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1.History and Critics of Voucher Privatization

In the first months after the velvet revolution there was a general consensus among economists and politicians of various convictions about the following basic principles of economic transformation:

  • 1) urgency of the fast dismantling of the administrative system of central planning;

  • 2) liberalization of prices and restoration of the coordinating function of market;

  • 3) liberalization of foreign trade and exchange rates;

  • 4) restrictive fiscal and monetary policies to prevent hyperinflation;

  • 5) privatization of a considerable part of state-controlled economy

At that time these basic principles were supported both by the right wing liberal economists such as Vaclav Klaus, Tomas Jezek, Vladimir Dlouhy, Karel Dyba and others and by the left-of center economists such as Valtr Komarek, Ota Sik or Milos Zeman. Only a few isolated voices such as the Communist Party economist Zdenek Haba strongly disapproved with some of these principles.

Already in the first half of 1990 opinions began to diverge. The main disagreement was about the way and speed of practical implementation of the basic principles. The mentioned liberal right wing economists submitted to the government a detailed and well substantiated scenario of the rapid and radical strategy of economic transformation. This scenario involved very fast privatization of the great majority of state enterprises and a fast transfer of governmental controls to the selfregulating function of the market.

On the other hand, the group represented by the then Deputy Prime Minister V. Komarek, deputy M. Zeman and a number of other ministers and economists shared the view that the transition should be much more gradual and that government should retain significant and active role in controlling economic processes. Although this group came up often with vehement criticism of the liberal wing, it was not able to elaborate its own consistent proposal for an alternative strategy. It lost its first battle when Valtr Komarek resigned and freed the post of the Deputy Prime Minister for Vaclav Klaus.

The right wing strategy of radical economic transformation was adopted by the Government and was launched in the course of 1991. Its critics continued in their attacks from their positions in academia, in the Parliament, and in political parties. Valtr Komarek and Milos Zeman were in some of their opinions strongly supported by other academic economists e.g. M. Matejka from the Prague School of economics or Milan Zeleny from Fordham University in New York. They had their sympathizers among some Czech politicians and even more among economists and politicians in Slovakia. During this process the critics began to move more and more to the left and finally in the period of pre-election campaign at the beginning of 1992 both Komarek and Zeman became prominent spokesmen of the Social Democratic Party. With the approaching elections they are escalating their attacks against the government strategy and their language is becoming more and more blunt. It is now quite evident that the differences go far beyond the mere disagreements about the speed of transformation. The very principles of the economic transformation and the nature of the targeted economic system are now in question. Against the official goal of the western-style private free market economy, the leftist critics are proposing a kind of "third way" solution, with markets controlled by the government, mixed private, state, and workers ownership and strong social policies.

Since the very beginning, one of the major disputes concerned both the extent and speed of liberalization of the domestic and foreign trade, as well as the extent and speed of privatization. At issue was not so much the so-called small privatization, i.e. the privatization of retail outlets, restaurants and small enterprises of local nature, but mainly the large privatization, i.e. the privatization of large state enterprises.

The government’s scheme resulted from the view that it was impossible to increase substantially the economic efficiency without a well operating free market and without the restoration of private property rights. Therefore, it wanted to start the transformation by a large scale liberalization of domestic and foreign trade, with subsequent privatization of substantial part of the Czechoslovak economy. This was to be done in two waves in the course of a few years.

The alternative left wing scheme would on the contrary leave much greater share of the economy in state ownership and would spread both the market liberalization and privatization of the remaining state enterprises over a much longer period. This was justified by reasoning that because of the low market value of the highly inefficient state enterprises and the devalued exchange rate, presumably deviating significantly from the purchasing power parity, a cheap sell-out of the national wealth to foreign capital could follow. In order to prevent this outcome the left wing scheme recommended revaluation of the Czechoslovak currency, imposition of government controls over foreign trade and rationing of hard currency.

Further, before accomplishing the full liberalization of prices and before a more substantial privatization it wanted to restructure the whole economy and increase its efficiency under government directions, and with the use of "scientific predictions" of new technologies and selection of industries with comparative advantage.

It was not said, however, by what magic the state officials would be able to achieve today the tasks, dealt with unsuccessfully in the past by a huge team of planners. They would have to decide correctly, what is beneficial to produce in Czechoslovakia, what to export and what to import, how to optimally allocate investment and how to choose the best technology. And this all, without private property rights and with market signals still distorted.

There has been also a heated dispute over the form of privatization. As the Czechoslovak population evidently did not have enough savings to purchase stock of state enterprises for their actual value, and as the sale of the greater part of the state property to foreign capital was not considered desirable, the method of voucher privatization was adopted by government.

Voucher privatization means a give away of the state property to people free of charge. Each adult is entitled to 1000 investment vouchers which he or she can use for the purchase of shares of state enterprises that were in the meantime transformed into joint-stock companies. According to the original plan, by far the greatest part of the state property should have been distributed for vouchers and only a smaller part of some selected enterprises should have been sold directly to the domestic or foreign capital. Further, a more significant entry of foreign capital was anticipated only after the conclusion of the first wave of voucher privatization, when the secondary financial markets would come into existence.

