom right and top left corners. Because of the causal interaction

between FDI and political capitalism, countries are likely to become

increasingly dependent on one or the other. If political capitalism is

pervasive enough, it is likely to deter FDI from all but natural resource

sectors by destroying business con¢dence. Similarly, political capital-

ism will damage the formal bureaucratic character of the state, damag-

ing domestic growth, thereby eliminating one of the major ``pulls'' for

FDI. The absence of political capitalism, combined with presence of

high levels of FDI in particular, will spur economic growth, which will

pull in more FDI. Furthermore, because foreign owned ¢rms are far

more dynamic than domestically owned ¢rms, we will expect them tohave much higher survival and growth rates. Hence, over time a larger

and larger proportion of the GDP is created in foreign owned ¢rms.47

Considering all the cases, we can say that the selection of strategies

is based on ¢ve variables: the inherited institutional order, the exist-

ence of networks of political and ¢nancial power, privatization poli-

cies, the strength of democratic institutions, and the existence of

interested foreign direct investors. To the extent that countries have

di¡erent values for these variables, their economic systems will di¡er

as described above.

It is clear that these ¢ve factors are not all randomly distributed among

the di¡erent postcommunist countries. A full sociohistorical analysis

of their variation within the postcommunist world would almost cer-

tainly uncover a good deal of contingency (not the least of which stems

from the legal-institutional legacy) in a very complex causal account.

Still, the historical outcomes seem to follow a pattern. This pattern can

be partially explained by the balance of power within the late-commu-

nist and postcommunist power-elite. To over-simplify drastically, there

are four potential groups that will constitute this power-elite: the old

political elite (bureaucrats, ``reds,'' or nomenclatura), technocrats (ex-

perts), humanistic intellectuals (dissidents), and representatives of for-

eign capital.48

These groups may in turn form alliances with non-elitegroups like organized labor or agrarian smallholders. Within this elite,

it is the balance of power between these groups and the networks that

bind these groups together that to a signi¢cant extent creates the

structure of opportunities that confront managers during the transi-

tion, and thus is indirectly responsible for the di¡erences in country

outcomes.

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When the transition to postcommunism is led by the old political

bureaucrats, we can expect an outcome illustrated near the upper left

corner of Figure 1. The reproduction of political elites will signify that

there will be many more agents with clientelistic ties to those with

state power, creating many opportunities for political capitalism. Such

political capitalism will make foreign investors quite wary of investing

in anything but scarce raw material sectors (where they have no

choice). Furthermore, the old political elite will have an interest not

only in political capitalism, but in discouraging strategic foreign in-

vestment, since, generally, they will want only to privatize through the

creation of client owners. Furthermore, in such countries led by the old

political elite, democratic institutions will be weaker. Indeed, the proc-ess of democratization is the process of eliminating the monopoly of

political power exercised by this group. The lack of democracy makes

political capitalism and clientelistic ¢nancial strategies more likely,

because elites will have greater despotic power and reduced account-

ability. Finally, such elites will not have much of an interest in estab-

lishing the conditions for growing capitalism from the ground up by

promoting small private ¢rms. State ¢nance is channeled to large-scale

clients, and a dense and di¤cult regulatory environment will allow

ample opportunities for graft. Political capitalism will lessen the for-

mal bureaucratic nature of the state by de¢nition ^ eroding the stable

legal and monetary environment in which private ¢rms can best thrive.

When the transition is lead by the other types of actors, such as

managers and intellectuals (possibly in alliance with workers or

MNCs), there will be a much greater circulation of elites, and there

will be more genuinely democratic institutions established. As a result,

far fewer opportunities for political capitalism and ¢nancial clientelism

will exist. There will also be more interest in creating conditions con-

ducive to small and medium sized ¢rm formation and growth. The

outcome will be further in the direction of what is indicated the lower

right corner of Figure 1. If there is enough FDI, there may well be

rapid economic growth.49

As with any sociohistorical account, any causes that have been identi-

¢ed can themselves be interrogated for their historical causes. Thus,

one can ask: What are the reasons that the political bureaucratic

faction of the postcommunist power-elite is stronger than the other

factions in some countries and not others? One variable a¡ecting this

outcome is the inherited structure of national identity. If the Soviet

Union was historically seen as a colonial oppressor, those political

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elites associated with it will have signi¢cant ``negative'' political capi-

tal. Another factor might lie in the interaction of Soviet domination

with the process of industrialization. That is, in those countries that

essentially industrialized under the dictates of the Soviet plan, the

political bureaucracy is likely to be far stronger (more legitimate) than

in those countries where there was already extensive industrialization.

In already industrialized societies, the ``middle classes'' exist prior to

the communist regime. As Szelenyi showed for Hungary's ``socialist

entrepreneurs,'' these pre-communist elites are likely to transmit their

belief systems to their children, who are likely to ¢ll elite positions in

the communist order.50 In most cases, these elites will retain a sense of independence from (if not resentment toward) the communists, as well

as a separate identity.51 In contrast, in the countries that industrialized

under the communist regime, technocrats and intellectuals were cre-

ated de novo out of members of traditional classes. Quite possibly these

intellectuals and technocrats will feel more politically loyal than their

counterparts in the already industrialized Soviet world, for they were

literally made intellectuals by the communist regime. Thus, they are

selected for on the basis of loyalty, and will not have a sense of lost

autonomy at the hands of the communists, but rather will be grateful

for an increase in power, status, and material well-being.52 Nor will the

general population be as likely to punish the post-communist elite for

their historical involvement with the communists, as the communists

led a successful `èxtensive'' industrialization drive, and thus will be

credited with the very real modernization that ensued.

