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Frankfurter

Institut für

Transformationsstudien

Jörg Glombowski

PRIVATISATION IN FORMAL MODELS

OF TRANSITION

No. 6/02

Jörg GLOMBOWSKI

Privatisation in Formal Models of Transition

Prof. Dr. Jörg Glombowski is professor for economic theory and deputy speaker of the graduate college European Integration and Societal Change at the University of Osnabrück. In Summer 2002, he worked as a visiting scholar at the Frankfurt Institute for Transformation Studies.

Privatisation in Formal Models of Transition

1. Various approaches to the relationship between privatisation and transition

In almost all accounts of the transition process, privatisation is considered to be a crucial element of structural reforms. However, the notion of privatisation is ambiguous. Sometimes its meaning refers to all forms of creating private enterprises, including newly established private firms. Sometimes it is used in a rather formal juridical sense to indicate the substitution of state property by private forms of property of any kind, often followed by a classification of those forms and their specific incentive structures. Sometimes it is defined in a more specific or restricted sense, i.e. including restructuring and the implementation of modern forms of management as essentials. Very often the notion is not even defined and it is left to the reader to find out, what exactly is meant.

In formal models of the transition process, it will help to have a closer look at the assumptions which are made with regard to the objective functions of privatised enterprises, the form of markets they are supposed to operate in, the way wages are determined, and the role the state is assumed to play in the process of privatisation and further market regulations. The remainder of the paper focuses attention on a limited number of theoretical positions with regard to privatisation.

First, we deal with the position the issue of privatisation takes in the influential transition analyses of the World Bank (1996), the EBRD (2000) or the IMF (2000). Here, privatisation figures as one of a small number of key variables indicating reforms. A combination of indicators for reforms and economic stabilisation serves as a predictor for economic performance.

Secondly, we discuss a model by Chadha et al. (1993) who basically identify privatisation and transition by describing transition as a process in which the private sector gains an ever larger share of the economy at the cost of the state sector. Their focus lies on the different labour markets operating in these sectors and the incentives they provide for employees to move from the state to the private sector.

Thirdly, we have a closer look at a politico-economic theory of privatisation (Boycko et al. 1996) in which politicians are assumed to prefer state enterprises to private enterprises for political reasons, even if they operate inefficiently. According to this theory, restructuring and efficiency gains are directly linked to privatisation since after privatisation it becomes more costly for politicians to make privatised enterprises pursue their political goals related to re-election chances (e.g. high employment).

2 F.I.T. Discussion Paper 6/02

Fourthly, we discuss authors like Blanchard (1997) who see privatisation as a two-step process, in which we have a formal change of ownership first (e.g. creating joint-stock companies and establishing small-scale insider ownership), which is not accompanied by restructuring, which, however, may follow later on if ownership shifts to new (outside) owners. Analysis here is focussed on the motives of insiders, who have become the first private owners for instance by mass privatisations, to sell their shares to outside owners who then take on the business of restructuring.

Fifth and finally, we have a look at a model by Roland and Sekkat (2000) in which the career perspectives of state-enterprise managers preparing for positions in the private sector are the main driving force for restructuring, possibly to be used as a vehicle by a government who wishes to push privatisation and restructuring forward.

In a concluding section, the various theoretical positions will be compared and critically assessed. One line of argument will be that the theories are all partial ones, each one abstracting from the clues the others provide. While the approaches all highlight some essential points, they all seem to suffer at the same time from the adoption of neoclassical methodology, i.e. their ahistorical and universalistic perspective - or, to put it differently, their neglect of the specific social differences under which privatisations occur.

2. The ‘conventional wisdom’ of the World Bank (1996)

The international monetary institutions, backed and dominated by the rich Western countries, are very influential, since the credits they give to countries in financial trouble are mostly conditional on the adoption of economic and social policies the institutions judge appropriate. The influence extends the field of economic policy and reaches out to economic theorizing, which is undertaken by their large scientific staffs and forms the background of their policy advices and performance judgements.

In their theorizing pertaining to transition, privatisation plays an important role. There are high-brow and low-brow versions of the theory.1 For this occasion, I think, the consideration of a rough-and-ready version, followed by a number of criticisms, will be sufficient for the purpose at hand.

In the basic account of the transition process, as presented in the World Development Report of 1996 and repeated as well as sophisticated since then, the success of transition is directly linked to the development of a composite index,

1 I acknowledge readily that there are marked differences between various individual authors

affiliated with the organisations under discussion. Yet they seem to form a kind of theoretical continuum and no profound opposition.

J. Glombowski: Privatisation in Formal Models of Transition 3

called the liberalisation index. One of its three components is the degree of privatisation realized. Privatisation is measured as the share in national output produced by companies in private ownership. It is claimed that rising values of this index are empirically linked to better performances with respect to output and price stability. I have tried to argue elsewhere (Glombowski 1999) that this claim is somehow shaky and I will not repeat the whole argument here. I will rather try to show which issues are neglected in the World Bank’s account.

Whenever privatisation is assumed to make a positive contribution to economic efficiency and overall performance of an economy, this clearly cannot be attributed to changes in the form of ownership alone. Greater efficiency is to manifest itself in new methods of production, new and better quality of goods, a concentration on activities in which the enterprises in question have competitive advantages, reduction of costs, new forms of organisation including improved human resource management, marketing and finance. In general, one would suppose that in order to bring these changes about, new managements are needed or at least a considerable amount of retraining and a change of attitudes, incentives and objectives.2 If a state enterprise is privatised in a Western country, the new private owners – very often already existing private firms - will have command over financial funds or will have access to the (international) capital market(s). They will be able to send a couple of their top managers to run the privatised company. Moreover, there is a market for managers in case one needs additional professionals. There may be problems of motivation and changing standard practices, because people who have been working in the state enterprises for long may be unable or unwilling to adapt to new circumstances quickly or at all. Yet, competitive pressures and the profit expectations of shareholders are strong forces heading for change. The state, or rather the political party/ parties in the government, may be committed to privatisation for ideological reasons. On the other hand, it may be forced to sell state property in order to consolidate its budget and unwilling to loose control. While there is no guarantee that privatisation will reach its goals, chances are reasonable that it will work out right.