It is interesting that not only the left wing critics but also the authors of the government version of the transformation strategy had an exaggerated mistrust of foreign capital. Various restrictions hindering the entry of foreign capital were based on the mistaken overconfidence in the attractiveness of the Czechoslovak economy for foreign investors. Overestimated were also the quality of Czechoslovak enterprises, cheap work force and their professional skills while deeply underestimated were the risks the foreign investors would have to take.

Of no less interest is to compare the Czechoslovak voucher form of privatization with the form proposed in Poland and some other East European countries as well as with the original version proposed for Czechoslovakia by Jan Svejnar from Pittsburgh University. This method was based on the distribution of a certain part of state property free of charge among people through the system of several investment funds established and administered by the State. To give all citizens equal proportion of the privatized property, and at the same time, to reduce their risks, it was proposed to distribute all the property equally, let us say to ten investment funds, and then distribute their shares equally to all citizens. Through this "double portfolio" system each individual citizen could obtain an equal share in each of the thousands of privatized firms.

The just described method was based on the correct assumption that most people are risk averse and it would also ensure a relatively high level of equality in the distribution of property among citizens, however, it would have to be organized by government officials in a large centralistic scheme. One can hardly imagine that such a scheme could raise lively interest of people in investing and stimulate spontaneous development of secondary capital markets. The Czechoslovak government version originally did not count at all with investment funds and rather naively assumed that each Czechoslovak citizen would become a stock broker. Nonetheless, its advantage was decentralization, spontaneity and possibility of adjustments. Due to economic freedom and competitiveness not ten but over four hundred investment funds spontaneously evolved. This in turn stimulated the interest of people in voucher privatization.

The left wing criticism rejected the voucher privatization from the very beginning. It denigrated it as a "non-traditional" method of privatization, ascribing to it bad properties of all kinds. It also preferred other forms of privatization and specifically privatization by employee ownership.

Voucher privatization was criticized for distribution of the state property free of charge. Supposedly, citizens would get property which they had not helped to create and consequently they would not have an appropriate attitude towards it and would not manage it properly. People would try to get rid of the effortlessly acquired property as soon as possible and they would sell the shares acquired for vouchers immediately. Thus the property distributed free of charge would be converted into the demand for consumer goods. Voucher privatization would thus allegedly unleash a rapid process of inflation. Moreover, by exchanging shares for vouchers firms would not get new capital which they needed so badly for modernization and further growth.

These arguments are erroneous. True, under communism it was the government who decided on investment and thus on the accumulation of property. The source of investment, however, was the forced saving of citizens. The free-of-charge distribution of state property may be considered a restitution, i.e. a just return of the property which people created by their work and saving and which was taken from them in the past by the government. It is also wrong to assume that people would not care about property obtained free of charge and that they would try to get rid of it as soon as possible. In the third part of my Lecture I will try to answer the question of what a rationally behaving household will do with the property acquired through voucher privatization and I will demonstrate there, that the fear of inflation is greatly exaggerated.

The argument that by exchanging shares for vouchers enterprises will acquire no additional capital is not relevant either. New capital for companies is created on primary financial markets when savings are used to purchase newly issued equity. Privatization, be it in the form of exchange of shares for vouchers or their sale for money, is similar to secondary financial markets, where only changes in the owners of the existing capital take place. Even when the shares are sold for money, the newly privatized firm receives nothing, because all the proceeds from privatization go to the former owner, i.e. the State.

It was also frequently argued that the voucher privatization would create a large number of small and inexperienced owners who would not be in a position to exert a sufficiently strong pressure on managers and perform the entrepreneurial role in restructuring and modernization of privatized firms. It is symptomatic that at the moment when it became evident that certain privatization funds could control a significant portion of all investment vouchers, the very same critics quickly forgot about their previous argument and began to alarm about the extensive monopolization of the Czechoslovak economy and to demand radical reduction of interests that the funds could own in privatized firms. It is also revealing that many government economists expressed very similar concerns.

Against voucher privatization the left wing alternative sets most often privatization by distributing shares to employees. Presumably, the advantage of employee ownership is that with their share in capital, employees would also acquire a share in profits and would participate in the management of the firm. Thus the managers would allegedly get under control of well informed and strongly interested co-owners. Profit sharing should also motivate employees to higher performance and better quality of work and thus result in increased efficiency of the enterprise.

The advantages of this form of privatization have been documented almost exclusively by references to the ESOP system which has been recently rapidly spreading in the USA. It has been claimed that the American experience proved that profits and incomes of companies with employee co-ownership grew more rapidly then profits and incomes of other companies. Repeated were also generally known data showing that the number of corporations included in the ESOP system grew from 1600 in the year 1974 to 8100 in 1985 and that the number of employees involved in this plan increased in the same period from 250 thousand to 8 million.