Conclusion

Policy was designed by neo-classical scholars to let ``private owners''

operating on the ``market'' restructure industry in order to close the

developmental gap with the West. We see that these policies did not

always (or even usually) work as they were intended to. Firms were not

always successfully restructured in the postcommunist economies asSachs and others anticipated. While the privatization and the opening

of the market provided an important context for the organizational

change that occurred during the transition, the actual changes in gov-

ernance structures were dependent on a number of factors exogenous

to those processes. To a signi¢cant extent, the managerial strategies

employed by ¢rm insiders determined how newly private ¢rms would

respond to liberalized markets.

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In some cases, the economic restructuring was in the direction of

greater e¤ciency. For example, the employment of ``clone company''

strategies often created more `è¤cient'' organizations ^ smaller, more

focused, less bureaucratic. They resulted in more competitive sectors.

Small Joint Ventures created similarly e¤cient organizations, with

greater access to investment capital. Privatization by foreign multina-

tionals has mostly led to e¤ciency gains as a result of large investments

into new technology and access to external markers. However, other

managerial strategies created governance structures that did not in-

crease e¤ciency or dynamism. This is particularly the case with polit-

ical capitalist, ¢nancial clientelist, and permanent satellite strategies,

in which organizational transformation is completely unrelated, ornegatively related, to any e¤ciency considerations.

The conclusion is that the neo-classical theory of transition, by itself, is

inadequate. The introduction of ``markets'' and ``private property'' by

themselves do not create ` e¤cient'' organizational outcomes. The

equation of markets with e¤ciency, dating back to Adam Smith's

notion of the invisible hand, ignores the embeddedness of economic

activity and thus social structure, asserting that markets have the same

e¡ects everywhere.53 Thus, privatization and markets themselves do

not lead to e¤ciency and development in the post-communist econo-

my. Rather, their e¡ects are dependent on the local social structure of

the societies they impact.

In this respect, the experience of the postcommunist countries in the

transition to capitalism mirrors the experience of the transition to

capitalism in Western Europe. Brenner showed that the growth of the

world market in the late medieval period had contradictory e¡ects on

di¡erent places in Europe, based on what this article calls the ``gover-

nance structure'' of agrarian organizations (and what Brenner calls

Social Property Relations). These Social Property Relations were in

turn dependent on the relative political strength of landlords and

peasants. The opportunities made available by the growth in the

``world market'' were seized in very di¡erent ways based on the balanceof power that had evolved between these two economic groups. While

the world market was the precursor to massive e¤ciency gains and

agricultural capitalism in England, the very same opportunities pro-

vided by the world market led to `èconomic retardation'' in France

and the backwardness wrought by the ``second serfdom'' in Eastern

Europe.54

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Thus, I argue here that the impact of ` globalization'' or global capital-

ism on organizations is dependent on the micro-level actions taken by

particular local actors. Who the private owners are, and how they

become these owners, interacts with market opportunities to deter-

mine the e¡ect of market integration. The managerial strategies se-

lected by ¢rm actors are very much in£uenced by the larger institu-

tional, or macro-socioeconomic, environment.When this environment

is shaped by the old bureaucratic elite, the country will very likely not

experience a successful transition.55

Apart from the theoretical implications, there are clear policy implica-

tions from this analysis as well. If the problem is that ¢rm managersare embedded in clientelistic political and ¢nancial networks, then

those policies that minimize the activation of these ties will result in

the best economic outcome. An obvious way to a¡ect this is to shape

the privatization policy to this end. While economists discussed policy

options of how to privatize, the stakes in this decision were not fully

appreciated. The dominant position among the neo-classical econo-

mists was that the faster the transition, the better ^ so basically any

means of privatizing, as long as it happens quickly, is better than no

privatization at all. Of course, sales to strategic (foreign) investors were

seen as the most desirable form of privatization; but in the absence of

this, a voucher-style give-away was a second best alternative. Manage-

rial ownership was seen as less desirable, with worker ownership seen

as the very worst solution.

Paradoxically, the neo-classical economists' emphasis on rapid large-

scale privatization created a massive advantage for those economic

elites with exactly the wrong types of networks: those linking them

with political and ¢nancial elites. Voucher privatization, by creating

ample scope for those with such ties to mobilize resources to centralize

dispersed citizen-shares, makes such activity much more likely. Such

quick privatization also creates owners with very little experience,

knowledge, or ability to monitor ¢rm managers. This makes success-

ful restructuring much less likely, which makes actors more likely toact exclusively in their private interest, and pursue parasitic satellite

strategies.

Instead of pursuing large-scale privatization at any cost, the logic

presented in this article suggests that postcommunist states should

instead only sell large state owned enterprises to strategic investors.