In former socialist countries, the perspectives for successful privatisations are quite different. There may be underdeveloped capital markets, lack of managers with the appropriate skills and motivation, lack of competitive pressures and a vast range of links with state officials and policies, which make it worthwhile for managers to concentrate on non-economic activities (rent-seeking, lobbying, corruption, support of election campaigns) in order to be successful, rather than to concentrate on economic performance under competitive environments.

2 Havrylishyn/ McGettigan (1999: 10) pose the question “whether it is possible to expect old

dinosaurs to learn new profit-maximizing tricks after privatization, or whether it is better to give up on them”.


The real factors explaining the success or failure of transition therefore seem to lie behind the surface of formal privatisations, which means that rather those relevant factors would have to be used to construct a “liberalisation” index.

It must be admitted that to some degree this need is understood by the international monetary institutions, but the form in which this is done is flawed for various reasons. There are political motives for this as well as reasons related to the economic theory employed. The monetary institutions have to cooperate with governments of their member states, even if they have little confidence in their capabilities or commitments to create Western-style market economies. In particular, they cannot criticize government officials for all kinds of illegal activities or policies favouring certain enterprises by tax exemptions, provision of low-interest credits, granting of favourable contracts, protecting them from legal procedures and the like.3 What they can do is to ask for good public governance and proclaim certain universal standards of government conduct. In doing so, they are more or less obliged to make use of the standard assumptions of traditional state theory, i.e. that the state acts – in principle - to protect and enhance the common social good, representing the will of the people or to behave like a benevolent dictator. Of course, mainstream economic theory has long since adopted the new political economy view of politics, according to which politicians, voters, bureaucrats, parties, pressure groups, unions and governments follow their own individual or collective interests. If one would seriously try to analyse politics and economics in transition countries from this angle, one would find that there is an enormous amount of opportunities to use the new freedoms of private enterprise for all kinds of purposes and actions which run counter to the spirit and rules of fair competition in the market place and proper government behavior.

3. Privatisation and the shift from the state to the private sector (Chadha/ Coricelli/ Krajnyák 1993)

There are quite a lot of two-sector models in the history of economics. The model presented by Chada, Coricelli and Krajnyák (1993, henceforth CCK)) bears some familiarity to two-sector growth models and models discussed in development theory. Its focus, however, lies on transition economies. This motivates the authors’ distinction between a state sector and a private sector. Transition is defined as the time-path leading from an economy with a high share of the state sector to one with

3 The article by Wolf/ Gürgen (2000) is an interesting example for the limits of criticism IMF-

officials have to respect. While it gives a lot of examples for corruption, it does not give names and often it avoids to name the country in which the events took place. It also provides an example of the use of moral appeals when corrupt behaviour seems individually rational under prevailing circumstances.


a low share. Besides ownership, which basically determines the sectors, there are at least four more characteristics in which the sectors differ:

(1) Although both sectors are assumed to produce according to a Cobb-Douglas function4, the sectors show different factor elasticities;

(2) State and private enterprises are in a different situation with respect to the labour market. While private enterprises deal with individual workers and pay efficiency wages, state enterprises face monopoly unions which maximize the utilities of their memberships;

(3) State enterprises are assumed to receive state subsidies, while private enterprises do not;

(4) The initial levels and the time paths of human capitals differ between the sectors.

Both sectors are linked via the labour market and social security provisions: the monopoly union has to take into account the wage rate in the private sector as well as the unemployment rate and the level of unemployment benefits provided by the state, when it determines its utility-maximising level of state sector wages.5 The private employers also have to take the unemployment ratio into account, since it enters the supply curve of the representative worker.6

In the static version – i.e. without accumulation of (human) capital - the model produces a temporary equilibrium (or rather a set of equilibria for different parameter constellations), determining both wage rates and both employment shares, the unemployment ratio, the level of work effort in the private sector as well as the level of government spending on unemployment benefits and subsidies to state enterprises.

4 A production function relates the input of factors of production, e.g. labour and real capital, to the

volume of output. The Cobb-Douglas-function (dating from the 1930ies) is a special but very often used functional form to express this relationship. It entails „constant returns to scale“, i.e. if all inputs are increased by the same percentage, output expands with the same percentage. It allows for factor substitution against each other and implies positive, but declining, additions to output when the input of only one factor is increased while the amounts of the other inputs are held constant. Moreover, it implies that income distribution among factors of production are constant, if factors are rewarded according to their marginal productivities. These constant income shares coincide with the „factor elasticities“.

5 The idea behind “monopoly union” theory is (in the present framework) that members not employed in the state sector will receive either unemployment benefits or find a job in the private sector and earn wages prevailing there. The unemployment ratio determines the chance to become unemployed or find a job in the private sector. Total utility of the membership to be maximised by the union is the sum of wages earned in the state sector plus the incomes obtained by members either by private employment or by collecting unemployment benefits.

6 Efficiency wages theories assume that employees will choose utility-maximising levels of work effort, depending on the relationship between effort (output) and wages offered. In the present context, the authors assume that the threat of getting unemployed will effect this relationship by putting pressure on work effort.


