What went wrong with Russian privatisation?

[Shann Turnbull <sturnbull@mba1963.hbs.edu>]

Dear Employee Ownership in Privatization discussion group
(http://cog.kent.edu/grppriv.html)

My view of what went wrong with Russian privatisation (and all others) in
my previous post late last night is compatible with the view of the US
scholars who drafted Russian corporate law.  Refer to: 

Russian Privatization and Corporate Governance: What Went Wrong? 
BERNARD S. BLACK, REINIER KRAAKMAN and ANNA TARASSOVA
Stanford Law School, Harvard University and University of Maryland
Date Posted:September 22, 1999.  
Working Paper Series
The paper can be downloaded without charge from
http://papers.ssrn.com/paper.taf?ABSTRACT_ID=181348

On page 64 the authors state:
"But they and we were all wrong.  As with many religious beliefs, the faith
that any private owner was better than the state as owner rested on an
unexamined premise  - that a country has the will and the infrastructure to
control managerial discretion manifested through overt self-dealing."

The authors quote Andrei Shleifer and Robert Vishny, key Western advisers
on Russian privatisation, who said in 1998 "Privatisation works because it
controls political discretion".

Both statements quoted above re-enforce my analysis that a division of
power WITHIN all firms is required to provide checks and balances and that
power needs to be meaningfully shared with the customers, employees and
suppliers to provide countervailing power to management but also to the
State by introducing and embedding democracy at the stakeholder level of
each individual firm.

In this way the need "that a country has the will" with its regulators, to
control management is minimised by building self-regulation into the
corporate architecture of the firm as described in the paper I presented at
conference organised last year by Bernie Black titled 'Corporate Charters
with competitive advantages'
http://papers.ssrn.com/paper.taf?ABSTRACT_ID=10570  forthcoming, St. Johns
Law Review, Winter, 2000.  Refer also to 'Competitiveness with
Self-Regulation' http://papers.ssrn.com/paper.taf?ABSTRACT_ID=45321 and
'Corporate Governance Reform: Improving Competitiveness and
Self-Regulation'  http://papers.ssrn.com/paper.taf?ABSTRACT_ID=41383

The narrow and US ethnocentric view of the theory of the firm and corporate
governance of Shleifer & Vishny is discussed in my survey of corporate
governance which critiques their survey. Refer to
http://cog.kent.edu/lib/turnbull4.html  The need for a division of power in
all employee owned firms was identified in 1980 by US Scholar Paul
Bernstein in his book 'Workplace Democratization: Its Internal Dynamics' as
described in my 951 word article "Employee Governance"
http://cog.kent.edu/lib/turnbull3.html  

Black, Kraakman & Tarassova support my introductory statement to the
discussion group on September 21 archived at
http://cog.kent.edu/archives/eopriv/msg00006.html refer to item:

"4. There is no theoretical basis to support the view that privatisation is
more efficient than stakeholder ownership and control and there are
arguments to the contrary.  (Refer to my article on 'Stakeholder
Cooperation' " http://papers.ssrn.com/sol3/paper.taf?ABSTRACT_ID=26238   )

My papers cite the 1992 report for The Council on Competitiveness by
Michael Porter. He found evidence in Japan and Germany to support his
recommendations on pages 16 & 17 to corporations, institutional investors
and government policy makers that both ownership and control be shared with
employees, customers, suppliers and host community.  So not only could
stakeholder governance control "overt self-dealing" by management but it
could also increase competitiveness.  See also my 'Corporate Charter' paper
and 'Stakeholder Governance' http://cog.kent.edu/lib/turnbull6/turnbull6.html