This initially will take the form of foreign direct investment. However,

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if enough FDI is not forthcoming, postcommunist governments

should resist the temptation to privatize by giving property away.

Some ¢rms that are heavily ``value destroying'' should be allowed to

go bankrupt under two conditions. First, that the bankruptcy does not

create serious supply bottle-necks downstream. Very often, because of

the monopolistic market structure favored by the communists, there is

only one supplier of important industrial inputs. Even if substitutable

commodities are available elsewhere, they will probably be prohibi-

tively expensive. Thus, a bankruptcy can set o¡ a chain reaction,

destroying otherwise healthy ¢rms. The decision to bankrupt enter-

prises should also factor in the extent of the development of the private

economy in the area in which the ¢rm is located. A strong privatesector will maximize the employment prospects of laid-o¡ workers.

Other ¢rms should be managed by the state for an extended period of

time in accordance with a coherent industrial policy geared to promot-

ing manufacturing exports. It should be remembered that such state

owned enterprises spearheaded post-World War II ``catch-up'' in France

and Italy.

Instead of giving property away, the postcommunist governments

should concentrate on privatization by creating new companies: to

grow capitalism from the ground up. This can be accomplished with

policy conducive to small enterprise creation and growth (tax breaks,

special credits, collectives, clear and simple regulations, information

about market opportunities, and other institutions to aid in coopera-

tion). In addition to creating the conditions for the creation of clone

companies, MEBOs can be used to privatize small and medium sized

companies. When the most successful of these types of ¢rms grow

enough, they can privatize the large state owned enterprises. Because

they did not create their companies through the use of clientelistic

¢nancial or political connections, they will in all likelihood have been

selected for on the basis of maximizing the price:cost ratio better than

their competitors. These are the neo-classical agents the neo-classical

theorists implicitly assume will arrive on the scene once the economy is

privatized.56

This use of an industrial policy would require a major reversal of the

transition policies promoted by the neo-classical economists. These

economists invoked a neoliberal vision of the state. Because markets

had to be allowed to allocate resources, there should be no industrial

policy, and no developmental state. However, this article demonstrates

that it was much more than the market and e¤ciency that drove the

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creation of capitalism in Eastern Europe. If networks linking manag-

ers to the state and to state banks are implicated in the construction of

``private market economies'' even when neoliberal policies are imple-

mented, one can conclude that state involvement is inevitable in one

form or the other. If this is so, then this should be above board and

subject to democratic control, not hidden in the back room, where

``postcommunist primitive accumulation'' has occurred.57 Thus, state

involvement can be shaped to bene¢t the public interest instead of

private interests. In essence, this ``private'' industrial policy must be

nationalized or perhaps ``socialized'' in order to create a modern cap-

italist economy.58

Acknowledgment

The author would like to thank the reviewers and the Editors of Theory

and Society for their many excellent comments and suggestions.

Notes

1. The seminal article that sets out this theoretical agenda is Mark Granovetter's

`Èconomic Action and Social Structure: The Problem of Embeddedness,'' Ameri-

can Journal of Sociology 91 (1985): 481^510. The label ``New Economic Sociology''

comes from Granovetter's ``The Old and New Economic Sociology,'' in Beyond the

Marketplace, edited by R. Friedland and A. F. Robertson. (New York: Aldine de

Gruyter, 1980), 89^112. Also see Neil Smelser and Richard Swedberg, ``The Socio-

logical Conception on the Economy,'' in The Handbook of Economic Sociology,

edited by Neil Smelser and Richard Swedberg (Princeton: Princeton University

Press, 1994).

2. See Je¡rey Sachs,``The Economic Transformation of Eastern Europe: The Case of

Poland,'' (The Frank E. Seidman Distinguished Award in Political Economy. Ac-

ceptance paper by Je¡rey Sachs) (Memphis, Tenn.: P. K. Seidman Foundation,

1993), 3; Je¡rey Sachs, Reforms in Eastern Europe and the Former Soviet Union in

Light of the East Asian Experiences (Cambridge, Mass.: National Bureau of Eco-

nomic Research., 1996); R. Frydman, C. Gray, and A. Rapaczynski, Corporate

Governance in Central Europe and Russia (Budapest: CEU Press, 1996); Rey Koso-

lowski, ``Market Institutions, East European Reform, and Economic Theory,''

Journal of Economic Issues 26 (1992): 673^705; David Lipton and Je¡rey Sachs,

``Creating a Mark et Economy in Eastern Europe: The Case of Poland,'' Brookings

Paper on Economic Activity 1 (1990); Stanley Fischer and Alan Gelb, ``The Process

of Socialist Economic Transformation,'' Journal of Economic Perspectives 4 (1991):

91^106; Oliver Blanchard, Maxim Boycko, Marek Dabrowski, Rudiger Dorn-

busch; Richard Layard, Andrei Shleifer, Postcommunist Reform: Pain and Progress

(Cambridge, Mass.: The MIT Press, 1993), 10^11; Carlin, Reenen, and Wolfe,

`Ènterprise Restructuring in the Transition: An Analytical Survey of the Case

529

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Study Evidence from Central and Eastern Europe,'' Working Paper No. 14

(London: European Bank for Reconstruction and Development, 1994), 72; see

also Kenneth I. Spenner, Olga O. Suhomlinova, Stena Thore, Kenneth Land,

and Derek Jones, ``Strong Legacies and Weak Markets: Bulgarian State-Owned

Enterprises during Early Transition,'' American Sociological Journal 63 (1998):

599^617.