By its very definition, a static solution cannot explain transition as a process. The solution needs to be dynamised and this is achieved by introducing exogenous paths of human capital accumulation. It is the assumption of a faster human capital accumulation in the private sector which creates a solution in which its shares in total output and employment increase, thus producing “transition”.7

As all highly abstract models, the CCK-model is guilty of a bunch of simplifications and implausible specifications of relations. Nevertheless, it has some charm and it even allows one to show under which assumptions transition according to the model will not succeed, i.e. will “derail”.

We will concentrate our discussion on the particular way in which privatisation is embedded in this model. By linking privatisation to a specific sector and specific forms of behaviour, it is economic behaviour and not the juridical status which is of central importance to the model. Two of its aspects deserve positive recognition. The first one is related to the state. The model makes clear that the success of the private sector depends negatively on the amount of favours the state grants to the state sector.8 One can develop this point by modelling the way in which subsidies of state enterprises are financed. If this should be mainly done by taxing the private sector, the latter’s perspective for development seems rather limited. Also a matter of consideration could be the way in which unemployment benefits are paid for.9 The second positive aspect is the recognition of different employer-worker relationships in both sectors, which restricts the profit orientation of state enterprises, while this goal is decisive for private enterprises. However, one may seriously doubt whether the use of two Western-type labour market models (i.e. “monopoly union” and “efficiency wages”) in the framework of a transition model is really adequate for this special economic and political environment.10

The model leaves more to be desired. One point in question is the modelling of the production process. Taking just two different production functions for both sectors does not explain how differences in efficiency between the sectors are supposed to be brought about. Why should state enterprise managers not be able to implement the same type of technology then private sector managers? Moreover, it is strange

7 This is just one of the two possibilities CCK consider. The alternative they discuss basically

comes down to the same thing. 8 Whether the preferential treatment of the state sector can be taken for granted, remains to be

seen. According to Boycko, Shleifer and Vishny, this hypothesis does not seem to apply to Russia, for which case they found: “In its allocation of credits and subsidies, the government evidently did not discriminate between state and privatised firms” (1995: 131).

9 I introduced some payment/finance mechanisms to study the behaviour of the model for a lecture I gave recently at Chemnitz University. This paper is available upon request.

10 While Brainerd (2002) uses a third type of Western model, she applies this to both sectors to test the hypothesis of different parameters for the two sectors.


to have a two-sector model without any inter-industry demand-supply relations.

We can envisage that the development of the private sector could be slowed down by supply restrictions and monopolistic price behaviour of state enterprises or their preferences for dealing with other state enterprises.11

A final weak point seems to be the treatment which capital accumulation is given in the model. While human capital is a variable in the Cobb-Douglas function, physical capital is not taken explicitly into account (so somehow it must show up via its effect on the other factors). This neglect is astonishing, since privatisation entails, as one of its essential elements, the sale of state-owned assets to private owners. So one would be interested in the details of this transfer and the supply of the necessary funds.12 In old fashioned growth theory it is physical capital which serves as a vehicle of technical progress (or restructuring). Therefore, the introduction of physical capital, its wear and tear, its devaluation and accumulation could tell us a lot about the specificity of transition, and it would be interesting to model the differences in capital accumulation and capital productivities between the sectors. Also, the addition to domestic investment by foreign direct investment, possibly associated with some technology and management transfer, would be of interest. The neglect of physical capital is not really compensated for by the introduction of human capital stocks in both production functions, since there is no convincing modelling of their accumulation over time. Here, it would have been interesting to argue why capital accumulation in the private sector should outpace that in the state sector, since it is this very process that is responsible for “transition”. A bunch of other critical questions could be formulated with respect to human capital accumulation: Who is the producer of it? Who finances this accumulation and who are its owners? Is its total to be subdivided into two components belonging the two sectors?

4. A politico-economic theory of privatisation (Boycko/ Shleifer/ Vishny 1995 and 1996)

In this paragraph, we will sketch and discuss a model of privatisation by Boycko, Shleifer and Vishny (1996) – in short BSV - which differs a lot from the previous one. It is microeconomic in character, makes use of cooperative game theory (Nash bargaining solution) and features economic as well as political actors. Although it is

11 An example of such intersectoral relationships would be the dependence of the private sector on

energy supplies provided by the state sector. 12 Of course, we may also have greenfield investments and foreign capital provision. This,

however, stresses the importance of assumptions with respect to real capital accumulation and finance.


applicable to privatisation in other types of countries, the argument focuses mainly on transition countries.

Privatisation basically means three things in BSV’s approach: share ownership is shifted from the state to private owners, control rights are shifted from politicians to managers, and the right to residual profits is transferred from the state to shareholders and (their) managers. BSV are particularly interested in the circumstances under which privatisation leads to restructuring, which is understood as the reduction in the number of employed workers and increases in profits. BSV consider it as an empirical fact that privatised enterprises work more efficiently than state-owned ones, with overemployment being the most relevant variable indicating inefficiency. This slack creates the opportunities for restructuring.

In the general argument, the spectrum of actors is extended and they can be ranked according to their preferences for high employment/disregard of profits or vice versa. So at the one end, we have employees and their unions, followed by ordinary politicians, who feel that their popularity is related to high levels of employment. At the other extreme, we have great outside shareholders, who only care for profits, while managers do so by and large. There are also “reformers”, e.g. Thatcher, Salinas, Klaus, whose preferences are close to those of shareholders and managers, although possibly for different reasons. Finally, there are politicians of a different kind, i.e. the ministers of finance, who differ from ordinary politicians in that they care for incomes from the state-owned enterprises and do not like to subsidise unnecessary employment. In BSV’s formal model we just have two players: a (representative) politician caring for high levels of employment and a (representative) manager mainly interested in profits. They also represent those actors with preferences close to their own ones.

