Aslund_6_Privatization - the establishment of private property rights

Privatization: The Establishment of Private Property Rights

Postcommunist privatization was unprecedented, with over 150,000 large and medium-size enterprises, hundreds of thousands of small firms, and millions of apartments and houses privatized in a decade.
The private sector grew from nearly nonexistent to producing almost two-thirds of GDP, marking a fundamental change.
The privatization of public enterprises was initially introduced by Margaret Thatcher in Britain and Augusto Pinochet in Chile around 1979.
The US started advocating it abroad in 1985, with relevant literature emerging in 1987.
Privatization aroused intense passion, encompassing politics, law, justice, morals, and economics and acting as a dividing line between socialist and capitalist societies.
Thatcher's slow pace of privatization was not feasible for postcommunist countries, necessitating novel approaches.
The concreteness of privatization (e.g., housing) caused confusion about enterprise value, as many state factories were obsolete and overstaffed.
The nationalization of production means was a key Marxist-Leninist dogma, and large-scale privatization was not seriously discussed until 1988.
A consensus then formed that privatization was necessary because public enterprises served politicians' objectives rather than maximizing efficiency.
Popular disillusionment with public enterprises was significant, exemplified by the Russian term "kolkhoz" (collective farm) becoming synonymous with chaos.
Defining "private" was complex, with many post-communist countries requiring 70% private ownership for classification due to state influence.
The state often retained a "golden" share with veto power, undermining other owners' rights.
Privatization was often restricted, limiting new owners' ability to change the shop's profile, lay off workers, or choose suppliers.
Discussions on privatization were divided into small enterprises, large/medium-size enterprises, and land/real estate.
Small enterprises were easiest to privatize, while large/medium-size enterprises were more complex and contentious.
Land reform and real estate privatization involved the largest wealth transfer but received less national attention, often handled locally and constrained by traditional claims.
The importance of new enterprises was initially overlooked.
The differing aims of privatization led to intense debate due to its significant impact on the formation of new societies.

Differing Aims of Privatization

The primary goal was political: to separate enterprises from the state, foundational for democracy and pluralism.
A second goal was establishing a market economy based on independent, private enterprises.
Justice was a third major consideration.
Initial ownership claims and control over property constrained privatization strategies.

The Political Goal: Depoliticization of Enterprises

Reformers aimed to break up hegemonic state power, making private ownership the foundation of freedom and democracy.
Friedrich Hayek argued private property is the most important guarantee of freedom.
Boycko, Shleifer, and Vishny (1995) viewed political influence over economic life as the fundamental cause of inefficiency, and depoliticization as a principal objective.
Price liberalization and privatization depoliticize by removing politicians' control over resource allocation and firms.
Under communism, managers were selected based on political criteria.
The cure was separating politicians from property, prioritizing control over politicians rather than managers, as managers' interests are closer to economic efficiency.
Separating the state from enterprises was difficult due to the state's re-emergence in various forms.
Industrial ministries, despite initial defeat, saw recurring proposals for new holding companies reminiscent of old ministries.
Networks between regional officials and state enterprise managers remained strong.
Natural monopoly ministries were the worst opponents of reform and remained largely unified.
Building a new middle class of educated, property-owning people was another liberal political objective, favored by Vaclav Klaus ´ and Yegor Gaidar through voucher privatization and new startups.
Privatization is a political process, reflecting the art of the possible, requiring a broad coalition built on compromises among stakeholders (managers, employees, officials).
Establishing consent among stakeholders was key to successful reforms.
Stakeholder demands varied by country and prior legislation, requiring adjusted privatization schemes.
Stakeholder privatization, however, contradicted effective corporate governance aspirations because incumbent managers and employees were often unsuitable owners.
Making shares freely tradable was a potential cure for problematic property rights distribution.

