TRANSFORMING STATE ENTERPRISES IN POLAND:
EVIDENCE ON ADJUSTMENT BY MANUFACTUTING FIRMS
by Brian Pinto, Marek Belka, and Stefan Krajewski
Poland was one of the first East European nations to begin moving toward a free-market economy, but it has ended up having one of the most difficult transformations in the region. The Big Bang in 1990 had a very severe impact on the economy, and the government ended up slowing down or even reversing many of the reforms intended at ending socialism in Poland.
"Transforming State Enterprises" argues that there may be some very solid reasons for taking a gradual approach towards privatization, rather than the shock therapy approach of selling or giving away state enterprises as soon as possible. What they do see as being important is quickly instituting "hard budgets" (i.e. eliminating subsidies and allowing firms to go bankrupt) and allowing import competition and free prices. In other words, while a market economy is needed quickly, a privatized one is not quite as much of a priority.
There are, of course, many economists who disagree with this approach, such as Oliver Blanchard, et al, in the article "Reform in Eastern Europe". He argues that "Privatization of these firms...is urgent. The longer Eastern European countries wait, the more de facto privatization and plundering of state assets will have taken place, in a way that is sure to lead to a political backlash and the failure of the reform program. Thus privatization must take place before firms have been restructured."
There is also the argument that the managers of state-owned enterprises have had 40 years to make them viable operations and have been unable to do so, so it's unlikely that they could do any better now.
The authors of "Transforming State Enterprises" see the situation very differently, however. They argue that the situation has changed greatly in state-owned enterprises since the transformation began. Where once managers were guaranteed jobs, the managers now know that the days of state- owned enterprises are numbered, and that if they don't perform well now, they may no longer have a job after privatization.
The authors do stress that the pace of reform has to be definite, and this is one problem that they see with "shock therapy," since after the initial push, there is often a tendency to back away from such severe measures, as was the case in Poland. This type of backing away sends a message that the government is not completely committed to reform, and will cause managers to not take the government as seriously in future reform measures.
Another point they make is the importance of hard budget constraints. During the heydey of Communism state-owned enterprises were used to having the government give them whatever subsidies they needed to continue operating. For these enterprises to truly begin reforming they need to be given the message that there will be no more subsidies, and that if they run out of money they may even go bankrupt.
Overall, the authors believe that consistency is more important than speed in the transformation and that the worst approach is kind of "stop-and-go" method, where the government sometimes moves towards reformand sometimes does nothing.
Instead, there needs to be a clear vision of where the country is heading in the government, one which states that privatization is going to happen, but that the state-owned enterprises will be given the opportunity to reform themselves before they are privatized. The authors see this approach as being more politically feasible and even more economically viable, since once the firms are privatized they will be healthier than they would have been in a rapid transformation.
There is the analogy that to cross a canyon, you have to take a big step to cross it, not a small one, or you will fall in. The problem with this, though, is that though Poland took a big leap, it still fell in, and suffered some serious economic consequences which caused some to believe they shouldn't have made such a leap at all.
Maybe the best way, then, is to build a bridge across the canyon first. It takes longer, but once in place it becomes much clearer that you will be able to get across that canyon. This seems to be the heart of the authors' argument, that giving the enterpises a chance to improve themselves may be a way to build that bridge and avoid a sudden impact during the transformation.
TRANSFORMING STATE ENTERPRISES IN POLAND: EVIDENCE ON ADJUSTMENT BY MANUFACTUTING FIRMS by Brian Pinto. Marek Belka, and Stefan Krajewski Brookings Paperst on Economic Activity, Part 1-1993, pp. 213-261.
Note: Brian Pinto was the senior economist at the World Bank ResidentMission in Poland when this paper was written. Marek Belka and Stefan Krajewski are professors of economics at Lodz University in Poland. The World Bank provided some financial support for this study.
Does Polish Experience Support Theory of Pinto et al?
There are now some promising signs that Poland's worst times are behind it. Radio Free Europe recently reported that the country's exports shot up by 16% over last year, and the World Bank is predicting that Poland will grow by 5% over the next 5 years. Not all of the news is good, though, since inflation is still a serious problem (it could reach 30% for the year) and there are still a huge number of firms which have not been privatized.
But it hasn't been a smooth road getting to this point. In June of 1992 only a fifth of the state-owned enterprises had actually been privatized, and industrial production had dropped by 20% from the year before. The worst problems came in industries such as transport and electric engineering, where the goods produced were sub-standard for the world market and no longer could be sold in large quantities to the Soviet Union.
So the question then is, do the theories of "Transforming State Enterprises" still make sense given what has actually happened in Poland? To try to answer this question, the authors looked at a set of 75 state-owned enterprises in Poland and analyzed whether or not they were actually reforming themselves, even though they had not yet been privatized.
What they found was that there were some very clear differences between the firms, with some making a great deal of progress and others on the verge of failing. They concluded that there were three important factors that caused state industries to reform themselves and become more efficient. These were a hard budget (no subsidies), big bang methods in reforming prices, and a belief by managers that their performance would be rewarded after privatization if they did well.
In the area of hard budgets, they found that the industries reformed themselves much more quickly after managers became convinced that the government was not going to bail them out if the firm ran into trouble. They found in a survey of managers of these enterprises that "in 1990 banks acted like cashiers, eager to dole out money. By 1992, banks were behaving like partners with an equity stake in the company and had become highly conscious of quality." By this time, firms began using cash management systems to make sure that they knew where their money was going, which was a good sign that the industries were definitely taking all of this seriously.
One of the biggest worries about letting enterprises stay state-owned for too long was that the managers would loot the company before it became privatized, selling off assets and keeping the profits for themselves. The authors of this study don't believe that this has happen, saying that they found that in their sample of firms, "profitable companies are not prone to decapitalization...By contrast, decapitalization is pronounced in firms suffering losses...Decapitalization can thus be interpreted as more of an adjustment phenomenon than a deliberate attempt to squander state assets." So most of the selling off of assets has occurred in firms which truly needed the money to survive, while in the successful companies (which do have the most valuable assets) managers have been careful to keep the firms intact.
So in conclusion, the theories of the paper "Transforming State Enterprises" do seem to have held up well during Poland's transformation. Shock therapy seems to be a necessary step in reforming the prices and ending subsidies to companies, but gradualism may be a better strategy for privatization. The state-owned enterprises do seem to be operating like real businesses, so the fact that Poland still has many firms which need to be privatized may not be such a bad thing. Of course, they do need to be moving towards privatization, or this study is no longer valid, since there won't be any motivation for firms to restructure. But as the authors conclude, "Poland's experience...shows that rapid changes in ownership may be unnecessary, and that restructuring before privatization may be desirable." Poland is moving in the right direction, and the most recent economic news reinforces the fact its economy is improving at a slow, but definite, pace.
Pinto, Brian, et al, "Transforming State Enterprises in Poland: Evidence on Adjustment by Manufacturing Firms," Brookings Papers on Economic Activity,Part 1-1993, (Brookings Institute, Washington, D.C., 1993), pp. 213-261.
HANDOUTS IN CLASS
Blanchard, Olivier, "Reform in Eastern Europe" (MIT Press, Cambridge, MA)
"Eastern Europe: Struggling to Stay on the Reform Track", (Testimony to Joint Economic Committee, June 8, 1992)
Radio Free Europe-Radio Liberty Report, October 17, 1994.