Share ownership is assumed to be divided between the state and private shareholders including managers. The decision rights are either in the hands of the politician (a minister of industry, for example) or the representative manager. The utility functions of the politician and the manager differ basically in that the politician gives a positive weight to excess labour spending while the manager gives a negative weight to overemployment since this reduces profits.

When the decision rights are in the hands of the politician, he does not have to take the manager’s position into account. Yet to him there are not only political benefits but also political costs associated with overemployment. Those costs enter his utility function and are linked to the arguments and fights with the minister of finance, whom he has to convince that he has to give up (part of) the profit the state is entitled to as a shareholder.13 Whenever the political benefits of high employment

13 If the state does not own any shares or only insignificant percentages of the total, there would be

no relevant loss to the budget. But then the state or rather the (spending) politician is not likely to


spending exceed the political costs to the politician, he will engage in spending to stabilise or increase employment.

One could expect that the minister would choose a manager or appoint a bureaucrat to run the firm who shares his preferences. But in BSV’s perspective this possibility is excluded since they hold that managers’ preferences are always dominated by profit motives. The control rights resting in the hands of the politician create a “case” for analysis, in which the manager considers to “bribe” the politician in order to gain permission for restructuring, that is for running the firm efficiently by eliminating overemployment. The “bribe” as such adds to the utility of the politician while the permission for restructuring reduces that part of his utility associated with high employment. The bribe has to be subtracted from the manager’s utility, but it helps raising his (and the treasury’s) profits while reducing the political costs for the politician associated with the finance minister’s opposition. BSV show under which parameter constellations a joint net gain occurs and how it would be divided between the politician and the manager if the solution of their bargaining problem were “Nash”.

BSV argue – with some regret - that bribes are illegal and therefore of restricted use as a vehicle for efficiency. This need not necessarily be the case. We can imagine, for instance, contributions for the politician’s electoral campaigns by “successful” managers, which may overcompensate the political damage to the politician caused by rising unemployment.14

The more interesting case illuminating the problem of restructuring arises when the decision rights are in the hands of the manager. Now it is up to the politician to “bribe” him, although legally, to stick to an unnecessary high level of employment by offering the manager subsidies which compensate the loss to him and the private shareholders for not restructuring. The politician has to “sell” this strategy to the finance minister, who will not only have to tolerate the loss of profit income for the budget, but possibly also have to finance the subsidy, or rather that part of the subsidy which does not come back to the treasury in the form of rising profits/ diminished losses. The accomplishment of this delicate task means deductions from the politician’s utility derived by securing high employment. Once again, BSV employ a Nash bargaining solution to find out whether a utility increasing deal is feasible and how it would look like, or, on the other hand, what the chances are that the deal fails and the manager goes ahead with restructuring. Without going into the details of modelling here, the result is that restructuring becomes more likely the higher the privately owned share of assets is and the higher the political costs of

hold the decision rights. 14 The argument that illegality of an action is sufficient to exclude it from consideration sounds

strange, since in reality we have a lot of illegal behaviour. Other branches of political economy (including contributions by Shleifer) just address this.


incurring budget deficits from income losses and extra expenditures turn out to be.

In the final paragraphs of their paper, BSV relax some of their assumptions in an informal discussion. They allow, for instance, for the possibility that small insider shareholders have less profit oriented preferences than big outside shareholders, which makes restructuring less likely. Also they argue that large outside shareholders like holding companies or funds are less likely to favour restructuring if they are politically influenced. Finally, they relate the opposition of the finance minister to the specific mechanisms by which subsidies are financed. If this is done by budget deficits and inflation, it might be easier for the politician to achieve his political goals. Under a restrictive monetary policy, however, this way-out may be blocked and restructuring enhanced.

It is an attractive feature of the BSV-model to introduce a range of political and economic agents and to show that their utility maximizing interaction can lead to socially suboptimal decisions. It also provides some policy implications, which are more or less in line with mainstream economics in the West, particularly in the USA. The model contains a lot of problematic features as well. Whenever they are modified or additional elements taken into account, the results will be less clear-cut and the simplistic policy advices will loose a lot of their plausibility. I will just give a few examples of what one may object to.

I think, the general claim that private profit maximizing companies always work more efficiently than state–owned ones, is wrong. Empirically, there are quite some examples for companies, in which the state is a relevant owner and also where strong unions exert some influence,15 who do quite well. On the other hand, there are a lot of examples for badly run private companies pressing the state to subsidize them. The politicians may not be responsible for the (management) failures of private enterprises, yet they may still feel that they gain in popularity by subsidies helping to boost private employment. Whether, as a rule, subsidies are offered by the state in exchange for high employment, or whether, as a rule, private companies press the state to provide assistance because they got into trouble remains to be assessed.

BSV present a partial analysis with some unsystematic excursions into macro relations. In a general equilibrium analysis, more consequences of politicians’ actions must be taken into account. Higher unemployment, for instance, produces higher unemployment benefits which have to be financed, at least in an environment in which the market does not miraculously provide full employment.

Subsidising parts of the economy may also be in order if local and regional

15 Some economic theorists of corporatism would argue that big encompassing unions would take

on a macroeconomic viewpoint and would not necessarily block efficiency improvements.


consequences of bankruptcies would be too heavy to bear. Subsidies, moreover, may play an essential role in restructuring if this is seen in a dynamic setting, related to regional and technical development.

Still, the BSV model provides an interesting starting point to develop more refined models, possibly with implications the authors would not like. In our context, the approach is particularly useful for comparisons with other models of privatisation, which are more limited in scope.