The Key Economic Goal: Building the Foundation of a Market Economy

Privatization had at least seven major economic objectives.
The foremost aim was to build a well-functioning market economy and breed new private enterprises.
Tomá´s Jeˇzek stated privatization's primary purpose was not to increase company efficiency but to transform the government's role in the economy.
Ludwig von Mises said that Socialism is the abolition of rational economy.
Exchange relations between production-goods can only be established on the basis of private ownership of the means of production.
No clear line delimits a socialist economy from a capitalist economy, but no Western economy has a public sector producing more than one-third of GDP.
Empirical evidence shows private and privatized enterprises outperform public enterprises worldwide.
This was particularly evident in former socialist countries, where public enterprise mismanagement was notorious.
Enterprises needed real owners, leading to the conclusion that only privatization could establish them.
Companies had to be made independent from state-imposed networks.
Privatization was needed to break enterprises free from such noneconomic considerations.
Askar Akaev stated that efficiency is primarily determined by the market structure and the development of competition.
The main goals of privatization are, therefore, to change property relations, to form the market structure and to reinforce competition.
Foes of privatization argued that competition and demonopolization were more important, but no contradiction existed.
No competition agency succeeded in breaking up state enterprises, but this occurred on a mass scale in the privatization process.
Privatization helped impose hard budget constraints on enterprises.
State enterprises receive more subsidies than private firms.
Socialist countries were littered with rundown factories, crowding out new enterprises, necessitating the exit of obsolete enterprises and the entry of new firms (Schumpeter's creative destruction).
A hard budget constraint was a precondition, and bankruptcy the ultimate verdict.
For years, few companies went bankrupt, but many sold underutilized assets, creating an asset market and breeding new enterprises.
Enterprise restructuring involves improving allocative efficiency (reallocation of resources from old to new activities) and X-efficiency (restructuring within surviving firms).
Only strong owners (principals) could control and motivate managers (agents).
Single, powerful owners were ideal, while dispersed ownership was considered ineffective.
Outside owners were economically preferable, but inside ownership dominated, with employees unlikely to focus on profitability, risking property rights usurpation by managers.
Western experts emphasized the value of foreign direct investment, involving management skills, capital, and technical know-how.
Large-scale privatization was a precondition for creating a real capital market, leading to rational capital allocation.
Since privatization schemes were not likely to engender an efficient initial structure of ownership, small owners had to sell to facilitate accumulation of shares by strong new owners.
Stock markets had to be developed early on and be sufficiently transparent for meaningful corporate governance.
Initially, investment was widely considered a major objective of the privatization process, but this was not the case.
Sales of enterprises do not involve any real investment.
Logically, reformers opposed sales because they diverted private savings to the state treasury.
The initial hopes for foreign investment were exaggerated by the lasting communist belief that international capital was dying to enter the former communist countries.
In the West, state revenues are usually a major reason for privatization, but this was a subordinate issue in most transition countries, where systemic change and justice dominated the debate.
The market value of public corporations was small, however, Hungary was an exception.
A postcommunist government was financially better off giving its enterprises away than trying to run them itself, because only strong private owners could undertake the necessary restructuring.
- Annual tax revenues from successful privatized enterprises soon dwarfed the highest possible sales prices of an enterprise.

What Justice?

