Privatization and corruption in transition economies.

• Author: Kaufmann, Daniel
• Position: Privatization: Political and Economic Challenges

"If you think privatization is corrupt, try without it."

--Anonymous official, in response to the Ukrainian parliament's decision to halt the privatization program on the grounds of possible corrupt methods (1994)

Introduction and Initial Conditions

Background

The scale of privatization now underway in the transition economies of the former Soviet Union (FSU) and Central and Eastern Europe (CEE) is historically unprecedented. During the decade of the 1980s, about 6,000 firms were privatized throughout the world. During the first half of the 1990s, in contrast, well over 50,000 medium- and large-scale enterprises have been privatized in these transition economies--almost 10 times the number in half the time. Furthermore, these figures do not include hundreds of thousands of small-scale enterprises also privatized in the CEE/FSU region during the period--over 75,000 in Russia, 35,000 in Ukraine and 22,000 in the Czech Republic.(2)

The perception has emerged, in parallel with this historic ownership transfer, that corruption has reached endemic levels in the transition economies of the FSU and CEE alone.(3) While empirical evidence is naturally elusive for such activities, some micro-surveys as well as anecdotal evidence--much of it widely reported in the freer press--is suggestive.(4) Moreover, empirical evidence now exists tracing the evolution of the unofficial component of the transition economies.(5) For the FSU, the share of the unofficial economy's contribution to the overall economy (unreported value added as a percentage of GDP) is estimated to have increased almost three-fold over the 1989-1994 period, from 12 percent to 33 percent. Although overall output has contracted sharply during the transition, the unofficial economy has grown significantly, in absolute as well as real terms. While the increase in its share in the CEE countries was smaller, the overall share of the unofficial economy there still exceeds 20 percent.(6) By comparison, similar measures for industrialized countries suggest that in most countries the share of the unofficial economy in GDP is in the single digits or teens.

It is reasonable to assume some positive correlation between the relative magnitude of the unofficial economy and corruption in a country, considering the practical necessity of obtaining informal support from government officials for these unreported activities. For example, an enterprise survey of 200 firms in Ukraine and Russia indicates that firms that significantly underreport their activities have also had to make higher extra-legal payments than those that underreport less.(7)

Against this background, it is not surprising that privatization and corruption have been perceived as closely linked in the FSU and CEE economies.(8) For these countries, privatization, in its many forms and variations, places a substantial share of the entire wealth of the economy "on the table" for sale or transfer from state to private interests. At the same time, the fiduciary controls that ordinarily operate to ensure that government transactions are fair and transparent have been largely crippled.(9)

In this article we examine the relationship between corruption and privatization. Without privatization, the transition economies had no real hope of climbing out of the bankruptcy into which they had been placed by the central planners, with their politically-inspired, monumentally inefficient allocation of resources.(10) At the same time, there is a growing consensus today that corruption has negative effects on the costs of doing business, on aggregate investment, and on growth.(11) Is corruption the inevitable price to be paid for privatization? Where the transition continues, as it must, does broad-based privatization result in greater corruption than where privatization is delayed, partial or absent? Can privatization programs be designed to lessen the corruption that occurs during their implementation? Looking past the transactions themselves, can privatization--even if corrupt in its implementation--ameliorate corruption in the post-privatization era?

Given the rudimentary nature of the literature in this area, the lack of empirical data and the relative youth of the transition, this effort should be seen as a first investigation, and by no means conclusive on the topic. Further work in this area will be needed before the issues we address here are settled. Yet the analytical approach to the links between privatization and corruption we take here, complemented by a review of the initial evidence we have gathered, do suggest certain insights that challenge conventionally held beliefs on the links between privatization and corruption. Further, in this paper we suggest a methodological approach that can be used by analysts and practitioners to assess the factors increasing or ameliorating corruption during the privatization process and in its aftermath.

Initial Conditions: Post-Soviet Corruption and Spontaneous Privatization

We define corruption to be, simply, the abuse of official power for private gain. We circumscribe the meaning of private gain to significant financial payoff (or equivalence in kind), and do not address related issues of patronage.(12) In the main, our definition encompasses two categories: the misappropriation of wealth for the benefit of a government official and the extraction of rents--whether in the form of bribes, kickbacks or special "favors"--from private entities.

The conditions prevailing in the FSU and CEE in the period immediately before and after the breakdown of the socialist system created an ideal medium for the growth of "monetary" corruption. For many countries in the region, the origins of this situation reach back to czarist Russia, whose officials were generally considered to be pervasively corrupt at all levels.(13) During the socialist era, the currency of corruption shifted, although not its prevalence, as the socialist central planners emphasized large-scale industrial investment at the expense of the production of consumer goods. This shift, together with the relative scarcity of cash and hard currency, limited opportunities for cash bribes.(14) Instead, mid-level bureaucrats had to be content to vie for preferred access to scarce, low quality consumer goods and perks, such as access to dacha houses on the outskirts of the capital, better schools, vacations in sanatoriums and "study tours" abroad. Further, instead of cash corruption, many transactions were in the form of patronage for jobs in public enterprises and thereby related to political power and favoritism rather than large bribes or kickbacks. While patronage was rampant, blatant forms of corruption were somewhat held in check by the discipline of the Communist Party, draconian anti-bribery laws and the rigidity of the overall system itself.

At the outset of the transition, with the emergence of more cash, hard currency and Western consumer goods, the basis for more traditional forms of corruption was fully reestablished. At the same time, political chaos and the demise of the Party removed the main external constraints to rent-seeking behavior on the part of the managers of state enterprises and other government officials. Perestroika, with its encouragement of parallel, profit-oriented activities on the part of state-owned enterprises, had placed those enterprises on the path of independent profiteering at the expense of the state. The legal system was--and in many countries still is--often inadequate to address even elementary notions of private property ownership, individual commercial autonomy or the necessary limitations on the authority and discretion of government officials. In those cases where appropriate legislation has been enacted, the means to enforce these new rules of law--courts, trained judges, lawyers and the entire legal infrastructure--is lacking.

The transition from the exploitation of power and access to goods and special perks to the unchecked appropriation of wealth for private use was facilitated by the previous regime's philosophical insistence that capitalism and the free market were lawless and corrupt at their core. Being thrust into the free market as inadvertent capitalists, many bureaucrats and citizens felt no cultural imperative to discourage the unbridled pursuit of wealth by any means.(15)

It was against this background that the issue of privatization arose. In fact, there was no considered decision to privatize by democratically weighing the pluses and minuses and carefully formulating an efficient strategy. The decision was thrust upon these new countries' leaders by the breakdown of the discipline of the old system and the absence of new institutions to replace it. Well before any formal privatization strategies were approved and implemented, a particularly corrupt form of "spontaneous privatization" was taking place informally through the blatant theft of state assets and diversion of revenues from state enterprises by their managers.(16) The reformists in government, who understood that privatization was crucial to a successful transition to the market, saw early on the dangers of wholesale spontaneous privatization. They anticipated that such activities would give enormous political power to the old nomenklatura who opposed rapid reforms and enterprise restructuring, and they feared a popular political backlash would stall, if not reverse, the privatization process, or even reform itself.(17)

In the remaining sections of this article, we discuss, first, the factors that determined the privatization strategies now being employed in the FSU and CEE, and we provide a brief description of each strategy; We then identify the transactional characteristics that can be hypothesized to result in more or less corruption in the implementation of privatization strategies. An analysis of how various privatization strategies might contribute to less corruption in the...