3. Gil Eyal, Ivan Szelenyi, and Eleanor Townsley, Making Capitalism without Capital-

ists: Class formation and elite struggles in postcommunist Central Europe (London:

Verso, 1998); Peter Gowan,``Neo-Liberal Theory and Practic e for Eastern Europe,''

New Left Review 213 (1995): 3^60; Lazlo Andor and Martin Summers, Market

Failure: Easter n Europe's ` Economi c Miracle'' (Pluto Press: London, 1998).

4. Geo¡rey M. Hodgson,``The Return of Institutional Economics'' in The Handbook

of Economic Sociology, edited by Neil Smelser and Richard Swedberg (Princeton:

Princeton University Press, 1994), 60.5. European Bank for Reconstruction and Development, Transition Report (London:

EBRD, 1999), 16; Marth de Melo and Alan Gelb, ` A Comparative Analysis of

Twenty-Eight Transition Economies in Europe and Asia,'' Post-Soviet Geography

and Economics 37 (1996): 270. De Melo at the time was the Lead Economist of the

Policy Research Department and Head of the Core Team for the World Develop-

ment Report for 1996.

6. See Peter Murrell, ` What is Shock Therapy? What Did it Do in Poland and

Russia?'' Post-Soviet A¡airs 9 (1993): 111^40; Gowan, ``Neo-Liberal Theory and

Practice for Eastern Europe.''

7. Janos Kornai observed that ` [No] forecast of the serious recession [can] be found in

the early theoretical writings to outline the program for the transition.'' (``Tranfor-

mational Recession: A General Phenomenon Examined Through the Example of

Hungary's Development,'' Discussion Paper No. 1 (Collegium Budapest/Institute

of Advanced Study, 1993), 2, note 3. This includes Kornai's own work.8. Je¡rey Sachs, Understanding Shock Therapy, Social Market Foundation (1994), 25.

9. Sachs uses the term ` the developing world'' but he clearly means developed, or else

how would they narrow the gap with the West? It is also clear from the context of

the passage. If he meant that postcommunist countries would attain rates of growth

higher than African countries, for example, shock therapy would have never been

compelling to anyone in the East or West.

10. Sachs ` Understanding ShockTherapy,'' 25. Italics in original.

11. See European Bank for Reconstruction and Development, Transition Report (Lon-

don: EBRD, 1996), 11. The Czech Republic has the highest rating, closely followed

by Hungary and Slovakia (both tied with Poland and Estonia).

12. Within this three country sample frame, there was not a random selection of

cases. Thus, the di¡erences in the cases in the di¡erent countries are in no way

statistically representative of the di¡erences among the populations of cases in

these three countries. These data are only used to illustrate the various strategies

pursued by managers. The inferences about country-wide di¡erences made in this

article are thus more accurately understood as hypotheses waiting to be systemati-

cally tested.

13. Of course, there may well be other managerial strategies not uncovered in the case

studies.

14. Jadwiga Staniszkis uses a similar, but not completely identical, notion of political

capitalism in Poland, see The Dynamics of Breakthrough (Berkeley: University of

California Press, 1991).

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15. Many ¢rms in the Czech Republic had the German-style of corporate control in

which there is a Supervisory Board in addition to a Board of Directors as in the

Anglo-American system.

16. See Maurice Zeitlin, ``Corporate Ownership and Control: the Large Corporation

and the Capitalist Class,'' American Journal of Sociology 89 (1974): 1073^1119;

Maurice Zeitlin and Richard E. Ratcli¡, Landlords and Capitalists: The Dominant

Class of Chile (Princeton: Princeton University Press, 1988); G. William Domho¡,

Who Rules America Now? A View from the 1980's (New York: Simon and Schuster,

1986); John Scott, Corporate Business a nd Capitalist Classes (Oxford: Oxford Uni-

versity Press, 1997).

17. This property form is not the same thing that David Stark identi¢ed as recombi-

nant property. This is not a mixture of private and state ownership (only one bank

with partial state ownership was a signi¢cant owner of MegaChem ^ thus the state

is not a major shareholder as in Stark's case study Heavy Metal ). See ``Recombi-nant Property in European Capitalism,'' American Journal of Sociology 101 (1996):

993^1027. In the framework of this article, Stark's recombinant property can be

thought of as a combination of auto-cross ownership and satellite strategies with

partial state ownership. While a real phenomenon in Hungary, this ownership

pattern was primarily found in some very capital intensive industries in 1993^1994,

prior to full privatization. For an empirical critique of Stark, see King, The Basic

Features of Postcommunist Capitalism in Eastern Europe: Firms in Hungary, The

Czech Republic and Slovakia, 33^35 and Eric Hanley, Lawrence P. King, and Istvan

Ja ¨ nos To ¨ th, ``Path-Dependence or Dependent Development,'' (Mimeograph, 2000).