Regards 

Shann

At 11:11 PM 2/11/1999 , you wrote:
>To solicit an answer to the question raised by the last posting I am
>sharing a copy of this post with Jeffrey Sachs who I invited last month to
>participate in the COG discussion at http://cog.kent.edu/
>
>Let me explain from my own perspective why all privatisations are flawed,
>not just those in Russia.  It is for the reason noted by Sachs that
>"Philosophers have long noted that power corrupts".  All privatisations are
>based on the Anglo system of corporate governance where control is
>concentrated in a unitary board.  Directors of a unitary board have
>absolute power to manage their own conflicts of interest.  They posses the
>power to corrupt both themselves and the performance of their business.  
>
>The adverse consequences of the flawed Anglo system of corporate governance
>is held in check in mature market economies which have developed a web of
>external checks and balances.  The intrinsic flaws of the Anglo system has
>been hidden by the ethnocentricity of US scholarship in the theory of the
>firm and the past ignorance of US scholars of alternative self-enforcing
>systems of corporate governance described in my survey of corporate
>governance listed at http://cog.kent.edu/lib/turnbull4.html  
>
>As a result, the UK government has had to introduce special regulators to
>supervise their privatisations but this did not stop directors paying
>excessive salaries. The solution is to introduce divided power WITHIN
>privatised firms to introduce internal checks and balances.  Competing
>centers of power can be established by involving different stakeholder
>constituencies as discussed in my articles such as 'Stakeholder governance'
>http://cog.kent.edu/lib/turnbull6/turnbull6.html and 'Stakeholder
>Cooperation' http://papers.ssrn.com/sol3/paper.taf?ABSTRACT_ID=26238  Ways
>in which elements of self-governance can be introduced to public sector
>firms without privatisation are set out in: 'Best Practice in the
>Governance of GBEs', in The Australian Public Sector: Pathways to Change in
>the 1990s', ed. J. Guthrie, pp. 99-109, IIR Pty. Limited, Sydney, 1995.
>
>Regards
>
>Shann
>
>
>At 05:22 PM 2/11/1999 , you wrote:
>>That made interesting reading. It would be nice to know why the author
>>feels that the approach of mass privatisations in Russia was flawed. Many
>>developing countries which have huge state enterprisesis are being advised
>>to go in for mass privatisations to repay govt. debt and bring autonomy and
>>benefits of privatisation for the growth of such enterprises.
>>
>>Umesh Gala
>>
>>12:18 01/11/99 -0500, you wrote:
>>>Central European Economic Review
>>>October 25, 1999      
>>>Lessons of Transition
>>>A reform architect looks at what worked --  and what didn't
>>>By JEFFREY  SACHS  
>>>--Mr. Sachs is director of the Center for International Development  at
>>>Harvard University. He was one of the architects of Poland's economic
>>>reforms, and subsequently served as an adviser to many governments in the
>>>region, including Estonia, Kyrgyzstan, Mongolia, Russia, Slovenia and
>>>Ukraine.   
>>>
>>>Once, when Chinese Communist leader Zhou En-lai was asked whether the
>>>French Revolution had been a success or failure, he replied, "It's too
>>>early to say." Ten years after the fall of the Berlin Wall and eight years
>>>after the collapse of the Soviet Union, it's perhaps too early to assess
>>>the social transformations in Central Europe and the former Soviet Union.
>>>Yet, with weeks remaining until the new millennium, and many key choices
>>>facing the West in policies toward Central Europe, the Balkans, and Russia,
>>> it's important to learn what we can from the drama of the past decade.  
>>>
>>>There certainly have been surprises. Poland -- everybody's "basket case"
>>>of 1989 -- proved to be the most durable and dynamic reformer. Poland's
>>>economic growth easily outshines all of the other transition economies. By
>>>contrast, the Czech Republic, which was everybody's favorite for a smooth
>>>transition, finds itself mired in recession and controversy. Yugoslavia
>>>exploded, and the rest of the Balkans remains embattled in economic
>>>difficulties. The Baltic States, especially Estonia, outpaced the rest of
>>>the former Soviet Union as expected, but the transition has proven more
