Article For The Independent

18 October 1996

Privatising Russia

Roger Kerr

PRIVATISING RUSSIA

Since abandoning communism, Russia has given the general impression of lurching from political crisis to crisis, of foundering efforts to shift to a free-market economy in the face of resistance by entrenched industry interests, and of repeatedly teetering on the brink of a return to centralised and authoritarian forms of government.

Much of this picture is true enough: politics in Russia has been - and remains - turbulent and unpredictable, and the resistance to change is real. Yet it would be wrong to underestimate the amount of economic reform that has somehow been achieved despite all the difficulties. I came away from a recent visit to Russia impressed by the progress that has been made in five short years.

Russia is now a relatively open economy, with tariff levels on many goods not too different from our own. Price control has been removed from most goods. There is no longer a black market exchange rate, and exchange controls look set to go in the next year or two. Inflation has been tamed, and the budget deficit, though high, is coming down. Government spending is quite low compared to most western countries, though many government services are admittedly in a truly awful condition. The tax system is also in disarray.

Perhaps the single most important economic development in Russia has been the mass privatisation programme that took place between 1992 and 1994. It was a programme which occurred with extraordinary speed: in less than two years, two-thirds of all Russian industry was shifted into private hands.

The programme was conducted in a very different manner from New Zealand's own privatisation programme. New Zealand followed the textbook approach. With few exceptions, each business was first readied for sale, then sold by open tender to the highest bidder. Such an approach not only maximised revenue to the taxpayer but also placed the business in the hands of an owner most likely to manage it efficiently.

The Russian privatisation programme faced a rather different - and more urgent - set of constraints and imperatives. The economic reformers had to deal with industries consisting of grossly inefficient firms, a culture where the norms of market behaviour were lacking and would have to be acquired through practice, and an instinctive resistance to privatisation by the workers and managers of the state businesses.

Many analysts - both Russian and western - argued that in the circumstances privatisation should be slow and deliberate. Companies should first be restructured under government ownership, the basic legal framework of a market economy should be put in place, and only then should asset sales proceed. Yet such an approach would soon have run aground for lack of political support, or at best taken decades to achieve since thousands of firms were involved. During this time the benefits of privatisation would have been long delayed.

According to the Russian economist and leading reformer Maxim Boycko, the team that won the debate on privatisation and drove the programme shared three basic beliefs. First, they believed Russians were fundamentally no different from other people, in that they would respond rationally to economic incentives. Despite Russia's long history of collectivism, they held the view that if ordinary Russians were given the chance to become investors and pursue profits, they would do so in large numbers.

Secondly, the reformers recognised that the basic cause of economic inefficiency had been the politicisation of economic life. Russian firms were run for the benefit of their political bosses and the managers and workers in the plants. Consumers were entirely secondary.

Thus the principal goal of the privatisation programme was to depoliticise economic life - to substitute market control for political control. This was not a task that could be delayed. Nor could the task of privatisation be left in the hands of the politicians and ministries themselves: they were part of the problem, not the solution.

Thirdly, the reformers recognised that the Russian government was not the de facto owner of its assets in the way that most western governments are legally and in practice the undisputed owners of state businesses. In Russia, substantial control of enterprises was exercised by managers, workers and local governments, to the extent that the decision to privatise could not be taken without their implicit consent.

These considerations strongly influenced the form taken by the Russian privatisation programme. If the timetable were not to stretch out endlessly, the political opposition from the stakeholders in each firm needed to be neutralised by allowing them to retain a large degree of ownership. While this strategy might appear neither efficient nor equitable to a westerner, there was no other realistic alternative if large numbers of assets were to be shifted rapidly to the private sector.

But the privatisation programme also needed the support of the wider public. For that reason, it was decided that privatisation needed to include some form of public share giveaway. This would make the programme a genuinely populist one. In the end, vouchers were chosen as the mechanism for involving the general public: every Russian was given the opportunity to pick up a voucher allocation for a nominal fee.