Privatization was a matter of justice, but four moral imperatives contradicted one another: restitution to old owners, equitable free distribution to the people, free distribution to the employees, and market sales to the benefit of the state.
Restitution meant returning property to the original owner or legal inheritors, embraced in the Baltic republics and East Germany.
Liberal economists, like Vaclav Klaus ´, objected to restitution, noting that many people suffered beyond property loss, such as deaths and incarcerations.
There were technical challenges, like destroyed land titles, Communists, and fires.
East Germany faced 2 million claims, clogging courts and stopping projects.
Some restitution occurred in Central European countries, particularly with farmland and real estate, whereas medium-size and large enterprises were avoided.
In the CIS, restitution was hardly an issue due to lasting communism.
From the conclusion that the suffering under communism could not be assessed came the idea to distribute all property evenly to the whole population through mass privatization.
All citizens could be given vouchers with claims to state property, and the state could auction property for vouchers.
Milton Friedman is credited as the originator of voucher privatization, whereas in Russia this idea was broached by the neoliberal Moscow economist Vitaly Naishul, who wrote a book on voucher privatization in 1987
Vaclav Klaus ´ became its main protagonist in the postcommunist world.
Opponents argued that this radical solution was communism in reverse and accused the adherents of “market bolshevism”.
A more socialistic idea was free distribution of shares to the workers of each enterprise.
Managers often exploited this argument to their own benefit.
A contrary view was that no property should be given away but sold at a market price, which was held in Hungary, Estonia, and Poland.
Moral objections arose because only controversial groups (communist officials, criminals, dubious businessmen, and foreigners) had money to buy enterprises.
Sales would require more time than mass privatization.
A plausible argument was to utilize the large monetary overhang for privatization, but in practice it proved impossible to organize privatization before price liberalization had been unleashed.
In the former Soviet Union, bank savings were inflated away by massive monetary emissions under socialism and ensuing price liberalization.
Those hurt demanded compensation, possibly through privatization. This option was investigated in Russia, but with no success.
In Ukraine, the liberal Deputy Prime Minister Viktor Pynzenyk revisited this idea after stabilization in 1996. A law established state liability for lost savings, and valued them at 160 percent of GDP.
“Compensation certificates” for lost savings were issued to be used as privatization vouchers. However, limited repayments have been done.

The Specter of Spontaneous Privatization

When communism collapsed, control over enterprises varied by country.
In the Soviet Union, the Law on State Enterprises of 1987 made incumbent state enterprise managers quasi-owners, by rendering them independent of the industrial ministries, which could no longer sack them
In Poland, workers’ councils had assumed power, arousing parallels with Yugoslav workers’ self-management
Worker council strength was in doubt in Hungary
The state and its industrial ministries remained the real owners of state enterprises in Czechoslovakia, Romania, and Bulgaria.
The politics of privatization differed accordingly, but the relative strength of political groups was poorly understood in advance.
The power of workers, trade unions, and industrial ministries was exaggerated, whereas the power of state enterprise managers was underestimated.
Ownership rights to an asset are usually divided into control rights and cash flow rights.
Control rights encompass deciding on the usage of an asset, while cash flow rights are the rights to the yields.
The standard problem in the former communist countries was that these rights had been separated.
The state formally maintained cash flow rights and part of the control rights, namely, the eventual sale; state managers had most of the control rights over state enterprises. These property rights had to be united to allow for efficient enterprise management.
Incumbent state managers had already started a large-scale spontaneous privatization in Poland, Hungary, and the Soviet Union.
Often a manager “leased” the state enterprise he managed, gaining control also over its cash flow. Usually, leasing gave the manager, or nominally the workforce, the right of a gradual management–employee buyout at a very low price.
Managers also tapped money from “their” firms through transfer pricing.
Even in the Czech Republic, managers of state-owned enterprises established private companies under their ownership and siphoned state-owned assets into these companies through various dubious techniques.
So-called tunneling or management theft through transfer-pricing has remained notorious in most postcommunist countries.
Managers often indulged in asset-stripping and stole “their” enterprises bare.
An early focus of privatization was to stop spontaneous privatization, which was seen as inequitable, slow, and inefficient, benefiting the incumbent managers. It was feared it would arouse a popular political backlash against reform.
The urgency of privatization varied with the degree of economic and legal crisis.
The Soviet Union was in a rampant economic crisis, with output in free fall and widespread lawlessness. The saying went “what is not privatized will be stolen,” underlining the need for speedy privatization.
Without effective state authority, the only way of remedying the crippling inefficiency of post-socialist state enterprises is to move as fast as possible toward a genuine property regime
The absence of any effective state authority, or selling of property or enterprises was a huge obstacle. The only capital markets socialist countries had permitted were marginal markets for summer houses and small machinery.
Hungary had a formal stock market, but it was a bogus institution at which state banks traded marginal stocks in state banks for no economic purpose.
Without markets, no asset prices existed, and book prices or historical costs reflected the old distorted prices.
Commercial law was rudimentary, although more developed in Poland and Hungary because of their substantial legal private sectors, enabling them to opt for more complex schemes of privatization than other countries.
Naturally, no state administration for privatization existed, and the old industrial ministries were unsuitable for managing privatization, which they either opposed or wanted to exploit.
Each country built up a relatively decentralized, large privatization administration, leaving most real estate and enterprises to be privatized by regional and local administrations.
The privatization authorities persistently fought the old industrial ministries over control of state enterprises.
Legal, commercial, or administrative expertise for privatization was lacking, and Western consultants and investment bankers did not have the right know-how.
Hungarians argued in a normal Western fashion that privatization had to be proper, creating strong owners with good corporate governance, and that the state should receive due revenues.
he precondition for such a view was that the state was capable of managing public enterprises.
Privatizers also hoped to thrive on chaos, launching privatization before the old establishment had recovered and reinforced its claims on public property.
Their aim was to create a critical mass of private enterprise to secure the survival of a market economy.
The vast unregulated public property would inevitably entice many top officials into corruption.
High pace required the mass mobilization of people, which would render privatization more equitable as well.
Thus, privatizers saw mass privatization as a way to regularize and speed up privatization, and all postcommunist countries but Hungary, East Germany, and Azerbaijan opted for some mass privatization.