5. A two-step theory of privatisation and restructuring (Blanchard 1997, Aghion/ Blanchard 1998)

Blanchard’s theory of post-communist transition (Blanchard 1997) has a fairly broad scope. Just like CCK he develops a two-sector model of transition, in which the labour market and fiscal policy are important elements. On the other hand, he pays special attention to the motives of those actors who are concerned with privatisation and restructuring16, which reminds us of BSV. We will see, however, that Blanchard’s perspective differs from those of the other authors in a number of respects.

Blanchard does not simply identify restructuring with the reduction of excess employment. Restructuring for him is also connected to changes in production programmes and techniques. Even if employment would not be negatively affected by restructuring, some people would loose their jobs i.e. be replaced by others, because they do not fit the new requirements. This is true for workers but also for managers. Consequently, one has to expect some opposition or reservations from the perspective losers. Blanchard also emphasizes the necessity of investments for restructuring. With respect to privatisation, he draws a clear distinction between insider and outsider privatisation. Insiders gain by privatisation, since they become entitled to share in the profits of their firms. But their motivation to raise profits by cutting employment or wages is limited. Moreover, they will not be able to finance investments out of savings and will have problems to obtain outside funding e.g. by bank credit, since the inside owners could always choose to spend profits by rising wages or managerial salaries. Therefore, prospects for restructuring under insider privatisation are doubtful.

Outsiders will be more inclined to invest, to modernize production, to reduce the numbers of workers or to replace incumbent workers and/ or managers by better suited ones. For Blanchard the most relevant question with respect to transition becomes, whether or under which circumstances insiders17 will be willing to sell 16 A simplified version of the resale decisions of workers and managers after initial insider

privatisation is provided by Aghion/ Blanchard 1998. 17 The relevant actors for Blanchard are the workers, not the managers: „Restructuring is a


their shares to (strategic) outside investors, whether individually or by collective action, i.e. under the assumption of collusion.

In modelling this choice, the alternatives open to insiders who will possibly have to leave the firm are either other jobs and the associated wages or unemployment associated with unemployment benefits. Therefore, these variables and the probability of the outcomes enter their decision problem. It is interesting to see that for Blanchard the position of managers is very similar to that of workers and that politicians do not play any active role in preventing restructuring.

It would take too much time to introduce the full model, or rather the series of models, here. So I will just give a rough outline of Blanchard’s “benchmark model” and its results and add some hints at what is added to it in the course of Blanchard’s exposition. There are four different categories of firms, i.e.:

- unrestructured state-owned firms;

- unrestructured insider-owned firms;

- restructured outsider-owned firms;

- new private firms.

New private firms have a higher level of labour productivity, which is assumed to be equal to that realised by outsider-owners after acquiring a majority of shares from insiders and subsequent restructuring. The remaining two types of firms show the old lower labour productivity. The latter are assumed to spend their whole incomes on wages and salaries. When Blanchard talks about two sectors, he actually defines – just like CCK - a modern and a traditional one on the basis of productivity levels achieved, with privatised firms existing in both sectors, i.e. the unrestructured firms controlled by insiders being a part of the traditional sector while the new ones and those taken over from inside-owners by outsiders make up the modern sector.

The new private sector expands employment in proportion to the profits it realizes. The rate of profit depends on private sector wages, which in turn depend on the labour market situation, i.e. the situation of labour demand as measured by the relation of jobs created relative to unemployment.18 With high unemployment the

decision taken by the workers in the firm. It takes place if workers expect to be at least as well off under restructuring as under the status quo” (Blanchard 1997: 107). This means that for the case of direct outsider privatisation the state leaves the decision right to the workers. It is more natural to assume that workers decide on outsider privatisation if they were inside owners before. In Aghion/ Blanchard 1998, managers as inside owners are added to the picture.

18 With respect to the labour market, we find a similar distinction between the state and the private sector as in CCK. Blanchard’s use of the „flow approach“ to the private labour market may be


private sector can afford to pay low wages, making it profitable and able to expand. Without restructuring, employment in the state and insider-owned firms is constant and wages coincide with the low level of productivity, which means that any potential profits are consumed. In both types of unrestructured firms, the decision to hand over firms to restructuring outside investors is taken by the workers. They compare their actual situation (state sector wages and guaranteed employment) with their prospects after restructuring, when most of them will earn private sector wages while others will become unemployed and only receive unemployment benefits. Agreement to hand firms over to outside investors presupposes attractive private sector wages and/ or high unemployment benefits.

The main case of transition sketched by Blanchard starts with a high rate of unemployment and low private-sector wages, which makes a small new-private sector profitable and produces a rise in private employment. The high rate of unemployment makes restructuring initially unattractive for workers in traditional firms. Yet employment growth in the new-private sector will, after a certain time span, push private wages and raise the probability to find a new job there up to the point, where restructuring becomes attractive for workers in traditional firms. Blanchard’s benchmark model then shows a time path in which the expansion of the private sector leads restructuring in the sense that the private sector employs exactly those workers that have to leave restructuring firms. This process keeps on going, with constant rates of unemployment and wages, until transition is completed. The end of the transition period therefore is the end of the traditional low-productivity firms.

If workers own shares in their enterprises as a result of prior privatisation schemes, their choices with respect to restructuring will be modified, because now they will take the prospective dividends from their shares into account or the price an outside investor will offer them with a view to after-reconstruction profits. The perspective of a positive capital income after restructuring will change the balance in favour of restructuring, although this effect may be small. Therefore, mass privatisation as a first privatisation step may positively influence the later chances for outsider privatisation and restructuring as a second step in transition. Also, reasonable unemployment benefits or temporary subsidies to cushion employment decline may have these effects.