The standard procedure was for a privatised firm to offer 29 percent of its shares for vouchers in open tenders. While many firms would have preferred to allocate these shares to stakeholders, a presidential decree meant most firms came into line with the government's intentions. Meanwhile, the vouchers were becoming the first liquid security in modern Russia. They were bought by street entrepreneurs, then sold on regional exchanges to investors amassing large blocks.

Some people sold their vouchers for cash. Others used them to buy shares in their own company. Some joined private voucher investment funds. Still others bid for shares directly in voucher auctions. There were big swings in the price of vouchers, largely reflecting the ebb and flow of political developments.

The number of voucher auctions rapidly accelerated: soon up to 1000 firms were holding auctions each month. In the last frenetic month of the programme almost 3000 firms were sold, including many of the largest in Russia. In all, over 14,000 firms were privatised through voucher auctions, involving almost 18 million workers.

In these last months, voucher auctions were on everyone's lips. There was heavy television advertising by the voucher funds, and the word privatizatsiya was ubiquitous. A pop song with the unlikely title of 'Wow, wow, voucher!' even reached number five on the Russian hit parade. (When our own PPTA joins former Russian comrades in singing that tune we will know that the education millennium has arrived.)

Not all voucher auctions went off equally well. Sometimes firms managed to rig the procedures so that their stakeholders were advantaged even more than usual. And some of the regions with communist governments, as well as some regions whose ethnic sensibilities made them suspicious of things Russian, were much slower to embrace privatisation.

Nonetheless, privatisation was an outstanding success. One of the chief reformers, Anatoly Chubais, commented that the 20-month programme was the first such major national exercise since the 1917 revolution to finish on schedule, and to accomplish more than it had promised.

Russians proved that they were far from uninterested in the mechanisms of capitalism. Workers and managers mostly took the opportunity to acquire shares in their company. Ninety-eight percent of Russians were not too cynical to claim their voucher entitlement. Few regarded it as worthless, and Russia now has more private shareholders than the whole of Western Europe.

As a result of the privatisation programme, the ownership structure of Russian firms has been massively altered for the better. Instead of being controlled by politicians, two-thirds of Russian industry is now owned by interests that have a far greater incentive than formerly to maximise profits through producing goods consumers wish to buy. And while corporate governance structures are certainly not perfect, the pressure of competition is inevitably leading to some rationalisation of ownership structures. Corporate restructuring and the introduction of western joint venture partners into the privatised firms is now proceeding.

Moreover, the privatisation programme has helped to create a class of people who have a direct stake in a liberal economic order, and who can be expected to press for that order to be preserved and extended. The new capitalists have an incentive to see the strengthening of sound commercial law - so important to an economy based on contract.

This constituency also has every reason to press for liberalisation elsewhere in the Russian economy. There are still sectors which are badly lagging in the reform programme. Chief among them is agriculture where the collectivist ethic has remained strong - a phenomenon not unfamiliar to New Zealanders.

The gradualist approach to agricultural reform has seen collective farms remaining largely unrestructured and still in state hands. Despite its vast land area, Russia faced major food shortages in 1991/92 and had to be bailed out by the West. Previously it managed to feed itself because the tiny percentage of private plots were tolerated through sheer necessity. Land reform - meaning privatisation - is now one of the government's top priorities.

Despite the success of the privatisation programme, there is no room for false optimism about Russia. The country still faces a huge challenge in making the transformation into a society based on respect for the rule of law - a cultural trait rarely prominent at any stage of Russian history.

Law-breaking is ubiquitous, and organised crime a common feature of the commercial landscape. Commercial laws themselves are mostly not bad, but enforcement is extremely poor. Corruption is a major problem, and the communist regime left behind a legacy of income differentials that are among the widest in the world.

There is no guarantee that the next few years will see Russia moving down the path of a strengthened civic culture and market economy. A coup is still possible in Russia. Alternatively, the traditional Latin American model of lawlessness, excessive politicisation of economic life, economic stagnation and wide income disparities may still be Russia's future.

Nonetheless, some cautious optimism is justified. Economic liberalisation in Russia - as everywhere - changes the dynamics of the political game. The more people come to see themselves as having a stake in a market economy and in a democratic and liberal society, the greater the pressure to continue to evolve in that direction.