Choices of Privatization

Initially, the eventual scope of privatization was barely discussed. Reformers privatized in accordance with the law of the least resistance, as public property abounded.
Still, a tacit understanding was that Western Europe had a public sector of “normal” size. Some industries caused special problems.
In the Czech Republic, enterprises of emotional national value, which would not be privatized were known as the “family silver”. In Russia, the kernel of the defense industry was excluded from privatization.
In Ukraine, the communists specified thousands of enterprises to be excepted. Natural resources and monopolies were controversial everywhere because people feared they would be sold off too cheaply.
Domestic ownership of agricultural land was treasured by peasants, who feared speculative purchases by absentee landlords. Few opposed the privatization of multiple small and medium-size enterprises and most big manufacturing enterprises.
A standard compromise was to establish a list of industries or enterprises that would not be privatized for the time being.
This discussion led to some broad principles:
- Privatization had to lead to real, clearly defined, private property rights.
- The new owners must effectively control management.
- Economic efficiency should be promoted both within the privatized enterprises and in the economy as a whole.
- Privatization had to be socially acceptable.
The choice of privatization method varied with the nature of the property, political situation, bureaucratic capacity, and prior claims.
The five main alternatives were:
- open sales,
- management or employee buyout,
- mass privatization,
- restitution, or
- bankruptcy and liquidation.
In contrast to the strife over liberalization and macroeconomic stabilization, both reformers and rent seekers aspired to privatization.
The process of privatization has involved many surprises for everybody, and the inability to predict outcomes probably facilitated privatization.

Small-Scale Privatization: If Started, Swiftly Done

The most reformist countries had pioneered limited small-scale privatization of retail shops before the end of communism, and in every country small shops and kiosks were easily privatized, but it was vital to get it done.
Several preconditions had to be in place.
- First of all, the government had to authorize local authorities to privatize small public enterprises because the central government lacked the necessary administrative capacity.
- Second, local governments needed to establish a privatization administration.
- Third, local governments had to decide to sell rather than lease, often persuaded by a financial squeeze.
Usually, small-scale privatization was delayed until these decisions were made, but once the process started it was swiftly completed within two years because everybody realized they had to act fast to seize their share.
Before small-scale privatization, a heated discussion raged about whether shops should be sold at auctions, which liberal economists favored, or cheaply to the employees, preferred by them.
Some auctions took place in many countries, but the bulk of small enterprises was sold cheaply to insiders.
Auctions led to faster structural changes, not least because of fewer liens and residual regulations.After privatization, most problems were caused by local regulations, such as short leases on premises, licenses that must be renewed each year, limited rights to change the profile of a shop, restrictions on the laying off of workers, and dependence on state wholesale trade.
Although these problems arose from the lack of freedom of trade, they were often reinforced by conditional privatization. For years, no difference could be noticed between state shops and privatized shops inMoscow,whereas new private shops looked splendid.
Frequently, even the staff did not know whether their shop had been privatized or not. Yet after small-scale privatization, market forces started biting.
In the region as a whole, hundreds of thousands of small enterprises have been privatized, and the success of small-scale privatization is underscored by the absence of discussion about it.