18. See A. Walters, ``How fast can market economies be introduced? '' European Busi-

ness Forum, Financial Times Conference, November 26^27, 1990. M. Nuti, ` Priva-

tization of socialist economies: general issues and the Polish case,'' paper presented

at the 1st Conference of the European Association for Comparative Economic

Studies, Verona, 27^29 September 1990; Michal Mejstrik, `Èconomic Transforma-tion, Privatization, and Foreign Investment in the Czech Republic,'' in Iliana

Zloch-Christy, editor, Privatization and Foreign Investment in Eastern Europe

(Westport, Conn.: Praeger Publishers, 1995), 56; Eva Voska, ``Spontaneous privati-

zation in Hungary,'' in John S. Earl, Roman Frydman, Andrzej Rapaczynski,

editors, Privatization in the Transition to a Market Economy: Studies of Precondi-

tions and Policies in Eastern Europe (New York: St. Martin's Press, 1993), 106;

Jadigwa Staniszkis, The Dynamics of Breakthrough (Berkeley: University of Cali-

fornia Press, 1991), 38^40.

19. Judit Karsai and Mike Wright, Accountability, Governance and Finance in Hun-

garian Buy-Outs,'' Europe Asia Studies 46 (1994): 1007.

20. Szelenyi, `The Rise of Managerialism: The New Class After the Fall of Commu-

nism.''

21. See King, ` Beyond Manichean Economics.'' The primary di¡erence is that green-

¢elds will likely import more of their inputs, although over time this di¡erence may

disappear.

22. General Electric's purchase of Tungsram in Hungary is a notorious example of

this. GE bought the Hungarian £agship light-bulb maker Tungsram, which had a

7 percent market share in Western Europe. GE, which at the time had only a

2 percent share of the Western European market, thus more than tripled its market

share in this crucial export area. The fact that they ceased local production of most

output made this privatization tantamount to eliminating a rival through a hostile

takeover.

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23. King, The Basic Features of Postcommunist Capitalism: Firms in Hungary, The

Czech Republic and Slovakia, 47^72; and Lawrence P. King. ``Foreign Direct Invest-

ment and Transition,'' European Journal of Sociology 21 (2000): 227^258.

24. For an extended discussion of types of foreign ownership in postcommunism, see

King, The Basic Features of Postcommunist Capitalism: Firms in Hungary, The

Czech Republic and Slovakia. See King, ` Beyond Manichean Economics: The

Developmental Impact of Foreign Direct Investment in Postcommunist Society,''

2000, Manuscript.

25. For the United States, see Naomi Lamoreaux, ``Banks, Kinship, and Economic

Development: The New England Case,'' Journal of Economic History 46 (1986):

647^667; and Naomi Lamoreaux, Insider Lending: Banks, Personal Connections,

and Economic Development in Industrial New England vol. 3 (Cambridge: Cam-

bridge University Press, 1994). For England, see Franklin Allen, ``Stock Markets

and Resource Allocation,'' in Capital and Financial Intermediaries, edited byC. Mayer and X. Vives ( Cambridge: Cambridge University Press, 1993). See also

P.L. Cottrell, The Finance and Organization of English Manufacturing Industry

(London: Metheun, 1980). For Scotland, see C.W. Munn, ` Scottish Provincial

Banking Companies: An Assessment,'' Business History 23 (1981): 19^41. For

Germany, see Richard Tilly, Financial Institutions and Industrialization in the

Rhineland, 1815^1870 (Madison: University of Wisconsin Press, 1966).

26. See Max Weber, Economy and Society: An Outline of Interpretive Sociology, edited

by Gunther Ross and Claus Wittich (Berkeley: University of California Press,

1978); and Robert Brenner, ``The Social Basis of Economic Growth,'' E. O.Wright

and Jon Elster, editors, Analytical Marxism (Madison: University of Wisconsin

Press, 1986).

27. See Lawrence King, ` Explaining Variation in Postcommunist Economic Perform-

ance: The Role of Rapid Large Scale Privatization,'' paper presented at Center for

Economic Policy Analysis, New School University, November 6, 2000.28. See Gil Eyal, Ivan Szelenyi, and Eleanor Townsley, Making Capitalism without

Capitalists: Class formation and elite struggles in postcommunist Central Europe ;

See Maurice Zeitlin, ``Corporate Ownership and Control: the Large Corporation

and the Capitalist Class''; and Scott, Corporate Business and Capitalist Classes.

29. See Robert Brenner, ` Agrarian Class Structure and Economic Development in Pre-

Industrial England,'' Past and Present 70 (1976), 30^75; ``The Social Basis of

Economic Growth.''

30. The CEO of this ¢rm was also politically connected, only he was a political

dissident who published underground books and made illegal documentaries dur-

ing the Communist period. This re£ects the di¡erence in the con¢gurations of the

postcommunist power elite in the Czech Republic and in Slovakia (see Gil Eyal,

` Anti-politics and the spirit of capitalism: Dissidents, monetarists, and the Czech

transition to capitalism,'' Theory and Society 29 (2000): 49^92.

31. See Brenner, ``The Social Basis of Economic Growth,'' Weber, Economy and Soci-

ety, see also The Basic Features of Postcommunist Capitalism for an expansion of

this point in the postcommunist environment.

