SCIENTIFIC AMERICAN June 1994 107

THE ANALYTICAL ECONOMIST

When new leaders came intopower in eastern Europe andthe states of the former Soviet

Union, they found themselves saddledwith an unwanted inheritance: tens ofthousands of businesses, from shopsto steel mills that encompassed entirecities. Central planning and governmentcontrol of these myriad enterprises hadled to the economic disaster that sweptcommunist governments out of power.Yet transferring these state-owned com-panies to private hands is proving to benearly as much of a headache as wastrying to run them. ÒItÕs not just a puÝof smoke and a wave of the wand, andthe companies belong to the citizens,Órues Anthony A. Repa, an economic ad-viser to the Polish government.

The problems of privatization aresimple to state but tricky to solve. Mostcitizens have no money with which topurchase corporate shares, and manyenterprises are in such perilous Þnan-cial condition that few people wouldwant to buy them. Even solvent busi-nesses come encumbered with now ir-relevant assetsÑapartment complexesand sports stadiums among themÑthatmake valuation diÛcult.

Countries have taken various ap-proaches to shedding state property,according to economists at the WorldBank. In the territories of the formerEast Germany, a federal agency manag-es businesses and properties while try-ing to arrange their sale or return toformer owners. In Russia and in theCzech and Slovak republics, in contrast,citizens have received coupons withwhich they can buy shares in state-heldconcerns. In Poland, privatization hasfollowed several strategies, includingfocusing on foreign investors and oninvestment funds that act as proxiesfor citizens with coupons. Most of theemerging market nations have also tak-en a more informal approach to priva-tizing small businesses by selling themto their managers or by auctioning them.

Coupon schemes are popular becausethey avoid many problems that arisewhen state property is sold for cash.Nemat ShaÞk of the World BankÕs Cen-tral Europe Department lists some ofthese drawbacks in a recent report onthe Czech experience: foreigners caneasily outbid citizens; the few people

who have money can acquire the lionÕsshare of formerly public assets; andthe low price paid for Þrms because ofgeneral lack of capital distorts futuremarket patterns. But coupons entail adiÝerent problem. Unlike cash sales,they generate no government revenueand no capital for modernizing a Þrm.

At the same time, unless special pre-cautions are taken, coupon privatiza-tion may diÝuse corporate ownershipso widely that eÝective governance isimpossible. In Russia, some kind of gov-ernance has been preserved by reserv-ing a percentage of shares in each en-terprise for managers and workers. TheCzechs and Slovaks took another ap-proach, according to ShaÞk. They en-couraged the development of mutualfunds to which citizens signed overcoupons. In theory, the funds can keepa closer watch on each company thancan individual shareholders.

In Poland, this form of privatization,when it is implemented, will be some-what more intricate. CitizensÕ couponsbuy shares only in investment funds;the funds, in turn, purchase companiesand manage them. The share pricesrise and fall depending on the marketÕsassessment of the companies they in-vest in, thus providing incentives forcareful oversight. Only about 450 Pol-ish enterprises, out of a total of about9,000, will be subject to mass privatiza-tion, Repa points out. Other companiesare being groomed for foreign sale orhave been acquired by their managersin leveraged buyouts.

Although such subtle manipulationsof market structure may help provideeÝective oversight of companies andgive the public access to the capitalistdream of shared ownership, they donot necessarily address the problemsof actual restructuring needed for sur-vival. Almost all these businesses needcapital for new investment, and manyare burdened by the debts that piled

up in the old days of central planning.Firms that cannot survive in their

present form may be subjected to whatis called asset liberation (on Wall Streetit is known as Òrape, loot, pillageÓ). Dur-ing this process, auditors strip out prop-erty or businesses that might fetch agood price on their own and discardthe remainder. This tactic is explainedby the rationale that it is far cheaper forthe economy to shut a plant down andpay workers for two or three years un-til they can Þnd other jobs than it is topay people to lose money indeÞnitely.

Asset liberation is, however, a com-plex undertaking. The commingling ofgovernment and business produced in-numerable company towns throughouteastern Europe and the former SovietUnion. In these sites an electric powercompany might own not only genera-tors and oil reÞneries but housing forits employees, day care centers and ca-sinos. Some of these adjuncts can besold for a proÞt; others must be takenover by a state or municipality if theunderlying company is to be soldproÞtably.

Ironically, remnants of the politicalliberalization that marked the earlystages of the transition to market econ-omies may be hindering the last stagesof privatization. In their Þnal years, cen-tral authorities ceded ownership ofmany enterprises to provincial or mu-nicipal governments. Towns and citiesare even more strapped for resourcesthan are national governments, so theyare unwilling to bear the brunt of clos-ings that would eventually beneÞt theeconomy as a whole.

In one instance, the economic transi-tion seems to be occurring most suc-cessfully independently of state-led ef-forts. The private sector in Poland hasbeen growing rapidly, contributing about50 percent of the gross national prod-uct last year. ÒPoland is looking poten-tially like the economic tiger of the re-gion,Ó Repa notes. ÒThe growth of theprivate sector has been spontaneous. Ithas not been the result of privatization,but the result of a couple of million newbusinesses.Ó In fact, Repa explains, theprivate sector is encouraged by ongoingineÛciencies in the vestigial state-runsector: ÒIn a competitive market, it givesthem an advantage.Ó Whether jealous,unfrocked apparatchiks will permit thatadvantage to persist remains to be seen.ÑPaul Wallich and Marguerite Holloway

For Sale: One Country, As Is

The problems of privatization are simple to state but tricky to solve.

Copyright 1994 Scientific American, Inc.