Transition   Privatization   

Privatization in Eastern Europe 

By Vichentie Milea

By James T. Tita

Richard J. Stendardo

Privatization in Eastern Europe  

By Vichentie Milea

One of the major tasks former Communist countries were confronted with after 1989 was the transition to a market economy.  In this process of economical transition privatization of state-owned companies became the most important policy on the governments' agenda.  Since state run companies were often inefficient, wasted precious capital resources and depended on the state to keep them afloat, the privatization of these companies was believed to relieve the state of unnecessary pressure and free up capital for other more important programs.  In most countries outside of the eastern block where privatization occurred, it also became an important resource of profit for the government.

 Privatization is thought to increase efficiency for a number of reasons: a) enterprises will no longer have to satisfy the political agenda of the state, as it had happened during the heavy industrialization period in the communist era, and b) as part of the free market mechanism, these newly privatized firms will have to focus mainly on profit making, or face change in the leadership as stock owners become unhappy with its performance.  In Eastern Europe privatization was forced to happen before the governments were ready and in a viable economic situation.  The reason for this fact was that by the time the governments would have been in a viable economic position to proceed with this policy, the state owned enterprises would have lost a considerable portion of their value as a result of employee and manager theft and self interests.  At the same time economic output had to be "jumpstarted" and growth resume, even though some people might lose their jobs in the restructuring process.

 The actual process of dismantling the state run companies ran into problems as insufficient funds were found in the native economies that would compensate the state for its assets.  This meant that a good portion of companies had to be sold to foreigners, as it happened in Hungary. Another option would be to sell companies to alliances of former managers and employees, as it happened in Romania, Poland and Russia.  Lastly, the issue of returning to former owners their confiscated properties usually created various conflicts and slowed down the privatization reforms.

In order to maintain an equal redistribution of these state owned assets, governments handed to the public vouchers and coupons in a controlled manner.  These tools were used in order to avoid inflation, since they could not be used to buy anything (except other state owned assets in Latvia and Slovenia).  In the Czech Republic financial intermediaries provided alternatives to personal ownership of vouchers, while Poland used a number of mutual funds to divide the coupons and restrict consolidation of ownership.

 In the big picture, this rapid process of privatization had some major weaknesses.  The most important was the fact that this process did not bring about an exchange of capital either to the government or to the newly private companies.  In this way the state could not alleviate the pressures that affected its treasury while the private companies did not receive any starting capital to restructure.  Another flaw was the upside of the equal distribution that meant company leadership was usually fragmented, not lending itself to facilitating the important profit making decisions that were soon to follow.  

As the process of privatization got under way, the new sector could be divided into state run and private firms, under the direction of either native citizens or foreigners.  Furthermore the private sector could be separated into ownership by employees, managers or other individuals.  From the very limited resources available for research there have not been dramatic deviations in economic performance among these different types of ownership.  Overall the private companies have the upper hand in restructuring and long term profit strategies, while they also exhibit lesser degrees of over-employment.  What seems surprising is the seemingly equal performance between companies owned by foreigners and the ones owned by native citizens.  Common sense would lead us to believe that foreigners have easier access to outside financial services and investment, while they are also in possession of more up-to-date  technical and managerial expertise.  At the same time it seems too soon to draw conclusions in the light of continued economic reform present in most of the Eastern European countries.

The start of the privatization process represents a milestone in the transition to a market economy.  This action sets the course for future economic reforms and imposes a strong constraint to the return of communism in any shape or form by giving birth to a new middle and upper class bent on profit-making.  At the same time it represents a vote of confidence for increased foreign investment and it allows for future integration with the European Union.  While the economic performance might not have drastically improved, such actions require time to solidify and are also heavily dependent on other economic reforms.  Through a process of trial and error, Eastern European countries will continue to proceed on the path of economic reform, ultimately joining the ranks of their Western neighbors.



Estrin, E. Privatization in Central and Eastern Europe.


Davis, R. Junior and Angela Gaburici.  The Economic Activity of Private Farms in Romania during Transition. Just how Competitive are they?





Report on the paper
by Yali Peng

James M. Tita:

In the article, Privatization in Eastern European Countries, Yali Peng a economist at the University of Oregon, explains privatization and the problems associated with it. Yali believes that Privatization is necessary for several reasons. First, in a desire to move to a free market system in which supply and demand are the basis, Privatization is the efficiency tool used to obtain this. Second,  privatization will greatly stimulate competition intern leading to a vitalized economy. Third, privatization will improve firms in the market by creating productive management, making these firms effective. Finally, you can boost foreign investment which these economies need to stabilize their countries economy. Third, privatization will improve firms in the market by creating productive management, making these firms effective. Finally, you can boost foreign investment which these economies need to stabilize their countries.