>>>difficult than predicted. And Russia has perplexed us all. It failed to
>>>fall into utter chaos, as predicted by the gloomy Sovietologists. But it
>>>has also stubbornly refused to become a "normal" country, as hoped for by
>>>reform-minded economists like me. We thought the end of communism would
>>>bring a quicker social rejuvenation in Russia, though I always argued that
>>>the path would be tough and that Russia would need considerable help from
>>>the West.    
>>>  
>>>In other words, optimists and pessimists can find evidence to support
>>>their past predictions, but both have been surprised in one way or another.
>>> This kaleidoscope of success and failure nonetheless offers some general
>>>lessons:  
>>>
>>>Markets work, but require a solid legal framework to function well. The
>>>end of price controls and the floating of exchange rates at the start of
>>>economic reforms succeeded in ending chronic shortages and bringing
>>>long-absent goods to the market. Quick liberalization unleashed the
>>>beneficial forces of supply and demand, but speedy privatization didn't
>>>have a similar effect. When privatization was rushed through via mass
>>>voucher schemes -- as in Czechoslovakia in 1991, Russia in 1993, and much
>>>of the rest of the former Soviet Union after that -- the result was usually
>>> corrupt asset grabs, managerial plunder of enterprises, and paralysis at
>>>the firm level. It didn't unleash the beneficial effects of private
>>>ownership.  
>>>
>>>Civil society is critical to successful transformation. Philosophers  have
>>>long noted that power corrupts. Even when governments begin with good
>>>intentions, they often become corrupted, if power is left unchecked. Sure,
>>>constitutions can provide some modest checks, but civil society -- with
>>>associations of professions, religions and regions -- must provide the
>>>deeper balance. Stalin was no fool: He kept his grip on power largely by
>>>murdering and dispersing every manifestation of civil society. In Poland,
>>>some vestiges of a civil society survived. (Stalin once complained that
>>>putting communism in Poland was like putting a saddle on a cow.) The Roman
>>>Catholic Church and the Solidarity movement deserve much credit for the
>>>success of Poland's reforms, even though they often opposed many specific
>>>policy proposals. In Russia, where civil society was dead, the government
>>>acted with impunity and the results have been tragic.  
>>>
>>>Geography influences the pace and depth of transformation. Ironically,  the
>>>single most important factor determining success has proven to be the
>>>reform country's distance from Frankfurt. The closer the country is to
>>>European Union markets, the more successful and dynamic the transformation.
>>> States bordering the EU, such as Poland, Hungary, the Czech Republic,
>>>Slovakia, Slovenia, Croatia and the Baltic States, have done much better at
>>> attracting foreign direct investment, expanding exports and generally
>>>achieving a successful transformation. Farther away, some of the Balkan
>>>States are doing downright poorly. And the non-Baltic former Soviet Union
>>>is in worse shape still.  
>>>
>>>History casts a long shadow in social life. 1989 was supposed to be a
>>>fresh start, the awakening from a nightmare. But we must be honest; 1989
>>>also awakened ancient antipathies and mythologies that had been repressed
>>>in the Communist era. Who would have thought that in the late 20th century
>>>Serbian mythologies over the Battle of Kosovo of 1389 could galvanize a
>>>population behind the murderous cynicism of Slobodan Milosevic? History
>>>conditions different societies to expect different things of their leaders.
>>> In Russia, society expects little and gets less. In Poland, much more was
>>>expected -- and demanded -- of the post-1989 leaders, and much more was
>>>obtained in good governance.  
>>>
>>>Initial conditions matter in economic restructuring. During the 1990s,
>>>glib comparisons between countries flew a mile a minute, without taking
>>>into account vast underlying differences in economic structures.
>>>Comparisons were often drawn between Russia and China, even though only 20%
>>> of the Chinese work force was in state-owned enterprises while the Russian