According to this simple model, transition is inevitable, though it may take a long time to be accomplished. However, Blanchard also shows that refinements of the model can give rise to various “derailments” originating from the way in which unemployment benefits and their finance are determined.19

considered as a variant of the efficiency wage model. He also operates with a zero profit condition for the state enterprises.

19 I have produced some versions of the CCK-model, combined with elements of Blanchard’s and


Blanchard’s analysis seems to me more appropriate than others discussed here for a number of reasons, e.g. the role real investment is given and the way social security provision is taken into account. On the other hand, it leaves a couple of doubts with respect to its basic pre-conceptions. Consider, for instance, the role workers play in this story. While they are strong in the beginning, they end up weak. How is this change brought about? In the beginning the workers are vested with the right to approve or to dismiss privatisation and restructuring. Whether this is in accordance with facts of life may be doubted, yet it may apply approximately to a transition country like Poland. Such a strong position does not fall like manna from heaven and could be explained by the existence of strong unions, which they acquired during the struggle against the old regime. If workers succeed in securing substantial private ownership titles by certain privatisation schemes due to the political positions of their unions and political allies, it seems unplausible to reduce their later status to that of individual utility maximizers making choices regarding future income streams. Their choices are likely to be collective ones or to be influenced by the stance their unions or their political allies take. Yet unions do not appear in Blanchard’s account, the second stage of privatisation becomes a purely private matter of income maximisation. On the other hand, their were no outside investors in the beginning. Somehow they enter the scene and are invested with superior financial capabilities and abilities to restructure, which neither the state nor the insiders ever seem to have. The same discontinuities apply to the role of managers. While initially they are insiders on the same level as workers, after the second stage of privatisation they turn out to be efficient instruments of outside owners’ interests.

Another critical remarks seems to be in order with respect to quantities involved in workers’ decisions. The number as well as the values of shares workers obtain by privatisation schemes may be too small to be considered crucial in decisions for restructuring and consequent job losses. Compensation schemes in cases of closures or gratifications for voluntary leaves may turn out to be more significant. Here, the relationship with the first point of criticism comes in. Compensation payments for workers will typically not be negotiated individually but be dealt with by collective bargaining or in parliament.

A final remark concerns the property rights of shareholders and workers as stakeholders. If workers or workers’ councils have the legal right to veto privatisation schemes or to decide on the type of privatisations to be effected, it seems implausible to assume (implicitly) that after the second stage of privatisation property rights are exclusively hold by (outside) owners. Workers and their organisations may try to appropriate some property rights in the negotiations, i.e. some representation in the governing boards or some legal regulations against mass

Ruggerone’s (Ruggerone 1996) models, to look into cases in which transition can get stuck. While this subject certainly is interesting, it cannot be pursued her any further.


dismissals etc.

Putting the argument together, one could argue that Blanchard’s analysis depicts workers as behaving irrationally, because they needlessly restrict their activities and range of instruments.20

6. State-enterprise restructuring prior to privatisation (Roland/ Sekkat 2000)

Roland and Sekkat make use of a principal-agent model to discuss whether the existence of a private sector and its demand for managers influences the behaviour of managers in state enterprises, especially with respect to restructuring. They demonstrate, in the framework of a highly stylised model, that the existence of a private sector can induce state managers to engage in restructuring, because it may lead to their staying on in case of privatisation or to attractive job offers elsewhere. Also, the ratchet effect,21 operating to restrict effort in a central planning system with the state as the only party on the demand side in the market for managers, is largely removed by the existence of private competition, which makes it more attractive for state enterprise managers to restructure their firms.

We will not go into the technical details of the modelling, but rather focus on the characterisation of the actors and sketch the main thrust of the modelling and the argument. First of all, we have two kinds of managers in state firms, i.e. “good” and “bad” ones with respect to their capabilities to restructure their enterprises or to run them efficiently. Vis-à-vis the managers we have politicians or rather the government, who set the incentives (salaries) for the managers. Finally, there is the private sector, represented by outside owners, competing with the state sector for managers. Workers do not explicitly appear as actors in the model. There are no privatised firms operated by inside owners, and managers cannot change their type by investing in human capital.

The relationship between the state and the managers of its firms is depicted as a principal-agent relationship. Both types of managers maximize personal utilities by choosing between a high and a low level of effort with respect to restructuring.

Moreover, both are assumed to have identical disutility of effort characteristics. There is a production function relating the results of state enterprises to the capabilities of managers and their chosen effort levels, providing – in principle - four different outcomes. Of course, bad managers choosing the low effort level produce 20 Workers appear as some kind of „Hans im Glück“ (a figure from a German fairy tale), trading

initially highly valued possessions stagewise for lower valued items and ending up with nothing but feeling happy subjectively.

21 The „ratchet effect“ refers to the upward revision of planning goals and norms by the state following upon improvements in production. Anticipating those revised higher goals, managers’ incentives for improvements and restructuring are weakened.


the worst results, while good managers with the high effort level produce the best. A crucial assumption is that good managers are assumed to produce the same intermediate result with low effort as bad managers with high effort.22 The state tries to maximize its income, i.e. profits minus manager salaries. In doing so, it takes the utility-maximizing decisions of managers into account. The state acts under the restriction of full employment for managers. While the state is well-informed about the shares of good and bad managers in the total, it does not posses information about the capabilities of individual managers, i.e. it does not know which manager is a good or a bad one.

The best one-period result the state could obtain would be the one associated with full information. In this case, the state would offer both types of managers salaries equivalent to their disutilities of labour which would be just high enough to induce the high effort level and good performances, i.e. maximum outputs and state incomes.

