The Centre for Research into Post-Communist Economies


Transition: Privatisation and Private Property

A CRCE Seminar Briefing

26 June 2001

Survey of the Issues

The abysmal failure of communism showed in the annual rise in inventories of between 10 and 20 per cent and in a considerable proportion of production capacity standing idle, not being capable of producing anything needed. In spite of huge investment amounting to between 30 and 40 per cent of GDP, useful growth was low � if �growth� is the right word. It would appear that workers� wages in Poland are three times lower than in 1940, while in Austria they have risen three to four-fold.

The results were somewhat better in Slovenia (the part of Yugoslavia not engulfed by war) but even there stocks accumulated and enormous investment yielded poor results. The Slovene wages at present are perhaps 10 to 20 per cent higher than before the war, i.e. than in 1940, but are considered excessive for economic equilibrium. Workers� self-management in a quasi-market framework functioned better than central planning, but the results were poor nonetheless.

In other words, neither central planning nor self-management provided consistency in the economy, let alone an optimum. Dynamism, the growth of productivity, was entirely absent.

Prescription for transition
Transition was meant to remedy all these problems. In 1989, when the economic failure of communism became clear for all to see, the generally accepted prescription called for markets, private property and entrepreneurship. Yet the initial concern everywhere was with macroeconomics. In fact, communist economies needed inflation to work at all, since unsaleable inventories and non-performing investment could not be financed otherwise. In most transition countries, inflation has been reduced to about 10 per cent. Some economists claim that this is all that is needed because this reduction allegedly imposed a hard budget constraint on �enterprises�. But although the governments have taken over overwhelmingly bad debts in order to help the banks, the banks continue to accumulate non-performing loans because of political pressure to sustain loss-making enterprises.

Even if enterprises succeeded in making both ends meet, however, this improvement would simply mean that such enterprises are performing more or less normally at the previous very low level. Since in order to achieve this result it will presumably be necessary to dismiss workers, there is an urgent need to launch new enterprises. One also hopes that efficient new investment in old enterprises would take place. Reforms should be leading to �restructuring�: closure of enterprises working at persistent losses, streamlining of output in accordance with demand, and � last but not least � development of new enterprises to absorb unemployment and better investment to improve productivity. The last two tasks are eminently a matter for �entrepreneurs�.

Entrepreneurial function
According to Schumpeter, entrepreneurs discover new goods to produce, produce goods in newly-invented ways, and seek new markets. On this basis, they have to organise production and distribution at prices which best cover their costs. Since such decisions must necessarily be made for the future, they are taken under conditions of uncertainty and involve risk. There is no way of telling in advance whether a decision is �correct� � no control or supervision is possible since observers know as little as entrepreneurs, and possibly much less. The only proof of �correct� decisions comes later, and consists of an excess of prices over costs.

Here is where �private ownership of the means of production� has the clear advantage over the alternatives. Entrepreneurs who make mistakes lose part of their property and finally all of it. In contrast, their production and their wealth expand if their decisions are right. In addition, entrepreneurs put pressure on each other to improve overall performance through competition. The markets and competition force decision-makers towards consistency, optimality and dynamics.

Transition to private ownership
The re-introduction of private ownership of the means of production is difficult, but it is vital in order to achieve the development of entrepreneurship. Yet many politicians and economists closed their eyes to this problem, either because they have never understood how a successful economy works, or because they wish the problem would simply disappear � a consequence of their dislike of private property. Let us not forget that communism and left-wing ideology in general condemned private ownership of the means of production and that, on the whole, people are receptive to this stance because they envy those who have more property than themselves.

So far, three ways of allocating property have emerged, which indeed may be the only ways:

1) distribution to all and sundry;

2) sale of property;

3) redistribution of property to previous owners.

General distribution
This method is generally known as voucher privatisation, which means that minimal shares of various enterprises are distributed according to some kind of formula, to all members of a community. People accept these shares with pleasure � as small as they may be, they represent manna from heaven.

Of course, this distribution contributes little to successful decision-making. The supposed owners have other work to do, so that they participate in various votes under passing influences. In the end, it is not a disaster if they lose their easily-acquired share provided they can find another job when �their� enterprise fails.

