Summary of paper by
in Economic Policy, October 1992
by Tanya L. Porquez
In this article from Economic Policy, Patrick Bolton and Gerard Roland discuss the privatization strategies of various countries, in particular, Czechoslovakia, East Germany, Hungary and Poland. These countries share a common bond where previously they each took part in the centrally planned economic system where most, if not all, of the countries' main industries and businesses were owned and operated by the government. Beginning in the late 1980s, steps have been taken to privatize some of these companies formerly under the Soviet system. This article is divided into five sections. The first of which is background information on the current standing each country. The second part discusses the strategies for long-term privatization and how to build a market system. the third section assesses Bolton and Roland's privatization strategy of choice, auctions, and the pros and cons on using cash and non-cash bidding. Section four is mainly about the financial restructuring of state firms and reforms that are needed within the rest of the state sectors. Finally, the last section contains the authors' conclusion.
The first country Bolton and Roland evaluate is East Germany. Here the East Germans have achieved a very rapid privatization with the help of Treuhandanstalt, the East German Privatization Agency. The privatization mode of choice began with the selling of public assets, where sales are a result of bilateral negotiations. Auctioning is usually used only when selling small businesses. When considering sales, there are a number of things that are considered. For instance, whether or not there are restructuring plans, investment opportunities, the creation of jobs, as well as the selling price. Treuhandanstalt does have some strict measures. For instance, they favor cash sales, do not allow buyer consortia, do not accept deferred credit payments, but do allow some foreign investment in east Germany. Of 1,041 management buy-outs, 243 of the sales were to foreign investors at the end of February 1992 (1).
Hungary is quite a unique example in Eastern Europe. Unlike most of the other countries, Hungary had a reasonably large private sector at the beginning of the post-communist era. Due to the early beginnings of a private financial sector, Hungary currently has a large percentage of foreign investment. In 1991 alone, Hungary received more than 50% of the total foreign direct investment in the entire eastern portion of Europe(2). The article states that there are two approaches to privatization: privatization from above and privatization from below. The Privatization from above method is also called "active privatization" is one of the first privatization schemes implemented by the State Privatization Agency(SPA). In the outset, 20 enterprises were in the program but it's slow results and low economic gains have proved this method to be not very effective. Also, privatization from above includes SPA's 'Privatization programs' and 'preprivatization', which is the privatization of small, family businesses and shops. Privatization from below is the privatization of a particular industry initiated by a potential investor or the enterprise themselves. It is also overseen by the SPA. Most privatization from below include the privatization of small and medium-sized companies in processing industries whose transformation is company-initiated and transformed into a joint stock company. This must all be approved by SPA. 'Preprivatization' entails the auctioning of small businesses, but this program has been stalled due to unclear objectives and implementation problems.
In July of 1990, the first Polish Privatization bill was passed which created the legal framework for privatization. Poland has transformed former state enterprises into joint stock companies and has opted for liquidation in some cases to by-pass commercialization stages. The method of liquidating small enterprises has been working quite effectively. There have been 950 cases of privatization through liquidation in companies with 200 employees or less. The Mass privatization program involves 400 large enterprises whose shares which will be distributed among 20 'national wealth management funds'. Each fund has a single director, 60% of enterprise shares, with 33% of the shares in any given fund. This fund will have controlling interest in the firm(3). For small businesses, most of the privatization has been done at the municipal level in the auction form. In some cases, employees were given preemptive rights and preferential rates for leasing the company with which they worked. This method has been very successful as 75% of shops and stores have been privatized in this manner.
In Czechoslovakia, privatization has been taking place in two ways: Small privatization and Large privatization. The small privatization is done by the method of auctions in local committees. The large privatizations are based on the Voucher system and the direct sales methods. If an offer for a company is for the purchase of its equity, then direct sales are allowed. This does not exclude offers from foreign investors. Usually 60% of the company's equity is expected to be offered to the voucher program. The voucher books are distributed to the entire population age 18 and above, and are valued at 30,000 Kcs. The Czech program is based on the idea of free distribution, since individuals can make a bid for shares individually or invest them in Investment funds like, Harvard Capital Consulting. More than 60% of the existing voucher books are invested in these types of investment intermediaries(4).
Bolton and Roland next suggest that two basic strategies are being chose by Poland and Czechoslovakia, Germany and Hungary. The say that Hungary and East Germany "have opted for the 'piece-meal' sale of state assets while the other two countries favor mass privatization programs with give-away schemes"(5). The main advantage to the Czech and Polish way is the speed in which they achieve privatization, although it is still necessary for them to take stock of the property given away. This should really be done before privatization is done as it is very time consuming. Also, Bolton and Roland argue that giving away state assets can cause disagreements about the rents various groups can pay which may lead to a delay in decision-making. The impact on the budget is the main drawback to the give-away scheme because macroeconomic stability is necessary for reforms and growth and giving away state assets would undermine this. Yet another problem to this method is the fact that in a give-away plan, the old managerial staff is left in place while the transition to privatization is being made. There is no interim management after the deal is made.