Under the assumed lack of information, the same first period result with respect to production levels can only be obtained by offering three different levels of remuneration, such that both types of managers would be motivated to do their best. This solution, however, would imply a lower net state income because in order to make the good managers perform best they have to be paid more than the high-effort bad managers.23 Still, this would be the optimal one-period solution to the state under uncertainty about the type of managers.

The extension of the model to two periods brings a significant change. Providing different remunerations for top performance and second-rate performance in the first period would provide the state with the hitherto unknown information about the types of managers at the end of the period (by looking at the results) and enable it to pay only strict equivalents of the disutilities of labour in the second period. The good managers will anticipate from the beginning that their rents would disappear in the second period if they perform with high effort in the first. Under the assumptions of the model they find it utility maximizing to deliver only second-class performance and thus to produce the same results as their less capable colleagues with high effort.24 By doing so, the state will not obtain the information necessary to identify the different types of managers, giving rise to the same results for both periods. The production process would show inefficient results. The state can possibly bring about a better solution than this by offering a higher rent for top performance in the first period, which would compensate good managers sufficiently for the loss of rents in the second period. While production would be efficient,

22 This special assumption is needed in the set up of the model to create uncertainty on behalf of

the government about the type of managers they are dealing with. 23 In other words, the good managers working with high effort obtain a rent due to the lack of

information. 24 Instead of a “separating equilibrium”, we would obtain a “pooling equilibrium”.


overall state income would decrease. Moreover, this solution might be too costly if the share of good managers in the total were too large. The ratchet effect would either trigger low effort by highly capable managers, or it would ask for too high rents to be paid to capable managers in the first period.

The situation changes, when a private sector exists. Now the knowledge about manager types would not enable the state to pay both types of managers only according to their disutility levels associated with high effort: The private sector would be prepared to offer higher rewards to good managers who identified themselves by good first period results. Since the state cannot any longer eliminate rents of those managers in the second period, managers in the private as well as in state firms will exert high effort and will bring about efficient results. According to Roland and Sekkat, their model helps to explain, why we can observe restructuring in state enterprises before their privatisation. Of course, this does not render a substantial measure of privatisation unnecessary, since it is this privatisation which improves the motivation of state managers by giving them alternatives.25

This model provides an interesting application of principal-agent theory. And certainly it addresses a relevant feature of transition economies, i.e. the existence of pre-privatisation restructuring efforts, or restructuring of state enterprises. On the other hand, some of its features appear quite odd.

Let me just make a few remarks about the role of the state to illustrate this point. It is depicted to follow established practices, when net income maximisation is assumed and the state managers’ jobs are guaranteed. But then the assumption of ignorance with respect to the type of managers seems strange: Did the Nomenklatura system produce appointments just by chance? If the state did not learn about the types of managers in the past, why should it be able to do it now?

Somehow, the character of the state must have changed, otherwise we would not have a private sector providing alternative employment opportunities for managers. And we must assume that the state operated as an agent of privatisation, at least to some degree. But why should the state then respect a full-employment restriction for its managers? Why should it not make use of the threat of getting unemployed as a strong incentive to deliver high performances? We have seen that in other models discussed so far, unemployment, at least of workers, was a crucial feature of transition, as it is in reality. In Roland’s and Sekkat’s model it does not show up, which makes one wonder what the origins of productivity gains associated with higher management efforts are supposed to be? Certainly, they are neither related to new techniques requiring real investments, nor to human capital increments, since

25 To be sure, it is both: past privatisation, because this creates competition in the market for

managers, and future privatisation, since this provides the incentive to disclose the private information about the types of managers.


both are absent from the story.

If a reform government, having already paved the ground for a private sector, were committed to the progress of transition, it could eliminate the ratchet problem simply by telling the managers that all their firms would be privatised in due course and that their firms rank high on the list for sale to strategic investors.

7. A critical assessment

When the transition period started, economic theory was not really prepared to present theoretical accounts of the developments to come. However, there was no lack of optimism or confidence with respect to the economists’ abilities to understand what was going on or to provide helpful advices, whether asked for or not. Our little survey can be taken as a demonstration that – in the meantime – economists have developed a range of models to explain the transition process or at least certain key aspects of it. Although they all shed some light on the overall subject, I do not think it is justified to be content with what has been achieved so far.26

The core ingredients of the models presented are all applications of models existing before transition started. The references to the types of models employed (cf. the entries in row 2 of the following table) will prove this. Applying old instruments to new uses, of course, is quite legitimate. But the question comes up whether they are really adequate or sufficient to deal with new situations.

The models presented reproduce the micro-macro divides to be found in most of economic theory and differ a lot in character as to their general or partial approaches. Take, for instance, Roland’s and Sekkat’s application of principal-agent modelling. It is a pure micro model and a very partial one indeed, since almost everything is assumed to be given from the outset, i.e. the abilities of managers, the technical conditions of production, a private sector of a given size, a state with an invariable objective function etc. Quite different in character is the empirical analysis of de Melo, Denizer and Gelb, which is all-encompassing with respect to the circumstances taken into account. Here, however, not much attention is paid to the actors and their motivations, while some of their empirical results seem to be contrived.

Starting from different perspectives as such may cause no harm, since there may

26 Of course, this criticism would only be justified if the small sample could be considered, by and

large, as representative.


exist lines along which the findings can be integrated or islands of theory might be linked. But this becomes difficult if we have to realize that theoretical focuses differ, that there are outright contradictions with respect to basic assumptions about the relevant actors and various political philosophies behind the economic arguments.