The results of this proprietary �innovation� is that, in most cases, the old communist managers remain in place. Such managers were not all bad, but most were apparatchiks appointed by the Party for their loyalty, rather than for their business acumen. Besides, they are agents � i.e. they act on behalf of others � so that on the whole their aims are not the aims of the owners. These managers want high pay and possibly important-looking offices. All these features are familiar in big corporations all over the world, wherever �governance� is separated from ownership. The situation is nevertheless much more difficult in transition countries because ownership is much more dispersed and the managers were chosen by politicians in the first place.

To make matters worse, newly-promoted shareholders are almost invariably advised to deposit their shares into investment funds which are supposed to look after their interests. Thus another layer of people who act for others is inserted, resulting in a double agency structure.

Large corporations with a more concentrated ownership of shares and with huge economies of scale are known to function in all parts of the world, mostly successfully, but in transition countries the same governance structure is often imposed on small enterprises where it leads to waste. Slovenia has, taking account of population differences, apparently 50 times more public limited companies [soci�t�s par actions] than the Netherlands. And in view of dispersed ownership, such companies function much as they did under self-management.

Other countries have often not even bothered to establish public limited companies, but simply informally introduced some kind of workers� self-management. Furthermore, some shares (in Slovenia up to 60 per cent of them) ended up in government hands via various pension, development and indemnity funds. What with many sorts of managers of the old school, the economies of transition countries are run by old hands in the same old way.

Sale of enterprises
A sale is not really privatisation at all � it simply means that the government gives up one form of capital in exchange for another. The question then arises as to what it does with the proceeds.

Sales to domestic buyers are always suspect because it is far from clear where buyers could have obtained the money required to purchase the company. If they borrow, there is always the suspicion of political interference in banks and, hence, corruption. Moreover, if a loan is procured through political means the borrower knows that there will be more of the same available from the same source, and hence will not behave with the same caution as a normal private borrower.

If foreigners buy, the whole operation is simply investment by foreigners and, as has been pointed out, the question arises as to what the government will do with the proceeds of the sale. It is also worth asking whether money coming from foreign countries is perhaps money that the communist party salted away abroad when the collapse of communism became imminent.

The proper use of the proceeds of sales to foreigners would be investment, but naturally not government investment, since this is precisely the kind of action the whole transition is supposed to avoid. A very welcome possibility seems to be the practice of lending of such funds to budding entrepreneurs starting new small enterprises. Since domestic banks cannot be entrusted with allocating loans, this activity should be an taken on by the European Bank for Reconstruction and Development, which is set to start micro-lending operations in a few places in Eastern Europe. (See �Development Bank Finds Grassroots Lending Lucrative� by Tom Buerkle, International Herald Tribune, 24 April 2001, p. 15, copy attached). Domestic proceeds of sales would have to be distributed by an international bank for two reasons: danger of political interference, coupled with a complete lack of knowledge about evaluating projects submitted for financing in former communist countries.

A frequent respectable suggestion is that the proceeds of state capital sales should be used to reduce government debt. But if the conditions of lending do not require immediate repayment, it is more advantageous to use the available capital for micro-lending or, indeed, for paying compensation to dispossessed previous owners. Both should normally produce earnings higher than interest rates.

Micro-lending would help to establish small and medium-size enterprises, which in turn would exert competitive pressure on companies created through voucher privatisation (many of which will, by necessity, survive for some time), hence encouraging better performance � assuming, of course, that free entry into the market is maintained.

Return to original owners � the sole genuine privatisation
As described, the general distribution of vouchers or shares does not foster entrepreneurship. Although much better, the lending or micro-lending by banks necessarily makes the selection of recipients of loans a matter for bank personnel. The restitution of property to its previous owners or their families is the sole means of re-establishing normality. Property returns to the hands of those who have acquired (earned) or preserved it by means of economic activity, which is the criterion justifying ownership from an economic point of view.

Because of the long period of communist dispossession, property in the main will mostly pass to heirs of original owners. The usual criticism is that they may not be the best candidates for entrepreneurship. Who knows that they are not, and who else is supposed to be better prepared or more talented? Under normal conditions, inheritance is accepted as the way in which property passes from the deceased to survivors, and it does not seem to work all that badly.

At any rate, at least a part of the country�s wealth will not be hopelessly dispersed after restitution , but will pass from the government (party) into the hands of independent persons. The share of wealth in the hands of independent individuals would be much larger if compound interest was calculated and paid at the time of restitution or payment of compensation. If we assume that about 10 per cent of a transition country�s wealth is expected to be restituted and that the compound interest of 5 per cent for the appropriate period of 40-50 years is the original amount multiplied by ten, practically the entire wealth of a country should be given to the original owners. It would hardly be acceptable to the voters, however, if such a solution were introduced, although it might be deemed to be just.