Milan Zeleny full of optimism predicted that soon after the year 2000 most of the American economy would be owned by employees. To support his enthusiasm Zeleny did not hesitate even to quote a positive statement of Michael Milken, made shortly before this crook started to serve the ten-year prison sentence for what may have been the biggest financial fraud in the history of the capitalist system.

Neither Milan Zeleny, nor anybody else from the proponents of employee ownership quoted from the book "Paying for Productivity - a Look at the Evidence" edited for Brookings Institution by Alan S. Blinder. There they could have read that the American ESOP was far from being what they presented it for. In the USA, ESOP is taken almost exclusively for one of many forms of fringe benefits which the employers provide their employees in addition to their salaries. Despite its rapid growth in recent years, its size is still very small in comparison with other more disseminated forms of fringe benefits such as for example contributions to pension funds.

Although the American ESOP gives employee share in profit it provides almost no participation in the management of the firm. The portion of employee shares in most cases ranges only between 3 to 10 percent of the shareholders equity of the participating corporation and employee’ shares in the ESOP plan usually do not establish the right of vote.

Included in the above mentioned book is also an extensive study of at present probably the most prominent American economist of Czech origin Jan Svejnar, who is a recognized specialist in this branch of economics. With a co-author Michael Conte they made an exhaustive survey of studies which attempted to test empirically the hypothesis that the firms incorporated in the ESOP plan have higher profits or are generally more efficient. A careful interpretation of econometric results lead them to the rejection of this hypothesis. Econometric results showed that the enterprises incorporated in the ESOP plan were not less efficient, however, with the exception of one single study, the efficiency gains were not statistically significant. The authors concluded that employee ownership by itself did not provide sufficient stimuli for higher efficiency of enterprises. This applied particularly to the ESOP system where the forms of participation in the management were very weak.

Employee shares are usually non-transferable and therefore also non-tradable. If the substantial part of privatization were to be implemented through employee ownership it would weaken secondary capital markets and retard their further development. But well functioning secondary capital markets are indispensable for efficiency of market mechanism.

This form of privatization is also very unjust to population. The distribution of state property through employee ownership means to give a high share to those employees whom the communist state placed inadvertently to highly efficient enterprises and give almost nothing to those who had to work in enterprises that are today at the brink of bankruptcy. And what about the employees of offices, schools, police, army and other institutions that will not be privatized? Had they not participated by their forced savings in the creation of the state property?

When we distribute state property accumulated by the communist state to citizens and have no evidence about the share created by each individual the principle of equal opportunity requires to give each the same proportion. And this is exactly what voucher privatization does.

Concentrated attacks against voucher privatization even if in our opinion mostly unjustified resulted already at the very beginning of the transformation process in the political decision to give "equal opportunity" to various "traditional" and "nontraditional" forms of privatization. Voucher privatization was the "nontraditional" form while "traditional" forms included sale of enterprises to the existing managers, restitutions to original owners, sale to domestic or foreign capital, and privatization through employee ownership. Each enterprise was requested to draft its own well-documented "privatization project" that would propose the most suitable combination of privatization methods for the enterprise. The public then had the right to draft alternative "competitive privatization projects" for any state enterprise.

All these facts led quite understandably to the decrease of the share of voucher privatization in the total privatized property as well as in the repeated delays of the start of the first wave of privatzation. The reason was that sufficient time had to be provided to settle restitution claims, draft original and competitive privatization projects and to review them by ministries of privatization and in some cases also by republic governments or even by the Federal Government.

Finally, I will mention the most recent criticism of voucher privatization or rather the criticism of the activity of some privatization funds related to issued guarantees or "options" for paying certain minimal amounts for voucher books invested in the fund. Perhaps the most apt formulation of this criticism was presented by Jan Svejnar in the recent discussion published in the weekly RESPEKT and showed also on TV. Similar criticisms by other authors also appeared in press.

It concerns the danger of a financial collapse in case that after the end of the first wave of privatization market price of the portfolio of some privatization fund would fall below the level of financial guarantees issued by it. Thus, e.g. the mentioned Harvard Fund guaranteed that twelve month after the end of the first wave it would pay either 10,350 Kcs or the market price, whatever is higher, to each of its shareholders who would want to withdraw from the fund. Some fund issued guarantees for 15,000 Kcs, 20,000 Kcs or even more.

As there exists no free market of voucher books nobody knows today what is the expected market price of an average portfolio per one voucher book. If this price were only slightly higher than the guarantee issued by some fund it could easily happen that after one year people would start to request the guaranteed value of their shares and the privatization fund would have to sell the shares acquired through privatization in order to be able to pay off its shareholders. Sudden increase in the supply of shares may further reduce - even if only temporarily - their market price and, consequently also the average market price of the fund’s portfolio below the guaranteed sum. In such a case there could occur a run on funds, i.e. the shareholders might request en masse the payments for their shares and by chain reaction the financial markets might collapse.

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