The Impact of Privatization in Post-Communist Countries

Presented by Saul Estrin

Department of Management

13th April 2007

Outline of Presentation

The Issues Policies, Institutions and Privatization Sequencing of Privatization Privatization of Growth Privatization and Company

Performance Conclusions

Objective To evaluate the economic effects of

privatization, focusing on experiences in post communist countries and China

Transition economies as a laboratory of systemic change

Findings

Privatization to foreign owners raises efficiency; less clearcut in China because domestic ownership also raises TFP

Domestic private ownership raises TFP, but less than foreign ownership, in CEE and Ukraine but not in Russia

Findings

Ownership concentration important Worker ownership does not have

negative effect on performance New firms more efficient than existing

ones, especially foreign start-ups

Policies, Institutions and Privatization

Megginson and Netter (2001) show privatization improved company efficiency and profitability in developed and middle income economies

Privatization seen as pivotal, even defining, in transition process

What Were the Reasons for Privatization? Problems of corporate governance in

state owned firms (SOEs) market for corporate control and capital markets

ownership concentration

outsider ownership

soft budget constraints

Policies in Transition Economies Type 1 Reforms - Stabilization, price

liberalization, privatization, social safety net

Type 2 Reforms – development and enforcement of laws, regulations and institutions conducive to market economy

Policies in Transition Economies Type 2 reforms easier in EU Accession

countries Everywhere progress relatively slow

and modest

Corruption Perception Index 1998 - 2006

0

1

2

3

4

5

6

7

8BulgariaCzech RepublicEstoniaHungaryLatviaLithuaniaPoland

RomaniaRussiaSlovak RepublicSloveniaUkraine

Index of Economic Freedom 1995 - 2007

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.019

95

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Bulgaria

Czech RepublicEstonia

Hungary Latvia

LithuaniaPoland

Romania

RussiaSlovak Republic

SloveniaUkraine

Privatization Methods

Need for fast privatization because: Price reforms not enough to improve efficiency of SOEs

State likely to continue to meddle in SOEs

Managers would decapitalise SOEs

Political need to forestall return of communists

But how to privatize thousands of firms while ensuring equity and political viability. Led to “mass privatization”

Privatization Methods

Serious concerns about the quality of privatization (ie retained state ownership, long agency chains, insider ownership) and whether privatzation had taken place before the relevent legal and institutional framework were put into place.

Private Sector Share of GDP

0102030405060708090

Czech Republic

Hungary

Poland

Slovak Republic

Slovenia

Estonia

Latvia

Lithuania

Bulgaria

Romania

Russia

Ukraine

Sequencing of Privatization

Govenments sequence privatization because: Avoid transaction and congestion costs

Reveal information about firms to buyers

Avoid opposition (“gradualism”!)

Avoid unemployment

Which Firms Do They Privatize First?Gupta,Ham, Svejnar,2000 Firms that are more profitable Firms with higher market shares Firms in industries subject to greater

demand uncertainty and in downstream industries (needing flexible management)

Important implications for reverse causality

Which Firms Do They Privatize First? Firms in industries subject to greater

demand uncertainty and in downstream industries (needing flexible management)

Important implications for reverse causality

Privatization and Growth

Plane 1997 on developed economies: privatization has stronger positive effect on growth when it occurs in infrastructure and industry

Zinnes, Eilat and Sachs, 2001: privatization increases GDP growth when accompanied by institutional reform

Bennett, Estrin and Urga, 2007

Sample of 26 transition countries, 1991-2003. Panel data and GMM methods with fixed effects

GDP growth associated with investment in physical and human capital, private sector and capital market development and privatization method

Bennett, Estrin and Urga, 2007

Countries which predominatly used mass privatization methods enjoyed significantly higher growth post-privatization compared to those that used other methods

Growth not associated with private sector or capital market development

Privatization and Company Performance

Foreign Direct Investors Strategic Owners Entrepreneurs

Methodological Issues

Previous studies indicate astonishing variation in findings, from strong positive to strong negative effects of privatization

Methodological Issues

Reasons partly methodological: early studies used small/unrepresentative samples, unable to control for selection/endogenity, and data peiod too short

We use all available studies (150 plus) and categorise by quality of estimation method and sample size

Overview of Approach Three categories of paper (C1-3); focus on

C1 ( large samples, control for selection) papers

Large variety of performance measures (TFP, labour productivity, profitability, financial performance, sales, employment, wages)

Overview of Approach

Look at studies in CEE, CIS and China Focus on TFP and profitability results

Foreign Direct Investors in Transition Economies

9 C1 studies of TFP (out of 21); 4 C1 studies of profitability ( out of 13). All post 1998

all show privatization to foreign owners increase TFP or profitability

Foreign Direct Investors in Transition Economies

Holds in countries with both weaker and stronger institutions e.g Hungary, Czech republic, Poland, Russia and Ukraine

Example: Brown Earle and Telegdy, 2006 (TFP), Claessens and Djankov, 1999 (profitability)

Foreign Direct Investors in China 5 studies, best three are C2 Positive significant effect of foreign

ownership on TFP ( Hu, Song, Zhang, 2005)

Domestic Owners in Transition Economies Domestic private ownership raises TFP

but the effect is quantitatively smaller than for foreign ownership

Reasons for previous ambiguity in literature is failure to take account of selection effects

Domestic Owners in Transition Economies TFP effect positive in CEE but negative in

Russia (Brown, Earle, Telegdy); suggests institutional quality important

7 studies look at insider ownership; effects insignificant in 6 and positive in one

Two of the three C1 studies find the effects on profitability to be positive

Domestic Owners in China

No C1 Studies yet! Results mixed but generally weakly

positive for TFP and profitability

Domestic Owners in China Possible explanation: Tian and Estrin, 2007, find

that impact of private ownership is U-shaped. Initially ROA decreases as private ownership increases, and then rises. Explain by concentration of state ownership and benefits dominant state ownership can bring in China

Entreprenerial Ownership

Sabirinova et al, 2005 find foreign start ups less efficient than existing foreign owned firms, more efficient than domestic start-ups, which are more efficient than existing domestic firms

Entreprenerial Ownership

Commander and Svejnar, 2007,find domestic start-ups less efficient than foreign owned firms but not different from domestic or state owned firms.

Conclusions Clear picture is emerging from

methodologically sound studies on transitions economies.

Despite reservations about the methods at the time, privatization not a failure when considered more than ten years hence

Conclusions 1 Privatization to foreign owners clearly

raises performance relative to state ownership, and to domestic private ownership

Privatization to new domestic owners also raises performance if institutions are better developed, ie CEE and China relative to Russia

Conclusions 2 Reasons for Superior Performance of

Foreign Owned Firms Limited skills and access to world markets of domestic owners

and managers

Domestic ownership sometimes associated with looting,

tunnelling, defrauding minority shareholders, reducing

performance

Privatization process prevented domestic ownership

concentration initially; it took time to squeeze out dispersed

shareholders.

Conclusions 3 Results highlight importance of good

management and corporate governance, access to world markets, prescence of functioning legal and institutional system for company performance

Foreign firms bring in expatriate managers and train local ones

Conclusions 4 Their corporate governance compensates

for underdeveloped local institutions, laws and norms

They bring access to global distribution networks.

Domestic owners can achive the same in time, and are increasingly doing so however.