Tales from two privatizations: Russia and the former East Germany.

• Author: Thomas, Scott
• Position: Privatization: Political and Economic Challenges

Introduction: Microeconomic Analysis

The transition from a centrally planned to a market economy currently taking place in Eastern Europe and the former Soviet Union is complex and difficult to understand, both for individuals actively involved with the local changes and for those viewing it from the outside. The scale of the problems faced by the governments of countries in transition is often underestimated by policymakers who raise expectations of economic growth in short time periods. Statistics based on macroeconomic data often show that transition results, especially in privatization of industry, are rapidly approaching levels of Western economies. However, "hands-on" microeconomic information illustrates the persistent underlying problems of economic transition.

Macroeconomic statistics can present a picture of overall economic success while concealing failures in large segments of the economy as many individual companies continue to struggle with the transition. Macroeconomic information makes intercountry comparisons difficult for several reasons, including the limited reliability of data, both historic and current. The historical, demographic and geographic differences among the countries of Eastern Europe and the former Soviet Union are as vast as the differences among the approaches used to undertake the economic reforms. Diverse backgrounds and approaches within Russia, where the collapse of central control has spawned a large number of independent regional and local authorities, further complicates macroeconomic analysis. For these reasons, analysis of individual privatization cases can be used to identify problems of the transition and pin-point the progress of and limits to economic reform.

Almost seven years after the beginning of the Eastern European privatization, a large number of macroeconomic statistics are now being evaluated to determine the level of success of the transition from planned to market economies. Gross national product, unemployment, real wages, foreign investment and cost of living indices show a wide range of results from the various privatization programs throughout the former planned economies.

Two of the most diverse examples of privatization are Russia and the former East Germany. In both cases, macro statistics show a picture of progress towards a market economy. However, after five years of working on the microeconomic level with companies in both countries, it is apparent to me that privatization policy shortcomings overlooked by ministries in Moscow and Berlin persist in both countries.

From the following cases, four key factors for success in privatization can be identified. Two macroeconomic factors stand out from my work as playing a vital role in economic transition: 1) maintaining a stable economic and legal system and 1) patience and support from the West. However, the focus of this paper will be on the two microeconomic factors: 1) general management skills and adaptation to Western business practices as well as 2) accountability and an understanding of the importance of accurate financial information.

The Economic Transition: Macroeconomic Context

In 1989, East Germany's communist government quickly disappeared. Similar to the Wirtschaftswunder (economic miracle) in West Germany after the Second World War, the instant economic and political transition facilitated by funds of almost $700 billion occurred without significant internal resistance. (1) This high level of investment in East Germany is often neglected when comparing privatization results. Other factors were at least as important as the massive transfer of funds. Perhaps most significant of these was the adoption of a stable constitution and legal system. Federal subsidies to companies ranging from environmental clean-up to funding depleted pension accounts helped make investment palatable to Western firms. For individual companies, a clearly defined set of business rules and legal stability, from contracts to tax law, were also very important.

Method of Privatization Characteristics Purchase Contract Company acquisition, often with investment and employment guarantees. Over 10,000 successfully completed in East Germany. Management Buy-out Former East German management acquire the company, often with federal assistance. Almost 3,000 privatizations. East Germany Return of Expropriation Return of the actual company or restitution for expropriation by Nazi, Soviet, or East German government. Communalization Return to local communities, including schools, apartments and sports facilities. Liquidation The closing of over 3,000 companies deemed not salvageable. Voucher Division of ownership through shares, primarily given to employees. Open Incorporation Full public ownership, with financial reporting requirements. Russia Closed Incorporation Limited stockholder companies, lower foreign investment potential. Communalization Return to local communities, including schools, apartments and sports facilities. Acquisition Company acquisition by unofficial means.

In Russia, real economic reforms began in November 1991 with the appointment of two young economists, Yegor Gaidar and Anatoly Chubais, to President Boris Yeltsin's first cabinet. However, there was no clear support for the earlier reform efforts and no stability. This was underscored by their expectation of holding office only for a few months.(2) Over the next five years the economic transition in Russia made progress, but instability remains a major factor that only time can change. Many of the issues dealt with quickly in Germany have yet to be addressed in Russia. Two macroeconomic factors that still require attention are legal stability and foreign investment security. Most companies in Russia are at a disadvantage compared with those in Eastern Europe for a number of reasons, including a lack of geographic proximity to Western markets and a lack of previous ties to Western partners.

Language and cultural understanding also play an important but less tangible role in successful privatizations and the transition to develop market-driven companies. Less than 10 percent of the 12,000 companies that the German...