32. Fictitious names are used to protect the con¢dentiality of interviewees.

33. ``Voucher Funds'' refers to investment companies that gain control of the citizen

investment ``vouchers'' that all Czechs over 18 years of age had a right to buy as a

citizen for a small sum (about one-¢fth of an average monthly salary). Each

voucher c erti¢cate would have 1,000 investment points with a book value of about

60,000 Crowns ($2,000 ^ which was closer to the average yearly wage). These

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voucher points could then be invested during rounds of bidding on many of the

over 2,000 state-owned enterprises approved for privatization. There was little

interest in the program, until investment companies were established that o¡ered

shares in their company in exchange for the privatization vouchers. After a year

they promised to buy back the shares for ten to ¢fteen times what the person paid

for them (this was possible because they were sold at such a discount to citizens).

This was too good a deal for most Czechs to pass-up, and 82 percent of adults

participated. Of the 5.95 million vouchers, 72.2 percent went to these funds, and the

rest were invested by individuals (see Pavel Mertlik, ``The Czech Republic,'' in

Brigitta Widmaier and Wolfgang Potratz, editors, The Future of Industry in Ce ntral

and Eastern Europe (Gelsenkirchen: Institut Arbeit und Technik. 1996), 59.

34. One could question the veracity of this story. Possibly an infusion of illegally earned

cash resulted in the purchase of the bank. Even if this were the case, it would not

change the theoretical conclusions. The capital is still obtained through clientelisticnetworks, only to ma¢a groups and not ¢nancial institutions directly. Of course,

most of the wealth accumulated by ma¢a groups ultimately came from the state, so

this is merely a variation on a common theme.

35. Je¡rey Sachs, Poland's Jump to the Market Economy (Cambridge: MIT Press,

1993), xii.

36. This is a process in which commodities sold between subsidiaries of the same

company have set the prices to minimize ``pro¢ts'' in subsidiaries with already high

pro¢ts (thus reducing the total tax bill).

37. Eric Hanley, Lawrence P. King, and Istva ¨ n Ja ¨ nos To ¨ th, ``Path-Dependence or

Dependent Development.''

38. On the postcommunist societies being ruled by a power elite with these elements,

see Gil Eyal, Ivan Szelenyi, and Eleanor Townsley, Making Capitalism without

Capitalists ; Erzsebet Szalai, ``The Power Structure in Hungary after the Political

Transition,'' in Christopher G.A. Bryant and Edmund Mokrzycki, editors, TheNew Great Transformation (Routledge: London and New York, 1994).

39. See Juan Linz and Alfred Stepan, Problems of Democratic Transition and Consolo-

dation: Southern Europe, South America, and Post-Communist Europe (Baltimore:

Johns Hopkins University Press, 1996) for their excellent and concise historical

account of the transition process.

40. H. Demsetz, `The Theory of the Firm Revisited,'' Journal of Law, Economics and

Organization 4 (1988): 141^162, Armen Alchian and Harold Demsetz, ``Production,

Information Costs, and Economic Organization,'' American Economic Review 57

(1972): 777^795; Fama and Jensen, ``Separation of Ownership and Control,'' Jour-

nal of Law and Economics 26 (1983): 300^325.

41. See Hanley, King, and To ¨ th, ``Path-Dependence or Dependent Development.''

42. See Ha-Joon Chang, ``Globalization, transnational corporations, and economic

development: can the developing countries pursue strategic industrial policy in a

globalizing world economy,'' in Dean Baker, Gerald Epstein, and Robert Pollin,

editors, Globalization and Progressive Economic Policy (Cambridge: Cambridge

University Press, 1998), 110.

43. See King, The Basic Features of Postcommunist Capitalism.

44. Hungary had much higher levels of FDI than the Czech Republic until the last few

years, when the rate increased dramatically, bringing the Czech Republic up almost

to the Hungarian level. Thus, it seems possible that Czech managers were able to

forge some network ties with Western managers over the past ten years ^ ties that

their Hungarian counterparts forged in the late socialist p eriod.

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45. For a discussion of dependent development, see Peter Evans, Dependent Develop-

ment: The Alliance of Multinational, State, and Local Capital in Brazil (Princeton:

Princeton University Press, 1979); Fernando Henrique Cardoso and Enzo Faletto,

Dependency and Development in Latin America, expanded and emended edition

(Berkeley: University of California Press, [1969], 1979); Fernando Henrique Car-

doso, `Àssociated-Dependent Development: Theoretical and Practical Implica-

tions,'' in Alfred Stepan, editor, Authoritarian Brazil: Origins, Policies, and Future

(New Haven, Conn.: Yale University Press, 1973, 142^176); and in the post-

communist context, King, The Basic Features of Postcommunist Capitalism in East-

ern Europe, Hanley, King, and To ¨ th, ``Path-Dependence or Dependent Develop-

ment.''

46. This latter index was constructed from data from a survey conducted by the Euro-

pean Bank for Reconstruction and Development (London: EBRD, 2000), 21, and

the higher the score the more ``capture.''47. See King, ``Foreign Direct Investment and transition.''