Large-Scale Privatization: The Biggest Headache

Large-scale privatization was the greatest drama of transition, and it remains controversial.
Here all the political, economic, and technical problems of privatization coalesced.
The questions were as many as they were daunting. Governments had to decide what to privatize and who should do it.
A vast volume of legal acts had to be drafted and adopted by parliaments. Some enterprises were broken up first. The property of each enterprise had to be specified.
Then, enterprises were corporatized, and sales were organized by special privatization committees. Often, privatization vouchers or coupons were distributed. Demand and supply had to be matched.
Frequently, the legal and technical problems became so cumbersome that mass privatization was stalled for years in countries as different as Poland and Ukraine.
The design of large-scale privatization varied significantly between countries that otherwise pursued similar reforms.
Typically, one country opted for one primary method of large-scale privatization but pursued other options in parallel, and failure could abort the initial choice.
Statistics on privatization are amazingly poor.
Sales to outsider owners dominated only in East Germany, Hungary, Bulgaria, and Estonia.
The main alternative, mass privatization with vouchers, prevailed in the Czech Republic, Russia, Latvia, Lithuania, Moldova, Armenia, Georgia, Kazakhstan, and Kyrgyzstan.
Unexpectedly, management-employee buyouts were most prominent in Poland, Slovakia, Romania, and Ukraine.
In Belarus and Turkmenistan, no large-scale privatization took place.
The choice of privatization strategy went through two phases.
- Initially, privatization was an intellectual and idealistic exercise, which gave birth to the many voucher schemes and untold harebrain schemes.
- Next, powerful economic and political interests were mobilized, and privatization became the art of the possible.
The strategies that were the most equitable and the least corrupt emerged first, but over time they were downgraded to the benefit of strategies that accommodated vested interests.
Voucher privatization and international public offerings are, in principle, transparent and involve little administrative discretion. They should generate the least corruption.
Reformers fought primarily over these two options, but neither has become all that significant. Instead, the dominant privatization strategies have been management and employee privatization, spontaneous privatization, and direct sales, which offer no transparency but allow great administrative discretion.
The cleanest form of privatization, liquidation, has played only a minor role, because few understood its charm.
Equity has played some role, promoting voucher privatization and employee privatization as the most equitable forms of privatization.

Initial Public Offerings

In the West, initial public offerings (IPOs), that is, sales of stocks on the stock exchange, have been the standard form of privatization of large companies.
Immediately after Poland had announced that it would privatize, half a dozen of London-based investment banks sent their missionaries to Warsaw to preach the virtues of IPOs, largely at the expense of the UK Know-How Fund.
Many sound arguments favored IPOs. First, it was the most public and transparent form of privatization, with extensive disclosure of information. Second, the privatization would be open both to the public and foreign investors. Third, outside investors would enter with the right incentives and fully entitled to restructure the company. Fourth, the pricing would be done by the market, guaranteeing the maximum revenue for the government. Fifth, corporate governance would be ideal, and IPOs would form the basis for a sound stock exchange.
Yet there were serious objections. First, the required information would not be available for years, delaying privatization. Second, the cost of an IPO was so large that few enterprises could come into question. Third, IPOs could alienate the population because foreign investors were likely to dominate, and they would acquire the stocks cheaply because of the dearth of domestic capital. Fourth, existing stakeholders had no incentive to accept IPOs.
In the first decade, Poland, Hungary, and Estonia undertook a score of IPOs each, but hardly anybody else did. IPOs provided an excellent foundation for the Warsaw Stock Exchange, but they became insignificant for privatization during the first decade of transition. The critics proved right: IPOs were never a feasible option for substantial privatization.