 Peng believes that this necessity of privatization drives these countries towards it but at different rates. The factors that cause these slowdowns and determine policy are  that property rights must be newly defined to create a market economy and political stabilization. This according to Peng leads into the difficulties of Privatization. First their is a "Catch 22",a market is needed for privatization but the purpose of privatization is to create a market. Second, you need people willing to buy, but people don't have the necessary money to purchase these firms. Third, people do not understand how markets work must first learn how these markets work. Fourth, people are afraid about foreign investors taking control of their countries. Thus in determining privatization processes governments must take this into account.

 In looking at the different countries privatization methods, Peng explains the Czechoslovakia coupon offering  the slow progress in Hungary, Polands ambitious privatization plans and Romania's privatization Bill, and comes to four basic assumptions on what these governments are trying to do. First these governments are sensitive about foreign ownership and they try to restrict as much as possible(Czechoslovakia). Second Large enterprises are designed to be sold while small businesses are meant to be auctioned off(Poland). Compensation for privatization should be given to employs in t terms of stock which only Poland has done. And finally the method that is being used in Poland of  distributing to adult citizens. Peng also mentions the Lipton and Sachs model of Paralysis of Privatization, privatization will turn into a political battle where none will win, and how Poland method has adopted many of Lipton and Sachs suggestions.

I believe Peng has a point, if you look at western European countries, many of whom are privatizing many state enterprises, their are the financial structures that Peng sees necessary. Even though these transitions are not going as smoothly as desired compared to eastern countries they are doing extremely well. Peng recognizes that many of the difficulties stem from the communist era and that the slowdown in privatization can only be expected. I feel that this transition period even though long and hard when it finally is successful then the people will be able to enjoy free markets with a understanding of what both prosperity and hardship is.  

PRIVATIZATION IN EASTERN EUROPE by Yali Peng in East European Quarterly, Jan 1993


Report on Privatisation of Socialist Economies
by Mario Nuti

Richard J. Stendardo

The process of privatization is crucial to any nation's transformation from a socialist economy to a free market system.  Mario Nuti states in his article "Privatization of Socialist Economies: General Issues and the Polish Case" that privatization will "inject life into the inert traditional system, de-politicize economic life, and harden budget constraints."  Nuti establishes three criteria for successful privatization: divesting of the power held by the government to private organizations, fair distribution of state owned assets, and proper sequencing of privatization when utilized with liberalization and stabilization policies. 

 As the central planning committees of the formerly socialist Eastern European countries begin to give up power, it is essential that this power be transferred to private organizations whether they are pension funds, foreign investment groups, or employee ownership groups (Employee Stock Ownership Plans, Trusts, or Personal Equity Plans).  This lesson was learned in Hungary where "re-subjectivisation" had to take place after the Ministry of Justice stated that "enterprises belong to themselves" in 1984 and was not corrected until after 1990.  This legislation took most of the basic rights of ownership and, in effect, gave them to a Hungarian government that was already trying to distance itself from them.  In order to privatize later, the government had to retake control of industry and then reestablish ownership rights.  Nuti suggests that the best recipients of this control would be a combination of holding corporations, pension funds, and banks.

According to Nuti there is no good way to distribute the state's assets to the private sector, but he recognizes a free distribution to the citizens as being the most equitable.  He says this would generate a high level of public support and create a new capital market instantly.  However, Nuti also believes this policy must be accompanied by a strict macroeconomic policy to hold down inflation and serious restrictions on the trading and buying of shares in order to prevent an unfair advantage for those who have access to more liquid assets or better information.

     The third and final requirement for successful privatization in Nuti's plan is a proper sequence of the reforms.  He believes that before firms can be privatized, stabilization and fiscal reform must take place.  Nuti states that inflation must be brought under control in order to determine the real value of each industry's assets and that demonopolization must occur to help prices adjust to a real market value.  Finally, Nuti wants redistribution of capital among the state owned firms in order to make them more competitive.   

 I agree with Nuti that power (in the form of property rights) must be transferred to private corporations and that free distribution of state assets to private citizens must be undertaken in order to have successful privatization, especially because this would create a middle class of entrepreneurs who would have great incentive (in the form of  profit) to restructure firms efficiently.  However, privatization must occur soon after price liberalization begins.  Even if prices drop to market determined levels, the firms, under continued government control, would take dramatic losses and the government would have a huge budget deficit which could not be maintained.  Only successful privatization of firms can make them competitive enough to compete at market determined price levels, and thus complete the transition process.  By delaying privatization, a nation will doom itself to many unnecessarily painful years.

Nuti, D. M.  Privatisation of Socialist Economies: General Issues and the Polish Case. Transformation of Planned Economies.  Paris: OECD, 1991.



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