48. On the postcommunist societies being ruled by a power elite consisting of bureau-

crats (possessors of political capital), technocrats (possessors of cultural capital of

the technological variety (techne ¨ )), and dissident intellectuals (possessors of cultur-

al capital of the teleological variety (telos)) with these elements, see sources in note

12. These elites may form alliances with non-elites, such as workers (think of Solid-

arity in Poland or miners in Russia or Serbia) or small holders. In addition, it is

clear that in such countries as Hungary, where foreigners own the commanding

heights of the economy, representatives of MNCs must be counted as at least

potential members of the power-elite.

49. In these countries, the main di¡erences will result from the relative power of the

managers versus organized workers and foreign capital within the power-elite. If

managers are unconstrained by foreign capital (or a state under intense pressure

from IFIs, probably a result of signi¢cant external debt) they may favor strategiesthat block outside strategic investors. Thus, the Czech Republic, without Hungary's

massive external debt at the time of the transition, opted for voucher privatization.

This decision, and the resulting opportunities for political and especially ¢nancial

clientelism, probably accounts for the Czech Republic's lower rate of growth over

the last several years (see ``The Yoke of Capitalism: Czechs coming to terms with

heaps of bad debt,'' New York Times, January 16, 2001, C1,8). Similarly, labor in

Poland blocked the rapid privatization of large state owned enterprises ^ creating a

policy that relied more on growing capitalism from the ground up than in Hungary

or the Czech Republic. This much slower privatization of large SOEs, with a strong

promotion of small and medium enterprises, probably accounts for Poland's supe-

rior economic performance. While these di¡erences are consequential, over time

they will probably diminish as these countries converge around a dependent capi-

talist system. Despite these di¡erences, these regimes are much closer to each other

than to the systems dominated by political capitalism. Moreover, they can be

expected to converge with each other, as witnessed by the Czech Republic's massive

acceleration of FDI in the past three years, bringing the total invested almost up to

the Hungarian level.

50. Ivan Szelenyi, Socialist Entreprenuers (Madison: University of Wisconsin Press,

1988).

51. Szelenyi's Socialist Entrepreneurs demonstrated the importance of the transmission

of culture from pre-communist generations to their children. These middle classes

may well have had democratic values before the imposition of Soviet-style totali-

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tarianism. Some will have been Western-style ``professionals'' ^ and therefore were

accustomed to self-regulation by the community of professionals. They would

naturally chafe at the despotic rule of the Communist Party.

52. Indeed, the Soviets actively sought to ` create'' these intellectuals in order to create a

loyal base of support to strengthen the then shaky Soviet rule (which was extra-

anxious not to be perceived as a continuation of Russian Imperial domination).

(Ovsei Shkaratan, ` Ethnic and Nationality Problems and Con£icts in Etacratic

Society,'' paper presented at the Center for Social Theory and Comparative His-

tory. UCLA, March 11, 1991).

53. See Brenner,``The Social Basis of Economic Growth.''

54. In Eastern Europe, landlords were able to re-establish feudal-style domination over

their peasants. This created landlords that responded to new market opportunities

by increasing the intensity of agricultural labor, not labor saving technology. Apart

from these landlords having no incentive to compete on the basis of e¤ciency (butevery incentive to pursue ``political accumulation''), it is extremely costly for them

to ensure that coerced labor actually uses any labor saving technology, since they

do not bene¢t from this activity and will probably subvert it. In France, peasants

were able to defeat the landlords, establishing peasant control over property. This

resulted in typical safety-¢rst strategies by agricultural holders and the small-scale

division of land, limiting specialization, innovation, and accumulation. Only in

England, where the landlords were strong enough to expel the peasants from their

lands, but not strong enough to force them back into feudal-style obligations, did

modern capitalist ``social property relations'' emerge (capitalist owners, managers,

and free wage laborers). This unleashed dynamic agrarian capitalism, which in turn

begat industrial capitalism. Brenner, ` Agrarian Class Structure and Economic

Development in Pre-Industrial England.''

55. This conclusion di¡ers from Michael Burawoy's analysis of the transition in a way

that mirrors the di¡erence between this analysis and the neo-classical analysis. ForBurawoy, postcommunism necessarily leads to a shrinking of economic output, a

process he calls `èconomic involution.'' This article has argued that while some

managerial strategies contribute to `ìnvolution,'' others contribute to ` evolution'' ^

most prominently strategies involving foreign direct investment for large compa-

nies and to a lesser extent MEBOs, clone companies, and small JVs.

56. Something very close to this scenario has been transpiring in China. Capitalist and

capitalist-like economic organizations were allowed to grow up with a series of

reforms starting in 1978. Privatization of large state owned enterprises did not

begin until 1994, and has been implemented selectively in areas where the private

economy was strong enough to absorb many of the laid-o¡ workers. See Yuanz-

heng Cau, Yingyi Quian, and Barry R. Weingast, ``From Federalism, Chinese Style

to Privatization, Chinese Style,'' Working Paper Number 126, The Davidson Insti-

tute Working Paper Series (1997), 15; Barry Naughton,``China's Economy: Bu¡eted

from Within and Without,'' Current History (1998): 276.