Direct Sales or Investment Tenders

The advantages of direct sales or investment tenders were that one or a few outside owners would acquire dominant ownership and be motivated to restructure enterprises, and they could attract foreign investors.
Through investment tenders, the state could demand substantial investment and reap considerable state revenues. For certain big enterprises in need of a specialized Western owner, this was the only plausible option for survival.
The disadvantages, however, were palpable. Direct sales were not transparent, and investment tenders even less so.
The many conditions that were negotiated with government officials bred maximum administrative discretion and corruption. They were the least equitable privatizations, and they offered no incentives for stakeholders who resisted them.
This was the worst form of formal privatization. All countries have undertaken some direct sales and investment tenders, but they became the primary form of privatization only in East Germany, Hungary, Estonia, and Bulgaria, and they were perceived as successful merely in Hungary, Estonia, and the Czech Republic, the countries with the best public administration.
The East German privatization was presented as an extraordinary success at the time, which must be one of the greatest achievements of government propaganda on record, because the outcome is anything but impressive.
The sales were heavily concentrated to West German companies, signifying a very closed shop.
Among other postcommunist countries, only Estonia followed the East German example, and the unpopular privatization strategy is considered to have contributed to the loss by the Estonian reform government in the 1995 elections .
Looking to the east and south, the results of direct sales and investment tenders have been uninspiring. The state revenues have been insignificant, because these sales were akin to corrupt giveaways to the rich and powerful. Investment commitments were hardly ever substantiated.
When Pavlo Lazarenko was the prime minister of Ukraine in 1996–7, he considered the privatization of large enterprises so sensitive that he took them over himself and privatized many to his own benefit.
In Kazakhstan, major metallurgical assets were sold off to dubious businesspeople in discrete deals.
In Russia, the infamous “loans-for-shares” sales of stocks in a dozen major companies took place in late 1995 after voucher privatization had ended and all other forms of privatization had been blocked.
In particular in Russia, Ukraine, and Kazakhstan, such privatizations coincided with the evolution of large “financial-industrial groups.” Still direct sales were preferable to leaving enterprises with the state.
In the longer term, the economic results of the oligarchic groups improved spectacularly. The economic recovery of Russia, Kazakhstan, and Ukraine was driven by large financial-industrial groups in energy and metals. But the political reaction against the oligarchs rendered their property rights insecure.

Voucher Privatization

Voucher privatization was the pet idea of liberal economists and the chief invention of postcommunism.
It became the dominant form of privatization in the Czech Republic, Russia, Latvia, Lithuania, Moldova, Armenia, Georgia, Kazakhstan, Kyrgyzstan, and initially in Slovakia, but almost all countries issued some vouchers.
Mass privatization through vouchers, distributed to virtually the whole population, was theoretically attractive. It was fast, and it would create a market and an equitable wealth distribution.
The distribution of vouchers alleviated the shortage of domestic demand for property purchases. Because the whole population would benefit, it had great popular potential. Its administration was much less costly and complex than IPOs, since voucher auctions simplified evaluation problems.
However, voucher privatizations were riddled with many practical, administrative, and political problems.
Their main economic disadvantage was that they led to dispersed ownership with ineffective corporate governance.
As a result, people were disappointed, obtaining less than their anticipated share of national property, especially as their expectations had been exaggerated by the reformers’ propaganda about the potential benefits of privatization.
Initially, the new voucher funds in the Czech Republic appeared genial, facilitating investment by ordinary people, but popular enthusiasm evaporated when the head of the biggest voucher fund eloped to the Bahamas with a considerable fortune.
After they had emerged as major owners, they opposed regulation.
In Russia and Ukraine, voucher funds emerged but just faded away, offering no benefit to their many tiny investors.
As no country managed to solve the problem of corporate governance of investment funds, it was probably insolvable.
Even so, voucher privatization made a huge contribution to privatization. Thanks to voucher privatization, two-thirds of many CIS economies were actually privatized.
The alternatives were no privatization or much more corrupt privatization.
The fast mass privatization allowed to restrict the informal privatization
Initially, the Czech Republic excelled with eminent enterprise restructuring thanks to dominant outsider ownership.
In the long run, however, the murky nature of the Czech voucher funds might have hampered the country’s economic development.
Voucher privatization suffered from exaggerated popular expectations, but those expectations facilitated privatization.
It has become commonplace to blame voucher privatization for any unrelated problem, including insider privatization and management theft.
After 1999, however, mass privatization appears to have been the distinguishing feature of the countries with the highest economic growth.
Voucher privatization facilitated the fastest, biggest, and least corrupt privatization at minimal administrative costs.
It was also comparatively equitable, and after some delay, it has facilitated substantial industrial restructuring.
Most important, the resulting property rights are widely accepted as legitimate.