For East Germany and Hungary, Bolton and Roland state that these countries are "not likely to meet the fiscal constraint since the revenues generated by a massive sale of state assets would be low"(6). This is due to the Stock-flow constraint, which means the most a government can get out of selling stock of state assets is a flow of Savings. This can be relaxed if assets from the state are allowed to be sold to foreign investors. Also, this creates incentives for governments to delay privatization to increase the profits they may make in sales.
The next section discusses eliminating the stock-flow constraints, auctions and bidding with cash and non-cash bids. Bolton and Roland contend that the best way to break the stock-flow constraint is to introduce securities which would allow state assets to be sold for a cut of the future profits made by that asset. This would make it easier to quicken privatization and not reduce the total benefits from the sale. The authors then suggest that privatization agencies or the government should set up auctions that accept cash as well as non-cash bids since this will not only "resolve the revenue shortfall problem but also achieve better matching between firms and managerial teams"(7). This is different than the idea that privatization should take place at different level. This is due to the fact that when there are various stages of development, it is easier to create a good management team, and it will allow for a system where the state is more efficient since its claims vary from one enterprise to another.
Concerning the ways of bidding at the auction, Bolton and Roland state that allowing two types, cash and non-cash, are the best means. When non-cash bidding is allowed, it show that governments are willing to transfer assets to the private sector for claims on their equity or debts which will create a healthy anti-inflationary bias in the economy which will protect the real claims in the private sector. Also Non-cash bids can make it possible for the little investors who are short on capital but have a lot of experience purchase larger companies over a larger investor with the immediate capital but with little experience in the industry. The winning bid can reveal a great deal about an investor. It can tell you about the investor's willingness to pay and their ability to run an efficient business. A cash bid may only reveal the investor's ability to pay. There is a risk, however, that some bids may not be very serious or valid ones, but a minimum payment before the bid might discourage such practices. Bolton and Roland do admit that auctions are much easier to do with small and medium-sized enterprises where a concentrated management-ownership structure is preferable. But why choose Auctions over Bilateral negotiations anyway? Well, there are two main reasons: 1) There is likely to be more competition for a particular business, 2) the selling price of the business might be higher, 3) you just might get the best combination of owner-managers and corporation, and finally, auctions can save you time when figuring out the value of assets to be privatized(8).
The final discussion is about the financial restructuring and reforms that are needed within the government. Here the notion of giving new enterprises a "clean slate" by writing-off their debts is discussed. This sounds like a great idea, but unfortunately the burden of the cost of that action will fall on the government at a time when it is most vulnerable. Then through the increase of taxes over a period of time, the government will hope to recover. The best example of writing-off debt is East Germany. Treuhandanstalt wrote off up to 75% of debts incurred by East German companies. luckily, West German taxpayers were there to take care of the otherwise devastating financial repercussions. It would be unlikely that any of the other countries could sustain such a shock to the economy.
There are four main conclusions by Bolton and Roland. The authors from the beginning stated that they felt that state assets should not be given-away but auctioned. This is because Giving-away schemes can cause inflation to increase, disrupt the budget and potentially ruin the new democracies in Eastern Europe. They believe that the loss of cash-flow on the government budget from the formerly state-owned companies is the most important issues for Poland, Hungary and Czechoslovakia. They feel that the collection of tax revenues will become increasingly difficult as firms become privately owned, so they must try to obtain the maximum amount of proceeds from the sale of state assets. This is difficult because it goes against the idea of privatizing as fast as possible, since this method needs to be well planned out and is a slower process.
The next suggestion is that there must be complete change of management once privatization has taken place. Bolton and Roland contend that under a voucher system, as in Czechoslovakia, privatization of cash-flow will take place, but the control of the company will not be privatized as the old management will still be in place. In the case of Poland, they have created a financial intermediaries that do not replace the former management, but does supervise them.
The third conclusion is that the stock-flow constraint and valuation problems that occurred due to there not being a capital market must be solved. he means of doing this, although not a perfect solution, is by auctioning off state assets and accepting cash as well as non-cash bids. This way is more efficient, speed up privatization and introduce balanced budgets and a capital market. Additionally, this will allow governments to be able to write-off debts before privatization takes place.
The final conclusion is that the problems concerning mass privatization must not be underestimated. Large industries are more likely to have a separate owner and control since those who are the winning bidders will only won a fragment of the cash-flow claims. Bolton and Roland also suggest that privatized banks monitor the management of these large corporations.