57. See King, The Basic Features of Postcommunist Capitalism in Eastern Europe.

58. Indeed, there is ample evidence that the adoption of a neoliberal approach to the

transition ^ which provides the ideological ``cover'' for the ``private'' industrial

policy ^ has, ironically, undermined the comparative advantage possessed by post-

communist societies ^ relatively cheap, but skilled and educated, labor. By allowing

``the market'' to restructure the institutions of the postcommunist e conomy, most

governments allowed those institutions that create this comparative advantage to

atrophy: public funding of technical education and support for R&D. According to

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Metlik, The Czech Republic is a clear example of this process. With its neoliberal

and individualistic bias, the Klaus government eroded the base from which the

Czech Republic was best poised to ``catch-up'' with the West. Real expenditures on

education decreased by more than 50 percent from 1990 to 1993, compared to 1989

(Mertlik, ``The Czech Republic,'' 77). Similarly, the Czech Republic had an exten-

sive system of secondary professional schools and professional training schools,

jointly funded by the government and enterprises, which were responsible for turn-

ing out highly quali¢ed craft production workers. Since 1991, enterprises, subject to

the devastating ``transitional recession'' and restrictive ¢scal policies that accom-

panied shock therapy, were unable to continue this expenditure. The government

refused to make up for this shortfall in ¢nancing, arguing that the ``market'' had

rejected this type of education. The government has also drastically cut funding to

the network of research centers of the Czech Academy of Sciences even in nominal

terms. As a result, a massive brain drain of scienti¢c personnel, particularly in thenatural sciences, has occurred (Mertlik, ``The Czech Republic,'' 78). Researchers in

all institutions have decreased from 46,000 at the end of 1989 to about 13,000 at the

end of 1993. Of these, those with doctoral degrees decreased from 9,000 in 1989 to

about 5,000 at the end of 1993. This drop-o¡ has not been compensated for in

private enterprises either ^ where ``[T]he R&D departments of enterprises ... were

mostly disestablished or dramatically reduced'' (Mertlik, ``The Czech Republic,''

78).This has occurred in Russia as well. Amazingly, in only two years (from 1993 to

1995) the number of technicians in Research and Development per million of the

Russian population fell from 905 to 688, a drop of just under 24 percent (World

Bank, 1999, World Development Indicators CD-Rom). Tertiary enrollment as a

percent of gross enrollment decreased by 21 percent from 1990 to 1996.

Appendix 1: Data sources and description of case studies

The data for this article come from two types of sources: legal records ¢led by

¢rms in court registries and publicly available stock and business information;

and interviews conducted in 1995, 1996 and 1998 with CEOs or other top

executives in a total of 60 ¢rms (28 in Hungary, 17 in the Czech Republic, ten

in Slovakia and ¢ve in Slovenia).

Type of enterprise Number of

employees

Hungary

Case 1 Textile factory 1800

Case 2 Bank 30

Case 3 Electronic equipment maker, installer and service provider 40

Case 4 Electronic machinery manufacturer, importer, distributor

and service provider

25

Case 5 Chemical manufacturer 250

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employees

Case 6 Hospital equipment importer, distributor, installer and

service provider

15

Case 7 Agribusiness 300

Case 8 Financial consultant 7

Case 9 Wood furniture producer 300

Case 10 Electricity utility 400

Case 11 Diversi¢ed holding company 2500

Case 12 Agricultural trader 1300

Case 13 Chemical industry machine maker 160

C ase 14 Petrol eu m in dustry p lann ing an d mach in e maker 500

Case 15 Petroleum producer and processor 19000


C ase 17 Tel ecommun ication s comp on ents manu facturer 800

Case 18 Electronics manufacturer 1500

Case 19 Chemical engineering 200

Case 20 Furniture manufacturer 22

Case 21 Pharmaceutical distributor 141


Case 23 Clothing manufacturer 130

Case 24 Clothing manufacturer and retailer 200

Case 25 Aluminum manufacturer Under

liquidation


Case 27 Clothing manufacturer 117Case 28 Aluminum manufacturer 350

Czech Republic

Case 1 Software producer 600

Case 2 Computer assembly and sale 31

Case 3 Engine manufacturer 500

Case 4 Press agency 230

Case 5 Chemical, pharmaceutical and petrochemical holding

company

10000

Case 6 Chemical trading company 560

Case 7 Chemical importer 39

Case 8 Agricultural importer holding company 340

Case 9 Retailing company 400

Case 10 Computer sales 160Case 11 Bank 4325

Case 12 Investment fund and broker 5000

Case 13 TV station 400

Case 14 Travel Agency 22000

Case 15 Travel information service 10

Case 16 Pharmaceutical manufacturer 1300

Case 17 Chemical importer and distributor 40

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employees

Slovakia


Case 2 Diesel engine manufacturer 400

Case 3 Candy manufacturer 800

Case 4 Travel agency 200

Case 5 Agribusiness 100

Case 6 Water and sewage public utility 2900

Case 7 Electronics manufacturer 200

Case 8 Automobile parts manufacturer 1200

Case 9 Telecommunications 37000Case 10 Bank 100

Slovenia

Case 1 Construction and engineering 75

Case 2 Consulting/engineering company 19

Case 3 Fuel importing and distribution 3000

Case 4 Publisher 150

Case 5 Publisher 90

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