>>> figure exceeded 90%. Neither country smoothly solved the problem of
>>>reforming the state-owned behemoths, but China didn't have to; it could
>>>rely on its vast nonstate sector -- with hundreds of millions of workers --
>>> to carry forward the reforms. Similarly, the chaos in Poland in the 1980s
>>>helped to create the basis for rapid growth in the 1990s. By the time the
>>>reforms began, the Poles had effectively smashed the stultifying hand of
>>>central planning. By contrast, central planning was still very much intact
>>>in Czechoslovakia until the Velvet Revolution in November 1989. As a
>>>result, the Czech Republic and Slovakia are much more burdened by
>>>unprofitable state enterprises today.  
>>>
>>>Western actions make a huge difference, but have consistently fallen
>>>short. Perhaps the most damaging view in the West has been the persistent
>>>feeling that the success or failure of transition was none of our business.
>>> The glib optimists held that reform would be its own reward; simply
>>>introduce markets and all will work out well, they said. The pessimists
>>>maintained that no matter what we did, the situation would be terrible in
>>>the transition economies for a generation to come, so why waste the money
>>>and effort? These rationalizations of inaction proved tragically wrong.
>>>When the West helped -- as with canceling Poland's debts or giving Poland a
>>> special fund to stabilize the currency -- the results repaid the efforts
>>>many times over. When help was withheld, such as when Yugoslavia appealed
>>>for a rollover of foreign debts in 1990 only to be rebuffed by finance
>>>officials in Europe, the inaction contributed to catastrophe. Ultimately,
>>>history will judge the EU, the U.S., and the International Monetary Fund.
>>>But overall, the slogan of the decade should be: "You pretend to reform,
>>>and we will pretend to help you." The EU has delayed membership of the
>>>countries of Central Europe for much too long. The EU and the U.S. were too
>>> cheap and too narrow-minded to provide Russia with adequate financial help
>>> in the early days of reform. And their Balkan policies have been a
>>>decade-long study of neglect, missed timing, and inadequate response.  
>>>
>>>On a more personal note, my watchwords as an economic adviser to the
>>>region were: Go for quick internal reforms, seek ample international
>>>assistance, pay attention to morality, and insist on transparency in the
>>>actions of all parties. This formula got a lot right, and in the places
>>>where it was actually applied -- in Poland, Estonia, or Slovenia -- the
>>>results have been salutary. But I was too optimistic about the
>>>possibilities of mass privatization, an approach that I now think was
>>>flawed. In the case of Russia, I repeatedly warned that reforms were going
>>>off the rails. I even resigned from advising Moscow nearly six years ago,
>>>and issued a strong public warning against Russian corruption and Western
>>>inattention. Sadly, that particular forecast has proven correct.  
>>>
>>>Somehow, though, Russia's fragile democracy still survives, and could
>>>provide a base on which to build. We can only hope that in the early years
>>>of the next century, the new Russian and U.S. presidents will find the
>>>wisdom and energy to fulfill the hopes of the democratic revolutions of a
>>>decade ago.  
>>>
>>>*******
>>>--
>>>Dan Bell
>>>International Program Coordinator
>>>Ohio Employee Ownership Center
>>>Kent State University
>>>Kent, OH 44242
>>>(330) 672-3028
>>>(330) 672-4063 fax
>>>dbell@kent.edu
>>>http://www.kent.edu/oeoc/
>>>
>>>
>>
>
>Shann Turnbull
>P.O. Box 266 Woollahra, Sydney, Australia, 1350
>Phone: 02 9328 7466 office; 02 9327 8487 home
>Fax: 02 9327 1497 home & office.  Mobile 0418 222 378
>Outside Australia, replace first "0" with "61" after international access code
>Life long E-mail: sturnbull@mba1963.hbs.edu
>http://www.mpx.com.au/~sturnbull/index.html
>

Shann Turnbull
P.O. Box 266 Woollahra, Sydney, Australia, 1350
Phone: 02 9328 7466 office; 02 9327 8487 home
Fax: 02 9327 1497 home & office.  Mobile 0418 222 378
Outside Australia, replace first "0" with "61" after international access code
Life long E-mail: sturnbull@mba1963.hbs.edu
http://www.mpx.com.au/~sturnbull/index.html