My overall impression is that the various approaches are far from painting a coherent theoretical picture. This could be demonstrated in detail with respect to the agents being present - or absent – in the stories and the motives guiding their behaviour. While for Blanchard workers’ choices in state enterprises are crucial for restructuring, BSV and Roland/ Sekkat focus on interactions between the state (politicians) and managers, however, in a completely different settings with quite different assumptions about the figures’ characteristics. In general, differences in the treatment of the state are large. While in Roland/ Sekkat the state tries to achieve efficient production, politicians are the main cause of inefficiency in BSV. In Blanchard and CCK, however, governments are objects of concern and advice, yet no hopeless cases.

All approaches seem to have the basic contention in common that “one size fits all”, i.e. that one theory can account for all the different transition experiences,27 or to put it differently, that the real existing diversity can be reduced to “cases”. Of course, this is in line with mainstream economic thought, but the simplifications come at the cost of neglecting the significance of different historical and cultural backgrounds and the importance of political swings.

27 This methodological point is explicitly stated in BSV 1995 with regard to human motivations

and, in particular, to causes, consequences and necessities of privatisations all over the world. Cf. BSV 1995, 9ff. A much more sceptical position vis-à-vis the explanatory power of pure economics, whether neoclassical or neo-institutionalist, is outlined by Major (1999b).


Worlbank 1996; de Melo/ Denizer/ Gelb 1996

Chadha/ Coricelli/ Krajnyák 1993

context stabilisation, reform politcies

sectoral development in transition

type of model empirical-statistical approach (macro regression analysis)

development economics, two-sectoral models, growth theory, labour market theory

notion of privatisation formal definition according to ownership

identified with restructuring

labour market(s) monopoly union (state sector) versus efficient wages (private sector)

investment dependent on liberalisation emphasis on human capital accumulation

restructuring loosely related to privatisation

consequence of privatisation

role of the state normative perspective, functional account

subsidies, taxes, unemployment benefits, employer

role of managers state sector: stable employment; private sector: profit maximizers


Boycko/ Shleifer/ Vishny 1996

Blanchard 1997 Roland/ Sekkat 2000

privatisation, restructuring and policies

transition incentives and restructuring

new political economy macroeconomic theory, labour market theories

principal-agent models

ownership and right of management

outsider ownership right to select management

political determination of employment

flow theory of labour market

market of manager services

depends on profit, influences productivity

central issue, identical with reduction of employment

necessary for productivity increases

raises profits and manager incomes

“politicians”, “reformers”, finance ministers

social security included in the model

state is principal, tries to maximize its income

identical with profit maximizers

pursue interests of insiders (workers) or big outsiders

two types of managers: good and bad ones; utility maximization; career concerns


References

Aghion, P./ Blanchard, O.J., 1998: On Privatization Methods in Eastern Europe and Their Implications. Economics of Transition 6 (1), 87-99

Blanchard, O., 1997: The Economics of Post-Communist Transition. Oxford: Oxford UP

Boycko, M./ Shleifer, A./ Vishny, R.W., 1995: Privatizing Russia. Cambridge/ London: MIT Press

Boycko, M./ Shleifer, A./ Vishny, R.W., 1996: A Theory of Privatisation. Economic Journal (106), 309-319

Brainerd, E., 2002: Five Years after: the Impact of Mass Privatization on Wages in Russia, 1993-1998. Journal of Comparative Economics (30), 160-190

Chadha, B./ Coricelli, F./ Krajnyák, K., 1993: Economic Restructuring, Unemployment, and Growth in a Transition Economy. IMF Staff Papers 40/93, 744-780

De Melo, M./ Denizer C./ Gelb, A., 1996: Patterns of Transition from Plan to Market. The World Bank Economic Review (10), 397-424

EBRD (European Bank for Reconstruction and Development), 2000: Transition Report 2000. London

Glombowski, J., 1998: Transitie, en wat het IMF, de OESO en de Wereldbank er (niet) over zeggen. In: B. van Riel, L. van Eerden, S. Stoop, C. van Diek (eds.): Het kapitalisme sinds de jaren ´70. Tilburg: Tilburg University Press, 119-134

Glombowski, J., 1999: Zur Divergenz der Inflationsverläufe in den Transformationsländern. In: H.-J. Stadermann, O. Steiger (eds.): Herausforderung der Geldwirtschaft. Theorie und Praxis währungspolitischer Ereignisse. Marburg: Metropolis, 149-180

Havrylyshyn, O./ McGettigan, D., 1999: Privatization in Transition Countries. Lessons of the First Decade. International Monetary Funds, Economic Issues (18). Washington D.C.

IMF (International Monetary Fund), 2000: World Economic Outlook. Focus on Transition Economies. (October)

Major, I. (ed.), 1999a: Privatization and Economic Performance in Central and Estern Europe. Lessons to be Learnt from Western Europe. Cheltenham/ Northhampton: Edward Elgar

Major, I., 1999b: Theories of Privatization and the Specific Features of East European Privatization. In: I. Major (ed.): Privatization and Economic Performance in Central and Estern Europe. Cheltenham/ Northhampton:


Edward Elgar, 43-58

Roland, G./ Sekkat, K., 2000: Managerial Career Concerns, Privatisation and Restructuring in Transition Economies. European Economic Review (44), 1857-1872

Ruggerone, L., 1996: Unemployment and Inflationary Finance at the Early Stages of Transition. Economic Journal 106 (435), 483-494

Wolf, Th./ Gürgen, E., 2000: Improving Governance and Fighting Corruption in the Baltic and CIS Countries. The Role of the IMF. International Monetary Funds, Economic Issues (21). Washington D.C.

World Bank 1996: World Development Report 1996: From Planning to Market. Washington D.C

frankfurter institut für - viadrina european university...least four more characteristics in which...

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