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CID Archive: Publications Archive: HIID Papers

"Privatization and Corruption in Transition Economies"

Daniel Kaufmann and Paul Siegelbaum


Summary

The formalization of privatization as a reform strategy was forced on the transition economies by the simple fact that social, political and legal/fiduciary controls had collapsed in the wake of the Soviet Union’s break-up. The theft of assets effectively started, in fact, a few years before communism fell. Following the break-up, the State’s assets were being stolen by enterprise managers, politicians and bureaucrats at an intolerable rate and, for most countries, the only alternative to sanctioning wholesale theft was to make the process somewhat more transparent and participatory and to try and direct these assets to other hands — in pursuit of socially and economically more positive goals.

This paper analyzes how different privatization paths (whether formalized or not) may have affected the incidence of corruption. The analytical framework discussing the determinants in this link draws from the contract theory and property rights literature. Given the weaknesses in the system of legal and cultural fiduciary controls, we posit that, during the transition, corruption will be related to the scope of control rights over economic activity in the hands of politicians and bureaucrats. When the rights to cash flows from privatized assets can be impaired through the exercise of control rights in the hands of politicians and bureaucrats, the opportunity for extracting rents through the collection of bribes arises.

This "control rights" framework is applied to a detailed discussion of the link between privatization and corruption during the unprecedented transition that these countries have faced. We first review what impact different privatization strategies had on control rights of politicians and bureaucrats over privatization transactions — as a direct source of corruption. We then analyze the impact of privatization on post-privatization economy-wide corruption, assessing what control rights were diminished or enhanced by different approaches to privatization. In this situation, in addition to government control rights that continue to exist in relation to specific enterprises (corporate governance), we assess what impact privatization has on government control rights over public finances and licenses sought after by enterprises.

From this framework, a number of specific factors emerge to analyze each of these two situations. Where privatization program implementation is the focus, the following are emphasized: speed, the level of administrative discretion employed, transparency and access to information, and whether or not the program is administered by a government agency differing from the one which previously owned the assets in question. Applying these factors to the most common methods of privatization points to voucher-based mass privatization and liquidation as the least corruption-prone implementation methods. In contrast, management-employee buyouts and spontaneous privatization are highly conducive to corruption in their implementation, principally due to their slow pace, high levels of discretion and lack of transparency. Initial public offerings and tenders and trade sales fall between the two extremes, with the disadvantages of slow speed of implementation balanced against the advantages of transparency and independent administration.

The same framework was then applied to post-transaction corruption stemming from different privatization structures. In terms of control rights over enterprise governance, we suggested that liquidation, with its reshuffling of the ownership links and complete severing of residual state connections, is the most favored method, followed by voucher-based mass privatization and initial public offerings. The latter two methods suffer from the common failure to sell the state’s entire interest at one time. Tenders and trade sales would score far better, but for the common practice of applying residual legal obligations for the state to monitor and enforce over time. Ignoring its obvious ethical failings, spontaneous privatization evaluates relatively well on a number of criteria (relevant for post-privatization), with the dramatic -- and significant -- exception of the fundamental corruption evident in its very existence, as well as the incidence of lingering obligations to politicians and bureaucrats which many spontaneously-privatized enterprises inherit as the price of official tolerance. Finally, management-employee buyouts are seen as the most conducive to long-term corruption.

An important conclusion that emerges from the analysis and evidence is that from a corruption standpoint, taking into considerations all other characteristics of the transition, privatization -- with all its inadequacies -- is preferable to its absence. While the survey of experts we carried out suggests that overall privatization does not have a good reputation in CEE/FSU, these same experts point out that the incidence of corruption is, or would be, larger without privatization, and that corruption is more prevalent in non-privatized sectors. Similarly, we present complementary evidence which is suggestive in terms of extralegal and unofficial activities being more prevalent in CEE/FSU settings that have privatized less. Further, we present incipient evidence pointing to a positive association between privatization and some hardening of the budget constraint (i.e., less discretionary public handouts or tax exemptions, as well as between privatization and market liberalization (i.e., less discretionary licenses in the hands of politicians and bureaucrats). Since the reduction of control rights by politicians and bureaucrats over public finance and licenses to enterprises are key for the reduction of corruption, this evidence is consistent with the analytical framework we have presented.

From the analysis and emerging evidence, practical implications emerge. First, the notion that transition economies are already fully in the post-privatization stage needs to be revisited; privatization in the transition economies, while unprecedented in its scope so far, is far from over. Given the magnitude of the holdings that still remain in the hands of the state, a faster and simpler second stage of privatization initiatives and programs ought to be implemented. Where politically feasible, recapturing some of the daring early days of mass privatization programs in some countries may be warranted. Suitably adapted with the lessons learnt, speedy privatization of remaining state interests is likely to reap substantial benefits compared with the alternatives. In this context, the outright cancellation of residual state ownership in partially privatized enterprises could be considered as well.

Our framework of government control rights and depoliticization does not suggest any kinder dispensation for sectors other than the enterprise sector, not yet subject to serious privatization efforts. To the contrary, in some countries in the region corruption has in large part been fueled by the lack of privatization in agriculture and in parts of the energy sector, where the old nomenklatura has continued to benefit from large handouts, kickbacks, and huge monopoly rents. Excessive gradualism, coupled with the vested interests of the old nomenklatura in this area, have extracted a heavy toll for these economies — inter alia, in terms of corruption. Thus, a bolder and transparent approach to privatize land and agricultural assets is needed.

In a bolder privatization program to complete the process, the next phases can be designed to minimize the potential for corruption. Experience in the first five years of privatization indicates the desirability of speedy mass privatization techniques, resulting in full transfer of the interests sold, without special deals for insiders and without attaching lingering investment or employment obligations. For those enterprises in the worst shape financially, liquidation should be the preferred alternative. International tenders and trade sales should be reserved only for the most obviously attractive candidates, where international interest and independent administration and monitoring of the sales is likely, while MEBOs should be avoided. Where possible, branch ministries and other ex-owners should be excluded from the process, to sever the old control rights relationships, and replaced by specialized agencies supplemented with expatriate technical assistance.


Published in the Journal of International Affairs, Vol. 50, No. 2 (Columbia University).

 

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