The discrepancy has arisen because the communist investment was so incredibly inefficient. If net investment over the years was 10 to 20 percent, the present wealth should be higher than it is. But then the urgency to end the communist regime would not be so great.

The persons entitled to restitution find themselves, as owners of a plant, in the same situation as the original owners. They can act swiftly (unless the government prevents them through �regulation�) and bear responsibility for their own actions. If they act with care and interest and possess talent and knowledge, they will prosper and bestow prosperity on their customers. If not, they will go out of business.

This is, in fact, the aim pursued by transition.

Of course, such people may also use their compensation, if that is what they have received, to buy existing enterprises, or � if there are no viable enterprises since the communist decisions were so inefficient � they should be able to purchase equipment from failed enterprises and start new ventures. Furthermore, they can lend their assets to other entrepreneurs (the selection will be theirs) or deposit it with a bank they trust (possibly a micro-lending bank).

Resistance against restitution
All that has been said sounds logical and promising, but the communists and their friends will not have it. Resistence is based on the well-known communist doctrine of the abolition of private property, and the experience of communist leaders that keeping property in state hands equips them with the absolute power which they crave

From the very beginning of transition, the communists have opposed the restitution of property. In so far as it was decreed in spite of their opposition, they are ready to change the law retrospectively. They are trying to prevent physical restitution since this method takes real assets out the hands of their comrades. It also requires compensation. This enables them to claims that the taxpayers have to strain to pay the previous owners, whereas in fact they only strain in order to pay for property which is occupied by communists � the very people who have thus far managed it so badly. The communist judges (one should not forget that communist judges are still in situ) interpret the existing restitution acts in ways which can hardly be believed.

All in all, the communists despise law since the will of the party is supposed to be supreme. In accordance with this attitude, they despise property as they certainly do not understand its economic function. If circumstances force them to accept private property (even Lenin did so under NEP) they try to make property rights as precarious as possible. This is how Alasdair Palmer describes Chinese communist �capitalism�:

It is also important to remember that China is not a Western-style capitalist country, and it shows no sign of turning into one. The legal system does not entrench the right to private property, quite the contrary. The law, such as it is in China. makes no concession to private property. Although the party would probably be physically unable to take back the assets and businesses now controlled by private individuals, it retains the legal authority all communist states give themselves to do exactly that � that is why the party is able to confiscate the possessions of anyone it does not like. And it does so on a regular basis. (The Times, 7 January 2001).

Even small and medium-size enterprises are hated by communists because they cannot be fully controlled. So private enterprises have to pay taxes on the spot, while large enterprises can be subsidised by delayed tax payments. Large enterprises also delay payments of debts to small enterprises, as frequently does the government itself, which can become lethal for the latter, especially as the courts work in a communist way. Finally, banks may refuse loans to private enterprises.

Under the circumstances, one can hardly expect much private initiative and economic prosperity as long as communists are dominant or even influential in governments, since they are posed to prevent what, in the end, makes countries (including transition countries) prosperous.

Proper solutions for the problems of transition are clearly formulated in the Resolution 1096 adopted in 1996 by the Parliamentary Assembly of the Council of Europe.

Its Article 10 reads in part:

Furthermore, the Assembly advises that property ... which was illegally or unjustly seized by the State, nationalised, confiscated or otherwise expropriated during the reign of communist totalitarian systems in principle be restituted to its original owners in integrum ... In cases where this is not possible, just material compensation should be awarded.

Further, Article 11 welcomes lustration and decommunisation laws, explaining:

The aim of these measures is to exclude persons from exercising government power if they cannot be trusted to exercise it in compliance with democratic principles, as they have shown no commitment to, or belief in them in the past ...

The message is clear and in line with sober analysis of the situation, if the aim is for transition countries to succeed and join the West in prosperity and freedom. Yet the Western countries, as always, vacillate and glory in being soft on the communists, allowing them to live on and strike again.

Further reading

Criticism of Self-Management Still Relevant by Ljubo Sirc, CRCE, 1994.

A Liberating Economic Journey: Post-Communist Transition, Essays in Honour of Ljubo Sirc, edited by Andrzej Brzeski and Jan Winiecki, CRCE, 2000.

Ljubo Sirc CBE
Centre for Research into Post-Communist Economies
57 Tufton Street
London SW1P 3QL
May 2001