Manager or Employee Privatization

In many countries, managers and employees had such strong claims to state enterprises that nothing but insider privatization was feasible.
The real choice was between giving ownership to insiders and leaving enterprises in nebulous collective ownership while subject to extensive management theft.
Manager or employee privatization dominated in a motley group of Poland, Slovakia, Romania, Ukraine, Tajikistan, and Uzbekistan. Only the Polish privatization was geared toward employees, whereas elsewhere managers took charge.
Insider privatization had three great advantages. It was fast. It created legitimate property rights. Administratively, it was the easiest form of privatization. Otherwise, insiders would block privatization whenever they could.
Some argued that management-employee buyouts could enhance efficiency because the incentives for managers and employees would improve.
A drawback was that incumbent managers, who needed to be replaced by outsiders, were entrenched. The insiders had poor incentives to act fast, which was likely to slow down restructuring.
Some of the wealthiest companies in the region underwent insider privatization benefiting their managers. Outstanding examples are Gazprom and the two respected Russian oil companies, Lukoil and Surgut.
These managers were allowed to get away with their booty, because they were not only strong but also considered competent, and they wisely accepted privatization.
Lukoil and Surgut were initially slow to restructure, but they have accelerated.
Curiously, insider privatizations are probably the least criticized major privatizations, and a positive revision of insider privatization is also due on the same lines as the voucher privatization. The resulting property rights are widely respected, although insider privatizations are not at all equitable.

Bankruptcy and Liquidation

Bankruptcy is one of the best forms of privatization, but little studied and poorly understood.
- First, the very threat of bankruptcy imposes a hard budget constraint on enterprises.
- Second, it ousts failing managers.
- Third, it is the most effective and comprehensive means of restructuring of enterprise assets, because all old debts are wiped out. Executors may split up a misconceived company and sell off its assets piecemeal.
- Fourth, a bankrupt enterprise is sold through executive auction, the preferred method of privatization.
- Fifth, bankruptcy improves the competitive environment and levels the playing field because government subsidies to loss-making enterprises are terminated.
- It opens markets captured by subsidized producers and frees up underutilized productive resources.
- Finally, bankruptcy is a complete sale, leaving no residual state equity.
Bankruptcy took time to catch on. Bankruptcies gained early significance in Central Europe and the Baltics. In Poland, liquidation with ensuing sales of the enterprise became a major means of privatization of medium-size firms.
Atypically, Hungary introduced a draconian bankruptcy law with an automatic trigger in 1992, which resulted in an explosion of more than 14,000 bankruptcies that year.
Only Estonia embraced liquidation intentionally as a privatization strategy, and the results have been excellent.
Many other countries introduced bankruptcy laws, but it took a long time before they became effective. In Russia, bankruptcy became significant only with a new Bankruptcy Law in March 1998, the edge of which was reinforced by the financial crash of August 1998. Bankruptcy dealt a devastating blow to the old system.
For bankruptcy to become effective, several related laws had to be in place, a commercial code, a civil code, and some laws regulating debts.
Bankruptcy proceedings were personnel intensive, and they were delayed by understaffed courts.
Finally, bankruptcy produced a credible threat of exit for those who did not pay. Bankruptcy also had drawbacks. One was that it required the usage of courts, which stood out for their malfunctioning and corruption.
Bankruptcy has become a favorite means of corporate raiders in CIS countries, and they may undermine the security of property rights.
Overall, however, bankruptcy was highly useful, and for years it was one of the greatest sins of omission in the postcommunist transformation.

