Privatization: a case study in corruption.

• Author: Celarier, Michelle
• Position: Privatization: Political and Economic Challenges

The current era of privatization, conceived and begun by Britain's Thatcher government, was borne of a political movement opposed to statism. For over a decade, privatization has been a critical ingredient of the free market agenda that assumed the private sector would create more efficient companies than the government. Not surprisingly, the potential for corruption in privatization was ignored in the ideological zeal of the times and, for a variety of political and economic reasons, has continued to be downplayed in the very countries where it is so rampant. Now, however, a surge in corruption in many, if not all, of the privatization programs in the developing economies of countries like Russia and the former Soviet satellites has forced the issue to the forefront.

The high costs of corruption are both economic and political. Unscrupulous privatizations have cost countries such as Russia, India and Mexico billions of dollars in bailouts and other state-absorbed losses, which have contributed to inflation and have slowed, if not halted, on-going economic transformation. Communists and extreme nationalists around the world exploit the rampant corruption in their countries to win converts and attempt to unseat governments. In the end, corruption in privatization threatens to undermine the very market economics that privatization programs were designed to promote.

To illustrate the issues raised by corruption in privatization, this essay will first address some of the reasons why privatization is so susceptible to corruption, then look at a variety of countries--including Russia and the former communist bloc countries, along with India and Mexico--to show some of the corrosive economic effects of corruption in privatization and the political dangers accompanying it.

One of the biggest problems developing countries face is pressure from multilateral institutions, such as the International Monetary Fund (IMF) and the World Bank, to privatize as part of their market transformation and as a prerequisite for financial support, long before they have the independent regulatory, legal or judicial framework in place to effectively stop corruption. Only after serious problems surfaced in countries such as Mexico and Russia have multilateral institutions finally begun to recognize that these structural reforms are critical to the economic transformation to capitalism.(1)

The absence of governmental regulatory systems makes the privatization process a hotbed for corruption. Because state enterprises do not practice the same type of rigorous commercial accounting and valuation of assets as do private companies, transforming their books to meet the standards of the marketplace--where the value of assets is likely to decline when competition is introduced--is always a complicated process that leaves great room for interpretation.(2) This difficulty in determining the market value of state assets creates a margin that can easily be filled by bribes.

Moreover, even if governments engage in a competitive bidding process for the sale of their assets, as is often required by the multilateral institutions, bids are generally confidential, and the power to make the final decision usually lies in the hands of an individual minister.(3) Thus, the rules are only as good as the political environment in which they exist. Countries with a long history of corrupt governments will also be likely to engage in corrupt privatizations.

To compound the problem, in many instances, even those countries where anti-corruption laws exist, deeply ingrained customs legitimize practices such as bribe-taking or insider dealing. Pakistan, for example, has anti-bribery laws, but they are routinely ignored. Before the recent fall of the government of Benazir Bhutto on corruption charges, World Bank consultants reported being stymied in their attempt to bring competitive bidding practices to the country, because paying bribes was seen as an extension of the tradition of giving presents to tribal chiefs to "make sure things get done."(4)

Nowhere has the success of privatization been of greater importance to the world community than in the former communist countries of Eastern and Central Europe and the former Soviet Union, especially Russia. Certainly corruption predated modern Russia's free-market system, reaching epic proportions during the Brezhnev regime, which many historians point to as a critical juncture in communism's demise.(5) Rather than mitigating corrupt practices, the fall of the Soviet bloc--and the free enterprise that came with it--opened the floodgates to a new wave of graft, making corruption in privatization in the former communist countries the rule rather than the exception.

The problem dates back to the first sales of state assets in Hungary, a country whose decades of "goulash communism," a quasi-mixed economy, seemed to make it a perfect candidate for privatization. Even under the communist government, laws enacted in 1989 gave company managers the authority to sell state assets and foreigners the right to purchase them. The combination led to a boom in unregulated and largely unscrupulous privatizations and a public outcry that the nomenklatura, the communist elite who controlled the nation's assets, were the main beneficiaries of the capitalist revolution.

In one notorious case, the managers of Apisz, a stationery retailer, created a shell company in which they were the majority shareholders, then transferred 80 percent of the company's assets there before selling the holding company to a foreign buyer, leaving the state with the remaining unprofitable assets and a load of debt. Though only a small deal, it was so distasteful that even the Hungarians' foreign banker, Citibank, walked out on it. At least a dozen such deals created huge losses for the state while lining the pockets of the companies' nomenklatura managers, before a public outcry stopped them.(6)

The economic hardships that accompanied the transition to capitalism were difficult enough for the populace to tolerate, but the abuses of privatization created further ammunition for communists who still clung to the belief that free enterprise was theft, allowing them to regain power in Poland and Hungary. In a 1992 speech before the Sejm, the Polish parliament, one of the country's many prime ministers, Jan Olszewski, expressed the backlash most eloquently: "We've learned that the invisible hand of the market is the hand of the swindler, garnering funds from the public trust."(7)

The fragile democracies of the former Soviet empire were advised by...