Privatization of Land, Real Estate, and Housing

The ownership of land, real estate, and housing differed greatly in various socialist countries for arcane historical reasons. Nor was their privatization particularly related to other reform policies. Because these privatizations were so peculiar.
Real estate falls into three major categories: agricultural land, commercial real estate, and housing. The efficacy of their privatization depended on the existence of a legitimate form of privatization, and only two forms were perceived as legitimate: restitution to former owners and privatization to tenants.
Restitution was exercised widely in the whole of East-Central Europe, especiallyfor housing and collective farmland, accounting for about three-quarters of all farmland in East Germany, Czechoslovakia, Hungary, Bulgaria, Romania, and the Baltics.
Usually, old land titles had remained on the books and could be restored, and a lot of land and housing soon found legitimate owners. In Czechoslovakia, agricultural land held by collective farms had never been formally socialized, facilitating its restitution.
In 1990, Romania undertook a swift spontaneous land reform by allowing peasants to retake their old land. The other form of legitimate privatization was the transfer of ownership to occupants of agricultural land or housing, which became standard in the CIS, where residents possessed such strong quasi-property rights to their apartments that they claimed them for free.
Little has been as difficult to privatize as commercial real estate. Because communism had not recognized private property, new commercial real estate had been neither properly delineated nor registered.
The various property rights were often distributed among several state organizations in an unwieldy fashion.
The privatization of land and real estate was even more political than other forms of privatization.
It was crucial that privatization took place and resulted in property rights that were respected and could be freely transferred through sales.
When this was not the case, for example, in Russian and Ukrainian agriculture, local magnates with good contacts with the regional governors accumulated hundreds of thousands of hectares. As usual, restrictions benefited the wealthy and well-connected rather than the original landholders, who received a lower price because of liens.
In many countries, it took about a decade to sort out the property rights of commercial real estate and only then a long-delayed construction boom could take off to respond to the pent-up demand for new offices. Even in 2006, a quarter of Warsaw, especially its center, was stagnant and dilapidated because its property rights remained in dispute.
Poland is the only East-Central European country that has never promulgated a law on restitution. The conclusion is that all economic arguments about how to undertake real estate privatization were at best irrelevant but probably harmful because political perceptions were all-important.
Restitution was most effective both in processing privatization and generating legitimate property rights, whereas auctions were rare and unpopular. After privatization, normal land and real estate markets have evolved where governments allowed them. The second best solution was to just let people possess their housing and agricultural land.

New Enterprise Development: The Ultimate Success

This idea was popular. Many Soviet citizens could not imagine that small enterprises could be productive or relevant for economic growth, seeing no point in facilitating their entry even after the end of communism.
A few countries differed. The main exception was Poland, where communists failed to collectivize agriculture, which had remained private. From 1956, Poland and Hungary accepted a revival of small, urban enterprises.
By the early 1980s, these two countries already had a class of self-made, wealthy, private businesspeople, making Poles and Hungarians realize the economic significance of small entrepreneurs and a good business environment. So did the Balts, who cherished a petty bourgeois ideal of peasants, craftsmen, and shopkeepers that represented the normality of the interwar period, when they had enjoyed independence. They lived for E. F. Schumacher’s slogan “small is beautiful,” and they wanted to revive their old beautiful world of smallness.
Over time, the understanding of the need for small enterprises grew, but two very different perspectives on how to promote small entrepreneurship took hold.
The radical reformers